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IFRS 17 Insurance Contracts

Date recorded:

Cover note (Agenda Paper 2)

At the October 2018 meeting, the Board discussed the overview of the main concerns and implementation challenges raised by stakeholders about the requirements in IFRS 17 Insurance Contracts. At the same meeting, the Board tentatively the criteria for evaluating proposed amendments (Agenda Paper 2C of the October 2018 IASB meeting). This meeting considers the following issues:

Presentation

Separate presentation in the statement of financial position of groups that are assets and groups that are liabilities

Paper 2A Presentation of insurance contracts on the statement of financial position

Agreement to present separately portfolios of insurance contracts that are assets and portfolios of insurance contracts that are liabilities and portfolios of reinsurance contracts that are assets and portfolios of reinsurance contracts that are liabilities

Presentation and measurement

Separate presentation and measurement of premiums receivable and claims payable

No change to the current IFRS 17 requirements

Measurement

Use of locked in discount rate to adjust the contractual service margin (CSM)

Paper 2B

Discount rates, risk adjustment and OCI option

No change to the current IFRS 17 requirements

Measurement

Subjectivity in determining discount rates and risk adjustment

No change to the current IFRS 17 requirements

Measurement

Risk adjustment in a group of entities

No change to the current IFRS 17 requirements

Presentation

Other comprehensive income (OCI) option for insurance finance income and expense

No change to the current IFRS 17 requirements

Defined terms

Definition of insurance contract with direct participation features

Paper 2C

Variable fee approach

No change to the current IFRS 17 requirements

Measurement

Limited applicability of risk mitigation exception – non-transitional requirements

No change to the current IFRS 17 requirements

 

Limited applicability of risk mitigation exception –transitional requirements

No vote—deferred to the discussion of transitional requirements for OCI option.

Measurement

Business combinations: classification of contracts

Paper 2D

Business combinations

No change to the current IFRS 17 requirements

Measurement

Business combinations: contracts acquired in their settlement period

No change to the current IFRS 17 requirements

Measurement

Reinsurance contracts held: expected cash flows arising from underlying insurance contracts not yet issued

Paper 2E

Future cash flows in the measurement of reinsurance contracts held

No change to the current IFRS 17 requirements

Measurement

Interim financial statements: Treatment of accounting estimates

Paper 2F

The treatment of accounting estimates in interim financial statements

No change to the current IFRS 17 requirements

The Board is asked whether they agree with the staff recommendation of amending the requirements in IFRS 17 for presentation of insurance contracts on the statement of financial position as per Agenda Paper 2A below and not to amend for other topics per Agenda Paper 2B–2F. The remaining nine topics from the list of issues presented at the October 2018 Board meeting (Agenda Paper 2D) will be considered at a future meeting.

Presentation of insurance contracts on the statement of financial position (Agenda Paper 2A)

This paper addresses two topics.

The need to allocate premium cash flows and the liability for incurred claims to each group of insurance contracts for presentation in the statement of financial position

Background

The existing requirement in IFRS 17 reflects all the rights and obligations arising from a group of insurance contracts as a single asset or liability, i.e. the unit of account is a group of insurance contracts. Each group balance consists of a liability for remaining coverage and a liability for incurred claims. IFRS 17:78 requires separate presentation of groups of insurance contacts that are assets and liabilities and does not permit their offsetting.  

The premium allocation approach (PAA) is an optional simplification of the general model to measure the liability for remaining coverage of contracts that meet specified criteria. Applying the PAA, an entity measures the liability for remaining coverage of a group of insurance contracts on initial recognition at the amount of the premiums received less any insurance acquisition cash flows paid (if the entity’s policy is not to expense such costs on initial recognition).  An entity needs to allocate premium cash flows and the liability for incurred claims to each group of insurance contracts to determine if that group of insurance contracts is in an asset or a liability position. The requirement to present separately groups of insurance contracts that are assets and groups of insurance contracts that are liabilities are the same as under the general model.

The need to allocate cash flows to the individual groups represents a significant implementation challenge for many prepares who have several different systems currently allocating cash at a much higher aggregation level, reflecting the way these cash flows are managed. Stakeholder proposals range from amending the level of aggregation for the presentation in the statement of financial position to be a portfolio, rather than group, to amending the measurement requirements for PAA.

Staff analysis

In both the general model and the PAA, the insurance revenue is recognised as services are provided. The timing of cash flows does not affect recognition and measurement of insurance revenue and insurance service expense, but it affects the measurement of insurance contracts group asset or liability.

Staff recommendation

The PAA is a simplification of the general model. To change the measurement requirements for PAA would result in it being a different model, and accordingly is not recommended.

The staff sees merit in providing the practical relief to present insurance contracts at a higher level of aggregation in the statement of financial position, balancing this with the requirements of the Conceptual Framework prohibiting offsetting. The loss of information from offsetting is acceptable when considering the cost relief and the amendment would not disrupt existing implementation processes. Accordingly, the staff proposes to require entities to offset groups at the portfolio level for presentational purposes. This would amend IFRS 17:78 so that instead of presenting separately groups that are assets and liabilities, the entity would be required to present separately portfolios of insurance contracts that are assets, portfolios of insurance contracts that are liabilities, portfolios of reinsurance contracts held that are assets and portfolios of reinsurance contracts held that are liabilities.

The staff notes that regardless of the presentation requirements, the identification of premiums received and claims incurred at the group level would often be required for measurement purposes and for determining amounts recognised in the statement of financial performance (e.g. for determining discount rates used on initial recognition).

Board discussion

The Board noted that the staff recommendation is not consistent with the principles of the Conceptual Framework, IAS 1 Presentation of Financial Statements and IAS 32 Financial Instruments: Presentation. Nonetheless, most of the Board members agreed with the staff recommendation as the benefits of the amendment outweighs its costs.

The Board tentatively agreed 13:1 with the staff recommendation to amend the Standard.

Separate presentation and measurement of premiums receivable and claims payable

Background

IFRS 17 requires an entity to measure a group of insurance contracts as a net balance of all fulfilment cash including premiums receivable and claims payable. Some stakeholders think that the premiums receivable and the claims payable would be better reflected if entities were to measure and present them separately applying IFRS 9 Financial instruments.

Staff analysis

Measuring premiums receivable and claims payable separately from insurance contracts would result in internal inconsistencies in IFRS 17. The principles in IFRS 17 create a single bundle of rights and obligations. In developing the Standard, the Board considered the presentation approaches, but concluded that presenting components as separate assets suggest that those assets and liabilities are different and not related to each other. Amending this would reduce comparability between the entities and also unduly disrupt implementation already underway.

Staff recommendation

Staff recommends no amendments to IFRS 17, but note that IAS 1:55 permits the presentation of additional line items by disaggregating the required line items, headings and subtotals if required to understand an entity’s financial position. Applying that, an entity may be able to present a disaggregated component of a line item, i.e. present the amount of premiums receivable and claims payable included in the carrying amount of the insurance contract liability. The requirement does not permit separate presentation, and only permits for the required line items to be disaggregated when this is relevant to the understanding of an entity’s financial position.

Board discussion

The Board tentatively agreed with the staff recommendation not to amend, voting unanimously.

Discount rates, risk adjustment and OCI option (Agenda Paper 2B)

This paper addresses four topics.

Use of locked-in discount rates to adjust the CSM

Background

IFRS 17 requires an entity to measure insurance contracts as a sum of fulfilment cash flows and the CSM. An entity needs to adjust the CSM for changes in estimates of cash flows that relate to future service, however the adjustments are measured at the locked-in discount rate that applies on initial recognition. The difference to the current discount rate measurement represents an insurance finance income or expense reflected separately in profit or loss or OCI depending on the presentation accounting policy choice.

Some stakeholders prefer the CSM to be re-measured using current discount rates, but the Board noted that such an approach would be appropriate only for insurance contracts with direct participation features. 

Staff analysis

A change in estimate may be due to the inclusion of a cash flow that was not included in a previous estimate or the removal of an expected cash flow. Making an adjustment to the CSM at the current rate would have no internal consistency (resulting revenue will also be difficult to substantiate) and a change in discount rates would be part of the insurance service result rather than insurance finance income/expense. The CSM would reflect the difference between amounts determined using discount rates that applied when the CSM was initially recognised, adjusted by the current discount rates. The remaining balance of the CSM would therefore reflect a mix of discount rates applied at different times. During the development of IFRS 17, all of this was considered and it was concluded that for insurance contracts without direct participation features, an entity should use the locked-in discount rate to measure the CSM.

Staff recommendation

No amendment to IFRS 17 relating to discount rates used to determine the adjustment to the CSM is proposed.

Board discussion

Some Board members noted that this implementation concern is not widespread. The Board discussed this issue a number of times during the development of IFRS 17. Therefore, the Board tentatively agreed to support the staff recommendation not to amend the standard, voting unanimously.

The risk adjustment in a group of entities

Background

At the May 2018 IFRS 17 Transition Resource Group (TRG) meeting, the views of the TRG members were split on the level of aggregation for determining the risk adjustment. Some read IFRS 17:37 as requiring or allowing different measurement of the risk adjustment for non-financial risk for a group of contracts at different reporting levels. On the other hand, some of the TRG members read IFRS 17 as requiring the risk adjustment for non-financial risk to be determined from the perspective of the entity issuing the contract, which does not change depending on whether the reporting entity is the issuing entity or a consolidated group that includes the issuing entity.

Staff analysis

The TRG discussion indicated that some entities already have systems in place to manage different risk adjustments for different reporting levels. Although the TRG discussion might indicate a diversity in practice, most entities are expected to apply IFRS 17 as requiring that the risk adjustment for non-financial risk is determined from the perspective of the entity issuing the contract (i.e. it does not depend on reporting levels)

Staff recommendation

The staff notes that a clarification to the above requirement in IFRS 17 would not help to address all of the possible differences as it is expected that they vary from entity to entity.

Therefore, the staff propose no amendment to IFRS 17 regarding a possible clarification about the level at which to determine the risk adjustment for non-financial risk in a group of entities.

Board discussion

In the brief discussion on this issue, several Board members highlighted the need for consistency, but acknowledged that the issue of diversity on this aspect is not widespread, the risk adjustment measurement is inherently diverse and the Standard supplements it by disclosures. The benefits of consistency in this case would not outweigh the significant disruption from amending the Standard. The Board tentatively agreed with the staff recommendation not to amend the Standard, voting 13:1.

The subjectivity in the determination of discount rates and risk adjustment

Background

IFRS 17 is principle-based and requires an entity to measure insurance contracts by discounting cash flows using current, market-consistent discount rates that reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contract and reflecting the risk adjustment for non-financial risk. IFRS 17 supplements this with extensive disclosure requirements to allow users of financial statements to understand how those amounts might differ from entity to entity.

Some investors expressed concerns that the principle-based nature of IFRS 17 could limit comparability between insurance entities.

Staff analysis

Discount rates and the risk adjustment for non-financial risk are fundamental components of the measurement model in IFRS 17. Any change to make the requirements more prescriptive than the existing requirements of IFRS 17 for determining those components would unduly disrupt implementation that is already underway.

Staff recommendation

The staff proposes no amendments to IFRS 17 to prescribe the discount rates used to measure insurance contracts or to limit the number of risk adjustment techniques that an entity can use.

Board discussion

Some Board members pointed out that during the standard-setting phase, the Board has spent a lot of time on writing the measurement objectives and having a principles-based standard. The Board voted unanimously to support the staff recommendation not to amend.

The OCI option for insurance finance income or expenses

Background

IFRS 17 permits an entity to choose to present insurance finance income or expenses either in profit or loss or disaggregated between profit or loss and OCI. This choice is made on a portfolio-by-portfolio basis. Most stakeholders expressed concerns that permitting, but not requiring, a presentation of the effect of some changes in financial assumptions in OCI could impair comparability between entities. Some investors have expressed the view that the OCI option for insurance finance income or expenses adds unnecessary complexity to their analysis of the information reported by entities applying IFRS 17. 

Staff analysis

Although, staff thinks that amending IFRS 17 to require, rather than permit, entities to present insurance finance income or expenses either entirely in profit or loss or partly in OCI would increase comparability between entities, this would unduly disrupt implementation already underway. In addition, the Board already exposed for comments those alternative accounting treatments in the proposals that preceded IFRS 17 and while the overall feedback on those proposals was mixed, the reasons for the introduction of OCI option are still valid.

Staff recommendation

Therefore, the Board should not amend IFRS 17 to require, rather than permit, entities to present insurance finance income or expenses either entirely in profit or loss or partly in OCI.

Board discussion

Several Board members considered this to be a difficult issue, as offering an accounting policy choice disrupts comparability. However, the Board debated this issue at length during the standard-setting phase. The Chairman stated that he hopes the market forces would act as a discipline and would deter entities from using the OCI option. Furthermore, the Standard requires additional disclosures to bring comparability. The Board tentatively agreed with the staff recommendation and voted 13:1 in favour of not amending the Standard.

Variable fee approach (Agenda Paper 2C)

This paper addresses two topics.

Definition of an insurance contract with direct participation features

Background

IFRS 17 distinguishes between insurance contracts with and without direct participation features. The general model for insurance contracts without direct participation features is modified for insurance contracts with direct participation features—measured using the variable fee approach (VFA).

Some stakeholders are concerned that the scope of the VFA is too narrow, whereby, similar contracts are being accounted for differently.

Staff analysis

The Board developed the scope of the VFA in response to feedback during the development of IFRS 17. The staff thinks that it would not be possible to amend the scope of the variable fee approach without also reconsidering the modifications to the general model that comprise the VFA. Any approach to amend it is likely to add complexity to IFRS 17.

Staff recommendation

The staff thinks that the definition of an insurance contract with direct participation features appropriately identifies those contracts for which the Board thought modifications to the general model were necessary.

Therefore, the Board should not amend the requirements in IFRS 17 relating to the definition of an insurance contract with direct participation features.

Board discussion

Several Board members noted that having a variable fee model invariably draws a distinction between different types of contracts. Having two models will always have a cross over point. However, while many contracts have similar management intent and outcomes and are managed in a similar way, there are significant differences in policyholder expectations between contracts in the scope of VFA, and those that are not.

The Board voted unanimously to tentatively agree with the staff recommendation not to amend the Standard.

Limited applicability of the risk mitigation exception

Background

Some entities hedge direct participating insurance contracts with derivatives, measured applying IFRS 9. To prevent mismatches, IFRS 17 includes an option for the entity in specified circumstances to recognise the effect of some changes in financial risk in the insurance contracts in profit or loss, instead of adjusting the CSM. IFRS 17, consistent with the transition requirements for hedge accounting in IFRS 9, requires prospective application of the risk mitigation option from the date of initial application of the Standard.

Some stakeholders are still concerned that the approach to risk mitigation activities in IFRS 17 is too narrow.

Staff analysis

The existing risk mitigation exception was intentionally designed to reduce accounting mismatches that would otherwise be introduced by the VFA. It reduces such mismatches by allowing an entity to treat some changes in insurance contracts in the same way as they would be treated applying the general model. The staff thinks that an amendment to IFRS 17 to extend a deliberately narrow exception to broader circumstances of other risk mitigation activities and to permit retrospective application of the risk mitigation option would cause significant loss of useful information for users of financial statements by increasing complexity and by reducing comparability between entities. Such an amendment would also bring inconsistencies with, and potentially override the requirements of, IFRS 9 and may result in ‘cherry picking’.

Staff recommendation

The staff recommends that the Board should not amend the non-transitional requirements in IFRS 17 relating to risk mitigation activities and relating to the prohibition of retrospective application of the risk mitigation option.

The issue about the risk mitigation for reinsurance contracts held will be discussed in a separate paper at a future meeting.

Board discussion

Regarding the non-transitional requirements, the Board members noted that there is no new information to make any changes in this aspect. The Board voted unanimously to tentatively support the staff recommendation not to amend the Standard.

Regarding transitional requirements, the Board did not vote.  Amending the Standard would bring a conflict with the principle prohibiting the use of hindsight. Not amending the Standard would have a potentially significant CSM impact and potentially a long-term effect on future profitability. Future broader discussion needs to consider this issue again together with the discussion of transitional requirements for the OCI option (under the general model requiring nil balance for cumulative OCI reserve). 

Business combinations (Agenda Paper 2D)

This paper addresses two topics.

Classification of acquired contracts as insurance contracts

Background

IFRS 3 Business Combinations (as amended by IFRS 17) requires contracts acquired in a business combination to be assessed for classification as insurance contracts on the basis of terms as at the acquisition date, rather than the inception of the contract as it was previously required by IFRS 3. In June 2018, the Board tentatively decided to amend IFRS 3, so that the above amendment applies only to business combinations that occur on or after the IFRS 17 effective date.

This requirement adds complexity and costs and it could result in a different accounting treatment at different reporting levels within a group. Some stakeholders suggest re-introducing an exception to the general classification requirements of IFRS 3 for insurance contracts and making use of that exception optional for an entity.

Staff analysis

Staff notes that an amendment to reintroduce an exception would not unduly disrupt implementation, however, it would cause significant loss of information, adding complexity for users of financial statements and reduce comparability. Differences in accounting caused by a business combination are not unique to insurance contracts. Other Standards do not require exceptions.

Staff recommendation

The staff recommends no amendments to IFRS 17 or IFRS 3 relating to classification of contracts acquired in a business combination.

Board discussion

The Board members noted that one of the objective of IFRS 17 is to bring it more in line with other Standards. For this, it is important to remove the exemption from IFRS 3. The Board tentatively agreed with the staff recommendation not to amend the Standard, voting unanimously.

Identification of the insured event for acquired insurance contracts

Background

IFRS 17 applies the general principles of business combinations in IFRS 3 to insurance contracts acquired in a business combination. Some stakeholders noted that applying IFRS 17 requirements to contracts acquired in a business combination results in implementation challenges and costs. In addition, some of those stakeholders noted that users of financial statements could consider the information provided applying IFRS 17 requirements to be misleading or counterintuitive because similar contracts will be accounted for differently based on whether they have been issued by an entity or acquired by the entity during their settlement period.

This issue is similar to that discussed at the September 2018 TRG meeting, which was not related to business combinations—whether the entity’s obligation to pay amounts subject to insurance risk after an incurred claim should be treated as a liability for incurred claims or a liability for remaining coverage.

Staff analysis

The staff thinks that an amendment to introduce an exception to the general requirements for the determination of the insured event for insurance contracts acquired in a business combination, as suggested by some stakeholders, would cause significant loss of useful information. It would increase complexity for the users of financial statements because it would reduce comparability with the requirements for other transactions. 

Staff recommendation

The staff proposes no amendment to the requirements in IFRS 17 relating to the determination of the insured event for insurance contracts acquired in a business combination.  

Board discussion

Several Board members agreed with the staff recommendation based on the principles of IFRS 3. However, some have had more sympathy for preparers applying only the premium allocation approach to their issued contracts and not having the necessary software to do the general model CSM accounting for the purchased contracts and asked for practical expedients. Others disagreed with introducing further expedients at this stage. In referring to the September 2018 TRG discussion, the Vice-Chairman drew a distinction between deciding whether an adverse claim development on future claims is treated as a claim or coverage and considering adverse claim development on past claims. In considering the granularity of the assessment for purchased contracts, the Board members thought that there would still be grouping of contracts, and the annual cohort requirement would consider the date of acquisition (rather than date of initial issue). Furthermore, in looking at the estimation of CSM requirement on initial recognition, a parallel was drawn to entities buying portfolios of loans and having to fair value them individually.

Board tentatively agreed with the staff recommendation not to amend the staff recommendation, voting 13:1.

Future cash flows in the measurement of reinsurance contracts held (Agenda Paper 2E)

This paper discusses future cash flows in the measurement of reinsurance contracts held. Other aspects of the accounting for reinsurance contracts held will be discussed in a future meeting.

Background

A fundamental aspect of measuring an insurance contract is determining which future cash flows should be included in the measurement, i.e. determining which cash flows are within the contract boundary. The contract boundary should be determined on the basis of the substantive rights and substantive obligations created by the contract for the entity.

Stakeholders have expressed three concerns about applying the contract boundary requirements to reinsurance contracts held: 1) operational complexity of estimating cash flows related to future underlying contracts; 2) potential mismatch between an insurance contract liability and a reinsurance contract asset; and 3) inconsistent recognition of the CSM on reinsurance contracts held and underlying insurance contracts issued.

Stakeholders suggest modifying the contract boundary requirements in IFRS 17:34 and recognition requirements in IFRS 17: 62(a) for reinsurance contracts held.

Staff analysis

The staff thinks that modifying the contract boundary requirements in IFRS 17 for reinsurance contracts held is not justified. Any amendment would result in a significant loss of useful information.

An amendment that proposed to achieve ‘mirror’ accounting between the reinsurance contracts held and the underlying insurance contracts issued was previously considered and rejected by the Board during the development of IFRS 17 because such an approach is contradictory to the fundamental principle that a reinsurance contract held should be accounted for in the same manner as insurance contracts issued, including reinsurance contracts issued.

Staff recommendation

Therefore, the staff proposes no amendment to IFRS 17 for future cash flows for reinsurance contracts held.

Board discussion

Several Board members noted that the staff paper and material used in the educational session were very helpful in explaining the three issues raised. One Board member regretted that there is no accounting standard for insurance contracts held and drew an analogy to reinsurance contracts held, before the underlying contracts are issued. Another Board member pointed out the analogy between the issuer and the holder of a reinsurance contract, noting that the holder potentially has more information to make the estimates. The Board tentatively agreed with the staff recommendation not to amend the Standard, voting unanimously.

The treatment of accounting estimates in interim financial statements (Agenda Paper 2F)

Background

IFRS 17 requires entities not to change the treatment of accounting estimates made in previous interim financial statements when applying IFRS 17 in subsequent interim financial statements or annual financial statements. The timing of the reporting date matters because changes in expected fulfilment cash flows relating to future coverage are reflected in CSM, whereas experience adjustments are presented in profit or loss. Depending on the frequency of reporting, the entity may have updated its expectation at the last reporting date, so that the change in current cash flows was expected and reflected in the CSM, as opposed to being unexpected and impacting profit or loss.

For entities that report more frequently than annually, stakeholders have raised concerns that the recalculation of the CSM and profit or amounts would be burdensome and would make the interim reports less indicative of the annual results. Some stakeholders suggest extending IFRS 17:B137 to other types of reports, such as management accounts. Other stakeholders propose amending IFRS 17:B137, so that its application is optional to increase comparability between entities with different interim reporting frequencies.

Staff analysis

Extending the requirement in IFRS 17:B137 applicable to interims to any type of reporting and amending the requirement so that its application is optional would add complexity for preparers and users of financial statements and would reduce comparability among entities.

Staff recommendation

Therefore, the staff proposes no IFRS 17 amendment for treatment of accounting estimates in interim financial statements.

Board discussion

The Board tentatively agreed with the staff recommendation not to amend the Standard, voting unanimously.

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