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Insurance contracts (IASB/FASB)

Date recorded:

Papers 2, 2A, 2B, 2C

This meeting is the first following the end of the comment period on the exposure drafts that IASB and FASB issued in June 2013. Although the joint IASB/FASB meeting this month was non-decision making it was important because the Staff of the IASB and FASB summarised the feedback received on their respective insurance exposure drafts. The IASB and FASB members jointly discussed the results of the comment letter analysis and the outcome of the fieldwork that was performed during the comment period, setting the scene for the redeliberations in 2014.

Both Boards have received a large number of responses (194 for the IASB and over 200 for the FASB) from users, preparers, regulators, accountants and actuaries amongst others. Additionally, both Boards have reported on the results of their user outreach activities.

The joint discussion was structured around the seven questions included in the IASB exposure draft.

Unlocking the contractual service margin

On the first question concerning the unlocking of the contractual service margin (CSM), a majority of the IASB respondents broadly supported the proposal. However, most suggested that to be conceptually meaningful, the risk adjustment should also be part of the unlocking mechanism rather than impacting profit or loss. In contrast to the IASB view that this would be too complex, a majority responded that this would be possible. Further, many wanted to refine the proposals in relation to the period and pattern of CSM recognition and some questioned the IASB definition of service. Other proposals were to adjust the CSM for additional variables and to reverse losses previously recognised in profit or loss on onerous portfolios before re-establishing the CSM.

On this question, the FASB feedback was that an overwhelming majority of respondents who supported the notion of a margin wanted it unlocked. There was a change of opinion mentioned by two FASB members who had previously supported a locked margin being prepared to unlock it in order to make the profit or loss more current and more comparable with the profit or loss of non-insurers. These FASB members referred to this as being ‘good complexity’ which was worth exploring in order to achieve convergence with the IASB.

Mirroring approach

The second question was about the application of the mirroring approach to contracts that require the entity to hold underlying items and specify a link to the returns from those underlying items. Most respondents, whilst being sympathetic to the intention of the two Boards, have widely criticised the proposals as being too complex. Another concern raised by many constituents was around the inconsistent measurement of participating contracts as compared to all other insurance contracts. The extent of this would depend on the extent of application of the mirroring approach, with many questioning the clarity of the scope for the proposal. The outreach activities confirmed that differences of interpretation did exist. Further, many respondents objected to the inconsistent treatment of options and guarantees across contracts depending on whether the mirroring approach was applied, and stated that these should always be measured at a current value. There were concerns from some, including preparers and regulators, about using the mirroring approach when the assets backing the liabilities are measured at cost or amortised cost. Further concerns were expressed about the potential misstatement of the CSM on initial recognition.

The suggestions received were to abandon the mirroring approach altogether and focus on eliminating accounting mismatches on the asset side; to further restrict the scope of the mirroring approach; or to reduce the complexity. The Board members were rather surprised at the comments received. It is interesting to note that the FASB received mostly positive feedback with very few comments in this area. The Staff noted that this was probably due to the types of contracts that are common in the US; the FASB definition resulting in a narrower scope of the mirroring approach; and US GAAP already requiring the bifurcation of embedded derivatives.

Presentation of revenue and expenses

The third question was on the presentation of insurance contract revenue and expenses, where respondents’ views on the IASB proposals were mixed. Those that supported the proposals were largely general insurers which were likely to apply the Premium Allocation Approach (PAA) and whose presentation requirements were not exposed for comments but were similar to those proposed in the exposure draft. The new requirement was also welcomed by conglomerates and certain banking groups which have substantial insurance operations. Those opposing the proposals were mostly from the life insurance industry, who particularly opposed the exclusion of the investment component from insurance contract revenue and expense. Many questioned the meaningfulness of the revenue figure, the complexity and cost of calculating it and obtaining the required data for perceived little benefit. There was general concern about the understandability and usefulness of the proposed insurance contract revenue measure and the absence of the volume information requested by users. Many opponents wanted to revert back to the summarised margin presentation and also proposed other volume measures such as ‘premiums written’. The feedback to the FASB was similar.

Some IASB members expressed the view that perhaps this feedback is simply resistance to change and this is ‘an opportunity to show leadership’. A few IASB members suggested that a summarised margin approach might be the best outcome, with some wanting to report this in profit or loss (e.g., general insurers applying the PAA), whereas those that do not would only include the summarised margin and volume information in the notes to the financial statements. A few FASB members expressed similar views about reverting back to the summarised margin approach with volume disclosures in the notes. One IASB member suggested improving the summarised margin by including volume information (but specifically not describing it as revenue) and presenting this in the Income Statement, given that many policyholders would receive only the primary financial statements.

Presentation of the effect of changes in discount rate in OCI

The fourth question was the mandatory use of other comprehensive income (OCI) to present changes in the liability discount rate. Most constituents welcomed the ability to use OCI for this purpose, but many (particularly life insurers) disagreed with a mandatory application because of the accounting mismatches that would arise. In particular, insurance companies operating in jurisdictions where insurance liabilities are measured using current values and financial assets are reported at fair value through profit or loss viewed this as a backward step. The mixed measurement model for financial instruments and recycling of assets’ gains and losses on derecognition means that accounting mismatches are almost unavoidable with the current proposal. Some consider that the extent of accounting mismatches increases as a result of asset/liability management. Both those supporting and opposing the OCI solution viewed it as too complex to apply. Non-life insurers raised concerns about applying a discount rate locked at policy’s inception to discounting of their incurred claims, preferring to use the rate at the date of the claim. Overall, most constituents proposed that the OCI solution should be made optional. Other solutions were to use a discount rate reset at the beginning of the period, to use an effective interest rate as defined in IFRS 9 or to use an asset-based discount rate.

The feedback to the FASB was similar in requesting that the OCI solution should be optional. Other concerns were about the application of the bottom-up and top-down approaches and differences in application noted during outreach activities. Many respondents preferred using an asset-based discount rate. The FASB Board members mentioned that it would be important to ensure that the definition of discount rate between IASB and FASB is converged. The FASB members recommended that comments aimed at avoiding any volatility in profit or loss should be separated from comments focusing on eliminating volatility caused by accounting mismatches because economic mismatches should be reflected in the results.

Transition to the new Standard

Most respondents welcomed the IASB revisions and practical expedients introduced to the proposals for transitioning to the new Standard. Most thought they would need 3 years to implement the proposals, with some small and medium entities needing, perhaps, a longer period. One of the concerns raised was around the lack of data extending back beyond 10 years. Given the implicit difference in precision of the CSM measurement before and after transition, some thought that further simplification should be introduced to make the measurement of the CSM easier to calculate. Additionally, in some jurisdictions (notably in Japan), there is a concern that on transition the estimation of the CSM could result in negative equity. One Board member suggested that, given the difficulty in retrospectively estimating the CSM, one solution would be to estimate it prospectively, effectively fair valuing the contract on transition and re-estimating the CSM subsequently.

The feedback to the FASB indicated that transition would be easier to implement if the margin was unlocked. Another suggestion from respondents was to allow the use of hindsight. The FASB members were particularly interested in transition given that the CSM will affect profitability for many years after transition. In terms of the period of implementation respondents thought they would need between 3 and 8 years.

Costs and benefits and likely effect of the Standard

Most respondents were concerned with costs and complexity of the proposals. Many respondents to the IASB urged the introduction of the new IFRS to increase comparability, even if this in some ways was a backward step for their jurisdiction. The majority viewed convergence with US GAAP as a benefit but differed in the priority they gave to this objective as compared to the swift finalisation of IFRS 4 Insurance Contracts. Some (mainly from Europe) thought convergence should not delay implementation of the new IFRS, whilst others, mainly from the US and Canada, urged convergence.

The feedback to the FASB from users was mixed although many urged convergence. However, the majority of users supported only targeted improvements to current US GAAP for long-duration contracts, and also stated that existing US GAAP for short-duration contracts works well.

Other matters discussed by the FASB

Of the other issues covered by the FASB ED, the main comments of US constituents addressed the following areas:

  1. The majority supported different models for long- and short-duration contracts, and there was some support for making the Building Blocks Approach (BBA) optional. The US property and casualty industry and the US users oppose changes to current US GAAP. Many commentators considered that the FASB exposure draft does not properly describe the criteria that would result in the mandatory application of the PAA.
  2. Many respondents agreed with the type of fulfilment cash flows that should be included in the new US pronouncement. About half of the respondents agreed that cash flows assumptions should be updated at the end of each reporting period, but expressed concerns about the volatility this might cause if quarterly reporting was required. Many stated that assumptions should only be updated when there were changed conditions that were not considered to be temporary.
  3. Concerns over the definition of portfolio were raised in several comment letters.
  4. Many respondents supported a single margin, with nearly all supporting margin unlocking (rather than the FASB’s locked-in proposal).

The FASB members felt that the scope of the PAA and the BBA could potentially be addressed during drafting. They decided to deliberate in the future about whether quarterly reporting would need to show changes in assumptions or whether this should only be required annually. The FASB wanted to ensure they achieved convergence with the IASB on the definition of portfolio, and there was greater support for converging on unlocking the margin.

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