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Insurance contracts

Date recorded:

The package of papers for the Board discussion considered the remainder of the planned technical decisions on accounting for insurance contracts: Agenda Paper 2 provided a summary of the issues to be considered and the next steps, Agenda Paper 2A considered whether, and if so at what level, insurance contracts should be aggregated for the purposes of (a) recognition of losses on onerous contracts, and (b) the allocation of the contractual service margin (CSM); and Agenda Paper 2B considered whether and how to specify how to determine the effect of discretion in participating contracts under the general model. Agenda Paper 2C summariseed the background and context of the IASB’s project on insurance contracts, and Agenda Paper 2D provided a high-level overview of the Board’s model for insurance contracts based on the decisions to date. The staff did not expect to discuss Agenda papers 2C and 2D at the meeting.

Level of aggregation (paper 2A)

The need to consider the level of aggregation arises because in some circumstances gains are treated differently from losses, therefore an accounting mismatch may be created if contracts were accounted for individually. For example, on initial recognition, and entity would recognise a positive CSM over the coverage period, but recognise a negative CSM immediately in profit or loss. Subsequently an entity would recognise changes in fulfilment cash flows relating to future service as adjustments to the CSM over the remaining coverage period as long as they do not result in a negative CSM. However, such changes are recognised immediately to the extent that they would otherwise result in a negative CSM. In addition, there may also be other differences in the treatment of gains and losses in allocation the CSM, depending on how the current specification of the allocation of the CSM is interpreted.

In order to avoid the recognition of inappropriate losses that arise on individual contracts just because expected events across a group affect individual contracts differently, the staff thinks that the Board should specify a level of aggregation to be used in determining whether a group of contracts is onerous. The Board is asked to consider whether a loss for onerous contracts is required to be recognised only when the CSM is negative for a group of contracts which at inception have cash flows that the entity expects will respond in similar ways to key drivers of risk in terms of amount and timing, and had similar expected profitability.

The other aspect for which the level of aggregation is relevant is the allocation of the CSM. For those contracts for which the coverage period ends earlier than the average coverage period of the group measuring contracts on an individual basis would mean that the CSM associated with those contracts would be fully recognised in profit or loss over the shorter period up to the point when the coverage period ends, whereas measuring the contracts on a group basis would not necessarily mean that the CSM associated with those contracts would be fully recognised in profit or loss when the coverage period ends.  The Board is asked to consider whether an entity could meet the objective of recognising the remaining CSM in profit or loss over the remaining coverage period in the systematic way that best reflects the remaining transfer of the services to be provided by grouping contracts that have cash flows that the entity expects will respond in similar ways to key drivers of risk in terms of amount and timing, on inception has similar expected profitability, and have coverage periods that are expected to end at a similar time.

Board discussion

First question – Level of aggregation for onerous contracts

A Board member felt that specifying the aggregation based on groups of contracts with similar percentages of CSM over associated premiums to implement the principle of aggregating contracts with similar expected profitability was rather prescriptive and rules-based, and expressed a preference for principles. There was also a concern that the use of the word 'similar' would result in different interpretations. Another Board member broadly agreed with the move towards consistency with IFRS 15. A further Board member considered that moving to a portfolio approach was desirable as this reflected the business model of insurers.

A Board member felt that if the claims experience worsened for some contracts within a group, but improved for other contracts within the same group, it should be possible to offset losses against profits. However, he felt that if the claims experience of the whole portfolio worsened significantly, or if the claims experience was assessed to be significantly worse shortly after inception, those contracts should be put into a separate group.

A Board member stated that the wording was open to different interpretations and questioned whether marginally loss making contracts should be grouped separately from profitable contracts if the other features were the same, whether reassessment was required if there was a substantial difference in the value of contracts sold compared to what was expected, and how profitability should be defined (with particular reference to the allocation of costs). The Staff stated that whether contracts had similar profitability required judgement, and that there would be guidance on the allocation of expenses. A Board member stated that the same test should be applied irrespective of the value of contracts issued. Another Board member expressed the view that given there is a definition for 'onerous contracts', it is unnecessary to further define costs.

A Board member stated that he struggled with the concept of similar profitability as the nature of insurance is that different contracts will have different outcomes in terms of claims. Another member suggested that the Staff provides examples of what is meant by 'similar profitability'.

Tentative decision

The Board unanimously approved the Staff recommendation.

Second question - Level of aggregation for the allocation of the contractual service margin (CSM)

The Staff noted that they added a third criteria: that contracts were in the same group when they expected to end at a similar time. Two Board members stated that they considered that there was no need for the additional criteria. One of these members stated that he would prefer the requirement to be more principles based, such that if the allocation would leave the balance of CSM at the end of the period to represent the profits on all remaining contracts. If all contracts lapse or mature in the period the CSM should be nil. The debate that followed appeared to lead to the conclusion that the third criteria did not add a great deal, that the objective was important, and that the mechanics by which the objective is met should be left open. The Staff agreed that the CSM only relates to contracts in force and that rigid criteria were not required to achieve that accounting objective.

The reminder of the discussion on this topic was deferred to enable the Staff to reword the third criteria.

Level of aggregation – addendum (2A addendum)

The paper summarises the key points from the Board’s discussion on 19 January aiming to clarify whether the objective is to allocate the CSM on an individual contract basis with groupings permitted if they can meet the objective. The paper considers whether specifying objective of allocation on an individual contract basis would force the entities to apply it that way and whether explicit groupings guidance is required.

The paper recommends that:

a) The objective for the allocation of the CSM is to recognise CSM for an individual contract in profit or loss over the coverage period in a way that best reflects the transfer of services under the contract. This means that the CSM for contracts where the coverage period has ended has to be fully recognised in profit and loss.

b) Entities can group contracts provided the objective above is achieved.

c) The objective is deemed to be achieved (a ‘safe harbour’) if the following criteria are met:

  1. The contracts are in the group that:
  2. Have cash flows responding similarly to key risks in terms of amount and timing and
  3. Have similar expected profitability at inception (measured as CSM percentage of a the premium)
  4. The group CSM is adjusted to reflect expected duration and size of the contract remaining after the end of the period.

Several Board members expressed concern at the reference in the first criteria to an individual contract rather than to a group of contracts, which could be misinterpreted. The Staff stated that the adjustment would be made at a group level, but the objective applies to each contract. However, they confirmed that they would clarity what was intended when drafting the new Standard, and they would also provide examples.

The Board members clarified that the Insurance standard requires different levels of aggregation for different purposes. The same lowest level of aggregation could be used for all purposes, but does not need to be. The level of aggregation for onerous contracts, for example, would be met by criteria in paragraph (c) (i). The level of aggregation for determining the risk adjustment can be at a much higher level. Some Board members suggested that there is a difference in measurement and allocation, while the Staff members did not see that distinction. In the Staff view there is no need to track individual contracts but the group needs to be adjusted if the entity is aware that different contracts in the group behave differently. Some Board members had reservations about a clear reference to individual contract in the objective. They wanted to add ‘individual contract or group of contracts’, where the group would meet the conditions in paragraph (c). However, some members saw criteria in paragraph (c) that as too restrictive, since they were ‘safe harbour’ criteria, whereas inserting a word ‘group’ in the objective without any constraints could be interpreted too widely.

Tentative decision

The Board agreed that the wording would need to be revised, but voted twelve against two to support the Staff recommendation that the objective of the CSM allocation is to achieve very homogenous groups, that grouping is allowed if that objective is met and there should be a ‘safe harbour’ example of a grouping that definitely meets the objective.

Third question – Exception for the effect of regulation

The discussion of paper 2A focussed around the effect of regulation on the recognition of CSM. The paper recommended that there should be no exception to the level of aggregation for determining onerous contracts or determining the allocation of the CSM as a result of regulation. This point provoked a lively debate. For example, gender equality regulations mean that insurers need to charge the same premium to male and female drivers even if the risks are different.  As a result, economically female drivers may be subsidising male drivers, however, considered as a portfolio, the risk and overall profitability to the insurer remain the same. Viewed as two separate portfolios, the CSM of the female drivers would be much higher, whereas the male drivers CSM may result in a group of onerous contracts. Some members viewed this result as not reflecting the economic substance, whereas others viewed it as appropriately highlighting the different profitability of the two portfolios. There was also a concern that allowing for the effect of regulation required defining what “regulation” was and it would create an undesirable precedent for other industry groups.

Tentative decision

The Board approved the Staff recommendation with 10 members voting for and 4 against.

Specifying the effect of discretion in the general model (paper 2B)

This paper addresses how the effect of discretion for participating contracts which do not meet the definition of direct participating contracts (to which the variable fee approach would be applied), which therefore fall within the scope of the general model. Participating contracts will often include cash flows that the entity expects to pay, but which it has discretion to change, which are included in the fulfilment cash flows. Changes in estimates of discretionary cash flows would adjust the CSM because they are regarded as relating to future service. The 2013 Exposure Draft simply stated the principle that changes in future service adjust the CSM.

At the November 2015 meeting the Board considered four ways to distinguish changes caused by market variables (that are recognised in the statement of comprehensive income) and changes in discretionary cash flows (that adjust the CSM). At that meeting the staff recommended using the market as a benchmark to determine the effect of discretion. Some Board members suggested an approach that combined two of these views. The staff think that such an approach would require an entity to specify at the inception of the contract how it viewed its discretion, and to use that specification to distinguish between the effect of changes in market variables and changes in discretion. Entities that gave different specifications about discretion would get different results from similar contracts, but the staff think that the different results could provide useful information to the users of financial statements because such information reflects the entity’s perspective about its discretion.

The staff think that there are two finely balanced viable alternatives. The Board is asked to consider whether it wishes to require an entity (a) to specify how it determines the effect of discretion, which is effectively relying on the principle in the 2013 Exposure Draft; or (b) specifying further guidance by stating that an entity must determine the effect of discretion by reference to the market.

Board discussion

Several Board members preferred the second suggestion, which was that an entity would be required to determine the effect of discretion by reference to the market. A Board member stated that it is useful for users of financial statements to know the expected or targeted rate of return, and another expressed the view that in many cases it is possible to identify the effect on the fulfilment cash flows arising from changes in market variables.

Tentative decision

The Board unanimously approved the second Staff suggestion.


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