The New Insurance Contracts Accounting Standard: History in the making IABA Conference, August 7,...
-
Upload
myron-thompson -
Category
Documents
-
view
214 -
download
1
Transcript of The New Insurance Contracts Accounting Standard: History in the making IABA Conference, August 7,...
The New Insurance Contracts Accounting Standard: History in the making
IABA Conference, August 7, 2010
Tara Hansen and Gareth Kennedy
Page 2
Agenda
► Introduction and project background ► The proposed models► Income emergence► Conclusion
Introduction and project background
Page 4
Why is this important to me?
►FASB joined the insurance project in October 2008► Project will now impact US GAAP even if SEC doesn’t
require IFRS
►SEC work plan► Plan to make a decision in 2011 on requiring adoption of
IFRS by US companies
►NAIC Solvency Modernization Initiative► Monitoring developments from the IASB and Solvency II► Insurance Accounting Standards Working Group asked to
propose solution by end of 2011
Page 5
IASB — discussion paper
issued
Insurance contracts project timeline
FASB — invitation to comment
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
JuneMay November
August
End of comment periods (IASB and FASB)
IASBExposure
Draft Final standardImplementation
date
Implementation
FASB — Joined the
project
October
IFRS 4 Insurance Contracts
JanuaryJanuary
IASB and FASB meetings to develop accounting
standards
Jan. 2009 thru July 2010 July Aug.
2012 and 2013 statements filed under US GAAP
Fiscal2012
Fiscal2013
Fiscal2014
PotentialTransition
Restate openingbalance sheet
Fiscal2011
Run US GAAP and new insurance standard parallel
Form 10-K are produced for year ended December 31, 2014 with comparatives for fiscal years 2013 and 2012.
Quarterly information required as of March 31, 2014 with balance sheet comparative to Dec. 31, 2013 and
income statement to March 31, 2013.
First year of new standard 2014
Development of the new standard
Nov.
End of comment period
FASB Exposure Draft or Discussion
Paper
Page 6
Project considerationsConceptual accounting framework
►An exposure draft on the Conceptual Accounting Framework Project indicated that relevance and faithful representation are the fundamental qualitative characteristics of financial information
►Relevant - information that has predictive value or confirmatory value
►Faithful representation - complete, free from material error, and neutral
►Also the draft indicated comparability, verifiability, timeliness, and understandability are enhancing qualitative characteristics
►Materiality and cost are pervasive constraints
Page 7
Project considerations Revenue recognition
Key Concept Implication
Performance obligation ► The promise in a contract to transfer economic resources to a customer
Satisfaction of performance obligation
► Goods – when enforceable rights or access to goods transfer to customer► Services – when a service or access to a service is provided
Revenue recognition ► Revenue is recognized when contract asset increases or contract liability decreases.
Revenue can be recognized at two occasions:► when the contract is obtained (if a contract asset is recognised)► when a performance obligation is satisfied
Page 8
Project considerations Financial instruments project
► Recently published IFRS 9 will require investments to be recorded at fair value with changes in value flowing through profit and loss
► Exceptions are provided for:►Debt instruments with only basic loan features and the
asset is held to collect the cash flows under the company’s business model, amortized cost can be used
►Equity instruments not held for trading through an irrevocable election, with dividends through profit or loss and changes in fair value through OCI
► FASB has published separate exposure draft
The proposed models
Page 10
FASB IASB
FASB/IASB proposed insurance contracts measurement model
► The unbiased, probability-weighted average of future cash flows expected to arise as the insurer fulfils the obligation
► The time value of money
► An amount that eliminates any gain at inception of the contract minus an amount equal to the incremental acquisition cost(composite margin)
Current estimate of future cash flows
Discount
Composite margin
Current estimate of future cash flows
Discount
Risk adjustment
Residual margin
► The unbiased, probability-weighted average of future cash flows expected to arise as the insurer fulfils the obligation
► The time value of money
► A risk adjustment for the insurer’s view of the uncertainty (amount and timing) associated with the future cash flows
► An amount that eliminates any gain at inception of the contract minus an amount equal to the incremental acquisition cost
Page 11
UPR simplification
►IASB has tentatively decided that unearned premium will be used during the pre-claims period for short duration contracts as a simplification to the four building block approach. This would eliminate the need for a residual margin to eliminate day 1 profits
►FASB is currently debating this approach and recently discussed it in an education session
Page 12
Discount rates
►The Boards tentatively decided that the discount rate should reflect the characteristics of the liabilities, rather than the characteristics of assets held to back the contracts, unless the contracts share those characteristics
►The Boards have indicated that the discount rate could consist of:
►The risk-free rate►A liquidity premium►An adjustment for non-performance risk/own credit
standing (not to be included in the measurement)
Page 13
Acquisition costs
►The IASB tentatively decided to exclude from the initial measurement of the residual margin an amount equal to the incremental acquisition costs
►The FASB recently changed their tentative decision to include acquisition cost related to a contract in the cash flows used to measure the contract value at inception.
Page 14
Recognition
►The IASB has agreed in principle and the FASB has tentatively decided that the insurer should recognize the rights and obligations arising from an insurance contract on the earlier of:
►The insurer being on risk to provide coverage to the policyholder for insured events; and
►The signing of the insurance contract.
Page 15
Presentation of the performance statement
Summarized Margin Year 1
Year 2
Risk adjustment *
Residual Margin *
*(FASB – one composite margin)
Insurance Margin
Experience adjustment
Changes in estimates
Investment income
Interest on insurance liability
Net interest and investment
Profit
Expanded Margin Year 1
Year 2
Revenue
Policyholder benefits
Expenses
Release of benefit and expense accrued in
previous period
Insurance Margin
Experience Adjustment
Changes in estimates
Investment income
Interest on insurance liability
Net interest and investment
Profit
Page 16
Level of aggregation
►Boards tentatively decided:►“That an entity should measure any risk adjustment at a
portfolio level of aggregation; to retain the definition of portfolio of contracts in the existing IFRS 4 as Contracts that are subject to broadly similar risks and managed together as a single portfolio; and
►That residual or composite margins should be determined at a cohort level of aggregation, by grouping insurance contracts by portfolio and, within the same portfolio, by date of inception of the contract and by length (or life) of the contract.”
Page 17
Comparison of proposed models to Solvency II
Attribute Proposed FASB Proposed IASB Solvency II
Scope All companies reporting under US GAAP
All IFRS listed companies
EU insurance companies
Measurement Current assessment of the obligations
Current assessment of the obligations
Market consistent with entity parameters
Risk Margin/
Adjustment
Method
Not applicable Not yet prescribed CoC (Directive) and rate prescribed (QIS5) with 1-year VaR capital standard
Own Credit Standing
Possibly included Excluded Excluded
Disclosures To be defined but more than current US GAAP
Similar to current IFRS Solvency & Financial Condition report
Discount rate Risk-free plus an adjustment for illiquidity and possible for OCS
Risk-free plus an adjustment for illiquidity
Risk-free plus 50% of the illiquidity adjustment (QIS5)
Income emergence
Page 19
Income emergence – assumptions
► $1,000 of premium is written at time zero for one year of coverage with expected losses of $800
► Incremental acquisition costs are $200, losses include ALAE and ULAE, and there are no other expenses
► A risk free yield curve is used to discount the liabilities► Return on invested cash is 3.0% per annum► There is no tax or reinsurance► Actual reserve development does not differ from expected► Payments are made just prior to the end of each time
period
Page 20
Income emergence – assumptions
► The risk adjustment for the proposed IASB model is estimated using a “Cost of capital” approach with return on capital set such that it equals the amount of discount
► The amortization of the composite margin uses a formula as tentatively decided by the FASB
► Investment income is on available cash only ► Losses are paid out over 10 years► The UPR simplification is ignored
Page 21
Comparison of income emergenceCurrent US GAAP incomeCurrent US GAAP
Time = 0 0.5 1 1.5 2 2.5 3
Written Premiums 1,000 - - - - - -
Unearned Premiums 1,000 - - - - - -
Earned Premiums - 500 500 - - - -
Claims Expense -
(400)
(400) - - - -
Discount - - - - - - -
Risk Adjustment - - - - - - -
Acquisition costs -
(100)
(100) - - - -
Underwriting Income - - - - - - -
Investment Return - 12 12 11 10 9 8
Income - 12 12 11 10 9 8
Page 22
Comparison of income emergence Proposed IFRS income
Proposed IFRSTime = 0 0.5 1 1.5 2 2.5 3
Written Premiums 1,000 - - - - - - Unearned Premiums - - - - - - - Earned Premiums 1,000 - - - - - -
Claims Expense (800) - - - - - -
Discount 70 - - - - - - Risk Adjustment (70) - - - - - - Residual Margin - - - - - - -
Acquisition costs (200) - - - - - -
Underwriting Income - - - - - - -
Unwind of Discount on Claims Reserves - (11) (10)
(9)
(8)
(7)
(6)
Unwind of Risk Adjustment - 8 8 8 7 6 6 Unwind of Residual Margin - - - - - - -
Income After Unwind - (3) (2)
(1)
(0)
(0) 0
Investment Return - 12 12 11 10 9 8
Income - 9 10 10 10 9 8
Page 23
Comparison of income emergence Proposed US GAAP incomeProposed US GAAPTime = 0 0.5 1 1.5 2 2.5 3
Written Premiums 1,000 - - - - - - Unearned Premiums - - - - - - - Earned Premiums 1,000 - - - - - -
Claims Expense (800) - - - - - -
Discount 70 - - - - - - Composite Margin (70) - - - - - -
Acquisition costs (200) - - - - - -
Underwriting Income - - - - - - -
Unwind of Discount on Claims Reserves - (11) (10) (9)
(8)
(7)
(6)
Unwind of Composite Margin - 20 20 3 3 3 3
Income After Unwind - 9 11 (6)
(4)
(3)
(3)
Investment Return - 12 12 11 10 9 8
Income - 21 22 5 6 6 5
Page 24
Insurance contracts considerations – P&CComparison of baseline profit emergence
Page 25
Insurance contracts considerations – P&C Discount rate change scenario at t=2
A 50 basis point increase in the interest rate at t=2, causes a significant increase in the expected income at t=2 for the proposed US GAAP and IFRS models.
Page 26
Insurance contracts considerations – lifeExample – Product Features
Page 27
Insurance contracts considerations – lifeExample – FASB/IASB Insurance Contracts Approach
Page 28
Sample Results – UL New Business ProjectionPre-tax Net Income
* Investment Income based on Invested assets = U.S. statutory reserves + 350% RBC* Investment Income based on Invested assets = U.S. statutory reserves + 350% RBC
Page 29
Insurance contracts considerations – life Comparison of profit emergence by investment strategy
Conclusion
Page 31
Key effects that will interest management
► Transparency► Investors will get a much greater insight into insurance companies► Companies who efficiently use capital and make adequate risk
adjusted returns will find it easier to raise capital
► Income volatility► Income from insurance liabilities will be subject to interest rate
fluctuation► Asset-liability management will become more critical for P&C
companies who’s management wish to minimize the effect of interest rate changes on income
Page 32
Increased actuarial involvement
► Discounting and risk adjustment calculations
► Capital modeling
► Asset-liability modeling
► Attribution analysis