the world bank the advanced program in accounting and auditing regulation a new era of prudential...
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The World Bank The Advanced Program in Accounting and Auditing RegulationA new era of prudential rules and financial reporting for insurance
Catherine Guttmann
16 May 2006
2GDNL Program –Module 25 (2) © 2006 Deloitte
Outline of presentation
• In line with IAIS work, new risk-based solvency requirements (Solvency II) are
underway at the EU level
• Complete, prudent, relevant, common accounting principles as a pre
requisite for assessing insurer’s capital requirements and enhancing the
ability of insurers to call for capital
• What are the main features of IFRS for insurance companies (as of today,
Phase I)
• IFRS 4 – Phase II – A common valuation of insurance liabilities for accounting
and solvency purposes ?
3GDNL Program –Module 25 (2) © 2006 Deloitte
In line with IAIS work, new risk-based solvency requirements (Solvency II) are underway at the EU level
• Solvency II as a consequence of insufficient efficiency of Solvency I 85 insurance companies have been under regulator’s close scrutiny, in the last five
years in Europe, because of capital inadequacy under Solvency I, of which 20 have ultimately disappeared :– Administrative sanction
– bankrupcy
Main Reasons : Inadequacy of the pricing of the contracts Under estimate of insurance liabilities, including embedded options granted to policy
holders Inadequate asset/liability management
– Duration
– Liquidity
– …
Inadequate reinsurance coverage linked with insufficient insurance risk diversification Inadequate corporate governance and internal control
4GDNL Program –Module 25 (2) © 2006 Deloitte
In line with IAIS work, new risk-based solvency requirements (Solvency II) are underway at the EU level
• Solvency II as a convergence between insurance and banking sector More and more similar products
e.g. : Catastroph bond versus insurance contract Saving contracts Climatic derivatives
In line with IAIS thinking : more prospective assessment and control of the risks :
Insurance Financial Operational …
both on management and supervisor’s side
5GDNL Program –Module 25 (2) © 2006 Deloitte
Fev 2007 : Final Directive
Jui 2007 : Adoption
2008 : Elaboration of detailled implementation guidances
2009-2010 : Transposition of the directive by each Member State
2010 : Application Solvency II
Removal of 19 Directives EU in existence
In line with IAIS work, new risk-based solvency requirements (Solvency II) are underway at the EU level – The Calendar
May 01 jan 03 jun 04 dec 04 may 05 apr 06 oct 06 dec 06 feb 07 jun 2007 2008 2009 2010May 01 jan 03 jun 04 dec 04 may 05 apr 06 oct 06 dec 06 feb 07 jun 2007 2008 2009 2010
• Inventory on Solvency I
• Assessment of the relevance / adaptation of banking rules to insurance
•Considerations into the form of a future system of prudential control
•Study leads by european insurance supervisors on Solvency I and recommendations on the Solvency II project
Project of Directive proposed for adoption
Preparatory works
19991999
Phase I Phase II
Project of Directive Directive Solvency II
June 2004 : 1st wave of calls for advice (Pillar II)
Dec. 2004 : 2nd wave of calls for advice (Pillar I)
May 2005 : 3rd wave of calls for advice (Pillar III)
June 2005 : Amended Framework for consultation
Sept 2005 : 1st quantitative impact study (QIS 1)
April 2006 : 2nd quantitative impact study (QIS 2)
Oct 2006 : 1st draft of Directive
Dec 2006 : 2nd draft of Directive
6GDNL Program –Module 25 (2) © 2006 Deloitte
In line with IAIS work, new risk-based solvency requirements (Solvency II) are underway at the EU level
SOLVENCY II
March 06
CEIOPS answer – 3rd wave of calls for advice
Oct 06
1st draft of Directive
July 07 Feb 07
Final Directive Directive proposed for adoption
Results QIS 1
Starting QIS 2 on MCR & SCR)
Feb 06 April 06 Sept 06
Results QIS 2
2rd draft of Directive
Dec 06
Key phases of short term development
7GDNL Program –Module 25 (2) © 2006 Deloitte
In line with IAIS work, new risk-based solvency requirements (Solvency II) are underway at the EU level
3 pillars structure
Capital Adequacy
Value based approach- Solvency Capital Requirement (SCR)- Min. Capital Requirement (MCR)
Insurance Liabilities
Risks linked to the asset more specifically integrated
Capital Adequacy
Value based approach- Solvency Capital Requirement (SCR)- Min. Capital Requirement (MCR)
Insurance Liabilities
Risks linked to the asset more specifically integrated
Supervisory Review
Corporate Governance
Asset/Liability Management
Efficiency of internal control
Investment policy
Reinsurance program
Process of prudential supervision
Supervisory Review
Corporate Governance
Asset/Liability Management
Efficiency of internal control
Investment policy
Reinsurance program
Process of prudential supervision
Market Regulation
Information for public and control
Transparency principle
Information requirements (disclosures)
Financial communication
Market Regulation
Information for public and control
Transparency principle
Information requirements (disclosures)
Financial communication
Pillar IPillar I Pillar IIPillar II Pillar IIIPillar III
Solvency II
8GDNL Program –Module 25 (2) © 2006 Deloitte
• MCR/SCR (CFA n°9, 10, 11, 13, 14)
• 2 levels of solvency requirement : MCR and SCR
Insurance Liabilities
MCRMin. Capital Requirement
SCRSolvency Capital
Requirement
Level 0: Mortality risk
Level 1: floor
Level 2: capital target Surplus
Prudential graduated intervention
Risk considered as unacceptableby policy holders
In line with IAIS work, new risk-based solvency requirements (Solvency II) are underway at the EU level
- Internal models
- Standard approach
9GDNL Program –Module 25 (2) © 2006 Deloitte
Complete, prudent, relevant, common accounting principles as a pre requisite for assessing insurer’s capital requirements and enhancing the ability of insurers to call for capital
• Relevant information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting their past evaluations
Prospective approach
Unlocking of the assumptions
• Completeness : no omission
As far as possible, all items valued in the balance sheet
e.g. : guarantees, options
10GDNL Program –Module 25 (2) © 2006 Deloitte
Complete, prudent, relevant, common accounting principles as a pre requisite for assessing insurer’s capital requirements and enhancing the ability of insurers to call for capital
• Common :
– Same definitions (substance over form)
Definition of financial assets and liabilities
Definition of insurance contract
Definition of financial risk, or insurance risk, ...
– Same accounting rules
Convergence between countries
Convergence between insurance and banking
11GDNL Program –Module 25 (2) © 2006 Deloitte
Complete, prudent, relevant, common accounting principles as a pre requisite for assessing insurer’s capital requirements and enhancing the ability of insurers to call for capital
• Prudent : – Valuations have to contend with the uncertainties
– Those uncertainties are to be recognised and valued
– However, the exercise of prudence doesn’t allow deliberate overstatement of liabilities
No double counting with solvency capital requirement
Conclusion : a prerequisite, a priori, in coherence with IFRS framework
12GDNL Program –Module 25 (2) © 2006 Deloitte
What are the main features of IFRS for insurance companies (as of today, Phase I)
• 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
13GDNL Program –Module 25 (2) © 2006 Deloitte
What are the main features of IFRS for insurance companies (as of today, Phase I)
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 »
14GDNL Program –Module 25 (2) © 2006 Deloitte
What are the main features of IFRS for insurance companies (as of today, Phase I)
Definition of financial and insurance risks
• 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 »
15GDNL Program –Module 25 (2) © 2006 Deloitte
What are the main features of IFRS for insurance companies (as of today, Phase I)
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
16GDNL Program –Module 25 (2) © 2006 Deloitte
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
Consequence : an insurer balance sheet
Major changes with fair value orientation
Local GAAP
17GDNL Program –Module 25 (2) © 2006 Deloitte
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
18GDNL Program –Module 25 (2) © 2006 Deloitte
IFRS 4 – Phase II – A common valuation of insurance liabilities for accounting and solvency purposes ?
• 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
19GDNL Program –Module 25 (2) © 2006 Deloitte
• Approach A – Current Entry Value
Principles : Approach A 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)• A margin for risk and uncertainty• 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
Main issues : valuation approaches under consideration
20GDNL Program –Module 25 (2) © 2006 Deloitte
• Approach B – Current Exit Value (Transfer Value)
Principles : Approach B 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 B :• 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
Main issues : valuation approaches under consideration
21GDNL Program –Module 25 (2) © 2006 Deloitte
Main issues : valuation approaches under consideration
Asset
Approach B – "Business to Business”
Asset
Approach A – "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
22GDNL Program –Module 25 (2) © 2006 Deloitte
• 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), pattern of amortisation• Definition and level of the servicing margin (market reference ?)• Policyholder behaviour ? Surrenders, futur premiums, renewals …•IAS 39 for investment contracts ? 39 to be amended ?•Own credit risk•Discretionary participating features : liability or equity or separate component of equity ?
Main issues : valuation approaches under consideration