insurance accounting alertfile/iaa-feb2015.pdfinsurance contracts project is expected to be in...
TRANSCRIPT
IASB discusses transition relief for application of the new insurance contracts standard (after the implementation of IFRS 9)
OverviewDuring its January meeting, the International Accounting Standards Board (IASB, or Board) continued redeliberations on its 2013 Exposure Draft Insurance Contracts (ED). The Board discussed transition relief for financial assets upon the adoption of the new insurance standard and the staff requested the Board:
• To confirm the proposed transition guidance on financial instruments in the ED
• To consider providing further transition relief to permit or require an entity to reassess the business model for financial assets at the date of initial application of the new insurance contracts standard
With regard to the second point above, the staff believe that because the mandatory effective date for IFRS 9 Financial Instruments (January 1, 2018) is now expected to differ from the effective date for the new insurance contracts standard, consideration should be given to additional transition relief. The staff commented that, even if the insurance contracts standard is issued in late 2015, its mandatory effective date is expected to be after that of IFRS 9. This is because of the Board’s intention to allow for an implementation period of three years from issuance of the insurance contracts standard. The Board will discuss the effective date for the new insurance contracts standard at a future meeting, once the redeliberations on the model for participating contracts features have been completed.
What you need to know
• The Board tentatively decided to permit entities to newly apply or revoke the fair value option in IFRS 9 for financial assets on the initial application of the new insurance contracts standard
• The Board agreed to consider proposals for further transition relief to permit or require an entity to reassess the business model for financial assets when adopting the new insurance contracts standard
• The Board tentatively decided not to consider deferring the mandatory effective date of IFRS 9 for entities that issue insurance contracts
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2 Insurance Accounting Alert - February 2015
Transition proposals in the EDIn the ED, the Board proposed that, on the initial application of the new insurance contracts standard, an entity is:
• Permitted to newly designate financial assets under the fair value option in IFRS 9 to eliminate (or significantly reduce) an accounting mismatch
• Required to revoke previous fair value option designations for financial assets if the accounting mismatch that led to the previous designation under IFRS 9 no longer exists
• Permitted to newly designate an investment in an equity instrument as measured at fair value through other comprehensive income in accordance with IFRS 9 and is permitted to revoke previous designations
This transition relief provides an entity, on initial application of the new insurance contracts standard, with the possibility to make new designations of financial assets or to revoke previous designations under IFRS 9 in order to minimise accounting mismatches. Without this transition relief, these designation options would only be available on initial application of IFRS 9.
All Board members agreed to confirm the transition relief proposal, as set out in the ED.
Additional transition reliefThe staff pointed out that as the mandatory dates for IFRS 9 and the new insurance contracts standard are not expected to be aligned, entities issuing insurance contracts may have to prepare for the IFRS 9 classification and measurement criteria for financial assets at a time when there is still uncertainty over how insurance contract liabilities under the new insurance contracts standard will be measured. Many preparers, according to the staff, are concerned that they will be required to apply the
classification and measurement requirements of IFRS 9 without the opportunity to fully evaluate the implications of the new insurance contracts standard.
The staff therefore asked the Board to consider exploring further transition relief that permits or requires an entity to reassess the IFRS 9 business model for financial assets at the time of initial application of the new insurance contracts standard. The staff proposed that this reassessment should be in the same manner as the assessment of the business model that the entity would perform on initial application of IFRS 9, but taking into account the facts and circumstances existing at the date of the application of the new insurance contracts standard.1
The Board briefly discussed providing regulated insurance entities with the ability to delay the effective date of IFRS 9 to align it with the effective date of the new insurance contracts standard. The majority of Board members, however, noted the importance and benefits of having one effective date for IFRS 9 implementation for all entities, even if the new insurance contracts standard is not yet finalised. As a consequence, the Board acknowledged that it is important to consider additional transition relief to make the adoption of the two standards on different dates less onerous for entities (in terms of both accounting mismatch issues and practical implementation challenges).
A few board members suggested considering further the option to defer IFRS 9 for specific ring-fenced elements of entities issuing insurance contracts. One of the board members said he could accept the staff proposal, but, nevertheless, viewed it as a suboptimal solution with a revolving door for adopting IFRS 9, which would then require revisiting the classification and measurement of financial instruments, with significant cost implications ultimately borne by investors.
However, most Board members did not wish to explore further any deferral of IFRS 9 and countered that a specific exemption relating to insurance could end up being for an unknown period of time until the new standard is issued. Furthermore, the Board members believe that there are unresolved problems of defining the insurance entities or specific assets backing insurance liabilities to be exempted and the unwanted effect this would have of having two completed standards (IAS 39 and IFRS 9) in place at the same time for financial instruments.
Even though many Board members were sympathetic to the staff’s business model proposal, the discussion then turned into a debate on the reassessment of the business model under IFRS 9 on adoption of the new insurance standard. One board member was concerned this reassessment could undermine (and interfere with) the business model concept in IFRS 9 if the same situation and facts are subjectively assessed twice, which could potentially lead to two different conclusions. Some board members also noted that the business model is a matter of fact and not a choice under IFRS 9.
1 IFRS 9 specifies that an entity reclassifies all affected financial assets only when there is a change in business model for managing financial assets. This is determined by senior management as a result of external or internal changes and must be significant and observable. Therefore, unless the high threshold for reclassification in IFRS 9 is met, without this relief, an entity would be unable to change the classification of financial assets when applying the new insurance contracts standard.
3Insurance Accounting Alert - February 2015
Other Board members highlighted that business models can change (or ‘morph’) over time. As the underlying IASB staff paper points out, a change in accounting policy on applying the new standard may be one factor causing an insurer to modify the objective of the business model under which financial assets are held. Yet such modifications are not likely to meet the high threshold for reclassifying financial assets in accordance with IFRS 9. However, if the entity had adopted IFRS 9 after the modified objective was in place (rather than before), the entity might have come to a different conclusion about the objective of the business model and may have classified the financial assets differently.
Allowing an entity to reassess its business models as part of the transition for the new insurance contract standard would lower the hurdle of a change in classification compared to the reclassification guidance in IFRS 9. This relief seems reasonable to most Board members. A few Board members noted that IFRS 9 does not provide a choice as to business model, and they expect that the decisions made on the business model previously would likely hold in most circumstances.
Thirteen Board members agreed with the staff proposal and also agreed not to consider deferring the mandatory effective date of IFRS 9 for entities that issue insurance contracts; one IASB member disagreed. Accordingly, the Board asked the staff to continue to work on a proposal for further transition relief and will consider this proposal at future meetings. This proposal will include: the exact conditions and mechanics of such relief; whether reassessment should be required or permitted; and further consideration of the consequential issues arising from this transition relief – such as whether it is to be applied prospectively or retrospectively and how to determine which financial assets this would apply to.
What’s next?The Board has essentially completed the development of the model for non-participating contracts at previous meetings, including the measurement on transition to the new insurance contracts standard.
The Board’s next meeting on the insurance contracts project is expected to be in February. The topics have not yet been announced, but will likely cover further re-deliberations on participating contracts. The IASB expects to publish a final standard in late 2015.
How we see itWith the expectation that the effective dates for IFRS 9 and IFRS 4 will not be aligned, the Board faces a real dilemma. On one hand, the Board acknowledges the natural link between IFRS 9 and IFRS 4 for entities issuing insurance contracts and the burden that would arise for these entities if the effective dates of the two standards are not aligned. On the other hand, the Board is very wary of creating a special transition relief for entities issuing insurance contracts that would come with many challenges and complications.
Based on the tentative decision made during the January meeting, the Board chose to follow the latter view and direct the staff to develop a proposal accordingly. Whatever solution the Board follows, it will always be suboptimal to an alignment of IFRS 9 and IFRS 4 based on a 2018 effective date. But such alignment now seems beyond reach because of the current status of the insurance contracts project and the Boards intention to allow for a three-year adoption period after issuance of the final standard.
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