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Draft for discussion at ICAEW IISC meeting, 20th June 2005 - page 18 / 51





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indirectly (unless the amounts payable to a policyholder depend on the performance of specific assets).

    • 3.

      the measurement of fair value should include an adjustment for the premium that marketplace participants would demand for risks and mark-up in addition to the expected cash flows.

    • 4.

      fair value measurement of an insurance contract should reflect the credit characteristics of that contract, including the effect of policyholder protections and insurance provided by governmental bodies or other guarantors.

  • The measurement of contractual rights and obligations associated with the closed book of insurance contracts should include future premiums specified in the contracts (and claims, benefits, expenses, and other additional cash flows resulting from those premiums) if, and only if:

    • 1.

      policyholders hold non-cancellable continuation or renewal rights that significantly constrain the insurer’s ability to reprice the contract to rates that would apply for new policyholders whose characteristics are similar to those of the existing policyholders; and

    • 2.

      those rights will lapse if policyholders stop paying premiums.

  • Acquisition costs should be recognised as an expense when incurred.

  • The Board will consider two more questions later in phase II:

    • 1.

      Should the measurement model unbundle the individual elements of an insurance contract and measure them individually?

    • 2.

      How should an insurer measure is liability to holders of participating contracts?

What are the implications of IFRS4 for UK life insurance accounting? Generally, apart from additional disclosures, and the loss of the existing formats (which will be generally welcomed), no significant changes are required for life insurance (and reinsurance) contracts. In particular the Board’s general permission to continue existing accounting policies (even where these are excessively prudent) will leave the calculation of policyholder liabilities unchanged. There is no requirement to change the accounting for deferred acquisition costs. The limited prescriptions in relation to participating contracts will mean that the FFA can, if insurers wish, continue to be classified as a liability even though this will no longer be required by UK law (for companies moving to EU-adopted IFRS) after 2004.

With regard to options and guarantees embedded in insurance contracts, the IASB accepts that ‘insurers need not, during Phase I, recognise some potentially large exposures to items such as guaranteed annuity options and guaranteed minimum death benefits. These items create risks that many regard as predominantly financial, but if the payout is contingent on an event that creates significant insurance risk, these embedded derivatives meet the definition of an insurance contract. The IFRS requires specific disclosures about these items…In addition, the liability adequacy test requires an entity to consider them’ (BC194). With regard to this test it is noted that because of the significance of these exposures the Board decided that the minimum requirements for an existing liability adequacy test should include considering cash flows resulting from embedded options and guarantees; and that this is also implied if the alternative IAS37 measurement is required. However, the Board did not specify how those cash flows should be considered and in particular the IFRS does not specify whether the liability adequacy test considers both the time value and the intrinsic value of embedded options and guarantees (BC99; BC101). Where the embedded options and


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