The IDW appreciates the opportunity to comment on the Exposure Draft Insurance

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1 Mr Hans Hoogervorst Chairman of the International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom 23 October /550 Dear Mr Hoogervorst Re.: IFRS Exposure Draft 2013/7 Insurance Contracts The IDW appreciates the opportunity to comment on the Exposure Draft Insurance Contracts. General Remarks The IDW welcomes the decision to re-expose Insurance Contracts, thereby addressing concerns such as accounting mismatches and short term volatility. Moreover, we welcome the fact that the revised proposals have been aligned more closely with existing and forthcoming requirements (e.g. IAS 18, IFRS 9). In general, we agree with the proposed amendments. However, we would like to comment on certain matters, as set out below. 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,

2 page 2/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts (b) subject to the condition that the contractual service margin should not be negative; and 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? The IDW shares the IASB s view that the contractual service margin should represent the unearned profit that the entity recognises as services are provided under the insurance contract. This provides relevant information in this context that faithfully represents the entity s financial position and performance. Therefore, we agree with paragraph 30(c) and (d) of the Exposure Draft, i.e. the contractual service margin should be adjusted to compensate changes in the estimate of the expected present value of future cash flows related to future coverage and other services. We support the restriction to cash flows, which relate to future coverage and other future services. Accordingly, we consider it consistent to recognise the effect of any other movement of the cash flows in profit or loss in the current period, as these movements do not relate to future services. We generally believe that the concept for adjusting the contractual service margin is a sound accounting concept for reporting unearned profit, where the initial and subsequent measurement is consistent with revenue recognition requirements and proposals. However, we do not agree that certain other effects that relate to future coverage and services are recognised in profit or loss or OCI and not reflected in the contractual service margin. Since the contractual service margin represents the unearned profit, we believe that it would be consistent to adjust the contractual service margin as well for: the effect of changes in discount rates for the discounting of future cash flows, except when recognising this effect in profit or loss or OCI would significantly reduce accounting mismatches. changes in the estimate of the risk adjustment related to the compensation for risks associated with future periods at the reporting date compared with the measurement at the prior reporting date for the same future periods. changes in cash flows of certain derivatives (i.e. minimum guarantees) that are expected to vary indirectly with the returns from underlying items, provided that the derivatives relate to the future service under the contract (refer to our answer to question 2 for details).

3 page 3/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts The restriction regarding the discount rates (as proposed in the first bullet point) is necessary to avoid significant accounting mismatches. Such accounting mismatches could arise if the returns on assets that match the related liability were recognised in profit or loss or OCI but the contractual service margin was adjusted to reflect changes in the discount rate of the related liability. In all other cases the effect of changes in the discount rate should be considered in adjustments of the contractual service margin. Without being adjusted both for changes in the risk adjustment for future periods and the discounting effect of future cash flows resulting from changes in the interest curve, the treatment of the contractual service margin in the subsequent measurement will be inconsistent with the initial measurement and will lose its meaning as unearned profit. If losses were shown as a consequence of increases in the risk adjustment, despite the contractual service margins being sufficient, users could be misled because they could have the impression that premiums were insufficient and one of the intentions of introducing the risk adjustment would be thwarted. We are concerned as to the proposal that the contractual service margin is released only over the coverage period. We believe that an economic approach should be adopted in order to match earnings with the services provided. In certain circumstances, the main services are provided after the coverage period (the period during which the entity provides coverage for insured events) as the actual damages become apparent; thus in such cases the coverage period may not be the appropriate period to release the contractual service margin. We agree that the contractual service margin should be adjusted for the time value of money through accretion of interest. However, we do not agree that the interest rate determined at the inception of the contract should be used. We believe that applying the current interest rate would reduce complexity and cost. Furthermore, this would be consistent with our proposal to adjust the contractual service margin for the effects of changes in the discount rate, i.e. the effect of changes in time value of money and the definition of the contractual service margin as unearned profit. In our view, the Exposure Draft is unclear as to how to proceed if losses have been recognised in profit or loss according to paragraph 60 (a) or (f) and the situation then improves, such that it can be expected that losses will be recovered and future profits will be earned. Some believe that any such recovery would immediately result in a new contractual service margin. However, we believe that in such cases no contractual service margin should be recognised until all prior losses have been recovered in profit or loss. Otherwise, different profits or

4 page 4/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts losses may be reported, depending on the frequency of reporting. In our view, the Board should provide additional guidance to clarify this issue. We believe that paragraphs B 37(c) and BCA 113, which provide guidance on the level of aggregation, should also be clarified. We suggest the Board clarify whether the possibility of aggregation of contracts applies only to initial recognition or whether it also applies to the subsequent measurement of insurance contracts. In our opinion, the latter would be appropriate. Question 2: Contracts that require the entity to hold underlying items and specify a link to returns on those underlying items 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) (b) (c) 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? 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 (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)? recognises changes in the fulfilment cash flows as follows: (i) (ii) 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; 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

5 page 5/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts (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? The IDW generally supports the proposals on contracts that require the entity to hold underlying items and specify a link to returns on those underlying items, as this will eliminate or significantly reduce accounting mismatches. In our view, this approach addresses the concept of surplus sharing prevalent in Germany. These contracts typically specify a link between the payment to the policyholder and the returns on the assets and liabilities of the entity as a whole and are therefore within the scope of paragraph 33. However, we are concerned that the approach proposed by the Board will add significant complexity. For example, we question whether the cash flows that are expected to vary directly with the returns on the underlying items can always be clearly identified as separate from the cash flows that are not expected to vary directly. Such distinction may only be made arbitrarily. In addition, we believe that implementing such segregation of cash flows in entities accounting systems will be complex and burdensome in practice. Moreover, it would be demanding from an auditor perspective. Irrespective of these concerns, we believe that it would be principles-based, if any technique of segregating cash flows was not described in detail in the final standard itself but rather be explained in the illustrative examples. The proposed mirroring approach introduces apart from closely related and not-closely related embedded derivatives a third category of embedded derivatives with features which are considered to vary indirectly with the returns of underlying items (paragraph 66(b)). According to the proposals, the changes in value of such derivatives would be recognised in profit or loss. However, this treatment is different from that of other closely related embedded derivatives, which are often included in the probability-weighted cash flows. For such derivatives, changes are recognised in profit or loss (e.g. experience adjustments), OCI (changes in the discount rate) or reflected in the contractual service margin (changes in estimates of cash flows related to future services).

6 page 6/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts This proposal could create additional accounting mismatches, short term volatility and inconsistencies, for example, with those guarantees that are embedded in contracts to which paragraphs 33 and 34 do not apply. In this respect, we believe that the obligation resulting from a derivative (such as a guarantee for minimum payments) that is considered closely related to the insurance contract, relates to the future service provided under the contract as well. Hence, the contractual service margin should be adjusted for changes in estimates of the relevant cash flows. Considering the added complexity of the proposed mirroring approach, we believe that the approach currently developed by the industry (refer to the EFRAG Draft Comment Letter, Appendix 5) might constitute an alternative, which is less complex and at the same time effectively reduces accounting mismatches. Therefore, we believe that the proposed alternative approach should be subject to further research and considered by the Board as to whether it proves to be a practical and overall consistent approach. Question 3: Presentation of insurance contract revenue and expenses 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 believe that the proposed presentation of insurance revenue and expenses provides consistency with the general revenue principles of IAS 18 Revenue. Comparability to other industries would be enhanced if IAS 1 Presentation of Financial Statements format requirements were to apply. Also, we welcome the fact that the Exposure Draft now proposes a concept, where the reported revenue for contracts under the premium-allocation approach (simplified approach) is comparable to the reported revenue for contracts under the building block approach. In our view, this is conceptually sounder than the previous proposals of the IASB. However, we are concerned that the additional complexity and the costs associated with the proposed presentation may not outweigh its benefits. We are particularly concerned that the determination of insurance contract revenue and

7 page 7/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts expenses will be complex and burdensome in practice. In this context we suggest the Board clarify paragraph 58, as we believe that it is not sufficiently clear which investment components have to be excluded from insurance contract revenue and incurred claims. Without such a clarification, the identification of investment components might be applied inconsistently and arbitrarily by entities. Particularly for life insurers, the proposed statement of profit or loss and other comprehensive income will result in the presentation of information (including the reporting of that key performance indicators) that is significantly different from that currently used in the insurance industry and provided to the users of financial statements. Considering the implications for the usefulness of financial statements and the practicability of the proposed methods, the IDW supports neither the currently proposed revenue approach nor the previously proposed summarised margin approach. We believe that the respective recommendations should be provided by the preparers and users of financial statements, rather than by the auditors, as these groups should conclude whether the benefits for users outweigh the related costs for preparers. But we do recommend whatever presentation concept is to be included in the final standard that volume information, such as premiums written, claims expenses and operating expenses (administration and acquisition costs), should be presented either on the face of the statement of profit or loss and other comprehensive income or in the notes. Question 4: Interest 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 underwriting performance from the effects of the changes in the discount rates by: (a) (b) 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 affect the amount of those cash flows; and 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

8 page 8/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts (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? The IDW generally agrees with the proposal to recognise certain changes in discount rates in OCI, as this approach addresses the concerns about short term volatility being presented in profit or loss (as described in our comment letter on the Exposure Draft 2010/8 Insurance Contracts, dated 29 November 2010). Also, we believe that the proposed concept for the recognition of changes in discount rates will reduce accounting mismatches if financial assets are both managed within the hold and sell business model and result in payments of principal and interest only. These assets would be measured at fair value through OCI. However, the proposed concept can still lead to significant accounting mismatches if the underlying financial assets have different measurement bases under the relevant standards (i.e. IFRS 9). For example, if financial assets are managed under a different business model or do not qualify for fair value through OCI due to their contractual cash flow characteristics (e.g. derivatives), a mismatch will still arise either in the balance sheet and OCI (if the assets are measured at amortised cost) or both in OCI and profit or loss (if the assets are measured at fair value through profit or loss). Such accounting mismatches could be significantly reduced by an option to recognise the effects of changes in the discount rate for insurance liabilities in profit or loss. Such an option should be available at a portfolio level under the condition that the entity decides whether to use this option at the time a new portfolio is generated. In addition, once used, the option would have to be applied consistently over time. The Exposure Draft requires the recognition, in profit or loss, of the interest expense determined using the discount rates that applied at the date that the contract was initially recognised. For the liability for incurred claims (including incurred but not reported claims) it might be difficult to identify the corresponding locked-in interest rate especially for those contracts existing at the date of transition. From a practical point of view, we would consider it acceptable to use the interest rate at the date of the incurrence of a claim as the locked-in rate rather than the rate that applied at the date the contract was initially recognised.

9 page 9/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts In addition, as already mentioned in our comment letter on the Exposure Draft 2013/3 Financial Instruments: Expected Credit Losses, dated 19 June 2013, it would be preferable not to have two distinct effective dates for IFRS 9 and the new IFRS 4. Therefore, we would welcome the IFRS 4 project being finalised to allow simultaneous application of the standards. However, if two different effective dates were to be required by the IASB, we recommend that reclassifications should be allowed on the effective date of the later standard 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? We agree with the proposed approach to transition. Regarding the interaction with IFRS 9, please refer to our answer to question 4. 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? 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. We believe that the answer to this question especially with regards to the costs for preparers and users of financial statements should be provided by the preparers and users themselves. However, from the auditor s perspective, we would like to comment on the effects the Exposure Draft will have on the

10 page 10/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts work to be performed by auditors. We believe that the Exposure Draft would increase the complexity of an audit. Such increased complexity and additional audit procedures would, for example, relate to the following areas: Interest expenses determined using the discount rates that applied at the date that the contract was initially recognised would be recognised in profit or loss. These expenses would need to be separated from the effects to the carrying amount of the insurance contract that is due to the discount rate applicable at the reporting date. Hence, both current and initial interest rates would need to be verified. For cash flows that are expected to vary directly with returns on underlying items changes would be recognised on the same basis as the underlying items. An audit of this technique requires additional scrutiny of links between fulfilment cash flows and underlying items. This includes the audit of proper matching between recognition of fulfilment cash flows and recognition of changes in the value of those underlying items. In addition, auditors would need to verify the proper cut off of fulfilment cash flows that vary indirectly and that are not expected to vary with the returns on the underlying items, since changes are recognised differently. Insurance entities would need to apply complex calculation rules and maintain additional data characteristics to meet these requirements. In addition, we believe that it is not sufficiently clear which investment components would have to be excluded from insurance contract revenue and incurred claims (refer to our answer to question 3). Therefore, without clear criteria it will be difficult to audit the appropriate exclusion of investment components. Disclosing an equivalent level of risk for the disclosed risk margin would involve additional actuarial calculations that would also need to be audited. The contractual service margin would be unlocked and influenced by several parameters, including accretion of interest at an historic rate. Hence, the calculation would not be straightforward as it does not just involve an unwinding over time, but a new calibration for each reporting period.

11 page 11/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts 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? We believe that further clarification is needed. Please refer to our answer to question 1 regarding: - recovery of losses and reinstatement of the contractual service margin (paragraph 60 (a) and (f)) - level of aggregation (paragraph B 37 (c) and BCA 113) question 2 regarding: segregation of cash flows (paragraph B 34) question 3 regarding: investment components (paragraph 58). Other Comments: Reinsurance contracts (cedant entity accounting) The purchase of reinsurance can result in a gain for the cedant if the amount paid by the cedant is less than the expected present value of cash flows plus the risk adjustment. The Exposure Draft requires the cedant to recognise such a gain (negative contractual service margin in the reinsurance held) over the coverage period of the reinsurance contract held. The IASB may consider whether this appropriately reflects the economic substance of the reinsurance transactions in case of proportional reinsurance. It could be argued that the cedant is no longer exposed to any risk related to the reinsurers share in the insurance contract liability and that it would be consistent to recognise the gain that results from a lower price for reinsurance immediately in profit or loss. When considering this issue further we believe that the IASB should take into account that the reinsurance contract would not exist without the underlying business. This may justify an approach that considers both underlying contracts and related reinsurance assets in conjunction. When buying reinsurance on an individual gross basis the cedant effectively locks in a part of the unearned profit of the underlying business. We wonder whether this actually justifies a deferral of that share of profits. Furthermore, for the presentation of the financial position, users may expect that the reinsurance asset represents the reinsurers share in the underlying liabilities according to the contractual terms. This may not be the case if the reinsurance asset is calibrated to the reinsurance premium less reinsurance commission for reinsurance arrangements on an individual loss basis. It could be argued that there is no connection between the reinsurance commission and acquisition or administration cost of the cedent, but a mean to share the profit of the underlying business between the reinsurer and cedent.

12 page 12/12 IDW CL to Mr Hans Hoogervorst on ED/2013/7 Insurance Contracts We would be pleased to answer any questions that you may have or discuss any aspect of this letter. Yours sincerely Klaus-Peter Feld Executive Officer Uwe Fieseler Director International Accounting