The IAIS has continued its consideration of the Insurance Contracts project in parallel with the IASB’s own considerations. Those jurisdictions concerned with potential volatility in profit or loss from the IASB’s proposals have further elaborated on the issues presented in the 30 November 2010 comment letter by considering some possible solutions. These jurisdictions continue to have substantial concerns with potential volatility in profit or loss, and as such it is important for the IAIS to convey these possible solutions.

 

The following summarises some of the key concerns outlined in the original IAIS response letter to the ED:

- Many insurers that issue long-term products use an assessment of long-term cash flows to price their products. This asset-liability management (ALM) is an important part of the management and analysis of this business.

- The proposals in the ED did not reflect this approach to ALM. Profit or loss volatility would be the result of implementation of the ED due to differences between insurers’ long-term investment expectations and current market yields.

- Short-term fluctuations resulting in volatility do not necessarily capture the long-term nature of this business. Working group members believe that insurer profit or loss should only be impacted by volatility that is reflective of the claims experience and underlying trends of the economic phenomena of insurance activities.

 

Subsequently, the IAIS analysed all possible changes to insurance liabilities according to the building blocks. However, it is fair to say that the areas of greatest concern surround the selection of the discount rate.

The IASB has made progress in its consideration of the discount rate, and it appears to be heading towards a decision to allow greater flexibility in the methodology of determining the discount rate. However, this does not fully allay the concerns of any jurisdiction which was concerned about volatility when the IAIS issued its response to the ED. The IASB has affirmed its view that the discount rate should be based on the characteristics of the liabilities and the IAIS supports that view. However, there are inherent differences in the characteristics of an insurer’s liabilities and the characteristics of an insurer’s assets. Short-term market fluctuations will result in different changes in value of the assets and liabilities, no matter how well matched the insurer’s assets are to the duration of its liabilities. The IAIS is of the view that if this volatility is shown in profit or loss it will not be representative of the performance of the insurer during the reporting period.

 

While the IAIS believes its analyses are equally applicable to both non-participating and participating contracts, there may potentially be some additional complicating factors relating to participating contracts.

 

Insurers do not respond to changes in the yield curve by selling their entire portfolio and reinvesting in new assets to reflect the new yield curve. Insurers manage their investments in such a way so as to achieve a stable investment return from their portfolio to fulfil their insurance contract obligations. Therefore, a performance result derived from a short-term change in the yield curve as if all future cash flows are affected by this change is not appropriate. This is the crux of the IAIS concern about the volatility in profit or loss that may result from the proposals in the ED.

 

Insurers – whose business strategy is to fulfil insurance contracts and hold associated financial instruments for the long-term – should not be required to measure them at fair value through profit or loss. Fair value through profit or loss does not necessarily reflect the way cash flows related to these instruments will be realised or expended.

There are a number of alternatives that would address concerns with such inappropriate profit or loss volatility resulting from the ED proposals. While the IAIS has different preferences among the solutions as to which best address this issue, it is essential for the IASB to address this critical issue.

There is a danger that if the proposals are not modified, insurers may use non-GAAP measures to communicate their performance results. The IAIS is concerned about distortions in market participants’ behaviour and managerial and corporate decisions as a result of the proposals.

 

Banks - whose strategy is to hold loans and deposit liabilities for the long term – are not required to measure them at fair value through profit or loss. The same reasoning regarding the long-term nature of the cash flows that led the IASB to provide a default attribute of amortised cost for such instruments is equally applicable to insurers. The two sectors compete for capital. Perceptions of higher volatility of earnings in the capital markets typically lead to a higher cost of capital.

The IAIS presents three forms of solution to the volatility: liability measurement solutions; presentation solutions; and other solutions.

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