Post on 22-May-2020
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
5
• 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