Insurance Contracts – Phase II

Date recorded:

Project plan

The Board reviewed the project plan. Although the staff remains confident that the Discussion Paper would be published in December 2006, some Board members were more sanguine, suggesting that the issues still to be reviewed by the Board were not trivial.

Reporting changes in insurance liabilities (other than premium presentation)

The Board discussed whether an insurer should be required to present separately any specified components of the changes in the carrying amount of insurance liabilities (to be specified later). The issue is closely related to the issue of whether an insurer should present all premiums as revenue, all premiums as deposit receipts, or some premiums as revenue and some premiums as deposit receipts (the 'gross or net' question).

The Board seemed not to agree the detail in the staff recommendations; rather it agreed that the Financial Statement Presentation project should drive the presentation. The Discussion Paper should ask constituents whether certain items related to the change in the measure of the insurance liability should be disclosed, either on the face of the financial statements or in the footnotes. The subsequent Exposure Draft would address these issues in greater detail.

Investment contracts: comparison of IAS 39 and IAS 18

The Board considered whether the Discussion Paper should document the key differences that exist between the proposed current exit value model for insurance contracts and the current treatment of investment contracts under IAS 39 and IAS 18, and seek feedback on whether the Board should consider eliminating these differences.

The staff identified the following significant differences:

  • (a) Liability measurement at inception:
    • (i) the current exit value model is based on expected values. Under IAS 39 the liability is subject to a minimum of the surrender value; and
    • (ii) under IAS 39 and IAS 18, non-incremental origination costs are likely to give rise to a loss at inception, even if the contract is priced to recover those costs. Under the current exit value model, this is not likely to be the case (see appendix for further discussion)
  • (b) Subsequent measurement of liability:
    • (i) the current exit value model is based on expected values. Under IAS 39 the liability is subject to a minimum of the surrender value; and
    • (ii) the current exit value model is based on current values. Under IAS 39, where an investment contract is measured at amortised cost, some assumptions are locked in: in particular, although the cash flows are based on current estimates,1 the measurement reflects the original effective interest rate (including the original quantity and price of risk).
  • (c) Income and expense recognised in profit and loss at inception:
    • (i) the current exit value model recognises gains on inception (if any gain arises). Under IAS 18 gains are not likely to be recognised at inception unless it could be demonstrated that a service had been performed at that time; and
    • (ii) treatment of origination costs

The items identified by the staff highlighted areas in which the Board seemed uncomfortable with the model being developed for insurance and how it interacts with existing standards, creating the possibilities for accounting arbitrage. Some Board members were firmly of the view that if an insurance contract contained a financial instrument that was not inseparable from the insurance risk, that financial instrument should be accounted for using IAS 39. Other Board members noted that this idea almost presupposed unbundling insurance contracts.

The Board seemed to agree that a basic approach would be concentrate on the notion of the interdependence of cash flows already in IFRS 4. Therefore, if the cash flows are so interdependent that to unbundle them would lead to arbitrary allocations between the components of the contract, unbundling should be prohibited. However, if the cash flows are not interdependent, then the contract should be unbundled. The Board agreed to raise this issue in the Invitation to Comment.

Should there be a portfolio basis for measurement?

The Board discussed the issue of whether insurers should measure their rights and obligations under insurance contracts on a portfolio basis rather than contract by contract.

The Board agreed that risk margins should be determined for a portfolio of insurance contracts that are subject to broadly similar risks and managed together as a single portfolio (again, this wording is consistent with IFRS 4). However, the Board agreed that the diversification benefits between portfolios was not part of initial measurement. The Board saw a distinction between a portfolio of similar risks and a collection of portfolios of different risks. (Thus, if an insurance company managed a portfolio of marine risks and another of environmental risks together, the risks inherent in the two portfolios would fail the 'broadly similar' test, but the diversification within the marine book and within the environmental book would meet the 'broadly similar' test.)


The Board agreed to modify its previous position (April 2006) to require unbundling of insurance contracts unless the insurance element and the financial element were 'so interdependent that an entity cannot measure the financial element separately (that is, without considering the insurance element)' or similar words, in which case it would be prohibited. This position is based on the existing guidance in IAS 39 AG33(h).

Policyholder participation rights

The Board recognised that there was a dilemma created by the definitions of a liability and equity with respect to policyholder participation rights. In most cases, policyholder participation rights would not meet the definition of a liability, because there is usually no unconditional obligation to pay them. However, policyholders may not be shareholders, so the participation rights are not dividends.

Board members drew an analogy between policyholder participation rights and dividends on cumulative preference shares. Current accounting standards do not require recognition of such dividends unless they are declared, but the entity is often prevented from paying a dividend on ordinary shares unless it first pays a dividend on the cumulative preference shares. In other words, not all retained earnings can be attributed to the ordinary shareholders.

The Board agreed to explore whether it was possible to develop a presentation (either on the face of the financial statements or in the footnotes) that would enable an entity to distinguish those elements of shareholders' equity to which the shareholders did not have a claim, either by way of dividend or on liquidation. The presentation would show the restriction on distribution/ appropriation of retained profit attributable to the policyholders. (This would affect both the balance sheet and the statement of recognised income and expense.)

Universal life contracts

The Board discussed aspects of accounting for universal life contracts - those that permit the insured, after the initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. Some Board members expressed deep dissatisfaction with some of the consequences of the model being developed by the staff. However, after discussion, the Board agreed not to change their prior articulated Preliminary View but directed the staff to conduct further research on the effects of 'guaranteed insurability' once the Discussion Paper is issued.

Crediting rates in universal life contracts

The Board discussed a proposal that estimates of crediting rates [in a given situation] should reflect what the insurer actually expects to do [in that situation], rather than assume that the insurer pays the absolute minimum that can be contractually required. Some Board members expressed deep discomfort about this concept, especially the implications of such an approach on the notion of 'exit value' discussed earlier in the meeting (see 19 September). The Board did not seem to conclude on this issue.

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