Insurance contracts (IASB and FASB)

Date recorded:

In the joint meeting held on 30 January 2013, IASB and FASB discussed how insurers applying the building block approach should allocate insurance contract revenue between periods if there is a change in the estimates of the pattern of expected claims and how the amount of insurance contract revenue remaining to be earned in the future for contracts in force as of the transition date should be determined. This meeting followed an education session of the IASB on the previous day with IASB Staff analysing its views and recommendations described in Papers 2A/96A and 2B/96B as presented below.


Presentation of insurance contract revenue when there is a change in pattern of expected claims (Paper 2A/96A)

This issue only relates to the presentation of the insurance contracts revenues that the Boards have decided to require based on the earned premium method. The Staff considered the implications of a change in the estimates of the pattern of the expected claims on the allocation of insurance contract revenue between periods.

It should be noted that this allocation is purely for presentation purposes given that is arises from the decomposition of the movements in the insurance contract carrying amount calculated using the building blocks approach. No changes to the net result in the period would arise from any of the alternatives presented by the Staff in this paper.

The Staff paper considered whether the allocation of insurance contract revenue in each period should be:

  1. fixed at initial recognition, i.e. remaining revenue should be allocated on the basis of the initial estimates of the pattern of expected claims, or
  2. updated if and when estimates change, i.e. remaining revenue should be re-allocated prospectively to reflect the latest estimates of the pattern of expected claims.

The Boards decided in October 2012 that for presentation purposes an insurer should allocate as revenue the premiums received for insurance coverage and other services between periods in proportion to the relative value of the coverage and other services that the insurer provides in each period.

In applying this method, revenue is recognised when the insurer provides coverage or other services, i.e. when it expects to incur the costs of claims and related expenses and as the margin is released. The measurement of the revenue earned each period is based on the assumptions used in determining a component of the building blocks liability, specifically the liability for remaining coverage (LfRC). The insurance contract revenue for each period is measured as the amount by which this component reduces in the period as a result of the insurer satisfying its obligations to provide coverage or other services. In other words this approach decomposes the insurance contract liability based on the building blocks and assigns to certain components the role of representing revenue in the statement of comprehensive income. The other components instead are presented as expenses.

As an insurer decomposes the building blocks amount at the end of a period, the Staff considered whether the expected claims used to determine the insurance contract revenue for that period should be based on the original estimates for the period or the most up-to-date estimates. In the second case, the original estimates would be amended for any subsequent changes up to the start of the period. In other words, the Staff presented the Boards with the issue of whether the changes in assumptions for expected claims should be attributed to the revenue or expense line in the statement of comprehensive income.

In seeking a method of measuring insurance contract revenue that is broadly consistent with general revenue recognition principles, the Staff identified two possible approaches.

The first approach (Approach A) would treat each period of coverage contained in a particular reporting period as a separate performance obligation and allocate revenue to each period on the basis of the original estimates of the expected claims and margin release for that period. Therefore, revenue for each period would be fixed on initial recognition, being allocated to each period on the basis of initial estimates of the pattern of expected cash flows.

The second approach (Approach B) would treat each period of coverage as progress towards complete satisfaction of a single performance obligation, and allocate remaining revenue by reference to the most up-to-date estimates of expected claims for the current and future periods.

The Staff believe this is consistent with releasing the residual margin (single margin for FASB) on a pattern that reflects the release of uncertainty (or risk) during the period and that the most recent estimates of the pattern of expected claims, which would be an integral component of the revised insurance liability under the building blocks approach, provide a more relevant measure of progress than the original estimates. Hence, the Staff favoured the latter (Approach B) as the most effective method for recognising revenue for types of contracts to which the building block approach applies (typically life insurance type-contracts) and recommended it to the Boards.

The Staff preference to this method was reinforced by what they identified as a significant practical advantage for updating estimates given the IASB’s tentative decision to ‘unlock’ the residual margin. Applying the IASB proposals, most changes in estimates will be offset against the residual margin (they will be recognised immediately in profit or loss only if and to the extent that contracts are onerous). Therefore approach B could require less tracking than approach A for entities applying the IASB proposals. The need to track the historical development of the most recent estimates has been identified as one of the most significant operational challenges for measuring insurance contract revenue. Accordingly, applying approach B could make the measurement of insurance contract revenue simpler for insurers applying the IASB proposals.

In the discussions that preceded the vote, there was some criticism on the approach proposed by the Staff (Approach B) by one IASB member who expressed his concerns for a method which would leave room to the insurance companies to play with their revenue based on expectations of future claims. The same IASB member stressed that insurance contract revenue is an important performance metric among insurance companies and thus he felt uncomfortable with seeing it fluctuating between periods based on change in expectations of future claims. Instead, he expressed his preference in presenting the impact of changes in the initial estimates of the expected claims in the bottom-line insurer’s profit (underwriting result) rather than in the insurance contracts revenue.

Another IASB member raised some concerns around the theoretical basis and true consistency of the recommended approach with the revenue recognition principles and suggested that if the Boards go ahead with supporting this method, then a sound justification of this method even from a theoretical basis would be required in the Exposure Draft’s text.

After this debate the majority of the Board members agreed that (1) the analogy of progress towards complete satisfaction of the contract obligations would be reasonable and consistent with revenue recognition principles; (2) the most recent estimates of the pattern of expected claims provide a more relevant measure of progress than the original estimates; (3) prospective (and current) re-allocation of remaining revenue is consistent with other aspects of the building block model.

In the vote that followed, the majority of the IASB member’s voted for the Staff recommendations with only 2 members voting against. The FASB supported unanimously the Staff recommendations.


Determining how the residual/single margin at transition should be utilised to determine future revenue presentation (Paper 2B/96B)

The Boards then discussed the second topic of the day analysed in Staff’s Paper 2B/96B. This Paper discusses determining, for contracts in force as of the transition date, the amount of premium that will be earned in the future under the proposed guidance.

Also in this case the exercise is purely for presentational purposes. The transition requirements discussed in October 2012 determine the residual margin. However, on transition insurers should determine the part of the liability for remaining coverage that is used to determine the amount of the revenue to be recognised in the statement of comprehensive income (SoCI) after transition. Given the previous tentative decisions reached by the IASB and FASB, the Staff presented different recommendations.

On transition to the new accounting standard an insurer would be required to present revenue and expenses in the SoCI for the reporting period on or after the effective date and for all comparative periods presented. An entity will use assumptions used in the measurement of a component of the insurance contract liability to estimate the amount of the revenue recognised by reference to specific changes in the building block liability. Similar to the measurement of contracts under the premium allocation approach, the insurance contracts liability under the building blocks approach might be thought of as including a liability for incurred claims (LfIC) and a liability for remaining coverage (LfRC). The LfRC component can be used to estimate the revenue. By estimating separately the components of the LfRC, the insurer would avoid recognizing more revenue than the total consideration charged to the policyholder plus accreted interest.

The IASB Staff recommended to the IASB that:

  1. In determining the residual margin through retrospective application of the new standard, an insurer shall assume that all changes in estimates of the risk adjustment between initial recognition and the beginning of the earliest period presented were already known at the date the contract would have been initially recognised. This would mean that the risk adjustment at inception is assumed to equal the risk adjustment on transition; and consequently that
  2. when retrospective application is impracticable, an insurer shall estimate the residual margin maximizing the use of objective data (i.e. that an insurer should not calibrate the residual margin to the insurance liability measured using previous GAAP)

In the discussion that followed, one IASB member did not favour the first part of the Staff recommendation as described in (a) above on the grounds that this solution would overstate the residual margin on transition and proposed to search for other possible methods that would not lead to an overstatement to the residual margin at the transition date.

IASB members acknowledged that in any approach or method followed a degree of subjectivity would inevitably be introduced and thus agreed to accept the Staff recommendations. In the vote that followed for part (a) of the Staff recommendations 14 IASB members voted for and 1 against it. In the part (b) of the Staff’s recommendations, the IASB members reached a unanimous agreement.

After IASB’s vote, the FASB Staff members analysed their recommendations to the FASB. The FASB Staff proposed that:

For the contracts in-force at transition, the amount of the revenue to be recognised after transition should be determined as follows:

  1. For contracts for which the margin is determined through retrospective application, the insurance contract revenue remaining to be earned as of the date of transition should be determined retrospectively utilising the assumptions applied in the retrospective determination of the margin.
  2. For contracts for which retrospective application is impracticable because it would require significant estimates that are not based solely on objective information, the remaining insurance contract revenue to be earned shall be presumed to equal the amount of the liability for remaining coverage (excluding any investment components) recorded at the date of transition (plus accretion of interest).
    1. The liability for remaining coverage for these contracts at the date of transition shall be presumed not to consist of any losses on initial recognition or changes in estimate of future cash flows recognised in profit or loss after the inception of the contracts.
    2. The remaining insurance contract revenue to be earned shall be limited to the total expected cumulative consideration for in-force policies in the portfolio (plus interest accretion and less investment component receipts).
    3. The remaining insurance contract revenue shall be allocated to periods subsequent to the date of transition in proportion to the value of coverage (and any other services) that the insurer has provided for the period (i.e. applying the pattern of expected claims and expenses and release of margin).

There was no deliberation from the FASB members on this topic who directly proceeded to vote unanimously in support of the Staff recommendations.

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