IFRS4 Insurance Contracts Phase I by vow15418


									IFRS4 Insurance Contracts
Phase I

Topical Actuarial Issues, 1.4.2004, Prague

Jiří Fialka
   Reasons for issuing the standard
   Approach
   Difficulties
   Scope of IFRS4
   Solutions for Phase I
   Changes from ED5 to IFRS4
   Outlook
Reasons for issuing the standard

 No IFRS on insurance contracts

 Diverse current practices

 IFRS intended to form EU accounting basis
  from 2005
Fair value approach proposed in DSOP, but

because „not feasible for the IASB to complete
  its insurance project .. in 2005“

IASB decided to

 Make limited improvements to accounting
 without requiring major changes that may
  need to be reversed, and
 require detailed disclosure.
Difficulties – What is fair value?
 No observable market evidence about fair
  value of insurance liabilities

 Existing practices contradictory to other IFRS
  standards and even framework

 To get „calculated fair value“, number of
  theoretical and implementational issues need
  to be resolved
   Market value margins, Embedded derivatives,
    Market/Entity specific data
Difficulties – Who is against fair

Powerful lobby against the new standard
 „North American Insurers“
   But Canadian and Mexican insurers did not join
    the initiative
   Is US GAAP the accumulated wisdom?

 European insurers
 Japanese insurers
   Number of them might be virtually insolvent, if
    realistic valuation introduced
Difficulties – IFRS4/IAS39 mismatch
 Most commentators criticised the
  inconsistencies between the measurement of
  assets (IAS39) and liabilities (existing
  insurance accounting) – mismatch

 Various solutions considered
     Relax tainting rules on HTM assets
     Create new asset category
     Adjust measurement of liabilities
     Shadow accounting
Scope of IFRS4
IFRS4 is applicable to:
   Issued (re)insurance contracts and held
    reinsurance contracts
   Issued financial instruments with a discretionary
    participation feature (!)

IFRS4 is not applicable to:
   Product warranties issued directly by a
    manufacturer, dealer or retailer
   Direct insurance contracts that the entity holds
    (policyholder accounting)
Scope – definition of insurance

“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 or other beneficiary if a
  specified uncertain event (the insured event)
  adversely affects the policyholder or other
Solutions for Phase I
 To classify products as insurance or
 To use current accounting practice for
  insurance contracts
 To eliminate extreme features contradicting
 To allow some improvements
 To prevent divergence from framework
 To introduce Liability adequacy test
 To require disclosure
Solutions: To classify products as
insurance or investment
3 groups of products:
   Insurance products – subject to IFRS4
   Investment contracts with discretionary
    participating features – subject to IFRS4, subject
    to minimum calculated by IAS39
   Other investment contracts – subject to IAS39
   IAS39 Demand Deposit Floor, limited DAC
Discretionary participating features (DPF)
   Contractual right to receive additional payments
      Likely to be significant portion of total payments,
      Amount or timing at the discretion of the insurer, and
      Based on performance of the company (assets return or
       other criteria)
Solutions: To use current accounting
practice for insurance contracts

 What are current accounting practices?

 Local or consolidation?

 Could different accounting policies be

 Are all CEE practices compliant?
Solutions: To eliminate extreme
features contradicting framework

 Catastrophe and equalization provisions are
  not liabilities

 If currently recognized liabilities are not
  adequate, additional liability should be
  provided for

 No offset of insurance liabilities and
  reinsurance assets
Solutions: To allow some
 Accounting policies for insurance contracts
  may be changed if, and only if, the change
  makes the financial statements more
  relevant and reliable, judged by the criteria
  in IAS 8
 The change need not be sufficient to achieve
  full compliance with all those criteria
 When changes in the accounting policies for
  insurance liabilities are made, some or all
  financial assets may be reclassified into the
  category measured at fair value with all
  movements in the profit and loss account
Solutions: To prevent divergence
from framework
An insurer may continue to apply, but not
 change to:
   Non-discounting insurance liabilities
   Do not introduce additional prudence in insurance
   Including future investment margins in insurance
   Measuring contractual rights to future investment
    management fees
   Using non-uniform accounting policies for the
    insurance liabilities and related DAC of
   Recognition of future investment margins
Solutions: To introduce Liability
adequacy test

 If there is an existing liability adequacy test
  using current estimates of future cash flows,
  resulting in the recognition of any potential
  inadequacy, IFRS4 does not impose further

 If no LAT required, IAS37 should be used
Solutions: To require disclosure 1
Explanation of reported amounts
   Accounting policies
   Material amounts of assets, liabilities, income and
   Process used to determine significant assumptions
    and, when practicable, quantified disclosure of
   Effects of changes in assumptions, showing
    separately effect of each change with material
    effect on financial statements
   Changes in insurance liabilities, reinsurance assets
    and DAC
Solutions: To require disclosure 2
Amount, timing and uncertainty of cash flows
   Objectives in managing risks and its policies to
    mitigate risk
   Terms and conditions of insurance contracts which
    have a significant impact on cash flows
   Information about insurance risk including
    sensitivity to key variables, concentrations of
    insurance risk, details of actual claims compared
    with previous estimates (10 year maximum)
   Information about interest risk and credit risk
   Sensitivity of embedded derivatives to interest
    risk and credit risk
Changes from ED5 to IFRS4
 Clarified definition
 Permission to remeasure some insurance
  liabilities for changes in interest rates
 Exemptions
 Liability adequacy test
 Changes in accounting policies
 Reinsurance accounting
 Disclosure
 Discussed solutions of AL mismatch
Changes from ED5 to IFRS4 -
Clarified definition
 Improved wording on the definition of
  significant insurance risk
   Plausible scenario  Scenario with commercial
   Trivial  Insignificant
 Surrender charges waived on death not
  sufficient for insurance product classification
 Pure endowment is insurance, unless risk
  transfer is insignificant, portfolio approach
 Investment contracts with DPF – closer
  treatment to insurance contracts than in ED5
Changes from ED5 to IFRS4 - Permission
to remeasure some insurance liabilities
for changes in interest rates

 Permitted but not required

 Might be applied to some liabilities, but not to
  all similar liabilities as IAS8 would otherwise

 Assumed use of simplified models that give
  reasonable effect of interest rate changes
Changes from ED5 to IFRS4 -

 Exemptions confirmed, which resulted in
  some board members dissenting from IFRS4

 Deleted sunset clause that would have made
  the exemption expire in 2007

 New exemption allowing different accounting
  policy for some insurance liabilities
Changes from ED5 to IFRS4 -
Liability adequacy test

 ALL contractual cash flows should be
  considered (incl. expenses and cash flow
  from embedded options and guarantees)

 Premature to specify how to treat embedded
  options and guarantees
Changes from ED5 to IFRS4 -
Changes in accounting policies
 More general approach replaced strict
  individual rules – guidance, what is more,
  and what is less relevant and reliable
 Changed wording to excessive prudence
  paragraph: do not introduce additional
 Rebuttable presumption that introducing
  future investment margins will result in less
  relevant and reliable financial statements
Changes from ED5 to IFRS4 -
Reinsurance accounting
 Restriction of the profit or loss recognised at
  inception of the reinsurance contract was

 Instead, requirement for cedant to disclose
  extent to which profit or loss include gains
  that arose at inception of reinsurance
Changes from ED5 to IFRS4 -
 Insurer has to make judgement calls on
  emphasis and aggregation

 Insurer should disclose a sensitivity analysis
  for all variables that have material effect,
  including observable market prices and rates

 Disclosure includes material changes in
  insurance liabilities, reinsurance assets and
  DAC … as reconciliation
Changes from ED5 to IFRS4 -
Discussed solutions of AL mismatch
 Shadow accounting
   Recognised but unrealised gain or loss on asset
    may affect the measurement of insurance
    liabilities in the same way that a realised gain or
    loss does … through equity
 Permission to remeasure some insurance
  liabilities for changes in interest rates
 Rejected assets solutions
   Relaxing tainting rules for Held-to-maturity
   Creating new category of „Assets Held to Back
    Insurance Liabilities“
Outlook - Timetable

                                 ED for                                                    Fair value disclosures
                                phase 2?

                        IAS                                                   First IAS
           ED for       balance                           Interim             financial
           phase 1      sheet                             reporting?          statements                            Phase II?

31/12/02             31/12/03                 31/12/04                  31/12/05                  31/12/06           31/12/07

                          Period covered in first   Period covered in first
                              IAS financial             IAS financial
                               statements                statements

                                                                                                          SUNSET CLAUSE
Outlook – Phase II
Board decisions November 2003
    Phase II should be a high priority project
    On restarting the Board should return to a study of the basics
    Round discussions and field visits should be conducted during
     exposure draft phase
    Specialised task forces should be established to assist staff
    Insurance Advisory Committee should be retained as forum for
     staff to discuss higher-level issues and as convenient means of
     obtaining feedback on progress
    Working group of staff experts from national standard setters
     should assist staff
    Selected industry participants should make presentations to Board
     on problematic issues
    Project should restart in May 2004
    Board should aim to complete exposure draft by June 2005
    Board should encourage “non insurance” parties to become more
     actively involved

 How would IFRS4 influence CEE insurance

 Only accounting rules, or change in the
  business management?

Thank you for your attention!

Contact: jfialka@kpmg.cz

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