Insurance contracts

Date recorded:

Whether an insurer should, unless impracticable, apply the proposed Standard retrospectively

Most preparers, standard-setters, auditors and users of financial statements support the IASB’s decision that insurers should estimate the contractual service margin (CSM) at the beginning of the earliest period presented. Many noted that the benefits of applying the revised proposals would outweigh the increased costs. However, there are some concerns about the operational complexity and possible lack of data needed to apply the proposed approach, the subjective nature of the estimates and the extent to which such estimates are auditable. Also, it is possible that, at the beginning of the earliest period presented, some insurers will recognise accumulated losses in equity because interest rates have fallen since the date the insurance contracts were initially recognised.

The Staff recommended that at the beginning of the earliest period presented, an entity should apply the Standard retrospectively in accordance with IAS 8 unless this is impracticable.

The Staff observed that this recommendation provides comparability between contracts written before and after the date the proposed Standard is applied, provides information necessary for trend analysis and also addresses the concerns expressed in the feedback received on the 2010 Exposure Draft (ED).

One IASB member commented that he felt that full retrospective application would not be appropriate for many insurers because of the significant diversity and differing regulatory requirements in each country, which would therefore penalise insurers in some jurisdictions very heavily. The Staff expressed the view that these situations reinforced the need to apply the proposals retrospectively. The same IASB member noted that, for example, in Malaysia where the market is not mature, there are no long-dated government bonds; therefore, insurers are obliged to invest in assets with shorter durations that do not match the average insurance liability duration. The Staff responded that such insurers would be able to make an accounting policy choice to account for the effect of changes in discount rate in other comprehensive income (OCI). The IASB member expressed concern that such insurers, even though having positive equity on a fair value basis, would be obliged to record artificial negative equity accumulated OCI at the date of transition, and would recycle this to profit or loss over many years. Another IASB member had similar concerns and cited the example of long duration contracts issued in Asia, where interest rates had subsequently declined , which would result in significant amounts of negative equity.

An IASB member supported the Staff recommendation because the Standard must achieve comparability now rather than to implement the proposals over the remaining lives of the contracts in force at the date of transition. She also felt that the presentation and disclosure requirements would ensure that the readers of the financial statements would not be misled. The Staff added that their intention regarding 'impracticable' was to interpret this word as defined in IAS 8.

Another IASB member commented that where losses had been recognised under previous GAAP, these would be recognised again under the new model. A further IASB member felt that the IASB should allow some method other than retrospective application and should permit progressive introduction of the new requirements as the changes were so significant.

An IASB member questioned whether full retrospective application should be required because of the extraordinary complexity, subjectivity and cost. He also expressed concern at the prospect of individual insurers being able to adopt full retrospective application for some products and business lines, but not for others where this was impracticable. He felt that a fair value approach without the use of OCI should be permitted at the date of transition.

Another IASB member stated that it was important to make it clear that the IASB was not considering a prospective application of the new model, and expressed the view that full retrospective application should not be taken off the table and that there should be no grandfathering provisions for contracts in force at the date of transition.

When called to vote by the Chairman, nine out of 14 IASB members voted in favour of the Staff recommendation.


Whether the simplified approach proposed in the 2013 ED should be modified

The Staff were aware of concerns that under the simplified approach the risk adjustment at contract inception uses the risk adjustment as measured at the beginning of the earliest period presented, which would understate the risk adjustment and therefore overstate the restated CSM. The Staff therefore recommended that if retrospective application of the proposed Standard is impracticable, an insurer should use a modified version of the simplified approach proposed in the 2013 ED. In this new approach an insurer would estimate the risk adjustment at contract inception by adding to the risk adjustment at the beginning of the earliest period presented the amount associated with the expected release of the risk adjustment before the beginning of the earliest period presented. The expected release of risk should be determined by reference to similar insurance contracts that the insurer issues at the beginning of the earliest period presented.

When called to vote by the Chairman, the IASB members were in unanimous agreement with the Staff recommendation.


Whether an alternative 'fair value approach' should be applied when it would be impracticable for an insurer to fully restate and also to apply the simplified approach

The Staff noted that issues arise with full retrospective application when there is a lack of historical information or when estimates cannot be made without the use of hindsight. The simplified approach addresses the use of hindsight by effectively requiring the use of complete hindsight. The fair value approach deals with situations where there is also a lack of historical information by using information at the beginning of the earliest period presented rather than at the date of initial recognition inception of the contract.

The Staff recommended that if the simplified approach is also impracticable, an entity should apply a 'fair value approach' at the transition date, using current interest rates. The difference between this fair value and the fulfilment cash flows at the transition date would be recognised as a CSM or as a loss in retained earnings. The insurer would determine the discount rate used for determining interest expense in profit or loss, and the related amount of OCI accumulated in equity, by estimating the discount rate at the date of initial acquisition of the insurance contract using the method in the simplified approach proposed in paragraph C6(c) and (d).

The Staff noted that the CSM would not be based on the premium that had been charged for the contract therefore comparability will be limited for those contracts that were restated using this fair value approach.

An IASB member stated that material portions of the discount rate curves would not be known for Asia because government bonds’ maturities have been comparatively short in the past and for that reason the recommendation was not realistic. The Staff responded by stating that in such situations the non-observable discount curve would have to be extrapolated.

Two IASB members expressed the view that allowing three different approaches to transition within the same insurer would undermine comparability. A further IASB member stated that insurers may try to use extensively the third approach as this may prove to be attractive in respect of the recognition of future profits.

The Staff noted that the definition of 'impracticable' under IAS 8 has always been a high hurdle. They expressed the view that the matters raised by constituents and the IASB members during the debate did not appear to stem from a conceptual concern but from a cost/benefit issue.


Disclosure requirements

The Staff recommended that for each period presented for which there are contracts that were measured in accordance with the simplified approach or the fair value approach, an insurer should disclose the information for contracts for which retrospective application is impracticable proposed in paragraph C8 of the 2013 ED separately for contracts measured using the simplified approach and contracts measured using the fair value approach.

When called to vote by the Chairman, eleven out of 14 IASB members voted in favour of the Staff recommendations.


Next steps

The IASB will hold an educational session on 13-14 November 2014 when the European CFO Forum is expected to set out its proposals for an alternative model to account for participating contracts. The next IASB meeting is on 17 to 21 November. The only remaining topic to be re-deliberated by the IASB is the accounting for participating contracts, including transition requirements. Once the IASB has completed these re-deliberations the 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 in 2015.

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