Direction is getting clearer - PowerPoint Presentation

Slide1

Direction is getting clearer

but major concerns remain on the tableIFRS 4 Phase II Update

IASB and FASB joint meetings –

June 2012

Francesco Nagari

20 June

2012Slide2

Agenda

Highlights of decisions and education sessions from this month joint meetingsDetailed analysis of the Staff recommendations and Board discussionsUpdate on timetable and next stepsIFRS 4 Phase II - Webcast (June 2012)

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Highlights from joint IASB/FASB meetings

‘Earned premium’ emerges as the preferred revenue recognition pattern to explore (joint education session)Joint decision to allocate ‘clearly linked and attributable’ cash flows to unbundled components under the relevant standardFinancial instruments fair value option will be available for assets under the fair value through other comprehensive income

IASB highlights a preference to treat acquisition costs as part of the liability (IASB only education session)

FASB Chair comments on the possible disengagement from convergence on insurance

Updated technical plans support Deloitte’s prediction of Q4 2012 publication of next milestone document

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Details of IASB/FASB education session - 12 JuneMeasuring earned premium (volume information): papers 2B-C/84B-C

BackgroundStaff presented three methods for measuring earned premiums (investment components):

‘Earned Premium’: premium receivable for services provided in the period (ED recommended it for PAA but not for BBA)

‘Written Premium’:

for contracts initially recognised in the period expected PV of all cash inflows within contract boundary = premium, outflows and margin= expense

‘Premium Due’: premiums when revenue is expected to be receivable, corresponding increase in liability = expense (ED rejected it for BBA, later preferred)

Staff noted that there has been mixed

feedback from users and prior interactions with the Insurance Working

Group and a preference from constituents cannot be identified

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Details of IASB/FASB education session - 12 June Measuring earned premium (volume information): papers 2B-C/84B-C

Staff recommendation/ questions: The Staff recommended an ‘earned premium’ basis

Concerns with operational challenges were flagged

Staff questions:

Do the Boards find the information provided by the ‘earned premium’ approach useful?

Any other issues to consider in the outreach with IWG and future sessions?

Discussion

Boards supported the Staff recommendation

Debate on revenue recognition versus change in insurance liability notes absence of a unanimous view

Points to consider forward:

Cost/benefit

N

on claims related cash flows / Acquisition costs

U

nit of account

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Details of IASB/FASB meeting 12 JuneAllocation of cash flows to unbundled components

– paper 2A/84AStaff recommendationFor those components to be unbundled:

Measure investment cash flows (CFs) as if stand alone contract sold

After excluding unbundled investment component’s CFs (or unbundled embedded derivative) allocate consideration, discounts or premiums to insurance, goods and services and investment components

If more than one unbundled component, allocate CFs on a rational and consistent basis

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Details of IASB/FASB meeting 12 JuneAllocation of cash flows to unbundled components

– paper 2A/84A (cont.)DiscussionConcerns over several items:

Conceptual nature of ‘allocation’

Conceptual basis to prevent substantially prepaid items not to be expensed (e.g. acquisition costs)

Reliability of the attribution of disbursements to components and

Reliability of the allocation of shared costs across components

Despite these concerns Boards seemed supportive of the staff recommendation

Decision

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IASB

FASB

In favour of Staff recommendation

Unanimous

Unanimous Slide8

Details of IASB/FASB meeting 13 JuneFinancial Instruments through OCI – refinement of eligibility criteria

BackgroundAt the May meeting the Boards

approved

the creation of FVOCI for eligible debt instruments

Separate business model tests for amortised cost (AC) and FVOCI debt instruments

If contractual cash flows are

not

solely payments of principal and interest (including credit risk)



FVTPL (residual category)

Question

Do debt instruments have to pass contractual cash flow characteristics test for classification as FVOCI?

Decision

Both Boards agreed that to qualify for FVOCI:

Financial instruments have to pass contractual cash flow characteristics test

and

Be managed within the relevant business model

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Details of IASB/FASB meeting 13 JuneFinancial Instruments – Fair Value Option – IASB only

BackgroundIFRS 9 currently allows fair value option on initial recognition:

For financial assets – to eliminate or significantly reduce accounting mismatch

For financial liabilities IFRS 9 carries forward the IAS 39 three criteria

to eliminate or significantly reduce accounting mismatch

if a group of financial liabilities / assets or both is measured and performance evaluated on a fair value basis

if it contains embedded derivatives requiring bifurcation, to FV the hybrid

Introduction of FVOCI as ‘default’ (if criteria are met) impacts on the application of FVO

IASB Decision

To extend FVO to financial assets that would otherwise be measured at FVOCI, if doing so eliminates or significantly reduces accounting mismatch

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Details of IASB/FASB meeting 13 JuneFinancial Instruments – Fair Value Option (FASB)

BackgroundCurrent FASB guidance allows FVO To financial assets and liabilities if the entity manages net exposure on FV basis and reports on that basis to management

To hybrid financial assets or liabilities to avoid bifurcation of embedded derivatives

Following FASB May tentative decision, hybrid financial assets will no longer be subject to bifurcation thus making the FVO only applicable to hybrid liabilities

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Details of IASB/FASB meeting 13 JuneFinancial Instruments – Fair Value Option (FASB)

FASB Staff recommendation – in essence to more closely align with IASBFor financial assets to allow irrevocable FVO on initial recognition if

it eliminates or significantly reduces a measurement or recognition inconsistency

For financial liabilities to allow irrevocable FVO on initial recognition if:

it eliminates or significantly reduces a measurement or recognition inconsistency;

group of financial assets and /or liabilities is measured and performance evaluated on FV basis in accordance with a documented risk management or investment strategy;

hybrid financial liabilities contain embedded derivative that would require bifurcation otherwise

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Details of IASB/FASB meeting 13 JuneFinancial Instruments – Fair Value Option – FASB (continued)

DiscussionConcern over ‘having options’ FVO for groups of financial assets and/ or liabilities measured on FV basis – to permit or require?

Decision

To allow irrevocable FVO at initial recognition:

for hybrid financial liabilities unless the embedded derivative or derivatives do not otherwise require unbundling or it is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative is prohibited;

for a group of financial assets and liabilities if the entity manages the net exposure relating to those financial assets and financial liabilities (which may be derivative instruments) on a fair value basis

and

the entity provides information on that basis to the reporting entity’s management.

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Details of IASB education session - 14 JuneTreatment of acquisition

costs - paper 2DBackgroundAt the May joint meeting:IASB voted to included acquisition costs (AC) within insurance liability

FASB did not vote but expressed a preference for an asset recognition although agreed to explore netting against the single margin with no impact on comprehensive income to attempt convergence with the IASB

Discussion

The discussion led to revisit several past decisions:

Option 1: expense AC as incurred

Option 2: recognise an asset and amortise it over the coverage period

Option 3: expense AC as incurred and release a part of residual margin to cover them with a nil effect to net income

Option 4: same as option 3 but presented net

Option 5: include the asset as a deduction from the insurance liability and amortise it over time using separate drivers from the margin (to be determined) with no revenue upfront

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Details of IASB education session - 14 June

Treatment of acquisition costs (continued)

Summary of options

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Pros

Cons

Option 1 – expense as incurred

Expense as it does not provide service

Simple

Upfront loss on profitable contracts

Liability is inflated

Option 2 – asset

Consistent with Revenue project

Aligns with FASB preference

Easier to amortise (if straight line)

Nil initial income impact

Need to consider for onerous contract test

Separate presentation

Amortisation to be consistent with service and RM release.

Option 3 – expense as incurred and release part of RM to offset it

Nil initial income impact

Avoids need to track an asset and amortise it over time

Less relevant volume information

Revenue can be recognised before coverage started

Option 4 – same as option 3, but presented net

Nil initial income impact

Avoids upfront revenue

Less relevant volume information

Option 5 – include DAC in insurance liability and release separately over time

Nil initial income impact

Avoids upfront revenue

Volume information is unaffected

Subsequent impact is greater than in option 3 and 4

Need to have separate amortisation driverSlide15

Details of IASB education session - 14 June

Treatment of acquisition costs (continued)Conclusion

No decisions, as not a decision making session

The IASB asked the

Staff to explore option to include an asset from AC as part of the carrying amount for the insurance liability and that it would be released over time and avoid upfront revenue

Majority of IASB members (9) supported this suggestion (even though no formal vote)

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FASB Advisory Council - 5 JuneReport on insurance contracts project

As she commented on the status of the various projects FASB Chair Leslie Seidman is reported to have said to her Advisory Council that“FASB would now take a step back and decide how to proceed. It will decide whether to do targeted improvements to U.S. generally accepted accounting principles or move forward with a more wholesale set of changes that will not end up in a converged standard.”

 “We have twice now gone back to the board table to try and resolve those differences because of a very strong desire to end up with a converged solution on insurance. I'm disappointed to report that after a couple of different attempts, we're simply not reaching converged conclusions on insurance in what I would call fundamental aspects of the proposals.”

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Next steps and timetable

Next joint meeting expected in week of 16 JulyInsurance Working Group meeting on 25 and 26 June in LondonMajor topics that remain to be deliberated:Unlocking of residual margin – finalise the mechanics and unit of account

Presentation of premiums in the income statement – choose among existing options

Transition regime and effective date

Publication of next due process document is currently targeted for Q3-Q4 2012 for IASB with FASB now disclosing Q4 2012 – Deloitte expected both Boards to be towards the end of Q4-2012

Decision awaited on status of next IASB due process document

Final accounting standards should be released by the end of 2013

Deloitte expects that the mandatory effective date will not be earlier than 1 January 2016

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Contact details

Francesco NagariDeloitte Global IFRS Insurance Leader+44 20 7303 8375fnagari@deloitte.co.ukLink to Deloitte IFRS Insurance materials:

https://www.iasplus.com/deloitte/en/projects/project47

Insurance Centre of Excellence:

insurancecentreofexc@deloitte.co.uk

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