IASB Approach
- amount initially recognised is unwound but not remeasured
- updated for current estimates - updated for market rates
Residual margin
adjustment Risk Time value of money - updated for current estimates
Current unbiased probability weighted estimates of future cash flows
Figure 3: Subsequent measurement At each subsequent measurement date, the liability will reflect
current estimates of cash flows, current discount rates and a risk adjustment that reflects the remaining risk of uncertainty about the amount and timing of those cash flows. Any changes in the estimates are recognised immediately in the income statement.
Short-duration model The IASB’s proposal requires a ‘simplified model’ to be used
for measurement of short-duration contracts of approximately 12 months or less using the present value of premiums as a proxy for the contract liabilities. Premiums would be recognised in the income statement in a systematic way over the coverage period and any reported claims would be measured using the building- block approach outlined above (including risk adjustment). An onerous contracts test (analogous to the premium deficiency test) is required for contracts that are measured using the simplified model and, under this approach, the income statement presentation is akin to current insurance industry practice. The FASB has not settled on a view on this matter.
For captive insurers, which commonly issue 12-month contracts,
being able to use the simplified model (if also adopted by the FASB) would clearly reduce the impact of the changes.
Impact for captive insurance
companies The measurement and presentation aspects of the insurance
contracts project are certain to receive the most attention in the captive insurance arena. The following observations outline some of the implications and issues for captive insurance companies:
MEASUREMENT:
• The use of probability-weighted cash flows is not currently a common element of estimates of insurance liabilities. The objective of this approach is to incorporate variability in the estimate of cash flows by identifying all possible scenarios (even those that are remote) and making unbiased estimates of the probability of each scenario. Such an approach results in
52 CAYMAN CAPTIVE
a statistical mean, rather than a ‘best estimate’ or ‘most likely’ outcome. For contracts providing coverage of low-frequency/ high-severity claims, the approach may well result in more conservative reserves when compared to ‘expected level’ in the current approach. This change will also require actuaries to modify the methodology used to value claim liabilities.
• The requirement to discount will achieve consistency across companies by requiring all companies to use risk-free rates. This will be a departure from many captives reporting under US GAAP (especially those owned by SEC registrants) that presently do not discount loss reserves.
• The use of an explicit risk adjustment in the IASB model may be one of the more controversial aspects (and is one of the areas that the FASB was unable to reach consensus on), especially given that it is in addition to the probability-weighted cash flows that will have already given ‘weight’ to some of the more remote possible outcomes of the contract.
• The proposed FASB model for recognition of the composite margin will have the effect of delaying recognition of any contract profits over an extended period (because of the weight given to the claims payout period). For profitable captives, this will introduce a further layer of conservatism.
• As captives commonly have policies that don’t extend beyond 12 months, the simplified model for short-duration contracts will lower the impact of the measurement changes, and the presentation will be also more familiar to users. Additionally, the IASB short-duration model is mandatory for contracts that meet the criteria; accordingly, captives with contracts that meet both criteria will be using two different measurement and presentation models, which is cumbersome. This could be an issue for captive programmes that purchase multi-year excess coverage, which the proposals would currently require application of the full model even if the underlying policies were 12 months or less.
PRESENTATION:
• For almost all captives applying the full model building- block approach, the income statement presentation will be a significant change from the way results are presented today.
- updated for market rates
FASB Approach
- amount initially recognised is unwound but not remeasured
- updated for current estimates
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