2009 washington freedman 11a
TRANSCRIPT
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U.S. GAAP, From Basic Application to Current
Topics Seminar
August 31 September 1, 2009
11A: IFRS for Insurance Contracts; IFRS 4
(Intermediate)
Mark Freedman
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IFRS 4, Insurance Contracts
Mark Freedman
Ernst & Young
August 31 September 1, 2009
Society of Actuaries GAAP Seminar
Page 2
Background
Product classification
Insurance contract measurement
Agenda
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IFRS guidance for an insurance company balance sheet
Investments:Equities,
fixed interest,
loans
Insurance
Liabilities PhaseI
Other assets Other liabilities
Insurance
liabilities and
investment
contracts with
discretionary
participation
features
Investment
contract
liabilities
Investment
contract DAC
IAS 39
IAS 40
IAS 18
Insurance DAC IFRS 4
PVIF IFRS 4
Various
IFRS 4
IAS 39
Various
Various
Property
Equity
Page 4
There is a phased approach to insurance contracts.
IFRS
INSURANCE
PROJECT
Phase I Implemented 2005
Phase II
Uniform, likely new, insurance
measurement standard
Phased approach for insurance
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Exemption from IAS 8
Absent a specific relevant standard, reporting entities look to IAS 8Accounting Policies, Changes in Accounting Estimates and Errors forguidance on adopting accounting policies.
IFRS 4 exempts insurance and investment contracts withdiscretionary participation features, but not other investmentcontracts, from IAS 8, effectively allowing insurers to continue existingaccounting policies, with certain limitations and modifications.
Insurers are also given relief from the strict requirements of IAS 8 ifthey wish to change accounting policies for insurance contracts,either at the time of adopting IFRS or later. They can make a change
to a policy that is more relevant but not less reliable or more reliablebut not less relevant than the current policy.
Page 6
Key requirements under IFRS 4
Changes in IFRS 4 accounting policies
An i nsu rer may change its account ing pol ici es fo r in sur ance cont ract s if , and onl y if , thechange makes the financial statements:
more relevant and no less reliable, or
more reliable and no less relevant
An i nsu rer shall j udge relevance and rel iabi lit y by the c ri teri a in IAS 8.
Relevance economic decision-making needs of users
Reliability
represent faithfully the financial positions, financial performance and cash flows of theentity
reflect the economic substance of transactions, other events and conditions, and notmerely the legal form
are neutral, ie free from bias are prudent; and
are complete in all material respect
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Background
Product classification
Insurance contract measurement
Agenda
Page 8
Product Classification defines accounting treatment
Phase I
Investment contracts
Discretionary Participation
Investment contracts
Insurance contracts
*Subject to certain modifications
Existing
Accounting*
Existing
Accounting*
Existing
Accounting*
Existing
Accounting* Amortised Cost
-or-Fair Value**
Amortised Cost
-or-Fair Value**
Product classification - Why is it important?
**Possibly with separate accounting
for service component
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Is there significant
insurance risk present
in the contract?
Is there a
deposit component to thecontract? If so, is the deposit component
independent of the insurance
cash flows?
Are any elements of
the benefit driven by discretionary
participation
Insurancefeatures present
in contract
Classified as an
investment contract
Deposit component
Yes
No
Insurance and deposit
components of contract must, if
not recognised, be unbundled
and valued separately
Yes
No
Insurance
component
Product is an Investment
Contract without discretionary
participation features
Product is anInsurance Contract
Product is an Investment
Contract with discretionary
participation featuresYes
No
Classification flowchart
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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.IFRS 4.Appendix A
The same definition and tests apply to reinsurance.
Definition of insurance
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Financial risk is the risk of a possible future change in one or moreof a specified interest rate, financial instrument price, commodityprice, foreign exchange rate, index of prices or rates, credit ratingor credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to thecontract.
Insurance risk is risk, other than financial risk, transferred from theholder of a contract to the issuers
If both financial risk and significant insurance risk are present,contract is classified as insurance.
IFRS 4.Appendix A
Considered over life of the contract including option periods
Insurance versus financial risk
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Significant if, and only if, an insured event could cause an
insurer to pay significant additional benefits in any scenario,
excluding scenarios that lack commercial substance.
Additional benefits must be for pre-existing risk and do not
include:
Charges that would be made on cancellation or surrender
Loss of ability to charge policyholder for future services (e.g., if a
contract terminates on death)
Possible reinsurance recoveries as these are classified separately
IFRS 4.Appendix B22 - B28
Significant insurance risk
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Additional benefits include timing risk Whole life contract (payment known, timing unknown) has additional
benefits
Contract where death benefit is equivalent to maturity benefit (i.e.,maturity benefit adjusted for time value of money) does not haveadditional benefits
Classification on a contract by contract basis Contracts entered into simultaneously with the same policyholder count as
one contract
Products may be classified homogeneously on materiality grounds
IFRS 4.Appendix B22 - B28
Significant insurance risk
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No quantitative guidance given.
Rules of thumb currently being adopted for internal consistency Benefit paid on death exceeds benefits payable on survival by more than
x% (term assurance)
Plausible scenario exists under which the death benefit exceeds thesurvival benefit by x% or more at any time during the policy term(guaranteed minimum death benefit in unit-linked contract)
Benefit payable on survival exceeds the benefit payable on death by morethan x% (pure endowment, life contingent annuity)
The ultimate result on reinsurance may exceed x% of premium earned byreinsurer.
Quanti tative measures
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Examples of significant insurance risks
Significant Insurance Risk?Insured Event Occurrence and Cost
YESCostly and feasible event in scenario of commercial substance
even if it is extremely unlikely
NOContingent amount to be paid is insignificant in all scenarios of
commercial substance
NOLoss of ability to charge for future services
NOWaiver on death of surrender charges
NOUnfeasible event in any scenario of commercial substance
YESSignificant additional benefits payable under insured event
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Comparison to US GAAP
SFAS 60, SFAS 97 Limited
Payment, SFAS 120
SFAS 60, SFAS 97 Limited
Payment, SFAS 120
SFAS 97 Universal LifeSFAS 97 Universal Life
SFAS 91, SFAS 97 InvestmentSFAS 91, SFAS 97 Investment
InsuranceInsurance
Generally InsuranceGenerally Insurance
Insurance or Investment(depending on significance of insurance risk)
Insurance or Investment(depending on significance of insurance risk)
US GAAP classification IFRS classification
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Examples of insurance and financial risks
Insurance - significant insurance risk
Most property/casualty insurance contracts
Term assurance and pure endowment assurance
Life contingent annuities
Whole life contracts
Variable annuities with significant death benefit
Fixed or variable (unit-linked) with significant life contingent annuity
guarantee
Most reinsurance contracts
Financial guarantees of specific third party debts
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Examples of insurance and financial risks
Investment - insignificant insurance risk Reinsurance contracts that do not transfer any significant reinsurance
risks
Short-term endowment contracts
Variable or unit-linked without significant death benefit (e.g. 101% valueof units)
Pension accumulation contracts without significant death benefits
Contract exposed to lapse or expense risk only
Financial derivatives
Deferred annuity with no life contingency or insurance guarantee
Guaranteed investment contract or bond
Product warranties issued directly by manufacturer
Reinsurance catastrophe bonds with triggers not directly related to theissuers losses
Financial guarantees linked to credit index
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Is there significant
insurance risk present
in the contract?
Is there a
deposit component to thecontract? If so, is the deposit component
independent of the insurance
cash flows?
Are any elements of
the benefit driven by discretionary
participation
Insurancefeatures present
in contract
Classified as an
investment contract
Deposit component
Yes
No
Insurance and deposit
components of contract must, if
not recognised, be unbundled
and valued separately
Yes
No
Insurance
component
Yes
No
Unbundling
Product is an Investment
Contract without discretionary
participation features
Product is an
Insurance Contract
Product is an Investment
Contract with discretionary
participation features.*
*Likely none in North America
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Unbundling seperate presentation and measurement of insurance and investmentcomponent.
Some insurance contracts contain both an insurance component and a deposit component.In some cases, an insurer is required or permitted to unbundle those components:
Unbundling is required when: The insurers existing accounting policies do not require recognition of the deposit
component and
The insurer can independently measure the deposit component from the insurancecomponent
Unbundling is allowed when the insurer can independently measure thedeposit component from the insurance component
IFRS 4.10 12
Unbundling is intended to require recognition of deposit elements of contractsthat in some accounting regimes were not reflected, such as in somecatastrophic reinsurance arrangements. Given the requirements of US GAAP,this will have little effect on US insurers.
When do you unbundle?
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Unbundling examples
Some riders interact with underlying contract. Some riders do not.
Rule of thumb:
If premium is from fund do not unbundle
If separate premium unbundle - really treat as separate contractsIf the rider benefit is insurance and the underlying contract is insurance, then there is
no need to unbundle.
Riderbenefits
Cost of life cover made through charges to fund. Unbundling is complex and
therefore would not be required
Where separate risk premium for fixed death benefit, then unbundling required.
Unit-linked
contracts
Insurance cash flows are integrated with deposit cash f lows and contract should not
be unbundledWhere term assurance is attached and premium is recorded for joint contract and
practicably inseparable, then contract will not be unbundled.
Where term assurance is attached and premium is recorded separately, thencontract will be unbundled.
Traditional
insurancecontracts
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Is there significant
insurance risk present
in the contract?
Is there a
deposit component to the
contract? If so, is the deposit component
independent of the insurance
cash flows?
Are any elements of
the benefit driven by discretionary
participation
Insurance
features present
in contract
Classified as an
investment contract
Deposit component
Yes
No
Insurance and deposit
components of contract must, if
not recognised, be unbundled
and valued separately
Yes
No
Insurance
component
Yes
No
Discretionary participation features (DPF)
Product is an Investment
Contract without discretionary
participation features
Product is an
Insurance Contract
Product is an Investment
Contract with discretionary
participation features
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Contractual right to additional payments as a supplement to
guaranteed minimum payments
Likely to be a significant portion of the total contractual payments.
Amount or timing is contractually at the discretion of the issuer
Contractually based on
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
Profit or loss of the company, fund or other entity that issues the contract
IFRS 4.Appendix A
Defini tion of DPF
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Investment contracts with discretionary participation features aremeasured under IFRS 4
Investment contracts without discretionary participation featuresare measured under IAS 39 Investment management services separated and measured under IAS 18
IFRS 4.2
Measurement of DPF
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Background
Product classification
Insurance contract measurement
Agenda
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During Phase I, existing accounting policies apply with certainmodifications
Prohibited certain accounting policies are prohibited as they do not meetthe IFRS framework
Mandated certain accounting policies must be implemented if they are notalready in the existing accounting policies
Al lowed to continue, but not start certain accounting policies that do notmeet the IFRS framework can continue, but cannot be implemented.
Can be started certain accounting policies can be introduced.
Insurance contract measurement
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The following accounting policies are prohibited Amounts for catastrophe provisions for potential claims beyond the term
of existing contracts
Amounts for claims equalisation provisions
Offsetting of reinsurance assets and direct liabilities
IFRS 4.14
This is no different from US GAAP.
Prohibited policies
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The following accounting policies are mandated if they are not
already present
Liability adequacy testing
Impairment of reinsurance assets
IFRS 4.14
Mandated pol icies
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Current liability adequacy test applies if Test at each reporting date using current estimates of future cash flows
(including guarantees and options)
If these are greater than current liability, liability is increased anddeficiency flows through profit and loss
Otherwise Liability Adequacy Test under IAS 37 Provisions,Contingent Assets and Contingent Liabilities Fair value like calculations
IFRS 4.15-19
US companies may have to change loss recognition policies fordeferred annuities that are insurance contracts under IFRS butinvestment contracts under US GAAP to avoid having them fall under
IAS 37.
Mandated Policies:Liability adequacy test
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Reinsurance asset is reduced and reduction flows through income
statement if it is impaired
Reinsurance asset is impaired if:
Objective evidence of an event after initial inception that the cedant may
not receive all amounts due to it
The impact of the event can be reliably measured
Impairment may be reversedIFRS 4.20
This guidance is similar to US GAAP.
Mandated Policies:
Impairment of reinsurance assets
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The following accounting policies may continue but companies
may not switch to these where they are not already applied
Using an undiscounted liability basis
Measuring future investment management fees at a value greater than the
acquisition costs
Using non-uniform accounting policies for subsidiaries
Using excessive prudence in the valuation of liabilities
IFRS 4.25
Policies that may continue
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The following accounting policies can be started subject to certainrestrictions Use of current market discount rates and use of other current variables for
selected liabilities
Use of shadow accounting
Use of asset based discount rates
Only if part of a comprehensive accounting po licy which makesfinancial statements more relevant and reliable
An example is the adoption of FAS 60 for the
measurement of liabilities for traditional policies. If FAS60 is more relevant or more reliable than the existingaccounting policy, then discounting at asset yields isacceptable.
Policies that may be started
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Measure liabilities using current market interest rates
Current market interest rates Can include investment spreads only if already included
Otherwise presumably risk free rates
Can move to using current assumptions for other variables at the same
time
Can be performed for any designated liabilities
All changes in liabilities must flow through income statement
IFRS 4.24
The ability to use current assumptions for variables that are locked in
under current accounting policies is intended to allow for movement
in liabilities that is more consistent with movement in investments, asassets are generally measured at fair value.
Current market interest rates
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Shadow accounting
Quantify impact of realising gains on liability and related assets
If unrealised gains flow through P&L the effect on the measurement of
liabilities and related assets flows through P&L
If unrealised gains flow through equity as OCI the effect on the
measurement of liabilities and related assets flows through equity as OCI
IFRS 4.30
The use of shadow accounting is new to many companies not using US GAAP. The point
that the treatment of shadow movement follows the treatment of unrealized gains and
losses (ie, through P&L or in OCI) is the common application of the guidance in IFRS 4.
Shadow accounting
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Distributable surplus must be classified as liability or equity
Disclosure of movement in statement of equity if any distributable surplus
classified as equity
Distributable surplus classified as liability taken into account in liability
adequacy test
IFRS 4.34
This means, for example, that a PDO associated with a closed block
of contracts from a demutualized company could be reported as a
component of equity rather than as a liability. Few insurers in Europe
took the alternative to classify distributable surplus as equity and it is
doubtful that US insurers will find this attractive.
Insurance contracts with DPF