28 March 2013

Insurance Europe CFO Forum response to the IASB´s ED Classification and Measurement: Limited Amendments to IFRS 9

As the revised IFRS 4 ED is not yet available, Insurance Europe CFO Forum's assessment on IFRS 9 cannot be finalised until such time as they are able to assess both draft standards together.

Insurance Europe CFO Forum welcomes the introduction of the Fair Value through Other Comprehensive Income ("FVOCI") category as a positive development and believes it represents a significant improvement to existing IFRS 9 - in combination with the use of FVOCI in IFRS 4 - for insurance companies. The FVOCI measurement category is a critical element of accounting for financial instruments by insurance companies as it will facilitate improved performance reporting for certain insurance business models. Insurance Europe CFO Forum appreciates the efforts that the IASB has taken to re-open IFRS 9 and introduce FVOCI (in conjunction with the use of OCI in IFRS 4).

When considering IFRS 9, it is important to understand the asset-liability management of insurance companies. Insurance business is centered around asset-liability management in which insurance liabilities, guarantees and related assets (including derivatives) are managed together. The accounting should reflect this linkage. Accounting requirements that deal with individual components in isolation, separate from the overall asset-liability management ("ALM") strategy, which result in different measurement and presentation requirements for different components of the ALM strategy, do not adequately reflect the insurance business and the related performance in earnings. As such accounting and performance reporting must reflect ALM and avoid accounting mismatches - changes in insurance liabilities and the associated backing assets should be presented together: either in the income statement or in OCI. If the related changes are reported in different places, performance reporting does not provide useful information. Whilst Insurance Europe CFO Forum acknowledges that current measurement of assets and liabilities in the balance sheet may present useful information to investors, depending on the nature of the insurance products and the related assets, there is a specific need for different measurement categories for the statement of comprehensive income.

As Insurance Europe CFO Forum´s views have consistently highlighted, the interaction between assets and liabilities is the fundamental core of an insurer's approach to managing its business and reporting its performance. Insurance Europe CFO Forum thinks the business model approach outlined in the ED does not reflect the linkage between assets and insurance liabilities.

Consequently, Insurance Europe CFO Forum believes that the interaction between IFRS 4 and IFRS 9 needs further consideration to take account of ALM and avoid accounting mismatches. A comprehensive and consistent approach to FVOCI and Fair value through P&L ("FVPL") measurement models for both assets and insurance liabilities is needed.

Insurance liabilities and related assets at FVOCI

To adequately reflect insurers´ ALM strategies, Insurance Europe CFO Forum believes that FVOCI measurement should be available for an asset classes that back insurance contract liabilities that are measured at FVOCI.

While insurers do use simple debt instruments in order to match insurance liabilities, the asset strategy is often more complex, for example, involving the use of derivatives in order to diversify credit exposure and manage interest rate risk. Other asset classes may include investments such as equities, investment property, mortgages and other loans. Hence, for FVOCI to be appropriate for all types of insurance business, eligible assets must be extended to cover a wider scope of asset classes without limitation due to cash flow characteristics.

Widening the scope of assets at FVOCI would be consistent with presenting the effect of changes in the discount rate in OCI. When the current proposals in IFRS 4 and IFRS 9 are taken together, IFRS 4 will allow the effect of changes in discount rates to be presented in OCI whilst IFRS 9 permits FVOCI only for simple debt instruments and would not allow FVOCI for other debt instruments and assets in a ´held to collect' business model or those assets that would be required to be at FVPL. This will create unnecessary accounting mismatches because assets relating to the same liabilities will be split across three categories in IFRS 9.

The contractual cash flow characteristics test is too narrow to identify all debt instruments that should be eligible for amortised cost or FVOCI measurement. The current test proposed will result in mandatory FVPL measurement for some debt instruments for which amortised cost or FVOCI is a more appropriate measurement basis. Thus, Insurance Europe CFO Forum believes debt instruments which are not significantly different from simple debt instruments, should not be mandatorily classified as FVPL.

For assets held under a ´held to collect´ model, a FVOCI option is necessary to reduce or eliminate accounting mismatches. Insurance Europe CFO Forum notes that IFRS 9 requires assets in a ´held to collect´ business model to be measured at amortised cost. This would result in an accounting mismatch if IFRS 4 Phase II, as currently proposed, requires interest rate movements on liabilities to be reported in OCI. As such, the interest rate movements would be reported in OCI for the liability and the assets would be reported at mortised cost.

Although IFRS 9 has a FVOCI category for equity instruments, the restriction on recycling means that this approach is not consistent with the nature of the insurance liability. This is particularly so for participating contracts, where the investment returns, (including gains and losses), are ultimately passed to the policyholder.

Insurance liabilities and related assets at FVPL

As Insurance Europe CFO Forum has continuously expressed in the context of the discussions on accounting for insurance contracts, there are circumstances where FVPL best reflects the management and performance measurement of certain insurance portfolios. Therefore Insurance Europe CFO Forum continues to believe that the proposals for IFRS 4 should not mandate the use of OCI in all circumstances. Similar to the current option in IFRS 4 ("Phase 1"), it must include the ability to measure insurance liabilities at FVPL.

For such circumstances, Insurance Europe CFO Forum welcomes the introduction of the FVPL option in the IFRS 9 ED for assets that would otherwise be classified as FVOCI. Taken together with the need for FVPL in IFRS 4, this FVPL option should provide the ability to classify both assets and insurance liabilities at FVPL in those circumstances where FVPL provides better information to users. However, the combined effect of the current proposals in IFRS 9, and the tentative decisions for IFRS 4, does not achieve this result.

Until Insurance Europe CFO Forum is able to assess the inter-linkage of the lASB's accounting alternatives for assets and liabilities in both IFRS 9 and IFRS 4, Insurance Europe CFO Forum is unable to conclude its comments on the amendments to IFRS 9.

As Insurance Europe CFO Forum highlighted in its December 2012 and February 2013 letters, insurers should not be required, (but be permitted), to adopt IFRS 9 before the mandatory effective date of IFRS 4. Otherwise it may put into question the usefulness of financial reporting for users in the period between IFRS 9 and IFRS 4 adoption, as users will experience two major changes in an insurer's financial statements in short succession.

Comment letter

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