Cover note (Agenda Paper 2)

At this meeting, the Board continued its discussions on finalising ED/2019/4 Amendments to IFRS 17. The Board has now discussed all but two topics for which it decided to consider further feedback from respondents to the ED.

The staff expect to present papers on the remaining topics—the effective date of IFRS 17 and the extension of the IFRS 9 temporary exemption in IFRS 4—at the March 2020 meeting. At the same meeting, the staff expect to request the Board’s permission to start the balloting process for finalising the amendments to IFRS 17.

The staff expect that the amendments will be finalised in mid-2020.

Contractual service margin attributable to investment services (Agenda Paper 2A)

In the ED, the IASB proposed to:

• a) clarify that the definition of the coverage units and coverage period for insurance contracts with direct participation features (direct participating contracts) includes the quantities of benefits and expected periods in which an entity provides investment-related services; and
• b) require an entity to allocate the CSM for insurance contracts without direct participation features based on coverage units determined considering the quantities of benefits and expected period of both insurance coverage and any investment-return service.

The IASB also proposed extended disclosure requirements on this topic.

Almost all respondents agreed that an entity should identify coverage units considering the quantity of benefits and expected period of investment-return service, if any, in addition to insurance coverage. Of those respondents, almost half did not provide any comments about the proposed specified criteria for when insurance contracts without direct participation features may provide an investment-return service.

However, some respondents expressed concerns about:

• a) the specified criteria for when an insurance contract may provide an investment-return service; and
• b) the operational complexity introduced by the proposals.

Staff recommendation

After analysing the comments from respondents, the staff recommended the Board:

• a) finalise the proposed amendment to IFRS 17 that would require an entity to identify coverage units for insurance contracts without direct participation features considering the quantity of benefits and expected period of investment-return service, if any, in addition to insurance coverage.
• b) confirm the specified criteria for when those contracts may provide an investment-return service in the ED, but replace references to ‘positive investment return’ with ‘investment return’ in these criteria.
• c) require an entity to include, as cash flows within the boundary of an insurance contract, costs related to investment activities to the extent the entity performs such activities to enhance benefits from insurance coverage for the policyholder, even if the entity has concluded that the contract does not provide an investment-return service.
• d) finalise the proposed amendments to IFRS 17 that would require an entity to disclose:
  • i) quantitative information about when the entity expects to recognise in profit or loss the contractual service margin (CSM) remaining at the end of a reporting period; and
  • ii) the approach used to determine the relative weighting of the benefits provided by insurance coverage and investment-return service or investment-related service.
• e) confirm the addition of the definition of ‘insurance contract services’ to Appendix A of IFRS 17, but not change other terminology used in the Standard (i.e. not replace ‘coverage’ with ‘service’ in the terms ‘coverage units’, ‘coverage period’ and ‘liability for remaining coverage’).

Board discussion

On recommendation (e) above, Board members noted that changing the terminology would have helped, but agreed with the concern that some preparers would read too much into the changes. This might lead to unintended consequences. Also, the existing educational material, including summaries of the TRG meetings, refer to the existing IFRS 17 language and it might be difficult for preparers to read the guidance when the terminology is outdated.

Board decision

12 Board members voted in favour of the staff recommendation. 2 Board members were absent.

Level of aggregation—annual cohorts for insurance contracts with intergenerational sharing of risks between policyholders (Agenda Paper 2B)

In the discussions leading up to the ED, the Board discussed feedback received on the level of aggregation, in particular the annual cohort requirement (see our summary from March 2019). Back then, the Board voted unanimously to leave the level of aggregation requirements of IFRS 17 unchanged.

Although the Board did not ask a question on the annual cohort requirement in the ED, some respondents commented on the Board’s decision to retain the requirements unchanged. Some of these respondents agreed with the Board’s decision, however, others suggested the Board propose an exemption to the annual cohort requirement for insurance contracts with intergenerational sharing of risks between policyholders.

Of those proposing an exemption, some suggested the exemption apply specifically to insurance contracts accounted for applying the variable fee approach, while others suggested it apply also to insurance contracts accounted for applying the general model.

Some suggested the exemption apply to contracts to which IFRS 17:B67 and B68 apply (i.e. contracts that share risk with policyholders of other contracts), with some respondents suggesting that the risk sharing should be substantial, or for substantially all risks.

After analysing the issue, the staff conclude that:

• a) the reason for providing an exemption would be that the costs of the annual cohort requirement could exceed the benefits of the resulting information for some contracts. Those costs include the need to apply considerable judgement in some circumstances to determine the assumptions and allocations that result in information that faithfully represents the contracts.
• b) because of the pressure that would fall on any such exemption and the danger of losing information about the effect of financial guarantees in the current economic environment, the exemption would need to be robust and well-defined.
• c) however, there is no way to specify such an exemption without the use of ‘bright lines’ which would be arbitrary and difficult to justify, and without developing a particularly complex set of criteria.
• d) the resulting complexity would disrupt implementation of the Standard and reduce the benefits of its ongoing application.

Staff recommendation

The staff recommended that the Board retain, unchanged, the annual cohort requirement in IFRS 17.

Board discussion

Several Board members highlighted that the staff had undertaken every effort, but did not succeed in developing an amendment that was robust enough to address the issue. The staff struggled with the fact that the annual cohort requirement is a principle, and an exception to a principle could not be worded as another principle. Instead, the staff would have had to draft a very clear and specific rules-based exception, similar to the investment entity exception in IFRS 10 or the temporary exemption to apply IFRS 9 in IFRS 4. This was unsuccessful as any rule the staff had tried to draft was perceived as arbitrary. Furthermore, it would have only addressed issues within a subgroup of the population that was supposed to be captured by the amendment. Board members stated that they would be able to accept retaining the existing annual cohort requirement, especially given that many of the concerns raised were with regard to fully mutualised contracts, which are less common. Also, loss making contracts would be identified and communicated earlier applying the existing annual cohort requirement. Users support that and stated that the cost would be too high while implementation of the existing requirement is already well underway. This would conflict with the Board’s stated objective of not disrupting implementation processes at this stage.

The Chairman stated that the insurance industry is currently under a tremendous amount of stress given the low interest rate environment, which will likely persist for quite some time. Experience with other Standards has shown that in these periods of stress, accounting requirements have to be robust. The income statement should provide early warning. Introducing arbitrary bright lines would give entities the opportunity for structuring, especially in stress situations. The fact that applying a requirement means additional cost is in itself not a reason not to have it. For example, the variable fee approach resulted in a higher cost for preparers, while the information produced by it is extremely useful.

One Board member reminded the Board that the annual cohort requirement was introduced as a simplification itself. Respondents to the consultation documents that led up to IFRS 17 had struggled with the previously proposed concept of similar profitability. The annual cohort requirement was seen as an appropriate solution to address these concerns, because the most important decisions with regard to an insurance contract are made at its initiation (risk level, pricing, etc.).

On a clarifying note, it was highlighted that the worked example in Appendix A to the paper is only one way of applying the annual cohort requirement for insurance contracts with intergenerational sharing of risks between policyholders. There may be other ways to apply the Standard.

Board members also acknowledged that most comments to this issue came from Europe, but explained that this does not mean the issue is unique to that jurisdiction.

Board decision

12 Board members voted in favour of the staff recommendation. 2 Board members were absent.

Applicability of the risk mitigation option—non-derivative financial instruments at fair value through profit or loss (Agenda Paper 2C)

For insurance contracts with direct participating features only and in specified circumstances, IFRS 17 includes an option for an entity to recognise the effect of some changes in financial risk on the entity’s share of the underlying items in profit or loss, instead of adjusting the CSM (so-called ‘risk mitigation option’). In the ED, the IASB proposed to amend IFRS 17 to permit an entity to apply the risk mitigation option for insurance contracts with direct participation features when the entity uses reinsurance contracts held to mitigate financial risks. The Board tentatively decided to finalise that amendment at its December 2019 meeting.

When developing the ED, the Board considered a suggestion from stakeholders that the risk mitigation option should also apply when an entity uses financial instruments other than derivatives, for example, bonds, to mitigate financial risk. The Board disagreed with this suggestion because the risk mitigation option was designed to address a specific accounting mismatch between insurance contracts with direct participation features and derivatives. Respondents to the ED suggested the Board revisit this decision, as it would further reduce accounting mismatches.

Some respondents explained that:

• a) entities often use a combination of derivatives and non-derivative financial instruments, for example, fixed income securities, to mitigate financial risk on insurance contracts with direct participation features.
• b) an entity may mitigate some financial risk using either derivatives or non-derivative financial instruments. Those respondents explained that often using non-derivative financial instruments can be less costly than using derivatives.
• c) an entity may mitigate some financial risk using non-derivative financial instruments when the availability of derivatives is limited.

Staff recommendation

After analysing the issue, the staff recommended the Board amend IFRS 17 to extend the risk mitigation option for insurance contracts with direct participation features in IFRS 17:B115. The extension would permit an entity to apply the option when the entity mitigates the effect of financial risk on the fulfilment cash flows set out in IFRS 17:B113(b) using non-derivative financial instruments measured at fair value through profit or loss (FVTPL). An entity would apply the option if, and only if, the conditions in IFRS 17:B116 are met.

Board discussion

One Board member asked why only FVTPL instruments should be eligible under the amendment, while, in practice, some entities use fair value through OCI (FVTOCI) instruments to mitigate their risks. The staff replied that the risk mitigation in IFRS 17 was always meant to be similar to IFRS 9, which only allows FVTPL instruments for hedge accounting. Also, and more importantly, in most cases the accounting effect would not be achieved with FVTOCI instruments even when the entity applies the OCI option in IFRS 17. It would only be achieved if the instrument and the insurance contract started and ended at the same time. To fix this issue, the OCI option would have to be amended, which is not within the scope of these amendments.

Board decision

12 Board members voted in favour of the staff recommendation. 2 Board members were absent.

Minor amendments (Agenda Paper 2D)

The ED:

• a) proposed minor amendments to the requirements in IFRS 17—as well as some minor consequential amendments to other IFRS Standards—to address a number of cases in which the drafting did not achieve the Board’s intended outcome; and
• b) included a number of editorial corrections to IFRS 17 that the Board had identified after IFRS 17 was issued.

Overall, respondents expressed support for the proposed minor amendments. However, some respondents expressed concerns or asked for clarifications about some of the proposed minor amendments.

Staff recommendations

The staff analysed those issues and recommended the Board finalise the minor amendments proposed in the ED with minor changes. For the detail of the changes, please refer to the agenda paper.

Board discussion

With regard to item 9 in the agenda paper (editorial correction to IFRS 17:B107), Board members said that the change is too important not to make it as it might affect how preparers read the eligibility criteria for the variable fee approach. IFRS 17:B102 is clear and the inconsistency could lead to disruption in the longer term. It was suggested that the staff draft educational material based on their analysis of the issue.

With regard to item 2 in the agenda paper (proposed amendment to IFRS 17:28), one Board member said it was an important change as it clarified which cohort contracts should be added to.

Board decision

12 Board members voted in favour of the staff recommendation. 2 Board members were absent.

Additional specific transition modifications and reliefs (Agenda Paper 2E)

The ED proposed adding three specific modifications and reliefs to the transition requirements in IFRS 17 in response to some challenges stakeholders raised relating to applying specific aspects of the transition requirements At its December 2019 meeting, the Board tentatively decided to finalise those modifications and reliefs.

In addition to providing feedback on the three specific modifications and reliefs, some respondents commented on the transition requirements in IFRS 17.

Some respondents continued to express concerns that the modified retrospective approach is too restrictive. Those respondents continued to suggest the Board permit an entity more optionality and flexibility generally when applying the modified retrospective approach, rather than providing specified modifications. Some also suggested the Board provide additional specific transition modifications and reliefs for entities applying the modified retrospective approach (for example, reliefs from the retrospective application of the annual cohort requirement and the requirement for interim financial statements), as well as transition reliefs within the full retrospective approach.

Staff recommendation

After analysing the issues raised in the feedback to the ED, the staff recommended the Board amend the transition requirements in IFRS 17 to:

• a) extend the modification in the modified retrospective approach and relief in the fair value approach relating to assessments that would have been made at inception or initial recognition to include the assessment of whether an investment contract meets the definition of an investment contract with discretionary participation features.
• b) amend the proposed modification in the modified retrospective approach for reinsurance contracts held when underlying insurance contracts are onerous.
• c) add a modification to the modified retrospective approach for entities that make an accounting policy choice not to change the treatment of accounting estimates made in previous interim financial statements.

For more detail on the staff’s recommendations please refer to the agenda paper.

Board decision

There was no discussion on this paper. The 12 Board members present supported the staff recommendations (a) and (b) with 12:0 and (c) with 11:1.

Other topics raised by respondents to the Exposure Draft Amendments to IFRS 17 (Agenda Paper 2F)

Many respondents to the ED commented on areas of IFRS 17 that the Board did not consider when developing the ED.

Staff recommendation

The staff analysed those issues and recommended the Board:

• a) amend IFRS 17:B66(f) to resolve an inconsistency between that paragraph and IFRS 17:B65(m). After that amendment, an entity would apply IFRS 17:B65(m) to include in the fulfilment cash flows the income tax payments and receipts that are specifically chargeable to the policyholder under the terms of an insurance contract.
• b) retain, unchanged, the requirements in IFRS 17:B113(b). That paragraph requires an entity to adjust the CSM of insurance contracts with direct participation features for the changes in the effect of the time value of money and financial risks not arising from the underlying items.
• c) not add any new requirements to IFRS 17 or publish any educational material relating to the accounting for insurance contracts that change their nature over time.
• d) retain, unchanged, the requirements in IFRS 17 relating to any other topics raised by respondents.

Board decision

There was no significant discussion on this paper. The Board voted in favour of the staff recommendations with 12:0 votes (2 absent).