AASB 17 Insurance Taskforce Update – September 2017

This month’s AASB 17 Insurance Taskforce update gives news from the Variable Fee Approach (VFA) work-stream.

Each of the work-streams is in the process of identifying issues and working through a process to address each of them as best we can at this stage.  This work in turn will feed into the draft information notes.

VFA Work Stream

The VFA Work Stream is one of the technical groups of the AASB17 Implementation Taskforce which overall is focused on producing an information note for Australian actuaries.  The VFA Work Stream particularly looks at the Variable Fee Approach and is divided into four sub-groups of two or three people focused on the many issues where treatment for contracts eligible to use the VFA may differ from the general operations under the new insurance contract accounting standard.

The work stream meets fortnightly, looking at a couple of issues each meeting.

Definition of the VFA

The VFA is a variant of the General Measurement Model under AASB 17 which is to be used for contracts with direct participation features.  These are defined in paragraph B101 of the standard as:

… insurance contracts that are substantially investment-related service contracts under which an entity promises an investment return based on underlying items. Hence, they are defined as insurance contracts for which:

(a) the contractual terms specify that the policyholder participates in a share of a clearly identified pool of underlying items;

(b) the entity expects to pay to the policyholder an amount equal to a substantial share of the fair value returns on the underlying items; and

(c) the entity expects a substantial proportion of any change in the amounts to be paid to the policyholder to vary with the change in fair value of the underlying items.

If a contract meets this definition then the entity must use the VFA to measure it – the entity doesn’t have an option.  A contract that does not meet this definition in its entirety is not able to use the VFA.

In terms of the definition, the work-stream discussed the following terms:

  • ‘Pool of underlying items’ – note that the entity does not actually have to hold the pool of underlying items – just that there is an enforceable link between benefits and returns on the underlying items (which could be an index, say).
  • ‘Substantial’ – the standard doesn’t actually define the term ‘substantial’, so it is unclear how ‘big’ the share needs to be, or exactly how much of the benefit needs to vary with returns on the underlying items.

Which products qualify for the VFA?

Before considering any of the other issues peculiar to use of the VFA, practitioners will need to know which products in the Australian market have direct participation features, and so should use the VFA.

The first thing to note is that what follows is indicative.  Practitioners will only be able to know for certain by looking at the particular terms of the contract. 

Furthermore, the above definition does not necessarily relate to whether contracts are defined as ‘participating’ under the Life Insurance Act 1995, or as ‘discretionary’ under LPS 340.  Some contracts not previously defined as ‘participating’ or ‘discretionary’ (such as some Investment Linked contracts, and Non-Par Investment Account products) may now have to use the VFA.  Conversely, some contracts previously defined as ‘participating’ (such as Par Group Risk) are unlikely to be able to use the VFA (in the case of Group Risk business, because it is not substantially investment related).

That said, we hope that investment related contracts currently defined as ‘participating’ or ‘discretionary’ would be able to use the VFA.

Current indications are that the following contracts are most likely to be able to use the VFA:

  • Participating Conventional; and
  • Investment Linked bundled with rider. 

Current indications are that the following contracts will probably be able to use the VFA. However, it will depend on any guarantee – if the guarantee is high then the benefit to policyholders will usually be fixed, and so not vary with the returns on the underlying items.

  • Participating Investment Account;
  • Participating Annuities; and
  • Non-participating Investment Account (i.e. business where the accounts stay within a range of 95% – 103% of the assets).

This would apply to both individual and group contracts (but note the comment above that Par Group Risk contracts will probably not be able to use the VFA – and the same applies to Non-Par Group Risk contracts with a profit share arrangement, for essentially the same reason).

The VFA will not be able to be used for any reinsurance contracts held.  And, obviously, guaranteed risk products issued by life, general or health insurers will not be able to use the VFA.

Note that the assessment of whether a contract is able to use the VFA is made at contract inception, even if the contract ceases to meet the criteria subsequently (unless it is modified in such a way that if the modification was made at inception the contract would not then have been able to use the VFA).

Once it is clear what products can use the VFA, there are other issues, which the VFA Work Stream has addressed, or will do so in the near future, including:

  • What things need to be done differently – what are the main differences between AASB 17 and MoS? 
  • What are the main differences between VFA and BBA? 
  • What is the pool of ‘underlying items’?
  • How should allowance be made for adjustments to the cash flows where they are affected by contracts in other groups (i.e. ‘mutualisation’)?
  • What VFA issues are peculiar to friendly societies and mutuals?
  • Asymmetry (due to guarantees – explicit or otherwise – to policyholders under such contracts);
  • Transition (there are particular rules applying at transition to contracts able to use the VFA);
  • Contract Boundary and Coverage (it is not clear what the contract boundary or Coverage is for such contracts) – we will work with the Aggregation and Portfolio Grouping work-stream.

So, there is plenty to consider, and plenty that will be different.

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