Insurance Contracts

Date recorded:

The aim of this session was purely to walk through some different examples and review the accounting implications of various models used. The 25 January meeting will run through the draft Statement of Principles continuing the insurance discussion. The examples reviewed were artificial and unofficial. They are based on unrealistic assumptions that are necessary to focus on the impact of the choice of the accounting treatments.

  • Example 1 was a year by year method, which is purely a cash accounting method. This is not popular with accountants due to this resulting in an up front profit and then losses being recognised later in the contracts life.
  • Example 2 was a year by year method with an onerous contract, provided for under IAS 37. This has the effect of smoothing out profits over the life of the contract but year 1 is still loss making with a large profit in year 2 (again in the early years of the contract).
  • Example 3 is a pure prospective method, which is a US GAAP method. This method has no risk adjustment, and the majority of the profit is recognised in year 1. Income after year 1 is the investment earnings only. It gives an odd provision on the balance sheet that is actually a very large debit balance that reverses over time.
  • Example 4 is the approach proposed by the Steering Committee. It is a prospective method with market consistent risk adjustment. It gives a profit in year 1 but this profit is small and is fairly consistent over the life of the contract.
  • Example 5 was an embedded value method, which is very popular with UK analysts. It spreads profit evenly over the contract with a similar pattern as the pure prospective method. The cash flows are discounted with risk, but the discount is at the embedded asset rate. There is an embedded value asset on the balance sheet that gives a notional value of cash flow adjusted for risk that the regulator requires the company to use. The liability on the balance sheet is the number that the regulator wants (which is required by the legal structure in some countries).

Example 4 seemed to be accepted by the Board, with further discussion planned at Friday's meeting.

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