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IASB reexposes proposals for insurance contracts

  • IASB (International Accounting Standards Board) Image

Jun 20, 2013

The IASB has issued a revised exposure draft (ED) on insurance contracts. The ED does not contain a proposed effective date since the IASB will decide on the effective date only upon completion of its redeliberations. The expectation is currently that the standard will become effective approximately three years after being published in its finalized form. The revised ED seeks constituent comment on five key areas. Comments on the ED close on October 25, 2013.

 

Background

The IASB originally issued Exposure Draft ED/2010/8 on July 30, 2010, in an effort to create a single standard that could apply to all insurance contract types on a consistent basis, addressing recognition, measurement, presentation, and disclosure requirements for insurance contracts.

The objective of the original as well as the revised ED is establishing the principles that insurers should apply to report the nature, amount, timing, and uncertainty of cash flows from insurance contracts. The scope of both EDs extended to all insurance contracts that an insurer issues and all reinsurance contracts that it holds as well as to investment contracts with a discretionary participation features that an insurer issues. However, the revised ED also contains list of contracts to which it does not apply.

According to the ED, a building blocks approach is used for measuring insurance contracts. Insurance contract liabilities are determined as the sum of a probability-weighted estimate of cash flows plus risk adjustment liability that measures the uncertainty in the amount and timing of the cash flows plus a contractual service margin liability that represents unearned profit in a contract.

 

Specific areas for comment

On the basis of the feedback received on ED/2010/8, the IASB and FASB have redeliberated the proposals and developed a revised exposure draft focussing on five key aspects of insurance contract accounting:

  1. Adjusting the unearned profit from insurance contracts.
  2. Accounting for contracts that specify a link to the returns on underlying items that the entity is required to hold.
  3. Presentation of insurance contract revenue and expenses.
  4. Presentation of interest expense between profit or loss and the other comprehensive income.
  5. Full retrospective approach to transition.

I. Adjusting the unearned profit from insurance contracts 

At initial recognition, the contractual service margin is calculated at an amount equal and opposite to the sum of: (1) the amount of the fulfilment cash flows for the insurance contract at initial recognition and (2) any cash flows that are paid (received) before the insurance contract is initially recognized.

Subsequently, the contractual service margin will be released to profit or loss over the coverage period as the insurer fulfils its obligations. The contractual service margin will also be adjusted prospectively for changes in future expected cash flows relating to future coverage. No limit has been imposed on the amount by which the contractual service margin can increase as a results of these changes. However, if the changes are so adverse that would cause the contractual service margin to become negative, the contract becomes onerous. In this case, any changes in the excess of the carrying amount of the contractual service margin at the date of change should be recognized immediately in profit or loss.

The insurer is not permitted to adjust the contractual service margin for changes in estimates of incurred claims, that is, if coverage has already expired and for changes in risk adjustment.

II. Accounting for contracts that specify a link to the returns on underlying items that the entity is required to hold

For participating contracts in which the contractual cash flows are linked to the returns of an underlying pool of assets, the insurer is required to measure and present those cash flows in the same way the assets backing those liability are measured and presented.

There are three possible cash flow behaviors in participating contracts and related accounting treatments:

  1. When the contractual cash flows vary directly with the underlying items.
    •  Measure and present these cash flows by reference to the assets’ carrying amount.
    •  No adjustment made to contractual service margin.
  2. When the contractual cash flows vary indirectly with the underlying items.
    •  Measure these cash flows using the general building blocks model, discounted at a current discount rate.
    •  Adjustment to contractual service margin will be made prospectively.
    •  Interest-related changes are always recognized in the profit or loss.
  3. When the contractual cash flows do not vary with the underlying items
    •  Measure these cash flows using the general building blocks model as required by the draft standard.

In all three cash flow behavior scenarios, the insurer is required to recognize changes in the risk adjustment liability in profit or loss.

III. Presentation of insurance contract revenue and expenses

The insurer is required to recognize revenue to each period in proportion to the reduction in liability over the remaining coverage period.

To get to the new revenue amount, an insurer needs to split cash outflows into those relating to future coverage from those associated with past claims yet to be settled. The amounts of cash outflows associated with the coverage that are expected in a particular period are added to the margin amounts described above to get the insurance revenue amount. The actual cash outflows, for example, actual benefits and expenses, are reported as insurance expenses.

These revenue and expense amounts need to have one final adjustment. If they include cash flows that would have been paid to policyholders in any event, such amounts must be disaggregated from the insurance revenue and expense lines because they represent deposit components.

IV. Presentation of interest expense between profit or loss and the other comprehensive income

The insurer is required to split the insurance contract interest expense into two components: the component that is based on historical discount rates that were market consistent when the contract was sold will be recognized in profit or loss while the interest expense derived from current interest rates will be presented in the other comprehensive income (OCI).

For participating contracts, the presentation determined under the mirroring approach will always take precedence over the OCI solution.

V. Full retrospective approach to transition  

Insurers are required to apply the requirements of the proposed standard as if they have always been effective.

The revised ED has provided some practical expedience and simplifications:

  • When a full restatement of the contractual service margin is impracticable, the insurer is allowed to estimate the contractual service margin using all the objective information that is reasonably available. In addition, insurers are required to make use of hindsight and are not required to identify all changes in estimates of cash flows that occurred between initial recognition and transition date.
  • As a starting point, insurers are required to determine the locked-in discount rates retrospectively on the basis of adjusting a market-observable interest rate yield curve for at least the past three years. If there is no market-observable yield, the discount rates can be determined using the closest market-observable yield curve. The same market-observable reference point must be used to determine the locked-in discount yield-curve for each of the years in the retrospective period.
  • The revised ED also requires reduced disclosure requirements. Insurers are not required to disclose previously unpublished information about claims development information that occurred five years before the end of the first financial year in which the standard is applied, which would normally be required for 10 years. Also, insurers are not required to disclose the amount of the adjustment for each financial statement line items that is affected, as required by IAS 8.

The revised ED also provides for the redesignation of financial assets at transition. At the beginning of the earliest period presented, an insurer is permitted but not required to redesignate financial assets to be measured at FVTPL if to do so would eliminate or significantly reduce an accounting mismatch. An insurer is required to revoke previous designations at FVTPL if the accounting mismatch that led to the previous designation is now eliminated.

 

Effective date

The ED does not contain a proposed effective date because the IASB will decide on the effective date only upon completion of its redeliberations. The expectation is currently that the standard will become effective approximately three years after being published in its finalized form.

 

Comment deadline

Comments on the five specific areas close on October 25, 2013.

 

Additional information

Note: On July 23, 2013, the IASB released an error note (link to the IASB's Web site) that included a number of corrections to ED/2013/7. The PDF versions of the ED have been updated on the IASB's Web site, but printed versions of the exposure draft have not been updated.

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