concepts of ifrs 4 insurance contracts & implementation ... bathwal.pdf · copyright birla sun...

Copyright Aditya Birla Nuvo Limited 2008

•Copyright Birla Sun Life Insurance Company Limited 2008

IFRS Seminar, The Institute of Actuaries of India - Mumbai, 17 October 2011

Concepts of IFRS 4 – Insurance Contracts

& Implementation Challenge

Presented by: Mr. Mayank Bathwal

CFO - Birla Sun Life Insurance Co Ltd.

Copyright Birla Sun Life Insurance Company Limited 2008

Outline for Discussion

IFRS 4 : Insurance contracts - Phase II

Measurement

Models

Accounting

and

Disclosure

Gaps

PresentationMajor

Implications

Overview & Project

timelines

IFRS 4 : Insurance contracts - Phase I

Product

Classification

Unbundling

/Embedded

Derivatives

Liability

adequacy test

Accounting

policies/

Disclosures

Definition

A

B


IFRS 4 : Insurance contracts - Phase I


Definition

A contract under which one party accepts significant insurance risk from another party

by agreeing to compensate the policyholder if a specified uncertain future event

adversely effects the policyholder.

Insurance Contract

Significant insurance risk

- Sufficient probability of occurrence &

- Sufficient magnitude of effect

Significant changes will be required in IT systems and actuarial models to bifurcate & measure the products as insurance and investment contracts

IFRS 4 Phase I

Key Impact


Product Classification flowchart

Contract components

Significant insurance risk ?

Insurance contract

IFRS 4

Unbundling ?

Yes

No Yes

IFRS 4 Deposit element: IAS 39

Insurance – IFRS 4

Financial risk ?

YesNo

Investment contractService contract

No

Any

Discretionary

Participating

Features ?

Accounting:

IFRS 4

Yes

IFRS 9 Fair value or

Amortised cost

IAS 18

Recognise

Revenue as

earned

IFRS 4 Phase I


Examples of Product Classification

Mortgage

Term

EndowmentPension

Term

Fund

Invidual Life- Insurance

Group - Insurance

Group - Invesmtnets

Invidual Life- Investment

IFRS 4 Phase I


Unbundling & Embedded Derivatives

Embedded derivatives should be

separated from host contract,

measured at fair value and changes

in fair value to be taken in profit and

loss

– This requirement applies to an

insurance contract also, unless the

embedded derivative itself is an

insurance contract

– An exception allowed when there is a

policyholder option to surrender an

insurance contract for a fixed amount

• The life insurance products in India are

designed in such a way that embedded

derivative components cannot be

separated from host contract

• Unbundling of insurance contracts has

also been prohibited in IRDA Report for

IFRS

IFRS 4 Phase I

Derivatives & Embedded Derivatives DefinedUnbundling

Some insurance contracts contain both insurance and deposit components. Unbundling is required if both the following conditions are met:

i. Insurer can measure the deposit component separately

ii. Insurer‟s accounting policies do not otherwise require it to recognise all obligations and rights arising from the deposit component.

If unbundled, IAS 39 will apply to the deposit component and IFRS 4 to the Insurance Component

• This will impact the top line of the

company as deposit component will be

reduced from the total premium and

accounted under IAS 39 Financial

Instruments

• IT systems needs to be upgraded /

modified to separately capture the

deposit component and recognise front

end fees as revenue


Liability Adequacy Test

An insurer shall assess at the end of each reporting period whether its recognised

insurance liabilities are adequate, using current estimates of future cash flows under its

insurance contracts.

IFRS 4 requires to perform liability adequacy test by the Actuary

The minimum requirements of test are the following:

- The test considers current estimates of all contractual cash flows, and of related cash

flows such as claims handling costs as well as cash flows resulting from embedded

options and guarantees.

- if the test shows that the liability is inadequate, the entire deficiency must be recognised

in profit or loss

The liability measurement principles are pretty stringent in India as negative reserves are

not considered in valuation of policy liabilities

IFRS 4 Phase I


•

Accounting policy

IFRS 4 Phase I

IFRS 4 permits to continue with current accounting

policies except;

Measuring insurance liability on undiscounted basis

Measuring contractual rights to future investment management

fees at an amount that exceeds its fair value – using non uniform

accounting policies for the insurance liabilities of subsidiaries

Catastrophe and equalisation provisions

Deposit components to the extent invested in various fund/s are to be

accounted as liability directly into the Balance sheet.

Benefits and claims paid on investment contracts directly need to be adjusted

against the liability.

Deferred acquisition costs (DAC) needs to be deferred over contract period

Deferred income (DOF) needs to be deferred and recognised as revenue

over the contract period.

Investment Contract;• Deposit accounting will reduce the top line of company

• DAC and DOF accounting will reduce volatility in the bottom line by equalising the acquisition costs and Income over the contract period

• Actuarial models & IT systems need to be upgraded to capture and track deposit component, DAC & DOF separately


Additional Disclosures

System changes for capturing disclosures such as sensitivity analysis, credit risk, interest rate and

maturity profile are required

IFRS 4 Phase I

Areas

Risk ManagementFramework

Details

Objectives & Policies

Risk identification and classification

Risk Mitigation Strategies & Review mechanism

Impact and Sensitivity of various risks

Insurance risk

Interest rate risk

Credit risk

ALM risk

Others

Basis used for classification of contracts into insurance contracts and investment contracts

Movement in Actuarial Liabilities


Impact : Balance sheet of an Indian Insurer

IFRS 4 Phase I

Particulars Impact

ASSETS

Non Current assets

Financial Investments Negligible

Current Assets

Financial Investments Negligible

Other Financial Assets Below 15%

EQUITY AND LIABILITIES

Retained Earnings Negligible

Other comprehensive income New item

Non-Current Liabilities

Other Financial Liabilities New item

Current Liabilities

Other Financial Liabilities Below 10%

Transaction costs on FVTPL

investments charged off.

Investments Fair valued

Impact on recognition of DAC

and DOF on investment

contracts

Deferred lease expense

charged off

Notional interest income

recognised on deposits given.

Premium/(Discount) amortised

on investments reversed.

Gain/(loss) on AFS recognised

in OCI


Financial Impact: Profit & Loss Account

IFRS 4 Phase I

Premium, Commission,

investment income and claims

on investment contracts are

removed from Profit & Loss

Account

DAC and DOF amortised

Notional interest income

recognised on deposits given

Premium and benefits and

claims on investment contract

impact adjusted in change in

investment liability

Particulars Impact

Income

Premium

Other income

Expenses

Commission Negligible

Operating Expenses related to Insurance

BusinessNegligible

Benefits paid (Net)

Change in investment liabilities

Profit/(loss) for the year Negligible

Depends on

product mix

Depends on

product mix


IFRS 4 Insurance contracts -Phase II


Overview

Current IFRS 4 definition of “Insurance” carried forward

Single model for all types of insurance contracts

– a „building block‟ approach to measure insurance liabilities

– a margin approach to report performance (income statement)

Measurement is current, i.e. no locking-in of assumptions (except for residual margin)

and based on a “fulfillment of obligations” notion.

Acquisition costs included in contractual cash flows, if incremental ; all other costs to

be expensed.

Implementation will be complex, but other projects can be leveraged

– Economic capital

Adoption of IFRS 9

– a „big bang‟ change for insurers

IFRS 4 Phase II


Project timelines

IFRS 4

Insurance

contracts

IASB –

Discussion

Paper

issued

Jan

End of

Comment

Periods (IASB

And FASB)

IASB –

Exposure

Draft

IASB and FASB

Meetings to

Develop

Accounting

standards

FASB –

Joined the

project

Reissue of

IASB

Exposure draft

Final

Standard

Implementation

Date

2005

FASB –

Invitation

to comment

May Aug Nov

2006 2007

Oct Jan’09 to Jul’10 Jul Nov

2008 2009 2010

TBD TBD

201? 201?

IFRS 4 Phase II

Phase 1 Phase II Implementation

H2 2012

End of

comment

period


Measurement Models - Building blocks

1 Expected future cash

flows

2 Discounting

3 Risk adjustment

Premium

4 Residual margin

IASB

5. Unallocated premium reserve for pre-claims liability short duration contracts

(FASB not decided yet)

Present value of fulfilment cash flows

FASB: Composite margin

Concept: what happens as the insurer fulfils contracts with policyholders over time

Consequence:

no gain at issue

IFRS 4 Phase II


IFRS 4 Phase II model- How does it work?

Cash inflows

o Premiums, including initial

premiums and future premiums

within contract boundary

o Potential recoveries (e.g., salvage

and subrogation)

Cash outflows

o Payments to (or on behalf of)

policyholders, including payments

in kind and Incurred but not

reported (IBNR)

o Claim handling costs

o Cash flows that will result from

options and guarantees embedded

in the contract

o Payments to policyholders as a

result of a contractual participation

term

o Transaction-based taxes and

levies (VAT, premium tax)

o Incremental costs of selling,

underwriting, and initiating

successful insurance contracts

o Policy administration and

maintenance costs

PV of future cash

inflowsRisk

adjustment

Nil

Short-

duration

pre-claims

liability

(net of

incremental

acquisition

costs)

Residual margin

PV of fulfilment cash flows

Diagram 1: Profitable contract

PV of future cash

inflows

Risk adjustment

Nil

PV of future cash

outflow

PV of fulfilment cash flows

Loss on inception

Liability adequacy test

Diagram 2: Non profitable contract FASB:

Composite margin

PV of future cash

outflow

Short-

duration

pre-claims

liability

(net of

incremental

acquisition

costs)

IFRS 4 Phase II


Phase II highlights- Key aspects of the ‘Building blocks’

1. Cash flows 2. Discounting 3. Risk margin 4. Residual margin 5. Unallocated

premium

Initial • Recognise

when being “on

risk”

• Unbiased

probability

weighted cash

flows

• At

contract/portfolio

level

• Reflect

characteristics of

contract

• Exclude “own risk”

• Risk free rate plus

allowance for

illiquidity

premiums

• Cost of capital,

conditional tail

expectation or

confidence level

methodologies

• Portfolio level

• No diversification

benefit between

portfolios

• Eliminate day 1

gain

• Interest accretion

• Portfolio level

(date of inception

and life of policy)

• Offset with

incremental

acquisition cash

flows

• Mandated contracts

less than 1 year

coverage

• Amortise

incremental

acquisition costs

• Onerous contract

test on fulfilment

cash flows

• Portfolio level

Subsequent • Re-measured • Re-measured • Re -measured • Not re-measured

• Release over

“coverage period”

• Release over

“coverage period”

• Onerous contract

test

Presentation

and

disclosure

s

• Reconcile

opening to

closing balance

• Present

separate

changes in

experience and

estimates

• Disclose

• Need to disclose

discount rate

applied

• Present changes

in discount rate

and interest

accretion

• Reconcile opening

to closing balance

• Present changes in

risk adjustments

• Disclose the

methodology basis,

inputs to calculate

risk margin and the

confidence level

achieved


to closing balance


to closing balance

including

premiums, claims,

expenses and

amortisation of

acquisition

expenses

• Disclosure of

additional liabilities

for onerous

contracts

IFRS 4 Phase II


Accounting and Disclosure Gaps

Data warehouse Outsourcing

General ledger Source systemsFront-end applications

Identify the data requirement needs from outsourced providers

Identify the general ledger accounts to which gaps relate.

Trace the general ledger transactions back to their source:

- Directly to source systems

- through the data warehouse(s).

Trace the transactions back to the front-end application, when appropriate.


Income Statement - Margin model

Summarized margin- Overview

(A 1) Risk adjustment

(A 2) Residual Margin

Underwriting Margin

(B) Losses on initial recognition

(C) Experience adjustment

(D) Changes in estimates

(E) Interest on insurance liability

(F) Investment income

Profit

Change in estimates flow through

income statement

Premium and claims are deposit

accounted

Investment income included in

income statement

Premiums, claims and expenses

can still be shown in the income

statement

IFRS 4 Phase II


IFRS 4 Phase II:-More than accounting impact

Anticipation of changes to product features due

to changes in profit signatures, regulatory capital

Significant changes to financial statement

presentation and disclosures; new processes

and controls

Alignment of financial and management

reporting metrics and processes

Training and communication

Profound impact on processes, data and

systems. The impact on closing processes

and reporting

Restructuring of the technology landscape is

expected to be complex and costly.

Process and controls

PM, MI, KPIs

Systems and data

People

Governance and

organisation

Policies

A number of key areas need to be considered

IFRS 4 Phase II


Insurance contracts Unearned Premium Reserve

(UPR)– at cost

Insurance contracts res./compos.

•margin deferred profit – at cost

Insurance contracts BE+risk margin

•at fair value (through P&L)

4. Hedge accounting (P&L or OCI) as variation to fair value option

3. Amortised cost (debt securities)

2. Fair value in OCI (equity securities)

1. Fair value through P&L

?

?

?

LiabilitiesAssets

How do you prevent the accounting mismatch?

IFRS 4 phase II versus IFRS 9

IFRS 4 Phase II


Business Implications

Insurers may see greater discipline in their pricing processes as a result of the new

model.

To reduce volatility in reported results - Insurers may consider changes to their

current product offerings, moving out of longer term products with embedded

guarantee towards products in which more investment risk is borne by policyholders.

Insurers may enter into outsourcing arrangements, restructure sales compensation

arrangements with their employees and buy more reinsurance to mitigate the impact

of proposed changes to the recognition of acquisition costs.

Phase II will place significant demands on skilled actuarial and finance resources.

Gaps are likely to be addressed by hiring additional resources, outsourcing to third

parties, training and redeploying skilled resource to focus on Phase II.


Challenges for insurers

Clarity and implementation guidance required from Institute of Actuaries, IRDA and

ICAI on the proposed changes

Resolution of the key issues and concerns raised

Significant systemic changes & dearth of trained resources

No field testing available to validate the practical results of implementation

Timing of the standard and effective dates not clear

Preparing two set of books for financial reporting & regulatory reporting

Divergence on certain issues between IASB and FASB to be addressed

Necessary changes in Tax laws, IRDA Act, SEBI Act, RBI Act and other regulations


Questions or Comments

E mail id: [email protected]

concepts of ifrs 4 insurance contracts & implementation ... bathwal.pdf · copyright birla sun...

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