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Insurance contracts

Date recorded:

Papers 2A and 2B were originally planned for discussion in February, but were deferred to this month due to time constraints.

Locking in the discount rate (Paper 2A)

The staff presented a paper for the Boards' consideration on the use of locked in discount rates. The Exposure Draft / Discussion Paper ("ED/DP") originally proposed an unlocked discount rate and many preparers commented that, among other things, an unlocked rate did not faithfully represent the economics of many insurance contracts, would result in greater volatility and parallels were drawn between the treatment of other financial assets and liabilities and insurance contracts.

The staff considered these comments, but did not find merit in the arguments put forward and so they concluded and recommended to the Boards that the discount rate should remain unlocked.

With little discussion, the Boards unanimously agreed support for the staff recommendations.

Discounting non-life contract liabilities (Paper 2B)

The staff presented a paper to the Boards focusing on whether certain (i.e. short-duration) non-life insurance contracts should be exempted from discounting. This paper originates from concerns raised by respondents, primarily property / casualty insurers in the United States, that the application of discounting to short-term non-life insurance contracts would not faithfully represent those contracts.

Having assessed these concerns, the staff recommended that the Boards:

  • exempt from discounting short-duration, short-tail claims where the settlement period is less than one year from the claim event;
  • apply discounting to long-tail claims with a reasonably determinable payout pattern; and
  • apply discounting to long-tail claims where the amount and timing of the cash flows may be uncertain.

The Boards spent a significant amount of time discussing the first staff proposal. Concerns were raised that this proposal would allow claims settled up to two years from contract inception to avoid discounting. It was noted that although the paper is only addressing non-life claims the current wording could also be read to include certain types of life insurance claims (for example short duration term insurance). Some Board members proposed reliance on the materiality concept used throughout IFRS, but this was opposed by other Board members who were concerned that the Boards had never actually defined the application of materiality, and that it would vary from jurisdiction to jurisdiction.

Overall, despite the significant debate, the Boards were unable to reach consensus on this issue and instructed the staff to investigate further and to bring this issue back as part of the consideration of the modified approach for short-duration contracts.

No disagreements were identified with the second staff proposal, but some Board members raised concerns that they couldn't see a difference between proposal two and proposal three. The staff advised the Boards that this separation arose from current practice for discounting of claims set out in proposal two and many concerns by respondents to the ED/DP on the discounting of uncertain claims. The staff concluded that they could not see any real circumstances in which proposal two and three would be different in practice. Overall, both Boards supported the staff recommendation for proposals two and three, but noted that some work may need to be done during the drafting phase.

Scope (Paper 2D)

The staff introduced a paper for the Boards to consider focused on resolving an issue identified from the ED/DP which affects the proposed scope of the insurance contracts standard. The paper did not consider financial guarantee contracts or financial instruments containing a discretionary participating feature. These two issues will be considered by the Boards later.

The main concern arising from the ED/DP was the treatment of fixed fee service contracts. Some respondents were concerned that the wording proposed by the ED/DP would result in the contracts that are clearly not insurance-related (e.g. fixed fee contracts for the provision of legal services) being included within the scope of the insurance contracts standard.

The staff proposed that the scope exclusion for fixed fee service contracts should be narrowed to apply only to those contracts that have the primary purpose of the provision of services and that would qualify for the modified approach for short-duration contracts.

The Boards engaged in a significant debate on this topic. Concerns were raised that the current wording proposed by the staff would result in non-insurers having to assess their contracts against the insurance contracts definition and to determine whether contracts (including those clearly not intended to provide insurance services) would fall within the scope of the modified approach for short duration contracts. A number of improvements were proposed (e.g. basing the decision on the substance of the product only and using unbundling to separate out the insurance components) but no universally acceptable solution could be agreed.

The Boards tentatively agreed with the idea of a scope exclusion for fixed fee service contracts that were primarily aimed at the provision of non-insurance services and instructed the staff to delete the reference to the modified approach to short duration contracts and consider the issue further. The Boards suggested that this issue should properly be considered as part of their consideration of the definition of an insurance contract.

The staff also asked the Boards to comment on the scope exclusions that were not tabled for specific discussion:

  • Product warranties issued by a manufacturer, dealer or retailer;
  • Employers' assets and liabilities under employee benefit plans and retirement benefit obligations reported by defined benefit retirement plans;
  • Contractual rights or contractual obligations that are contingent on the future use of, or right to use, a nonfinancial item;
  • Residual value guarantees provided by a manufacturer, dealer or retailer, as well as a lessee's residual value guarantee embedded in a finance lease;
  • Contingent consideration payable or receivable in a business combination; and
  • Direct insurance contracts that the entity holds (i.e. direct insurance contracts in which the entity is the policyholder).

Subject to the above discussion on the definition of an insurance contract, the boards agreed unanimously that these scope exclusions should remain as proposed in the ED/DP.

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