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IFRS for Insurance Contracts IFRS Society of Actuaries

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IFRS for Insurance Contracts IFRS Society of Actuaries Powered By Docstoc
					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
                      IFRS 4, Insurance Contracts
                      Mark Freedman
                      Ernst & Young
                      August 31 – September 1, 2009
                      Society of Actuaries GAAP Seminar




Agenda


Background
Product classification
Insurance contract measurement




                                                          Page 2
IFRS guidance for an insurance company balance sheet


        Investments:
          Equities,
                                          Equity              Various
       fixed interest,   IAS 39
                                          Insurance
            loans
                                       liabilities and
         Property        IAS 40
                                         investment           IFRS 4
                                       contracts with
                                       discretionary
        Investment
       contract DAC      IAS 18         participation
                                           features

                                         Investment
      Insurance DAC      IFRS 4             Insurance
                                           contract
                                        Liabilities – Phase   IAS 39
                                                  I
           PVIF          IFRS 4           liabilities

       Other assets      Various      Other liabilities       Various


                                                                        Page 3




Phased approach for insurance


There is a phased approach to insurance contracts.


                                   Phase I – Implemented 2005

           IFRS
        INSURANCE
         PROJECT

                                   Phase II –
                                   Uniform, likely new, insurance
                                   measurement standard




                                                                        Page 4
Exemption from IAS 8


Absent a specific relevant standard, reporting entities look to IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors for
guidance on adopting accounting policies.

IFRS 4 exempts insurance and investment contracts with
discretionary participation features, but not other investment
contracts, from IAS 8, effectively allowing insurers to continue existing
accounting policies, with certain limitations and modifications.

Insurers are also given relief from the strict requirements of IAS 8 if
they 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 reliable
but not less relevant than the current policy.


                                                                                                      Page 5




Key requirements under IFRS 4
Changes in IFRS 4 accounting policies

  An insurer may change its accounting policies for insurance contracts if, and only if, the
  change makes the financial statements:

  ► more relevant and no less reliable, or
  ► more reliable and no less relevant

  An insurer shall judge relevance and reliability by the criteria in IAS 8.
  ► Relevance – economic decision-making needs of users
  ► Reliability
      ►   represent faithfully the financial positions, financial performance and cash flows of the
          entity
      ►   reflect the economic substance of transactions, other events and conditions, and not
          merely the legal form
      ►   are neutral, ie free from bias
      ►   are prudent; and
      ►   are complete in all material respect




                                                                                                      Page 6
Agenda


Background
Product classification
Insurance contract measurement




                                                                        Page 7




Product classification - Why is it important?


   Product Classification defines accounting treatment


                          Discretionary Participation
 Phase I                     Investment contracts
                                                        Investment contracts
  Insurance contracts
                                   Existing
                                   Existing
                                 Accounting*
                                 Accounting*            Amortised Cost
                                                        Amortised Cost
      Existing
       Existing
     Accounting*
     Accounting*                                             -or-
                                                              -or-
                                                         Fair Value**
                                                         Fair Value**
  *Subject to certain modifications      **Possibly with separate accounting
                                         for service component


                                                                        Page 8
Classification flowchart



                                                        Are any elements of                                Product is an Investment
                            Classified as an
                                                  the benefit driven by discretionary        Yes          Contract with discretionary
                          investment contract
                                                             participation                                   participation features



                                                                                        No

                                  No                     Deposit component                              Product is an Investment
                                                                                                      Contract without discretionary
                                                                                                          participation features
                                                     Insurance and deposit
   Is there significant                         components of contract must, if
 insurance risk present                          not recognised, be unbundled
     in the contract?                                and valued separately


                                                                                              Insurance
                                 Yes                                                         component
                                                                 Yes



                                                                 Is there a
                               Insurance                deposit component to the                               Product is an
                           features present     contract? If so, is the deposit component      No           Insurance Contract
                              in contract             independent of the insurance
                                                               cash flows?




                                                                                                                             Page 9




Definition of insurance


   “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.




                                                                                                                             Page 10
Insurance versus financial risk


►   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.
►   Insurance risk is risk, other than financial risk, transferred from the
    holder 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


                                                                                Page 11




Significant insurance risk


    ►   ‘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




                                                                                Page 12
Significant insurance risk


►   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 have
        additional 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




                                                                                Page 13




Quantitative measures


►   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 the
        survival 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 more
        than x% (pure endowment, life contingent annuity)
    ►   The ultimate result on reinsurance may exceed x% of premium earned by
        reinsurer.




                                                                                Page 14
Examples of significant insurance risks

                   Insured Event Occurrence and Cost                             Significant Insurance Risk?
 Significant additional benefits payable under insured event                                YES


 Costly and feasible event in scenario of commercial substance                              YES
 even if it is extremely unlikely

 Waiver on death of surrender charges                                                       NO


 Loss of ability to charge for future services                                              NO

 Unfeasible event in any scenario of commercial substance                                   NO


 Contingent amount to be paid is insignificant in all scenarios of                          NO
 commercial substance




                                                                                                           Page 15




Comparison to US GAAP


    US GAAP classification                                                  IFRS classification

   SFAS 60, SFAS 97 Limited
   SFAS 60, SFAS 97 Limited                                                          Insurance
                                                                                     Insurance
      Payment, SFAS 120
      Payment, SFAS 120



      SFAS 97 Universal Life
      SFAS 97 Universal Life                                                  Generally Insurance
                                                                              Generally Insurance



 SFAS 91, SFAS 97 Investment                                                Insurance or Investment
                                                                            Insurance or Investment
 SFAS 91, SFAS 97 Investment                                         (depending on significance of insurance risk)
                                                                     (depending on significance of insurance risk)




                                                                                                           Page 16
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




                                                                              Page 17




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% value
      of 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 the
      issuer’s losses
  ►   Financial guarantees linked to credit index




                                                                              Page 18
Examples of insurance and financial risks


Classification unclear
► Pensions with return of premiums on death
► Property/casualty with experience payments/rating mechanisms
► Experience-rated group business, with premium deficit recoverable
   or significant premium stabilization reserve
► Waiver of surrender charge on death
► Products with rider options




                                                                                   Page 19




Change in level of insurance risk


►   Once insurance, always insurance, but can go from investment to
    insurance
►   Investment may change to insurance through:
    ►  Switch between funds, first fund has no insurance risk – second fund has insurance
       risk
   ► Take up of option to increase insurance risk
IFRS 4.Appendix B.29-30




        INVESTMENT                                         INSURANCE



                                                                                   Page 20
Unbundling

                                                                                        *Likely none in North America

                                                            Are any elements of                                Product is an Investment
                               Classified as an                                                               Contract with discretionary
                                                      the benefit driven by discretionary        Yes
                             investment contract                                                                participation features.*
                                                                 participation



                                                                                            No

                                     No                      Deposit component                                  Product is an Investment
                                                                                                              Contract without discretionary
                                                                                                                  participation features
                                                          Insurance and deposit
      Is there significant
                                                     components of contract must, if
    insurance risk present
                                                      not recognised, be unbundled
        in the contract?
                                                          and valued separately


                                                                                                  Insurance
                                    Yes                                                          component
                                                                     Yes



                                                                    Is there a
                                  Insurance                deposit component to the
                              features present     contract? If so, is the deposit component      No                  Product is an
                                 in contract             independent of the insurance                              Insurance Contract
                                                                  cash flows?




                                                                                                                                   Page 21




When do you unbundle?


Unbundling – seperate presentation and measurement of insurance and investment
component.
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 insurer’s existing accounting policies do not require recognition of the deposit
            component and
     ►      The insurer can independently measure the deposit component from the insurance
            component
►    Unbundling is allowed when the insurer can independently measure the
     deposit component from the insurance component
IFRS 4.10 – 12


Unbundling is intended to require recognition of deposit elements of contracts
that in some accounting regimes were not reflected, such as in some
catastrophic reinsurance arrangements. Given the requirements of US GAAP,
this will have little effect on US insurers.



                                                                                                                                   Page 22
Unbundling examples

Traditional          ►Insurance    cash flows are integrated with deposit cash flows and contract should not
insurance            be unbundled
contracts            ►Where 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, then
                     contract will be unbundled.


Unit-linked          ►Cost of life cover made through charges to fund. Unbundling is complex and
contracts            therefore would not be required
                     ►Where separate risk premium for fixed death benefit, then unbundling required.




Rider                Some riders interact with underlying contract. Some riders do not.
benefits             Rule of thumb:
                     ►If premium is from fund – do not unbundle
                     ►If separate premium – unbundle - really treat as separate contracts
                     ►If the rider benefit is insurance and the underlying contract is insurance, then there is
                     no need to unbundle.



                                                                                                                                    Page 23




Discretionary participation features (DPF)



                                                          Are any elements of                                    Product is an Investment
                             Classified as an
                                                    the benefit driven by discretionary           Yes           Contract with discretionary
                           investment contract
                                                               participation                                       participation features



                                                                                             No

                                   No                       Deposit component                                    Product is an Investment
                                                                                                               Contract without discretionary
                                                                                                                   participation features
                                                         Insurance and deposit
    Is there significant                            components of contract must, if
  insurance risk present                             not recognised, be unbundled
      in the contract?                                   and valued separately


                                                                                                   Insurance
                                  Yes                                                             component
                                                                   Yes



                                                                  Is there a
                                Insurance                deposit component to the
                            features present     contract? If so, is the deposit component        No                   Product is an
                               in contract             independent of the insurance                                 Insurance Contract
                                                                cash flows?




                                                                                                                                    Page 24
Definition of DPF


    ► 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




                                                                                    Page 25




Measurement of DPF


►   Investment contracts with discretionary participation features are
    measured under IFRS 4
►   Investment contracts without discretionary participation features
    are measured under IAS 39
    ►   Investment management services separated and measured under IAS 18
IFRS 4.2




                                                                                    Page 26
Agenda


Background
Product classification
Insurance contract measurement




                                                                            Page 27




Insurance contract measurement


During Phase I, existing accounting policies apply with certain
  modifications
►   Prohibited – certain accounting policies are prohibited as they do not meet
    the IFRS framework
►   Mandated – certain accounting policies must be implemented if they are not
    already in the existing accounting policies
►   Allowed to continue, but not start – certain accounting policies that do not
    meet the IFRS framework can continue, but cannot be implemented.
►   Can be started – certain accounting policies can be introduced.




                                                                            Page 28
Prohibited policies


►   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.




                                                                           Page 29




Mandated policies


►   The following accounting policies are mandated if they are not
    already present
    ►   Liability adequacy testing
    ►   Impairment of reinsurance assets
IFRS 4.14




                                                                           Page 30
Mandated Policies:
Liability adequacy test

►   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 and
        deficiency 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 for
deferred annuities that are insurance contracts under IFRS but
investment contracts under US GAAP to avoid having them fall under
IAS 37.



                                                                              Page 31




Mandated Policies:
Impairment of reinsurance assets

►   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 reversed
IFRS 4.20


This guidance is similar to US GAAP.




                                                                              Page 32
Policies that may continue


►   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




                                                                             Page 33




Policies that may be started


►   The following accounting policies can be started subject to certain
    restrictions
    ►   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 policy which makes
            financial statements more relevant and reliable


An example is the adoption of FAS 60 for the
measurement of liabilities for traditional policies. If FAS
60 is more relevant or more reliable than the existing
accounting policy, then discounting at asset yields is
acceptable.

                                                                             Page 34
Current market interest rates


►   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, as
assets are generally measured at fair value.


                                                                                  Page 35




Shadow accounting


►   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.




                                                                                  Page 36
Insurance contracts with DPF


►   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.



                                                                                Page 37

				
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