Highlighted was the publication of a draft comment letter to the IASB responding to Exposure Draft Regulatory Deferral Accounts.

In addition, the newsletter contains discussion on the following topics:

• Conceptual framework
• Leases ED
• Accounting Standards Advisory Forum
• EFRAG’s Proactive Projects
• Insurance project
• Financial Instruments: Expected Credit Losses ED
• EFRAG/OIC Proactive Project Business Combinations Under Common Control
• IFRIC 21 Levies
• Revenue recognition project
• IASB Request for Information Rate-Regulated Activities

Click for the EFRAG Update (link to EFRAG website).

The ED, published on 20 June 2013, proposes a comprehensive accounting model for insurance contracts.  It establishes principles to report the nature, amount, timing and uncertainty of cash flows from insurance contracts.

The field-test initiated by EFRAG and the major national standard-setters in Europe is meant to assist in the understanding of the implementation, impact, and costs and benefits of applying the proposed guidance. The field-test will also assess the understandability and usefulness of the information, including the proposed disclosures that will result from applying the requirements.

The field-test is accompanied with a questionnaire. It will start on 10 July 2013 and completed questionnaires should be returned by 11 October 2013. Entities wishing to participate in the field-test are asked to contact their national standard-setters (where applicable) or EFRAG. Copies of the questionnaire will be sent to them.

Further information is available through the press release on the EFRAG website.

The subject matter of the contract is to provide the European Commission with a general analysis of the impacts of 8 years of use of international financial reporting standards (IFRSs) in the EU for preparers and users of financial statements from the private sector. The study will include an overall assessment of whether the Regulation 1606/2002 of the European Parliament and the Council ('IAS Regulation') has met the two-fold initial objectives of ensuring a high degree of transparency and comparability of the financial statements of European companies and an efficient functioning of the market, in comparison with the situation before IFRS implementation in 2005.

It will also include a cost-benefit analysis and an assessment and analysis of the benefits and drawbacks brought by the IAS Regulation for different stakeholder groups.The study will support the Directorate General Internal Market and Services' objective to proceed with the evaluation of the IAS Regulation, to assess whether the implementation of the IFRSs in the EU has provided the expected benefits. It will determine whether the initial objectives of the IAS Regulation are still relevant and it will identify areas for improvement, if needed.

Please click for more information on the EU Comission website (available in all official languages of the EU).

The nine-page report contains the following three key policy recommendations, to promote further use of IFRSs in Japan:

1. Ease eligibility to use IFRSs voluntarily
   The BAC has concluded that two of three existing eligibility criteria to use IFRSs should be eliminated. The current requirements 1) that an entity shall be a public company and 2) that an entity is conducting financing or business activities internationally, would be deleted. The remaining criteria is that an entity has established a system to ensure appropriateness of consolidated financial statements in accordance with IFRSs. This initiative will make it possible for entities 1) that are going public and 2) that have no larger foreign subsidiaries to use IFRSs and thus will contribute to significant increase in the population of entities that are permitted to use IFRSs in Japan.
2. Introduction of 'endorsed IFRSs'
   In addition to maintaining the voluntary use of IFRSs as issued by the IASB in Japan, a new process of endorsement that may result in amendments to IFRSs is recommended to be introduced. The endorsement process would be conducted by the Accounting Standards Board of Japan (ASBJ), the local accounting standard setter, on individual standard of IFRSs, followed by approval by the FSA, separately from the existing designation process. In endorsing an individual standard, for the public interest and investor protection, three criteria would be considered: 1) basic thinking toward accounting standards, 2) practical burden (costs of preparation outweighing benefits), and 3) coordination with related institutions (application is difficult or too costly in light of industry regulation). The report states that any amendments to IFRSs should be limited to items that can be reasonably explained to international constituents, and that such endorsed standards would not be mandated for use. The BAC report expresses its expectation that the ASBJ act swiftly on endorsement, based on above key features of the new process.
3. Simplification of disclosure requirements in a separate financial statement under Japanese GAAP
   The BAC concluded that certain disclosures currently required in separate financial statements under the Japanese Financial Instruments and Exchange Act be simplified by means such as substituting them by similar ones under the Companies Act, except for entities that do not disclose consolidated financial statements or those in regulated industries for which other industry regulators are to be consulted. The report also noted that the enhanced or supplemental disclosure needs to be considered in responding to concerns over a decreasing level of disclosure in a separate financial statements.

In addition to above three key initiatives, the report also touched on the following in connection with the use of IFRSs:

1. Composition of a new stock price index
   It is expected that stock exchanges would consider the use of IFRSs in selecting public companies that comprise a new stock price index to be developed.
2. Mandatory use of IFRSs
   The report notes that it is not the appropriate time to decide on mandatory use of IFRSs in Japan. Discussions shall continue among constituents, based on future review of the results of the initiatives in the report (including the increase in IFRS users in Japan) and in light of the international environment such as developments in the United States and standards development by the IASB.

The issuance of the report is understood as the concluding event to this round of policy debates around use of IFRSs in Japan at the BAC level. It is expected that relevant parties such as FSA and ASBJ will act upon this report and will propose changes to regulations etc. in due course.

After these measures are taken as set out in the report, Japanese public companies may be able to use one out of four sets of accounting standards in their consolidated financial statements (subject to certain eligibility requirements):

1. IFRS as issued by the IASB
2. endorsed IFRSs
3. Japanese GAAP, or
4. US GAAP.

Click for:

• Access to the BAC final report (link to FSA website, in Japanese)
• English language translation of the final report (link to FSA website)
• Our earlier story on the June BAC meeting
• Handouts from the 19 June 2013 BAC meeting (link to FSA website, Japanese only)
• Webcast from Deloitte (Japan) discussing the report (in Japanese)
  

Click through for direct access to the notes:

Wednesday, 19 June 2013

• Comprehensive Review of the IFRS for SMEs (IASB only)
• IFRIC Update (IASB only)
• Annual improvements: Cycle 2011-2013 (IASB only)
• Annual improvements: Cycle 2010-2012 (IASB only)

You can also access the preliminary and unofficial notes taken by Deloitte observers for the entire meeting.

The world of insurance has always been a difficult one for financial reporting. It is often said that financial reporting in the insurance business is largely lost inside what has become popularly referred to as a black box. No one quite knows what is inside and comparability is in short supply. 

Why so? It is because, at present, the industry operates under a patchwork quilt of accounting practices, some of which date back to the days before IFRSs were introduced and which were, in effect, stitched together and grandfathered when IFRS 4 was introduced as an interim measure.

This is why trying to enable transparency in both profit reporting and the estimation of the inherent uncertainty of insurance cash flows was never likely to be easy. Regulators have warned that in an era of low interest rates some of the insurance industry may still be working off estimations of a return on assets which will not be achieved. But, under the current system of financial reporting, it may not be obvious.

At its heart this new exposure draft introduces change in limited areas with the IASB sticking with its previously exposed ‘building blocks’ approach, which deals with the measurement of the insurance contract. By requiring the measurement of the liability using current interest rates the proposed new standard will give investors and policy holders a much clearer and more reliable view of what is happening. It is fundamental. But of course it is not just about measurement. Matching assets and liabilities is a key feature of an insurance business and a faithful representation of the extent to which an insurer achieved that is obviously very important.

The new model will be a big change to implement and it will all take time to make this work. Extensive new data will be required for the transition, and for measurement in the future. Investment in technology is likely to be required as the result of the need for actuarial and accounting systems to be enhanced or developed to cope with the new financial reporting demands.

This is why the IASB is planning to give everyone around three years leeway from the publication of the final standard to get their implementation straight. But wiser souls may find that early planning for what is to come will make life easier in the long-term. Not that different from the basis of insurance itself.

Click for:

• More information on Exposure Draft ED/2013/7 Insurance Contracts
• Deloitte IFRS Podcast — Revised insurance contracts proposals interview
• IAS Plus project page on the IASB’s insurance project

Background

The IASB originally issued Exposure Draft ED/2010/8 on 30 July 2010 in an effort to create a single standard that could apply to all insurance contract types on a consistent basis, addressing recognition, measurement, presentation and disclosure requirements for insurance contracts.

The objective of the original as well as the revised ED is establishing the principles that insurers should apply to report the nature, amount, timing and uncertainty of cash flows from insurance contracts. The scope of both EDs extended to all insurance contracts that an insurer issues and all reinsurance contracts that it holds as well as to investment contracts with a discretionary participation features that an insurer issues. However, the revised ED also contains list of contracts to which it does not apply.

According to the ED, a building blocks approach is used for measuring Insurance contracts. Insurance contract liabilities are determined as the sum of a probability-weighted estimates of cash flows plus risk adjustment liability that measures the uncertainty in the amount and timing of the cash flows plus a contractual service margin liability that represents unearned profit in a contract.

Specific Areas for comment

Based on the feedback received on ED/2010/8, the IASB and FASB have redeliberated the proposals and developed a revised exposure draft focussing on five key aspects of insurance contract accounting:

1. Adjusting the unearned profit from insurance contracts
2. Accounting for contracts that specify a link to the returns on underlying items that the entity is required to hold
3. Presentation of insurance contract revenue and expenses
4. Presentation of interest expense between profit or loss and the other comprehensive income
5. Full retrospective approach to transition

I. Adjusting the unearned profit from insurance contracts 

At initial recognition, the contractual service margin is calculated at an amount equal and opposite to the sum of:  (a) the amount of the fulfilment cash flows for the insurance contract at initial recognition; and (b) any cash flows that are paid (received) before the insurance contract is initially recognised.

Subsequently, the contractual service margin will be released to profit or loss over the coverage period as the insurer fulfils its obligations. The contractual service margin will also be adjusted prospectively for changes in future expected cash flows relating to future coverage. No limit has been imposed on the amount by which the contractual service margin can increase as a results of these changes. However, if the changes are so adverse that would cause the contractual service margin to become negative, the contract becomes onerous.  In this case, any changes in the excess of the carrying amount of the contractual service margin at the date of change should be recognised immediately in profit or loss.

The insurer is not permitted to adjust the contractual service margin for changes in estimates of incurred claims, that is, if coverage has already expired and for changes in risk adjustment.

II. Accounting for contracts that specify a link to the returns on underlying items that the entity is required to hold

For participating contracts where the contractual cash flows are linked to the returns of an underlying pool of assets, the insurer is required to measure and present those cash flows in the same way the assets backing those liability are measured and presented.

Three possible cash flow behaviour in a participating contracts and related accounting treatment:

1. Where the contractual cash flows vary directly with the underlying items
   •  Measure and present these cash flows by reference to the assets’ carrying amount
   •  No adjustment made to contractual service margin
2. Where the contractual cash flows vary indirectly with the underlying items
   •  Measure these cash flows using the general building blocks model, discounted at a current discount rate
   •  Adjustment to contractual service margin will be made prospectively
   •  Interest-related changes are always recognised in the profit or loss
3. Where the contractual cash flows do not vary with the underlying items
   •  Measure these cash flows using the general building blocks model as required by the draft Standard

In all three cash flow behaviour scenarios, the insurer is required to recognise changes in the risk adjustment liability in profit or loss.

III. Presentation of insurance contract revenue and expenses

The insurer is required to recognise revenue to each period in proportion to the reduction in liability over the remaining coverage period.

To get to the new revenue amount an insurer needs to split cash outflows into those relating to future coverage from those associated with past claims yet to be settled. The amounts of cash outflows associated with the coverage that are expected in a particular period are added to the margin amounts described above to get the insurance revenue amount. The actual cash outflows, for example, actual benefits and expenses, are reported as insurance expenses.

These revenue and expense amounts need to have one final adjustment. If they include cash flows that would have been paid to policyholders in any event, such amounts must be disaggregated from the insurance revenue and expense lines because they represent deposit components.

IV. Presentation of interest expense between profit or loss and the other comprehensive income

The insurer is required to split the insurance contract interest expense into two components:  the component that is based on historical discount rates that were market consistent when the contract was sold will be recognised in profit or loss while the interest expense derived from current interest rates will be presented in the other comprehensive income.

For participating contracts, the presentation determined under the mirroring approach will always take precedence over the OCI solution.

V. Full retrospective approach to transition  

Insurers are required to apply the requirements of the proposed standard as if they have always been effective.

The revised ED has provided some practical expedience and simplifications:

• Where a full restatement of the contractual service margin is impracticable, the insurer is allowed to estimate the contractual service margin using all the objective information that is reasonably available. In addition, insurers are required to make use of hindsight and are not required to identify all changes in estimates of cash flows that occurred between initial recognition and transition date.

• As a starting point, insurers are required to determine the locked-in discount rates retrospectively based on adjusting a market-observable interest rate yield curve for at least the past three years. If there is no market-observable yield, the discount rates can be determined using the closest market-observable yield curve. The same market-observable reference point must be used to determine the locked-in discount yield-curve for each of the years in the retrospective period.

• The revised ED also requires reduced disclosure requirements. Insurers are not required to  disclose previously unpublished information about claims development information that occurred five years before the end of the first financial year in which the standard is applied, which would normally be required for ten years. Also, insurers are not required to disclose the amount of the adjustment for each financial statement line items that is affected, as required by IAS 8.

The revised ED also provides for the redesignation of financial assets at transition. At the beginning of the earliest period presented, an insurer is permitted but not required to re-designate financial assets to be measured at FVTPL if to do so would eliminate or significantly reduce an accounting mismatch. An insurer is required to revoke previous designations at FVTPL if the accounting mismatch that led to the previous designation is now eliminated.

Effective date

The ED does not contain a proposed effective date as the IASB will decide on the effective date only upon completion of its redeliberations. The expectation is currently that the standard will become effective approximately three years after being published in its finalised form.

Comment deadline

Comments on the five specific areas close on 25 October 2013.

Additional information

• Press release (link to IASB website)
• Access to ED/2013/7 Insurance Contracts (link to IASB website)
• Snapshot explaining the proposals (link to IASB website)
• Information about an upcoming IASB webcast on 25 June (link to IASB website)
• Deloitte IFRS Podcast — Revised insurance contracts proposals interview
• IAS Plus project page on the IASB's project on insurance contracts

Note: On 23 July 2013, the IASB released an error note (link to IASB website) which included a number of corrections to ED/2013/7.  The PDF versions of the ED have been updated on the IASB's website, but printed versions of the exposure draft have not been updated.