Block 3 and 4
As a consequence of the disagreement between the IASB and FASB on how to account for the volatility of insurance contract cash flows, the ED asks for feedback on two different proposals relating to the margin that represents the third building block. The model proposed in the ED is one that requires the uncertainty of the cash flows estimate to be explicitly measured in a risk adjustment liability, calculated using one of three permitted techniques set out in the ED.
Any accounting profit, that might otherwise be recognised if the insurance contract were measured as the sum of the expected value (i.e. the first and second building blocks) and the risk adjustment, is captured by a residual margin liability such that there can be no reported day 1 profit. The alternative model, as preferred by the FASB, is to avoid the explicit measurement of the estimation uncertainty and capture it together with any future profit in a “composite margin”, which would be subsequently released to profit based on the unwind of the insurer’s risk exposure and related uncertainty. The table below summarises the key areas and the differences under each approach.
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