Insurance Contracts Phase I

Date recorded:

Assets backing insurance liabilities

The staff noted that the Board had requested the staff to research why insurers cannot classify a higher proportion of their fixed-maturity investments as held-to-maturity. The staff reported that there appeared to be two main reasons:

  • If the asset liability management (ALM) involves duration matching, the portfolio needs to be rebalanced periodically to remain within the ALM targets. This would involve, for example, selling bonds that have deteriorated beyond the level the insurer has undertaken or is required to maintain.
  • For a life insurer, lapses could change at any duration. Thus, the insurer needs to keep an adequate buffer as available for sale at each duration. For example, for a twenty-year liability, a 2.5%buffer for each year would add up to 50%.

In addition the staff noted the Board had requested research into three potential approaches, these being:

  • (a) Relax the criteria for classifying a fixed-maturity asset as held-to-maturity and the related 'tainting provisions' in IAS 39. The tainting provisions are a way of ensuring that an entity classifies a financial asset as held-to-maturity only if the entity has a positive intent and ability to hold the asset to maturity.
  • (b) Create a new category of fixed-maturity assets that could be reported at amortised cost - Assets Held to Back Insurance Liabilities.
  • (c) Adjust the measurement of interest-sensitive insurance liabilities to reflect changes in interest rates that also have a corresponding effect on the fair value of fixed-maturity financial assets that are designated as backing those liabilities (and are carried at fair value and meet various restrictions to be determined).

The staff recommended the Board reject approach a and b above and continue discussions with insurers to assess whether approach c can be made workable.

It was noted that certain Board members believed there was no evidence insurers were matching insurance liabilities with assets at the level discussed and consequently no mismatch problem existed for which a solution was necessary.

The Board indicated a preference for a liability-based solution rather than an asset based solution (10-4).

The staff noted they would be meeting with representatives of certain insurance entities to pursue any potential solution taking the Board's guidelines into account.

Shadow accounting

The staff noted that the rationale for shadow accounting is that a recognised but unrealised gain or loss on an investment asset should have the same effect on the measurement of insurance assets (deferred acquisition costs) and liabilities that would have occurred had the gain or loss been realised. Stated differently, it is designed to record the knock-on balance-sheet effects of recognising unrealised gain or loss.

The staff recommended that the Board confirm explicitly that an insurer may (but is not required to) change its accounting policies so that a recognised but unrealised gain or loss on an asset affects the measurement of related insurance liabilities (and deferred acquisition costs) in the same way that a realised gain or loss does. If the unrealised gains or losses are recognised directly in equity, the related adjustment to the insurance liability or deferred acquisition costs should also be recognised in equity.

The staff further recommended that the Basis for Conclusions clarifies that shadow accounting is not the same thing as fair value hedge accounting and will not usually have the same effect.

The Board agreed with the staff's recommendations.

Temporary exemption from the hierarchy

The staff noted that the Board had previously requested clarification as to why ED 5 and the draft Exposure Draft on Exploration for and Evaluation of Mineral Resources take different approaches to the hierarchy.

The Board did not discuss this in detail but agreed with the staff recommendation that the Board should:

  • Maintain the temporary exemption from paragraphs 5 and 6 of IAS 8.
  • Delete the 'sunset clause', so that the exemption would not expire in 2007.

Changes in accounting policies

The staff noted that the exposure draft proposed that accounting policies for insurance contracts may be changed subject to certain conditions and subject to certain limitations on unacceptable policies.

The staff recommended that the absolute prohibition on introducing measurements that reflect future investment margins be replaced with a rebuttable presumption. The staff noted that the main purpose of this is to avoid blocking a switch to comprehensive methods of accounting for insurance contracts that involve asset-based discount rates.

The staff further recommended that changes in accounting policy for insurance contracts should be permitted if they make the financial statements more relevant and reliable, as proposed in ED 5.

The staff noted that it would follow from these recommendations that insurers would be able to introduce embedded value measurements, but only if:

  • They show that this results in more relevant and reliable information. This is not an automatic decision and will depend on a comparison of the insurer 's existing accounting with the way in which it intends to apply embedded value.
  • This increase in relevance and reliability is sufficient to outweigh the rebuttable presumption against including future investment margins.
  • The embedded value includes contractual rights to future investment management fees at an amount that does not exceed their fair value as implied by a comparison with current fees charged by other market participants for similar services.

The Board agreed with the staff's recommendations.


The staff recommended that there should be no change to the proposal in ED 5 that discounting should not be required in phase I, but an insurer should continue discounting of insurance liabilities that it already discounts.

The Board agreed.

Excessive prudence

The staff recommended that phase I should not try to define or eliminate excessive prudence.

The Board agreed.

Redesignation of financial assets

The staff recommended retaining the approach in ED 5, in particular to not restrict the redesignation to assets backing the insurance contracts for which the accounting policies were changed.

Certain Board members noted that this could be affected by any potential solution to the mismatch problem. Other than in this area, which was left pending, the Board agreed with the staff's recommendations.


The staff proposed clarifying in the implementation guidance and scope that:

  • Premiums paid by an employer on behalf of the employee where the employer issues the contract are employee benefits.
  • Policy holders of insurance contracts are not included.

The Board agreed.

The staff noted that commentators queried whether entities that provide services and/or parts whenever a breakdown occurs falls within the insurance contract scope. The Board believed they did but because Phase 1 does not require current practice to be changed this would be addressed in Phase 2.

Weather derivatives

The staff recommended no substantive changes in this area. The Board agreed.

Definition of an insurance contract

The staff recommended retaining the definition. The Board agreed.

Insurable interest

The staff recommended no changes in this area. The Board agreed.

Pure endowment

The staff recommended that there be no change in principle in this area but that it be reworded. The Board agreed.

Significance of insurance risk

The staff recommended that there be no change in principle in this area but that it be reworded to refer only to significant, insignificant and commercial substance. In addition the staff proposed adding further clarification in the areas of the basis for the significance test and surrender charges.

The Board agreed.

Embedded derivatives

The staff recommended the following changes:

  • (a) Changes to IG Examples 2.4, 2.6(a) and 2.11, which identify embedded derivatives that are interdependent with the host insurance contract; this interdependence suggests that they are closely related to the host contract.
  • (b) An explicit new exemption from the requirement to separate, and measure at fair value, options to surrender a contract with a discretionary participation feature.
  • (c) Permit unit-denominated payments to be measured at current unit values, for both insurance contracts and investment contracts, thus avoiding the apparent need to separate an 'embedded derivative'.

Concern was expressed as to the changes in a above. The staff were requested to consider this further.

Further concern was expressed that the loss recognition test does not require an entity to consider cash flows from all guarantees and options. The staff were requested to consider this further.

The Board agreed with recommendations b and c above.

Unbundling of deposit components

The staff recommended that:

  • Unbundling should be permitted if the deposit component (including any embedded surrender options) can be measured without considering the insurance component.
  • Unbundling should be required if some rights and obligations under the deposit component would otherwise remain unrecognised.

To implement these recommendations, the staff recommended that paragraphs 7 and 8 be reworded as follows:

7. Some insurance contracts contain both an insurance component and a deposit component (a component that would, if it were a separate instrument, be within the scope of IAS 39). An insurer may unbundle those components (ie account for those components separately) if it can measure the deposit component (including any embedded surrender options) independently without considering the insurance component. Furthermore, if the insurer can measure the deposit component independently, unbundling is required if the insurer 's accounting policies do not otherwise require it to recognise obligations or rights arising under the deposit component. If all obligations or rights under the deposit component are recognised, unbundling is not required, regardless of the basis used to measure those rights and obligations.

7A. The following is an example of a case when an insurer 's accounting policies do not require it to recognise all obligations under a deposit component. An insurer receives a payment from a reinsurer to compensate it for losses, but the terms of the contract mean that the insurer is compelled to make additional payments in future years as a direct result of the receipt from the reinsurer. The obligation to make those additional payments arises under a deposit component. If the insurer 's accounting policies do not capture that obligation, unbundling is required.

7B To unbundle a contract, an insurer shall:

(a) treat the insurance component as an insurance contract.

(b) treat the deposit component as a financial liability or financial asset under IAS 39.

8. Many traditional contracts provide surrender or maturity benefits that could be regarded as deposit components. Nevertheless, paragraph 7 does not require an insurer to unbundle those benefits if the insurer recognises its obligations to pay those benefits.

The Board agreed.

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