Insurance contracts

Date recorded:

The IASB held a meeting on 19 November 2014 during which it held an education session where representatives of the European Insurance CFO Forum (“CFO Forum”) presented their alternative proposal for the accounting for insurance contracts with participating features (“Alternative Proposal”). The Alternative Proposal is described in a paper prepared by the CFO Forum which provides an explanation of the Alternative Proposal with reasoning why this is needed in order to contribute to the IASB’s re-deliberations on its 2013 Exposure Draft; it also aims to address questions that the IASB may have and to assist the IASB in understanding why the CFO Forum considers that an alternative to the IASB’s current proposals for participating contracts is needed.

The Alternative Proposal is underpinned by six principles, which are:

  1. It would apply to all participating contracts effectively defined as those contracts with asset dependent cash flows. Irrespective of the presence of any requirement to hold underlying items from which the dependency stems from. This principle is to ensure consistent treatment of economically similar contracts
  2. It provides a single measurement basis with a single discount rate applied for liability measurement and consistency in the treatment of options and guarantees with all other cash flow
  3. It requires full unlocking of the contractual service margin (“CSM”) for all assumption changes that impact future profits, including assumptions impacted by the change in value of underlying assets and reinvestment assumptions. The CSM represents all expected future profits from the provision of services
  4. CSM is released to profit or loss in a way that best reflects the transfer of services under the contract
  5. The book yield of the current portfolio is used to determine the interest expense in profit or loss to provide consistency in the reporting of interest expense and interest income from investments
  6. The insurer elects to use the book yield to present the effect of changes in the discount rate in OCI or profit or loss as an accounting policy choice, which is needed to reflect the insurer’s asset liability management strategies.

The IASB was not due to take any tentative decisions on the Alternative Proposal. However there was an extensive and lively debate with the CFO Forum that is revealing of the current positions and concerns of individual members of the IASB.

The CFO Forum stated that participating contracts represent the bulk of many life insurers businesses, and there needs to be a genuine step forward, but there is wide concern that the IASB’s proposals from the 2013 ED need to be developed further. In the CFO Forum’s view, the Alternative Proposal provides a more meaningful and transparent way forwards.

The CFO Forum considers that the Alternative Proposal has the following key attributes:

  • It reports performance in a meaningful and useful way
  • It reflects the hybrid nature of the interconnection between the value to the customer and the reward to the insurer
  • It should provide a level playing field, providing consistent accounting treatment for economically similar products, and avoid creating artificial distinctions between products.

The representative of the CFO Forum stated that there was common ground between the Alternative Proposal and the IASB’s current views in the use of current values and the use of the building block approach. However, the CFO Forum has concerns about the artificial volatility in the earnings that could be created by the IASB’s current tentative direction on this final chapter in their redeliberation process. This direction would not be consistent with the economics of the participating contracts, would be difficult to understand and investors would not be able to easily use it to predict future results. The negative consequence of these features is that investors would not be willing to invest in insurers without requiring insurers to pay a higher cost of capital than other industries. The most important proposal to avoid this undesirable consequence is for the CSM to be fully unlocked so that it represents the full amount of unearned profits. The Alternative Proposal received support from EFRAG, standard-setters and other participants in the insurance industry.


The Alternative Proposal would be applicable to all participating contracts which provide policyholders with a right to receive a variable return either contractually or at the discretion of the insurer, as the CFO Forum considers these to be economically similar. The variable return could be based on the performance of specified contracts, realised and/or unrealised investment returns on a specified pool of assets, or the profit or loss of the insurer or that of the fund that contains the assets backing these contracts. The current redeliberations of the IASB are likely to result in a narrower scope than the Alternative Proposal as only contracts with an implicit management fee may end up being in scope. The CFO Forum stated that they felt it was necessary that the scope should not require the insurer to hold underlying items as this would scope out contracts that are economically similar to those scoped in and force upon them a less faithfully representative accounting model.

One IASB member asked whether there were currently any contracts where the shareholder’s share is 30% or 40%, which would be similar to the performance fee of a hedge fund, and whether this would qualify as an implicit management fee. The CFO Forum stated that they were not aware of any such contracts and that the typical insurer's participation was around 10% of the total returns distributed in participating business. They felt that a performance fee of a hedge fund is completely different from the compensation of the service rendered through a participating contract.

Some IASB members expressed concern that the economics of a contract may change over time, for example when a minimum interest guarantee is in-the-money for a prolonged period of time the obligation to make the customer participate in the underlying items would be overridden by the obligation to accrete the guaranteed rate. An IASB member asked that if an interest rate guarantee was expected to apply for the remaining life of the contract, whether the contract should be re-designated as a non-participating contract. The CFO Forum responded by stating that the initial designation as a participating contract should remain unaltered in such circumstances.


One yield curve is used for discounting in the Alternative Proposal. The CFO Forum explained that cash flows would not be bifurcated and clarified that where a single yield curve is used, the discount rate would need to change over time.

Discount rate and interest expense

The CFO Forum noted that the actual mix of underlying items should be reflected in the book yield.

Some IASB members expressed concern that the book yield approach would create accounting mismatches where the underlying items are accounted for at FVOCI, and questioned how the book yield would be determined when a participating contracts is not wholly dependent on the return from underlying items. One IASB member asked why the interest expense should not mirror the investment returns in the income statement. Some IASB members suggested that more guidance would be needed about transferring assets between portfolios and how this would impact the book yield. The CFO Forum noted that this does not occur often.  The IASB also raised questions on the book yield to be used if the participation was based on assets not held in the portfolio and what yield would be appropriate if a risk neutral valuation was used for at least part of the liabilities.  It was agreed that further work needed to be done in this area.

Unlocking the CSM

The CFO Forum confirmed that full unlocking of the CSM results in the re-measurement of profit at each reporting date, and the Alternative Proposal also addresses how the future profits will be allocated to each reporting period. The CFO Forum considers that unlocking the CSM is consistent with how the CSM is measured at inception and reflects the long-term performance of the insurer.

Under the Alternative Proposal, the CSM is also unlocked for the assumptions associated with the investment returns that will fund the insurer's revenues. The CFO Forum confirmed that both realised and unrealised profit would impact how much of the CSM would need to be remeasured. The CFO Forum noted that in some countries unrealised profits cannot be distributed to policyholders and that the discretionary participation is awarded via the realisation of those profits. One IASB member noted that the CSM was unlocked for items that would otherwise be presented in profit or loss, and asked why this would not also apply to items presented in OCI. The CFO Forum responded by stating that the need to unlock the CSM for items presented in OCI had been a lower priority as these do not affect profit or loss because they will unwind to zero over time. An IASB member commented that an investor would have to look at profit or loss, OCI and movements on the CSM to understand the performance of an insurer, which would be complex. Another IASB member commented that all the amounts in OCI in a sense represent future profits. A further IASB member asked whether the CSM should also be re-measured for non-participating contracts, to which the CFO Forum stated that this could be an option but that they had not discussed this.

Options and guarantees

Several IASB members considered that all changes should be recognised in the CSM and that OCI would only be used for the book yield approach. In response to a question from an IASB member, the CFO Forum stated that changes in the measurement of guarantees should be reflected in OCI if changes in the measurement of the corresponding assets are presented in OCI.

There were discussions about derivatives that are purchased to manage financial risk in a participating fund but are held outside it. The question was how the Alternative Proposal would take them into account in determining the unlocking of the CSM and the book yield. The CFO Forum explained that the CSM would be unlocked both for derivatives within the participating fund and for those outside the fund which are used to manage risks from participating contracts. Both the CFO Forum and the IASB agreed that some restrictions would be needed on unlocking the CSM for changes in the measurement of derivatives that are not within the participating fund.

Release of CSM

The driver for the release of the CSM to the income statement in the Alternative Proposal depends on the nature of the services provided under a participating contract such as the provision of insurance coverage, the administration of the contract and the provision of asset management services.

Some IASB members expressed concern that under the Alternative Proposal there may be a lack of consistency regarding the pattern of release of the CSM over the life of a contract. The CFO Forum noted that the mix of services would be different across existing participating contracts, therefore the best accounting principle is to assess it and disclose it at the inception of the contract. IASB Staff asked how the services would be weighted and why the Alternative Proposal suggests that when there is a changing profit pattern the release pattern of the CSM would not be updated. The CFO Forum stated that they believed that insurers can determine the services provided, but it would be complex to update the release of the CSM. An IASB member asked whether insurers would use the same CSM release pattern for similar contracts, and the CFO Forum stated that they would expect insurers to come to similar answers for the same contract.  

Unit of account

The Alternative Proposal notes that insurers manage participating contracts and the investment portfolios that back these contracts over current and future generations of policyholders. The CFO Forum considers that the CSM should be determined at a level that is consistent with such business model, which is likely to be at a higher level of aggregation than that reflected in the tentative decision that the IASB has taken in respect of non-participating contracts.

Several Board members expressed concern that the Alternative Proposal would use an open-ended portfolio whereby new contracts would continuously be added to it thus creating a cross-subsidy between contracts that incepted many decades ago and those that had recently incepted. On that basis, it would be unlikely that the CSM would become negative. The CFO Forum considered that if the contractual arrangement allow for the offsetting of gains and losses over different generations of policyholders, such contracts should be included in the same portfolio. An IASB member noted that such mutualisation affects the best estimate liability but the CFO Forum had not considered how this would impact the CSM, which reflects the shareholder’s interest in the contract.

Presentation and disclosure

There was some discussion about the need for additional disclosures concerning the different components and aggregation of insurance contracts, which could provide better insights into estimating future profitability and the contribution of different sources of profit to the overall profitability of insurance contracts.

One IASB member noted that disclosing the expected release of the CSM in future years and disclosing the effect of changes in options and guarantees in the context. The CFO Forum stated that many insurers disclose the expected run-off of profits, but some do this in five year blocks, and some annually, and some are on a discounted basis whereas others are on an undiscounted basis. The final question asked by an IASB member was whether the CSM should be remeasured for non-participating contracts, to which the CFO Forum stated they could imagine having a similar approach for those contracts.

Next steps

The IASB intends to evaluate the Alternative Proposal in the early months of 2015, following which it will take tentative decisions for the approach it will apply to participating contracts.

The CFO Forum expressed its willingness to continue to work with the IASB to evaluate options being considered.

Once the IASB has completed its redeliberations on participating contracts, the IASB Staff will consider whether the tentative decisions reached for non-participating contracts will need to be revisited.

The IASB expects to publish the final Standard on insurance contracts in 2015.

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