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Insurance contracts: IFRS 9 and IFRS 4 - first session

Date recorded:

IFRS 9 was issued in July last year and has an effective date of 1 January 2018. At that time, the IASB said it would consider how to address the challenges arising from IFRS 9 being implemented before the new insurance contracts Standard. These measures, confirmed at the meeting this week, would amend the current version of IFRS 4 Insurance Contract (IFRS 4) to give companies the option to defer the effective date of IFRS 9 until 2021 (the ‘deferral approach’) if and only if their business model is predominantly to issue insurance contracts. On expiry of the 'deferral approach' on 1 January 2021 insurers will have the option to reclassify from profit or loss to OCI some of the accounting mismatches and temporary volatility that could occur before the new insurance contracts Standard is implemented and to do so via an insurance liability adjustment rather than by using a different measurement for its financial instruments (the ‘overlay approach’).

An Exposure Draft setting out these measures will be published later this year for public consultation.

The discussion on the effective dates of IFRS 9 and the new insurance contracts Standard was structured with a set of agenda papers. Agenda Papers 14 and 14A were for information only. The first one introduces the other papers on the issues and solutions for the effects of having different effective dates for IFRS 9 and the new insurance contracts Standard. It provides an overview of the concerns about the different effective dates and summarises the approaches that could be pursued by the IASB in order to address those concerns. The second paper summarises the feedback received by the IASB in the outreach with users of financial statements and in two written submissions received from the IASB from users of financial statements and their representative organisations. This paper is for information only.

Different effective dates of IFRS 9 and the new insurance contracts Standard: The Overlay Approach (Agenda Paper 14B)

This paper considers when and how an entity may adjust profit or loss and other comprehensive income (OCI) to remove from profit or loss the effect of newly measuring financial assets at fair value through profit or loss (FVPL) in accordance with IFRS 9 that were previously classified at amortised cost or available for sale. That adjustment is referred to as ‘the overlay adjustment’.

Financial assets eligible for the 'overlay approach'

An entity is permitted to make an overlay adjustment in respect of financial assets that the entity designates as relating to contracts that are within the scope of IFRS 4, and the financial assets are classified at FVPL in accordance with IFRS 9 and would not have been classified as FVPL in accordance with IAS 39.

An entity may change the designation of financial assets only if there is a change in the relationship between the financial assets and contracts that are within the scope of IFRS 4.

There was general agreement that the Staff recommendation was the most practical solution. IASB Board members voted unanimously in favour of the Staff recommendation.

Re-designation of financial assets

An entity applies the 'overlay approach' prospectively to financial statements when the eligibility criteria presented above are met, and an entity ceases applying the 'overlay approach' when financial assets no longer meet the same eligibility criteria. Any accumulated balance of OCI relating to the overlay adjustments should be immediately recycled to profit or loss.

Although one Board member commented that it would be difficult to designate the assets when there are both banking and insurance activities within the same legal entity, the vote was unanimously in favour of the Staff recommendation.

Transition

An entity is permitted to apply the 'overlay approach' only when it first applies IFRS 9, and an entity should apply the 'overlay approach' prospectively to eligible assets on transition to IFRS 9. The entity should recognise as an adjustment to the opening balance of OCI an amount equal to the difference between the fair value of financial assets and their carrying amount determined in accordance with IAS 39 immediately prior to transition to IFRS 9, and the entity should restate comparative information to reflect the 'overlay approach' only if it also restates the comparative information in accordance with IFRS 9. An entity should stop applying the 'overlay approach' when it applies the new insurance contracts Standard and it is permitted to stop applying the 'overlay approach' in any reporting period. When an entity stops applying the 'overlay approach' it should reclassify any balance of the prior periods’ overlay adjustments accumulated in OCI to retained earnings as of the beginning of the earliest reporting period presented.

One Board member expressed concern about the ability of entities to ‘cherry pick’ between which approach is applied in order to manipulate which amounts are reported in profit or loss and which are reported in OCI. The Staff confirmed that there will be discipline around re-designation and disclosures requirements when management decide to discontinue the 'overlay approach'. In addition, entities will not be able to switch from applying IFRS 9 to applying IAS 39 again.

IASB members voted unanimously in favour of the Staff recommendation.

Presentation of the overlay adjustment in the statement of comprehensive income (SOCI)

When an entity applies the 'overlay approach' it should present a single line item for the amount of the overlay adjustment in the profit or loss or the OCI sections of the SOCI or both.

The Staff noted that if the overlay adjustment is included as a separate line item in profit or loss it would be presented after the shadow accounting adjustment. In response to comments made by two IASB members, the Staff agreed that the single line item could be included in profit or loss and in OCI.

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

Disclosure

When an entity applies an overlay adjustment, it should disclose this fact and the financial assets to which the overlay adjustment relates, the entity’s policy for determining the financial assets for which an overlay adjustment is made, an explanation of the amount of the total overlay adjustment in each period in a way that enables users of the financial statements to understand how it is derived, and the effect of the overlay adjustment on each line item in profit or loss.

One Board member questioned whether it would be better to provide disclosure relating to assets that have been transferred (which is similar to the profit on disposal). The Staff confirmed that this could be dealt with during the drafting of the new Standard.

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

Different effective dates of IFRS 9 and the new insurance contracts Standard: The 'deferral approach' (Agenda Paper 14C)

This paper discusses deferring the effective date of IFRS 9 for entities that issue contracts that are within the scope of IFRS 4 until the new insurance contracts Standard is applied. Deferral would be permitted (not required), therefore an entity could instead adopt the 'overlay approach', or could adopt IFRS 9 and not apply either the 'overlay approach' or the deferral approach.

The Staff recommendations set out below were conditional on the IASB deciding to choose the 'deferral approach' as their preferred approach to address the decoupling of the effective dates of IFRS 9 and the new insurance contracts Standard.

Deferral at the reporting entity level

Under the Staff recommendation for the 'deferral approach', deferral of the effective date of IFRS 9 would be permitted for an entity that issues contracts in the scope of IFRS 4 if that activity is predominant for the reporting entity, and it would apply to all financial assets held by that reporting entity. An entity would be required to initially assess whether insurance activities are predominant based on the level of gross liabilities arising from contracts within the scope of IFRS 4, but no quantitative threshold for the assessment of predominance would be set. A reassessment of whether insurance activities are predominant will be required if there is a demonstrable change in the corporate structure of the entity, and if the entity concludes that insurance activities are no longer predominant. In the event that predominance is lost the entity will be required to apply IFRS 9 from the beginning of the next annual reporting period, and to disclose the facts surrounding the reason why it is no longer eligible for deferral. An entity that has already applied IFRS 9 is not permitted to revert to applying IAS 39 through the 'deferral approach'.

There was general support for the proposed approach, but some concerns were expressed about the ‘predominant’ test. The discussion led to the decision that it would need to be clearly defined and that it would need to be a high hurdle, as there was a need to exclude banking activities. The IASB also agreed that an example of ‘predominant’ would be helpful, but this should not be a ‘bright line’. The example in the agenda paper referred to a situation where predominance would be achieved when two thirds of the total liabilities would come from contracts under the scope of IFRS and the IASB instructed the Staff that the final text should instead use a higher level to illustrate the example of a reporting entity with a predominance of insurance contracts liabilities.

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

Deferral below the reporting entity level

The key aspects of the Staff recommendation to reject the application of the 'deferral approach' at a level below the reporting entity are the complexity of the approach (due to the transfer of financial assets, see below) and the result of an inconsistent accounting for financial instruments in consolidated financial statements when financial assets are eligible for the deferral only by certain subsidiaries or alternatively by certain business units (those that would have to be defined as carrying 'insurance activities'). These features would not apply if the deferral is for the reporting entity and for all its financial assets. On the contrary, the application below the reporting entity would produce group of financial assets (at legal entity or business units if an even lower level was adopted) that would need to be related to the insurance contracts in the scope of IFRS 4. The Staff argued that it would still be necessary to assess if the predominance test is passed to elect the use of the 'deferral approach' if the level chosen was that of a subsidiary/legal entity. Finally, the Staff emphasised that the application of criteria to elect financial assets accounting under IAS 39 would have to be made compulsory rather than optional to ensure comparability.

One IASB member challenged the Staff conclusion and questioned how difficult it really is to identify the underlying assets that back insurance contracts particularly given the proposal in the 'overlay approach' to use a mere designation basis to produce the same accounting effects on profit or loss. However, when the IASB members voted their support was unanimous in favour of the Staff recommendation.

Transfers of financial assets where there is deferral below the reporting entity level

In the event that the 'deferral approach' is applied to a level below that of the reporting entity, transfers of financial assets between parts of the reporting entity to which the 'deferral approach' is applied and those that are not eligible for it are accounted for at fair value as at the date of the transfer with any gains and losses arising on those transfers recognised in profit or loss.

One IASB member expressed concern that transfers between insurance and other businesses might increase if the 'deferral approach' below the reporting entity is adopted. The later vote confirmed that the IASB did not favour the 'deferral approach' at a level below the reporting entity. However, on the case in question the vote was directed at ensuring that each option had been developed with full support of the IASB and twelve IASB members were in favour of the regime for internal transfers of asses with only two against the Staff recommendation.

Optional or mandatory deferral

An entity should be permitted, rather than required, to apply the 'deferral approach' to eligible financial assets. IASB members voted eleven in favour of and three against the Staff recommendation.

Presentation, disclosure and transition under the 'deferral approach'

Entities would be required to make extensive disclosures, including quantitative and qualitative information about carrying values, income and expense in profit or loss and OCI that would have been required if IFRS 9 had been applied from 1 January 2018.

At the time an entity applies the 'deferral approach', it applies IFRS 9 for the purposes of disclosure using the appropriate transition provisions in IFRS 9, and it would be permitted to stop applying the 'deferral approach' and apply IFRS 9 at the beginning of any annual reporting period before the new insurance contracts Standard is applied.

Several Board members expressed concern at the proposed level of disclosure. In response to these comments the Staff modified their proposal such that only qualitative disclosures would be required. In conclusion, the 'deferral approach' will not require the introduction of IFRS 9 via disclosure on 1 January 2018.

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

Which alternative for the 'deferral approach' is more appropriate?

IASB members voted unanimously in favour of the Staff recommendation that the 'deferral approach' at a reporting entity level (Alternative 1 in the agenda paper) would provide more useful information to users of financial statements. The 'deferral approach' at a level below the reporting entity has been rejected.

Proposing the 'deferral approach'

At this juncture the Staff took the IASB over the choice to address concerns about different effective dates of IFRS 9 and the new insurance contracts Standard.

Views expressed by the IASB members were evenly divided on the 'deferral approach'. Some IASB members stated that they had changed their views since this issue was previously discussed.

One IASB member stated that the 'deferral approach' was not creating a precedent, it was merely dealing with a problem, and that the package of disclosures would enable users to make comparisons between entities. Another member stated that requiring systems to be put in place for the expected loss model when entities may subsequently move to a fair value model was unreasonable.

Concerns expressed about the 'deferral approach' included the uncertainty regarding how long the 'deferral approach' would be in place, the fact that large insurers were important in capital markets and the lack of comparability that would exist would undermine capital market efficiency. In addition, some observed that there is a risk of the timeline for the implementation of IFRS 9 being challenged by other industries.

The Staff stated that the intention is to publish an information document with the proposals for the new insurance contracts Standard at the beginning of next year, to consider any comments that this may generate and to publish the new Standard by the end of 2016. One IASB member expressed pessimism about the likelihood of achieving such a timetable. The Chairman stated that the IASB is under considerable time pressure to issue the new insurance contracts Standard, and that there was a strong lobby action to persuade the European Union to make a ‘carve in’ and to achieve a deferral of IFRS 9 for the European Union insurers. He stated that he would be in favour of a clear time horizon to finish the new insurance contracts Standard, and that as EFRAG had publicly requested the IASB to finish the new insurance contracts Standard as soon as possible, the IASB would get strong support from several of its constituents to finalise the insurance contracts Standard without re-exposure.

IASB members voted seven in favour and seven against the Staff recommendation, with no abstentions.

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