Background

In previous meetings, the topic of whether accounting for financial guarantee contracts should be in accordance with IAS 39 or IFRS 4 has been discussed at length, with different possible approaches considered. However, the costs and benefits of this project, had in the past, led to a proposal to drop the project. However, the project was re-discussed by the Board.

The approach considered was to apply IFRS 4 if certain 'insurance' characteristics are significant, otherwise default to IAS 39.

The insurance characteristics are those that are commonly found in credit insurance contracts, but less commonly found in financial guarantees issued by banks; and those that generate accounting issues that are difficult to resolve in the short term (eg regular premiums, subrogation rights, significant origination costs, participation features).

The proposed features are as follows:

• Relatively significant direct acquisition costs.
• The overall final premium for the contract can be determined only at the end of the contract period because the contract contains:
  • profit sharing features or premium adjustments based on experience.
  • discretionary participation features (as defined in IFRS 4).
  • a method for determining the premium that depends on the total sales for the period.
• The premium is paid in instalments over the term of the contract rather than at inception.
• Payments to the counterparty are reduced by deductibles.
• Reinsurance contracts may be available to mitigate risk.

Whilst several Board members still believed the project should be dropped, the following reasons to keep the project were raised:

• It deals more with accounting issues (than contract details), which is useful.
• It gives guidance to non-insurance companies on how to account for guarantees.
• If dropped, entities will revert to the guidance given by the local regulators, which vary all over the world.

• More rigorous criteria (the current insurance characteristics noted above are too open). Wording to be amended to try and push banks into applying IAS 39, and insurance companies towards IFRS 4.
• Disclosures in the respective standards to be followed. (The original proposal was to have a catch all disclosure regardless of which standard was applied).

The possible exemption for inter-company guarantees is to be re-discussed at the next meeting.