Insurance Contracts – Phase II

Date recorded:

The discussions were based on agenda papers 10A - 10J.

Contractual cash flows that depend on policyholder behaviour (agenda papers 10A - C)

This discussion centred round an extremely simple example developed by staff of a two-year life insurance policy (see paragraphs 3-5 of the paper). The paper considered four possible presentations of the insurer's balance sheet. The Board agreed in principle with the second approach, whereby all future cash flows resulting from future cash flows from the contract were recognised. It was agreed that the right to benefit under the insurance contract represents an asset to the insurer, and that the asset meets the definition of an intangible asset in IAS 38. The intangible asset would be recognised subject to meeting various recognition criteria. It was generally agreed that the intangible asset was a customer relationship that arises out of a contract. This paper did not address how the asset and liability would be presented in the balance sheet (e.g. gross or net).

Summary of possible accounting approaches (agenda papers 10D - E)

Agenda papers D and E summarised the possible accounting approaches the Board is considering for insurance contracts. The papers were background information for other papers, and the Board was not asked to make any decisions on these papers.

Acquisition costs (agenda paper F)

[There is a small typo in the title immediately preceding paragraph 9 in the agenda paper - the title should read 'Acquisition costs and current exit value']

Again, the discussion centred round an example developed by staff. In the example, an insurance contract generates policyholder benefits with a present value of CU 900. The insurer has to incur costs of CU 100 to originate the contract, so will charge the policyholder at least CU 1,000. The contract has a single premium of CU 1,000 which is received at inception. The present value of the insurer's obligation is CU 900 (not CU 1,000). This is true in both the prospective and unearned premium approaches.

The Board agreed that in this example the insurer's liability is CU 900. They also agreed that acquisition costs should not be capitalised. They are only relevant in that they may be considered by the insurer in setting premiums. Furthermore, if these costs were separately capitalised, this would lead to problems of how to measure the costs subsequent to initial recognition.

The paper explored whether there is merit in separately presenting some other contractual rights or obligations, but the Board was not asked to make any decisions. The paper then considered which costs are acquisition costs. No decisions were made, but there was support for the costs encompassing more than just incremental costs. This is because the pricing of the contracts is a function of the costs incurred by the insurer, who will want to recover more than just incremental costs.

Liability adequacy test (agenda paper G)

Paragraph 10 of the paper summarised when staff determined that a liability adequacy test would be needed. The Board agreed with the conclusions except that many Board members felt that a test would be needed for subsequent measurement of both life liabilities and non-life pre-claims when a current entry value was used as a measurement basis.

Paragraphs 12-21 dealt with risk margins. In the example given in paragraph 14, the Board agreed that the liability determined using an adequacy test should be greater than CU105, although not necessarily CU 113 (as in paragraph 14c)). The measurement should be based on exit-value assumptions. As this represented a substantial change to the proposed model, staff will reconsider this example and re-present it at a later meeting.

Shortfall allocations were not discussed, but the Board did agree with the staff recommendations on subsequent accounting after a shortfall. Broadly, these were that if an insurer uses a current entry value approach for pre-claims liabilities, the liabilities also reflect the time value of money and risk margins. Thus interest should be added over time to the shortfall and the insurer should recognise income as it is released from the risk reflected in the margin in the shortfall. In an unearned premium approach, interest should not be accrued on a shortfall, to be consistent with the fact that interest is not accrued on unearned premium. However, because interest is not added, an additional shortfall may arise when the liability adequacy test is applied again. The Board also agreed that a shortfall should be reversed if it no longer exists.

Gain on initial recognition of insurance contracts (agenda paper H)

No decisions were made by the Board, although it was agreed that further work should be done to explore the consequences of not prohibiting the recognition of net profit on initial recognition. Further, analogies were drawn to IAS 39 and the recognition of day 1 profit. It was generally felt that there should be a principle that is applied consistently across all types of contract.

Non-life insurance contracts - Measurement attribute for pre-claims (agenda paper 10I)

The Board agreed with the staff recommendation that a prospective approach be taken for measuring non-life insurance pre-claims. Staff also proposed that, without creating a specific exception to the prospective approach, for short duration contracts unearned premium may often be a reasonable approximation to a prospective measurement. However, an insurer should not make this assumption without testing. This was discussed by the Board, with some Board members concerned that this would offer no relief to insurers, as in order to determine whether they could use an unearned premium approach, they would also have to measure using the prospective approach. Staff indicated that this was not the intention of the paragraph, and that they would reconsider the wording and bring it back to a later meeting.

The Board agreed that non-life claims liabilities should be discounted using a current discount rate.

Project planning (agenda paper 10J)

This paper was not discussed at length. Staff clarified that under the proposed timetable the Board could expect to see a first pre-ballot draft of a discussion paper in July 2006.

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