This document is provided as the basis for discussion with the objective to develop an ACLI position on the subject matter. These notes are based on staff’s analysis of tentative views of the IASB and FASB, reference to various resource documents, and prior ACLI discussions and position statements expressed in letters to accounting standard setters on the topic.

INFORMATION FOR DEPUTIES SUBGROUP

Date: December 28, 2010

Project: Insurance Contracts

Topic: Presentation of the performance statement

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Purpose

This paper discusses various issues about presentation of the performance statement for insurance contracts based upon the proposed guidance contained in the IASB Exposure Draft (ED) and the FASB Discussion Paper (DP). In our November 30, 2010 letter on the ED and DP, we stated that we do not support the proposed margin presentation approach. While we agree that the presentation should flow from the measurement of insurance contracts, we believe that the cash flow components of the building blocks, premiums, benefits, and expenses, are as essential to the measurement as the margin component and therefore merit equally prominent presentation on the face of the financial statements. In addition, we believe that the recognition of premiums as deposits, with expenses, claims and benefit payments as withdrawals would be a fundamental change to current practice, which may misrepresent the nature of the business and result in a loss of essential information for users of financial statements. We stated that the ACLI would follow up with additional comments and recommendations.

The ACLI submitted a letter to the two Boards on February 15, 2010 that contained our initial views on Presentation as the Boards deliberated various presentation alternatives leading up to the ED and DP. This letter should be reviewed as part of our discussion, which contained the following recommendations.

To achieve the board’s reporting objective and enhance transparency, we propose the following:1. Report the gross premiums, customer consideration, as revenue in accordance with the

terms of the insurance contract2. Disaggregate the major elements of the liability, for example, present value of benefits,

present value of expenses, present value of future premiums and present value of margins in the financial statement of position reflecting the nature of the business as determined by management

3. Separate the insurance activity from the investment activity within the business category in the statement of comprehensive income with the interest component associated with the elements of the insurance liability included in investment activity to better reflect the nature of the business

4. Enhance disclosures to report source of earnings by major segment

Presentation modelParagraph 69-74 of the ED describes the proposed Presentation guidance as follows:

Statement of financial position69 An insurer shall present each portfolio of insurance contracts as a single item within insurance contract assets or insurance contract liabilities.

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70 An insurer shall not offset reinsurance assets against insurance contract liabilities.

71 An insurer shall present:(a) the pool of assets underlying unit-linked contracts as a single line item, and not commingle it with the insurer’s other assets.(b) the portion of the liabilities from unit-linked contracts linked to the pool of assets in (a) as a single line item and not commingle it with the insurer’s other insurance contract liabilities.

Statement of comprehensive income72 At a minimum, an insurer shall include for insurance contract line items in its statement of comprehensive income that present the following amounts for the period:(a) underwriting margin, disaggregated either in the statement of comprehensive income or in the notes into:

(i) the change in risk adjustment.(ii) the release of residual margin.

(b) gains and losses at initial recognition, disaggregated either in the statement of comprehensive income or in the notes into:

(i) losses on insurance contracts acquired in a portfolio transfer (see paragraph 40(b)).(ii) gains on reinsurance contracts bought by a cedant (see paragraph 45(b)).(iii) losses at initial recognition of an insurance contract (see paragraph 18).

(c) acquisition costs that are not incremental at the level of an individual contract (see paragraph 39(b)).(d) experience adjustments and changes in estimates, disaggregated either in the statement of comprehensive income or in the notes into:

(i) differences between actual cash flows and previous estimates of those cash flows (ie experience adjustments).(ii) changes in estimates of cash flows and changes in discount rates.(iii) impairment losses on reinsurance assets.

(e) interest on insurance contract liabilities.

73 The changes in estimates of discount rates and the interest on insurance liabilities shall be presented or disclosed in a way that highlights their relationship with the investment return on the assets backing those liabilities.

74 An insurer shall not present in the statement of comprehensive income, except as noted in paragraph 75(a):(a) premiums, which instead are treated in the same way as deposit receipts; and(b) claims expenses, claims handling expenses, incremental acquisition costs and other expenses included in the measurement of the insurance contract, which instead are treated in the same way as repayments of deposits.

While the majority of FASB members agree with the IASB’s Margin Presentation for insurance contracts, the FASB has indicated a preference for a premium presentation for contracts measured under the modified approach.

Current activitySubsequent to the ACLI response on the ED and DP, the ACLI has discussed a variety of presentation issues that are, in part, dependent on other project elements such as, measurement and unbundling. For example, Deferred Annuity contracts that contain guarantees are expected to be within the scope of the insurance guidance. Would these contracts be unbundled with the account balance measured and reported separately? The answer might affect presentation.

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Participants in the Roundtables have expressed a variety of views with some supporting the IASB model and others supporting a premium approach. A common theme was that presentation should provide information that allows users to assess performance.

The IASB has indicated plans to address presentation issues beginning with their February 2011 meeting.

Questions for the SubgroupIn order to advance the discussion and decision making with respect to presentation the Subgroup is asked the following questions. Questions 4, 9, and 10 are new.

1. How would we describe the Principle for Presentation (Financial Reporting)?2. Do we agree that measurement should drive presentation? 3. If yes, what does it mean when the proposed guidance requires a net liability?4. Since insurance is scoped out of the Revenue project, what guidance, if any, should be

included in the insurance standard (see recommendation below)?5. De we support a single presentation approach for all contracts notwithstanding the

measurement approach, i.e., building blocks or modified approach? 6. What should be the level of disaggregation on the B/S? Should the level of disaggregation be

the same or different for the Income Statement, e.g., what about reinsurance?7. Should source of earnings be the driver for Presentation or supplemental, i.e., disclosures?8. Would our answer be the same for a multi-line entity with life and non-life business?9. What should be the Presentation guidance, i.e., what changes should be made to

paragraphs 69-74 in the ED?10. Are changes necessary to IFRS 8, Operating Segment, as a result of decisions made with

respect to question #9?

On the December 22, 2010 ACLI Deputies Conference call, the participants shared views on the presentation approach, specifically with respect to questions 1-3 above. The prevailing view was that the financial statements should: 1) provide useful information to the users, 2) should reflect the nature of the business, and 3) measurement of the insurance liabilities should drive presentation. It was noted that the proposed presentation guidance in the ED was not based on any set of principles but rather was a “how to” present information in the financial statements. Not only should the financial statements reflect the business model but that sufficient information should be provided (in the statements and/or notes) for users to assess the performance of the reporting entity.

Since the building blocks approach is a measurement of the expected value of the cash inflows and outflows, with an explicit margin, the concept of presenting a net liability was questioned. The issue was whether the presentation should disaggregate the components of the insurance liability, either on the face or in the notes, and whether the effects of reinsurance should be included to arrive at a net presentation? While not reaching any conclusion, the Subgroup agreed that further discussion should take into account prior ACLI thoughts on other related accounting projects-Revenue Recognition and Financial Statement Presentation. In addition, the Subgroup would need to expand their discussion to include segment reporting and non-GAAP measures.

To facilitate future discussions, the Subgroup will take into account the IASB Staff Draft of an Exposure Draft on Financial Statement Presentation (FSP) and the Exposure Draft on Revenue from Contracts with Customers (RCC) in developing a set of principles for the recognition of revenue and presentation of financial information for insurance contracts.

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As noted above the ED did not contain proposed guidance on revenue within paragraphs 69-74, which describe what and how the information should be reported. Since the RCC project scopes out insurance contracts, it seems appropriate and necessary to develop a set of principles for revenue recognition for insurance as well as presentation principles to address the unique characteristics of insurance contracts. The following section has been prepared as a “straw man” set of principles for the recognition of revenue and presentation.

Recognition of RevenueIn the RCC exposure draft, the following principles are described:

Paragraph 20 states:

an entity shall evaluate the terms of the contract and its customary business practice to identify all promised goods or services and determine whether to account for each promise good or service as a separate performance obligation.

Paragraph 25, states:

an entity shall recognize revenue when it satisfies a performance obligation by transferring a promise good or service to a customer. A good or service is transferred when the customer obtains control of that good or service.

Paragraph 34 states:

When an entity satisfies a performance obligation it shall recognize as revenue the amount of the transaction price allocated to that performance obligation

With respect to insurance contracts, the following revenue principles are proposed:

An entity shall evaluate the terms of the insurance contract and its customary business practice to identify all insurance rights and obligations and determine whether to account for them as a single amount or separately in accordance with the provisions for unbundling.

An entity shall recognize revenue representing the amount of the transaction price, i.e., customer consideration, when earned.

The transaction price is the amount paid or payable by the customer in accordance with the contractual terms of the insurance contract. For some insurance contracts, the consideration may be described as the “premium”, while other insurance contracts may describe the consideration as a “fee”. Regardless of the label, the amount represents the customer consideration.

The customer consideration is earned over the coverage period or immediately when the customer has completely satisfied their contract obligation and no amount of the consideration is separately measured and returned to the customer in event of the termination of the contract. The following examples illustrate how to apply the guidance.

Where the consideration under the terms of the contract is an annual amount (either labeled a premium or fee), the amount shall be recognized as revenue proportionally throughout the year as the entity is released from risk. Typically, in these contracts, the unearned amount would be refunded to the customer in event the contract is terminated. Cancellation of an auto policy by the customer before the expiration of the coverage period is an example.

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Where the contract terms require the customer to pay a single amount, and no portion of the amount is explicitly returned to the customer in event the contract terminates, the entire amount is recognized as revenue immediately when due. A single premium life income annuity is an example of this type of contract.

Basis for recommendation

There is a presumption that the components for an insurance contract are interdependent. Therefore, components are measured separately only when the guidance requiring unbundling applies.

Financial Statement Presentation

The final FSP accounting standard is expected to apply to all entities preparing financial statements in accordance with IFRS. FASB is expected to issue similar guidance. While the FSP guidance will likely be comprehensive, elements of the proposed guidance should be considered during the re-deliberations on the insurance contracts project.

The general features of financial statement presentation described in paragraphs 43-47 of the draft are as follows:

Purpose of financial statement presentation43 How an entity presents information in its financial statements is critical to effectively communicating that information to those outside the entity. Effective financial statement presentation provides disaggregated information organised in a manner that communicates clearly a cohesive financial picture of an entity.

Core principles of financial statement presentation44 An entity shall present information in its financial statements in a manner that:(a) disaggregates information to explain the components of its financial position and financial performance; and(b) portrays a cohesive financial picture of the entity’s activities.

45 The disaggregation and cohesiveness principles work together to enhance the understandability of an entity’s financial statement information.

Disaggregation principle46 An entity shall present information in its financial statements so that:

(a) the activities the entity engages in are clear;(b) the cash flows of the entity are clear; and(c) the relationships between an asset or a liability and the effects of a change in that asset or liability are faithfully represented across the statements of financial position, comprehensive income and cash flows.

47 An entity shall use the following factors in determining the items to disaggregate and present in its financial statements:(a) the function of the item;(b) the nature of the item; and(c) the measurement basis of the item.

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Paragraphs 62 and 65-68 provide detailed guidance that should also be considered.

Presenting information in sections, categories and a subcategory62 An entity shall present information in its financial statements about its assets, liabilities, equity, income, expenses and cash flows in sections, categories and a subcategory that are cohesive across the statements of financial position, comprehensive income and cash flows. An entity’s financial statements shall include the following sections, categories and subcategory if applicable:(a) a business section, containing:

(i) an operating category;(1) an operating finance subcategory; and

(ii) an investing category.(b) a financing section, containing:

(i) a debt category; and(ii) an equity category.

(c) an income tax section.(d) a discontinued operation section.(e) a multi-category transaction section.

Classifying information in sections, categories and a subcategory65 An entity shall classify items in its financial statements (assets, liabilities, equity, income, expenses and cash flows) into the sections, categories and subcategory on the basis of how those items relate to its activities (paragraphs 71−108).

66 An entity shall refer to the relevant IFRSs when classifying items in the equity category, the income tax section and the discontinued operation section.

67 An entity shall disclose in the notes to financial statements the basis for its classification of line items within the sections, categories and subcategory. In particular, an entity shall disclose the relation between the presentation of information in the financial statements and its activities.

68 An entity with more than one reportable segment shall classify items in its financial statements into the sections, categories and subcategory that reflect the functions of the items in its reportable segments (as defined in IFRS 8 Operating Segments).

With respect to insurance contracts, the following presentation principles are proposed:An entity shall present information in its financial statements in a manner that:

(a) disaggregates information to explain the components of its financial position and financial performance; and(b) portrays a cohesive financial picture of the entity’s activities.

An entity shall present information in its financial statements so that:

(a) the activities the entity engages in are clear;(b) the cash flows of the entity are clear; and

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(c) the relationships between an asset or a liability and the effects of a change in that asset or liability are faithfully represented across the statements of financial position, comprehensive income and cash flows.

Segment Reporting

The following paragraphs are extracted from International Financial Reporting Standard 8, Operating Segments, which replaced IAS 14, Segment Reporting, to serve as reference for deliberations on presentation for insurance contracts.

Core principle

1 An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.1

Operating segments

5 An operating segment is a component of an entity:

(a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity),

(b) whose operating results are regularly reviewed by the entity's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and

(c) for which discrete financial information is available.2

Disclosure

20 An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.

21 To give effect to the principle in paragraph 20, an entity shall disclose the following for each period for which a statement of comprehensive income is presented:

(a) general information as described in paragraph 22;

(b) information about reported segment profit or loss, including specified revenues and expenses included in reported segment profit or loss, segment assets, segment liabilities and the basis of measurement, as described in paragraphs 23–27; and

(c) reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets, segment liabilities and other material segment items to corresponding entity amounts as described in paragraph 28.

Reconciliations of the amounts in the statement of financial position for reportable segments to the amounts in the entity's statement of financial position are required for

1 Extracted from IFRS 8, Operating Segments. © IASC Foundation.2 Extracted from IFRS 8, Operating Segments. © IASC Foundation.

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each date at which a statement of financial position is presented. Information for prior periods shall be restated as described in paragraphs 29 and 30.3

3 Extracted from IFRS 8, Operating Segments. © IASC Foundation.

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