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Proposed EFRAG Response to ED5 - Addressing Issues in Insurance Contract Accounting

This proposed response by EFRAG provides feedback on various aspects of the Exposure Draft (ED) 5, including the scope, definition, and treatment of embedded derivatives in insurance contracts. The response emphasizes the need for consistency, reliability, and relevance in financial information and highlights the importance of introducing Phase II as soon as possible.

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Proposed EFRAG Response to ED5 - Addressing Issues in Insurance Contract Accounting

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  1. Proposed EFRAG response to ED5Jiří Fialka

  2. General comments • ED5 is temporary solution: Permits variety of accounting policies Permits non-uniform accounting policies even within the group • Resulting in: Inconsistency between accounting policies Incomparable financial statements

  3. General comments • Phase I should not be regarded as long term standard • Phase II should be introduced as soon as practicable • Sunset Clause welcome as a signal about IASB commitment to issue Phase II before 2007

  4. General comments • Changes in existing accounting policies must be towards policies used in phase II • Introducing „piecemeal changes“ might lead to a risk of less reliable and less relevant financial information Reinsurance dealt separately from insurance • Different measurement bases for assets and liabilities • FV of insurance assets and liabilities presented in disclosure from 31 December 2006 – how to calculate?

  5. Question 1 – Scope Question: • IFRS would not apply to: • Assets held to back insurance contracts • Financial instruments issued by insurance entity Proposed response: • ED5 addresses insurance contracts not entities • Mismatch between measurement of assets (FV) and liabilities (local GAAP) • IFRS for insurance contracts should be consistent with IFRS for financial instruments (IAS 39)

  6. Question 1 – Scope II Question: • Weather derivatives should be brought within IAS 39 unless they meet proposed definition of insurance contract Proposed response: • EFRAG finds this acceptable

  7. Question 2 – Definition of an Insurance Contract Question: • Is definition “contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder or other beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder or other beneficiary” appropriate? Proposed response: • If read in conjunction with related guidance in Appendix B then acceptable

  8. Question 3 – Embedded derivatives I Question: • Embedded derivative should be separated unless: • Meets the definition of insurance contracts • Option to surrender an insurance contract for a fixed amount Esp. required to separate and FV measured: • Put option or cash surrender option if surrender value is effected by the change of equity or commodity price or index • Option to surrender financial instrument that is not an insurance contract • Embedded derivatives transferring significant insurance risk but regarded as mainly financial are excluded from IAS 39

  9. Question 3 – Embedded derivatives II Proposed response: • Final situation (Phase II) – all embedded derivatives should be reflected at fair value, but significant implementation problems. It is now acceptable not to separate • Approach might need to be changed in Phase II (treatment host insurance as debt like contract) • Consistency should be reached with new IAS 39

  10. Question 3 – Embedded derivatives III Question: • Are specific disclosures about embedded derivatives adequate? • Should any other embedded derivatives be exempted from IAS 39? Proposed response: • Disclosure requirements are adequate • No others were identified

  11. Question 4 – Temporary exclusion from criteria in IAS 8 Question: • For accounting periods before 1 January 2007 exempted from IAS 8: • Insurance contracts (incl. reinsurance contracts) • Reinsurance contracts held Proposed response: • Potential problems can arise if final standard (Phase II) is not ready till beginning of 2007

  12. Question 4 – Temporary exclusion from criteria in IAS 8 Question: • Despite the exemption, the proposal • Eliminates catastrophe and equalization provision • Requires loss recognition test • Requires keeping insurance liabilities in B/S until discharged, prohibits offsetting insurance liabilities with reinsurance assets Proposed response: • Generally appropriate • Proposed different wording ensuring, that it will effect whole business • Further clarification of loss recognition test especially of “current estimate of future loss” required Additional guidance how to apply IAS 37 expected

  13. Question 5 – Changes in accounting policies Question: • Is appropriate that: • Insurer must satisfy specified requirements in case of changing accounting policies • In case of changes in accounting policies insurer can reclassify some financial assets to FV measured Proposed response: • Generally appropriate and acceptable (for phase I) • Entities should not be able to use non-uniform accounting policies, only acceptable for interim period

  14. Question 6 – Unbundling I Question: • Is unbundling appropriate and feasible in specified cases? Proposed response: • Agree that unbundling is required only if the bundled nature obscures the proper accounting for the obligations Suggests that unbundling solely for accounting purposes should not be required except in the case where the structure of the contract is clearly artificial Criterion for unbundling should be that “the CF of the insurance component and the investment component do not interact” rather than proposed criterion

  15. Question 6 – Unbundling II Question: • Should unbundling be required in any other cases? • Is it clear when unbundling would be required? Proposed response: • Agree with proposed standard • Comments are made under a) otherwise it is clear

  16. Question 7 - Reinsurance Question: • Proposed standard limits reporting anomalies when insurer buys reinsurance Proposed response: • Proposal is not appropriate (the detailed entire accounting for reinsurance will be addressed in phase II) • The proposal might lead to inconsistency in reporting resulting in artificial losses at the beginning of reinsurance contracts and gains in subsequent periods • Recommended that whole reinsurance accounting should be addressed in phase II • Financial reinsurance should be treated as financial transaction rather than insurance transaction

  17. Question 8 – Insurance contracts acquired in a business combination Question: • IAS 22 requires to measure at fair value of assets acquired and liabilities assumed in a business combination. Proposals permits split of the fair value to: • Liability measured in accordance with insurer’s accounting policies • Intangible asset excluded from IAS 36 and IAS 38 measured consistently with the related insurance liability Proposed response: • Confirmation whether intangible asset can be recognized in case of general insurance • Clarify whether open or closed book approach is more appropriate

  18. Question 9 – Discretionary participation features Question: • Discretionary participation features in insurance contracts or financial instruments are briefly addressed in ED5 (deeper addressing is expected in phase II) Proposed response: • Acceptable as interim solution • Unallocated surplus (unrealised gains and losses) related to participating business should be regarded as constructive obligation • Investment contracts with both discretionary and fixed element will continue in current accounting policies which is not consistent with other investment contracts – needs further guidance, if premium recognition continues

  19. Question 10 – Disclosure of the fair value of insurance assets and insurance liabilities Question: • Insurance assets and liabilities should be presented in disclosure from 31 December 2006 Proposed response: • Unreasonable to require fair value of insurance liabilities when FV rules not set down yet, might lead to different interpretations and non-comparability • Many insurers already provide such information on a voluntary bases

  20. Question 11 – Other disclosures I Question: • Requirement about the amounts in the insurer’s financial statements that arise from insurance contracts and the amount, timing and uncertainty of future CF from insurance contracts Proposed response: • The requirements are appropriate Certain requirements are too broad and if not read closely with the Implementation Guidance can be interpreted as too burdensome Rewording of proposed IFRS towards the Implementation Guidance suggested

  21. Question 11 – Other disclosures II Question: • Disclosures are framed as high level requirements with explanation in Implementation Guidance • Insurer would not need to disclose information about claims development that occurred earlier than five years before the first applying of proposed IFRS Proposed response: • This approach is appropriate • No changes should be made

  22. Question 12 – Financial Guarantees Question: • Transferor of a non-financial asset or liability should apply IAS 39 to financial guarantee given to the transferee in connection with the transfer Proposed response: • Agree Makes proposed standard applicable also to credit insurers and banks issuing financial guarantees meeting definition of insurance contract

  23. Question 13 – Other commentsMismatch – Measurement basis for insurance assets and liabilities • ED 5 is interacting with IAS 39 and creating measurement mismatch for insurance contracts as • Insurance liabilities are measured under existing accounting principles (usually amortized costs) • Assets backing theses liabilities are measured in market value (in most cases available-for-sale basis) • This results in volatility in equity even in case of perfect match of assets and liabilities

  24. Question 13 – Other commentsMismatch – Measurement basis for insurance assets and liabilities Proposed solution: • Very restricted relaxation of the tainting rules that constrain the held-to-maturity category in IAS 39 • Limited to Phase I

  25. Question 13 – Other commentsDeferred acquisition cost • Treatment of DAC for insurance and investment contracts should be harmonized otherwise might lead to the need of significant system changes implementation • Proposed amendment of IAS 39 to amortize costs directly attributed to the sale of the contract in line with revenue recognition to be consistent for all contracts and standards (IAS 18)

  26. Question 13 – Other commentsDefinition of an Insurance Contract • Case where death benefit exceeds the surrender amount is too wide (IG Example 1.2) and should be referred to surrenders where the penalty is in excess of the recovery of outstanding acquisition costs • Pure Endowment should be treated as insurance contract

  27. Discussion

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