IASB: A new accounting approach

The board also agreed to include a practical expedient to allow the use of the PAA for contracts with a coverage period of one year or less.

For other contracts the following eligibility criteria is applicable in order to use the PAA (applied at initial recognition of a contract):

a)It is unlikely that, during the period before a claim is incurred, that there will be a significant change in the expectation of net cash flows required to fulfill the contract; or

b) Significant judgement is required to allocated premiums to each reporting period. This may be the case if, for example, significant uncertainty exists about:

 i. The premium that would reflect the exposure and risk the insurer has for each reporting period; or
  ii. The length of the coverage period.

The IASB, which views the PAA as a proxy for the building block approach, unanimously agreed in favour of the view that an insurer should be permitted but not required to apply the PAA to contracts that meet the eligibility requirements.

On discounting and accretion of interest the IASB agreed that the time value of money concept should be applied to contracts that have a significant financing component. The following examples explain these requirements:

a) An insurance contract with a coverage period of three years, with premiums paid annually in advance, would be permitted to apply the practical expedient not to discount and accrete interest.

b) However, an insurance contract with a coverage period of three years, with all premiums paid at the beginning of the first year of coverage, would need to be analysed to determine if the financing component is significant, and if so, discounting and accretion of interest would be required.

The board next considered the treatment of acquisition costs in the PAA model at this meeting and agreed to include directly attributable acquisition costs. This is consistent with the decision made under the building blocks approach. However, the board voted in favour of an option to permit expensing all acquisition costs for PAA contracts if the contract coverage period is one year or less (consistent with the revenue recognition exposure draft proposal).

A FASB member suggested a new alternative for presenting acquisition costs, namely as part of the liability for remaining coverage under the PAA (or residual margin under the building blocks approach). A large majority of the IASB members tentatively supported the new alternative to offset acquisition costs against the liability for remaining coverage in the PAA model.

For contracts that apply the PAA, an onerous contract test should be applied in certain circumstances to the liability for remaining coverage. The IASB supported the staff proposal to include a risk adjustment in identifying and measuring onerous contracts. This is indicative of the number of IASB members that support a risk adjustment.

The outcome of the above discussions is favourable for South African short-term insurers. The practical expedients provided allows for the continued recognition of an unearned premium liability (liability for remaining coverage) on an undiscounted basis for the majority of the typical contracts issued by the industry. However, no contracts would be precluded from applying the building block approach. This might have appeal for groups of companies that have both long- and short-term insurers in the same group.

*This article was written by Dewald van den Berg of PwC and first appeared in the SAIA Bulletin, March 2012.