International Accounting
Standards Board
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The IASB’s project on
Insurance Contracts
Peter Clark
Senior Project Manager
International Accounting Standards Board
www.iasb.org.uk
May 2006
Overview
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Insurance contracts phase I
 IFRS
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International Accounting
Standards Board
4 Insurance contracts
IAS 39
Insurance contracts phase II
Convergence
May 2006
IFRS 4
Insurance Contracts
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International Accounting
Standards Board
Objectives
Scope
Definition of insurance contract
Recognition and measurement
Disclosure
May 2006
IFRS 4 objectives
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International Accounting
Standards Board
Limited improvements for 2005
Avoid
 delay
to phase II
 changes that phase II might reverse
May 2006
Scope
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International Accounting
Standards Board
Insurance and reinsurance
contracts issued
Reinsurance contracts held
No exemption from other IFRSs
 IAS
39 covers financial assets,
financial liabilities (‘investment
contracts’) and derivatives
May 2006
Definition of
insurance contract (1)
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International Accounting
Standards Board
A contract under which one party
(the insurer) accepts significant
insurance risk from another party
(the policyholder) by agreeing to
compensate the policyholder if a
specified uncertain future event
adversely affects the policyholder
May 2006
Definition of
insurance contract (2)
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International Accounting
Standards Board
Significant insurance risk
 Significant
additional benefits in any
scenario (that has commercial
substance)
 Not a percentage test
 Contract by contract
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Unbundling a deposit component
May 2006
Recognition and
measurement
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International Accounting
Standards Board
Exemption from hierarchy in IAS 8
Reinsurance
Discretionary participation features
May 2006
IAS 8
hierarchy (1)
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International Accounting
Standards Board
Criteria to use in developing an
accounting policy if no IFRS or
Interpretation applies specifically
 Relevance
 Reliability
 Other
IFRSs
 Framework
May 2006
IAS 8
hierarchy (2)
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International Accounting
Standards Board
Temporary exemption in phase I for:
insurance (or reinsurance) contracts issued
 reinsurance contracts held
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BUT
Do not change accounting policy unless
result is more relevant and reliable
 Limited changes required (due to hierarchy)
 May continue some existing practices, but not
introduce them
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May 2006
Limited changes
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International Accounting
Standards Board
No catastrophe or equalisation
provisions
Liability adequacy test
Reinsurance
Derecognition of insurance liabilities
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Only when the obligation is discharged or
cancelled or expires
May 2006
Limited changes:
Reinsurance
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International Accounting
Standards Board
Reinsurance contract
 No
special definition
(insurance between two insurers)
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No offsetting
Impairment test
 Incurred
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loss model (as in IAS 39)
Disclose gains at inception
May 2006
Some existing
practices may continue
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International Accounting
Standards Board
May continue, but not introduce:
 non-discounting of insurance liabilities
 off-market measurement of contractual
rights to investment management fees
 non-uniform accounting policies for
insurance liabilities of subsidiaries
 excessive prudence
 future investment spreads (rebuttable
presumption)
May 2006
Discretionary
participation features (1)
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International Accounting
Standards Board
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What are discretionary participation
features (DPF)?
Insurance contracts with DPF
Investment contracts with DPF
Premiums
Profit or loss attributable to DPF
May 2006
Discretionary
participation features (2)
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International Accounting
Standards Board
Contractual right to additional benefits:
 likely to be significant portion of total
benefits
 amount or timing contractually at the
discretion of the issuer, and
 contractually based on:
performance of specified contracts
 returns on specified assets, or
 profit or loss
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May 2006
Insurance contracts
with DPF
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International Accounting
Standards Board
Guaranteed element
 Policyholder
has unconditional right
 Must classify as liability
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Discretionary participation feature
 May
classify as liability, equity or split
 Do not show as mezzanine
May 2006
Investment contracts
with DPF
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May classify whole contract as
liability
 If
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International Accounting
Standards Board
so, apply liability adequacy test
May classify part or all of DPF in
equity
 Reported
liability not less than IAS 39
measurement of guaranteed element
May 2006
Contracts with DPF:
Premiums
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International Accounting
Standards Board
May report the whole premium as
revenue
 Even
for investment contracts
 Even if part or all DPF is classified in
equity
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Portion of profit or loss attributable
to equity portion (if any) of DPF
 not
expense, but allocation of profit
May 2006
Profit or loss
attributable to DPF
Profit for the period
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International Accounting
Standards Board
XXX
Attributable to:
Equity holders of the parent
XXX
Equity component of DPF
XXX
Minority interest
XXX
XXX
May 2006
Disclosure
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International Accounting
Standards Board
Reported amounts
Amount, timing and uncertainty of
cash flows, eg
 Sensitivity
analysis
 Claims development
May 2006
Financial Instruments:
IAS 39
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International Accounting
Standards Board
Financial assets
Financial liabilities
 ‘investment
contracts’
May 2006
Financial assets
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Economic mismatch or accounting
mismatch?
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International Accounting
Standards Board
NB disclosure implications
May reclassify some or all financial
assets as ‘at fair value through P&L’
May switch to current discount rates for
some or all insurance liabilities
‘Shadow accounting’
May 2006
‘Investment’
contracts
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International Accounting
Standards Board
IAS 39 applies
 Premiums = deposit receipt, not revenue
 Asset cash flows do not affect liability
measurement
 Service fee revenue (see IAS 18 Revenue)
Measure at:
 Fair value, or
 Amortised cost
May 2006
Phase II
Key objectives
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International Accounting
Standards Board
up to date estimates of:
cash flows
 an appropriate price for those cash flows
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use observable market inputs, where they
exist
a measurement attribute that users can
understand, as a basis for economic
decisions
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not just a computation
May 2006
Ingredients to meet
those objectives
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International Accounting
Standards Board
estimates of future cash flows
time value of money
a margin
May 2006
Future cash flows
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International Accounting
Standards Board
Current estimates
Unbiased
Probability-weighted (expected
value)
Principles, not detailed guidance
May 2006
Time value of money
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International Accounting
Standards Board
Even for non-life
Current market discount rates
Expected returns on actual assets
are not relevant (unless they affect
the liability cash flows)
May 2006
Margin
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International Accounting
Standards Board
As required by market participants,
for
 bearing
risk (risk margin)
 other services (profit margin)
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Not intended as a shock absorber
How calibrated?
 Gain
or loss at inception?
May 2006
A measurement attribute
users can understand?
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International Accounting
Standards Board
Current exit value:
 amount the insurer would expect to
have to pay today to another entity if
it transferred all its remaining
contractual rights and obligations
immediately to that entity
 … excluding any payment for other
rights and obligations
May 2006
Current exit value
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International Accounting
Standards Board
Best meets the objectives discussed
earlier
Relevant and reliable information to help
users with economic decisions
Does not imply that an insurer can, will or
should actually transfer the liability to a
third party
In most cases, insurers cannot transfer
the liabilities and do not want to do so
May 2006
Advantages of the
approach
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International Accounting
Standards Board
information on amount, timing and
uncertainty of contractual cash flows
consistent approach to changing estimates
of cash flows
coherent way to resolve new issues
consistency with IFRSs on other liabilities
(especially IAS 37)
margins are explicit and reflect release from
risk
clear reporting of economic mismatches
May 2006
Other points (1)
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Unearned premium:
 sometimes
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International Accounting
Standards Board
a reasonable proxy
Acquisition costs
 Expense
(deferral would be double
counting)
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Unit of account?
May 2006
Other points (2)
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International Accounting
Standards Board
Focus on contractual rights and
obligations
Embedded options and guarantees
Policyholder cancellation options
Participating contracts
Investment contracts
May 2006
Embedded Value?
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Increasingly common (life)
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International Accounting
Standards Board
Largely unregulated
Some similarity with current exit value
BUT
 includes future investment returns
 capital lock-in
 off-market measurement of contractual rights
to investment management fees
May 2006
Other relevant projects
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International Accounting
Standards Board
Conceptual Framework
Revenue
Liabilities / equity
Performance reporting
Financial instruments
May 2006
Phase II timetable
Discussion paper
Q4 2006
Exposure Draft
2008
Standard
2009
Implementation
?
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International Accounting
Standards Board
May 2006
Convergence –
general
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A high priority
SEC ‘roadmap’
 eliminate
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International Accounting
Standards Board
reconciliation to US GAAP?
Memorandum of Understanding
between the IASB and FASB
A two-way process
May 2006
Convergence –
insurance contracts
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International Accounting
Standards Board
A ‘modified joint’ project. FASB expects :
to issue Discussion Paper (not deliberated)
 to review the responses in assessing whether
to join in a joint project
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US mini projects on insurance:
Risk transfer
 Financial guarantees
 Life settlements
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May 2006
Convergence –
insurance contracts
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International Accounting
Standards Board
A ‘modified joint’ project. FASB expects:
to issue Discussion Paper (not deliberated)
 to review the responses in assessing whether
to join in a joint project
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US mini projects on insurance:
Risk transfer
 Financial guarantees
 Life settlements
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May 2006
Know More about IASB
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International Accounting
Standards Board
Our website www.iasb.org
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May 2006