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Insurers to Be Given a Choice for Presentation of Discount Rates

March 21, 2014

The IASB agreed to let insurers record changes in the discount rate in net income or other comprehensive income. The decision is part of the international board’s effort to write a final standard that requires insurers to update the assumptions about the payments they expect to make to customers every reporting period and report the effects of those changes in their financial statements.

The IASB agreed on March 18, 2014, to confirm a big part of its proposal to overhaul the accounting for insurance contracts by letting insurers record changes in discount rates in other comprehensive income (OCI).

In a change from its June 2013 proposal, Exposure Draft (ED) No. 2013-7, Insurance Contracts, the international standard-setter said using OCI would not be mandatory. Instead, insurers can also present changes in the income statement. Insurers that opt to use OCI would be required to provide more information in the footnotes to their financial statements about the effects of the changes in the discount rate for each reporting period.

The vote was part of the IASB’s effort to issue a final standard based upon ED No. 2013-7, which requires insurers to update the assumptions about their liabilities—the payments they expect to make to customers—every reporting period and report the effects of those changes in their financial statements.

The proposed standard is a response to years of criticism that looking at the financial statements of an insurance company is akin to looking at a “black box” because insurers make financial commitments to customers they may not pay for years. The standard-setter wants any company that offers insurance products—not just traditional insurance companies—to change the way they estimate its liabilities and update the assumptions on a regular basis.

The March 18 decision did not apply to insurance contracts with participating features, such as universal life policies, which provide customers with investment returns. The board plans to discuss contracts with participating features at a future meeting, according to the IASB staff.

ED No. 2013-7 proposed the mandatory use of OCI to present the effect of changes in discount rates on the measurement of insurance contracts.

Discounting is commonly used to estimate the current value of future costs. The IASB wants insurers to estimate interest expense using a discount rate that is evaluated every period for changes. Insurers had told the IASB that requiring changes in the discount rate to be recorded in the income statement could show wild swings that would mislead investors and analysts. The IASB agreed to the use of OCI so it would give these changes less prominence.

Most of the insurers and accountants who wrote comment letters about the proposal agreed with this assessment, saying the use of OCI would reduce short-term volatility on long-running contracts, such as life insurance policies. They also agreed that discounting would more clearly separate investing results from underwriting results, and give investors a better look at insurer finances. But several insurers said they didn’t want to be forced to use OCI. In some cases, using OCI would result in accounting mismatches with other parts of the financial statement, such as in equity if the assets backing insurance liabilities are measured at amortized cost, critics said.

A majority of the IASB on March 18 agreed with this assessment.

“OCI has its merits, but there are times when it doesn’t, and I think we need the option to get us out of those times,” IASB member Darrell Scott said.

Although Scott and his like-minded colleagues won out, several other IASB members voiced concerns that allowing an option would not be a good move.

IASB member Stephen Cooper, who has long criticized OCI because it is not well-defined, said the IASB would be taking what started out as a big black box “and making it into a lot of tiny, little black boxes.”

IASB member Patricia McConnell, who said she originally supported the use of OCI, had second thoughts based on all the concerns raised about accounting mismatches.

“Looking at this paper and all of the arguments for why the accounting mismatches might overwhelm those benefits and therefore we need an option, it convinces me that I was wrong in supporting the OCI option in the first place,” McConnell said. “The benefit of it isn’t there, and I don’t think that trying to correct that by giving an option is the right way to go. I think that will take away what little benefit users might have received from using the OCI option for the discount rate.”

Once a majority of the IASB agreed to the OCI option, the standard-setter next had to decide how to provide the choice.

The board weighed whether to allow it as a company-wide election that an insurer would use for all its policies, on a contract-by-contract basis, or based on portfolios containing several insurance contracts apiece. The IASB research staff recommended requiring the option to be used for all contracts within a portfolio, but the IASB did not settle this.

The board did decide on the information that would be required in footnote disclosures to help investors and analysts understand the components of interest expense associated with discount rates.

All portfolios of insurance contracts would be required to disclose an analysis of total interest expense and then broken down, at a minimum, into the amount of interest accretion determined using current discount rates; the effect on the measurement of the insurance contract of changes in discount rates in the period; and the difference between the present value of changes in expected cash flows that adjust the contractual service margin in a reporting period using discount rates that applied on initial recognition of insurance contracts, and when measured at current rates.

For portfolios of insurance contracts where the effect of changes in the discount rate are presented in other comprehensive income, the board would require an analysis of total interest expense included in total comprehensive income. The expenses would be broken down into at least two categories—interest accretion at the discount rate applied at initial recognition of insurance contracts reported in profit and loss for the period and the movement in OCI for the period.

The board also settled several other smaller pieces of the overall project that had to do with how an insurer makes estimates.

The IASB confirmed a requirement in the 2013 proposal that after inception, differences between the current and previous estimates of the present value of cash flows related to future coverage and other future services should be added to, or subtracted from, the contractual service margin, which measures the profits at risk.

The differences between the current and previous estimates of the present value of cash flows that do not relate to future coverage and other future services should be recognized immediately in the earnings statement, the board agreed.

The board also agreed that differences in the current and previous estimates of the risk adjustment that relate to coverage and other services for future periods should adjust the contractual service margin. Changes in the risk adjustment that relate to the coverage and other services provided in the current and past periods should be recognized in profit or loss.

The IASB has been working for more than a decade to develop an accounting standard for insurance contracts. In 2004, it published bare-bones guidance in IFRS 4,Insurance Contracts, which was meant as a temporary standard until a more complete accounting standard could be issued. Ten years later, overseas insurers remain frustrated by the lack of guidance in IFRS and want the IASB to wrap up its work soon.

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