Insurance contracts

Date recorded:

On 12 June 2012, the IASB and FASB held two separate insurance sessions. The first one was a two hour educational session on measuring earned premiums. The second was a one hour decision making meeting on the allocation of cash flows to the unbundled component.

Earned premiums

The education session focused on Agenda Papers 2B/84B and 2C/84C on earned premiums; these were very well received by the Boards who commented positively on their quality. The staffs discussed the goal of comparability between insurance and other industries, and the need therefore, to have a “revenue-like earned premium model”, as it was referred to. Most notably, they highlighted Appendix B of Paper 2B, which compares the three approaches outlined in the paper: earned premium, written premium and premium due.

After what appeared to be a beneficial roundtable discussion, the staffs summarised the current status and, going forward, indicated that they will focus their efforts on the earned premium approach, as there was less interest in the other two models. A handful of Board members felt this revenue construct does not mesh well with the other aspects of the project, given the focus has so far been on the liability measurement; this will likely be a topic of continued debate. Other items in relation to this topic will need to be considered by the staffs such as, acquisition costs, other non-claims related cash flows and unit of account.

The staffs will continue their efforts to perform user-specific outreach, and in particular explore whether the benefit of having volume information outweighs the cost incurred by preparers to produce that information, as well as whether it will be of real use.

Allocation of cash flows to unbundled components

The second session focused on Agenda Paper 2A/84A intended to help in the determination of how to allocate cash flows to various components of insurance contracts. For those components that the Boards tentatively decided to unbundle, the staffs recommended that:

  1. The cash flows allocated to an investment component and considered in the measurement (including interest credited) should be measured on stand-alone basis which means as if the insurer had issued the investment contract separately (without including the effect of any cross-subsidies or discounts/supplements),
  2. After excluding any cash flows allocated to unbundled investment components (or embedded derivatives recognised separately), the amount of consideration and discounts/supplements should be allocated to the insurance component and/or the goods and service component. The allocation should be done in accordance with the current revenue recognition proposals, and
  3. Cash outflows related to more than one unbundled component (for example, acquisition and fulfilment costs) should be allocated to those components on a rational and consistent basis. Once allocated, the insurer would account for those costs in accordance with the recognition and measurement requirements that apply to that component.

This topic was also covered in last week’s FASB education session. On both occasions, the focus appeared to be on Board members’ concern over the nature of “allocation”. Nearly all Board members felt the staffs should be clear on what disbursements are eligible for not being treated as an expense because the customer has substantially prepaid them, how to attribute those disbursements to the various components (for example, investment component or revenue component disbursements versus insurance contract disbursements given the different measurement attributes and treatment of the disbursement as costs, assets or deduction of a liability) and then finally for shared costs only, potentially how to allocate them across different component.

Both Boards voted unanimously in favour of the staffs’ recommendations, with a caveat that the attribution versus allocation language will be taken into account when drafting. Most notably, the staffs were asked to draft language such that when cash flows are clearly linked and attributable, those cash flows are kept within the unbundled component and treated according to the standard that governs the financial reporting of that component.

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