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Insurance contracts

Date recorded:

Discount rate in the Premium Allocation Approach

Staff Paper 2D discussed discounting and interest accretion under the Premium Allocation Approach (PAA) and it addressed the following:

  • whether to use the discount rate at the inception date of the contract or a current rate when discounting and accreting the liability for the remaining coverage;
  • whether the claims and interest expense for the liability for incurred claims should be presented, using the rate at inception of the contract or the rate at the date the claim was incurred. Subsequently that rate is locked–in for presentation in profit and loss;
  • the presentation of the losses and the interest expense for the onerous liability.

The staffs recommended that for the PAA, when the liability for remaining coverage is accreted or discounted, the rate that shall be required for its measurement is the discount rate at the inception of the contract.

Both the IASB and FASB members voted unanimously to support the staffs’ recommendation of using the discount rate at the inception of the contract.

The staffs then asked the Boards to choose the rate when the liability for incurred claims is discounted. The FASB staff recommended that the claims and interest expense is presented using the discount rate at the inception of the contract and that the rate is subsequently locked in whilst the IASB staff recommended the use of the discount rate at the date the claim was incurred, and that rate is subsequently locked in.

The majority of FASB members (6 out of 7 present)  tentatively supported the recommendation of the FASB staff to use the discount rate at the inception of the contract as based on their outreach with insurers that this method is less complex than using the rate on the date the claim is incurred.

The majority of IASB members, instead, initially supported the IASB staff recommendation of using the discount rate at the date the claim is incurred since it results in more useful information than the rate at the inception of the contract and that the claims expense is determined using a discount rate that reflects the market conditions at the time.

One IASB member argued that this issue is unlikely to be material to insurers since rates have not shown significant fluctuations during the past few years except for the period during the 2008-09 credit crisis and for that reason, he was in support of the rate at the inception of the contract due to its more limited complexity from an operational perspective.

Following that debate, and in the interest of convergence the IASB Chairman asked for another vote which resulted in the majority of IASB members (13 vs. 2) tentatively approving the use of the rate at the inception of the contract.

Participating Contracts

Staff Paper 2F considered insurance contracts that provide policyholders with the contractual right to share in:

  • The performance of a specified pool of insurance contracts,
  • The performance of a specified pool of assets, or
  • The profit and loss of the entity that issues the contract.

The prior tentative decisions on the ‘mirroring approach’ for participating insurance contracts require that an insurer, in order to avoid accounting mismatches, measures and presents the part of the obligation that relates to the underlying items on the same basis as it measurers and presents those underlying items. The IASB decided to achieve this goal by requiring that the measurement of fulfilment cash flows relating to policyholders’ participation should be based on the measurement of the underlying items in which the policyholder participates as utilised for the IFRS financial statements. They also decided that presentation of the changes in the “mirrored” insurance liability would go to profit or loss or other comprehensive income (OCI) consistently with the presentation of changes in the associated item.

The FASB implemented the ‘mirroring approach’ in a different way by requiring that an insurer measures the contractual obligation using the building blocks approach adjusted to eliminate accounting mismatches that reflect timing differences between the contractual obligation and the measurement of the underlying items in the statement of financial position that are expected to reverse within the boundary of the insurance contract. Like the IASB, they also required that changes in the liability for performance-linked participation contracts should be presented in the same way in statement of comprehensive income as the underlying item. It should be noted that the FASB definition of performance-linked participation contracts may be narrower than that considered in the IASB decision.

Both Boards had also agreed in the past that the discount rate for cash flows arising from participating contract should reflect the dependence of those cash flows on the performance of those assets and that those cash flows include both guaranteed and discretionary elements arising from current contracts regardless of whether paid to current or future policyholders.

Due to the difference noted above, there are situations where in accordance with the IASB’s tentative decisions, the ‘mirroring approach’ would apply and that would not be true under the FASB’s tentative decisions. Insurers will need to be aware of these instances and account for them accordingly as described in the paper.

The IASB staff asked the Boards whether further clarification is required of how changes in the insurance liability (including the effect of changes in discount rate) would be presented in comprehensive income when the ‘mirroring approach’ applies.

Both the IASB and FASB members voted unanimously that no further clarification was required as to how changes in the insurance liability would be presented in comprehensive income when the mirroring decisions apply.

However, some members noted that the drafting of the text needs to be specific to note that the ‘mirroring approach’ will take precedence over all other approaches including the “OCI solution”.  The IASB staff replied that this is noted and will be taken into account when drafting the final standard.

The FASB was asked to decide the accounting treatment where the ‘mirroring approach’ does not apply and to confirm that in that case, changes in the discount rates should be presented to profit and loss if the underlying items on which participation is based are recorded at fair value through profit and loss. The FASB members voted unanimously in favour of this staff recommendation.

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