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Insurance contracts

Date recorded:

Background

There were eight agenda papers prepared for the November Board meeting where the draft of IFRS 17 Insurance Contracts (draft IFRS 17) was discussed.

Papers 2A and 2B set out respectively the methodology used and the findings from the external testing of the draft IFRS 17. These papers were provided for information and the Board is not asked for decisions. They are not considered further in these summaries.

Paper 2C considered a possible response to the feedback received on the level of aggregation in the external review of the draft IFRS 17. Agenda paper 2D considered whether the requirements of the draft IFRS 17 on changes in the carrying amount of the contractual service margin (CSM) for experience adjustments should be amended. Agenda paper 2E considered a possible response to the issues relating to transition that have been identified in the external review and testing of the draft IFRS 17. Paper 2F discussed feedback from test participants about the requirements relating to accounting for the effects of financial risk when an entity applies the variable fee approach (VFA) and mitigates that risk with a derivative. Paper 2G summarised other 21 sweep issues that have arisen in the drafting process and external testing. Agenda paper 2H asked the Board to specify the mandatory effective date for IFRS 17, assuming that this is issued in the first half of 2017.

Insurance Contracts — Level of aggregation — Agenda paper 2C

The Staff recommended that (a) the definition of portfolio, i.e. a group of contracts subject to similar risks and managed together as a single pool, should be retained, (b) onerous contracts should be identified at initial recognition and be grouped separately from contracts that are not onerous at initial recognition, (c) insurance contracts that are not onerous at initial recognition should be measured by dividing them in each portfolio into at least two groups, the first is a group of contracts that have no significant risk of becoming onerous and the second is a group of other profitable contracts, (d) only contracts issued within the same year should be included within the same group, (e) the CSM for a group of contracts would be required to be allocated over the current period and expected remaining coverage to be provided, on the basis of the passage of time, reflecting the expected duration and size of the contracts in the group, and (f) a weighted-average discount rate should be permitted for the accretion of interest, with an averaging period of as much as one year.

Discussion

There was general support for the Staff proposals, which were considered to be realistic and workable, and were a good compromise between achieving the primary objectives in respect of onerous contracts, and contracts that are less resilient to changes in assumptions, which still will provide key information even though some granularity had been lost. It was suggested that some further guidance was needed on how mutualisation should be applied. Board members enquired if there could be circumstances which could effectively produce only one group, as for example in a jurisdiction where it is illegal to write loss making contracts. Other Board members observed that the risk of having an onerous group from those created out of highly profitable contracts was an appropriate way to focus the principles of the standard on the segment of the insurance contracts issued that would be more at risk. It was suggested that the drafting needs to make it clear that it is not intended that onerous contracts should be individually identified if the insurer has other ways to identify onerous contracts that can be applied (for example through the analysis of pricing parameters). It was noted that the requirements could be applied at a more granular level if more details were available from risk management processes. One Board member questioned why one year cohorts were required if the contracts had similar risks and profitability, but other Board members considered this necessary in order to ensure that the CSM is released when each contract expires.

Tentative decisions

The Board approved the recommendation on the number of groups, with 10 votes in favour and one vote against. In addition, the Board unanimously approved the Staff recommendation on the calculation of the locked in discount rates for accretion of interest on CSM to be an average of the discount rates used during the initial recognition of contracts for the year.

Insurance Contracts — Experience adjustments — Agenda paper 2D

The Staff recommended that for contracts measured under the general model when an experience adjustment directly causes a change in the estimate of the present value of the cash flows, the combined effect of the experience adjustment and the change in the estimate of the present value of future cash flows should not adjust the CSM but should instead be recognised in profit or loss. An experience adjustment directly causes a change in the estimate of the present value of future cash flows only when it causes a change in the future rights and obligations for the group of contracts.

For contracts measured under the variable fee approach, experience adjustments arising from non-financial risk that do not affect the underlying items, and any directly caused changes in the estimates of the present value of future cash flows, should not adjust the CSM but should instead be recognised in profit or loss.

Discussion

The Staff noted that this was the one issue where there was a range of comments and views. There was general agreement with recognising experience adjustments in profit or loss. One Board member noted that although he had previously advocated including experience adjustments in the CSM he agreed with the recommendation as the field testing had identified the extent to which experience adjustments would have adjusted the CSM.

Tentative decisions

The Board unanimously approved the Staff recommendations.

Insurance Contracts — Transition issues — Agenda paper 2E

The need to demonstrate impracticability before using the simplified approach and the fair value approach. The first Staff recommendation was that the requirements of IFRS 17 should be applied retrospectively in accordance with IAS 8 to groups of insurance contracts, unless it is impracticable. The second recommendation was for insurance contracts for which an entity cannot identify a group retrospectively and for groups of insurance contracts for which retrospective valuation is impracticable. In these instances a choice should be permitted between adopting a modified retrospective approach or the fair value approach, unless a modified retrospective approach is also impracticable, in which case the fair value approach must be used.

Concerns with the simplified transition approaches. The first Staff recommendations was that the objective of a modified retrospective approach should be to achieve the closest outcome to retrospective application that is possible using reasonable and supportable assumptions. The second recommendation was that the use of specified modifications should be permitted, using the minimum modifications necessary to meet the objective of the modified retrospective approach. The third recommendation was that, in applying a modified retrospective approach, there should be the maximum use of information that would have been used to apply a fully retrospective approach, but only if such information is available without undue cost or effort.

The date for determining the CSM for contracts with direct participation features. The Staff recommendation was that the CSM should be determined using the permitted modifications for the VFA determined at the beginning of the earliest period presented.

Fair value approach. The Staff recommendation was that under the fair value approach assessments should be allowed about (a) whether a contract is eligible for the variable fee approach, (b) how to group contracts, and (c) how to determine the effect of discretion on estimated cash flows for contracts subject to the general model. An entity can determine the effect of discretion either as at the inception of a contract, based on reasonable and supportable evidence for what the entity would have determined given the terms of the contract and the market conditions at that time, or at the beginning of the earliest period presented.

Grouping of contracts written within the same year. The first Staff recommendation was that as part of a modified retrospective approach and a fair value approach, an entity is permitted (a) not to divide contracts into groups that were written within the same year, (b) for groups applying the general model, to accrete and adjust the resulting CSM after transition using the discount rate at the beginning of the earliest period presented, (c) if the entity makes an accounting policy choice to disaggregate insurance finance income or expenses between profit or loss and other comprehensive income, for non-participating contracts it is permitted to base finance income or expenses included in profit or loss using the discount rate at the beginning of the earliest period presented. The second Staff recommendation was that if an entity chooses to base finance income or expense included in profit or loss using the discount rate at the beginning of the earliest period presented, it should make separate disclosures for amounts relating to insurance finance income and expenses for insurance contracts that were in force at the beginning of the earliest period presented and insurance contracts issued after the beginning of the earliest period presented, and disclose a reconciliation from the opening to the closing balance of the cumulative amounts included in other comprehensive income for related financial assets measured at fair value through other comprehensive income.

Disclosure of transition amounts and methods. The first Staff recommendation was that all the disclosures required by IFRS 17 relating to the CSM, insurance contract revenue and insurance finance income or expenses should be provided separately for insurance contracts that existed at the beginning of the earliest period presented and insurance contracts written after the beginning of the earliest period presented. The second Staff recommendation was that for all periods there should be an explanation of how the measurement of insurance contracts at transition was determined in order for users to understand the nature and significance of the methods used and judgements applied.

Discussion

One Board member noted the need to ensure that users are provided sufficient information to understand how transition has been applied. The Staff stated that disclosures would be important given that a collection of options will now be available and these option are also dependent on the information that is available for the insurance contracts to be restated. However, the fundament IAS 8 principle that full retrospective application must be applied to the maximum extent possible remains unchanged. The proposed modifications should only be used to the extent that they are necessary to achieve the restated balance sheet at transition date. One Board member expressed reservations about the ability to use the fair value approach even if information was available that would permit the simplified approach to be used. He was also intrigued that, based on the Staff paper, the fair value approach resulted in a smaller CSM. The Staff agreed that more educational material was needed to ensure that the requirements were understood. Two Board members considered that additional guidance was needed on how the CSM at transition would be run-off. Finally one Board member stated that he considered the OCI reset to zero to be an extraordinarily generous concession.

Tentative decisions

The Board unanimously approved the Staff recommendations.

Insurance Contracts — Mitigating financial risks reflected in insurance contracts — Agenda paper 2F

The Staff recommends that where the VFA is applied and a derivative is used to mitigate financial risks arising from the insurance contract and the underlying items, the effect of those changes in the financial risk should be excluded from the CSM when specified criteria are met and the entity has made this election in its accounting policies.

Discussion

There was no discussion about this issue.

Tentative decisions

The Board unanimously approved the Staff recommendation.

Insurance Contracts — Other sweep issues — Agenda paper 2G

This paper summarises 21 issues that have arisen in the drafting process and external testing. It includes the most significant changes that the Staff has made to draft IFRS 17 in the light of comments from Board members, the topic-based testing, and external review, together with the Staff’s proposed response. In particular issue 12 clarifies the VFA classification to allow the interpretation of contractual terms as inclusive of substantive obligations from laws and regulations. Issue 10 clarifies that for VFA contracts and those with asset dependent cash flows for which there is mutualisation among policyholders the level of aggregation to determine groups has to take the mutualisation features into account.

Discussion

There was very limited discussion on this issue.

Tentative decisions

The Board unanimously approved the Staff recommendation.

Insurance Contracts — Mandatory effective date of IFRS 17 — Agenda paper 2H

The Staff recommends that an entity should apply IFRS 17 for annual periods beginning on or after 1 January 2021, assuming that IFRS17 is issued in the first half of 2017, and an entity may apply IFRS 17 before 1 January 2021, provided it also applies IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers at the same time.

Discussion

One Board member considered that a period of 5 years was preferable between the date of publication of IFRS 17 and the mandatory implementation date in order to permit all insurance companies, including small and medium sized companies and those in emerging countries to implement the new Standard at the same date. He considered that there would only be marginal benefits in implementing IFRS 17 at the date recommended, and that the marginal costs of this would be huge. Several Board members disagreed with this view for various reasons, including that the new Standard was a significant improvement over current accounting, projects that last for extensive periods are generally not very efficient, smaller companies generally have fewer products, approximately 3 years was considered sufficient by most respondents to the Exposure Draft issued in June 2013, and companies have had plenty of time to consider the proposals.

Tentative decisions

The Board approved the recommendation on the mandatory implementation date, with 10 votes in favour and one vote against.

The Board unanimously approved the Staff recommendation on the early adoption of IFRS 17.

Next steps

The Staff will continue with the drafting process to reflect the decisions made in the November 2016 meeting, and will ask selected external parties to perform a fatal flaw review of a revised draft of IFRS 17.

The Staff expects to issue IFRS 17 in the first half of 2017.

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