© 2012 deloitte llp. private and confidential direction is getting clearer but major concerns...

© 2012 Deloitte LLP. Private and confidential

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 2012


Agenda

Highlights of decisions and education sessions from this month joint meetings

Detailed analysis of the Staff recommendations and Board discussions

Update on timetable and next steps

IFRS 4 Phase II - Webcast (June 2012)2


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 standard

Financial 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

3 IFRS 4 Phase II - Webcast (June 2012)


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

Background Staff 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



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:

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

2. 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 Non claims related cash flows / Acquisition costs Unit of account



Details of IASB/FASB meeting 12 JuneAllocation of cash flows to unbundled components – paper 2A/84A

Staff recommendation

For those components to be unbundled:

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

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

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



Details of IASB/FASB meeting 12 JuneAllocation of cash flows to unbundled components – paper 2A/84A (cont.)

Discussion

Concerns 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


IASB FASB

In favour of Staff recommendation Unanimous Unanimous


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

Background At 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



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

Background

IFRS 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



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

Background

Current 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



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

FASB Staff recommendation – in essence to more closely align with IASB

For 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



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

Discussion

Concern 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.



Details of IASB education session - 14 JuneTreatment of acquisition costs - paper 2D

Background

At 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



Details of IASB education session - 14 JuneTreatment of acquisition costs (continued)

Summary of options


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 driver


Details of IASB education session - 14 JuneTreatment 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)



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.”



Next steps and timetable

Next joint meeting expected in week of 16 July Insurance Working Group meeting on 25 and 26 June in London

Major 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



Contact details

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

Link to Deloitte IFRS Insurance materials:https://www.iasplus.com/deloitte/en/projects/project47

Insurance Centre of Excellence:[email protected]


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

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© 2012 Deloitte LLP. Private and confidential19 IFRS 4 Phase II - Webcast (June 2012)

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