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Insurance Contracts – Phase II

Date recorded:

The IASB continued its discussion of various aspects of accounting for insurance contracts, the output of which will be a Preliminary Views discussion document (the PV document). This meeting discussed the following topics, some of which were carried forward from the April 2006 meeting:

  • Universal life contracts
  • Unit-linked and index-linked payments (the Board had a brief discussion of this paper in April 2006, but did not complete its deliberations)
  • Credit characteristics of insurance liabilities
  • Overview of relevant FASB projects
  • Reinsurance
  • Salvage and subrogation
  • Business combinations and portfolio transfers

The Board was scheduled to discuss, but did not have time to address the following:

  • Policyholder participation rights
  • Changes in insurance liabilities

The Board noted the most recent project timetable, which includes a meeting with the Insurance Working Group in late June 2006 and a full schedule of topics for discussion at the July IASB meeting. If all topics to be included in the PV document are discussed by the end of that meeting, a first pre-ballot draft of the PV document could be ready in July or early August, with the intention of publishing the document by December 2006.

The IASB staff noted, as a procedural point, that the usual drafting procedures would be followed, with the exception that the threshold for publishing the PV document would be eight positive votes, rather than nine as would be necessary for an exposure draft or IFRS.

Universal life contracts

The Board discussed the appropriate accounting for 'universal life contracts', which is a type of permanent life insurance that allows the policyholder, after their initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. Such a policy also permits the policyholder to reduce or increase the death benefit more easily than under a traditional whole life policy. To increase the death benefit, the insurance company usually requires the policyholder to furnish satisfactory evidence of continued good health.

The staff suggested that there were two possible accounting approaches, called for convenience the 'components approach' and the 'integrated prospective approach.' The staff introduced the benefits and limitations of each approach.

The Board had an inconclusive debate, but it was evident that Board members were uncertain of the real distinction between the two approaches. Some expressed concern about how the integrated prospective approach was being modelled, commenting that too many things hinged on issues surrounding the model. Several Board members noted that the component approach was more transparent than the integrated prospective approach.

Board members commented that resolving the issues surrounding the two accounting approaches would be assisted by a comprehensive numerical example.

The Board agreed to suspend discussion of these issues until the next meeting.

Unit-linked and index-linked payments

The staff introduced the topic by explaining that the staff were seeking to address a perceived accounting mismatch when an insurance fund is essentially a closed-end fund and all cash flows will ultimately be distributed to the policyholders. The staff proposed that if the assets of the unit-linked fund cannot (even using all available accounting options) be recognised and measured at fair value (for example, treasury shares), the carrying amount of the liabilities should exclude the portion of the benefit that depends directly on the difference between the carrying amount of the assets and their fair value.

Some Board members challenged the premise of the proposed presentation, noting that the mismatch was caused not by accounting but by the definitions of assets, liability and equity, under which treasury shares were not assets of the issuer.

There was no real support for the staff position with respect to unit-linked payments, and the staff will return with other proposals. The Board did raise the question whether a fair value option approach might be possible, but there was significant concern about defining the boundaries for such an option. Board members were concerned that such an option would result in 'do what you like' accounting for unit-linked insurance contracts.

No formal votes were taken on these issues, although it was evident that Board members were satisfied that index-linked insurance contracts would likely be accounted for as derivatives.

Credit characteristics of insurance contracts

The Board discussed whether the credit characteristics of an insurance liability should affect its measurement. Board members stressed that the credit risk being addressed was that of the insurance contract, not the insurer. However, the risks attaching to an individual insurance contract would have an effect on the credit risk of the insurer. After a short debate, the Board agreed:

  • For the following reasons, the current exit value of a liability is, conceptually, the price for a transfer that neither improves nor impairs the credit characteristics of the liability:
    • The transferor would not willingly pay the price that a willing transferee would require for a transfer that improves those characteristics.
    • The policyholder (and regulator, if any) would not consent to a transfer that impairs those characteristics.
  • At inception, the credit characteristics of an insurance liability are unlikely to have a material effect on either premium rates or the current exit value. A policyholder is unlikely to buy insurance if the policyholder thinks the insurer may not satisfy its obligations in full. If the credit characteristics affect the initial measurement materially, the insurer should disclose the effect.
  • Conceptually, the subsequent measurement of an insurance liability at current exit value should reflect changes in the effect of its credit characteristics (ie changes in the probability of default or changes in the price for possible default).
  • If the margin is calibrated initially to the premium and that margin is frozen at inception, it could be argued that the margin would incorporate the effect of credit characteristics at inception (argued above to be negligible) and would not reflect subsequent changes in the effect of those credit characteristics.
  • If the measurement of an insurance liability does incorporate the effect of a change in its credit characteristics, the effect should be disclosed. (In developing the improvements to IAS 39 and the amendments to the fair value option, the Board noted that it may be difficult to identify the portion of a change in fair values that relates to a change in the effect of credit characteristics. However, this problem should not arise for insurance liabilities, because the effect would need to be included explicitly in a measurement model, rather than estimated from observable market prices).

Update on relevant FASB projects

The Board received a brief summary of developments in FASB projects relating to various aspects of accounting for insurance contracts.

Some Board members were concerned about not including the conclusions of the FASB's work on risk transfer in the PV document. However, it was noted that the FASB was using the IASB's definition of an insurance contract and that any differences should be minor.

The Board agreed with a staff recommendation that the PV document should not address accounting by policyholders for interests in and obligations under insurance contracts. However, several Board members asked the staff to explore ways raising the awareness of this issue among constituents.


After a brief debate, the Board agreed that:

  • The measurement attribute for reinsurance assumed (inwards reinsurance) should be current exit value.
  • The measurement attribute for reinsurance assets (outwards reinsurance) should be current exit value.
  • For risks associated with the underlying insurance contract, a risk adjustment typically:
    • increases the measurement of the reinsurance asset.
    • is equal in amount to the risk adjustment for the corresponding portion of the underlying insurance contract.
  • The conclusion on risk adjustments for reinsurance assets may also be relevant for policyholder accounting. The Board will consider policyholder accounting after the discussion paper stage.
  • The carrying amount of reinsurance assets should be reduced by the expected (probability-weighted) present value of losses from default or disputes, with a further reduction for the margin that market participants would require to compensate them for bearing the risk that defaults or disputes exceed expected value (expected loss model).
  • Given the Board's tentative decision to use current exit value as the measurement attribute for insurance contracts, there is no need for specific restrictions to prevent the recognition of misleading gains or losses when an insurer buys reinsurance.
  • A cedant should recognise at current exit value its contractual right, if any, to obtain reinsurance for contracts that it has not yet issued. In practice, that current exit value may not be material in many cases.

Salvage and subrogation

The Board agreed that:

  • Insurance liabilities should be measured net of the impact of related salvage and subrogation rights that the insurer would acquire on paying a claim.
  • Once an insurer acquires salvage or subrogation rights (generally by paying a claim under the insurance contract), the insurer has an asset. The insurer should measure that asset initially at current exit value.
  • Until the Board has discussed reimbursement rights in the project to amend IAS 37, the Board should not conclude on how an insurer should measure salvage and subrogation rights after initial measurement.

Business combinations and portfolio transfers

The Board agreed that:

  • IFRS 4 permits an expanded presentation for insurance contracts acquired in a business combination or portfolio transfer. When it completes phase II of the insurance contracts project, if any significant differences remain between current exit value and fair value, it might be necessary to consider retaining the expanded presentation. If no significant differences remain, the expanded presentation would be redundant.
  • When an entity takes over a portfolio of insurance contracts in a portfolio transfer, the current exit value of the portfolio at that date is likely to equal the consideration received, less the fair value of any other assets received (e.g. investments or recognisable intangible assets relating to customer relationships). If the current exit value is a different amount, the transferee should recognise the difference as income or expense.

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