Accounting of acquisitions costs incurred before a contract’s coverage period
The staff paper provided four alternatives:
- Not recognised until the related coverage period begins
- Recognised as an expense when incurred
- Recognise acquisition costs as a prepayment asset and derecognise when the coverage period begins, when the acquisition costs are included as part of the liability
- Recognise as part of the insurance contract liability when incurred
The staff recommended alternative 4 after considering the complexity, operational concerns and costs of applying alternative 3 for little or no benefit provided to users of the financial statements. This alternative was also consistent with the Boards tentative decisions on acquisition costs incurred on the inception of the insurance coverage.
One IASB member noted that applying alternative 4 to costs for new portfolios may be less faithful of the economic reality than alternative 3. The suggestion to allow both options based on facts and circumstances was not approved.
Both the IASB and FASB board members voted unanimously in favour of option 4 which is in line with their tentative decisions.
The staff explained that the objectives of the transition requirements proposed are to:
- provide a consistent measurement of the insurance liability,
- allow comparability of earnings at transition and subsequently, and
- be practical and meet the cost benefit test.
The main transition issue relates to determining the residual margin for in-force contracts that have an unexpired cover. The residual margin has to be determined from inception date and allocated over time to restate the transition residual margin balance that would be added to the expected value plus risk adjustment. These elements of the transition balance sheet do not pose particular problems because they will be valued on transition date using current data irrespective of the inception date of the underlying contracts. The restatement of the residual margin is particularly difficult for contracts that have been issued long time ago and where the insurer continues to have an unexpired cover to the policyholder at transition date. These contracts would require a residual margin on transition and not all necessary data could be available to complete the restatement.
The staff proposed the retrospective approach with a practical expedient for portfolios of contracts written prior to the earliest period for which restatement of the residual margin is practicable. This means that insurers are required to restate as far back in time as possible. However when they reach the limit for practicable restatements of past residual margins they would be able to apply the staff expedient which would permit the insurer to estimate the restated residual margin for those older contracts using all of the objective information that is reasonably available. The staff proposed to explain that an insurer’s efforts to obtain such objective information for this estimate should not be “exhaustive”.
During discussion among Board members, it was suggested that more guidance be introduced, in particular on the length of the time companies should go back to for restating the opening residual margin. Additional disclosure requirements on how the opening risk adjustment is determined were also called for in an attempt to mitigate the risk of profit manipulation.
IASB approved with a majority of eleven against four the staff recommendation whilst FASB voted for the same on a unanimous basis.
The staff also recommends that all disclosures required by IAS 8 be applicable on transition, as well as additional disclosures around practical expedient and estimation. Both the Boards voted unanimously in favour of the staff proposals in relation to transition disclosure.
The subject of discount rates was next, a paper that was presented by the FASB staff. The staff noted that their proposals for the determination of the discount rate at transition date attempted to reflect the three objectives stated earlier for the transition requirements. In particular, the decision to have an OCI solution poses the question of the amount that should be taken to OCI form the application of a discount rate at transition date based on market interest rates at that point in time. This restatement would be required because the insurance contracts sold in prior periods would have the effect of discounting been unwound at the “locked-in” initial discount rate with the difference with the insurance liability remeasured using the discount rate linked to interest rates at the balance sheet date being taken to OCI. The staff provided three alternatives for the determination of the discount rate upon transition:
- based on market interest rates at transition date;
- using the discount rate applied under current accounting standards; or
- determining a range of discount rates in accordance with the standard based on interest rates observable in the respective periods.
The staff recommended alternative 3 since it meets or partially meets the three objectives noted above. In particular it would allow insurers to calculate the amount of the OCI component of the insurance liability at the transition date. Both Boards voted unanimously in favour of alternative 3.