The Boards have been presented with a model of accounting for reinsurance contracts based on the proposed 'building blocks' insurance contracts recognition and measurement model. Accounting by both the reinsurer and the cedant was considered.
Accounting by reinsurers
Because reinsurance contract is a type of insurance contract purchased by an insurer, the Boards unanimously approved the staff recommendation for reinsurers to use the same recognition and measurement principles for issued reinsurance contracts as insurers use for issued insurance contracts. Board members noted that in applying the same principles to measuring contract liability, the reinsurer and the cedant would still have different assumptions resulting in different amounts being recognised in their financial statements.
Accounting for reinsurance asset by cedants
The Boards considered a proposal to measure the reinsurance recoverable asset as:
- a) the present value of expected future cash flows required to fulfil the reinsurance portion of insurer's obligation
- b) plus the risk margin (but not residual margin) that is included in the measurement of the reinsured portion of the contract obligation
- c) plus residual margin arising from the reinsurance contract
- d) less the impact of possible impairment of reinsurance asset due to credit losses and coverage disputes measured on an expected value rather than on incurred loss basis
The staff clarified that the risk margin to be included in the measurement of reinsurance asset is the reinsured portion of the cedant's risk margin on its direct insurance liability. The Board members questioned why this risk margin increases the value of the asset. The staff explained that this margin simply mirrors the effect of the uncertainty around the insurer's direct contract liability that was passed to the reinsurer, and it can be viewed as protection asset.
In discussing the reinsurance asset residual margin, the staff clarified that this margin is not linked to the residual margin on the initial direct insurance contract. It is also not the residual margin that reinsurer would recognise in its own financial statements. Instead it represents the balancing figure between elements (a) and (b) and the premium paid under the reinsurance contract. The question of whether this margin can be negative is yet to be discussed.
The proposed adjustment for impairment raised questions of potential double counting. One question was whether, if the insurer expects to receive only the present value of expected cash flows (element a), then does that mean that both margins need to be written off immediately as impairment? The staff explained that adjustment for impairment is to incorporate future credit losses expected to take place after inception and not on initial recognition. Staff will bring back, for discussion at a future meeting, the potential issue of double counting, better wording for the impairment adjustment, and some examples of reinsurance asset calculations. Leaving aside the potential need for rewording of impairment adjustment, the Boards approved the proposed measurement model.
The Boards unanimously voted not to allow offsetting of reinsurance recoverable (assets) against insurance liabilities either in the balance sheet or in profit or loss unless there is a legal right of offset.
The Boards unanimously agreed that reinsurance does not result in derecognition of related insurance contract liabilities unless the obligation specified in the insurance contract is [legally] discharged, cancelled or expired.
Accounting for ceding commissions by cedant
The staff proposed that the cedant should treat ceding commission received from the reinsurer consistently with proposed accounting for acquisition costs. The Boards have tentatively agreed in the past to expense insurance contract acquisition costs as they are incurred. Therefore, the ceding commissions received would also be recognised in profit or loss. Because the ceding commissions would result in recognition of income by the cedant, there was a general concern for reinsurance contract structuring opportunities to affect the split between ceding commission and reinsurance premiums.
The Board members questioned whether ceding commissions only relate to proportional reinsurance, where the link to the underlying direct insurance contract's cash flows is clearer. The staff will research the issue further for non-proportional reinsurance. For proportional reinsurance only the Boards unanimously approved the staff recommendation for the cedant to recognise ceding commissions in the same way as acquisition costs.
Issues of symmetry
The Boards deliberated the issue of symmetry in accounting for cedant's reinsurance asset and insurance liability. Board members agreed that proposed model would result in the same measurement method applied to both reinsurance asset and insurance liability, except that reinsurance asset includes an impairment adjustment while insurance liability does not include insurer's own credit risk. The Boards also looked at the issue of symmetry in accounting for the reinsurance liability by the reinsurer and the reinsurance asset by the cedant, but decided not to proceed further with this question.
The staff have looked at whether the proposed insurance model can be applied to policyholder accounting and what issues, if any, can this highlight for accounting by insurers. Overall, the staff propose that the building blocks insurance model can be applied to policyholder accounting but would need further research. Of the particular issues reviewed for policyholder accounting, only two were highlighted as potentially impacting on insurer's accounting as well, if symmetry between insurer and policyholder accounting models is important. Those issues were the tentative decisions on expensing of acquisition costs under both IASB and FASB models and on participating rights under FASB model. From policyholder's point of view, all premiums paid would represent an asset including the acquisition costs. This would not be symmetrical with insurer's accounting. The FASB model proposes to recognise participating features as part of insurance contract liability only if there is a legal or constructive obligation to pay these cash flows; otherwise they would be a component of equity. From the policyholder's point of view the higher premium paid for the participating feature would represent an asset, highlighting the difference from the insurer's accounting. The Boards agreed (FASB - unanimously, IASB - all but one member) not to consider further, at this stage, the issues of symmetry between insurer's and policyholder accounting other than to review the treatment of acquisition costs and participating rights.
A further question was whether the exposure draft (ED) should include policyholder accounting. The boards agreed not to include policyholder accounting in the scope of the ED. However, the definition of insurance would apply equally to insurers and policyholders.