© 2012 Deloitte LLP. Private and confidential Aggregating contracts and disaggregating deposit components IFRS 4 Phase II Update IASB and FASB joint meetings

© 2012 Deloitte LLP. Private and confidential

Aggregating contracts and disaggregating deposit componentsIFRS 4 Phase II Update

IASB and FASB joint meetings – March 2012

Francesco Nagari

30 March 2012


Agenda

Highlights of decisions from this month joint and separate meetings

Detailed analysis of the Staff recommendations and Board discussions

Update on timetable and next steps

IFRS 4 Phase II - Webcast (March 2012)2


Highlights from joint IASB/FASB meeting 21 March

Unit of Account

‒ Similar portfolio definitions approved for risk adjustment, residual and single margin. The Staff will work on the wording to ensure that the same objective is achieved

Investment Components – Identification for disaggregation

‒ Both Boards agreed to define investment components as amounts payable regardless of insured event occurring

‒ This concept will be used for presentation only.

Investment Components – Measurement and presentation in the SOCI

‒ IASB voted to exclude investment components from aggregate premium in comprehensive income. FASB asked for a follow-up session prior to their vote.

Investment Components – Presentation in the statement of financial position

‒ Both Boards agreed to not disaggregate investment components on the balance sheet provided adequate disclosures were made in the notes

3 IFRS 4 Phase II - Webcast (March 2012)


Highlights – IASB and FASB separate meetings

FASB only meeting on 7 March

Scope of contracts with discretionary participation features

‒ FASB unanimously supported Staff recommendation to scope out financial instrument with discretionary participation features confirming divergence in this area

IASB only meeting on 20 March

Possible use of OCI (education session)

‒ Little support was shown by IASB for an OCI solution in general

‒ A loss recognition test for the OCI solution to accelerate loss recycling to income under certain scenarios was also substantially unsupported



Details of joint meeting – 21 March

Paper 2A/81A - Unit of Account (UoA)

Background

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Items affected by a UoA decision UoA decisions

• Contract boundary • Portfolio level (previously agreed)

• Risk adjustment (IASB only)• Across portfolios based on the risk

appetite neutrality underpinning the risk adjustment concept

• Onerous test• Initial measurement of residual/

single margin• Subsequent release of residual/

single margin

Focus of this paper

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Paper 2A/81A – UoA (cont.)

Staff recommendations summary :

Alternative 1 (IASB Staff)

The UoA used to determine the residual/single margin at initial recognition and perform the onerous test should be the portfolio defined as contracts that are:

1) subject to similar risks; [same as the ED]2) managed together as a single pool; and [same as the ED]3) priced similarly relative to the risk taken on. [new criterion]

The UoA used to release the residual/single margin should not be prescribed, provided it is performed in a manner consistent with the objective of releasing the residual margin over the coverage period

• to the period(s) in which the service is provided [for the IASB]; • or of releasing the single margin in the period(s) in which the insurer is released from

risk [for the FASB].





Staff recommendations summary :

Alternative 2 (FASB Staff)

The unit of account used to determine the residual/single margin at initial recognition, release the residual/single margin, and perform the onerous contract test should be the portfolio.

Portfolio of insurance contracts should be defined as contracts that are:1) subject to similar risks; [same as IASB staff and the DP]2) managed together as a single pool; [same as IASB staff and the DP]3) priced similarly relative to the risk taken on; [same as IASB staff] and4) with a similar duration and similar expected patterns of release of the residual/single

margin. [new criterion]

The 4th criterion limits the maximum level of aggregation and eliminates the need for a cohort or sub-portfolio definition for the subsequent release of the residual/single margin



Discussion and decisions Boards questioned whether

‒ criteria 1-3 are indicators of a broader principle

‒ ‘managed together’ is a necessary criterion Debate around ‘priced relative to risk taken on’ criterion led to combining it with the risk

homogeneity test Boards agreed that the definition should cap the level of aggregation Debate around the criterion to guide the release of residual/single margin led to a

different final position – see next page

Next steps

IASB and FASB Staff to work on the wording to ensure the same objective is achieved, even if differences in wording remain

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© 2012 Deloitte LLP. Private and confidential9




IASB decision (9 vs. 5) FASB decision (unanim.)

A portfolio of insurance contracts should be defined as contracts that are:i. subject to similar risks and priced similarly relative to the risk taken on; and

ii. managed together as a single pool. ii. have similar duration and similar expected patterns of release of the single margin.

The unit of account used to determine the residual margin and perform the onerous test should be the portfolio.

The unit of account used to determine and release the single margin, and perform the onerous contract test should be the portfolio.

The unit of account used to release the residual margin should not be prescribed. However, the release of the residual margin should be performed in a manner consistent with the objective of releasing the residual margin over the coverage period to the period(s) in which the service is provided.



Papers 2F/81F, 2G/81G, 2H/81H Separation of investment components

Background and objectives ED and DP proposed to unbundle certain investment components: explicit account

balances Feedback on unbundling was critical of the ED and DP proposals Boards remain concerned over deposit components presented as part of aggregate

premiums At their November joint meeting:

‒ FASB tentatively agreed to unbundle explicit account balances

‒ IASB preferred to disaggregate instead of unbundling (no vote) The Staff proposed to achieve certain objectives with the separation of investment

components

a) Provide a basis to determine total aggregate premium in comprehensive income

b) Improve comparability with other financial institutions

c) Provide liquidity risk measure (e.g. amounts payable on demand)




Paper 2G/81G Determining aggregate premium for insurance component

Summary of Staff recommendations

1. Definition of investment component

An amount that the insurer is obligated to pay the policyholder or beneficiary regardless of whether an insured event occurs

2. Presentation and measurement in the statement of comprehensive income

Exclude from the aggregate premium the present value of investment components (defined as above), measured consistently with the measurement of the overall insurance contract liability



Details of joint meeting – 21 MarchPaper 2G/81G Determining aggregate premium for insurance component (cont.)Discussion on the definition of an investment component

The Staff presented four alternatives

A.No separation

B.Separate explicit account balances only (as defined at November 2011 joint meeting)

C.Separate amounts payable to policyholder regardless of insured event occurring

D. Separate amounts insurer estimates will be returned to the policyholder and/or their beneficiaries

FASB

• FASB proposed to introduce first the unbundling of investment components if distinct from the insurance component and then disaggregating from the insurance liability those amounts payable to policyholder regardless of insured event occurring.

• This was referred to as ‘alternative C+’

• The Staff will bring back a new analysis to assess the viability of ‘alternative C+’


Vote on definition IASB FASB

Alternative C 9 vs. 5 Unanimous


Details of joint meeting – 21 MarchPaper 2G/81G Determining aggregate premium for insurance component (cont.)Discussion on presentation and measurement in the SOCI The debate appeared to highlight FASB’s greater appetite for unbundling (i.e. Separate

measurement of the investment component as if it is a separate contract) over disaggregation (i.e. Separate presentation of investment components after the whole insurance contracts has been measured)

The vote on the second proposal had the following outcome

We expect that this new FASB paper would also propose the solution on whether ‘alternative C+’ will be part of the new accounting standard

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Vote on measurement IASB FASB

Approve Staff recommendation

Unanimous No vote, Need separate meeting




Paper 2H/81H Statement of Financial Position PresentationSummary of Staff recommendations

• Insurers should not be required to present disaggregated investment components separately from the insurance contract in the statement of financial position

• Disclose in the notes Portion of insurance contract representing aggregated portions of premiums

received (and claims / benefits paid) that were excluded from the statement of comprehensive income (i.e. investment components as defined in previous paper)

The amounts payable on demand

Discussion After having considered and rejected the use of measurement bases from IFRS and

US GAAP financial instruments accounting for the balance sheet disclosure of disaggregated investment components the Boards agreed to avoid that altogether

Several IASB and FASB members summarised the discussion by noting that the issue did not present itself with an obvious answer, therefore disclosure is more appropriate to address different user objectives




Paper 2H/81H Statement of Financial Position Presentation (cont.)

Conclusion

Next steps

• The issue on whether this decision should be a requirement or a disclosure policy choice will be discussed at a future meeting

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IASB FASB

Approve Staff recommendation 11 vs. 3 4 vs. 3



Details of FASB only meeting – 7 March

Scope of contracts with discretionary participating features (DPF)

Background Currently contracts with DPF are not insurance contracts because there is minimal or

no insurance risk IASB has extended the scope of insurance contracts accounting to these contracts,

restricting this to insurance industry only (28 February IASB only meeting) FASB noted that IASB new definition would include re-insurance contracts that do not

transfer insurance risk both written by insurers and held by insurers as cedants/policyholders

Summary of Staff recommendation

To scope investment contracts with discretionary participating features out of the insurance contracts standard

Conclusions

Unanimous approval of the Staff recommendation



Details of IASB only meeting – 20 March

Paper 2B – Recognising changes in the insurance liability in OCI

Education session IASB Staff presented a series of papers summarising the reasons for and against using

an OCI solution for insurance contracts In addition they discussed the mechanics of the OCI solution presenting two main

alternatives that will include in OCI

‒ all changes from discount rate; and

‒ all changes in cash flows from interest rate sensitive assumptions (options, guarantees, inflation assumptions, lapses)

The unwind of a locked in discount rate, release of margin, experience and changes in cash flows due to changes in non-interest rate sensitive assumptions will always be presented through profit or loss

‒ Alternative A would present in the income statement the adjustment to the current interest expense to remove the differential to OCI

‒ Alternative B would present directly the locked in interest expense with the differential being recognised directly in OCI




Paper 2B – Recognising changes in the insurance liability in OCI (cont.)

In addition Staff also proposed that the recycling through income of losses recognised in OCI should be accelerated under a “loss recognition test”

The loss recognition trigger could be based on: [Liability discounted at current discount rate – Liability discounted at inception rate] > margin [Liability discounted using rate of return on investment – Liability discounted at inception rate]

> margin Other qualitative factors indicate that insurer expects to use own capital to satisfy insurance

liability If loss recognition test is triggered the discount rate would have to be re-set Amount of loss to be recycled if test is triggered:

The entire amount of losses recognised in OCI The loss calculated under the selected trigger The loss above the margin A combination of the above but the discount rate is not re-set




Paper 2B – Recognising changes in the insurance liability in OCI (cont.)

DiscussionThe Board members raised a number of objections, some already considered by the Staff:

Lack of principle around the use of OCI Need to consider IFRS 9 proposals Reduced relevance of the income statement Changes in interest sensitive cash flows as well as discount rate may be in OCI Accounting mismatch from having investments at amortised cost will merely shift to

OCI Options and guarantees are economic cash flows which may never be reflected

through income The loss recognition test brings losses from declines in interest rates result through

income while gains remain in OCI

Overall there was no desire to use an OCI solution



Next steps

Minor matters carried forward from March – IASB and FASB

‒ Unit of account – FASB and IASB Staff to ensure convergence on principle even if different wording

‒ Disaggregation of investment components – Staff to do more work around alternative C+, to unbundle distinct components first

‒ No separation of investment components on the Balance Sheet – to permit or require Matters carried forward from March – IASB

‒ Staff to develop a detailed paper around use of OCI / financial instruments accounting

Matters carried forward from March – FASB

‒ FASB to have another meeting on measurement of investment components excluded from presentation in comprehensive income



Next steps and timetable

Next joint meeting on insurance expected in week of 16-21 April with new education sessions likely to be held in the prior week

Major topics that remain to be deliberated:

‒ Unlocking of residual margin / subsequent measurement of single margin

‒ Presentation of premiums in the income statement

‒ Reinsurance – cedant’s accounting

‒ Transition and effective date

‒ Financial assets held to back insurance contracts – redeliberation on IFRS 9 classification and measurement

Publication of next due process document is currently delayed to Q3-Q4 2012 (both IASB and FASB)

‒ Decision awaited on status of next IASB due process document

Final accounting standards should be released by the end of 2013



Contact details

Francesco NagariDeloitte Global IFRS Insurance Leader+44 20 7303 [email protected]

Link to Deloitte IFRS Insurance materials:http://www.iasplus.com/agenda/insure2.htm

Insurance Centre of Excellence:[email protected]


mailto:[email protected]

http://www.iasplus.com/agenda/insure2.htm

mailto:[email protected]

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© 2012 Deloitte LLP. Private and confidential23 IFRS 4 Phase II - Webcast (March 2012)

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© 2012 Deloitte LLP. Private and confidential Aggregating contracts and disaggregating deposit components IFRS 4 Phase II Update IASB and FASB joint meetings