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U.S. comment letter on insurance contracts

Published on: Oct 25, 2013

An excerpt from the comment letter is shown below:

We support the Board’s objectives of improving, simplifying, and enhancing the financial reporting requirements for insurance contracts and of increasing the comparability and decision-usefulness of information about such contracts. We believe that the Board’s proposal, with certain modifications, would help advance these objectives.

We agree that the application of insurance accounting should be based on the characteristics of an entity’s contracts or portfolio of contracts, not on the entity’s industry. We also understand the Board’s rationale for granting the scope exceptions indicated in the proposed ASU; however, we believe that the Board should further amend and clarify the exceptions for warranties, financial guarantee contracts, and certain fixed-fee contracts.

Further, we agree that the building block approach (BBA) and the premium allocation approach (PAA) should be viewed as two distinct accounting models. We share the Board’s view that the BBA should incorporate a single margin; however, we believe that the final ASU should require an entity to unlock the margin each reporting period to reflect its revised assumptions about the ultimate expected profitability of an insurance contract portfolio. We do not believe that entities should be compelled to recognize the effects of changes in expected cash flows attributable to changes in the discount rate in other comprehensive income (OCI). Such changes should be recognized in OCI unless an entity makes an irrevocable election to recognize them in net income. An entity should be able to apply this election at the level of disaggregation it deems necessary to eliminate accounting mismatches; it should not be forced to make an entity-wide accounting policy election. We also continue to support giving entities an unrestricted, fair value option for their financial assets. A fair value option may be necessary to avoid accounting measurement mismatches when such assets are managed with insurance liabilities.

In addition, we generally agree with the mechanics of the PAA; however, we believe that revenue for a portfolio of contracts accounted for under the PAA should not be recognized fully over the coverage period when the liability for incurred claims is measured without any provision for risk during the settlement period. In such circumstances, an entity should either (1) recognize revenue over both the coverage and claim-settlement periods (unless the entity qualifies for and elects to use a practical expedient) or (2) apply a risk adjustment to the liability for incurred claims. Further, we agree that an entity should account for the time value of money when its effects are significant.

We remain proponents of convergence because we believe it benefits investors. We also fear that significantly divergent models under U.S. GAAP and IFRSs could lead to higher adoption costs for multinational entities (both those domiciled in the United States with foreign subsidiaries and those domiciled overseas with U.S. subsidiaries), could create accounting arbitrage opportunities, and may ultimately require the FASB and IASB to revisit the insurance contracts project at a later date to address matters on which divergence is likely to cause practice issues. We acknowledge, however, that the needs of the IASB’s constituents in this project differ from those of the FASB’s. Unlike existing U.S. GAAP, IFRSs do not have comprehensive guidance on accounting for insurance contracts. We also understand that some of the FASB’s constituents believe that there is no need for comprehensive reconsideration of the guidance under U.S. GAAP on insurance contracts. In light of these challenges, we accept that that the boards may be unable to agree on a completely converged accounting model. Accordingly, we encourage the FASB to continue to work with the IASB to converge as many aspects of the insurance accounting model as possible as long as the FASB concludes that such convergence would improve U.S. GAAP or otherwise meet the needs of financial statement users.

We believe that the final ASU should contain implementation guidance that more clearly demonstrates how the ASU’s principles will apply to specific contract types and circumstances. In particular, the final ASU’s illustrations should more clearly describe the basis or rationale for the Board’s conclusions. In the appendix below, we identify, in certain of our responses to the proposal’s questions, specific aspects of the proposed ASU that we believe would benefit from enhanced implementation guidance.

The Board also should be mindful that as a result of its conclusions in other standard-setting projects (e.g., its projects on accounting for financial instruments), it may need to revisit the guidance on accounting for insurance contracts. Ideally, the Board would align the effective dates of these projects so that entities could avoid incurring incremental adoption costs as a result of modifying investment strategies and financial reporting systems to comply with new standards. At a minimum, the Board should give entities that adopt the insurance contracts standard “one-time” opportunities to reclassify their investment portfolios or to modify hedging strategies to align their risk management practices with the accounting requirements of new ASUs.

We highly recommend that the Board conduct field testing before finalizing an ASU on insurance contracts. The final ASU’s effective date also should allow ample time for implementation and transition. We understand that some entities question whether they could accumulate all of the information they would need to comply with the proposed requirements in time to meet quarterly reporting deadlines. A sufficient implementation period will give preparers and auditors time to identify, and the Board time to address, any remaining practicability issues that may affect adoption and to clarify aspects of the ASU that may otherwise lead to diversity in practice. The transition period should also be long enough for entities to (1) establish or modify their information technology and financial reporting systems, (2) establish adequate internal controls over those systems, and (3) compute the appropriate transition adjustments. Further, regulators such as the SEC may need time to amend their rules to reflect the new accounting requirements, and stakeholders such as preparers, investors, analysts, and auditors will need time to train their personnel. The Board also should perform outreach with noninsurance entities to determine whether those entities will require additional time to adopt the final ASU.

We also strongly encourage the Board to establish an implementation group to identify, well before the final ASU’s effective date, those issues requiring interpretation to help ensure consistent application of the ASU. We hope that much of the guidance in the final standards will be converged; therefore, the FASB should coordinate its efforts with the IASB to resolve any future interpretive issues.

Full text of the comment letter is available below.


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