The IASB and FASB continued their discussions on insurance contracts by considering project axioms and assumptions, the discount rate for non-participating contracts, the cash flows included in the model, explicit rate adjustment, the recognition of gain or loss at inception, unlocking the residual or composite margin and a refresher on the presentation models.
Project axioms and assumptions
The boards tentatively confirmed the axioms and assumptions (listed below) that will underlie the development of the project's future direction. Those axioms and assumptions will provide a common understanding of the factors that will influence the staff in their analysis and will be a starting point for further decisions. (The observer notes for this session list some areas in which the staff plan specific follow-up work in some areas covered by the assumptions.) In addition, the IASB noted that the model would be developed on the assumption that the financial assets backing the insurance contracts would be measured in accordance with IFRS 9 Financial Instruments. The IASB has no current plans to change the classification and measurement requirements in IFRS 9. (Note: for a more detailed description of the project to replace IAS 39 see the project summary by clicking here.
- An ideal measurement model would report all economic mismatches (including duration mismatches) that exist and would not cause any accounting mismatches.
- An ideal accounting model should reflect both the intrinsic value and time value of options and guarantees embedded in insurance contracts.
- Money has a time value and an entity more faithfully represents its position when it measures its liabilities in a way that includes the time value of money.
- The boards will develop a standard for insurance contracts, rather than requiring current or proposed generic standards that might otherwise apply.
- The standard will deal with the accounting for insurance contracts from the perspective of the insurer, and not for the assets backing the contracts or for the entities that issue those contracts. For the IASB, the financial assets backing the contracts would be measured in accordance with IFRS 9.
- The boards will develop a standard based on an accounting model that regards insurance contracts as creating a bundle of rights and obligations that work together to generate a package of cash inflows and outflows.
- In general, the final standard will measure insurance contracts at the portfolio level.
- The accounting model should be based on current estimates, rather than carrying forward estimates made at contract inception and inputs that are consistent with observable market data, where available.
- The cash flows incorporated in the measurement of the insurance liability are those that will arise as the insurer fulfils the insurance contract.
- The model will use the expected value of future cash flows rather than a single, most likely outcome.
- The measurement of the liability will not reflect changes in the insurer's own credit standing.
All IASB and FASB members supported these axioms and assumptions, noting that the axioms and assumptions will be revised if necessary.
Discount rate for non-participating contracts
The boards tentatively decided to confirm the approach in the IASB's exposure draft (ED) Insurance Contracts and the FASB's discussion paper (DP) Preliminary Views on Insurance Contracts that the objective of the discount rate is to adjust the future cash flows for the time value of money and to reflect the characteristics of the insurance contract liability.
The boards tentatively decided not to prescribe a method for determining the discount rate and that the discount rate should:
- be consistent with observable current market prices for instruments with cash flows whose characteristics reflect those of the insurance contract liability, including timing, currency and liquidity, but excluding the effect of the insurer's non-performance risk;
- exclude any factors that influence the observed rates but that are not relevant to the insurance contract liability (eg risks not present in the liability but present in the instrument for which the market prices are observed, such as any investment risk taken by the insurer that cannot be passed to the policyholder); and
- reflect only the effect of risks and uncertainties that are not reflected elsewhere in the measurement of the insurance contract liability.
All IASB and FASB members supported those decisions.
The boards plan to explore in a future meeting whether a practical expedient should be allowed for determining the discount rate in specific circumstances.
Cash flows included in the model
The boards discussed the proposed requirement that an insurer should measure an insurance contract using an explicit, unbiased and probability weighted estimate (ie expected value) of the future cash outflows, less future cash inflows that will arise as the insurer fulfils the insurance contract.
In relation to expected value, the boards tentatively decided to clarify:
- that the measurement objective of expected value refers to the mean that considers all relevant information; and
- that not all possible scenarios need to be identified and quantified, provided that the estimate is consistent with the measurement objective of determining the mean.
All IASB and FASB members supported the decision.
In relation to costs included in fulfilment cash flows the boards tentatively decided:
- to clarify that all costs that an insurer will incur directly in fulfilling a portfolio of insurance contracts should be included in the cash flows used to determine the insurance liability, including:
- costs that relate directly to the fulfilment of the contracts in the portfolio, such as payments to policyholders, claims handling, etc (described in paragraph B61 of the ED);
- costs that are directly attributable to contract activity as part of fulfilling that portfolio of contracts and that can be allocated to those portfolios; and
- such other costs as are specifically chargeable to the policyholder under the terms of the contract.
- to confirm that costs that do not relate directly to the insurance contracts or contract activities should be recognised as expenses in the period in which they are incurred;
- to provide application guidance based on IAS 2 Inventories and IAS 11 Construction Contracts; and
- to eliminate the term 'incremental' from the discussion of fulfilment cash flows that was proposed in the ED / DP (ie paragraph B61 of the ED).
The majority of IASB members (one voted against) and the majority of FASB members (one voted against) supported this decision.
Explicit risk adjustment
The IASB's ED proposed to include an explicit risk adjustment in the measurement of an insurance liability. The FASB's DP did not include an explicit risk adjustment in the measurement of an insurance liability. he boards tentatively decided that, if there are techniques that could faithfully represent the risk inherent in insurance liabilities, the inclusion of an explicit risk adjustment in the measurement of those liabilities would provide relevant information to users. The majority of IASB members (one voted against) and all FASB members supported this decision. The boards plan to consider in a future meeting:
- how insurers have determined a risk adjustment in practice;
- whether to recognise an explicit risk adjustment; and
- whether the residual or composite margin should be unlocked in a way that reflects changes in the insurance risk being borne by an insurer.
The recognition of gain and loss at inception
The boards tentatively confirmed the proposal in the ED and the DP that an insurer should not recognise any gain at inception of an insurance contract. The majority of IASB members (two voted against) and all FASB members supported this decision.
The boards tentatively confirmed the proposal in the ED and the DP that an insurer should recognise any loss on day one immediately when it occurs, in profit or loss (net income). All the IASB and FASB members supported this decision.
Unlocking the residual or composite margin
The ED / DP proposed that the residual / composite margin would be locked in at inception and released in a profit and loss over time. The boards considered whether and how the residual or composite margin might be unlocked.
The boards were not asked to make any decisions on this topic.
Refresher on presentation models
The boards considered a refresher on the approaches to presentation that were considered when the ED and the DP were being developed, in order to provide background information for future board discussion.
The boards were not asked to make any decisions on this topic.
The boards will continue their discussion on insurance contracts at an additional meeting on 1 and 2 March 2011.