Office of the Superintendent of Financial Institutions
October 25, 2013
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
The Office of the Superintendent of Financial Institutions, Canada (OSFI) appreciates the opportunity to comment on the Exposure Draft (ED) on Insurance Contracts. We recognize that the ED applies equally to both life and non-life (P&C) insurance contracts. Our comments relate to both industries, but with particular emphasis on the impact on life insurers.
Since we last wrote to you in 2010, Canadian life insurers have experienced three years of very low interest rates. The Canadian accounting methodology (Canadian Asset Liability Method) has worked to incorporate market changes while taking account of the long-term nature of the Canadian life insurance business. We, along with the Canadian Actuarial Standards Board, support improvements that are being made to the current Canadian methodology. But we feel it is important to recognize the benefits of the Canadian approach to accounting for life insurance companies as it has some similarities to the accounting principles proposed in the 2013 ED. We feel the Canadian experience is valuable to the IASB’s work to complete a standard on insurance contracts.
As you are aware Canada has successfully used one set of general purpose financial statements (or accounts) for all stakeholders since 1992. As a prudential regulator, we believe that using the same financial statements as industry for regulatory reporting and capital determination is good practice, and one we would like to see continue. We are concerned that, if the ED is finalized as proposed, OSFI would likely need to make significant adjustments to the financial statements for regulatory capital purposes. Moreover, the adjustments in question may have the effect of relaxing rather than constraining the assumptions that lie behind the requirements of the standard.
While the 2013 ED proposals are a major step towards creating an international approach on accounting for insurance contracts, OSFI believes some adjustments and clarifications are required to the proposals in order for Canada to continue to be able to use one set of financial statements for regulatory purposes. We are concerned with how the top-down approach could be interpreted and applied to long-duration insurance contracts, how an insurers’ asset-liability management is presented under these proposals, and the possibility that Canada may be one of the few countries with a well-developed insurance industry that would adopt the revised IFRS on the effective date prescribed by the IASB. Finally, we recognize that some complexity in the standard is unavoidable to accommodate different insurance markets around the world. Nevertheless, we encourage the IASB to try and keep the standard as simple as practical to provide the appropriate amount of flexibility while facilitating its use by insurers and their stakeholders.
In our 2010 comment letter, OSFI noted the potential for significant, inappropriate volatility if short-term fluctuating market rates were used to discount very long-duration liabilities. The IASB has confirmed that either a bottom-up or top-down approach could be used to determine the discount rate. However, due to the high-level nature of a principles based standard, we understand there are a wide range of views of how the top-down approach could be interpreted for the long duration discount rates as currently drafted in the ED. We are pleased that the exposure draft allows more weight to be put on long term estimates than on short-term fluctuations when forecasting unobservable discount rates for long-duration liabilities. We believe current period fluctuations should not exaggerate the volatility of very long-dated liabilities. As such, long-duration liabilities beyond the observable period where deep and liquid markets exist should grade to a slow-moving long-term rate.
The IASB proposes in the ED to segregate the effects of changes in discount rate for insurance contract liabilities in Other Comprehensive Income (OCI). We understand the rationale for the use of OCI is to respond to comments from the 2010 ED to address Profit & Loss volatility arising from changes in the current discount rates that are applied to the cash flows in insurance contracts. However, we have concerns that the IASB’s proposals in the Exposure Draft for Classification and Measurement: Limited Amendments to IFRS 9, together with the proposals in this ED for mandatory use of OCI, continue to, or even increase, the accounting mismatches when certain types of assets are used to support insurance contract liabilities. We believe the use of OCI for insurance contract liability measurement should be optional, rather than mandatory as currently proposed in the ED.
Asset Liability Management (ALM) practices are designed to ensure that there are sufficient assets to support insurance liabilities. This is achieved by investing in various types of assets with different attributes (e.g. yield, cash flow, risk and duration) that best fulfill various insurance liabilities obligations. Accounting standards should capture economic mismatches between assets and the insurance contract liabilities they support, but standards should not create accounting mismatches on their own. We believe the mandatory use of OCI may have an unintended consequence by reflecting both economic and accounting mismatches in the financial statements, making it difficult for users to distinguish between true economic mismatches and those created by accounting standards.
In order to fulfill various types of insurance liabilities obligations, investing in assets like mortgages, equities and derivatives instead of plain vanilla bonds could be appropriate for a portfolio that is well managed and diversified. We believe the interaction between IFRS 4 and IFRS 9 needs further consideration to take into account ALM practices of life insurers and to reduce accounting mismatches. We urge the IASB, while finalizing IFRS 9 and IFRS 4, to have a comprehensive analysis of the interaction between these two standards, as it is important that insurers reflect their asset-liability management in the accounting results. As a result, the proposals in this ED to present changes in discount rates in OCI should not be required, but instead be optional. Concerns with comparability can be mitigated if the optional use is governed with the alignment to asset-liability management or other similar criteria, accompanied by additional disclosures.
The adoption of revised IFRS 4 would represent a significant change for insurers. The Canadian Accounting Standards Board’s strategy for publicly accountable enterprises is to adopt IFRS as issued by the IASB. Given the recent experience with IFRS 10 and the European Union’s delay of the effective date, Canadian insurers were the first to adopt IFRS 10 on the effective date prescribed by the IASB. The Canadian insurance industry is concerned a similar outcome may result if the EU takes a similar decision for IFRS 4. Canadian insurers compare themselves against U.S., European, and Japanese peers. Given Canadian insurers will be impacted by any new standard, we ask the IASB to allow additional time for implementation of IFRS 4 by all jurisdictions and that all major economies with well-developed insurance industries implement at the same time.
A longer transition period will also allow preparers, auditors and actuaries to discuss interpretation issues to ensure the revised standard is implemented across jurisdictions as intended. Adequate time should be allowed for external auditors, actuarial standards setters, etc. to develop guidance to ensure the standard is consistently applied. The additional time should be beyond the three years that the IASB has indicated between finalizing the IFRS and the effective date. Three years is the amount of time that preparers would require to make systems and other operational changes. The additional time beyond three years is to allow preparers and auditors to develop interpretations so that preparers can then build them into their systems accordingly.
We also encourage the IASB to form an Implementation Group, similar to the one proposed for the Revenue Standard, to ensure the revised IFRS 4 is interpreted and applied consistently. We also agree with the suggestion made by other commentators that given this is a complex standard, it would be advisable to field test any further improvements to see how they work. We believe it is important to implement new or revised IFRSs appropriately the first time rather than having post-implementation reviews and amending standards afterwards. This approach would also be more cost-effective for preparers.
We would be pleased to discuss the contents of this letter and any other aspects of the work needed to finalize the Insurance Contracts Standard with the IASB. Ms. Karen Stothers, Senior Director, Accounting Policy Division (+1 416 973 0744) or Ms. Renée Chen, Director, Accounting Policy Division (+1 416 973 2055), would be pleased to assist you and your colleagues.
cc: Canadian Accounting Standards Board
Insurance Auditors Advisory Committee
Canadian Institute of Actuaries
Canadian Life and Health Insurance Association
Insurance Bureau of Canada