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Amendments to IFRS 17 'Insurance Contracts'

Date recorded:

Cover note (Agenda Paper 2)

At its October 2018 meeting, the Board discussed the overview of the main concerns and implementation challenges raised by stakeholders about the requirements in IFRS 17. At the same meeting, the Board tentatively decided the criteria for evaluating proposed amendments (Agenda Paper 2C of the October 2018 IASB meeting). At the December 2018 meeting, the Board had tentatively decided to propose the following amendments:

  • One-year deferral of the effective date of IFRS 17
  • The presentation of insurance contract assets and liabilities in the statement of financial position is determined using portfolios of insurance contracts rather than groups of insurance contracts

This meeting considers the following issues:

Discussion

The staff indicated that any remaining issues will be discussed before the end of the first quarter of 2019 and an Exposure Draft will be issued in the first half of 2019.

Insurance acquisition cash flows for renewals outside the contract boundary (Agenda Paper 2A)

Background

Entities pay agent commissions as part of the insurance acquisition cash flows for new contracts that entities expect policyholders to renew in the future. Commissions can be refundable or non-refundable, directly attributable to a group of contracts or directly attributable to a portfolio to which the group of contracts belongs. Appendix A of IFRS 17 defines insurance acquisition cash flows. They may include amounts paid and amounts expected to be paid in the future for the acquisition of contracts. Acquisition cash flows directly attributable to a group are allocated to that group only, whereas other acquisition cash flows directly attributable to a portfolio, are allocated in a reasonable manner to groups in a portfolio.

Insurance acquisition cash flows are accounted for by including them in the cash flows expected to fulfil the contract. The contract boundary limits the fulfilment cash flows to include only cash flows that arise from existing substantive rights and obligations, including those that arise from future contract renewals depending on specific facts and circumstances and the assessment of substantive rights and obligations. Not all expected future contract renewals fall within the group contractual boundary.

Some stakeholders have concerns relating to non-refundable commissions paid to agents, where the costs may be high and the entity expects to recover them only if there are future renewals. When future renewals fall outside the contract boundary of the newly issued group, they are ignored in the measurement of the group, whereas the entire agent commission is directly attributable to that group, making the group onerous. Some stakeholders stated that the existing requirements in IFRS 17 would result in inconsistent outcomes compared with other contracts within the scope of IFRS 15 Revenue from Contracts with Customers. The issue has been previously discussed at the IFRS 17 Transition Resource Group (TRG).

Staff analysis

The measurement approach is different in IFRS 17 and IFRS 15. However, the staff think that the Board could consider aligning the requirements of IFRS 17 more closely with those of IFRS 15 as that could provide useful information for users of financial statements and might not unduly disrupt the implementation process already under way. The staff note that the Board should not develop specific requirements on how to allocate part of the insurance acquisition cash flows to anticipated contract renewals, as guidance in IFRS 17:24 and IFRS 17:33 is sufficient.

Staff recommendation

  • The staff recommend the Board amend IFRS 17 to require an entity to:
  • Allocate to any anticipated contract renewals the part of the insurance acquisition cash flows that is directly attributable to newly issued contracts
  • Recognise the insurance acquisition cash flows allocated to anticipated contract renewals as an asset applying IFRS 17:27 until the renewed contracts are recognised
  • Test the resulting recognised asset for impairment each period before the related contracts are recognised and perform the impairment test based on the expected fulfilment cash flows of the related group of contracts
  • Recognise in profit or loss any impairment loss and the reversal of some or all of any such loss previously recognised as soon as the impairment conditions no longer exist or have improved

Discussion

The Board members broadly agreed with the staff recommendation. The Chairman and Vice-Chair expressed the view that the original IFRS 17 requirement was providing useful information and reflecting the difference between those acquisition cash flows that are recoverable from existing contracts and those that are not. Many Board members noted the differences between IFRS 17 and IFRS 15 models would not imply a ‘read across’ from IFRS 15. The amendment is a concession to better reflect the economics of the underlying business. The proposed amendment will make the amount of CSM larger than it was as per the existing requirements of IFRS 17. One issue with this amendment is that there could be a possibility of errors in developing the ‘anticipated contract renewals’, however that problem is present in all Standards. The IFRS 17 model is generally heavily based on estimates. The requirements of IFRS 17:32 and IFRS 17:33 provide guidance on how to anticipate and estimate the future cash flows. It was suggested to clarify that renewals are of those specific contracts (even if there may be several renewals), and not just any new business. Although an asset or liability is recognised from the date the insurance acquisition cash flows are incurred, that asset is tested for impairment. The amendment will, to some extent, align the requirements in IFRS 17 with IFRS 15.

Decision

13 of the 14 Board members supported the staff recommendation.

Reinsurance contracts held—onerous underlying insurance contracts (Agenda paper 2B–C)

Background

Insurance contracts issued and reinsurance contracts held are measured applying a consistent measurement approach based on fulfilment cash flows. However, for reinsurance contracts held, the entity receives insurance services. Therefore, the nature of the contractual service margin (CSM) for a reinsurance contract held is different, as it represents the net cost or net gain from purchasing reinsurance and IFRS 17 has developed guidance on how this net cost/gain should be recognised over the period that the entity receives services from the reinsurer.

The Board stipulated in IFRS 17:66(c)(ii) that the subsequent measurement of reinsurance cash flows changes must take into account whether or not changes in fulfilment cash flows from underlying insurance contracts adjust the CSM or are reported in profit or loss. If the latter, then this paragraph requires the cedant to account for the change in reinsurance contracts held in profit or loss rather than the reinsurance CSM. The staff note that this is a situation that occurs when an underlying group of insurance contracts becomes onerous after initial recognition because of adverse changes in estimates of fulfilment cash flows. There are other situations that would also be captured by IFRS 17:66(c)(ii) when changes in fulfilment cash flows of reinsurance contracts held related to future service would not adjust the CSM. These would apply to groups of contracts that become more onerous because this was not anticipated in prior period measurement. This would also apply to subsequent reversals of loss components.  When IFRS 17:66(c)(ii) applies and changes in fulfilment cash flows of underlying insurance contracts relate to future service but do not adjust CSM, to the extent that there are corresponding changes in estimates of fulfilment cash flows for the reinsurance contract held, those changes do not adjust the CSM of the reinsurance contract held, but are instead recognised in profit or loss. This achieves no net effect of the loss and gain in the profit or loss for the period to the extent that the change in the fulfilment cash flows of the underlying group of insurance contracts matches a change in the fulfilment cash flows of the group of reinsurance contracts held.

However, IFRS 17:66(c)(ii) may not apply on initial recognition and it does not apply when further insurance contracts are issued and join the onerous group, if that does not result in a change in the fulfilment cash flows of the reinsurance contract held. This would be the case when cash flows from underlying insurance contracts are already reflected in the measurement of the reinsurance contract held before they are issued and are later issued as expected. Some stakeholders are concerned that this view is too narrow and it could give rise to accounting mismatch. During the implementation of IFRS 17 some stakeholders have identified that the accounting mismatch may be significant in many circumstances. Agenda Paper 2C includes examples that illustrate the application of the requirements in IFRS 17.

Staff analysis

The staff paper considers possible amendments to resolve accounting mismatches created on initial recognition of onerous underlying insurance contracts when a reinsurance contract held is entered into earlier or at the same time as the onerous underlying insurance contracts. To allow matching of losses on underlying insurance contracts issued and gains on reinsurance contracts held, the amendment would need to apply at the time the underlying insurance contracts are issued and not before. Any amendment would apply at the initial recognition of a new onerous group of insurance contracts, when further onerous contracts are issued and join an existing onerous group and would continue to apply when there are adverse changes in fulfilment cash flows.

Two scenarios were analysed in this paper. The main concern expressed under both the scenarios is that the accounting mismatch could be frequent and significant in size:

  • Scenario 1—when a reinsurance contract held is in a net gain position and provides coverage for an underlying onerous group of insurance contracts
  • Scenario 2—when a reinsurance contract held is in a net cost position and provides coverage for both an underlying onerous group of insurance contracts and an underlying profitable group of insurance contracts

The following amendments are considered:

  • Possible Amendment A—deferred loss solution: The amendment would change the accounting for underlying insurance contracts to the extent that those contracts are covered by a reinsurance contract. However, this would be fundamental change to the IFRS 17 accounting model, would result in a significant loss of information and introduce complexity for users of financial statements. Therefore, the staff do not recommend this solution.
  • Possible Amendment B—immediate loss mitigation solution: The scope of the existing exception in IFRS 17:66(c)(ii) could be expanded to require an entity to recognise a gain in profit or loss when the entity recognises losses on onerous underlying insurance contracts. The gain would be recognised to the extent that a reinsurance contract held covers the losses of each contract on a proportionate basis. Applying this amendment, an entity would also be required to recognise a loss in profit or loss when it recognises a reversal of losses on onerous underlying insurance contracts, to the extent that a reinsurance contract held covers the losses of each contract on a proportionate basis. The staff recommend this solution, as it helps in avoiding the mismatch, avoid significant loss of useful information and reduces complexity.

Agenda Paper 2C provides illustrative examples to support the analysis in Agenda Paper 2B. Agenda Paper 2C contains no recommendations. It discusses the accounting for reinsurance contracts held when the underlying insurance contracts are onerous.

Staff recommendation

The staff recommend the Board amend IFRS 17 to:

  • Expand the scope of the exception in IFRS 17:66(c)(ii) to require an entity to recognise a gain in profit or loss when the entity recognises losses on onerous underlying insurance contracts, to the extent that a reinsurance contract held covers the losses of each contract on a proportionate basis
  • Require an entity to apply the expanded exception when the entity measures contracts applying the premium allocation approach (PAA)

Regarding the first bullet, the staff also note that in applying this amendment, an entity would also be required to recognise a loss in profit or loss when it recognises a reversal of losses on onerous underlying insurance contracts, to the extent that a reinsurance contract held covers the losses of each contract on a proportionate basis. 

Discussion

The Board members generally supported the staff recommendation with some Board members expressing concerns about the disruption of any implementation processes underway. The staff acknowledged the concerns and said that it could be potentially disruptive, however the staff do not think it is undue disruption. Stakeholders have repeatedly urged the Board to address the issue and the mechanics are similar to the existing model, so the systems do not have to be modified significantly. The proposed solution would bring IFRS 17 closer to the previous accounting treatment.

One Board member suggested that the term ‘proportionate’ should be defined in IFRS 17 with the staff acknowledging that they would carefully examine the wording, as even within the insurance industry the term was used with different meanings. What the staff meant here was reinsurance coverage proportionate to the claims incurred and not splitting up contracts.

The Vice-Chair expressed agreement with the pragmatic approach taken in efficiently addressing the accounting mismatch, but also the measurement of the corresponding gain. For proportionate reinsurance covering X % of claims, it is pragmatic to apply the same X % to the recognition of the gain, even though the CSM of the insurance contract issued is driven not just by premiums and claims but also by other cash flows. This is why the scope of the amendment is restricted only to proportionate contracts, as the same simplistic measurement would not be appropriate for non-proportionate contracts, where it is harder to consider what amount of the loss on the underlying insurance contracts is covered by the reinsurance contract held. The Vice-Chair also asked to emphasise in the wording that for this amendment the reinsurance is already in place or entered at the time of the underlying insurance contracts being issued, not entered into subsequently, as by then the loss on the onerous contracts issued would have already been recognised.

One Board member pointed out that for reinsurance contracts held that on initial recognition are in a net cost position, the entry proposed by the amendment (debit CSM / credit Profit) will increase net cost on day one and will increase future cost from reinsurance.

Some Board members acknowledged an appetite in practice to extend the scope of this amendment, but agreed with the staff to limiting the scope and, especially, not to include the underlying direct contracts or non-proportionate insurance contracts.

One Board member suggested that the amendment should add examples to illustrate the accounting treatment.

Decision

All Board members supported the staff recommendation.

Reinsurance contracts held—underlying insurance contracts with direct participation features (Agenda Paper 2D)

Background

The variable fee approach (VFA) applies to insurance contracts that meet the definition of insurance contracts with direct participation features. For VFA contracts, the CSM is adjusted for more changes in fulfilment cash flows than under the general model. It is adjusted also for the effect of changes in the entity’s share of the underlying items and for financial risks other than those arising from the underlying items, for example the effect of financial guarantees. Some stakeholders are concerned that measuring a reinsurance contract held by applying the general model when the underlying insurance contracts are measured applying the VFA may give rise to mismatches.

Staff analysis

Under IFRS 17:B109, both reinsurance contracts held and reinsurance contracts issued are excluded from the scope of the VFA.

The VFA was developed to give a faithful representation of insurance contracts that are substantially investment-related service contracts. The Board views these contracts as creating an obligation for the entity to pay policyholders an amount equal in value to specified underlying items less a variable fee for the service. Reinsurance contracts that the entity holds can, by definition, not be considered to be investment-related service contracts from the perspective of the entity. The staff think that to apply the VFA to contracts for which it was not developed would not be suitable.

Some stakeholders that have suggested permitting the VFA for reinsurance contracts held, also suggested a related amendment for reinsurance contracts issued. Reinsurance contracts issued cannot be VFA contracts, as it cannot be argued that the compensation to the reinsurer for services provided represents the returns it charges from a pool of underlying items.

Some stakeholders note that the economic effect of some reinsurance arrangements is to transfer both non-financial and financial risk from the entity to the reinsurer. For example, some reinsurance contracts are structured to share the entity’s share of the returns on underlying items between the entity and the reinsurer. However, generally, the underlying items are managed by the insurer and are not transferred to the reinsurer. The staff think that to apply the VFA to contracts for which it was not developed would not be suitable.

The staff therefore do not recommend that the Board amend IFRS 17 to permit an entity to account for reinsurance contracts it holds applying the VFA when the underlying insurance contracts are insurance contracts with direct participation features. The staff recommend to expand the scope of an existing risk mitigation exception in IFRS 17 relating to the accounting for insurance contracts issued to include not only derivatives, but also reinsurance contracts held, as it would not unduly disrupt the implementation underway. The current IFRS 17:B115 exception allows entities not to reflect the mitigation of risks with a derivative in CSM, but to present in profit or loss some or all of the changes in the effect of financial risk on the entity’s share of the underlying items, or the effect of financial risks other than those arising from the underlying items, for example the effect of financial guarantees.

Staff recommendation

To the extent that the entity meets the conditions in IFRS 17:B116, the staff recommend that the Board amend IFRS 17 to expand the scope of the risk mitigation exception for insurance contracts with direct participation features in IFRS 17:B115, so that the exception applies when an entity uses a derivative or a reinsurance contract held to mitigate financial risk.

Discussion

There was not significant discussion on this issue.

Decision

All Board members voted in favour of the staff recommendation.

Recognition of the contractual service margin in profit or loss in the general model (Agenda Paper 2E)

Background

Currently, IFRS 17 allows the recognition of the CSM only over the coverage period based on coverage units, as coverage services are provided. Following the June 2018 Board’s tentative decision to amend the definition of coverage for direct participating contracts to include the provision of both insurance and investment services many stakeholders were concerned with the resulting difference in recognition of CSM under the general model, where some contracts also provide both insurance and investment services, but the definition of coverage excludes provision of investment services. The issue has been previously discussed at the TRG.

At initial recognition, the CSM is determined as an unearned profit based on all the expected cash flows discounted at a current market-consistent rate. Hence it includes the effect of any difference between the expected return on an investment component promised to a policyholder and the market rate for such returns. Some stakeholders pointed out that subsequently recognising the CSM in profit or loss based only on the provision of insurance services is not consistent with that calculation to recognise the CSM in profit or loss over the period that difference arises.

For example, issues arise with insurance contracts where insurance services end significantly earlier than the end of the contract (resulting in no revenue in periods after the end of insurance coverage) and with deferred annuities, where an account balance accumulates before any of the insurance coverage begins, so that the revenue is recognised only when the annuity payments begin.

Staff analysis

The staff focused on the identification of the service related to investment returns for contracts outside the scope of the VFA and consequences of determining coverage units based on such a service. The service is similar to that provided by entities taking deposits and repaying it, often with some return. In the staff view, for insurance contracts without direct participation features the entity is providing a return that reflects the uncertainty of the cash flows to be repaid to the policyholder, just like any financial liability. The staff call this service ‘investment return service’.

In the staff view, the introduction of this investment return service concept provides more useful information but also introduces subjectivity. This relates to:

  • Circumstances in which the investment return service exists
  • Subjectivity in weighting of services
  • Cash flows in the contract boundary
  • Subsequent adjustments to the CSM
  • PAA eligibility

Circumstances in which the investment return service exists

The service exists only when the contract includes investment components. Unless the policyholder is certain to always receive their money back, there cannot be an investment returns related service. The service is not an asset management service, as there is no specified pool of underlying items to manage.

Therefore in a number of situations where the insurance coverage period does not coincide with the overall duration of the contract, there is no investment-related service, as there is no investment component because the repayment does not happen in all situations.

In considering payments to future policyholders, the investment return service is presumed to exist only when the policyholder that paid for the service received the service.  Accordingly, when all the investment components have been repaid to existing policyholders, there is no further investment return service in relation to future policyholders.

Subjectivity in weighting of services

This is similar to subjectivity existing in determining coverage units for VFA contracts.

Cash flows in the contract boundary

Fulfilment cash flows already include the allocation of fixed and variable overheads. For VFA contracts they include asset management cash flows. For general model contracts providing investment returns, service cash flows relating to the fulfilment of that service would also be included.

Subsequent changes to the CSM

While the type of service provided by general model contracts not meeting the scope of the VFA may be similar to that provided by VFA contracts, the nature of the fee is different. It is the nature of the fee that results in CSM unlocking under the VFA for changes in the entity’s share of the underlying items and for financial risks other than those arising from the underlying items, for example the effect of financial guarantees. This does not apply to non-VFA contracts. Accordingly, the staff propose no changes to the unlocking mechanism for the CSM.

PAA eligibility

Including investment return service may increase the number of periods when the CSM exists. In the staff view, this would increase the number of periods when the liability for remaining coverage exists and therefore may affect the determination of whether the measurement of the liability for remaining coverage under the PAA approximates the general model. Also including investment return service may increase the number of periods when the CSM exists making the entity potentially not eligible for the practical expedient for contracts with coverage of one year or less.

Staff recommendations

The staff recommend the Board:

  • Amend IFRS 17 so that in the general model the CSM is allocated on the basis of coverage units that are determined by considering both insurance coverage and any investment return service
  • Amend IFRS 17 to establish that an investment return service exists only when an insurance contract includes an investment component
  • Amend IFRS 17 to require an entity to use judgement applied consistently in deciding whether to include an investment return service when determining coverage units and not provide an objective or criteria for that determination
  • Amend IFRS 17 to establish that the period of investment return services should be regarded as ending when the entity has made all investment component payments to the policyholder of the contract, i.e. not including payments to future policyholders
  • Amend IFRS 17 to require the assessments of the relative weighting of the benefits provided by insurance coverage and investment return services and their pattern of delivery to be made on a systematic and rational basis
  • Confirm that, applying IFRS 17, cash flows relating to fulfilling the investment return service are included in the measurement of the insurance contract
  • Not change the requirements of IFRS 17 relating to which changes in fulfilment cash flows adjust the CSM in the general model
  • Amend IFRS 17 to establish that the one-year eligibility criterion for the PAA should be assessed by considering insurance coverage and an investment return service, if any

Discussion

A majority of Board members acknowledged that action by the Board is required and justified as new information was provided in the TRG discussions. The Board members agreed with the concept of investment return service with one Board member suggesting that the term should be defined in Appendix A of IFRS 17. The term ‘access to an investment return’ as used in the paper should not be used in the definition as it could be interpreted too broadly. One Board member expressed concern that the proposals as drafted in the agenda paper would not be strong enough.

Several Board members said that preparers will have to apply judgement in this area. In some cases it can be difficult to determine whether a service was actually provided. In applying that judgement, one Board member would consider whether it is something the customer would pay for. One member alluded to the concept of performance obligation versus activity required to perform in IFRS 15. The Vice-Chair said that a simple custodian service should not be seen as an investment service. It is important to consider whether the investment return service exists, as it is not optional to account for it.

The Board expressed support for the staff recommendation not to extend the scope to include VFA contracts. Several Board members said that the staff should also consider disclosure requirements when drafting the amendment. The general disclosure requirements of IAS 1 Presentation of Financial Statements might be sufficient. The staff confirmed that they will consider disclosure for all proposed amendments.

Some Board members referred to the materiality of investment services. The Vice-Chair warned that the term ‘material’ could not be used in the amendment as it refers to materiality in the context of financial statements as a whole. It would have to be a different term, like ‘de-minimis’, which is used in IFRS 9 Financial Instruments.

Decision

13 of the 14 Board members supported the staff recommendation.

Related Meeting Notes


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