Loans that transfer significant insurance risk (Agenda Paper 2A)

Background

IFRS 17 applies to all insurance contracts as defined in IFRS 17, regardless of the type of entity issuing the contracts, with some specific exceptions. Some stakeholders are concerned that IFRS 17 requires entities to account for some loans that transfer significant insurance risk as insurance contracts in their entirety. Examples of these contracts provided by stakeholders are the following:

• Mortgages with a death waiver contract
• Student loan contracts (with repayments being income contingent)
• Lifetime mortgage contracts (sometimes referred to as equity release mortgages)

Those contracts typically combine a loan with an agreement from the entity to compensate the borrower if a specified uncertain future event adversely affects the borrower, by waiving some or all the payments due under the contract. They are usually issued not as insurance contracts and often by a non-insurance entity.

While IFRS 4 Insurance Contracts allowed the separation of the loan component from the insurance contract, IFRS 17 prohibits this and requires separation only of distinct investment components. Because the loans are not distinct investment components, IFRS 17 applies to the entire contract. Stakeholders are concerned that non-insurance entities are not prepared to apply IFRS 17 to those types of contracts and suggest that, instead, IFRS 9 Financial Instruments should be applied.

The staff note that these contracts transfer insurance risk. The paper addresses situations where such contracts transfer significant insurance risk and meet the definition of insurance contracts. The staff have considered the approaches suggested by stakeholders:

Approach 1—allow separation of the loss component

The staff note that the loan component and the insurance component are highly interrelated. Separating those components could result in complex accounting that does not provide useful information if the contract contains interdependent cash flows that are not attributable to individual components. The staff does not recommend this approach.

Approach 2A—mandatory scope exclusion

The staff note that IFRS 17 would appropriately reflect the accounting for such contracts. IFRS 9 would provide useful information, for example by requiring measurement at fair value through profit or loss. The staff note that amending IFRS 17 to require entities to apply IFRS 9 to insurance contracts, for the types of contracts discussed in the agenda paper, might introduce a significant change for entities that currently account for those contracts applying IFRS 4 and are preparing to implement IFRS 17. The staff do not recommend requiring IFRS 9 for accounting for those types of contracts.

Approach 2B—optional scope exclusion

For the reasons stated in the analysis of Approach 2A, and to ease the implementation burden for some entities without disrupting implementation for others, the staff recommend allowing an entity a choice that is available contract-by-contract, rather than for all the insurance contracts discussed in the agenda paper. However, the choice for each contract should be irrevocable.

Staff recommendation

The staff recommended the Board amend the scope of IFRS 17 and IFRS 9 for insurance contracts for which the only insurance in the contract is for the settlement of some or all of the obligation created by the contract, by adding an optional scope exclusion in IFRS 17. The exclusion would allow an entity to apply either IFRS 17; or IAS 32, IFRS 7 and IFRS 9 to such contracts that it issues. Within the paper, there is a suggestion to allow such irrevocable choice on a contract-by-contract basis.

Discussion

The staff noted that the paper does not cover credit cards, which will be brought to the future meeting. Some members expressed concerns with a contract-by-contract accounting election proposed by staff. Some wanted to apply IAS 8:13 principle of applying the same accounting treatment to similar transactions. Others felt that this would result in consolidated entities consisting of both insurers and banks issuing similar contracts not being able to apply two different policies. Accordingly, a portfolio approach was suggested, based on the IFRS 17 definition of contracts managed together and subject to similar risks. It was clarified that election is not an accounting policy choice as it is defined in IAS 8. There was also discussion whether such loans would always be measured at fair value through profit or loss (by failing SPPI test), or whether this needs to be added as a precondition for an IFRS 9 choice. Some of the differences in IFRS 9 are its more narrow definition of contract, and different emphasis on what is significant compared to IFRS 17. Overall, the board members felt that IFRS 9 is a principle-based and sufficiently robust standard to handle complex financial instruments, and no further qualifications for a choice are necessary. The Board approved 13:1 the staff recommendation modifying the election choice to be by portfolio.

Transition—Optionality and comparative information (Agenda Paper 2B)

Background

When a fully retrospective application is impracticable, IFRS 17 gives entities a choice on a group-by-group basis of applying either the modified retrospective or the fair value approach. The modified retrospective approach permits a number of modifications, to the extent that there is no reasonable and supportable information to apply the requirement fully retrospectively. When entities do not have reasonable and supportable information to apply the modified retrospective approach, they have to apply the fair value approach. The fair value approach gives entities choices around specific aspects of the requirements.

The concern is around the impact of the transition options on reduced comparability affecting potentially a number of years (while the contracts existing at the transition date remain outstanding). The Board developed transition options as a compromise between the usefulness of information that approximates the full retrospective application and the practical difficulties of doing so due to the lack of information available to the entities. IFRS 17 requires extensive disclosures about the nature and significance of the methods used and judgements applied in determining the transition amounts for all periods while the contracts that existed at the transition date remain outstanding. In subsequent periods, the entities need to present separately the impact on the contractual service margin (CSM) and revenue of those contracts that were measured using the modified retrospective or fair value approaches.

The paper acknowledges that any options reduce comparability. The concerns could be addressed by requiring the fair value approach when the fully retrospective approach is impracticable and removing the options in the application of the fair value approach. However, this would unduly disrupt implementation and would re-open the aspect of the Standard that the Board has already consulted on in the 2013 Exposure Draft. Accordingly, the paper recommends no change to reduce the optionality on transition.

Regarding the requirement to provide restated comparatives, the concern is around the lack of a similar requirement for IFRS 9 financial assets and insufficient time to implement IFRS 17 before its effective date. The paper notes that permitting entities not to restate IFRS 17 comparatives would result in a significant loss of information. Additionally, the IASB has already tentatively decided to defer the effective date by one year, which would allow extra time for implementation. Entities can resolve the potential mismatches between financial assets and insurance contracts on transition to both IFRS 17 and IFRS 9 by choosing to restate comparatives for financials instruments under IFRS 9. Entities can start collecting the information necessary to apply IFRS 9 now without the use of hindsight. Accordingly, the staff recommend no change to the requirement to present restated comparatives for IFRS 17.

Staff recommendation

The staff recommended no changes to the existing transition options and requirement to present restated comparatives for the annual reporting period immediately preceding the date of initial application of IFRS 17.

Discussion

There was limited discussion on optionality, which is seen as necessary. The Board approved the staff recommendation unanimously.

On comparatives, several members highlighted their importance, given the fundamental change introduced by IFRS 17. The lack of IFRS 9 comparative disclosures is optional, provided the entity has relevant information to make such disclosures. The Board approved the staff recommendation unanimously.

Transition—Risk mitigation option and amounts accumulated in other comprehensive income on transition (Agenda Paper 2C)

Retrospective application of the risk mitigation option

Background

IFRS 17 contains a risk mitigation option to recognise the effect of some changes in financial risk in the insurance contracts in profit or loss in specified circumstances, instead of adjusting the CSM. This is because of an accounting mismatch that arises when entities purchase derivatives to mitigate risks of changes in financial assumptions. While the fair value of the derivative would be recognised in profit or loss applying IFRS 9, the change in the economically ‘hedged’ insurance contract would adjust the CSM applying IFRS 17.

Some stakeholders are concerned that IFRS 17 only allows for the risk mitigation option to be used prospectively even though risk mitigation activities may have been in place before the date of initial application of IFRS 17. However, the staff think that applying the risk mitigation option retrospectively without using hindsight is challenging. Allowing entities to choose to which relationships to apply the risk mitigation option with the benefit of hindsight effectively enables entities to choose the amount of CSM on transition and thus the future profit to be recognised in profit or loss.

Staff recommendation

The staff think that an amendment to IFRS 17 to permit retrospective application of the risk mitigation option would cause a significant loss of useful information relative to the information that would be provided by IFRS 17 for users of financial statements. Accordingly, the staff recommended that the Board retain the requirements in IFRS 17 relating to the prohibition of retrospective application of the risk mitigation option.

Discussion

One member felt that restriction due to cherry-picking risk unduly penalised those applying the standard in good faith. Others felt that the risk of cherry-picking was tainting the quality of information provided by every entity. The fully retrospective approach was seen as difficult because of the lack of a documentation requirement in the past for designations and risk management strategies, inherently opening the risk of cherry picking. Similarly, the requirement to account for all risk management strategies that existed at the time was also open to cherry-picking due to inability to ensure completeness of information, as entities would not have accounting records for all the strategies that were in place at the time. Accordingly, the Board memebers voted 13:1 to support the staff recommendation to not allow retrospective application of risk mitigation. However, the staff will bring to future meeting a paper on permitting risk mitigation prospectively from the date of transition, provided the strategy and designations were documented before the date of transition. Further, the staff announced that they plan to bring a paper that explores an alternative solution to the issuer, avoiding retrospective application.

Cumulative amounts included in other comprehensive income (OCI)

Background

When an entity chooses to disaggregate insurance finance income or expenses between profit or loss and OCI, it may be permitted or required to determine the cumulative amount of insurance finance income or expenses recognised in OCI at the transition date as nil in certain circumstances.

Some stakeholders raised concerns that the outcome of applying the transition requirements of IFRS 17 would result in determining the accumulated amount of insurance finance income or expenses recognised in OCI as nil, while the amount accumulated in OCI for the related assets would not be nil.

Permitting entities to deem the cumulative amount in OCI related to corresponding assets as nil at transition to IFRS 17 would involve an amendment to IFRS 9. The staff think this makes the transition requirements in IFRS 9 more complicated and would significantly reduce the comparability of information related to the financial assets held between insurers applying that amendment and entities other than insurers and insurers that do not apply the amendment.

Permitting entities to deem the cumulative amount of insurance finance income or expenses recognised in OCI for insurance contracts at transition at the same amount as the cumulative amount in OCI relating to related assets would affect the insurance finance income or expense that will be recognised in future reporting periods. The insurance finance income or expense recognised in profit or loss in future periods would reflect the historical discount rate for the assets held at transition date that the entity determines to be related to OCI on transition insurance contracts. The staff think that this approach, linking to the assets held, would introduce subjectivity and diversity and would reduce the usefulness of information provided on the performance of the insurance contracts.

Staff recommendation

The staff consider that the disclosure requirements in IFRS 17 are adequate to provide useful information to users of financial statements on the related assets, and therefore recommended that the Board should not amend IFRS 17 with respect to the cumulative amounts included in OCI.

Discussion

For non-VFA contracts the entity does not have to specify the underlying items. Sveral Board members highlighted the subjectivity of identifying the related assets, and therefore there is no direct link between the OCI on financial assets and OCI on insurance contracts. This is the case even if the entity applies the fully-retrospective approach. The Board voted unanimously to approve the staff recommendation.

Transition—Modified retrospective approach (Agenda Paper 2D)

Background

Entities unable to apply IFRS 17 fully retrospectively have a choice of applying the Standard on transition using either the modified retrospective or the fair value approach. Entities can choose to apply the fair value approach even if they could apply the modified retrospective approach. Under the modified retrospective approach, only to the extent the entities do not have enough reasonable and supportable information to apply a particular requirement fully retrospectively, they are permitted to apply certain modifications, provided they have enough reasonable and supportable information to do so. Any reasonable and supportable information available cannot be ignored in applying the modifications.  If they do not have enough reasonable and supportable information to apply the modified retrospective approach (e.g. there is not enough information to apply one of the required modifications), they have to apply the fair value approach.

There are several concerns expressed by constituents:

1. The difficulty of applying the modified retrospective approach, and whether any further modifications not specified in the Standard can be made by entities by applying the principle of approximating full retrospective application
2. The difficulty of establishing whether the entity does or does not have reasonable and supportable information, given the number of systems the entities uses and the way they previously collected information. The proposals are 1) to apply modifications even when the entity has reasonable and supportable information for a full retrospective application; or 2) to apply modifications even when the entity does not have reasonable and supportable information for them.
3. The difficulty of establishing cash flows that are known to have occurred for any particular group, because the entities did not typically track this information in this way.
4. For contracts acquired in a business combination or portfolio transfer, the liability for settlement of claims incurred before the contracts were acquired/transferred transfers a risk of adverse claims development and is a liability for remaining coverage. Preparers have reported difficulty of estimating CSM on transition for claims development coverage for contracts acquired in business combinations and portfolio transfers, where the claims are managed in the same way as claims on issued contracts. This concern is relevant under both fair value and modified retrospective approaches.
5. Whether modifications available to contracts accounted under the general model could be extended to direct participating (variable fee approach—VFA) contracts.

Staff recommendation

1. The staff recommended not to permit entities any further own modifications not already envisaged in the Standard, as that may risk moving further away from the full retrospective approach, will introduce choices and increase diversity. However, the staff think it may be helpful to add in the Basis for Conclusions a clarification that the existence of specified modifications does not preclude entities from:
   1. Making estimates necessary in applying accounting policy retrospectively as per IAS 8:51.
   2. Making estimates in applying a specified modification in the modified retrospective approach.
2. Retain requirements to apply any modification only to the extent reasonable and supportable information is not available for full retrospective application, but is available for applying the modification.
3. Under the modified retrospective approach, the paper recommends not to amend the specified modification related to the use of cash flows known to have occurred before the date of transition. This is because the staff think that IFRS 17:C12 does not preclude entities from applying the requirements of IAS 8:51, which specifically allows the use of estimates in retrospective application. IFRS 17:C6 requires the use of reasonable and supportable information. If the entity has not collected data on actual cash flows or has collected it at a different level of aggregation, an entity is required to use reasonable and supportable information to estimate such amounts.
4. For contracts acquired in a business combination or portfolio transfer to amend the transition requirement for classification of settlement of claims liability incurred before the contracts were acquired.
   1. In particular, to the extent the entity does not have reasonable and supportable information for fully retrospective application and applies the modified retrospective approach, to add a modification requiring to classify liability for settlement of claims incurred before the contracts were acquired as a liability for incurred claims.
   2. To the extent the entity does not have reasonable and supportable information for fully retrospective application and applies the fair value approach, to permit to choose to classify liability for settlement of claims incurred before the contracts were acquired as a liability for incurred claims.
5. To not extend the modifications available to contracts accounted under the general model to direct participating (VFA) contracts, on the basis that the CSM of VFA contracts is calculated differently to the CSM of contracts accounted under the general model.

Discussion

The staff highlighted that this paper does not address the level of aggregation, which will be brought to the next meeting. The discussion focussed on mainly on the need for educational material to explain that the modification requirements in IFRS 17 do not prevent the entity from making estimates that are necessary for retrospective application as per IAS 8:51, or for making estimates when applying a specified modification in the modified retrospective approach . Some Board members also suggested the need for more educational material on the entity’s transitional requirements, as they are summarised in the appendix A to the paper. The Board voted unanimously to approve the staff recommendation.