Accounting developments
The joint insurance
contracts project Over the past several years, momentum has been gathering
towards global adoption of a single set of accounting standards that could be consistently applied by companies and understood by investors around the world. In this context, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have been collaborating on a number of joint projects (there are about a dozen ongoing right now) and this article focuses on one of those projects—a single converged insurance standard that addresses recognition, measurement, presentation and disclosure for insurance contracts. When finalised, the standard will apply to all entities that issue insurance contracts, not just insurers.
The building blocks The proposals set out in the FASB discussion paper and IASB
exposure draft would create a single measurement model for all insurance contracts. This model portrays a current assessment of the amount and timing of future cash flow that the insurer expects its existing insurance contracts to generate as it exercises its rights and fulfils its obligations under the contract. This full model consists of the following building blocks:
1. An explicit, unbiased and probability-weighted estimate (i.e. expected value) of future cash outflows less future cash inflows. Incremental contract acquisition costs (such as commissions) would be included in the net cash flows, effectively deferring and amortising them over future periods, although not as an explicit asset. All other acquisition costs would be expensed as incurred.
2. A risk-free discount rate applied to the cash flows to reflect the time value of money.
3. The IASB approach would also include a third building block—an explicit risk adjustment to reflect the estimate of the effects of uncertainty about the amount and timing of those future cash flows, while the FASB proposal would not. For comparability/consistency purposes, the IASB proposal limits the range of permitted techniques for calculating the risk adjustment to certain value-at-risk techniques (such as confidence levels) or cost of capital.
Composite margin
Residual margin
adjustment Risk Time value of money
Current unbiased probability weighted estimates of future cash flows
Figure 1: FASB Measurement model Time value of money
Current unbiased probability weighted estimates of future cash flows
Figure 2: IASB Measurement model
4. At contract inception, both proposals would defer and amortise any excess of expected cash inflows over outflows to eliminate any initial profit, but would recognise any losses immediately. This amount is referred to as the composite margin under the FASB approach and as the residual margin under the IASB approach. Under the IASB proposal, the residual margin is recognised over the coverage period in a systematic way that reflects the insurance coverage provided. Under the FASB proposal, the composite margin would be recognised in proportion to the ratio of premium collections (to total premium) and claims payments (to ultimate losses).
CAYMAN CAPTIVE 51
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