IFRS for insurers

3rd African Actuarial Congress

Lome, Togo

IFRS Background

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• International Accounting Standards Board

• London-based, 14 members from 9 countries

• Dedicated staff

• Insurance Working Group (IWG)

• Worked with FASB (U.S. Financial Accounting Standards Board)

(2008-2010) (resumed in 2011 but that may be in jeopardy again)

• Pronouncements:

• IAS (International Accounting Standards)

• IFRS (International Financial Reporting Standards)

• These are identical – IAS was published before IFRS

History of Project - IASB

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• To provide information to users of financial statements

that is relevant for economic decision-making

• To eliminate inconsistencies and weaknesses in existing

practices

• To provide comparability across entities, jurisdictions and

capital markets

History of Project - Objectives

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• Phase 1 started in 1997

• 2001 Draft Statement of Principles

• 2004 Phase 1 ended with IFRS4 • Defined insurance

• Revised IAS 39, guidance for investment products

• Existing local GAAP with additional disclosure and loss recognition was permitted

• Still allowed diverse practices

• Applies to insurance contracts, not insurance companies

History of Project – Phase 1

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• Phase 2 started mid-2004

• IASB, IASB staff and IWG worked on a discussion paper called

“Preliminary Views” or “Discussion Paper,” released in May 2007

• Main text – 150 pages; Appendices – 80 pages

• Over 160 Comments letters

• Had something appealing and something offensive to everybody

• Issued ED (Exposure Draft) July 2010

• ED - 87 pages

• Basis for Conclusions - 95 pages

• Plus appendices with numerical examples

History of Project – Phase 2

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2004 2005 2006 2007 2008 2009 2010 2011

Discussion

paper published

May 2007 Comment

period closed

Nov 2007 Phase II exposure

draft

July 2010

Phase II work

begun

Jul 2004

FASB joins

project

Oct 2008

FASB DP

Sept 2010

2012 2013 2014 2015

Phase II

re-exposure draft

Dec 2012?

FASB

standard

2014/15?

FASB exposure

draft

Dec 2012?

Phase II standard

Late 2013?

Phase II Effective

Jan 2016?

Possible Timetable

Current IFRS

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Topics

• Product Classification – Briefly as this hasn’t really changed

• Discretionary Participation Features definition

• Reserving Basis

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Insurance contract definition

• A single definition of insurance contracts

“a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.”

• “A reinsurance contract is a type of insurance contract.”

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Discretionary Participation Features

(DPF)

A contractual right to receive, as a supplement to guaranteed benefits, additional benefits: that are likely to be a significant portion of the total contractual benefits;

whose amount or timing is contractually at the discretion of the issuer; and

that are contractually based on:

the performance of a specified pool of contracts or a specified type of contract;

realised and/or unrealised investment returns on a specified pool of assets held by the issuer; or

the profit or loss of the company, fund or other entity that issues the contract.

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Reserving Basis – policy reserves

• Use your local accounting basis

Many just continued with local GAAP (with adjustments)

Some multi-nationals applied consistent basis to all entities while others

differ by location

• May include shadow accounting

• Not required to eliminate excessive prudence but may not

introduce it

• Other changes allowed if “more relevant”

An insurer is permitted, but not required, to change its accounting policies

to reflect current assumptions

Can select only some liabilities without applying to similar liabilities

Can select specific assumptions without applying it to all assumptions

However, once selected, cannot “deselect”

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Reserving Basis – other reserves

• Embedded derivatives

Need to be unbundled if not also insurance

Exception for cash surrender value “put” options

• Unbundling of deposit elements

Required if accounting policy does not already require it be measured

Prohibited if it cannot be measured separately

Permitted otherwise

• Prohibit provisions for nonexistent claims are removed

No catastrophe and equalization provisions

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Reserving Basis – DPF

• Maintain existing policy or make it more relevant and/or reliable

• DFP Can be either implicitly or explicatively recognized

• They need to be shown as either equity or a liability (but not

some “intermediate” category)

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Reserving Basis - LAT

• A catch-all for reserving

• All options and guarantees need to be included based on

“current” estimates

• Any shortfall must go to the P&L

• If current accounting policy does not satisfy the above, then

adopt (the more onerous) IAS 37 guidance

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Reserving Basis - reinsurance

• Impairment for Reinsurance Assets only if:

there is objective evidence (trigger event) that cedant may not receive all

contractual amounts

that event can be reliably measured

• Otherwise, insurers may not impair reinsurance assets

Although more relevant / reliable argument also can be used

IFRS Phase II

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Topics

Background on the Measurement Model

Overview of the proposed model

Building blocks

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Measurement Model Background

Measurement model based on the following principle:

• Insurance contracts create a bundle of cash flows that work together to create a

package of cash inflows and outflows

Measurement model proposed for all types of insurance (and reinsurance) contracts

Model is a current assessment of insurer’s rights and obligations under contract

Model has three building blocks

A modified approach for short-duration contracts

Measurement model principles

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Current fulfillment value

Difference

Similarities

Composite

margin Risk

adjustment

Residual

margin

The amounts the insurer expects to

collect from premiums and pay out for

claims, benefits and expenses, estimated

using up-to-date information

Expected

value of

cash flows

Expected

value of

cash flows

Total

premiums

FASB IASB Customer

consideration

Discount

An adjustment of the uncertainty about

the amount of future cash flows

Contract profit (reported over life of

contract)

An adjustment that uses an interest

rate to convert future cash flows into

current amounts

Discount

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Building block 1: Cash flows estimate

Current — re-assessed at each reporting period

Incorporate, in an unbiased way, all available information about the amount and timing

of all cash flows

Probability weighted cash flows — Stochastic modeling may be required

If observable market data exists, incorporate in the model to the extent possible

Non-market variables utilize entity-specific cash flows

A current, unbiased and probability weighted estimate of

the contractual cash flows

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Building block 2: Discount rate

Discount rate based on characteristics of the insurance liability:

- Currency - Duration - Liquidity

Use an asset based discount rate ONLY if the amount, timing or uncertainty of the

cash flows depend on performance of assets, e.g. participating contracts

Discount rate is a market consistent interest rate based on a “risk free rate” plus an

illiquidity premium based on the characteristics of liability cash flows.

No further guidance on how to calculate the illiquidity premium

Disclosures on discount rate, impact of illiquidity and sensitivities

Adjusts first building block for time value of money

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Building block 3: Margins – Risk adjustment

Explicitly reported as a component of the insurance contract liability, defined as:

“the maximum amount an insurer would rationally pay to be relieved of the risk that

the fulfillment cash flows exceed those expected”

Re-measured at each reporting period; Estimated at portfolio level

Reflects diversification arising within a portfolio of insurance contracts

Diversification across portfolios of insurance contracts is not allowed

An adjustment to reflect uncertainty in the estimate of

fulfillment cash flows

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Confidence interval (or Value at Risk (VaR))

Likelihood that the actual outcome will be within specified interval

Easier to communicate and calculate compared to other techniques

Not useful for probability distributions that are not statistically normal

Conditional Tail Expectation (CTE or TVaR)

Reflects extreme losses; focuses on probability distribution tail → reflects aspects of

insurance

Judgment required to determine band and may need to change in future periods

Cost of Capital

Applied in pricing, valuations, regulatory reporting (e.g. Solvency II risk margin), etc.

Reflects est. cost of holding required capital to meet obligations with high confidence

Need to determine capital rate that reflects risk relevant to liability.

Three examples of techniques for estimating risk adjustment

Building block 3: Margins – Risk adjustment

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Building block 3: Margins – Residual Margin

A residual margin arises when:

PV of future cash inflows > PV of future cash outflows + risk adj.

Estimated at level of portfolio of insurance contracts, with same inception date and

similar coverage duration (cohort)

Calculated at initial recognition and earned over coverage period

Cannot be negative, as a loss must be recognized immediately through income

Interest expense accretion required using discount rate locked-in at inception

A margin to eliminate any gain at inception of the contract

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Building block 3: Margins – Composite Margins

A composite margin arises when:

• PV of future cash inflows > PV of future cash outflows + risk adjustment

Estimated at portfolio level of insurance contracts, with same inception date and similar

coverage duration (cohort)

Measured at inception and released as risk exposure unwinds based on the following

specified formula:

Premium allocated to current period + Current period claims and benefits

Total contract premium + Total claims and benefits

No interest accretion

A margin to eliminate any gain at inception of the contract

Current IFRS 4 Reporting

Insurance IFRS Seminar

Hong Kong, August 27, 2012

Michael Lockerman

Session 5