Exposure Draft - Insurance Contracts. ILAG is a trade body representing members from the Life Assurance and Wealth Management Industries.

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1 ILAG Investment & Life Assurance Group The Practitioner Voice International Accounting Standards Board 30 Cannon Street London EC4M 6XH 25 October 2013 Dear Sirs, Exposure Draft - Insurance Contracts ILAG is a trade body representing members from the Life Assurance and Wealth Management Industries. ILAG members share and develop their practical experiences and expertise, applying this practitioner knowledge to the development of their businesses, both individually and collectively, for the benefit of members and their customers. Our members are predominantly smaller UK companies; many are mutual in nature and typically do not have the resource to undertake field testing of the proposals in the timescale given while simultaneously implementing multiple regulatory changes. A list of ILAG members is at the end of this submission. Significant progress welcomed We are pleased to have the opportunity to comment on this Exposure Draft (ED) and welcome many of the improvements from the IASB in response to industry concerns in the original ED ( 2010 ED ), and the efforts it has gone through to involve and discuss the various issues with industry members. There has been significant progress since the 2010 ED and we welcome many of the changes outside the targeted areas that the IASB has made in response to feedback. In particular these include: Clarification that the top-down calculation of the discount rate is allowed Removal of previous restrictions on applicable methods for the Risk Adjustment Premium allocation approach no longer being mandatory for short duration contracts The presentation of revenue for short-duration contracts appears to lead to an approach that is very similar to current practice. Critical issues remain The new ED will represent a radical change for insurance companies reflecting a number of significant conceptual and operational changes from companies current practices. The cost of transition and the ability of companies, particularly smaller companies, to deal with the operational requirements of this complex standard will provide a significant challenge. In 1

2 addition, there are a number of key issues remaining that need to be addressed prior to finalising a Standard. These include: The proposal to require the use of other comprehensive income (OCI) to reflect changes in discount rates for all insurance contract liabilities, except where the mirroring approach applies, would be complex and costly. We believe that the mandatory use of OCI cannot be justified because it would provide less relevant and reliable information by introducing accounting mismatches in many circumstances. We recommend either allowing insurers the option to recognise movements in insurance contract liabilities due to changes in discount rates in profit or loss where this would avoid an accounting mismatch, or making changes in discount rates in profit or loss the starting point but allowing insurers the option to use OCI to recognise movements in insurance contract liabilities due to changes in discount rates where this would avoid an accounting mismatch. There would be significant systems costs associated with the mirroring proposals, particularly the need to disaggregate cash flows into those that vary with underlying items and those that do not. This would be exacerbated by the need to treat changes in fulfilment cash flows in different ways in profit or loss and OCI. We are not convinced that the measurement approach would be an improvement on the more market consistent measurement approach for participating contracts currently adopted under UK GAAP (and by those insurers currently applying IFRS 4). Where the fulfilment cash flows depend on underlying items, but also on a number of other factors, we recommend that the proposals do not enforce disaggregation of cash flows. The IASB s proposals would introduce significant volatility in profit or loss for UK with-profits business. It is unfortunate that the IASB has done much in the current ED to allay industry concerns about volatility in profit or loss, yet the most significant source of volatility for some UK insurers has not been addressed. We do not support the mandatory adoption of the insurance contract revenue approach. The expected benefits would not outweigh the cost to preparers that measure their contracts under the building block approach (BBA), not least the cost of enforced bifurcation of investment components. We support the principle of adjusting the contractual service margin (CSM) for changes in estimates of cash flows that relate to future coverage and other future services. However, the CSM should also be adjusted for changes in the risk adjustment for future benefits and services, and that the interest rate used to discount the CSM should be the current rate and not the rate at the inception of the contract. We also believe, when a previously recognised loss on an onerous contract reverses, that the change in estimates of future cash flows should be recognised immediately in profit or loss to the extent that it recovers past losses. It would be appropriate for a cedant to recognise a profit when buying reinsurance to the extent that it reverses a loss it has previously recognised if the underlying direct insurance contracts are onerous. We support the establishment of a contractual service margin for in force business at the date of transition. We recommend that the effective dates of the new Insurance Contract Standard and IFRS 9 are aligned. If the effective date of IFRS 9 is before the effective date of the new Insurance Contracts Standard it is important that entities should be permitted more flexibility to reconsider designations and classifications made on the adoption of IFRS 9 when transitioning to the new Insurance Contracts Standard. 2

3 We recommend removing the requirement for disclosure of the confidence interval equivalent for the risk adjustment. This disclosure would lack comparability, while significantly increasing the cost and complexity of the proposals. We recommend the use of qualitative reasoning to explain the calibration of the risk adjustment. Overall, the current ED is an improvement on the 2010 ED. The new proposals would achieve more consistency and comparability in the financial reporting of entities that issue insurance contracts, although we are not yet convinced that the other key objectives of increased transparency and relevance of the information reported would necessarily be met. There are still a number of critical issues to be resolved and the IASB should allow additional time for field testing its final proposals, for example by placing a review draft on its website to allow interpretation and implementation issues to be ironed out prior to issuing its new Insurance Contract Standard. Our responses to the specific consultation questions are attached. Yours faithfully Lynda Maynard Administration Team 3

4 Response to specific Consultation questions - Insurance Contracts Q1. Adjusting the contractual service margin (paragraphs 30 31, B68, BC26 BC41 and IE9 IE11) Question 1 Adjusting the contractual service margin Do you agree that financial statements would provide relevant information that faithfully represents the entity s financial position and performance if: (a) differences between the current and previous estimates of the present value of future cash flows related to future coverage and other future services are added to, or deducted from, the contractual service margin, subject to the condition that the contractual service margin should not be negative; and (b) differences between the current and previous estimates of the present value of future cash flows that do not relate to future coverage and other future services are recognised immediately in profit or loss? Why or why not? If not, what would you recommend and why? a) & b) Yes, subject to the comments below. The introduction of the adjustment to the CSM is a positive move, although the application of this change will be complex to implement. The ED would require all changes in the risk adjustment to be recognised in profit or loss. However, as noted in paragraph BC 36, changes in the risk adjustment would, potentially, comprise of three components: 1) a release from risk as the coverage period expires; 2) changes in risk for future benefits and services and 3) changes in risk that relate to incurred claims. We can see no reason why the CSM should not be adjusted for changes in the risk adjustment that relates to changes in risk for future benefits and services, rather than be recognised immediately through profit or loss. This would be more consistent with the general measurement approach. Interest would be accreted on the carrying amount of the CSM using the rate that applied when the contract was issued (the locked-in rate). Using a discount rate that reflects the current market conditions would be more consistent with the general measurement approach. Our response to question 4 is also relevant in this context. We agree that the CSM should be recognised in a systematic way that best reflects the transfer of services provided under the contract. However, it would be helpful if additional guidance was provided to improve comparability. We understand, for example, that a method of recognition in line with realised gains or bonus declarations is unlikely to be appropriate. Paragraph 30 implies that, if a previously recognised loss on an onerous contract reverses, the expected decrease in future cash flows would be established as a CSM. We think that any improvement should be recognised immediately in profit or loss to the extent that it recovers past losses. 4

5 Reinsurance ceded The ED proposes that, when a cedant buys reinsurance, if the present value of the fulfilment cash inflows plus the risk adjustment exceeds the present value of the fulfilment cash outflows arising under the reinsurance contract, the difference at initial recognition would be recognised as a CSM to remove any day one gain. We believe, however, that it would be appropriate for the cedant to recognise a day one gain on buying reinsurance to the extent that it reverses a loss previously recognised in profit or loss if the underlying direct insurance contracts are expected to be onerous. Q2. Contracts that require the entity to hold underlying items and specify a link to returns on those underlying items (paragraphs 33 34, 66, B83 B87, BC42 BC71 and IE23 IE25) If a contract requires an entity to hold underlying items and specifies a link between the payments to the policyholder and the returns on those underlying items, do you agree that financial statements would provide relevant information that faithfully represents the entity s financial position and performance if the entity: (a) measures the fulfilment cash flows that are expected to vary directly with returns on underlying items by reference to the carrying amount of the underlying items? (b) measures the fulfilment cash flows that are not expected to vary directly with returns on underlying items, for example, fixed payments specified by the contract, options embedded in the insurance contract that are not separated and guarantees of minimum payments that are embedded in the contract and that are not separated, in accordance with the other requirements of the [draft] Standard (i.e. using the expected value of the full range of possible outcomes to measure insurance contracts and taking into account risk and the time value of money)? (c) recognises changes in the fulfilment cash flows as follows: (i) changes in the fulfilment cash flows that are expected to vary directly with returns on the underlying items would be recognised in profit or loss or other comprehensive income on the same basis as the recognition of changes in the value of those underlying items; (ii) changes in the fulfilment cash flows that are expected to vary indirectly with the returns on the underlying items would be recognised in profit or loss; and (iii) changes in the fulfilment cash flows that are not expected to vary with the returns on the underlying items, including those that are expected to vary with other factors (for example, with mortality rates) and those that are fixed (for example, fixed death benefits), would be recognised in profit or loss and in other comprehensive income in accordance with the general requirements of the [draft] Standard? Why or why not? If not, what would you recommend and why? We agree with the general principle set out in paragraph 26(a) that, to the extent that the amount, timing and uncertainty of the cash flows that arise from an insurance contract depends wholly or partly on the returns from underlying items, the characteristics of the liability should reflect that dependence and the discount rate used to measure those cash flows should reflect the extent of that dependence. We also agree that measuring the fulfilment cash flows that are expected to vary with returns on underlying items by reference to the carrying amount of the underlying items would conceptually be one way of achieving this objective. 5

6 However, the requirement to decompose the cash flows as set out in paragraph 34 and to recognise changes in the decomposed fulfilment cash flows in accordance with paragraph 66 is likely to add significant complexity for UK insurers, particularly if their business includes with-profits contracts. We are not convinced that the resulting measurement approach would be an improvement to the more market consistent measurement approach currently adopted under UK GAAP (and by those insurers currently applying IFRS 4). As noted in paragraph BC 60 the measurement of insurance contracts to which the mirroring approach applies could differ depending on how the fulfilment cash flows are decomposed. Significant differences could also arise in how changes in the decomposed fulfilment cash flows are recognised in profit or loss and other comprehensive income when applying paragraph 66. How the requirements to adjust the CSM for certain changes in current estimates of future cash flows (paragraph B68) and to recognise interest expense in profit or loss using the discount rate that applied at the date that the contract was initially recognised (paragraph 60(h)) are applied depends on how the cash flows are decomposed. We recognise that the intended purpose of paragraphs B85 and B86 is to provide more consistency in the way that contracts falling within the scope of the mirroring approach are measured and how changes in the measurement of fulfilment cash flows are presented. Nevertheless, given the wide range of different contracts that would fall within the mirroring approach and the difficulty in interpreting and applying these paragraphs, we are not convinced that consistency would be achieved. The next section of our reply considers how these requirements might apply to UK withprofits contracts. Implications for UK with-profits contracts We have assumed that UK with-profits contracts would fall within the scope of the mirroring proposals. Under these proposals, the accounting is likely to become significantly more complex. Different cash flows would require different accounting approaches, for example: The investment element of changes in asset share would be in scope for mirroring, whereas other changes to asset share might be accounted for under the building block approach Changes in the value of options and guarantees would need to be disaggregated Changes in value of the cost of smoothing, arguably, would also need to be disaggregated. In the case where the fulfilment cash flows depend both on an underlying item and also on a number of other factors, it would be helpful if the proposals should not enforce the disaggregation of cash flows. One way to achieve the same overall objective as paragraph 34(a) would be to use a certainty equivalent approach to these cash flows under which the assumed investment return on the underlying assets equals the discount rate used. This would ensure that value of the mirrored cash flows would equal the fair value of the backing assets. We acknowledge that this approach could only be adopted if the backing assets were measured at fair value. The cost of options and guarantees would require separate, market consistent modelling to correctly capture the time value. An accounting mismatch would arise if the underlying assets were valued at fair value through profit or loss and the effect of changes in the current rate used to discount insurance contract liabilities was recognised in OCI. In our reply to Question 4 we recommend allowing 6

7 insurers an option to recognise changes in the current discount rate in profit or loss which would eliminate this mismatch, alternatively to allow insurers the option to use OCI to recognise movements in insurance contract liabilities due to changes in discount rates where this would avoid an accounting mismatch. Paragraph BC127 (b) acknowledges that the accounting for options and guarantees embedded in an insurance contract would be different when mirroring applies compared to the building block approach. Such inconsistency would be undesirable. The measurement of contracts for which the mirroring approach applies would be more consistent with the building block approach if there were no need to separate out any fixed benefits from the cost of guarantees. There is a specific issue for proprietary with-profits companies. Under the mirroring proposals, the shareholders share of the current contract holders asset shares and of the assets representing the unallocated estate would be recognised as equity, and movements in the value of these assets would be recognised directly in profit or loss. In contrast, under the current approach in UK GAAP (and IFRS 4), the shareholders interest is recognised as a liability and movements in the asset values are offset by an equal and opposite movement in the value of the liability. The IASB s proposals would introduce significant P&L volatility. It is unfortunate that the IASB has done much in the current ED to allay industry concerns about volatility in profit or loss yet the most significant source of volatility for some UK insurers has not been addressed. For contracts measured under the building block approach the CSM is recognised in profit or loss over the coverage period as services are provided to the contract holders. For UK withprofits contracts the main service provided to contract holders is the management of their asset shares to provide an investment return. The shareholders interest in these asset shares is not accessible to shareholders immediately, and is typically released over time through future bonus declarations. The shareholders interest in these asset shares is, therefore, linked to the provision of future services to contract holders. We suggest that the investment returns earned on the shareholders share of the contract holders asset shares should be recognised in profit or loss, as the asset management services are provided to contract holders by adjusting the CSM, and not in the period in which the investment returns arise. Mutual entities Under the ED proposals, a mutual insurance entity where contract holders participate in the whole of any surplus would have no equity, since there would be an assumption that all cash inflows (and any estate) would be paid out either to current or future contract holders. Hence there would be no facility for showing changes in the estate and the statement of financial position would not show the financial strength of the mutual entity. In contrast, under the current approach under UK GAAP (and IFRS 4) the estate (which represents amounts that are not directly attributed to current contract holders) is separately presented and so gives a mechanism for demonstrating the mutual entity s financial strength. The proposed presentation where the estate would not be separately presented but would be subsumed in the contract liabilities for the current generation of policyholders would not reflect the business model of a mutual insurance entity that is not closed to new business. Therefore, we recommend that the amount that represents the estate should be separately presented from the liabilities to current contract holders. Unit-linked business For unit-linked business, it is unclear when applying paragraph 34, if the expected cash flows in respect future annual management charges (AMCs) would be expected to vary 7

8 directly with returns on the underlying assets that the insurer is required to hold, or not. Moreover, if they are not expected to vary directly with returns on underlying assets that the insurer is required to hold, it is also unclear, when applying paragraph 66, if the expected AMC cash flows would be expected to vary indirectly with returns on the underlying items or if they would not be expected to vary with returns on the underlying items. Paragraph B68 (e) could imply that expected cash flows in respect of future AMCs are not expected to vary either directly or indirectly with returns on the underlying items. It is important that this is clarified since the accounting treatment, and in particular the presentation of changes in the present value of future AMCs, would be materially different depending on the approach adopted. There are a number of possible ways of applying the mirroring approach to unit-linked business. These include the following: 1) The unit fund is accounted for under the mirroring approach; and other cash flows are accounted for under the building block approach. The insurance contract liability would consist of a unit reserve; and a non-unit reserve based on the fulfilment cash flows plus a CSM. The fulfilment cash flows in this case would be all the non-unit cash flows. The CSM would be adjusted for changes in estimated present value of future AMCs since these cash flows would relate to the provision of future asset management services. 2) AMCs are unbundled from the insurance contract and are recognised under the new Revenue Recognition Standard; the unit fund would be recognised through mirroring of the underlying assets; and the other cash flows (excluding AMCs and related expenses) through the building block approach. The fulfilment cash flows would be all of the non-unit cash flows not recognised under the new Revenue Recognition Standard. 3) All cash flows are bifurcated into those which vary with the underlying assets and those that do not. For example, expected future AMCs would be split into a component which varies directly with the underlying assets and a component that does not vary directly with the underlying assets. The component that varies directly would be accounted under the mirroring approach and the other elements through the building block approach. Clarification of the approach intended by the IASB would be useful. Our preference would be for either the first or second approach. The second approach would provide consistency with that for unit-linked contracts that do not transfer significant insurance risk, although we appreciate that, under the current ED, it would not be possible to unbundle the asset management services for most unit-linked insurance contracts because the amount of the insurance benefit is typically affected by the returns provided by the asset management services. Q3. Presentation of insurance contract revenue and expenses (paragraphs 56 59, B88 B91, BC73 BC116 and IE12 IE18) Do you agree that financial statements would provide relevant information that faithfully represents the entity s financial performance if, for all insurance contracts, an entity presents, in profit or loss, insurance contract revenue and expenses, rather than information about the changes in the components of the insurance contracts? Why or why not? If not, what would you recommend and why? We agree that the proposed insurance contract revenue approach would probably provide relevant information for general insurers and those that write material volumes of short term life business for contracts that are measured under the Premium Allocation Approach (PAA). 8

9 It might also provide relevant information for mutual entities that issue long term insurance contracts, although we are not convinced that the benefits would outweigh the costs for this group of insurers compared to a premium due approach. For proprietary insurance entities that issue long term insurance contracts measured under the building block approach, a summarised margin style approach, combined with volume information in the notes might provide more relevant information. The proposed insurance contract revenue approach would be complex to undertake. We recognise that much of the information required for this approach would also be required for the summarised margin approach. However, the requirement to exclude investment components from both claims incurred and insurance contract revenue would add significant complexity. Although we agree that the disclosure of expenses and claims incurred would be useful information, it would not be necessary to present this information in the statement of profit or loss, or other comprehensive income. It could be disclosed in the notes to the accounts. It might be beneficial for a composite insurer that writes predominantly long-term insurance business to use the summarised margin approach to present the results of all of its business on a consistent basis. Similarly, a composite insurer that writes predominantly short duration business should not be precluded from presenting all of its business using the insurance contract revenue approach. We are concerned that investors and other external users, familiar with long term insurance business, would not recognise or value insurance contract revenue as either a substitute for what is currently reported as premium income, or a number they would use in their analysis. We think that users would continue to focus on existing or non-gaap sales volume measures included in the notes to the financial statement such as annual premium equivalent (APE), present value of new business premiums (PVNBP), or funds under management (FUM) rather than the proposed insurance contract premium measure. We note that EFRAG intends to test how difficult and costly it would be to disaggregate investment components and to prepare and present insurance contract revenue as part of its ongoing field-testing activities. The IASB should consider the results of this field-testing activity when weighing up the benefits and costs of the mandatory adoption of the insurance contract revenue approach. The expected benefits of presenting insurance contract revenue would not outweigh the cost for entities that measure their contracts under the building block approach, not least the cost of enforced full bifurcation of investment components. Although we understand the conceptual merits of an approach that would provide more comparability between the accounts of insurers with different business models and entities in other industries, we do not support the proposed insurance contract revenue approach as a mandatory requirement at this stage, and recommend that preparers should have the option to choose their presentation basis. Q4. Interest expense in profit or loss (paragraphs and BC117 BC159) Do you agree that financial statements would provide relevant information that faithfully represents the entity s financial performance if an entity is required to segregate the effects of the underwriting performance from the effects of the changes in the discount rates by: (a) recognising, in profit or loss, the interest expense determined using the discount rates that applied at the date that the contract was initially recognised. For cash flows that are expected to vary directly with returns on underlying items, the entity shall update those discount rates when the entity expects any changes in those returns to 9

10 affect the amount of those cash flows; and (b) recognising, in other comprehensive income, the difference between: (i) the carrying amount of the insurance contract measured using the discount rates that applied at the reporting date; and (ii) the carrying amount of the insurance contract measured using the discount rates that applied at the date that the contract was initially recognised. For cash flows that are expected to vary directly with returns on underlying items, the entity shall update those discount rates when the entity expects any changes in those returns to affect the amount of those cash flows? Why or why not? If not, what would you recommend and why? We do not consider that the proposals to recognise interest expense in profit or loss using discount rates that applied at the date that the contract was originally recognised would provide relevant information for the majority of insurers (and in particular UK insurers). The proposals would provide relevant information only for a limited number of insurers; eg those that do not actively manage their assets and use bonds that would qualify for fair value through OCI (FVOCI) measurement to back predominantly single premium cash flows. Under the proposed changes to IFRS 9, some financial assets may be accounted for at FVOCI, some at amortised cost and some at fair value through profit or loss (FVTPL) depending on the nature of the assets and the reporting entity s business model. IFRS 9 s fair value option allows financial assets to be accounted for at FVTPL where this reduces or eliminates an accounting mismatch where those assets would not otherwise qualify for FVTPL. Under the proposals contained in the ED, the effect of all changes in the current rate used to discount insurance contract liabilities would be recognised in OCI, except where the mirroring approach set out in paragraph 34 (a) applies. As recognised in BC127, and in Stephen Cooper s alternative view, it is inevitable that for many issuers of insurance contracts this proposal would lead to unavoidable accounting mismatches. Accounting mismatches would arise, for example, if an insurer is not able to account for all assets backing insurance contract liabilities at FVOCI (other than assets subject to the mirroring approach ). This would be the case where the investments include: Equity investments, derivatives or investment properties Bond investments where there is optionality (such as callable bonds) which would fail the proposed modified economic relationship test Bond investments where the insurer s business model does not lead to FVOCI classification. Some insurance contracts, such as some regular premium contracts, have significant reinvestment risk. If premiums are paid over a long period of time the market discount rates at the time that the assets are bought from the premium cash flows will be different from the discount rates at the inception on the insurance contracts. The amounts recognised in profit and loss as the discount rates unwind would not be comparable. In these circumstances the proposed model would not provide meaningful information to users of the accounts. When sales of assets backing insurance contract liabilities occur, the difference between the carrying and the realised values would be recycled from OCI to profit or loss. A feature of the proposed approach is that there is no equivalent recycling for the insurance contract 10

11 liabilities except when they are derecognised. If an insurer actively trades its assets, as in a fair value model, the mismatches that arise could be significant. This approach might also provide entities with scope to manipulate reported profit or loss by choosing when to realise asset gains and losses. The requirement to maintain two different sets of information about discount rates in the form of yield curves, and to perform two different calculations to measure insurance contract liabilities would, undoubtedly, have significant systems implications for UK insurers compared to the proposals in the 2010 ED which were more comparable with the existing basis adopted by UK insurers under UK GAAP (and IFRS 4). The mandatory use of OCI cannot be justified because it would provide less relevant and reliable information by introducing unavoidable accounting mismatches in the many circumstances referred to above. Insurers should have the option to recognise movements in insurance contract liabilities due to movements in discount rates in profit or loss where this would avoid an accounting mismatch; alternatively allow insurers the option to use OCI to recognise movements in insurance contract liabilities due to changes in discount rates, where this would avoid an accounting mismatch. We recognise that this would mean that all movements in insurance contract liabilities would not be presented in a consistent way. We see this as a consequence of the business model measurement approach for financial assets that fall within the scope of IFRS 9. The IASB s stated belief (BC147) is that accounting mismatches should be eliminated, or reduced to the best extent possible. We concur with the view that it is essential that the new Insurance Contracts Standard should not mandate the use of OCI to recognise changes in discount rates if this would introduce accounting mismatches that would otherwise be avoidable. Q5. Effective date and transition (paragraphs C1 C13, BC160 BC191 and IE26 IE29) Do you agree that the proposed approach to transition appropriately balances comparability with verifiability? Why or why not? If not, what do you suggest and why? Overall, we agree that the proposed approach to transition, appropriately, balances comparability with verifiability. We support the general principle of retrospective application and, in particular, the establishment of a remaining CSM for in-force business at the date of transition, as this is necessary to preserve the integrity of the post transition emergence of profit on that business. The establishment of a CSM at the date of transition will create a significant burden on preparers in terms of the data collection and system challenges it would pose. Not requiring insurers to undertake exhaustive efforts to obtain objective information for the purpose of applying paragraph C5 and the practical expedients in paragraph C6 would, therefore, be both necessary and appropriate. The simplifications proposed in respect of the estimates of expected cash flows, the risk adjustment and the discount rate applied at the date of initial recognition would reduce the scope for making retrospective judgements. It would also avoid the need to unwind and unlock the CSM and to account for changes in the risk adjustment between the date of inception and the earliest date on which full retrospective application is possible. We note that the proposed simplification in respect of the risk adjustment is likely to underestimate the risk adjustment at the date of initial recognition (and, consequentially, overestimate the remaining CSM at the date of transition).nevertheless, we consider this to be justified because of the benefits of simplicity and objectivity introduced by the current proposals. We concur with the IASB s tentative decision to allow approximately three years between the 11

12 date that the IASB finalises its new Insurance Contracts Standard and the mandatory effective date of that Standard. Any shorter period might not give preparers sufficient time to get ready for what will be a complex set of changes. At its meeting on 24 July 2013, the IASB tentatively decided to defer from 2015 the mandatory effective date of IFRS 9, which will be left open pending finalisation of the impairment and classification and measurement requirements. In determining the effective date of IFRS 9, the IASB should consider the interaction with the new Insurance Contracts Standard. In particular, it would be appropriate for the mandatory effective date of IFRS 9 and the new Insurance Contracts Standard to be aligned. This would enable insurers to implement both changes at the same time, avoiding the need to report and explain two significant changes in accounting in quick succession. If the effective date of IFRS 9 is before the effective date of the new Insurance Contracts Standard it is important that entities should be permitted more flexibility to reconsider designations and classifications made when adopting IFRS 9 (eg the use of the fair value option) when transitioning to the new Insurance Contracts Standard. Q6. The likely effects of a Standard for insurance contracts Considering the proposed Standard as a whole, do you think that the costs of complying with the proposed requirements are justified by the benefits that the information will provide? How are those costs and benefits affected by the proposals in Questions 1 5? How do the costs and benefits compare with any alternative approach that you propose and with the proposals in the 2010 Exposure Draft? Please describe the likely effect of the proposed Standard as a whole on: (a) the transparency in the financial statements of the effects of insurance contracts and the comparability between financial statements of different entities that issue insurance contracts; and (b) the compliance costs for preparers and the costs for users of financial statements to understand the information produced, both on initial application and on an ongoing basis. Clearly, having one common global standard would lead to an improvement in consistency, comparability and transparency between the financial statements of different entities in different countries that issue insurance contracts compared with current requirements under IFRS 4. However, based on the results of field testing carried out so far, and on member feedback, there is still a number of critical areas where the clarity and usefulness of information that would be reported under the current proposals could be substantially impaired. We have identified these areas in our responses to Questions 1-5. In particular, we do not believe that the mandatory requirement to recognise movements in insurance contract liabilities due to changes in discount rates in other comprehensive income and some aspects of the mirroring proposals would represent an improvement on current UK GAAP. Entities that issue insurance contracts have different business models reflecting the wide range of contracts that they issue and the regulatory environment in which they operate. We believe that the new Insurance Contracts Standard should provide more flexibility to allow entities to adopt approaches that would provide a closer economic fit with their business models. As indicated in our responses to questions 2, 3 and 4, we do not accept that a one size fits all approach should be followed where it would not provide relevant and useful information. 12

13 Care will also be needed to avoid disclosures that would give an unrealistic perception of comparability. With this in mind, we suggest that the requirement to disclose the confidence interval equivalent for the risk adjustment should be removed. This disclosure would require a significant amount of additional analytical work to be undertaken on a fairly granular basis. It is likely that different portfolios would have different confidence levels which would need to be combined in some way to provide a single value. This measure would not provide meaningful and useful information for users. Instead, we recommend the use of qualitative reasoning to explain the calibration of the risk adjustment. The costs of complying with the proposed requirements would certainly be higher compared with the 2010 ED. The proposals would be costly to implement; most entities would have to make major data, tracking and systems changes and be required to model a greater range of business and economic scenarios to satisfy the reporting requirements. The proposals would also undoubtedly lead to greater complexity in reporting and require significant supplementary material from preparers to educate stakeholders. It is difficult to form an accurate view on the relative benefits and compliance costs of the proposals. Although we can see the potential theoretical benefits for some of the proposals we are not currently in a position to attempt to estimate their economic value, nor are we able to attempt to estimate the economic value of the costs which, on a worldwide basis, are likely to be substantial. As previously noted ILAG members are predominantly smaller UK companies; many are mutual in nature and typically do not have the resource to undertake detailed field testing of the proposals in a relatively short period of time while simultaneously implementing multiple regulatory changes. The IASB should allow additional time for field testing its final proposals, for example by placing a review draft on its website to allow interpretation and implementation issues to be ironed out and to enable the costs of implementation to be more accurately assessed prior to finalisation of the Standard. Q7. Clarity of drafting Question 7 Clarity of drafting Do you agree that the proposals are drafted clearly and reflect the decisions made by the IASB? If not, please describe any proposal that is not clear. How would you clarify it? Overall the ED is generally well written and we support a principles based approach. However, we are aware that the current proposals are not being interpreted consistently in a number of areas, and it is important that such issues are clarified in the final Standard. We are concerned that, if amendments are made to the current proposals during the redeliberation period, further interpretation issues might arise in the final Standard. As stated in our response to Question 6 we ask that the IASB allows sufficient time for such issues to be identified and resolved before the Standard is issued, perhaps by placing a review draft on its web-site. There are a number of areas where clarification would be beneficial. These include: The mirroring proposals these are complex and, as currently drafted, there is a significant likelihood that they would be interpreted and applied differently by different preparers. We feel that more worked examples would be helpful. This would improve the clarity of the ED and lead to greater consistency of interpretation and application 13

14 between preparers. ILAG has not yet formed a view on alternative wordings. Directly attributable acquisition costs paragraph B66(c) lacks clarity about the type of costs that could be included in directly attributable acquisition costs. In particular, we understand that, although fixed and variable overheads that are directly attributable to fulfilling a portfolio of contracts would be included in its fulfilment, cash flows similar fixed and variable overheads that are attributable to the acquisition of the portfolio of contracts could not be included in directly attributable acquisition costs. The FASB s Proposed Accounting Standards Update Insurance Contracts (Topic 834) includes implementation guidance on the determination of qualifying costs. We suggest that the IASB includes similar guidance. Ends 14

15 ILAG Membership Members Affiliate Members AFM, AMPS Ageas Protect AXA Wealth Barnett Waddingham Canada Life Limited Capita Life and Pensions Services CFS CGI Defaqto Deloitte LLP Ecclesiastical Insurance Group Ernst & Young Family Investments Friends Life Foresters General Reinsurance (London Branch) Grant Thornton Hannover Re UK Life Branch HCL Insurance BPO Services Limited HSBC Bank PLC Hymans Robertson Just Retirement Limited KPMG London & Colonial Assurance PLC LV= Mazars Met Life UK Metfriendly MGM Advantage Milliman Oxford Actuaries and Consultants plc Pacific Life Re Partnership Assurance Phoenix Group Pinsent Masons PricewaterhouseCoopers Reliance Mutual RGA Royal London Group SCOR Global UK Limited. Skandia UK Suffolk Life Sun Life Assurance Company of Canada Swiss Re (UK Branch) Towers Watson Unum Wesleyan Assurance Society Zurich Assurance Limited Associate Members AKG Actuaries and Consultants Ltd Steve Dixon Associates LLP McCurrach Financial Services NMG Financial Services Consulting Ltd Squire Sanders State Street Investor Services 15