ifrs 4 phase ii updates - actuaries.org.hk 4 phase ii updates.pdf · page 3 overview ifrs 4...
TRANSCRIPT
Mike Wong, Ernest Yip, Steve Cheung 10 June 2015
IFRS 4 Phase II updates
Page 1
Agenda
1 Overview
2 Insurance contracts standard: non-par contract
3 Current discussion: par contract
Page 2
Section 1
Overview
Page 3
Overview IFRS 4 Insurance contracts & IFRS 9 Financial instruments – timeline
Ongoing IASB deliberations Implementation period Reporting
IFRS 4 phase II final standard?
IFRS 4 phase II effective date ?
IFRS 4 phase II first financial statements?
IFRS 4 phase II re-exposure draft
IFRS 4 phase II start of comparative period ?
IFRS 9 first financial
statements
IFRS 9 start of comparative period
IFRS 9 final standard
IFRS 9 effective date 1 Jan 2018
IFR
S 4
IF
RS
9
IFRS 9 deferred effective date for
Insurers?
2013 2014 2015 2016 2017 2018 2019 2020
Page 4
Overview A Standard that better meets the needs of users
Single accounting approach
Provides up-to-date market consistent information of
obligation including value of options & guarantees
Reflects time value of money
Treats services provided by underwriting activity as revenue and expenses in comparable way to other non-insurance business
Provides separate information about the investment and underwriting performance
Reflects the characteristics of the insurance contract rather than the risk related to asset/ investment
activity
The goal of new standard is to improve the quality of financial reporting by providing more transparent and comparable information.
Page 5
Section 2
Insurance contracts standard: Non-par contract
Page 6
Insurance contracts standard Building block approach – overview
Risk adjustment
Time value of money
Fulfilment cash flows
Contractual service margin
The unearned profit that the entity recognizes as it provides services
The compensation that an entity requires for bearing the uncertainties about the amount and timing of the cash flows
Discount rate that reflects the characteristics of the liabilities
An explicit, unbiased and probability-weighted estimate of future net cash flows that will arise as the entity fulfils the insurance obligations
Overview
Use of current market rate
Explicit estimate of the effect of
uncertainty about amount and timing of cash flows
Eliminate Day 1 gain
Profits earned over coverage period
Acquisition cost deferral
Reflect the impact of discount rate change through P/L or OCI
Spread the impact of changes in estimate of future cash flows over contract period
Page 7
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Represent the unearned profit that the entity will systematically recognize as it provides services under the contract
At initial recognition:
CSM is recognized as an amount opposite to the sum of:
The amount of the fulfilment cash flows for the insurance contract at initial recognition and
Any pre-coverage cash flows
Eliminate any day 1 gains
CSM shall not be negative. If the contract is onerous, all loss should be recognized in profit or loss
Example:
At inception of the policy,
BEL(0) = - 100
RA(0) = 20
Hence,
CSM(0)
= - BEL(0) – RA(0) = 80
Page 8
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Represent the unearned profit that the entity recognizes as it provides services under the contract
At subsequent measurement:
CSM at the end of the period equals to:
CSM at the start of the period
Plus accretion of interest using locked rate at the inception of the contracts
Minus the amount recognized for services that were provided in the period
Unlock for the difference between current and previous estimate of BEL and RA
Example:
CSM(0) = 80
Interest rate = 5%
Amortization = 20% per year
No change in future estimates of BEL and RA
CSM(1)
= CSM(0) x (1 + 5%) x 80%
= 80 x (1 + 5%) x 80%
= 67.2
Page 9
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Discount rate:
Use locked-in rate at the inception of the contract for accreting interest on the CSM and for calculating the change in PV of future CFs that offset the margin
Significant impact to
system and data storage
2005 cohort
2006 cohort
2007 cohort
2008 cohort
2009 cohort
2010 cohort
BEL
= 80 BEL
= 50
RA
= 30 RA
= 20
• Locked-in rates
• Previous non-
economic
assumptions
• Locked-in rates
• Latest non-
economic
assumptions
Change in future
estimates
Page 10
Unlocking of CSM:
Unlock CSM for changes in estimate of BEL and RA that relate to future services or coverages
Base Scenario 1 Scenario 2
Before Assumption Change
Favorable Assumption Change
Unfavorable Assumption Change
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
• No change in the total liability
• No P/L impact
• CSM is exhausted
• P/L impact = - 20
BEL = 100
RA = 80
CSM = 20
BEL = 90
RA = 70
CSM = 40
BEL = 120
RA = 100
Page 11
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Previously recognized losses:
Keep track of the previously recognized losses
Allow for accretion of interests and amortization of the balance going forward
Page 12
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Previously recognized losses:
Recognize favorable changes in estimates in P/L to the extent that they reverse the previously recognized losses
Favorable change = 200
Favorable change in future estimates Reverse previously recognized losses Recognize profit in P/L
Page 13
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Previously recognized losses:
Re-establish CSM when all previous losses are reversed
Favorable change = 400
Another favorable change in future estimates
Re-establish positive CSM of 150
Continue to reverse previously recogized losses and recogize profit of 250 in P/L
Page 14
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Profit recognition:
Recognize the remaining CSM in P/L over the coverage period in a systematic way that best reflects the remaining transfer of the services
The service represented by the CSM is insurance coverage that is provided:
on the basis of passage of time and
reflects the expected number of contracts in force
Page 15
Insurance contracts standard Building block approach - contractual service margin
Risk adjustment
Time value of money
Future cash flows
Contractual service margin
Level of aggregation:
Objective of the standard is to provide principles for the measurement of an individual insurance contract. In applying the standard, an entity could aggregate insurance contracts provided that it meets the objective; and
At initial recognition, onerous contracts should not be aggregated with profit-making contracts
Despite the clarity provided by the IASB, the industry is still concerned about the level of aggregation for determining CSM because it may not be in line with how they manage their business
Page 16
Statement of comprehensive income
Insurance contract revenue X
Total revenue X
Claims & expenses incurred X
Non-attributable expenses X
Losses at initial recognition of contracts X
Minus: reverse of previously recognized losses X
Total expense X
Underwriting result X
Investment income on the underlying assets X
Interest expense X
Investment result X
Other profit and loss X
Profit or loss before tax X
Income tax expense X
Profit or loss net of tax X
Other comprehensive income X
Total comprehensive income net of tax X
Insurance contracts standard Interest expenses and accounting option for the effect of discount rate change
• Investment result = Investment income on the underlying assets – Interest expense on insurance liability
• An entity can choose to present the effect of discount rate change in either P/L or OCI as its accounting policy
Present the effect of discount rate change through
P/L OCI
Interest expense Current
rate Locked-in rate
Other comprehensive income
-
Difference in interest expense calculated using current rate and
locked-in rate
Page 17
Insurance contracts standard Subsequent measurement – recap
Contractual service margin (Expected contract profit)
Future cash flows
Risk adjustment
Discounting
Fulfilment cash flows
Change in CFs related to past
and current services
Release of RA related to past
and current services
Effect of changes in
discount rates
Release of CSM
Interest expense at locked in
discount rate
Changes in the measurement of the insurance contracts would flow through different line items of the financial statements, depending on the sources of the changes.
Profit or loss: Underwriting result
Profit or loss: Investment result
Other comprehensive income
Change in estimates relating to
future services
Page 18
Insurance contracts standard Simplified approach - premium allocation approach
Premiums received (plus any
additional onerous contract liability)
Acquisition costs
Liability for remaining coverage
Liability for remaining coverage
► An entity may simplify the measurement using the PAA when: ► The coverage period at initial recognition is one year or less; or ► PAA produces a reasonable approximation of BBA
Start of coverage period Valuation date Insurance liability is extinguished
Page 19
Insurance contracts standard Simplified approach - premium allocation approach
Premiums received (plus any
additional onerous contract liability)
Acquisition costs
Liability for remaining coverage
Liability for remaining coverage
► An entity may simplify the measurement using the PAA when: ► The coverage period at initial recognition is one year or less; or ► PAA produces a reasonable approximation of BBA
Start of coverage period Valuation date Insurance liability is extinguished
Insurance contract revenue
► Recognition of insurance contract revenue in profit or loss
► On the basis of passage of time; but
► If the expected pattern of release of risk differs significantly from the passage of time, then on the basis of expected timing of incurred claims and benefits
Page 20
Insurance contracts standard Simplified approach - premium allocation approach
Premiums received (plus any
additional onerous contract liability)
Liability for remaining coverage
Present value of
expected cash flows
Risk adjustment
Liability for remaining coverage
Liability for incurred claims
► Measured using BBA
Start of coverage period Valuation date Insurance liability is extinguished
Acquisition costs
Insurance contract revenue
► An entity may simplify the measurement using the PAA when: ► The coverage period at initial recognition is one year or less; or ► PAA produces a reasonable approximation of BBA
Page 21
Insurance contracts standard Reinsurance overview – cedent’s perspective
CSM
Expected future cash
flows
Risk adjustment
Time value of money
CSM
Reinsured part of cedent’s liability
Expected future cash
flows
Risk adjustment
Time value of money
Cedent’s reinsurance
asset
CSM
Consistent assumptions as the underlying direct contract
Reflect the non-performance
risk
Positive/ negative CSM
► Measurement for reinsurance held
► Any net cost or net gain -> recognise as a CSM except there is net cost on the coverage relates to event that occurred before the purchase of the reinsurance
► To avoid asymmetric treatment between reinsurance and direct contracts
► After inception, if there are changes in future estimate of direct contract that would impact P/L, entity should also recognise in P/L the corresponding impact from the reinsurance contract
Separated from the direct contracts
Page 22
Bearing the risk
Provision of coverage and services
Non-distinct investment component
Contractual service margin
Risk adjustment
Expected claims and expense, and the part of the premium allocated to the
recovery of directly attributable acquisition cost
Present value of premium income at inception of the contract
Insurance contracts standard Presentation - insurance contract revenue
► An entity should:
► Present insurance contract revenue (ICR) and expenses in the statement of comprehensive income
► Be prohibited from presenting premium information
Performance obligations
Non-distinct investment components are excluded from the definition of ICR and claims
& expenses incurred
Page 23
Interest Allocate total revenue over the coverage period of the contract
Insurance contracts standard Presentation - insurance contract revenue
Year 1 2 3 4 5 6 7 8 9 …
Non-distinct investment component
Contractual service margin
Risk adjustment
Expected claims and expense, and the part of the premium allocated to the
recovery of directly attributable acquisition cost
1. Release in CSM 2. Release of RA relating to past coverage 3. Expected claims and expenses and 4. The part of the premium allocated to the recovery of
directly attributable acquisition costs
Present value of premium income at inception of the contract
Insurance contract revenue
Page 24
Statement of comprehensive income
Insurance contract revenue X
Total revenue X
Claims & expenses incurred X
Non-attributable expenses X
Losses at initial recognition of contracts X
Minus: reverse of previously recognized losses X
Total expense X
Underwriting result X
Investment income on the underlying assets X
Interest expense X
Investment result X
Other profit and loss X
Profit or loss before tax X
Income tax expense X
Profit or loss net of tax X
Other comprehensive income X
Total comprehensive income net of tax X
Insurance contracts standard Presentation – statement of comprehensive income
1
2
3
Page 25
Insurance contracts standard Transition
► Three approaches for transition are proposed:
Approach Conditions
Full retrospective approach When historical data exists and hindsight is not required
Simplified retrospective approach
When not all historical information is available but information about historical cash flows is available or can be constructed
Fair value approach When no historical information about cash flows is available to determine the CSM
Page 26
Insurance contracts standard Transition
► Re-designation of financial assets
► The IASB tentatively decided to consider providing further transition relief to permit or require an entity to reassess the business model for financial assets at the date of initial application of the new insurance contracts standard.
► The European Financial Reporting Advisory Group (EFRAG) had advised the European Commission to ask the IASB to defer the effective date of IFRS 9 for insurance businesses and to align it with the effective date of the new insurance contracts standard.
Page 27
Numerical example: Non-par contract
Page 28
A non-par product 10 year limited pay, whole life coverage
Issued in 1998
Sum assured upon death
Cash value upon surrender
IFRS 4 Phase I valuation: net-level premium approach
Locked-in valuation assumptions (discount rate = 7%)
IFRS 4 Phase II valuation: building block approach
Transition date: YE 2014
Numerical example Background
Page 29
Valuation date 1998 2014 2014 2014 2014
Non-economic assumption
1998 1998 2014 2014 Prudent
Discount rate 1998 1998 1998 2014 7.0%
BEL = (11.0)
BEL = 51.5 BEL = 46.9 BEL = 95.6
CSM = 6.3
CSM = 3.8
RA = 2.5
RA = 2.5
Initial measurement
Subsequent measurement Phase I
result = 116.6
RA = 4.7
RA = 4.8 CSM = 10.7
CSM = 10.7 (Unit in mil)
Phase II result = 108.8
<
1 2 3 4 5
Numerical example Overview of results – step by step
Transition
Page 30
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2014 2024 2034 2044 2054
Calendar year
Profit & loss
IFRS 4 Phase II investment result
IFRS 4 Phase II underwriting result
IFRS 4 Phase II profit & loss
IFRS 4 Phase I profit & loss
(Unit in mil)
In this example, on P&L:
► Phase I P&L ( black line): more
profit is released at later period ► Phase II P&L ( red line): profit
is accelerated ► Mainly due to underwriting
result ( color)
► Investment result ( color), can become negative under low interest rate environment
Numerical example Profit & loss
Page 31
Section 3
Current discussion: Par contracts
Page 32
► Mirroring approach in 2013 Exposure Draft:
► Applies when (i) the contract requires holding underlying items, and (ii) specifies a link between the payments to the policyholder and the returns on those underlying items.
► When applicable, measure the fulfilment cash flows that are expected to vary directly with returns on underlying items by reference to the carrying amount of the underlying items.
Current discussion Participating contracts - 2013 Exposure Draft
Behaviour of cash flows
Vary directly Vary indirectly Do not vary
Measurement By reference
to underlying items Building block approach
Presentation of measurement changes
Consistent with underlying items
Profit or loss Profit or loss or OCI,
following general requirements
Page 33
► The ‘mirroring approach’ proposed in the 2013 ED was considered by many respondents as being overly complex and not fit for purpose.
► In November 2014, the IASB held an education session in which representatives of the European CFO Forum presented their alternative proposal for the accounting for contracts with participation features.
Current discussion Participating contracts - industry concerns on 2013 Exposure Draft
Key principles of the alternative proposal:
1. Applicable to all types of participating contracts
2. One measurement basis for all insurance contracts
3. Fully unlocked CSM
4. CSM is released in P/L in a way that best reflects the transfer of services under the contract
5. Current portfolio book yield used to determine interest expense in P/L
6. The insurer elects to present the effect of changes in the discount rate in OCI or P/L as an accounting policy choice
Page 34
► The IASB held two educational sessions in 2015 to discuss the possible adaptions to the general model for contracts with participation features. No tentative decisions have been made so far.
► The staff proposed two possible views on the entity’s interest in such underlying items:
Current discussion Participating contracts – educational sessions by the IASB
View of entity’s economic interest Measurement model
Indirect participation
contract
As a share of economic returns from the underlying items
General model approach
Direct participation
contract
Promise to pay an amount equal to the value of underlying items less a variable fee for services
Variable fee approach
Page 35
► Three criteria for variable fee approach:
Current discussion Participating contracts – educational sessions by the IASB
The contract specifies a participation in clearly identifiable underlying pools of assets (or other underlying items).
1
The entity expects that a substantial proportion of the cash flow from the contract will vary with underlying items.
2
The entity expects that the policyholder will receive a substantial share of the returns.
3
Page 36
Current discussion Participating contracts – educational sessions by the IASB
► Key differences between indirect and direct participation contract:
Indirect participation contracts [General model approach]
Direct participation contracts [Variable fee approach]
Unlocking of CSM due to change in underlying item
The CSM would not be unlocked:
• The changes in estimates that arise because of changes in financial assumptions (change in discount rate) would be recognized in P/L or OCI
The CSM would be unlocked for changes in:
• The expected present value of variable fee for service and
• The expected present value of the cost of guarantees
Discount rate for accretion of CSM and unlocking
View 1: Follow the general model approach
• Locked-in rate
View 2: Follow the variable fee approach
• Current rate
• No need to accrete interest on the CSM as the measurement of the value of the underlying items already reflects the time value of money in the obligation
• Unlock the CSM using the current liability rate at reporting date
Page 37
Current discussion Participating contracts – educational sessions by the IASB
► Key differences between indirect and direct participation contract
► Assuming that the OCI option is permitted:
Indirect participation contracts [General model approach]
Direct participation contracts [Variable fee approach]
Interest expenses
The entity may choose as its accounting policy to determine the interest expense in P/L using • the current discount rate or • an effective yield approach
When the entity has not held the assets in each reporting period: • the entity may choose as its accounting policy to determine interest
expense in P/L using
• the current discount rate or • an effective yield approach. When the entity expected at inception to hold the assets and has held the assets in each reporting period. • the entity may choose as its accounting policy to determine interest
expense in P/L using either
• the current discount rate, • an effective yield approach or • a current period book yield approach
Page 38
Current discussion Participating contracts – educational sessions by the IASB
• In scope of variable fee approach; and
• The underlying items are held by the entity to ensure an exact match between the items underlying the obligation and the obligation itself exists
Current period book yield approach
► The interest expense would be equal and opposite to investment income on the underlying items.
Year 1 Year 2 Year 3 Year 4 Year 5
Investment income
70.0
164.7
61.7
64.8
68.1
Interest expense
(70.0)
(164.7)
(61.7)
(64.8)
(68.1)
Investment results 0 0 0 0 0
Other comprehensive income 10 12 32 (9) (20)
► The difference between the interest expense in profit or loss and the interest expense determined based on current rates would be reported in OCI for both the underlying items and the insurance liability.
Page 39
Insurance contracts standard Major open discussion points in IFRS 4
Participating contracts
► Variable fee approach ?
► Approach for universal life contracts ?
► Re-open debate on the general model ?
► Allocation of CSM over coverage period?
► Interest expense ?
► Presentation of changes in discount rates ?
► Transition
Level of aggregation
► Objective of IASB: measure CSM at individual contract level
► No compensation between onerous and profitable contracts
► “Mutualisation” in participating contracts
► Implications for non-participating contracts
Key items to be resolved ► Participating contracts ► Level of aggregation
No decisions taken
Significant impact
Thank you
Page 41
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