Response to Exposure Draft ED lnsurance Contracts. Dear Mr Hoogervorst,

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1 DE ECONOM~A Y COMPmTIVIDAD DIRECUÓN GENERAL DE SEGUROS Response to Exposure Draft ED lnsurance Contracts Dear Mr Hoogervorst, The Dirección General de Seguros y Fondos de Pensiones (DGSYFP) is the Spanish supervisor and accounting regulator for Spanish insurance companies and pension funds and appreciates the opportunity to provide input to the development of an international accounting standard on insurance contracts. We realize that this ED tries to considerer and revise the comments received for the previous ED. DGSYFP supports the "building block approach" for measuring insurance contracts and the unlocking of the Contractual Service Margin. However, we have some concerns regarding other aspects of the ED most of them related to accounting mismatches. So it is necessary to consider IFRS 9 and IFRS 4 together. The amendments outlined in the IASB's Exposure DraW Classification and Measurement: Limited Amendments to IFRS 9 do not address al1 of the accounting mismatches and introduce additional mismatches; Even understanding the existence of certain differences between the accounting and solvency approaches (for example in relation to Contractual Service Margin), it would be appropriate to make a greater effort of convergence between both criteria due to simplicity, comparability, and materiality principles. DGSYFP has provided its detailed responses to the questions raised in the ED in the attached Appendix 1. The attached Appendix 2 points out areas of the ED where no question was specifically asked. If you have any questions or wish to discuss this further with us, please feel free to contact Mr Fernando Moreno at fernando.moreno@mineco.es Maria Flavia Rodríguez-Ponga y Salamanca Directora General de Seguros y Fondos de Pensiones Mr Hans Hoogervorst Chairman of the IASB 30 Cannon Street London EC4M 6XH GroBbritannien Po, DE LA CASTEUANA, 44 TEL.: O0

2 DE ECONOM~A Y COMPETiTIVIDAD SECRETAR~A DE ESTADO Y DIRECCION GENERAL DE SEGUROS Appendix 1 Question 1-Adjusting the contractual se~ice margin -- Do you agree that financial statements would provide relevant information that faithfully represents the entity's financial position and performance if differences between the current and previous estimates of the present value of future cash flows 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 recognized immediately in profit or loss? Whv or whv not? If not. what wouid vou recommend and whv? 1 The initial no recognition of profits and the initial recognition of losses are consistent with the fulfilment value. The imputation of the Contractual Service Margin to P&L seems reasonable under a systematic approach that reflects the transfer of the services provided under the contract. DGSYFP supports the idea that the Contractual Service Margin has to be re-measured in order to reflect the profitability including changes arising from the reestimate of future cash flows. Besides DGSYFP does agree with the ED's proposal to adjust the Contractual Service Margin for differences between current and previous estimates of the present value of future cash flows as long as they relate to future coverage and other future services and the Contractual Service Margin does not become negative. However, there are two cases, where no adjustment of the Contractual Service Margin is made, and DGSYFP believes that it should be adjusted: A. - Changes in the risk margin. B. - Changes in cash flows when they relate to past coverage and other past services. In particular, why to exclude compensations of the Contractual Service Margin for future payment flows corresponding to claims that have already occurred (IBNR)? Question 2-Contracts that require the entity to hold underlying items and specify a link to returns on those underlying items PO. DE LA CASTELLANA, 44 TEL.:

3 Y COMPErnVIDAD DIRECCI~N GENERAL DE SEGUROS 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 fulfillment 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 fulfillment 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 (ie 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)? 1 (c) recognizes changes in the fulfillment cash flows as follows: I (i) changes in the fulfillment cash flows that are expected to vary directly with returns on the underlying items would be recognized 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 fulfillment cash flows that are expected to vary indirectly with the returns on the underlying items would be recognized in profit or loss; and (iii) changes in the fulfillment 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 recognized in profit or loss and in other comprehensive income in accordance with the general requirements of the [draft] Standard? 1 Why orwhy not? If not, what would you recommend and whi> It applies to insurance with benefits, unit-linked, and variable annuities. The provision is measured separately in two components: A.- Component linked to assets, which is recognized in profit or loss or other comprehensive income on the same basis as the recognition of changes in the value of those underlying items according to their book value. B.- Component not linked to assets (non-separable embedded options, minimum payments under the contract), according to the general methodology The first component is relevant only to avoid accounting mismatches when the asset is measured at amortized cost. PO. DE LA CATELLANA, 44 TEL.: W

4 Y COMPETITIVIDAD SKREIARÍA DE ESTADO i DIRUUON GENERAL DE SEGUROS Y FONWS DE PENSIONES Meanwhile, the ED specifies that changes in the provision will be recognized in profit or other comprehensive income depending on the relation to the underlying assets: direct link, indirect link and no link. The definition of the second type of relationship and how the accounting proceed (against income or other comprehensive income) needs further explanation, especially in relation to the effects of changes in the discount rate, to avoid the appearance of accounting mismatches. Question 3-Presentation of insurance contract revenue and expenses l Do you agree that financial statements would provide relevant information that faithfully represents the entity's financial performance if, for al1 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? Question Glnterest expense in profit or loss 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 undetwriting performance from the effects of the changes in the discount rates by: (a) recognizing, in profit or loss, the interest expense determined using the discount rates that applied at the date that the contract was initialiy recognized. 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 retums to affect the amount of those cash flows; and (b) recognizing, 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 recognized. For cash flows that are expected to vary directly with retums 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? PO. DE LA CASTELLANA. 44 TEL: W

5 Y COMPETmVIDAD AWYO A LA EMPRESA DIRECCI~N GENERAL DE SEGUROS Questions may arise regarding the equivalente of the appropriate interest rate curve used to discount liability risks (excluding the credit risk of the entity) and the risk-free curve plus the illiquidity premium. The practica1 application of the methods "top-down" and "bottomup" is not clear. Although the illiquidity premium is consistent with the fulfillment and transfer values of the provision, a concretion of its amount would be welcomed. The ED states that the variation in the provision arising from changes in the discount rate is recognized in other comprehensive income. The change in the discount rate (essentially risk-free curve) is determined by the financia1 markets and affects assets and liabilities. Although the recognition in other comprehensive income of changes in the discount rate reduces volatility in P&L, accounting misrnatches are generated when the assets are measured at amortized cost or at fair value through P&L. The second assumption could be solved by using the registration option in other comprehensive income or P&L, subject to the condition to avoid accounting mismatches. Question 5-Effective date and transition 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? The ED2013 approach to transition establishes retrospective evaluation of the provision in recognition of outstanding sewice rnargin estimate. This criterion make's possible to compare the accounting of the insurance provision before and after the entry into force. A lag of Solvency 2 seems to be inevitable so at least it would be desirable that IFRS9 and IFRS4 entry into force at the same time. Question 6-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? 1 Please describe the likely effect of the proposed Standard as a whole on: 1 P. DE LA CASELLANA, 44 TEL.: O0 FM.:

6 DE ECONOM~A Y COMPMVIDAD DIRECCI~N GENERAL DE SEGUROS (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. Question 7-Clarity of drafting / Do you agree that the proposals are drafted clearly and reflect the decisions made by the IACB? If not, please describe any proposal that is not clear. How would you clarify it? In this response letter we have pointed out some comments on the wording and application guidance where could be a lack of clarity. As for example: - Discount rate; - Risk adjustment and diversification benefits - Unbundling; - Contracts that require the entity to hold underlying items and specify a link to returns on those underlying items - Replicating portfolio of assets

7 Y COMPrnVIDAD SECRETA& DE ESADO DE ECONOM~A Y DIRECCI~N GENEML DE SEGUROS Appendix 2 Other comments on the ED 1.- Cash flows Although the admission of entity's specific hypotheses is consistent under the fulfillment approach, it reduces comparability between entities. General acquisition costs which cannot be directly attributed to the portíolio of an insurance contract are not considered in the calculation of the provision and are recognized in P&L. These costs could be included in the calculation of the provision as far as they have to be covered indirectly by premiums. According to the ED2013, the imputation of the direct acquisition costs surcharge to P&L is made under a systematic approach that reflects the transfer of the services provided under the contract. We think that income should be recognized in P&L relating to the direct acquisition costs. 2.- Risk adjustment The admission and lack of equivalente of different calculation methods can hinder comparative information between entities. So it would be desirable to concrete its configuration parameters. The ED2013 amends the diversification benefits between portfolios, set by ED2010, indicating that it should be calculated according to the degree of diversification benefit that the entity considers when determining the compensation it requires for bearing that uncertainty. It's a significant change that allows a closer approach to Solvency 2, but it again incorporates imprecision. On the other hand, for presentation purposes, entities need to report, in any case, the confidence level for the estimated risk adjustment. It does not seem consistent that IASB Shows a preference for this method while agrees to require the entities to do at least a double calculation as Solvency 2 provides as a methodology for calculating the risk adjustment the cost of capital. Po. DE ia C4íiEL!ANA, 44 TEL: O0