adoption of ifrs in the insurance sector catherine guttmann 15 march 2006 reparis workshops on...

Adoption of IFRS in the Insurance Sector

Catherine Guttmann

15 March 2006

REPARIS Workshops on Accounting and Audit Regulation, Vienna, March 2006

What does IFRS 4 – Phase I mainly say

33 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte© 2006 Deloitte

IFRS 4 – Phase I : Insurance Contracts

Main features of the IFRS

The IFRS on insurance contracts applies to all insurance contracts (including reinsurance contracts) and only to insurance contracts

Financial assets and liabilities of insurers

are treated by IAS 39

All IFRS standards apply to insurance companies

« Insurance contract » definition is a definition in substance and not a legal one : The standard on insurance contracts should then be used for

example in the banking industry



Definition of an insurance contract

An insurance contract is 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 futur event (the insured event) adversely affects the policyholder »

The « policyholder » is defined as : « a party that has a right to compensation under an insurance contract if an insured event occurs »



Definition of financial risk

An insurance risk is a « risk , other that financial risk, transferred from the holder of a contract to the issuer »

A financial risk is « the risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract »



Examples of insurance contracts

Are insurance contracts: Are not insurance contracts:- Insurance against theft or damage to

property

- Insurance against product liability, professional liability, civil liability

- Disability and medical cover

- Life contingent annuities

- Death benefit

- Catastrophe bond if the triggering event includes a condition that the issuer of the bond suffered a specified loss

- Financial contracts which don’t expose the insurer to significant insurance risk (investment contracts, financial reinsurance)

- Fronting

- Own insurance :

for example : product warranty is issued directly by a manufacturer dealer or retailer

- Catastrophe bond triggered by an external event for which the issuer doesn’t incure a specific loss



First consequence : classification of the contracts and valuation principles

Significative insurance

risk ?

IAS 39 / IFRS 4

Embedded derivative to separate

IAS 39

yes

DiscretionaryParticipating

Feature ?

discretionaryNon

discretionary

no

• IAS 39 for the financial component and liability adequacy test

•Local GAAP for the insurance component

• No need to separate

• Local GAAP and Liability adequacy test

Financial Component ?

Separate and Fair value the

Embeddedderivative

yes

yes

no

no


ASSET IFRS

Goodwill IFRS 3, IAS 36 Value business in force for insurance contracts IFRS 4 Value business in force for financial contracts IAS 39 Differed acquisition costs for insurance contracts and financial contracts with discretionary participating feature

Local GAAP / IFRS 4 / IAS 39

Differed acquisition costs for financial contracts IAS 39 Intangibles assets – Impairment IAS 38, IAS 36 Tangible assets - Impairment IAS 16, IAS 36 Differed tax assets and current tax IAS 12 Leases IAS 17 Financial assets IAS 39 Derivatives (including embedded derivatives) IAS 39 Loans IAS 39 Investment property IAS 40 Investments in Associates and joint ventures

o Equity method IAS 28, IAS 36

o Investment IAS 39 Other financial assets IAS 39

Cash and cash equivalent IAS 7, IAS 39 Reinsurance assets IAS 39

Reinsurance ceded IFRS 4 Financial reinsurance ceded IFRS 4, IAS 39

Second Consequence : an insurer balance sheet

Major changes with fair value orientation

Local GAAP


LIABILITY IFRS

Equity :

- Variation of fair value for available for sale financial instruments

- Cash flow hedges (effective hedge)

- Actuarial gains and losses (option)

- Discretionary participating features classifed as equity

IAS 32, IAS 1

IAS 39

IAS 39

IAS 19

IFRS 4

Minority interests IAS 27, IAS 1

Total Equity Insurance and reinsurance contracts qualified as financial instruments

IAS 39

Discretionary participating features classified as liability IFRS 4 / Shadow accounting

Insurance and reinsurance contracts non qualified as financial instruments, financial contracts with discretionary participating features

IFRS 4 / IAS 39

Derivatives (including embedded derivatives) IAS 39

Financial liabilities (option) IAS 32, IAS 39

Differed tax liabilities IAS 12

Contingent liabilities and provisions IAS 37

Current taxes IAS 12

Employee benefits IAS 19

Short term liabilities IAS 39

Reinsurers liabilities IAS 39

Leases IAS 17

Banking deposits IAS 7, IAS 39

Total Liabilities

Major changes with fair value orientation

Local GAAP

Orientations for Phase II


IntroductionThe objectives of Phase II

By splitting the insurance project into 2 phases, the IASB board has postponed several key subjects : Valuation of insurance contracts : keeping current accounting

principles

Qualification and treatment of discretionary participating features (shadow accounting)

Embedded derivatives

Revenue recognition

Phase II will have to deal with all these issues with the following underlying purpose: To get a better financial reporting

To reach a global consistency between all IAS standards (IAS 39, IAS 18, IAS 37, …) and the IFRS framework (comparability, reliability, substance over form,…)


Agenda of the Phase II project

A working group has been set up by the IASB board : Meeting every 2 month

Participants : CFO of major insurance groups :

– Allianz

– Axa

– Prudential

– AIG

– Nippon Life

– …

IASB board members

Members of IOSCO, IAIS,EFRAG

Actuaries (Chairman of IAA)

Analysts (Standard & Poors, DZ Bank AG)

Public debate

Regular publications


Agenda of the Phase II project Agenda

A Working Paper should be published by the Working Group Phase II before year end 2006

An Exposure Draft should be published in 2008 Final standard could be published before year end 2008

Juillet 2005 2006 2008 2009/2010

Working Group meetings

Working paper published

ED published Endorsement of phase II standard


Approach C – Current Entry Value

Principles : Approach C measures the insurance liability at the amount that the insurer would charge to a policyholder today for entering into a contract with the same remaining rights and obligations as the existing contract.

• Initial measurement :• Discounting of future projected cash flows using current yield curve (best estimate value)• Valuation of an implicit margin, equal to the difference between premiums and the best estimate value

• Next measurements• Best estimate value is calculated on current assumptions (economic and non economic)• The initial margin is amortised among the duration of the contract with the release of the risk

Some valuation approaches


Approach D – Current Exit Value

Principles : Approach D measures the insurance liability at the amount that the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity.Because there is no secondary market for most insurance liabilities, that amount would need to be estimated.

Specifically, approach D :• Measures the insurance liability as the present value of future cash flows arising from the contract (Uses a current risk-free discount rate).• Does not defer acquisition costs as a separate asset.• The measurement of the liability includes the margin that market participants would require for contractually assuming risks and providing services :

• Margin for risks and uncertainty AND• Margin for the servicing part included in the insurance contract (servicing margin)

• Profit at inception is limited :• by the level of the MRI and• by the level of the Servicing margin



Approaches C & D


Asset

Approach D – "Business to Business”

Asset

Approach C – "Business to Customers”

Global margin = Premiums – Exit Value best estimate

Net equity

Servicing margin

MRU

Exit Value best-

estimate

Net equity

Global Margin

Exit Value best-

estimate

Some gain at inception but limited by the SM and the MRI

No gain at inception

Separation and valuation of the 3 parts of the contracts :- exit value "best estimate"- Margin for risks- Servicing margin


IAIS is working on a similar model so that the same valuation for liabilities could be taken for solvency purposes and accounting

Questions still to be solved :

• Definition of the MRU (level of confidence ; Cost of capital), or pattern of amortisation• Definition and level of the servicing margin (market reference ?)• Policyholder behaviour ?• Paragraph 49 of IAS 39 for investment contracts


adoption of ifrs in the insurance sector catherine guttmann 15 march 2006 reparis workshops on...

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