Insurance contracts (IASB only)
The IASB held a meeting on 19 February 2013 which completed the planned technical decisions required to finalise its revised Exposure Draft on insurance contracts. This meeting followed an education session the previous day where the Staff analysed the papers that would be covered in the decision making session the following day.
In the first and perhaps the most important paper of the day (paper 2A) the Staff asked the Board’s permission to begin the balloting process for the revised Exposure Draft (ED) on accounting for insurance contracts. The three papers which followed paper 2A (papers 2B, 2C and 2D) were of informative nature and served to support the Board in its decision with regards to paper 2A, no decisions were required in respect of these three papers. The fifth paper (2E) asked the Board to decide on the much debated sweep issue rolled forward from last month’s meeting regarding the accounting on transition for insurance contracts that were acquired through a business combination. This concluded all the technical issues the Board had on its agenda to date and opened the path for the balloting of its revised ED.
Transition for contracts acquired through a business combination (Paper 2E)
The Staff started the day’s agenda in an inversed order and selected to address first the open sweep issue from last month’s agenda which covered the accounting treatment for in-force contracts at transition that were previously acquired through a business combination. In its updated recommendations the Staff effectively addressed the Board’s concerns in the previous meeting for consistency of the Staff’s recommendations with the requirements in IFRS 3 Business Combinations.
In the short presentation of its recommendations to the Board the Staff stressed the fact that the forthcoming IFRS would treat the insurance contracts acquired through business combinations and those originated by the insurer as similar transactions and therefore proposed similar measurement. However, because of the specifics of the business combination transaction, the Standard should require the use of the information available for business combination while maintaining consistency with the requirements in IFRS 3. Those specifics are accounted for as follows:
- the date of inception for those contracts is deemed to be the date of acquisition (i.e. the date of the business combination). The Staff believe that this is consistent with the recognition point for insurance contracts generally, which is the beginning of the coverage period (from the insurer’s perspective).
- the cash inflow for those contracts (i.e. premiums received) is deemed to be the fair value at the date of acquisition. Paragraph 142 of the Basis for Conclusions for the 2010 ED confirms that the fair value of the portfolio of contracts that were acquired through a business combination may be viewed as corresponding to the fair value of the consideration received (i.e. premiums received for contracts originated by the insurer).
The 2010 ED (paragraph 40) proposed that those contracts are measured at the date of the business combination at the higher of the following:
- the fair value of the portfolio. The excess of that fair value over the present value of the fulfilment cash flows establishes the residual margin at initial recognition. This is consistent with recognising a residual margin for the gains on day one when recognising insurance contracts that the insurer has originated; or
- the present value of the fulfilment cash flows. If that amount exceeds the fair value of the portfolio, that excess increases the initial carrying amount of goodwill recognised in the business combination. This is consistent with measuring contracts originated by the insurer using the present value of fulfilment cash outflows if this is higher than the present value of cash inflows. However, the difference is accounted for as goodwill (rather than as a loss in the statement of comprehensive income) because of the requirements in IFRS 3.
As a result of the above, the Staff believes that insurance contracts that are acquired through business combinations should be measured in a similar way to those that were originated by the insurer. Consequently, if this principle is applied to transition, the requirements for the contracts originated by the insurer should also apply to contracts acquired through business combinations.
Those requirements state that for in-force contracts at the transition date, the insurer should (a) measure the current value of fulfilment cash flows and (b) estimate the residual margin using the modified retrospective approach, which maximises the use of objective information. This would require estimating the residual margin at inception by comparing the risk-adjusted present value of cash outflows with the present value of cash inflows. In the case of insurance contracts acquired through business combinations the insurer would use the fair value of the acquired portfolio of contracts that are in-force at the date of transition as cash inflow related to those contracts (equivalent to premiums for contracts originated by the insurer) and (c) estimate the locked-in discount rate at the date of inception (i.e. at the date of the business combination).
The Staff believe that the fair value of the acquired portfolio which is needed to estimate the residual margin as noted above would be available in most cases especially in the years after the introduction of IFRS 3 which requires insurers to estimate and maintain data of the fair value of the liabilities at the business combination date. However, the Staff recognised that for some contracts, fair value information might not easily be available, especially for contracts that were acquired as part of a business combination that occurred before the date at which IFRS 3 (and its predecessor) was effective and for business combinations, prior to the adoption of IFRS, which were accounted for using local GAAPs that do not account for assets and liabilities acquired at fair value.
In these cases, the Staff believes that lack of fair value information for some contracts at transition is similar to a situation in which the insurer does not have the information at the transition date about all the premiums that were received before the transition date. In this situation, according to the transition requirements proposed by the IASB for insurance contracts, the residual margin would be estimated by maximising the use of objective information available. This could include various estimation techniques, such as:
- estimating the residual margin by reference to the existing contracts, adjusting for different factors that might differentiate the margin in different periods; or
- estimating the residual margin by using historical assumptions about the profitability of similar contracts.
The analysis above as elaborated in Paper 2E succeeds in treating all insurance contracts at the date of transition under the same principles irrespective of whether they were originated by the insurer or acquired through a business combination. Consequently, the Board agreed unanimously with the Staff recommendations that, in applying the transition requirements for insurance contracts, an insurer should account for the in-force contracts that were previously acquired through a business combination using:
- the date of the business combination as the date of inception of those contracts; and
- the fair value of those contracts at the date of the business combination as the premium received.
Following the Board unanimous decision in the Staff first recommendation on this topic, the Staff proceeded to its second recommendation under this paper which considered the recognition of any gains or losses that would result when the insurer first applies the forthcoming insurance contracts Standard to insurance contracts previously acquired through a business combination. The main question to be answered here was if the resulting gains or losses should be adjusted against retained earnings or goodwill.
In the analysis provided in Paper 2E the Staff noted that when an entity makes the transition to a new IFRS, any adjustments are taken against retained earnings and not against goodwill. This is also applicable for Standards that require retrospective application to measure the assets or liabilities on transition. The Staff believes that:
- any retrospective adjustment to goodwill that is meaningful would require revaluation of all assets and other liabilities together with the insurance liabilities acquired during the business combination
- the amount of goodwill is viewed as a point in time calculation that reflect estimates that were included in the consideration transferred and should not be updated if using hindsight would result in reporting different amount. This is consistent with IFRS 3 that allows adjusting the amounts recognised as a result of the business combination to reflect new information about the facts and circumstances that existed as of the acquisition date. Those adjustments need to be done within a year and after that time, the entity could revise those amounts only to correct an error; and
- adjusting goodwill when making the transition to the forthcoming insurance contracts IFRS would create an exception to transition requirements in other IFRS. The Staff do not believe that this exception is justified for the forthcoming insurance IFRS.
Based on the above justifications the Staff asked for the Board’s vote on its second recommendation that, when an insurer first applies the forthcoming insurance contracts Standard to insurance contracts previously acquired through a business combination, any gains or losses should adjust retained earnings (rather than goodwill).
After a short discussion which mostly reflected the Board’s request to make these requirements as clear as possible in the new ED, the Board reached again a unanimous decision to support the Staff recommendations.
Permission to ballot a targeted revised Exposure Draft on accounting for insurance contracts (Paper 2A)
The Board decision on the ballot effectively concluded all the technical decisions started in December 2010 after the end of the comment period of the 2010 ED.
Before putting the paper to the vote the Staff underlined that all of the required steps in the IASB’s Due Process Handbook have been complied with and that the proposals for accounting for insurance contracts are sufficiently developed and therefore, the Staff recommends balloting the revised ED.
To assist the Board in its decision the Staff had prepared for this meeting a package of material which were either in the form of appendices attached to this paper or separate informative papers and therefore required no decisions by the Board.
In a brief summary those materials consisted of:
- Appendix A of paper 2A sets forth the reasons for undertaking the Insurance Contracts project and the need for a new IFRS on insurance contracts.
- Appendix B of paper 2A reviews the history of the project and describes the due process the IASB has undertaken in developing the proposals for accounting for insurance contracts.
- Appendix C of paper 2A shows how the IASB has adhered to the protocol for development of an Exposure Draft as set out in the IFRS Foundation’s Due Process Handbook, which was approved by the IFRS Foundation Trustees in January 2013.
- Appendix D of paper 2A sets out the main differences between the IASB’s and FASB’s decisions. Since 2008, the IASB and FASB have been deliberating the issues in the project jointly. The IASB and FASB have decided to issue separate Exposure Drafts and finalise those Exposure Drafts separately.
- Paper 2B Overview of the Board’s proposals provides a high level summary of the IASB’s proposals to be included in a new IFRS on insurance contracts.
- Paper 2C Comparison of the IASB’s tentative decisions to the comment letter summary is an overview of the ways in which the IASB has addressed the comments received on the 2010 Exposure Draft Insurance Contracts.
- Paper 2D Summary of comment letters on the IASB ED reproduces Agenda Paper 3E Summary of comment letters on the IASB ED, which was presented to the IASB at its meeting in January 2011.
The IASB Chairman thanked and complimented the Staff on its outstanding work in the Insurance Contracts Project all these years before proceeding with the vote.
In the vote that followed, the Board was asked to grant the Staff permission to begin the balloting process for the targeted revised ED on accounting for insurance contracts. The Staff also asked here if any of the IASB members intend to dissent from the proposal.
One IASB member who had dissented in the publication of the previous ED 2010 expressed his anticipation of greater resistance than expected to the Board’s presentation proposals in the new proposed ED but nevertheless he decided not to dissent this time due to the urgent need for a new Insurance Standard.
Another IASB member dissented from the Staff recommendations on the grounds of disagreement with the amended OCI presentation in the new proposed ED because in his opinion it is not conducive to good financial reporting.
All other Board members agreed with the Staff recommendations and granted permission for the balloting process to begin.
Then the Staff asked for the Board to vote on the proposed length of the comment period for the targeted revised ED. The Staff recommended a comment period of 120 days that would be sufficient for the stakeholders to understand and assess the implications of the new ED proposals and provide feedback with their comments. The Board agreed unanimously with the Staff recommendation on a 120 days comment period.
Finally, one Board member asked for an indication of the timeline and the expectations of the Staff on the date of finalisation of this process. The Staff responded that it would like to finish both analysing the comments, the roundtable and any another form of outreach activities as well as the fieldwork before 2013. This would be in line with the Staff’s target to present their comprehensive summary of the feedback to the Board before the end of 2013.
The same Board member also asked the FASB Staff which were attending this meeting for the FASB’s time plan on its Exposure Draft and whether there would be any overlap between the two. The FASB Staff responded that the FASB Board voted last week for the publication of the FASB’s Exposure Draft in June 2013 with a 120 comment letter period. The FASB’s ED will be a comprehensive exposure draft highlighting the areas of difference with current US standards and the IFRS revised ED.
This session came to an end with two suggestions from one Board member: to consider including Latin America in the outreach activities and field tests given this part of the world was not represented in the previous rounds of IASB’s outreach activities and, where there is overlap with the FASB’s new ED, that the Staff considers joint outreach activities with FASB in North America. The Staff welcomed these suggestions which would be taken into consideration in developing outreach plans.