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Insurance contracts (education session)

Date recorded:

Accretion of interest for the residual margin

The IASB members discussed several questions regarding accretion of interest on the residual margin.

The first question was whether interest should be accreted. The staff summarised the comments received on the exposure draft, where the respondents were split. Some felt that on a conceptual basis the discounting was required to ensure all parts of the model are measured on a same basis although it would add complexity. Others argued that the residual margin number only has a meaning at inception and any attempts to re-measure it are not relevant financial information. The staff plans to recommend accretion of interest to reflect the time value of money.

During the education session we noted that a few IASB members felt that accretion, while conceptually justifiable, would complicate the model unnecessarily with a material impact of its overall relevance to a wider number of users. Other IASB members felt that accretion is a natural consequence of how the residual margin is calculated and if all parts of the model are discounted so should be the residual margin. The staff highlighted that the overall amount of residual released over time will always be the same, but the pattern over time will be different.

The IASB then discussed which discount rate to use to accrete interest. The staff plans to recommend using the initial discount rate which would be subsequently kept “locked-in” to be consistent with other decisions reached on the residual margin and the OCI solution. When considering this proposal in light of the unlocking decision a few IASB members saw unlocking as making the overall model too complex. Others IASB members did not express the same level of concern. The discussion was summarised by noting that the ED residual margin was just a day one residual but now that the IASB had evolved it into an element of the model connected with the changes in profitability and performance caused by revised estimate in the future cash flows it should also reflect the time value of money. The staff commented on the concerns of operational difficulties stating that the indication from their outreach activities suggested this can be done at a reasonable cost.

Some IASB members observed that they would not be in favour of using a “locked-in” accretion rate because the measure of the contract should continue to be current with the difference to the “locked-in” rate reflected in OCI in the same way as for the rest of insurance liability measurement. Some IASB members felt any locked-in accretion would be potentially confusing and not representative of an insurer’s underlying performance. Other IASB members felt that accretion with a locked-in rate provides useful information because it is linked with the insurer’s expectations priced at inception. Given future cash flows expectations are always current a current accretion rate is not necessary.

Lastly the IASB considered the question of how to determine a “locked-in” discount rate and the possibility of not prescribing a method. No particular views emerged from this final phase of the educational session on this topic.

Disclosure

The staff presented a package of proposed disclosures and sought comment on these as a whole. However they did not cover disclosures on the residual margin, participating contracts and the ‘OCI solution’.

The first set of comment we noted was that the additional reconciliation of aggregate insurance contract liability and insurance contract assets showing the movements in each building block separately was an efficient way of reflecting changes in assumptions.

The debate was mostly on the new requirement to disclose the amount of capital the insurer holds to comply with regulatory requirements. The staff clarified that disclosure in this instance was not implying that regulatory capital was determined on a consolidated basis. Rather it was important that the entity would disclose its equity under IFRS and its regulatory capital and restrictions on that regulatory capital determined both at group and individual local jurisdiction levels. The entity would need to explain the difference between its IFRS equity and regulatory capital including the effects of differences between the regulatory measurements compared to those made under IFRS. The staff clarified that regulatory capital can be larger or smaller than IFRS equity due to different ways of treating some capital instruments (classified as debt under IAS 32 Financial Instruments: Presentation), different treatment of residual margin (possibly not viewed as a liability by some regulators), different views on consolidation and the amount of insurance liability.

One IASB member highlighted that this issue was more industry specific rather than insurance contract specific and the staff acknowledged this. Others clarified that there may be practical issues around the ability to audit the regulatory filings being done post the date of filing financial statements and potentially there should be a need for the IFRS to specify what regulatory capital the entity is reconciling to. Overall most felt this was a useful disclosure and that it would only need to be further clarified to make sure it does not result in future application issues.

Finally, to address the concerns of investors and analysts one IASB member suggested an additional disclosure around the maximum amount of cash flows/dividends that an insurer could declare at the end of reporting period based on its regulatory capital constraints.

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