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Insurance contracts

Date recorded:

Background

There are eight agenda papers prepared for the November Board meeting where the draft of IFRS 17 Insurance Contracts (draft IFRS 17) will be discussed.

Papers 2A and 2B set out respectively the methodology used and the findings from the external testing of the draft IFRS 17. These papers are provided for information and the Board is not asked for decisions. They are not considered further in these summaries.

Paper 2C considers a possible response to the feedback received on the level of aggregation in the external review of the draft IFRS 17. Agenda paper 2D considers whether the requirements of the draft IFRS 17 on changes in the carrying amount of the contractual service margin (CSM) for experience adjustments should be amended. Agenda paper 2E considers a possible response to the issues relating to transition that have been identified in the external review and testing of the draft IFRS 17. Paper 2F discusses feedback from test participants about the requirements relating to accounting for the effects of financial risk when an entity applies the variable fee approach (VFA) and mitigates that risk with a derivative. Paper 2G summarises other 21 sweep issues that have arisen in the drafting process and external testing. Agenda paper 2H asks the Board to specify the mandatory effective date for IFRS 17, assuming that this is issued in the first half of 2017.

Next steps

The Staff will continue with the drafting process to reflect the decisions made in the November 2016 meeting, and will ask selected external parties to perform a fatal flaw review of a revised draft of IFRS 17.

The Staff expects to issue IFRS 17 in the first half of 2017.

Insurance Contracts — Level of aggregation — Agenda paper 2C

The Staff recommends that (a) the definition of portfolio, i.e. a group of contracts subject to similar risks and managed together as a single pool, should be retained, (b) onerous contracts should be identified at initial recognition and be grouped separately from contracts that are not onerous at initial recognition, (c) insurance contracts that are not onerous at initial recognition should be measured by dividing them in each portfolio into at least two groups, the first is a group of contracts that have no significant risk of becoming onerous and the second is a group of other profitable contracts, (d) only contracts issued within the same year should be included within the same group, (e) the CSM for a group of contracts would be required to be allocated over the current period and expected remaining coverage to be provided, on the basis of the passage of time, reflecting the expected duration and size of the contracts in the group, and (f) a weighted-average discount rate should be permitted for the accretion of interest, with an averaging period of as much as one year.

Insurance Contracts — Experience adjustments — Agenda paper 2D

The Staff recommends that for contracts measured under the general model when an experience adjustment directly causes a change in the estimate of the present value of the cash flows, the combined effect of the experience adjustment and the change in the estimate of the present value of future cash flows should not adjust the CSM but should instead be recognised in profit or loss. An experience adjustment directly causes a change in the estimate of the present value of future cash flows only when it causes a change in the future rights and obligations for the group of contracts.

For contracts measured under the variable fee approach, experience adjustments arising from non-financial risk that do not affect the underlying items, and any directly caused changes in the estimates of the present value of future cash flows, should not adjust the CSM but should instead be recognised in profit or loss.

Insurance Contracts — Transition issues — Agenda paper 2E

The need to demonstrate impracticability before using the simplified approach and the fair value approach. The first Staff recommendation is that the requirements of IFRS 17 should be applied retrospectively in accordance with IAS 8 to groups of insurance contracts, unless it is impracticable. The second recommendation is for insurance contracts for which an entity cannot identify a group retrospectively and for groups of insurance contracts for which retrospective valuation is impracticable. In these instances a choice should be permitted between adopting a modified retrospective approach or the fair value approach, unless a modified retrospective approach is also impracticable, in which case the fair value approach must be used.

Concerns with the simplified transition approaches. The first Staff recommendations is that the objective of a modified retrospective approach should be to achieve the closest outcome to retrospective application that is possible using reasonable and supportable assumptions. The second recommendation is that the use of specified modifications should be permitted, using the minimum modifications necessary to meet the objective of the modified retrospective approach. The third recommendation is that, in applying a modified retrospective approach, there should be the maximum use of information that would have been used to apply a fully retrospective approach, but only if such information is available without undue cost or effort.

The date for determining the CSM for contracts with direct participation features. The Staff recommendation is that the CSM should be determined using the permitted modifications for the VFA determined at the beginning of the earliest period presented.

Fair value approach. The Staff recommendation is that under the fair value approach assessments should be allowed about (a) whether a contract is eligible for the variable fee approach, (b) how to group contracts, and (c) how to determine the effect of discretion on estimated cash flows for contracts subject to the general model. An entity can determine the effect of discretion either as at the inception of a contract, based on reasonable and supportable evidence for what the entity would have determined given the terms of the contract and the market conditions at that time, or at the beginning of the earliest period presented.

Grouping of contracts written within the same year. The first Staff recommendation is that as part of a modified retrospective approach and a fair value approach, an entity is permitted (a) not to divide contracts into groups that were written within the same year, (b) for groups applying the general model, to accrete and adjust the resulting CSM after transition using the discount rate at the beginning of the earliest period presented, (c) if the entity makes an accounting policy choice to disaggregate insurance finance income or expenses between profit or loss and other comprehensive income, for non-participating contracts it is permitted to base finance income or expenses included in profit or loss using the discount rate at the beginning of the earliest period presented. The second Staff recommendation is that if an entity chooses to base finance income or expense included in profit or loss using the discount rate at the beginning of the earliest period presented, it should make separate disclosures for amounts relating to insurance finance income and expenses for insurance contracts that were in force at the beginning of the earliest period presented and insurance contracts issued after the beginning of the earliest period presented, and disclose a reconciliation from the opening to the closing balance of the cumulative amounts included in other comprehensive income for related financial assets measured at fair value through other comprehensive income.

Disclosure of transition amounts and methods. The first Staff recommendation is that all the disclosures required by IFRS 17 relating to the CSM, insurance contract revenue and insurance finance income or expenses should be provided separately for insurance contracts that existed at the beginning of the earliest period presented and insurance contracts written after the beginning of the earliest period presented. The second Staff recommendation is that for all periods there should be an explanation of how the measurement of insurance contracts at transition was determined in order for users to understand the nature and significance of the methods used and judgements applied.

Insurance Contracts — Mitigating financial risks reflected in insurance contracts — Agenda paper 2F

The Staff recommends that where the VFA is applied and a derivative is used to mitigate financial risks arising from the insurance contract and the underlying items, the effect of those changes in the financial risk should be excluded from the CSM when specified criteria are met and the entity has made this election in its accounting policies.

Insurance Contracts — Other sweep issues — Agenda paper 2G

This paper summarises 21 issues that have arisen in the drafting process and external testing. It includes the most significant changes that the Staff has made to draft IFRS 17 in the light of comments from Board members, the topic-based testing, and external review, together with the Staff’s proposed response. In particular issue 12 clarifies the VFA classification to allow the interpretation of contractual terms as inclusive of substantive obligations from laws and regulations. Issue 10 clarifies that for VFA contracts and those with asset dependent cash flows for which there is mutualisation among policyholders the level of aggregation to determine groups has to take the mutualisation features into account.

Insurance Contracts — Mandatory effective date of IFRS 17 — Agenda paper 2H

The Staff recommends that an entity should apply IFRS 17 for annual periods beginning on or after 1 January 2021, assuming that IFRS17 is issued in the first half of 2017, and an entity may apply IFRS 17 before 1 January 2021, provided it also applies IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers at the same time.

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