Insurance contracts — Education session

Date recorded:

Overall measurement of fulfilment cash flows: interaction between the cash flows and the discount rate

The major issue discussed was whether different discount rates needed to be applied to cash flows that vary, and those that do not vary, with underlying items. The Staff noted that techniques were available that only required the use of one yield curve. However, they thought that dividing cash flows and applying appropriate discount rates to each might still be needed in order to provide consistency in the measurement of the contractual service margin (CSM) and the presentation of interest expense. The Staff asked the Board whether they had any comments or questions on the Staff’s analysis about the measurement of the fulfilment cash flows.

In response to a question asked by a Board member the Staff confirmed that their intention was that the choice was neutral, and that there was no default method.

In response to a question asked by another Board member, the Staff explained that in addition to using multiple discount rates, a single yield curve could be used combined with the different scenarios, e.g. the probabilities of death benefits being paid. The Staff noted that many insurers have developed and use such scenarios.

A Board member stated that it was clear what the fulfilment cash flows were, and summarised the differences between these and fair values (entity-specific cash flows and assumptions, no adjustment for own credit risk), but felt that there was confusion over the impact on fulfilment cash flows if the book yield approach was applied. This was only relevant to determining what components are reported in profit or loss, or in other comprehensive income (OCI), although there may be an impact on the discount rate for the CSM.

Another Board member stated that she felt that the main focus should be on the objectives rather than blessing or prescribing particular techniques, e.g. the use of single or multiple yield curves.

A fellow Board member stated that it was important that insurers were consistent in the methods they applied.

One Board member commented that many respondents did not like the mirroring exception, and that this presented practical and operational issues. Although it was necessary to divide cash flows in order to present interest expense respondents were unclear whether this was also required for measurement purposes.


Measuring the CSM – the adaptations that the IASB proposed in the 2013 ED and alternative adaptions proposed

The Staff asked the Board whether they had any comments or questions on the Staff’s analysis of the need for adaptations to account for the entity’s share of underlying items, and in particular, whether they had any comments or questions on the feasibility of identifying underlying items for contracts with participating features. The Board also commented and raised questions about the Staff’s analysis of the appropriate recognition pattern for the CSM for participating contracts and the treatment of changes in estimates of investment returns that affect the amount paid to the policyholder.

On Board member commented that there was great discretion for some participating contract, whereas other participating contracts were heavily regulated, which made it difficult to prescribe one model. He also commented that the mirroring exception was inconsistent with other IFRSs, including IFRS 9, therefore he felt that there should only be very narrow exceptions to the general approach.

Another Board member commented that there were significant economic differences with participating contracts, but the greater the variety of bespoke solutions resulted in more difficulty and complexity; therefore, he questioned whether the benefits outweighed the costs. The Staff commented that the discussions were about whether the Board wanted to address some or all of the objections to the proposals, and that some respondents felt that the mirroring exception works well whereas others want this to apply very narrowly.

A Board member commented that some investment management fees were very performance related, but unlocking the CSM for all investment management services would not be appropriate, e.g. where the underlying asset was an indexed fund, where there would be no performance related fees, and compared the proposal with a structured product that tracked the return from the FTSE 100 but with the guarantee of the return of the amount invested. He commented that insurers regard insurance related guarantees e.g. a death benefit, and financial related guarantees e.g. a guaranteed minimum return, as having an impact on one pool of profits, and therefore want unlocking for everything as this make it operationally easier. The Board member stated that on balance he favoured unlocking for changes in insurance risk, but not for financial risk (which would be very unpopular), but that these need to be looked at together.

A fellow Board member commented that participating contracts could cover extreme ranges of scenarios, and wondered how practical it would be to prescribe different accounting treatments for different types of participating contracts.

The Staff posed a question about whether the exercise of discretion influenced the judgement on the amount of fees charged for investment management services. One Board member stated that the more the return was prescribed the more the fees were like investment management fees, whereas if there was a high level of discretion they were less like investment management fees. She then expressed concern about the flexibility of earnings management provided by the amount and timing of crediting amounts to policyholders.

Another Board member stated that she remained sceptical about adjusting the CSM as this might result in the need to make a call on the dividing line between explicit/implicit investment management fees. She expressed concern about broadening of the application of exceptions where contracts may be economically similar, and using the exercise of discretion for the declaration of bonuses (which in some cases was affected by the exercise of discretion over the disposal of assets) to drive the recognition of income.

One Board member commented that many insurers would be accounting for investments at fair value through profit or loss (FVTPL), and asked why was it that changes in the value of investments which underlie participating contracts should not also be recognised in profit or loss rather than in the CSM.

Another Board member commented that it was important to account for similar items in similar ways, but was concerned about creating a unique model with greater complexity for participating contracts, and therefore favoured expediency. He posed the question that, although insurers had a lot of discretion over the amount and timing of amounts credited to participating contracts, how complex the Board wanted to make the model, and whether this additional complexity led to greater understandability?

Another Board member stated that he could get comfortable with full unlocking of the CSM because of the disclosure requirements (changes in the fulfilment cash flows and the impact on the CSM). However, the problem is that users will focus on the note disclosures, with profit or loss becoming a rolling average of the results, and questioned how meaningful it would be, although it might result in making the financial statements less of a 'black box'.

The IASB Chairman shared the previous Board member’s concerns about how meaningful profit or loss would be, and felt that allowing entities to account for all changes in the CSM would also undermine how meaningful the balance sheet would be.

A Board member stated that it would be more transparent and would provide better information if the adjustments were made in profit or loss, and felt that full unlocking was frightening as it would make profit or loss virtually meaningless. He preferred to allow the unlocking as proposed in the ED, and not to move to full unlocking.

A fellow Board member stated that they were trying to make the financial statements easier to understand. If all adjustments went into the CSM there would be a series of drivers as to what went into the CSM, which would differ from product to product, which would be too opaque.

The Chairman stated that the market was not wholly comprised of sophisticated investors, and therefore many decisions were based on what was in profit or loss, which should therefore reflect economic reality.


Where should changes in the value of options and guarantees be recognised?

The Staff asked the Board to consider whether there should be specific requirements for cash flows and interest rate changes relating to options and guarantees, and what options and guarantees these requirements would apply to. The Staff noted that if changes in options and guarantees were accounted for in the CSM this would cause an accounting mismatch if the insurer was economically hedged, as changes in the measurement of derivatives would be accounted for in profit or loss. The Staff asked the Board whether they had any comments or questions on whether there should be specific requirements for options and guarantees, and if so, whether they had any comments on how an entity should account for changes in the value of options and guarantees.

A Board member stated that if the Board did not like the use of the CSM, it would have to require changes in estimates to be accounted for in profit or loss. Problems would be compounded if these were accounted for through OCI.

In response to a question from another Board member the Staff confirmed that surrender options were not regarded as options or guarantees for the purposes of the current discussions.

A Board member commented that the mirroring proposals had failed, but there was some support for the general proposals. However, trying to apply the same approach to participating contracts as other insurance contracts does not work. He asked why changes in financial guarantees, e.g. guaranteed investment returns, should not be accounted for in OCI so as to be consistent with the treatment of non-participating contracts. The Staff commented that the consequential effect of any decisions taken on measurement on the presentation aspects, including the use of OCI for participating contracts would be explored later, and that locked-in discount rates did not work for participating contracts.


Presentation of interest expense

The Staff asked the Board whether they had any comments or questions on the Staff’s analysis of the presentation of interest expense for contracts with participating features.

One Board member asked whether the book yield approach would solve the accounting mismatch with underlying assets. The Staff replied that it would not provide a complete match with assets because of e.g. the accounting treatment of the impairment of assets. It would also be necessary for insurers to designate the assets against the insurance contracts, which some insurers currently do, whereas some do not.

In response to a question from a Board member the Staff confirmed that an entity would only use the book yield to measure the unwinding of the discount rate, and that this would not be used for the measurement of the liability.

Another Board member stated that he liked the book yield approach, which he felt was preferable to the OCI solution. However, he would prefer all changes to be accounted for in profit or loss, with an explanation of the movements provided in the notes. He also noted the problem of identifying the underlying assets (and noted that there are no specifically identifiable assets for e.g. Universal Life contracts) and their durations etc. which added complexity.


Other issues

The Staff asked the Board members whether they had any other issues that they would the Staff to research in respect of accounting for participating contracts.

A Board member asked for some research to be undertaken on the basis of charging investment management fees on different types of stand-alone investment management contracts.

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