Insurance Contracts – Disaggregating changes arising from changes in market variables in the statement of comprehensive income (SCI) – Background and objective (Agenda Papers 2A and 2B)

In March 2014 the IASB tentatively decided that for contracts without participation features the entity may choose as its accounting policy choice to disaggregate changes in discount rate between profit or loss and Other Comprehensive Income (OCI). If so, the presentation of interest expense in the SCI should be determined using the discount rate locked in at inception for the profit or loss account and accordingly the difference between that insurance investment expense determined using a cost and the one determined using a current discount rate is presented in OCI.

The papers address this presentation approach when it applies to contracts with participation features including the practical mechanics, whether different requirements are needed for some specific participating contracts in which there are no economic mismatches between the contract and the items held, whether such disaggregation between profit or loss and OCI should be an accounting policy choice and finally, whether there should be simplified transitional arrangements for the determination of the accumulated balance of OCI when retrospective application is impracticable.

Changes in estimates of cash flows arising from changes in market variables

The entity shall present changes in estimates of the amount of cash flows that result from changes in market variables in the SCI consistently with the changes in discount rates. The Staff expressed the view that it was necessary to present changes in future cash flows and future discount rates both in profit or loss or both in OCI. The rationale for this position is that for participating contracts the cash flows inherently integrate the effect of market and insurance risks and the time value of money measures the risk sharing of those market variables between the insurer and the policyholder. The Staff believed that it would be an improvement if the new insurance contracts Standard establishes a clear principle on how they should be presented when the split of the effect of time value of money between profit or loss and OCI is adopted.

IASB members voted twelve in favour and two against the Staff recommendations.

Objective of disaggregating changes arising from changes in market variables

The objective of disaggregating changes in the insurance contract arising from changes in market variables between profit or loss and OCI is to present an insurance investment expense in profit or loss using a cost measurement basis. Accordingly, the difference between presenting an insurance investment expense in profit or loss using a cost measurement basis and current measurement basis is recognised in OCI and these amounts reverse. The Standard should not specify detailed mechanics for the determination of the insurance investment expense using a cost measurement basis.

There was general support for focussing on the objective. One Board member expressed the view that trying to enforce particular methods could penalise entities in some jurisdictions. Another Board member stated that there needs to be consistency and comparability in the context of a ‘cost’ measure in profit or loss. The Staff confirmed that an objective for allocating the amounts over the life of the liabilities could be included in the Application Guidance and examples.

The IASB members voted unanimously in favour of the Staff recommendation.

Insurance Contracts – Disaggregating changes arising from changes in market variables in the SOCI – Modification of the objective for contracts with no economic mismatches (Agenda Paper 2C)

An inherent feature of a cost measurement basis is that accounting mismatches are more likely to arise. Eliminating accounting mismatches in profit or loss when applying a cost measurement basis in profit or loss could be simpler to achieve when there are no economic mismatches. Consideration was therefore given to whether the IASB wishes to modify the objective of disaggregating changes in market variables between profit or loss and OCI for a subset of contracts in which there is no economic mismatch. In such cases, accounting mismatches could be eliminated in profit or loss by presenting an insurance investment expense (or income) that exactly matches the gains or losses presented in profit or loss arising from items held to economically match those insurance contracts cash flows. This approach would be defined as the current period book yield approach.

Changing approaches

As the IASB has decided to modify the objective of disaggregating changes in market variables between profit or loss and OCI for contracts in which economic mismatches do not exist, if an entity is required to change between the cost measurement approach (e.g. the effective yield approach) and the current period book yield approach (and vice versa) it shall not restate the opening accumulated balance of OCI, it shall not recognise in profit or loss the accumulated balance of OCI on the date of the change or in future periods (i.e. accumulated OCI remains in equity), it shall not restate prior period comparatives, and it shall only disclose in the period in which the change of approach occurred what is the reason for the change, the effect of the change on each financial statement line item affected and the value of the contracts that no longer qualify for the current period book yield approach but previously qualified (and vice versa).

One Board member preferred to offer a choice between a cost measurement basis and a current period book yield approach. Another Board member stated that he would not change the opening OCI or comparatives as there would have been a change in economic circumstances in the current period. However several Board members considered that recognising accumulated gains or losses in profit or loss in the period of change and future periods was preferable, despite the added complication. A further Board member stated OCI should be amortised over the remaining contract life.

Following a change to the Staff recommendation such that accumulated gains or losses would be recognised in profit or loss in the period of change and future periods using the same assumptions as applicable to the approach used prior to the change the IASB members voted unanimously in favour of the amended Staff recommendation.

Modification to the objective for disaggregating changes in market variables between profit or loss and OCI

The Staff argued that when there is no economic mismatches between the cash flows from insurance contracts and the items held to fund those cash flows there is merit in considering whether the objective of disaggregating changes in market variables between profit or loss and OCI should be modified to present the insurance investment expense that eliminates accounting mismatches in profit or loss with reference to the accounting bases used for those items, irrespective of whether those items are measured using a cost measurement basis in profit or loss. Accordingly the difference between the changes in the contract arising from changes in market variables (e.g. changes in the fair value of the underlying items) and the insurance investment expense is recognised in OCI.

Economic mismatches do not exist when the contract is a direct participation contract (i.e. the entity has an obligation to pay the policyholders the fair value of the underlying items and therefore applies the variable fee approach), and the entity holds the underlying items, either by choice or because it is required to.

One Board member stated that the advantages of the current period book yield approach are significant but only where there are matched assets. He felt that both the current period book yield approach and the effective yield approach (an example of a cost measurement basis previously discussed by the IASB) should be available as many insurers will use the Fair Value through Profit or Loss for both assets and liabilities. Another Board member supported this view, and commented that the IASB had created a mixed measurement model, therefore it should not impose one method. A further Board member stated that more options resulted in more complexity, but could provide more useful information for users. He questioned whether such added complexity was worthwhile.

IASB members voted nine in favour and five against the Staff recommendation.

Insurance Contracts – Disaggregating changes arising from changes in market variables in the SOCI – Other issues (Agenda Paper 2D)

The first issue for contracts with participation features discussed through this paper was when changes in the insurance contract should be disaggregated between profit or loss and OCI, i.e. whether to extend to contracts with participation features the accounting policy choice to present the insurance investment expense in profit or loss using either a cost measurement basis or a current measurement basis.

The second issue was the possibility to introduce simplified requirements for the determination of the accumulated insurance investment expense using a cost measurement basis for the insurance contract when the entity applies the requirements for the first time (i.e. on transition). Such simplifications may be needed because an entity that chooses as its accounting policy choice to disaggregate changes in market variables between profit or loss and OCI would be required to determine the insurance investment expense reflecting a cost measurement basis (and accumulated balance of OCI) retrospectively, if practicable. Hence the question arises of what to do if this is not practicable.

Accounting policy choice

The IASB should extend to contracts with participating feature its previous decisions for contracts without participation features that an entity shall (a) choose as its accounting policy either to disaggregate changes in market variables between profit or loss and OCI by presenting an insurance investment expense in profit or loss using a cost measurement basis. Accordingly, the difference in the insurance investment expense presented using a cost measurement basis or a current measurement basis is presented in OCI; or to present the insurance investment expense in profit or loss using a current measurement basis, (b) apply that accounting policy to groups of similar contracts, taking into consideration the portfolio in which the contracts are included, the assets that the entity holds and how those assets are accounted for; and (c) apply the requirements in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors to any changes in that accounting policy.

IASB members voted thirteen in favour of and one against the Staff recommendation

Following the modification in the objective of disaggregating changes arising from changes in market variables between profit or loss and OCI when there are no economic mismatches between the cash flows from insurance contracts and those from the items held, an entity should instead choose as its accounting policy either to disaggregate changes in market variables between profit or loss and OCI by presenting an insurance investment expense in profit or loss using that modified objective. The difference in the insurance investment expense presented using that modified objective and a current measurement basis is presented in OCI. The alternative to that would be to present the insurance investment expense in profit or loss using a current measurement basis.

IASB members voted unanimously in favour of the Staff recommendation.

Simplified transition requirements for the accumulated balance of OCI

When retrospective application is impracticable the approach for determining the accumulated balance of OCI created by the insurance investment expense prior to the transition date for contracts in which changes in market variables affects the amount of cash flows will be set as follows: for contracts for which the objective is to present an insurance investment expense using a cost measurement basis in profit or loss (i.e. those applying an effective yield approach) an entity should assume that the earliest market variable assumptions that should be considered are those that occur when the entity first applies the new Standard (the transition date). Accordingly, the date when the entity first applies the new Standard, the accumulated balance of OCI for the insurance contract is zero; following the modification in the objective of disaggregating changes arising from changes in market variables between profit or loss and OCI, an entity applying the current period book yield approach should assume that the insurance investment expense (or income) is equal and opposite in amount of the accumulated gain (loss) presented in equity for the relevant underlying items the entity holds. Accordingly, an entity should assume that the accumulated balance of OCI is determined by disaggregating changes in market variables between profit or loss and OCI by presenting an insurance investment expense in profit or loss using that modified objective. The difference in the insurance investment expense presented using that modified objective and a current measurement basis is presented in OCI. As recommended before, the alternative to this treatment is to present the insurance investment expense in profit or loss using a current measurement basis.

IASB members voted thirteen in favour of and one against the Staff recommendation.