Taking stock (Paper 5/63)

The staff presented a brief paper to the Boards summarising the current status of the insurance project and the decisions taken to date. There was no significant discussion on the paper, and the most important issue arising is that June 2011 is now officially a 'working month' which will lead to the final ballot vote on the IFRS and resulting in its likely publication in July 2011.

Top down approaches to discount rates (Paper 5A/63A)

The staff presented a paper to the Boards addressing the application of the Boards' tentative decision on 17 February to permit both top-down and bottom-up approaches to determining the discount rate, with a focus on non-participating contracts.

The staff recommended that the Boards include application guidance in the final standard that:

• The top-down discount rate is not an asset rate, but should be determined to reflect the characteristics of the insurance contract liability
• An appropriate yield curve should be determined based on current market information. The yield curve can reflect the actual assets that the insurer holds, or be based on a reference (not replicating) portfolio which is determined to reflect the characteristics of the liability
• Where there are no observable market prices for points on the yield curve, the insurer should use an estimate consistent with the Boards' guidance on estimates — particularly the guidance on Level 3 financial instrument fair value guidance.

The staff confirmed that the IFRS will state that asset cash flows utilised for a top down discount rate valuation should be adjusted to reflect the characteristics cash flows of the liability. In particular, they should be adjusted for:

• Differences between the timing of the cash flows in the reference asset portfolio (or the insurer's own assets) and those of the liability to reflect the actual degree the durations match
• Risks inherent to the assets but which do not relate to the liability.

The staff also recommended that, as insurers using a top-down approach to determining the discount rate are likely to have found it impractical to apply a bottom-up approach, no further adjustments (e.g. liquidity / illiquidity) should be adjusted for.

The Boards' members asked a number of questions of the staff, largely focused on clarifying their understanding of the issues involved. A member suggested the use of a practical expedient for this process for non-insurance companies, but this did not receive significant support. The staff also clarified that the top-down discount rate is not an asset-based discount rate. It remains the discount rate reflective of the characteristics of the liability (in the same way that a bottom-up rate is not a risk-free discount rate) which has simply been determined on a different basis.

Overall the Boards' members supported the staff analysis and the conclusions they had reached without dissention. The staff should now finalise the analysis and prepare final wording for the standard on the valuation of discount rates for non participating insurance contracts.