Insurance contracts

Date recorded:

The IASB Chairman extended to FASB and FASB staff publicly the sympathy of all at the IASB on the death of Jeff Cropsey, who died suddenly in early July. He had been, Sir David noted, an extremely important part of the insurance contracts team and his contributions would be missed.


Unbundling insurance contracts

The Board discussed the results of the staff's additional research in developing the concepts behind a principle for when to separate ('unbundle') components of insurance contracts and discussed the proposed approach to unbundling to be included in the forthcoming exposure draft on insurance contracts.

The staff had explored both a 'significant interdependence' approach and a 'variability in the overall cash flows' approach, but had concluded that neither on its own was sufficient. Consequently, they proposed an approach that would limit unbundling to the particular components that the boards identified as the most relevant and prominent unbundling cases, namely policyholder account balances and embedded derivatives that are separated under existing bifurcation guidance.

The Boards had a thorough debate. Some supported the proposal; others wanted to identify either significant interdependence or variability in cash flows as the principle and then list what would reasonably be expected to be unbundled; at least one IASB member proposed an entirely different approach. A FASB member was concerned that the two principles identified by the staff worked with different components of the items that would be unbundled, but neither worked with all of them. He was concerned that the Boards were micro-managing the issue.

The FASB seemed more inclined to support the variability in cash flows principle, but a strong majority of the IASB favoured significant interdependencea concept already in IFRS 4.

The Boards moved on to discuss the components that would be unbundled. A FASB member was concerned that a proposed requirement to use the market rate in certain circumstances would be unnecessarily onerous and would result, at least in the US environment, in a 'search and destroy mission' by entities seeking to ensure that all possible information had been taken into account when determining the rate. The Boards agreed that this was not the intent and that the crediting rate for the account balance should be determined by the investment performance of the underlying investments (similar to pension accounting).

After these clarifications, the Boards confirmed that the unbundling principle should be:

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.

In addition, application guidance would be provided such that:

An insurer shall unbundle the following components of a contract that are not closely related to the insurance coverage specified in that contract:

(a) policyholder account balances that bear a crediting rate determined by the investment performance of the underlying investments (supplemented with additional guidance);

(b) embedded derivatives that are separated under existing bifurcation guidance; and

(c) goods and services provided under the contract that are not closely related to the insurance coverage, supplemented with the clarification that the intention is not to create or require an exhaustive search for goods and services that are not closely related but to deal with situations where goods and services have been combined with the insurance coverage for reasons other than economic.

Staff will work with Board members out of session to refine this guidance.


Unit-linked issues (follow-up)

The Boards discussed two follow-up issues for unit-linked contracts: the accounting mismatches that arise from the measurement of the assets backing unit-linked contracts; and the presentation of assets, expenses and income arising from those contracts.


Accounting mismatches

The Board noted that several issues arise in asset measurement for portfolios associated with unit-linked contracts, in particular when funds are consolidated or when the fund is an internally managed virtual fund. Three items were identified as posing problems: issuer's own shares held in the fund (in those jurisdictions in which this is permitted); real estate and investments in associates.

The staff proposed that these items should be added to the list of items that qualify for the application of the fair value option, in the interest of eliminating accounting mismatches. In addition, it would be necessary to specify that holdings of the insurer's own shares would qualify for recognition as an asset only in the circumstance in which the shares back unit-linked contracts (e.g., because they are in an index tracker fund or similar).

The Board had another vigorous discussion. One IASB member warned that the proposals were set the Board on a 'slippery slope', in particular with respect to own shares. Staff responded that the accommodation was being made only when there was a contractual link between the unit-linked insurance contract and the underlying fund.

In the end, the IASB voted (10 in favour) for the staff proposal, clarified to stress the contractual link between the unit-linked insurance contract and the underlying fund. The FASB was content with the modified proposal.


Presentation issues

With little discussion, both Boards agreed that an insurer should present the pool of assets underlying unit-linked contracts as a single line item and not commingle them with the insurer's other assets.

In addition, the Boards agreed that that an insurer shall present income and expense from the pool of assets underlying unit-linked contracts as a single line item, presented on the face of the statement of comprehensive income or disclosed in the notes, and not commingle them with income or expense from the insurer's other assets.


Simplified measurement (short-duration contracts)

The Boards have decided tentatively to require the premium allocation model for pre-claims liabilities of short-duration insurance contracts. This requirement puts some pressure on the line between short-duration contracts and other insurance contracts. This session was devoted to identifying the characteristics of a short-duration contract.

One related question facing the Boards was whether an insurance entity underwriting both short-duration and long-duration insurance contracts should use the same accounting model for all contracts; or whether all short-duration contracts should be accounted for using the premium allocation model and all other insurance contracts should use the building block approach. The staff's preference is the former approach.

The Boards ultimately agreed that the required application of the premium allocation model should be restricted to the pre-claims liability of short-duration contracts, which incorporate all the following features:

  1. the coverage period is approximately 12 months or less;
  2. the insurer is unlikely to become aware of events during the coverage period that could cause significant decreases in the expected cash out flows[*]; and
  3. do not contain significant embedded options or guarantees
[*] The IASB was evenly split on this issue and the FASB wholly in favour of including it, so it will be included in the forthcoming exposure draft with a related question in the Invitation to Comment.


Treatment of acquisition costs

The Boards discussed the treatment of acquisition costs. The Boards were confused because it seemed that one option was to expense as incurred and the other was to defer and amortise over the contract period (i.e., 12 months). Board members thought that these two were essentially the same. No firm decision was made (or if there was one, it was not obvious).


Discount rate: locked-in or updated?

Some IASB members would prefer to stay silent on the issue of the discount rate, mostly on the grounds that for short-duration contracts the effects of discounting will not be material. However, the IASB did agree to use a current rate for the accretion of interest to an unallocated premium liability (subject to the usual materiality constraint).

The FASB will vote on this issue later in July.


Residual margin for investment contracts with a discretionary participation feature [IASB-only issue]

With almost no discussion, the IASB agreed that the residual margin of a discretionary participating feature should be recognised in profit or loss over the life of the contract in a systematic way that best reflects the asset management services, as follows:

  1. on the basis of passage of time, but
  2. if the insurer expects to provide asset management services in a pattern that differs significantly from passage of time, it shall release the residual margin on the basis of assets under management.


Confirmation of alternative views and abstentions

Mr Smith confirmed his intention to present an Alternative View in the exposure draft, for the reasons given in June (see notes for that meeting). Mr Engstrom also confirmed that he is considering presenting an Alternative View, for reasons expressed in June.

Dr Paul Pacter will abstain, given that he has not participated in the development of the exposure draft other than this meeting.

Dr Elke Koenig said that she would vote in favour of the exposure draft, having followed the project closely and benefitting from being an observer at the IASB table since her appointment earlier in 2010.

The meeting closed at about 1900.

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