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Accounting for Insurance Contracts — A Joint Movement to IFRS

As the insurance industry moves ever closer to an accepted set of International Financial Reporting Standards (IFRS) - many uncertainties remain related to the nature, timing, and extent of accounting considerations for insurance contracts. Insurance companies will likely be facing significant change as the joint meetings between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) take place throughout 2011. 

Though the IASB and the FASB (the Boards) have made some headway discussing tentative impacts of possible new regulations, there is a general sense that the two groups will not reach any type of consensus until the fourth quarter of 2011 at the earliest, with actual effective dates indeterminate at this time. The joint committees of the two Boards are expected to be meeting in May 2011 for further dialogue. In light of the timing of these discussions and the expected push to later in the year for more concrete guidance, there are a number of areas that have already taken form related to the proposed insurance standards.

Areas of Significance

Several of the areas of greater significance moving toward convergence and agreement by the IASB and the FASB are outlined below, with some additional details and interpretations provided by Blackman: 

Risk-Measurement Model

The intent of the joint Boards is to establish a series of regulations that address measurement of risks associated with insurance contracts using a current-period methodology. This change would result in the reassessment of insurance liabilities each reporting period and would likely include such considerations as probability-weighted average future cash flows, periodic explicit risk adjustments that reflect current economic considerations, the time value of money, and residual margin on contracts.

• One of the most controversial topics within risk measurement is the concept of periodic “explicit risk adjustments” and how these factors might be utilized inconsistently within the industry. A component of this concept is the notion of a “conditional tail factor” for insurance reserving, which could be subject to a wide array of outside forces and economic factors. Currently the guidance on developing the explicit risk adjustment is limited and the Boards acknowledge that strong implementation guidance will be needed, should the move be made to finalize this concept. 

Unbundling Requirements

The two Boards have had numerous discussions surrounding the “unbundling” of components of an insurance contract that are not directly related to the insurance coverage itself. It is believed that features that may need to be unbundled from the insurance contract are certain policyholder account balances, certain embedded derivatives, and other goods or services provided under the contract that are not closely related to the economic substance of the insurance contract. For instance, a universal life policy may be split into one component for insurance coverage and another component for the financial-instrument features of the contract. The IASB’s current view is that any explicit unbundled non-insurance features of a contract should be accounted for using the relevant financial-instruments guidance in IFRS, subject to future modifications and changes. The FASB has not recently voted on this topic. 

• Currently, the Boards appear unclear on the actual requirements surrounding unbundling, other than for the fact that certain components of unbundling are likely to be included in any final rulings — pending further deliberations.

Discount Rates for Ultra-long-duration Contracts

The Boards are currently considering whether additional requirements are needed in cases where a contract’s long duration causes the interest-rate yield curve to extend beyond the point of available data inputs. One current consideration is to account for discount-rate changes in long-duration cash flows within Other Comprehensive Income. The Boards, however, have tentatively concluded that there is a strong desire to establish one accounting methodology for all insurance contracts and that separate treatment for ultra-long-duration contracts would not be consistent with this stated goal. 

• We generally agree that the intent of the Boards’ efforts is to develop one set of standards for insurance-contract accounting. Therefore, the notion of separate treatment for certain-duration contracts appears inconsistent with this construct. 

Unlocking of Profit Margins

The unlocking of profit margins could stand to be one of the most impactful changes currently being discussed by the joint Boards. Both the IASB and the FASB have expressed an interest in determining whether or not the unlocking of profit margins would cause too much volatility within the profitability of an insurance enterprise, or whether such unlocking would allow an organization to better reflect the impacts of future assumptions within the current accounting period. The FASB has raised concerns that the “floating” margins could result in unwanted consequences of smoothing and profit manipulation. 

• The joint Boards have agreed to have follow-up discussions related to the merits (and possible complexities) of unlocking margins. Future guidance, if any, on this topic will likely need to include very specific implementation guidance to set the overall framework that can be followed by insurance companies and foster comparability from one organization to the next. 

Next Steps

There is no clear set of agenda items that will be discussed by the IASB and the FASB later this year. Clearly, the Boards will have outside pressure to move expeditiously toward a consolidated series of standards for insurance contracts, and perhaps to issue a final set of recommendations in late 2011. 

Through a series of podcasts and publications, the Boards anticipate continued deliberation on a number of these key areas and Blackman Kallick will be regularly assessing the latest developments and conclusions reached by the Boards. Please visit us regularly at BlackmanKallick.com for updates and future considerations that may impact your organization.

For further information please contact Jerry Hufton at  jhufton@BlackmanKallick.com or 312-980-2961, Jeff Dertz at  jdertz@BlackmanKallick.com or 312-980-3224, Doug Youngren at  dyoungren@BlackmanKallick.com or 312-980-2944, or your Blackman Kallick representative.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.