Interest and discount rates
Staff first asked the Board whether they agreed with the recommendation in agenda paper 7G, paragraph 5 that the Board should not develop guidance in this project on the following topics:
- how to determine a discount rate for maturities beyond the term of instruments traded in observable markets; and
- how to develop interest rates for currencies in which there is little or no market in risk-free instruments.
The Board agreed with the staff recommendation.
The Board then discussed what measurement attribute should be used for insurance liabilities. Staff proposed that:
- a. The measurement attribute for insurance liabilities should be current exit value. Current exit value should be defined as the amount that the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity (and excluding any payment receivable or payable for other rights and obligations).
- b. An insurer should not be prohibited from recognising a net gain (net after acquisition costs) or net loss at the inception of an insurance contract. However, if an insurer identifies an apparently significant gain or loss at inception, it would need to check carefully for errors or omissions.
- c. The Board might conclude in the fair value measurement project that current exit value is synonymous with fair value. However, it would be premature to reach a conclusion on that point now in the project on insurance contracts, because the project on fair value measurement is still at an early stage. The staff recommends that the Board should, for the time being, define the measurement attribute for insurance contracts as current exit value. As work proceeds on the fair value measurement project, the staff will assess periodically whether it is appropriate to recommend merging the two concepts for the project on insurance contracts.
The Board were asked to vote on the above recommendation. 7 Board members voted in favour of the recommendation, 6 voted against, and 1 abstained. Generally, the Board members who did not vote in favour of the recommendations were concerned about the following issues:
- They preferred the alternative current value approach set out in the paper, whereby the margin is calibrated at inception to the actual premium charged. Under this approach, the margin reflects changes over time in the insurer's estimate of the amount of risk, but freezes the per-unit price of risk at inception. Further more, this approach would prohibit the recognition of any net gain at inception. Several Boar members were amenable to considering variations on this approach (for example where the per-unit price of risk is not frozen at inception).
- There were concerned about recognising a net gain at inception.
- There were concerns about how this approach tied into the revenue recognition project, and whether it was consistent with the proposals in that project.
- There was concern over how practical the approach recommended by staff was. It was possibly too idealistic, with too much emphasis on obtaining market prices where none exist.
Units of account
The Board discussed the level of aggregation of insurance contracts for measurement purposes. The Board generally agreed with the staff proposals on the level of aggregation - that a portfolio of contracts should contain contracts with similar risk characteristics. However there was some discussion over how much diversity can exist with a portfolio of similar contracts.
The Board was asked to consider whether a measurement model should unbundled the individual elements of an insurance contract and measure them individually. Staff proposed that unbundling deposit and service components for the purpose of recognition and measurement is likely to require arbitrary allocation and complex systems, and is unlikely to result in more representationally faithful financial statements. Unbundling should not be required.
There was some agreement with the staff proposal, but several Board members were concerned that the proposal meant entities had a free choice over whether to unbundled or not. There was also concern with how this tied into revenue recognition in other types of contract, where unbundling would be required in certain circumstances. Staff will consider whether there are circumstances in which unbundling should be prohibited.
Staff asked the Board to consider the issue of separate accounts. Certain contracts link the benefit amount to the fair value of a designated pool of assets operated in a way similar to a mutual fund. That is, the contract holder bears the risks and rewards of the account's investment performance and the issuer derives only fee income as an asset manager. Some life insurers sell contracts that combine such elements with other elements, such as life insurance cover or guarantees of minimum investment performance. Staff proposed that an insurer should recognise separate account assets, and the related obligation to pay policyholder benefits, unless the insurer has a contractual obligation to pay all cash flows from the separate account assets to the separate account policyholders. that is, unless:
- a. The insurer has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the separate account assets. This condition is not breached if the insurer provides such benefits as guarantees of investment performance or guaranteed minimum death benefits, but the insurer would need to recognise its stand-ready obligation to provide those benefits, and measure that obligation at current exit value (if the guarantee meets the definition of an insurance contract) or fair value (if the guarantee is a financial instrument).
- b. Contract, law, or regulation prohibit the entity from selling, pledging, or lending the separate account assets except for the benefit of the separate account policyholders.
- c. The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows outside the separate account, except for investments in cash or cash equivalents during the short settlement period from the collection date to the date of required remittance to the separate account, and interest earned on such investments is passed to the separate account.
- d. The insurer has substantially none of the risks and rewards of ownership of the separate account assets (other than the right to collect fees for providing investment management services).
It was noted that these are broadly the 'pass-through' criteria in IAS 39, but are being used as recognition, rather than derecognition, criteria. There was some concern about whether this was in conflict with the general recognition criteria in the Framework. Also, there was some inconsistency between criteria 'a' and 'd'. Possible solutions to this inconsistency included deleting 'd' or being consistent in the two paragraphs in the treatment of guarantees. This issue will be revisited by staff.
In its February meeting, the Board decided that when an insurer recognises rights and obligations arising under an insurance contract, it should also recognise the portion of the customer relationship that relates to future payments that the policyholder must make to retain a right to guaranteed insurability. Staff propose that the (recognised portion of) the customer relationship should be presented as part of the liability. The Board agreed with the staff proposal, with several Board members commenting that the two should not be presented separately as they are inextricably linked.
Staff will investigate how best to provide useful disclosure about the extent to which the overall liability 'package' incorporates cash flows that are enforceable.
The Board has previously concluded that the measurement of insurance liabilities should incorporate a margin. The Board's previous discussions have focused on margins designed to convey decision-useful information to users about the uncertainty associated with future cash flows (risk margins).
At this meeting, the Board concluded that the measurement attribute for insurance liabilities should be current exit value and that the measurement of insurance liabilities should, in addition to a risk margin, also incorporate a margin that represents an unbiased estimate of the compensation that market participants would demand for providing services (a profit margin), other than the service of bearing risk (the risk margin covers the service of bearing risk). The Board also noted that in practice, it will be difficult to separate these components.
Unit-linked and index-linked payments
The Board started a discussion about the measurement of policyholder payments that are denominated in terms of an internal or external investment fund or an index. However, due to time constraints, it was agreed to continue this discussion at the next Board meeting.