Participating Insurance Contracts

The Board discussed the main features of the participating contracts and were looking for a general principle of accounting for them. Participating contracts can be characterised by a policyholder paying a higher premium in order to participate in some of the risks and rewards of the underlying pool of insurance contracts. There are typically two elements in such contract: 'guaranteed minimum benefits' and a discretionary 'participating feature'. The participating feature usually has several elements where insurer can exercise discretion but is ultimately constrained by legal, regulatory and contractual terms. This management discretion means that some part of the participating feature may not meet the definition of liability in the Framework. Two proposed ways of accounting were discussed.

View 1: Treat cash flows arising from a participating feature in an insurance contract as integral to that contract in the same way as all other cash flows arising from the contract, including them in the measurement of an insurance liability on an expected present value basis, with no separate recognition.

View 2: Classify participating feature based on whether it meets the definition of liability, leading to bifurcation of the insurance contract. Under this approach 3 options are possible for the participating feature: 1) always recognise it separately as equity given the discretionary terms; 2) split the feature into two elements and classify it as liability to the extent legal or constructive obligation exists; 3) classify the feature as a liability or equity based on whether the features predominantly are that of equity or debt.

Many Board members disagreed with View 2 approach treating policyholder benefits that do not meet the definition of liability as equity because these funds were not due to equity-holders. Proponents of View 1 stated that treating participating features as part of an insurance liability recognised the fact that such features are embedded in an insurance contract and may not have commercial substance without it. It also avoided complex measurement required to bifurcate both the contract liability and insurance premiums. Some thought it may lead to better performance measurement because under view 1 liabilities and expenses for policyholder benefits would be recognised in the same period as the underlying insurance performance.

Supporters of View 2 approach argued that recognition of liability beyond legal or constructive obligation resulted in a departure from the framework. They viewed these benefits as discretionary until declared, and would record them in equity, but possibly in a separate undistributable reserve. Once declared, the liability would be recognised with a charge to the income statement.

IASB has tentatively voted for View 1, FASB for View 2. The two Boards will continue their deliberations.