IFRS Newsletter: Insurance

16 Pages·2014·0.87 MB·English

Issue 42, July 2014
IFR S LSWEN RETE
INSURANCE
Having fne-tuned the
model for non-participating
contracts, the Board’s
focus will now shift
to the accounting
for participating
contracts, with these
redeliberations
expected to be
fnalised later

in 2014.
MOVING TOWARDS INTERNATIONAL
Joachim Kölschbach,
INSURANCE ACCOUNTING
KPMG’s global IFRS
insurance leader This edition of IFRS Newsletter: Insurance highlights the IASB’s
discussion in July 2014 on its insurance contracts project.
Highlights
Rate used for subsequent measurement of the contractual service margin
For non-participating contracts, the locked-in rate at inception of the contract would be used
for:
l    accreting interest on the contractual service margin; and
l    calculating the change in the present value of expected cash fows that adjust the contractual
service margin.
Changes in accounting policy
The requirements in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors would
be applied without modifcation to changes in accounting policy relating to the presentation of the
effects of changes in discount rates.
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DECISIONS MADE ON FOLLOW-UP ISSUES FOR
NON-PARTICIPATING CONTRACTS
The story so far … What happened in July 2014?
hT e current phase o f the insurance proej ct aw s launched At this months’ meeting, the oB ard discussed of llou- w p
in May 200,7 hw en the IA BS published a discussion issues on the model of r nonp- articipating contracts that it had
paper, Preliminary Views on Insurance Contracts. More identie� d at previous meetings.
recently, the IA BS ree- px osed its revised insurance
hT e oB ard analysed respondents ’ ef edbac k on the DE and
contracts proposals of r public comment by publishing the
considered hw ich rate to use of r :
epx osure dratf 2/DE 01 7/3 Insurance Contracts t( he )DE in
uJ ne2� 01.3 • accreting interest on the contractual service margin ; and
eW epx ect the IA BS to complete its redeliberations o f the • calculating the change in the present value o f epx ected
insurance proposals in 2014 and publish a n� al standard in cash o� sw that aduj st the contractual service margin.
the r� st hal f o f 201.5
hT e oB ard decided that the locek di- n rate at inception o f the
contract ow uld be used.
Interaction with other standards
In addition, the oB ard discussed the reuq irements of r changes
hT roughout its redeliberations, the oB ard has considered
in the accounting policy to present the eef f cts o f changes
hw ether the accounting of r insurance contracts ow uld
in discount rates in prot� or loss or in other comprehensive
be consistent iw th other eix sting or uf ture standards,
income ICO( ) and considered concerns that entities might
including the ne w revenue recognition standard – IFR1�S 5
Revenue from Contracts with Customers1. Much o f the change their accounting policies rf euq ently, or only to achieve
a af vourable accounting outcome. hT e oB ard decided that
guidance contained in the DE aw s designed to align iw th
the reuq irements in IA S 8 Accounting Policies, Changes in
the IAs’BS and the FAs’BS oj int proposals on revenue
Accounting Estimates and Errors ow uld be applied iw thout
recognition.
modic� ation to changes in accounting policy relating to the
hT e oB ard has also considered many o f the decisions presentation o f the eef f cts o f changes in discount rates.
made in the ne w n� ancial instruments standard, IFR S 9
hT e oB ard also continued its discussions on the accounting
Financial Instruments – including the aw y in hw ich IFR S 9
of r participating contracts at an education session. hT e
might interact iw th the n� al insurance contracts standard
sta f f presented to the oB ard an eef f ctive yield approach of r
– because IFR S 9 iw ll cover a large maoj rity o f an insurers’
determining the interest epx ense to be presented in prot�
investments.
or loss as an alternative to the boo k yield approach that it
discussed at last months’ meeting. Most oB ard members
acnk olw edged the potential merits o f this approach and noted
that it aw s important to better understand its scope and
1 eS e our First Impressions : Revenue rf om contracts iw th mechanics, and ho w it ow uld compare iw th the boo k yield
customers. approach. oN decisions ew re made at the education session.
oH ew ver, the oB ard directed the sta f f to uf rther epx lore the
eef f ctive yield approach. hT e stas’f f agenda papers can be
of und online.
hT e oB ard iw ll decide at uf ture meetings hw ether – of r
participating contracts – entities ow uld be reuq ired or
permitted to present the eef f cts o f changes in discount rates
in ICO ; it iw ll also decide ho w to determine the interest
epx ense to be presented in prot� or loss.
Contents hT e oB ard iw ll continue its discussions on participating
contracts over the netx ef w months ; hoew ver, it has
substantially completed its redeliberations on the model
of r nonp- articipating contracts, subej ct to any changes
resulting rf om uf ture decisions on participating contracts. hT e
remaining other topics to be discussed at uf ture meetings
include transition and the eef f ctive date o f the n� al standard.
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RATE USED FOR SUBSEQUENT MEASUREMENT OF
THE CONTRACTUAL SERVICE MARGIN
For non- Accreting interest on the contractual service margin
participating
What’s the issue?
contracts, the
locked-in rate at hT e DE proposed that the locek di- n rate at inception o f the contract ow uld be used to accrete
interest on the contractual service margin. oS me respondents to the DE noted that a current rate
inception of the
should be used to accrete interest on the contractual service margin to:
contract would
be used for • be consistent iw th all other components o f the insurance liability ; and
accreting interest • avoid operational compleix ties and costs associated iw th tracik ng the locek di- n rates of r long-
duration contracts, particularly of r entities that choose to ree� ct changes in discount rates in
on the contractual
prot� or loss.
service margin.
What did the staff recommend?
hT e sta f f analysed the respondents ’ ef edbac k and believed that the use o f a locek di- n rate to
accrete interest on the contractual service margin ow uld be appropriate of r the of lloiw ng reasons.
Staff’s arguments for
Staff’s rationale
using a locked-in rate
It is conceptually Interest accretion should ree� ct the timing dief f rence betew en:
correct. • initial recognition o f the contract ; and
• the point in time hw en the service is provided,
rather than ree� cting the current price that the entity ow uld charge of r
the service at the reporting date.
In addition, using a locek di- n rate ow uld be consistent iw th IFR1�S 5
and ow uld treat the contractual service margin similarly to a
prepayment of r noni- nsurance services.
It is consistent with hT e contractual service margin ow uld :
other aspects of • be determined at inception o f the contract considering the time
the measurement value o f money ; and
approach for the
• not be subseuq ently aduj sted of r the eef f cts o f changes in
contractual service
discount rates.
margin in the ED.
oC nseuq ently, the contractual service margin at the reporting date
implicitly ree� cts the time value o f money as estimated at inception
o f the contract. Using a locek di- n rate to accrete interest on the
contractual service margin ow uld be consistent iw th that approach.
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Staff’s arguments for
Staff’s rationale
using a locked-in rate
It avoids hW en an entity chooses to present the eef f ct o f changes in discount
complexities that rates in ICO , the interest accreted on the contractual service margin
may arise from using determined by using a current rate ow uld need to be split betew en prot�
a current rate when or loss and ICO to treat the eef f cts o f changes in discount rates related to
the effects of changes cash o� sw and the contractual service margin consistently.
in discount rates are
hT is could be done by presenting:
presented in OCI.
• in proft or loss, the interest accreted at the locek di- n rate ; and
• in OCI, the dief f rence betew en interest accreted at the current rate
and the locek di- n rate.
oH ew ver, the amounts recognised in ICO ow uld not automatically
reverse to ez ro because the contractual service margin does not
euq al actual cash paid hw en the insurance liability is settled – i.e.
unliek the insurance liability, the contractual service margin does not
true up as cash o� w estimates change. As a result, the oB ard ow uld
need to determine ho w the amounts ow uld reverse rf om ICO .
hT e sta f f did not believe that the rate used to accrete interest on the contractual service margin
should depend on the entitys’ accounting policy of r presenting the eef f cts o f changes in discount
rates in prot� or loss or in ICO . Giving entities a choice o f hw ich rate to use ow uld result in dief f rent
amounts of r the insurance liability, depending on presentation choices, and thereof re ow uld
signic� antly decrease comparability betew en entities issuing insurance contracts.
As a result o f their analysis, the sta f f recommended that of r nonp- articipating contracts the locek d-
in rate at inception o f the contract be used of r accreting interest on the contractual service margin.
What did the IASB discuss?
oS me oB ard members epx ressed concerns about the operational compleix ties and costs o f
tracik ng locek di- n rates – in particular of r entities that choose to present the eef f cts o f changes
in discount rates in prot� or loss. hT ey suggested that entities be given an option to use locek d-
in rates or current rates. oH ew ver, the sta f f emphasised that using dief f rent rates ow uld result
in dief f rences in the measurement o f the insurance liability and in the recognition o f gains and
losses. oC nseuq ently, comparability betew en entities issuing insurance contracts ow uld be
signic� antly decreased. hT e sta f f also noted that one o f the reasons of r alloiw ng an option to
present the eef f cts o f changes in discount rates in prot� or loss or in ICO aw s that it aef f cts only
the presentation but not the measurement o f insurance contracts.
What did the IASB decide?
hT e oB ard agreed iw th the sta f f recommendation.
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For non- Calculating the change in the present value of expected cash
participating
fows that adjust the contractual service margin
contracts, the
What’s the issue?
locked-in rate at
inception of the hT e DE proposed that:
contract would
• the contractual service margin ow uld be aduj sted of r changes in the present value o f epx ected
be used. cash o� sw related to uf ture coverage and other uf ture services ; and
• the present value o f epx ected cash o� sw that aduj st the contractual service margin ow uld be
calculated using the rate at inception o f the contract.
oS me respondents to the DE believed that the proposals of r hw ich rate to use of r calculating the
change in the present value o f epx ected cash o� sw that aduj st the contractual service margin
ew re not clear and asek d of r claric� ation. tO hers disagreed iw th the use o f a locek di- n rate
because they believed that:
• the operational compleix ties and costs associated iw th tracik ng the locek di- n rates ow uld not be
uj stie� d ; and
• using a current rate ow uld better ree� ct the change in economic costs – some o f these
constituents ow uld preef r to aduj st the contractual service margin of r both the changes in
estimates o f uf ture cash o� sw and the eef f cts o f changes in discount rates.
What did the staff recommend?
hT e sta f f believed that using a locek di- n rate to calculate the change in the present value o f
epx ected cash o� sw that aduj st the contractual service margin ow uld separate the underrw iting
result rf om the investment result in a clearer aw y. hT ey argued that i f a current rate ew re used
of r calculating the change in the present value o f epx ected cash o� sw that aduj st the contractual
service margin, then some changes in discount rates that ought to be reported in the investment
result ow uld be reported in the underrw iting result through the release o f the contractual
service margin. hT e sta f f believed that the investment result over the lief o f the contract ow uld
not appropriately ree� ct the return on the investment activity and that this ow uld decrease the
2
comparability o f reported results betew en entities that issue insurance contracts.
2
Example
Fact pattern
• hT e contracts’ coverage period is v� e years.
• hT e policyholder pays a premium o f 1,07 0 at the beginning o f the coverage period.
• hT e epx ected claims at the end o f the coverage period are .398
• hT e discount rate at inception o f the contract is %5 and changes to 2 % at the end oe f Y ar 2.
• hT e ris k aduj stment is ez ro.
• At the end oe f Y ar ,3 the entity epx ects claims o f 1,03 ,7 rather than .398 hT e present value o f
the dief f rence is 6 73 applying the locek di- n rate o f ,%5 and 893 applying the current rate o f
2.% hT ese amounts ow uld aduj st the contractual service margin.
• hT e contractual service margin at inception o f the contract is 1,000 – i.e. present value o f
epx ected premiums o f 1,07 0 minus present value o f epx ected claims o f 07 0.
2 hT is eax mple is derived rf om the uJ ly sta f f paper 2 B Rate used to accrete interest and calculate the present
value of cash fows that unlock the contractual service margin.
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Reconciliation of the contractual service margin
Locked-in rate
Year 1 2 3 4 5 Total
pO ening balance 1,000 48 0 26 8 46 1,000
1
Interest accreted 05 42 43 4 2 132
Release o f contractual
2
service margin (210) (220) (232) (46) (48) (756)
hC ange in present value o f
epx ected cash o� sw - - )6 73( - - (376)
Closing balance 840 662 88 46 - -
Notes
1. pO ening balance o f contract ual service margin multiplied by the locek di- n rate o f 5 percent.
2. pO ening balance o f contract ual service margin plus interest accreted, divided by remaining coverage period.
Current rate
Year 1 2 3 4 5 Total
pO ening balance 1,000 48 0 26 6 53 1,000
Interest accreted a( t
locek di- n rate) 05 42 43 3 1 130
Release o f contractual
service margin (210) (220) (232) (34) (36) (732)
hC ange in present value o f
epx ected cash o� sw - - )893( - - (398)
Closing balance 840 662 66 35 - -
Comparison
iD ef f rence in closing
balance betew en locek di- n
rate and current rate - - 2( 2) 1( 1) - -
Amounts recognised in proft or loss
Locked-in rate
Year 1 2 3 4 5 Total
Underrw iting result
r( elease o f contractual
service margin) 210 220 223 46 48 756
1
Investment result 05( ) 4( 2) )65( 4( ) 2( ) (154)
Proft 160 178 176 42 46 602
Note
1. Interest accreted 43( ) plus the ef ef ct o f changes in the discount rate on changes in cash o� sw 2( 2.)
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Current rate
Year 1 2 3 4 5 Total
Underrw iting result
r( elease o f contractual
service margin) 210 220 223 43 63 732
Investment result 05( ) 4( 2) 43( ) )3( 1( ) (130)
Proft 160 178 198 31 35 602
Comparison
Year 1 2 3 4 5 Total
Underrw iting result
r( elease o f contractual
service margin) - - - 12 12 24
Investment result - - 2( 2) 1( ) 1( ) (24)
Proft - - (22) 11 11 -
hW en the locek di- n rate is used to calculate the present value o f cash o� sw that aduj st the
contractual service margin, the eef f ct o f changes in the discount rate on changes in cash o� sw
– i.e. 22 – is recognised in the investment result. hT e underrw iting result is not aef f cted by the
discount rate changes but only by the change in epx ected cash o� sw since inception. oH ew ver,
hw en the current rate is used the eef f ct o f changes in the discount rate on those cash o� sw is
recognised in the underrw iting result through the release o f the contractual service margin.
hT e sta f f also believed that additional compleix ties may arise hw en the current rate is used of r
calculating the change in the present value o f epx ected cash o� sw that aduj st the contractual
service margin and the entity chooses to present the eef f cts o f changes in discount rates in ICO ,
because the cumulative ICO ow uld be more dic� f ult to epx lain and calculate.
As a result o f their analysis, the sta f f recommended that of r nonp- articipating contracts the
locek di- n rate at inception o f the contract be used of r calculating the change in the present value o f
epx ected cash o� sw that aduj st the contractual service margin.
What did the IASB discuss?
hT ere aw s limited discussion o f this issue. nO e oB ard member believed that the eef f cts o f
changes in epx ected cash o� sw recognised in the n� ancial statements ow uld be dic� f ult of r
users to understand i f a locek di- n rate ew re used to calculate the change in the present value o f
epx ected cash o� sw that aduj st the contractual service margin. hT is is because:
• the uf ll� ment cash o� sw of r measuring the insurance liability of r balance sheet purposes ow uld
be calculated using a current rate ; and
• the change in the present value o f epx ected cash o� sw that aduj st the contractual service
margin ow uld be calculated using a locked-in rate.
hT e dief f rence resulting rf om applying dief f rent rates ow uld not aduj st the contractual service
margin but ow uld be recognised in prot� or loss or in ICO , depending on the entitys’ accounting
policy choice of r presenting the eef f cts o f changes in discount rates. eH believed that the eef f cts
o f changes in epx ected cash o� sw recognised in the n� ancial statements ow uld be easier of r
users to understand i f there ew re no dief f rences in the applied rates. oH ew ver, it aw s noted that
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using a current rate to calculate the change in the present value o f epx ected cash o� sw that aduj st
the contractual service margin ow uld also introduce compleix ties hw en an entity chooses to
present the eef f cts o f changes in discount rates in ICO because the amounts recognised in ICO
ow uld not automatically reverse to ez ro.
What did the IASB decide?
hT e oB ard agreed iw th the sta f f recommendation.
KPMG insight
Tracking discount rates
hT is months’ decision to use locek di- n rates to accrete interest on the contractual service
margin and to calculate the change in the present value o f epx ected cash o� sw that aduj st the
contractual service margin conr� ms that entities ow uld need to trac k discount rates.
nE tities that choose to present the eef f cts o f changes in discount rates in prot� or loss ow uld
not need to trac k discount rates to present the eef f cts o f changes in discount rates in the
n� ancial statements. oH ew ver, they ow uld need to trac k rates to determine the interest
accretion and the change in the present value o f cash o� sw that aduj st the contractual
servicem� argin.
nE tities that choose to present the eef f cts o f changes in discount rates in ICO ow uld need to
trac k discount rates of r presentation purposes. oC nseuq ently, of r those entities, using locek d-
in rates to accrete interest on the contractual service margin and to calculate the change in
the present value o f epx ected cash o� sw that aduj st the contractual service margin ow uld not
result in the same level o f additional operational compleix ties and costs.
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CHANGES IN ACCOUNTING POLICY
The requirements What’s the issue?
in IAS 8 would be
In previous meetings, the oB ard decided that :
applied without
• an entity could choose as its accounting policy to present the eef f cts o f changes in discount
modifcation
rates in prot� or loss or in ICO and ow uld apply that accounting policy to all contracts iw thin a
to changes in portof lio ; and
accounting policy
• application guidance ow uld be added to clariyf that, in accordance iw th IA S ,8 an entity ow uld
relating to the select and apply its accounting policies consistently of r similar contracts, considering the
presentation portof lio in hw ich the contract is included, the assets that the entity holds and the accounting
of r those assets.
of the effects
of changes in oS me oB ard members ew re concerned that n� ancial statement inof rmation ow uld not be
meaninguf l and comparable i f entities changed their accounting policies rf euq ently, or only to
discount rates.
achieve a af vourable accounting outcome. oC nseuq ently, the oB ard asek d the sta f f to consider
hw ether additional reuq irements are needed to address these concerns.
What did the staff recommend?
hT e sta f f considered the of lloiw ng uq estions.
Question Staff’s views
Are additional oN . hT e eix sting reuq irements in IA S 8 are suc� f iently restrictive
requirements needed for to prevent misuse.
changes in accounting
Under IA S :8
policy relating to the
presentation of the • a change in accounting policy needs to be uj stie� d as providing
effects of changes reliable and more relevant inof rmation ; and
in discount rates on
• comparability is ensured by retrospective application o f the
insurance liabilities?
change in accounting policy and disclosure o f the amounts o f
the aduj stments of r each period presented.
It ow uld be dic� f ult to argue that rf euq ent changes in accounting
policy ow uld result in reliable and more relevant inof rmation.
In addition, the costs associated iw th the retrospective application
o f an accounting policy are liek ly to prevent rf euq ent changes to
achieve a af vourable accounting outcome.
Would retrospective hT e occurrence o f mismatches betew en insurance liabilities
application of changes and n� ancial assets in comparative periods does not uj stiyf an
in accounting policy ecx eption rf om the general reuq irements in IA S 8 of r retrospective
for insurance liabilities application o f changes in the accounting policy of r insurance
be appropriate liabilities.
when changes in the
hW en the mi x o f assets bacik ng insurance liabilities changes,
accounting for fnancial
entities may change their accounting policy of r insurance liabilities
assets are applied
to reduce mismatches betew en the insurance liabilities and
prospectively?
related assets. oH ew ver, beof re the entity changes its accounting
policy of r the insurance liabilities, the n� ancial statements of r the
current and comparative periods are liek ly to include mismatches
as a result o f the gradual change in asset mi.x A restatement o f
comparatives hw en changing the accounting policy of r insurance
contracts does not necessarily result in additional mismatches.
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Question Staff’s views
In addition, n� ancial assets accounted of r under IFR S 9 are
reclassie� d prospectively only i f the business model of r managing
those n� ancial assets changes. oH ew ver, such situations are
not epx ected to occur very otf en. IFR S 9 states that changes in
the business model of r managing n� ancial assets are epx ected
to be very inrf euq ent and determined as a result o f etx ernal or
internal changes that are signic� ant to the entitys’ operations and
demonstrable to etx ernal parties.
As a result, the sta f f recommended that the reuq irements in IA S 8 be applied iw thout modic� ation
to changes in accounting policy relating to the presentation o f the eef f cts o f changes in discount
rates.
What did the IASB decide?
hT e oB ard agreed iw th the sta f f recommendation.
KPMG insight
Under IA S ,8 entities may voluntarily change their accounting policy only i f doing so results in
the n� ancial statements providing reliable and more relevant inof rmation. nE tities may need
to apply uj dgement in determining hw ether changing their accounting policy of r presenting
the eef f cts o f changes in discount rates ow uld provide reliable and more relevant n� ancial
statement inof rmation. hT e assessment o f hw ether the n� ancial statement inof rmation ow uld
be more relevant is liek ly to reuq ire :
• identiyf ing portof lios o f assets that bac k the insurance contracts ; and
• determining ho w the eef f cts o f changes in interest rates on those assets are accounted of r.
hT is assessment may change i f there is a change in those assets or ho w they are accounted of r.
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