11 September Ref: 9/167. Sir David Tweedie Chairman International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom

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1 11 September 2009 Ref: 9/167 Sir David Tweedie Chairman International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Dear Sir David The International Association of Insurance Supervisors (IAIS) welcomes the opportunity to respond to the IASB s exposure draft Financial Instruments: Classification and Measurement. The IAIS supports the IASB s endeavours to reduce the complexity of IAS 39. The IAIS represents insurance supervisors and as our comments and key concerns focus on the effect of the proposals as they relate to the insurance industry. Insurers are among the largest purchasers of financial instruments in the world. As a result, the outcome of the IASB s deliberations on the replacement of the current IAS 39 is of considerable interest to insurance supervisors, as well as the insurance industry. There is a need to have regard to the consistency of measurement on the asset and the liability side of the balance sheet. Asset/Liability management is vital to insurers. Therefore, there is an issue about the interaction of decisions made with respect to financial instruments with decisions to be made in the Insurance Contracts Phase II project. A significant number of IAIS jurisdictions believe that, under certain conditions, an additional attribute of fair value with movements through other comprehensive income (including recycling) should be available. Therefore, such an attribute would reflect realisations, interest and dividends through profit and loss. Circumstances under which this attribute would be utilised may include conditions of greater uncertainty, unreliability or potentially for matching purposes. However, in the time available the IAIS was unable to resolve the extent of the utilisation that should be available and its interaction with the business model. We would appreciate the opportunity to work further on this concept with the IASB. There is general agreement among IAIS jurisdictions to the implementation of a mixed attribute model for IAS 39. For insurance companies, an important factor and driver in considering the appropriate measurement basis for assets is the basis adopted to measure policy liabilities. We believe as an important objective that the IASB should strive as much as possible for consistency and matching of the bases used for valuing insurance company assets to those adopted for the liabilities. If not, there is the very real prospect of accounting mismatch emerging, where there is not an economic mismatch, in the balance sheet and/or the income statement. This means there is the risk these statements will not produce decision useful information and create room for manipulation, misleading information and International Association of Insurance Supervisors c/o Bank for International Settlements, CH-4002 Basel, Switzerland Telephone: Telefax: Website: iais@bis.org

2 perhaps inappropriate management behaviour. At present, the lack of finality on the liability measurement basis in the Insurance Contracts Phase II project (IFRS 4) makes it difficult to judge whether the proposals in this exposure draft for valuing assets will achieve the desired objective, or at least minimise as much as possible accounting mismatch (unless that is produced by economic mismatch). The updates to IAS 39 and the Insurance Contracts Phase II project have different timelines. IAS 39 is to be revised by early 2010 with the Insurance Contracts Phase II project due for completion in the 2nd quarter of The revised IAS 39 will be available for adoption retrospectively for financial statements as at the end of 2009 with mandatory adoption in presumed to be in Mandatory adoption of the Insurance Contracts Phase II standard is not expected to occur before The likely different adoption dates could lead to accounting mismatch issues or the need to change accounting methodologies in close succession unless a practical transition is granted to insurers. In the exposure draft, the dividing line between classifications is rules based with two criteria: the type of financial instrument and how it is managed. The IAIS believes that any standard that relies heavily on rules to make a distinction between classifications is likely to lead to accounting results not reflecting the economics of particular businesses. A significant number of members of the IAIS advocate classification based on the economics of the particular business, or therefore a form of 'business model' approach. The type of financial instrument should not be the sole determining factor in how instruments are classified. It is more important to consider how an entity manages those financial instruments. Accounting should match the business model. We realise that there would be concern about potential abuse of the judgement needed for classification under a business model approach, however we believe that it would be possible to design adequate safeguards against such behaviour. We would be pleased to work with the IASB on developing such safeguards. 1. Does amortised cost provide decision-useful information for a financial asset or financial liability that has basic loan features and is managed on a contractual yield basis? If not, why? Yes. Amortised cost can provide decision useful information for a financial asset or a financial liability. The decision usefulness of the information is influenced by the degree of consistency between asset and liability measurement. Where amortised cost is used, it is important to disclose the fair value in notes to the financial statements. 2. Do you believe that the exposure draft proposes sufficient, operational guidance on the application of whether an instrument has basic loan features and is managed on a contractual yield basis? If not, why? What additional guidance would you propose and why? No. See question Do you believe that other conditions would be more appropriate to identify which financial assets or financial liabilities should be measured at amortised cost? If so (a) what alternative conditions would you propose? Why are those conditions more appropriate? (b) If additional financial assets or financial liabilities would be measured at amortised cost using those conditions, what are those additional financial assets or financial liabilities? Why does measurement at amortised cost result in information that is more decision-useful than measurement at fair value? - 2

3 (c) if financial assets or financial liabilities that the exposure draft would measure at amortised cost do not meet your proposed conditions, do you think that those financial assets or financial liabilities should be measured at fair value? (a) The definition of basic loan features is considered too restrictive. The IAIS would prefer the criteria to be simply loan features which are evaluated on an economic basis according to expected cash flow characteristics. (b) This would differ from the IASB s draft because some tranches would be able to be recorded at amortised cost as the credit protection element could be immaterial and therefore that tranche could be managed on a contractual yield basis. 4 (a) (b) Do you agree that the embedded derivative requirements for a hybrid contract with a financial host should be eliminated? If not, please describe any alternative proposal and explain how it simplifies the accounting requirements and how it would improve the decision-usefulness of information about hybrid contracts. Do you agree with the proposed application of the proposed classification approach to contractually subordinated interests (ie tranches)? If not, what approach would you propose for such contractually subordinated interests? How is that approach consistent with the proposed classification approach? How would that approach simplify the accounting requirements and improve the decision usefulness of information about contractually subordinated interests (a) No. 5. Do you agree that entities should continue to be permitted to designate any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces an accounting mismatch? If not, why? Yes. This could have particular relevance to insurance liabilities as the Board moves towards completing the Insurance Contracts Phase II project. 6. Should the fair value option be allowed under any other circumstances? If so, under what other circumstances should it be allowed and why? Further consideration may need to be given to this dependent on developments on Insurance Contracts Phase II and IAS 39 Hedging. 7. Do you agree that reclassification should be prohibited? If not, in what circumstances do you believe reclassification is appropriate and why do such reclassifications provide understandable and useful information to users of financial statements? How would you account for such reclassifications, and why? No. Given the use of business model as a basis for classification it follows that if the business model changes then reclassification should be required with full disclosure of the circumstances of the business model change together with additional disclosures to prevent abuse. 8. Do you believe that more decision-useful information about investments in equity instruments (and derivatives on those equity instruments) results if all such investments are measured at fair value? If not, why? 9. Are there circumstances in which the benefits of improved decision-usefulness do not outweigh the costs of providing this information? What are those circumstances and why? In such circumstances, what impairment test would you require and why? - 3

4 Provided the fair values can be determined reliably, then the use of fair value will result in decision-useful information about investments in equity instruments. Supervisors are split on whether an unreliable fair value measure or the existing cost less impairment basis is more appropriate. 10. Do you believe that presenting fair value changes (and dividends) for particular investments in equity instruments in other comprehensive income would improve financial reporting? If not, why? A fair value through other comprehensive income category should serve to reflect the business model more appropriately (i.e. reflect that particular equity investments can be held for strategic purposes as well as having a cash flow / income-related attribute). The main concern here is that it seems inappropriate that realised gains and losses as well as dividends should be excluded from the income statement, particularly if they represent cash inflows used to match an entity s cash outflows. 11. Do you agree that an entity should be permitted to present in other comprehensive income changes in the fair value (and dividends) of any investment in equity instruments (other than those that are held for trading), only if it elects to do so at initial recognition? If not, (a) how do you propose to identify those investments for which presentation in other comprehensive income is appropriate? Why? (b) should entities present changes in fair value in other comprehensive income only in the periods in which the investments in equity instruments meet the proposed identification principle in (a)? Why? Yes. 12. Do you agree with the additional disclosure requirements proposed for entities that apply the proposed IFRS before its mandated effective date? If not, what would you propose instead and why? Yes but disclosures need to be re-assessed at the end of the revision of IAS Do you agree with applying the proposals retrospectively and the related proposed transition guidance? If not, why? What transition guidance would you propose instead and why? There is a question regarding the interaction of the transitional provisions in this standard and the future Insurance Contracts Phase II standard. The Board should provide sufficient flexibility at transition to avoid significant mismatch or changes in accounting principles. We are concerned about how comparatives will be shown under a retrospective application and indeed how one achieves a retrospective application based on the facts and circumstances that existed at first application. In the absence of more clarification, we favour prospective application for cost/benefit reasons. 14. Do you believe that this alternative approach provides more decision-useful information than measuring those financial assets at amortised cost, specifically: (a) in the statement of financial position? (b) in the statement of comprehensive income? If so, why? - 4

5 Few IAIS jurisdictions would support the alternate view as written. However, a significant number of IAIS jurisdictions believe that a different approach incorporating a fair value through OCI category with recycling would provide more decision useful information. 15. Do you believe that either of the possible variants of the alternative approach provides more decision-useful information than the alternative approach and the approach proposed in the exposure draft? If so, which variant and why? No. As an international body representing prudential regulators, we would welcome the opportunity to discuss possible ways forward with the IASB and its staff. If there is any way in which the IAIS can assist the IASB further, please do not hesitate to contact Rob Esson, Chair of the IAIS Insurance Contracts Subcommittee (tel: ; resson@naic.org) or Peter Windsor at the IAIS Secretariat (tel: ; peter.windsor@bis.org). Yours faithfully Peter Braumüller Chairman, Executive Committee Alfred Gross Chairman, Technical Committee The IAIS is an international organisation composed of insurance supervisors from more than 190 jurisdictions. One of its main objectives is to promote the development of well-regulated insurance markets. This includes the development and implementation of high quality financial reporting standards, and as such the IAIS has a keen interest in the work of the IASB. We have also provided significant input to the IASB, in particular with respect to the projects that will most influence the overall accounting model for regulated insurance enterprises. We are an official observer of the IASB's Financial Instruments Working Group and Insurance Working Group, a member of the Standards Advisory Council and participates actively in the Financial Crisis Advisory Group. - 5