The Staff summarised the tentative decisions taken by the IASB to date on aggregation which are intended to apply for all insurance contracts (e.g. contracts with and without participation features and contracts accounted for under the premium allocation approach). These decisions would have a limited impact on fulfilment cash flows, the risk adjustment and the allocation of overheads, but they would be crucial for the measurement of the Contractual Service Margin (“CSM”).

Contracts without participation features

The Staff clarified that the intention was to require the aggregation of contracts at inception but not subsequently. This was seen as a concession compared to the required accounting treatment for other assets and liabilities. IASB members commented that this would appear to allow cross-subsidisation between new profitable contracts against old loss making contracts, with the intention of maintaining equity between the different generations of policyholders. An IASB member noted that this was permitted in some countries and therefore it was important to identify what is allowed under the terms of the contract. Another IASB member noted that in some cases this could lead to a very large number of portfolios being required under the new IFRS. The Staff commented that they were not suggesting the need to have different portfolios when the risks differed only slightly. An IASB member responded that if the principle is to measure at the individual contract level this would push insurers in the direction of adopting a very granular approach, and she therefore wanted to check if this was the right principle. The Staff responded by stating that this judgment would be left to preparers in the final text of the new IFRS.

An IASB member commented that devising a consistent application of approach that was operational was very challenging. He asked whether the Staff had discussed the proposed approach with the insurance industry, and if so whether they had a sense of how the principle would be applied and whether this would be consistent across products and markets. An IASB member stated that the insurance industry was particularly concerned about the paper for the educational session, and several other members commented that insurers had been in contact with them expressing concerns about the proposals.

An IASB member observed that the new IFRS would have to explain how mutual insurance companies would aggregate contracts. Another IASB member stated that there is the need to find an operational way of achieving the principle of measuring each contract, and that in many cases a change in risk factors will affect all contracts in a similar way. He also stated that in his opinion the insurance industry was looking for a ‘big pot approach’ which would result in less relevant information.

There was some discussion on the proposal that the CSM should be determined separately for contracts which differ in profitability. IASB members expressed different views with one of them commenting that this requirement was not prescriptive and another noting that several insurers were unhappy with this proposal. The Staff observed that they had received mixed responses depending on the jurisdiction, with some insurers willing to make the change whereas others were not, due to the cost and complexity involved with it. Another IASB member shared his concern that if the unlocking of the CSM was combined with a high level of aggregation the result would be a giant smoothing mechanism which the IASB should not permit.

An IASB member stated that the discussion had identified critical issues that need to be addressed to ensure that insurers understand the principle (which they may not agree with). He felt that the duration of contracts should be part of the definition as this will affect the recognition of profits, and noted that the FASB had included duration as part of its definition. The staff commented that this was an important point, but the proposals specifically required that the CSM should be released on expiry of each contract.

Contracts with participation features

There are two additional features in contracts with participation features, which are relevant in the discussion on aggregation:

• where an insurer has discretion over the amount and timing of when the returns from underlying items are passed on to policyholders; and
• as a result of the above discretion, some payments may be paid to future participants in the participation pool (i.e. future policyholders).

The Staff paper set out the situation where contracts A and B provide returns from similar underlying items, and provide the insurer with discretion in deciding how much of the total return should be passed to each contract. At inception the insurer does not know which contracts will receive more and which will receive less than the average of the total return passed to policyholders. Where there are no financial return guarantees it is proposed that the insurer can determine the CSM by aggregating the contracts. However, differing levels of guarantees would indicate that there are different exposures to risk and therefore different profitability. Consequently it is proposed that the CSM for contracts A and B should be determined separately to faithfully reflect the different levels of profits emerging from the release of the CSM.

The Exposure Draft issued in June 2013 (“2013 ED”) requires the fulfilment cash flows to include payments arising from existing contracts that provide current or future policyholders with a share in the returns on underlying items, as there is a present obligation for the insurer to share a portion of the performance from existing contracts with the community of policyholders, including a policyholder who has yet to enter that community. Losses that arise when the insurer expects to fund the guarantees of generation X from the profitable contracts of generation Y or by issuing contracts to future policyholders should not be absorbed in the CSM of contracts of generation Y or future policyholders.

An IASB member stated that discretion adds a different dimension which needs to be taken into account. The 2013 ED provides a good principle absent discretion, but there is a need to develop a better principle when there is discretion. IASB members stated that discretion could be a legal or a constructive obligation, and the insurer needs both the right and the practical ability to exercise such discretion.

Next steps

The Staff noted that the IASB were generally happy with the principle of measuring each contract separately as it was set out in the 2013 ED and clarified during the 2014 redeliberation work. However, there is concern about the level of granularity in the aggregation of contracts that may be required, and the impact of discretion that is often present in participating contracts needs to be considered further.

Once the IASB has completed its redeliberations on participating contracts, the IASB Staff will consider whether the tentative decisions reached for non-participating contracts will need to be revisited.

The IASB expects to publish the final Standard on insurance contracts in late 2015.