Insurance Contracts Phase II

Date recorded:

Policyholder participation rights

Some insurance contracts give the policyholder both guaranteed benefits (these are benefits to which a particular policyholder has an unconditional right that is not subject to the discretion of the insurer, for instance, a death benefit) and a right to participate in favourable contract performance, but the insurer has constrained discretion over the amount and/or timing of distributions to policyholders. Similar policyholder participation rights are also found in some investment contracts (financial instruments) sold by insurers. The Board discussed whether an insurer should classify policyholder participation rights:

  • (a) entirely as a liability, or
  • (b) entirely or in part as an equity component of a compound contract that also contains a liability component. The liability component is the obligation to provide guaranteed benefits.

To aid the discussion, the Board considered various examples. In some scenarios the Board indicated its leaning but in other scenarios the staff were asked to explore, in more detail, how the contracts work in practice.

Separate from the individual examples discussed, the Board was asked to consider available accounting models and indicate its preference. The options discussed were:

  • (a) policyholder participation rights do not create an obligation until a particular policyholder has an unconditional right to a distribution arising from that right.
  • (b) if the policyholder participation right does not create an obligation, that suggests that a participating policyholder is buying a compound instrument with two components: a liability (the stand-ready obligation to pay the guaranteed benefits) and an equity component (the participation right).

The Board suggested a third alternative which received majority support. Under that model, there would be no split accounting, as this was viewed as onerous and conceptually flawed because it is questionable whether simply because the liability definition has not been met, the default classification is equity - the Framework states that if the liability definition is not met, recognise income. Under this alternative, when dividends are declared, the participation therein would be expensed in the income statement. The Board did not favour an allocation of net income between shareholders and participating policyholders (similar to the allocation required by equity holders of the parent and minority interests required for consolidated financial statements).

Investment contracts

For policyholder participation rights in investment contracts, the Board agreed with the staff recommendation to account for them in the same way as for participation rights in insurance contracts.

[The following portion of the discussion was held on Friday 31 March 2006]

Estimating cash flows

The Board discussed an 'early version' of material that could be included in the forthcoming Discussion Paper. [This session was very difficult to follow.] There was a long debate around the following principle and its application. The Board tentatively agreed that:

In estimating the current [entry/exit] value of insurance liabilities, an insurer should develop estimates of cash flows that:

  • (a) are explicit;
  • (b) incorporate, in an unbiased way, all available information about the amount, timing and uncertainty of all cash flows arising from the liabilities;
  • (c) are as consistent as possible with observable market prices; and
  • (d) correspond to conditions at the end of the reporting period.


Risk margins

The Board agreed that:

  • the objective of a risk margin is not to provide a shock absorber for the unexpected, nor is it to enhance the insurer's solvency. Instead, the objective is to convey decision-useful information to users about the uncertainty associated with future cash flows. A risk margin will satisfy that objective best if it is consistent with an unbiased estimate of the compensation that market participants would demand for bearing the risk in question; and
  • the Board should not prescribe specific techniques for developing risk margins. Instead, the Board should explain in the Discussion Paper (and ultimately in an IFRS) the attributes of techniques that will enable risk margins to convey useful information to users about the uncertainty associated with risk margins.


Embedded derivatives

The Board discussed the treatment of embedded derivatives (including embedded options and guarantees) included in a host insurance contract that is measured at current entry value. This was a preliminary discussion and the Board was not asked for a view.

Discount rates

The Board agreed that the objective of the discount rate is to adjust estimated future cash flows for the time value of money. The discount rate should be consistent with observable market prices for cash flows whose characteristics match those of the insurance liability in terms of timing, currency and liquidity. The observed discount rate should be adjusted to exclude any factors that influence the observed rate but are not relevant to the liability (for example, risks that are not present in the liability but are present in the instrument used as a benchmark). The Board agreed that, at this stage, it would not provide further guidance on how to achieve that objective.

Recognition and derecognition

The Board agreed that the conclusions in IFRS 4 Insurance Contracts with respect to the derecognition of an insurance liability are still valid.

Project plan

The Board received the latest project plan for the project. The current expected publication date for the Discussion Paper is December 2006.

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