Cash flow that arise as an insurer fulfils its existing insurance contract

The Boards discussed whether the expected present value of cash flows used in measuring insurance contracts should include the expected present value of all the future cash outflows and inflows that will arise as the insurer fulfils the insurance contract or whether to limit them only to the cash outflows and inflows that arise from the insurance liability.

The Boards considered a number of examples of cash flows and assessed whether and why they should be included in the measurement of insurance contracts. The Boards in general agreed with the inclusion of all direct cash flows arising from fulfilment of existing contracts and the fact that general overheads or income taxes would not be included in these cash flows. Nonetheless, many Board members expressed their concerns with the formulation of the principle as stated above. These Board members suggested that the principle should encompass all incremental cash-flows arising from the existing insurance contracts measured at the portfolio level. After a short discussion, both Boards agreed with this new principle. Nonetheless, the Boards asked the staff to articulate the principle in a way consistent with the existing guidance in the accounting literature (incremental and direct cash flows, including allocation of direct overheads) and provide any necessary application guidance.

The Boards discussed the potential reclassification of assets resulting from salvage right or liabilities resulting from claim to a general liability account. Some Board members expressed their view that any reclassification from insurance contracts would be too onerous and disclosures would be sufficient. No conclusion has been reached.

Acquisition costs

The Boards confirmed their tentative decision that an insurer should recognise acquisition costs as an expense when incurred. The Boards decided that the residual/composite margin should be reduced (but not below zero) by the amount of incremental acquisition costs incurred at initial recognition, by including that amount in the cash flows.

After a short discussion the Boards decided that the acquisition costs should be defined as direct incremental acquisition costs defined at the contract level. The Boards did not agree to include allocation of overheads into these costs nor the portion of the costs related to unsuccessful contracts. The Boards were concerned that decision to include these costs into acquisition costs would decrease the residual margin and lead to reporting of higher revenue at initial recognition (to offset the incurred acquisition costs).

Some Board members expressed some concerns about the agreed approach, notably lack of consistency with the decision taken on the cash flows (see above - the difference in the unit of account) as well as differences in a business model of the insurer (i.e. that there could be differences in reporting acquisition costs and revenue between an insurer that uses third parties and pays them commissions for acquisition and an insurer that uses internal resources for selling insurance contracts).

Unbundling

The Boards continued their discussion on the unbundling principle. At their May 2010 meeting the Boards agreed to base the unbundling principle on the notion of significant interdependence. Nonetheless, at that meeting the Boards asked the staff to refine the proposed guidance.

At this meeting, the staff proposed to formulate the unbundling principle as follows:

A component of an insurance contract should be unbundled if it functions independently from other components of that contract. A component functions independently if it is not significantly interdependent with other components of that contract.

The staff suggested adding the following factors that would indicate that a component is not significantly interdependent:

1. The component exposes the insurer only to risks that meet the definition of financial risk in IFRS 4.
2. A separate observable market or market price exists for that component.
3. The component alters the cash flows of the insurance contract in a manner that is not linked to or directionally consistent with the provision of insurance protection.
4. The component represents an account balance in accordance with the characteristics specified in US GAAP (ASC Topic 944-20-15).

Many Board members expressed their serious doubts whether the notion of significant interdependence was sufficiently operational as a principle. One Board member suggested a new unbundling principle that would require unbundling for all insurance contracts that allow the participant to redeem or withdraw the investment without triggering the insurance event and whose payoff does not relate to the insurance coverage (or expressed differently the variability of the cash-flows of that contract depends on financial factors).

Most Board members seemed to be attracted by this suggestion. The staff noted that the principle should be updated to reflect the interaction with any insurance component (that is, situations when partial withdrawals do not deactivate the insurance protection). The Board asked the staff to formulate the unbundling principle based on this new notion as expressed above and consider how operational would be the guidance.

Nonetheless, in case the new guidance was not sufficiently clear and operational the Boards decided to revert to the original staff proposal based on significant interdependence. The Boards agreed that should such situation arise, the ED would pose a question to constituents on how operational would be the principle based on significant interdependency.

Presentation

The Boards considered various models of presentation of the statement of comprehensive income. The Boards considered the four models that were already discussed at the February Board meeting - written premium model, allocated premium model, summarised margin model and expanded margin model. At that February Board meeting the Boards decided that measurement should drive the presentation of the statement of comprehensive income. As such the Boards agreed to pursue the expanded margin approach.

Several Board members expressed their uneasiness with the expanded margin model as that leads to the revenue figure being calculated (rather than reflecting actual customer consideration). In addition application of the expanded margin model would lead to reporting the amount equal acquisition costs as revenue.

After a brief discussion the Boards agreed that the best fit to the insurance model that is being developed is a summarised margin approach that would be supplemented by additional disclosure on the volume of the business and on the change of the insurance obligation. Most Board members agreed with that proposal.

Nonetheless, a significant minority of the Board expressed some concerns about the proposed approach. They noted that usage of the summarised margin presentation model might lead to lack of comparability with other financial institutions and might lead to presentation issues for insurers that have significant contracts that would be accounted based on the simplified model (based on the written premium). The Board members noted that summarised margin will lead to creation of an industry specific standard and the presentation model would not be consistent with the Financial Statements Presentation project (based on principles of disaggregation and cohesiveness). On the other hand, the majority of the Boards noted that the presentation model is driven by the measurement model and as this is specific, the presentation model should reflect this fact.

Interest accretion residual/composite margins

The IASB discussed an additional issue related to the accretion of the residual margin (The FASB decided not to accrete composite margin).

The IASB discussed whether to use a locked-in rate determined at inception or a current rate updated each period for interest accretion. The Board was split on the issue, as half of the Board members viewed the residual margin as the result of a system of present values of future cash inflows and outflows determined at inceptions, whereas other Boards members conceptually looked at insurance model as a current model that warrants use of a current rate. The Board agreed to ask a question on that issue in the forthcoming ED.