Sir David Tweedie, Chair
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH,
November 2010
Dear Sir David,
AFM Response to Exposure Draft on Insurance Contracts
1. I am writing in response to this consultation paper, on behalf of the Association of
Financial Mutuals. The objectives we seek from our response are to:

Provide our comments on the elements of the Exposure Draft that have a
material impact on UK mutual insurers.
2. The Association of Financial Mutuals (AFM) was established on 1 January 2010,
as a result of a merger between the Association of Mutual Insurers and the
Association of Friendly Societies.
Financial Mutuals are member-owned
organisations, and the nature of their ownership, and the consequently lower
prices, higher returns or better service that typically result, make mutuals
accessible and attractive to consumers.
3. AFM currently has 57 members and represents mutual insurers and friendly
societies in the UK. Between them, these organisations manage the savings,
protection and healthcare needs of 20 million people, and have total funds under
management of over £80 billion.
4. As many of our members are also members of the Association of British Insurers
(ABI) we have met with ABI and conclude that their response will address the
main issues for all UK insurers. This response therefore focuses on specific
issues that we as mutual insurers wish to highlight- either because they have a
specific affect on mutuals or because there is a general issue that has a more
material affect on AFM members.
5. As businesses that are run solely for the benefit of our member-customers, we
fully applaud all attempts to make accounting rules more straightforward for firms
to adopt, and more transparent and easier for consumers to read and interpret.
We therefore support the objective as stated in paragraph 1, “to establish the
principles that an entity should apply to report useful information to users of its
financial statements about the amount, timing and uncertainty of cash flows…”
6. Most members of AFM continue to adopt UK accounting principles, so the move
to IFRS accounting will in itself be significant. The likely proximity of that, the
requirements of the ED and of Solvency II represent a significant change in the
compliance and reporting landscape. They have created strong demand for
relevant skills, and for smaller firms in particular this has increased the costs of
accounting and actuarial support and reduced the supply. This has created a
disproportionate burden on small firms, and difficulty in prioritising work due to
the still uncertain timetable for complying with the ED.
7. Equally there are contract boundary differences between the IFRS requirements
and those of Solvency II, and there is a risk that this will defeat the stated
objective of improving clarity and consistency in reporting. We would prefer to
see closer alignment, of timetables and content, in order to achieve the stated
objectives of the ED.
8. More detailed responses to some of the questions posed are attached. We
would be pleased to discuss further any of the items raised by our response.
Yours sincerely,
Martin Shaw
Chief Executive
Association of Financial Mutuals
AFM Response to ED on Insurance Contracts
November 2010
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Responses to certain specific questions
Question 7 – Acquisition costs (paragraphs 24, 39 and BC135–BC140)
(a) Do you agree that incremental acquisition costs for contracts issued should be
included in the initial measurement of the insurance contract as contract cash outflows
and that all other acquisition costs should be recognised as expenses when incurred?
Why or why not? If not, what do you recommend and why?
As set out in the definition of a discretionary participation feature (DPF), the additional
benefits payable under a DPF may be wholly or partially based on the performance of a
specified pool of insurance contracts. In practice, this may be the case where, for
example, non-participating contracts are written in a with-profits fund and the profits on
those non-participating contracts are used to fund discretionary benefits to the withprofits policyholders.
Paragraph 24 of the ED requires the initial measurement of contracts to include all cash
flows that will arise as the insurer fulfils the contract. Where a DPF contract pays
benefits based on the performance of a pool of insurance contracts, paragraph 24 would
require the cash flows to be taken account in measuring the DPF contract to include
those benefits expected to be paid as a result of the performance of the pool of
insurance contracts (i.e. the DPF contract liability would take account of the "profit"
expected to be made on the pool of insurance contracts).
However, because of the requirement in paragraph 17(b) for the establishment of a
residual margin, the expected profits on the underlying pool of insurance contracts
cannot be anticipated and will only emerge over the period of coverage.
We believe that this represents an accounting mismatch that is not useful to the user of
the financial statements. It does not seem appropriate to require the liability in respect of
DPF contracts to take account of profits expected to made on insurance contracts until
such time as the standard permits the profits on those contracts to be recognised.
As a result we believe an additional sub-paragraph should be added to paragraph B62 to
clarify that "payments to current or future policyholders as a result of a contractual
participation feature where those payments are expected to arise from a specified pool
of insurance contracts to the extent that the performance of that specified pool of
insurance contracts has not been recognised" should not be considered in estimating the
contractual cash flows.
(These comments might also apply to Questions 2 and 10.)
AFM Response to ED on Insurance Contracts
November 2010
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Question 10 Participating features
Do you agree that the measurement of insurance contracts should include participating
benefits on an expected present value basis? Why or why not? If not, what do you
recommend and why?
We agree that the measurement of insurance contracts should include participating
benefits on an expected present value basis as this is consistent with the approach
taken for other types of business and other cashflows and it reflects the liabilities on the
most realistic basis possible.
We also agree that investment contracts with participating benefits should be valued on
the same basis as insurance contracts with those benefits for consistency reasons.
There is however a significant issue regarding the treatment of inherited estates (or
unallocated surplus) under the new regime. This is of relevance to all participating
business but is of particular interest to mutual insurers. An inherited estate is a balance
which has built up over time out of the returns potentially payable to participating
policyholders. Although ultimately payable to future participating policyholders (and
possibly others on a winding-up, for instance) in the meantime, it provides capital for the
continued operation of the fund. It is particularly important for mutual life insurers, being
their principal source of capital [mutuals can and some do have other forms of capital eg
subordinated debt].
We understand that the inclusion of the words “and future policyholders” in Appendix B
paragraph 61(j) means that payments to future participating policyholders are included
within the cashflows and therefore the inherited estate will be included as a liability of the
company. At present, the “Fund For Future Appropriations” under UK GAAP (or
“Unallocated Divisible Surplus” in current accounts under IFRS) are shown as a liability
and we agree with this presentation. However, these liabilities are currently separately
stated on the balance sheet.
The Board should clarify its intentions in this regard, particularly as this would appear to
contradict the proposals regarding the boundary of existing contracts. We believe that
payments to participating policyholders which do not form part of the expected cash
flows within the boundary of existing contracts, ie the unallocated surplus, are
fundamentally different from the expected payments that are within the boundary of
existing contracts. Hence we believe it would be misleading to users to include both sets
of cash flows within the same liability on the face of the balance sheet. As a result, we
suggest that the liability in respect of the unallocated surplus is shown separately from
the insurance contract liabilities on the face of the balance sheet.
It is worth noting that although this issue is of particular interest to mutual insurers for the
reasons outlined above, this same presentation would also be appropriate for
participating funds within shareholder owned insurers.
AFM Response to ED on Insurance Contracts
November 2010
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Question 11 – Definition and scope
(a) Do you agree with the definition of an insurance contract and related guidance,
including the two changes summarised in paragraph BC191? If not, why not?
(b) Do you agree with the scope exclusions in paragraph 4? Why or why not? If not, what
do you propose and why?
(c) Do you agree that the contracts currently defined in IFRSs as financial guarantee
contracts should be brought within the scope of the IFRS on insurance contracts? Why
or why not?
As the scope of IFRS and the ED appear to indicate that all insurers will be in scope, we
understand that the UK Accounting Standards Board will move towards IASB’s IFRS for
SMEs for non publicly accountable entities, and would thereby no longer issue its own
accounting standards. We understand that in other countries there will still be local
accounting standards in place for small entities that have no transactions across
borders.
Previously the ASB provided a moratorium for parts of its rules for the smallest firms- for
example, unincorporated non-Directive friendly societies were temporarily exempted
from FRS27. The loss of this exemption would add to the costs of implementation for
small firms, and open up imbalance with regulatory reporting. We suggest IASB might
explore the extension of its simplified regime into insurance, and consider how best to
align regulatory reporting with accounting standards.
AFM Response to ED on Insurance Contracts
November 2010
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