Download IASB Update Note No. 6 – Peter Wright and Nick Dexter This is the

IASB Update Note No. 6 – Peter Wright and Nick Dexter
This is the sixth in a series of Notes covering the deliberations of the IASB on the issue of an insurance
standard to replace IFRS 4. It is the first dealing with the period following publication in July 2010 of the
Exposure Draft of the standard (“The ED”). The IASB has discussed the standard at a large number of
meetings in 2011 to date, in some cases as often as three times a month, and the majority of these
discussions have been held jointly with the US FASB. This note covers all such meetings up to and
including that held on 31 May/1June.
It had been the intention to publish the final standard by the end of June 2011, but this timetable has now
slipped. This is unfortunate as the composition of the board (including its chairman) changes at the end
of June and a new board may wish to revisit some of the tentative conclusions already reached, thus
further delaying the finalisation of the standard.
It is still the target to complete board discussions and issue the standard by the end of 2011, but in view
of the changes from the proposals in the ED (see below) there may be a need for formal re-exposure or
at least making a draft of the standard available for what the IASB calls “additional outreach”. Clearly
either re-exposure or additional outreach would make the target unachievable.
The FASB is somewhat behind the IASB in the due-process for the production of a standard, having only
issued a discussion paper in 2010 rather than an exposure draft. However, the FASB is aiming to finalise
its standard by the end of 2012. The two boards will then consider how best to address any differences
which may exist between their respective standards. Both boards accept that the insurance industry
must be given some years from the issue of a standard before its adoption can become mandatory.
The more material tentative conclusions reached by the board over 2011 to 1 June are as follows:
Allowance for acquisition costs
The ED had limited the allowance to be made in the calculation of fulfilment cash flows to the acquisition
costs which are incremental at a policy level. The board concluded that the allowance should be
expanded to cover direct acquisition costs applicable at a portfolio level, which is the normal standard for
all expenses included in cash flows. It was also accepted (although this conclusion was not supported by
FASB) that the allowance for acquisition costs could include those related to unsuccessful selling efforts.
Similar rules will apply for setting the DAC asset for short term business.
Asset values
It was concluded that the insurance model would be predicated on the assumption that financial assets
backing insurance contacts would be measured in accordance with IFRS 9 Financial Instruments. It was
confimed that there are no current plans to change the classification and measurement approach set out
in IFRS 9. However, the FASB is currently redeliberating its classification and measurement requirements for
financial instruments and once FASB redeliberations are complete, the IASB plans to seek views on the FASB
model.
Other project axioms and assumptions that are being used to underlie the development of the project’s
direction are listed in the IASB’s February 2011 Update which can be found on its website www.ifrs.org
under the heading ‘Keeping Informed’.
Discount Rate
The approach set out in the ED (including the absence of an allowance for ‘own credit risk’) was
confirmed, but the need to use discounting in the assessment of the pre-claims liability for short term
business is to be reconsidered. It was also decided that additional guidance would be provided on when
the impact of discounting on short tail claims provision be deemed to be immaterial.
It has been decided not to prescribe a method for determining the discount rate but instead to provide
guidance regarding matters to be considered in determining the rate. The current recommendation is a “topdown” approach, which calculates a discount rate by reference to an asset rate adjusted for various items
including a market risk premium for expected and unexpected credit losses that would not be reflective of the
characteristics of the liability. It is expected that the following key principles will apply:
(a) An insurer should determine an appropriate yield curve based on current market information and
reflecting current market returns either for the actual portfolio of assets the insurer holds or for a replicating
portfolio.
(b) The insurer should use an estimate that is consistent with the IASB’s guidance on fair value
measurement
(c) Cash flows of the instruments should be adjusted for timing and risk differences between the assets and
the liabilities
(d) No adjustment need be made for remaining differences between the liquidity inherent in the insurance
contract liability and asset cash flows.
Recognition of gain and loss at inception
The approaches to recognition of gains and losses at inception as set out in the ED were confirmed.
Locking in the discount rate
The approach to locking in discount rates set out in the ED was confirmed.
Objective of the risk adjustment
It was decided to amend the objective of the risk adjustment to be “the compensation the insurer requires
to bear the risk that the ultimate cash flows could exceed those expected”. This removes the element of
the previous definition which some had criticised as introducing an element of ‘exit value’ into the building
block for contract provisions. In practice, it would seem that the change in wording makes little practical
difference to the end result.
The IASB re-confirmed its commitment to a separate risk margin whilst the FASB continues to support a
combined risk and residual margin. The two boards wish to explore whether the two approaches could
be made comparable through disclosure.
Contract boundary
The previous definitions contained in the ED meant that to avoid a renewal being treated as a new
contract, with all the resultant consequences for the measurement of fulfilment value, it was necessary to
be able to reassess the risk posed by each individual policyholder. This is now to be replaced by a test
applied at a portfolio level. This change will be of particular benefit to medical expenses business where
renewal premiums are assessed on a portfolio basis.
Definition of an Insurance contract
The definition and guidance contained in the ED have been confirmed.
Measurement of policyholder participation
It was tentatively decided that the measurement of the fulfilment cash flows should be consistent with the
IFRS treatment of the assets, liabilities and other performance related items in the financial statements.
To avoid creating accounting mismatches, an insurer should reflect any asymmetric risk sharing between
insurer and policyholder (eg “burn through costs”) in the contractually linked items arising from a minimum
guarantee using a current measurement basis
Changes in the insurance contract liability should be recorded in either profit or loss or other
comprehensive income consistent with the presentation of changes in the linked items. These same
rules should also apply to unit-linked business.
Unbundling
It was tentatively decided that an explicit account balance should be unbundled but an insurer shall not
unbundle an implicit account balance. Further work will be carried out on determining what constitutes
an explicit account balance; in particular whether this exists only where a policyholder can withdraw the
account balance without loss of insurance coverage.
Reinsurance
It was recommended that a reinsurance contract is deemed to transfer significant insurance risk if substantially
all of the insurance risk relating to the reinsured portions of the underlying insurance contracts is assumed by
the reinsurer. When an operating entity within a consolidated group transfers risk to an independent insurer
and this insurer passes the risk back to the consolidated group, the arrangement is to be treated as one
contract when determining significant risk transfer
When the amount recoverable on an underlying insurance contract is independent of the losses and amounts
recoverable on other underlying insurance contracts, reinsurers recognise reinsurance contracts applying the
recognition criteria for the underlying contracts. But it was recommended that a cedant would recognise a
reinsurance asset only when the underlying contract is recognised unless the amount paid under the
reinsurance contract reflects aggregate losses of the portfolio – then a reinsurance asset would be recognised
when the reinsurance contract coverage period begins.
It was recommended that the treatment of gains and losses at commencement on reinsurance contracts should
follow that for the underlying contracts, except that if there is a loss and the coverage provided by the reinsurance
contract is for future events, then the cedant should establish that amount as part of the reinsurance
recoverable, representing a prepaid reinsurance premium, and should recognise the cost over the coverage
period of the underlying insurance contracts.