Insurance Contracts

Date recorded:

Measurement objective and risk adjustment

The Boards discussed:

  • (a) whether the proposed building block approach would apply (i) to both future cash inflows and cash outflows arising from insurance contracts, or (ii) only to future cash outflows.
  • (b) whether the measurement objective should reflect the cost of fulfilling the obligation (as proposed by staff in December papers) or a different fulfilment notion and how the proposed risk adjustment relates to the measurement objective.
  • (c) further guidance on the risk adjustment, including the sources of information an insurer might use to estimate it.


Building block approach

The Boards agreed (IASB: 2 opposed; FASB: 2 opposed) that a building block approach that includes a risk adjustment for the effects of uncertainty about the amount and timing of future cash flows should be used for measuring the net combination of rights and obligations of insurance contracts. This implies measuring the gross cash flows rather than the net obligations. Getting to that decision was difficult. Board members from both the IASB and FASB expressed concerns that measuring the risk margin separately from other cash flows and options in the insurance contract. Some were concerned that the model proposed by the staff introduced one-way bias and lacked sufficient rigor to prevent it from being a 'pick a number' measurement. There was a long debate during which the staff tried to clarify what it was proposing. Some Board members were less than convinced and thought that they owed it to their constituents to evaluate the measurement methods identified, especially with respect to the measurement of risk. Other Board members thought that it would be impossible to prescribe one approach; however robust disclosure would provide some discipline that might, over time, improve measurement.

The Boards agreed that the contract position of an insurance contract should be presented net rather than gross.


Measurement objectives

The Board discussed a staff proposal that the measurement objective for insurance contracts should be expressed as '[an entity's current estimate of] the present value of resources required to fulfil the net obligation created by the insurance contract'.

Board members criticised the proposed measurement objective for several reasons. An IASB member disliked the lack of specificity in 'present value', noting that the discount rate must be specified. A senior member of staff noted that, unless otherwise indicated, IFRSs required use of the default risk-free rate. In proposing this measure, the discount rate did not take into account any risk adjustment - that was measured separately.

Other Board members criticised the proposed measurement objective as lacking any rigor sufficient to eliminate some of the more extreme measurement candidates identified in the agenda papers.

The Board did not conclude on this topic and will need to debate it again later.


Risk adjustment

In a very contentious debate, the Boards discussed whether the risk adjustment should be the amount the insurer would require for bearing the uncertainty about the resources it would require fulfilling the (remaining) net obligation from insurance contracts; and whether that risk adjustment should be re-measured throughout the life of the contract.

Several Board members expressed concerns about aspects of the proposals, although some defended them as the best possible solution available. The comments rehearsed many of the misgivings expressed in previous parts of this session. The Boards finally concluded that they would accept the staff recommendations (IASB 8 in favour; FASB: 3 in favour).


Policyholder behaviour

The Boards discussed the treatment of contractual features that permit policyholders to take actions that change the cash flows that will result from a contract. The discussion was focussed mainly towards the FASB, because the IASB had already reached tentative conclusions on the issues.

By a majority of 3 opposed; 2 in favour the FASB did not agree a staff recommendation that policyholder options be measured on a 'look through' basis using the expected value of future cash flows related to the option (to the extent they are within the boundary of the existing contract). As the IASB had previously accepted this recommendation, (and the consequence that no 'deposit floor' would apply), this issue will need to be resolved between the Boards.

The FASB agreed that expected cash flows from options, forwards, and guarantees not related to the contractual coverage in the insurance contract should be excluded from the expected insurance cash flows for that contract in measuring that contract.

The FASB also agreed that these options, forwards, and guarantees should be accounted for in accordance with IFRS or GAAP for that instrument, e.g., insurance contract accounting for those options which themselves result in insurance contracts.


Residual margins

The Boards agreed that if the initial measurement of an insurance contract results in a negative day-one difference, an entity should recognise that difference in profit or loss. In doing so, the Boards expressed unease about calling such contracts 'onerous', which some saw as a distraction.


Subsequent release of the residual margin to the income statement

The Boards discussed but did not conclude on how the residual margin should be recognised in the income statement. The Boards noted that the residual margin number was essentially a plug to avoid a Day 1 gain. The Boards did agree that the forthcoming exposure draft should specify how the plug should be amortised (i.e. the entity would not have the discretion to decide). The staff was asked to return to a future meeting with proposals.


Changes in expected present value of cash flows

The Boards agreed (IASB: 9 in favour; FASB: 4 in favour) that changes in the expected present value of cash flows should be recognised in income immediately.


Timetable for Board discussions

The Board was presented with, but did not discuss, a timetable for future Board discussions assuming that the exposure draft is issued in May 2010. The staff noted that 'several' of the additional Board meetings being scheduled would be needed if the timetable were to be met.

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