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									          Presidents Forum / Insurance Accounting

                IASB Insurance Contracts Phase 2
                       Status and IAA Role

                  November 2009 -- Hyderabad

                         Sam Gutterman

November 2009                                       Page 0
     Background

          International accounting convergence

          Insurance Contracts Phase 2 status

     IAA Role and Activities

November 2009                                     Page 1
International Accounting Convergence
                One single set of high-quality financial reporting standards for
                 companies world-wide
                No surprises with full transparency

          “The whole objective of the International Accounting Standards Board is to boost
           transparency by having one single set of high-quality standards for companies world-
           wide. The real secret for confidence in the markets is: no surprises and full
           transparency—that’s going to mean some pretty uncomfortable standards coming in
           the future.”
          “It’s silly having a different rule in the UK or Australia or the US when we should just
           see who’s got the better rule and let’s do it worldwide.”
                Sir David Tweedie, Chairman IASB

November 2009                                                                                    Page 2
International Accounting Convergence
          IFRS—International Financial Reporting Standards
          Standard setter—International Accounting Standards Board (IASB)
          Founded in 2001. Based in London
                 Replaced the International Accounting Standards Committee (IASC), which previously
                  published financial reporting standards referred to as International Accounting
                  Standards (IAS), used in countries without their own accounting standards setter
                 Impetus came from the G7 after the Asian Financial Crisis in the 1990s
                 Current convergence efforts given further push by the G20 this year
          IASC Foundation’s Trustees have oversight responsibility, with a Standards Advisory
           Council (SAC) that provides advice regarding the IASB agenda
                 The IASB develops IFRS and the International Financial Reporting Interpretations
                  Committee (IFRIC) provides interpretations of IFRS
                 Main functions of IASC Foundation trustees include
                – Appointing IASB members
                – Exercising oversight
                – Raising funds
          Monitoring Board, recently formed, made up of international regulators, provides
           oversight to the IASC Foundation

November 2009                                                                                        Page 3
International Accounting Convergence
                        Standard setting structure
    Monitoring Group
    5 members                              IASC                                       Trustees
                                        Foundation                                Geographical break-down
                                        22 trustees

                                                                                  Europe               8

                                                                                  North America        6

                                               Appoint                            Asia / Oceania       6
                                                                                  Rest of the world    2

                                          IASB                                             Board
              SAC                     Chairman plus
                        Advise                           Interpret   12 members   Geographical break-down
           46 members                  14 members

                                               Create                             Europe               4

                                                                                  North America        5

                                            IFRS                                  Asia / Oceania       4

                            High quality, enforceable and global                  Rest of the world    2

November 2009                                                                                         Page 4
International Accounting Convergence
      More than 100 countries require or permit
          the use of IFRS, or are converting
                                                                                        Top 10 Global Capital Markets

                                                                                        US                US GAAP
                                                                                        Japan             Converting to IFRS

                                                                                        UK                IFRS
                                                                                        France            IFRS
                                                                                        Canada            Converting to IFRS

                                                                                        Germany           IFRS
                                                                                        Hong Kong         IFRS
                                                                                        Spain             IFRS
                                                                                        Switzerland       IFRS or US GAAP

                                                                                        Australia         IFRS

            Countries seeking convergence with the IASB or pursuing adoption of IFRSs

            Countries that require or permit IFRSs

            Countries with no current plans to convert to IFRS

November 2009                                                                                                           Page 5
International Accounting Convergence – SEC Roadmap
    When might the transition to IFRS occur in the US?

            March 2007             August 2007              August 2008              January 2009-2014
            SEC roundtable         SEC concept           Roadmap was issued          Voluntary application of
            on US GAAP             release on use                                    IFRS permitted for
            reconciliation for     of IFRS for US                                    certain US registrants
            IFRS filers            registrants

                2007                2009                    2011                   2013                         2015

                            2008                  2010                  2012                      2014

          July 2007                                                                        January 2014
                                                    December 2007
          SEC proposal                                                                     Proposed roadmap
                                                    SEC roundtable on
          eliminating                                                                      targets potential
                                                    IFRS in the US
          US GAAP           November 2007                                                  mandatory adoption
          reconciliation    Reconciliation                                                 in 2014-2016?
          for IFRS filers   eliminated for IFRS                    During 2011
                            filers                                 SEC will reconvene to
                                                                   decide whether a
                                                                   mandatory conversion
                                                                   date should be set

November 2009                                                                                                          Page 6
Background - IASB and IFRS
Current IFRS 4 – Insurance Contracts
         IFRS 4 in its current form
          Adopted in 2004
          Applies to Insurance Contracts, not Insurance Companies
          Originally designed as an interim solution (2 years)
          Primarily relies on local standards (e.g. US GAAP in the US)
                 A great deal of diversity in practice
          Starting with current local standards
                   Eliminates liabilities for future claims (e.g. catastrophe reserves)
                   Requires a liability adequacy test (type depending on prior or newly adopted test)
                   Measuring liabilities on an undiscounted basis can be continued, but not introduced
                   No netting for reinsurance
                   Can make a subsequent change to entity’s accounting policy as long as it is more
                    reliable and no less relevant, or more relevant and no less reliable

November 2009                                                                                             Page 7
Background - IASB and IFRS
Current IFRS 4 – Insurance Contracts
     Definition of an Insurance Contract (not expected to change in Phase 2)
          “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”

     Insurance risk
          Risk other than financial risk transferred from the holder of the contract to the issuer.
                   Financial risk includes a change in interest rate, security price
                   Lapse, persistency or expense risk not insurance risk in a direct contract
                   Must relate to an uncertain future event that adversely affects the policyholder
                   Must be a pre-existing risk, rather than risk created by a contract (e.g., a gambling contract)
          No requirement for underwriting and timing risk.

     Significant
          Where an insured event could cause an insurer to pay significant additional benefits in any
           scenario, excluding scenarios that lack commercial substance (i.e., have no discernable effect on
           the economics of the transaction), irrespective of the likelihood of such event.
          The “additional benefit” is compared to that which would be paid if the insured event did not occur.

November 2009                                                                                                         Page 8
Background - IASB and IFRS
Current IFRS 4 and IFRS 7 – Insurance Contracts
     General disclosure principles

          Principle 1: Identify and explain significant amounts in financial
                 Accounting policies and significant assumptions
                 Changes in amounts and assumptions

          Principle 2: Help users understand future cash flows
                   Objectives in managing risks and policies for mitigating risks
                   Effect on cash flows of contractual terms and conditions
                   Insurance risks - sensitivity analysis, concentrations, loss development
                   Interest rate and credit risks

     Risk–oriented disclosure requirements

     Sensitivity analysis

November 2009                                                                                  Page 9
Insurance Contracts Phase 2
Insurance Contracts Discussion Paper (2007)
          Current IFRS method used in the accounting for insurance contracts is inconsistent
           across jurisdictions
          Results in too much diversity, less relevance and less reliability
          The IASB started with a clean slate to develop Phase 2
          The FASB agreed to pursue a joint project with IASB (will result in IFRS/US GAAP
           convergence on the financial reporting standard for Insurance Contracts) because of
           overlap with most of their other joint projects

                      Discussion       Comment         Phase 2          Phase 2        Phase 2
       Phase 2
                        Paper           period      Exposure Draft       IFRS            IFRS
      work begun
                      published         ended         published        published       effective
        Jul 04
                        May 07          Nov 07       February 10      June 2011?        2013?

                      FASB IToC
                       Aug 07                         We are here

November 2009                                                                               Page 10
Insurance Contracts Phase 2
Insurance Contracts Discussion Paper (2007)
     IASB Discussion Paper “Preliminary Views on Insurance Contracts”
          Published May 2007
          US Financial Accounting Standard Board (FASB) issued an Invitation to Comment

     Included ideas for financial reporting of insurance contracts:
          Basic model – current exit value
          Reflected policyholder behavior and acquisition expenses
          Other measurement issues
                 Reinsurance
                 Unbundling
                 Guaranteed insurability as the basis for recognizing renewal premiums
          Gain at issue possible, although expected to be small

November 2009                                                                              Page 11
Insurance Contracts Phase 2
Insurance Contracts Discussion Paper (2007)
    Many responses to the insurance contracts discussion paper were received; some

     Respondents expressed general support for:
            A single model for life and non-life
            3 building block approach, but many differences in opinion about each block
            Discount rate should not be asset-based
            Premiums as revenue
            Expensing of acquisition costs
     Were generally against:
            Including own credit characteristics
            Unbundling
            Service margins
            Guaranteed insurability test for future premium recognition
     And had mixed views on:
          Day 1 Profit
          Discounting loss reserves (non-life insurers in US generally against)

November 2009                                                                              Page 12
Insurance Contracts Phase 2
Joint Project of FASB/IASB
     It is expected that the outcome of Phase 2 will become US GAAP irrespective of if
      and when there is overall convergence between US GAAP and IFRS

     FASB joined project in late 2008
          Joint staff project as well

     Single Approach for all life and non-life insurance and reinsurance contracts
          Though a tentative decision by the IASB may lead to a distinction for pre-claims liability
           between short-duration and long-duration contracts (although no definition of distinction
           yet decided)

     Three basic building blocks of measuring liabilities are
          Expected future cash flows
          Time value of money
          Margin

November 2009                                                                                   Page 13
Insurance Contracts Phase 2
Overall Measurement Objectives
    Methods currently being considered for valuing liabilities:
        Fulfillment approach
                 FASB had tentatively agreed to this approach through October 2009
                 Expected present value necessary to fulfill obligations over time
                   – Expected cost based
                 Reasonably consistent with proposed revenue recognition (customer consideration model)
                   – Revenue recognized with performance of service
                 Single margin calibrated to premiums, although in November 2009 included explicit risk margin
          Modified IAS 37 approach (currently being developed, to be re-exposed in
           December, applicable to non-contractual obligations)
                 IASB leaning toward this approach
                 Modifications being made to apply to contracts
                    – No gain at issue
                 Transfer notion as in settlement, yet not fair value
                    – Explicit risk and service margin
                 Through October had initial incremental acquisition expense recognized as revenue
          For short-duration contracts an unearned premium approach
                 IASB agreed to mandate, although may discuss the mandatory nature in December
                 FASB hasn’t discussed yet
                 No separate building blocks
          Staffs currently reexpressing description of objectives

    Current exit value (transfer price as assessed by third party) is no longer being

November 2009                                                                                                     Page 14
Insurance Contracts Phase 2
Building Block 1 – Expected Value of Future Cash Flows
     Determining expected value:
            Identify each possible scenario
            Estimate the cash flows under each scenario
            Make unbiased estimate of probability of each scenario
            Treatment of administrative expenses – here or in margins?
            Expected not to require stochastic modeling

     Open application question for claims liability:
          Will insurers need to develop estimates of each possible scenario by identifying
           individual scenarios, estimating the cash flows for those scenarios, and then weigh
           them together in a probability weighted manner?
          Would current P&C non-life actuarial approaches be suitable for Building Block 1?

November 2009                                                                                    Page 15
Insurance Contracts Phase 2
Building Block 2 – Discount – Time Value of Money
    Discount rates
          Consistent with observable current market prices
          Apply to cash flows whose characteristics match those of insurance liability (not
           matching assets) in terms of:
                 Duration
                 Liquidity
                 Currency
          Discount all liabilities
                 Including claims liability
                 Coverage period
                    – Explicitly for long-duration contracts
                    – Implicitly for short duration contracts through unearned premium approach
          Possible interest rates being considered:
                 Risk free or similar rate
                 IASB considering whether liquidity adjustment appropriate
                   – Waiting for field testing results relating practicality concerns
                 Not insurer’s investment yield rate

November 2009                                                                                     Page 16
Insurance Contracts Phase 2
Building Block 3 - Margins
    Subsequent margin measurement (other than for claims liability)
          Contract fulfillment approach with composite margin
                 Depends on whether composite margin is remeasured
                 If not remeasured
                    – If allowed to be a shock absorber, to what extent deviations in actual experience
                       affect level of composite margin
                    – If not a shock absorber, most likely consistent with release of insurance risk, as that
                       is primary risk driver, but there are other possibilities
                 If remeasured, in a manner similar to risk margin
                    – Requires allocation of risk to each period or
                    – Prospective measurement based on assessment of uncertainty
          Revised IAS 37 model with two or three types of margins
                 Risk margin – consistent with previous slides
                 Service margin – no one quite sure what it is for (possibly administrative cost or markup
                  of internal expenses)
                 Residual margin – same issues as for composite margin above
     Residual margin would be equal to difference between present value of
      premiums and present value of benefits/losses and relevant expenses, less risk
          Key issue for long-duration contracts to the extent different margins (residual, risk and
           composite) released in a different manner

November 2009                                                                                            Page 17
Insurance Contracts Phase 2
Building Block 3 – Risk Margins
    Families of risk margin methods as given in IAA Risk Margins paper:
       Quantile methods
       Cost of capital
       Explicit assumptions (related to specific risk factors)
       Discount rate related
       Implicit

    Examples of approaches in current practice
     Cost of capital method
          Switzerland regulatory: Swiss Solvency Test using 6% cost and regulatory capital
          Solvency II in Europe
                 6% cost on regulatory capital, which is defined at a 99.5% chance of a loss in one year
     Quantile method
          Australian property & casualty claims liability
                 Minimum of 75% CTE
     Explicit method
          Canada, with strict ranges for each risk determined by the actuarial profession,
           accompanied by peer review

November 2009                                                                                               Page 18
Insurance Contracts Phase 2
Other Outstanding Issues
     Recognition of renewal premiums
          The IASB has now bought into recognizing fixed and determinable premiums
          Not yet discussed – flexible premiums, e.g., for universal life insurance
     Contract boundaries
     Treatment of non-guaranteed features
          Policyholder dividends
          Where charges or credits different than those guaranteed
     What is revenue
          All premium, no premium, sometimes premium
     Unbundling
          Especially if a contract has a deposit component
     Minimum cash value floor
          Currently none
     Own credit standing adjustment
     When a contract is recognized
          Made important since no-gain at issue requirement
     Reinsurance issues
     Many related overall IASB projects, including revenue, presentation, liabilities,
      financial instruments, fair values
November 2009                                                                          Page 19
IAA Role
     Insurance Accounting Committee
            Formed as committee of IFAA in 1996
            In response to IASC Insurance Contracts project
            Chair, Sam Gutterman
            Vice Chairs – Francis Ruygt, Paul McCrossan (through 2006), David Congram (from 2005)
     Represented on
            IASC Present Value Steering Committee (Gutterman)
            IASC Insurance Steering Committee (McCrossan)
            IASB Standards Advisory Group (McCrossan 2001-2006, Ruygt from 2009)
            IASB Insurance Working Group (Gutterman)
            IASB Financial Instruments Working Group (Ruygt)
            IAASB Consultative Advisory Group (Gutterman)
            IASB Employee Benefits Working Group (Jim Verlautz, with other actuaries)
     Taken part in
          Four IASB Education Sessions (2006-2008)
          Two FASB Education Sessions (2009)
     Commented on
          Each IASB Insurance Contracts Discussion Papers and Exposure Drafts
          Many other IASB papers and drafts

November 2009                                                                                        Page 20
IAA Activities
     Established general insurance listserve for currently about 315 interested parties
     Research papers
          Two joint research papers with American Council of Life Insurance
          Principle sponsor of IAA ad hoc Risk Margins Working Group Measurement of Insurance
           Liabilities: Current Estimates and Risk Margins (2009)
     Committee meetings
          Extensive meetings in conjunction with each IAA Council meeting
          Several standalone meetings
     Employee benefits – begun meetings and significant effort on a revised IAS 19
     Work with IAIS
          Attended many IAIS Insurance Contracts Subcommittee meeting
          Assisted in their development of several papers and comment letters
     Actuarial standards and education
          Developed 11 International Actuarial Standards of Practice related to Phase 1
                 Has served as educational guidance for actuaries around the world
          Beginning to discuss what guidance is needed to support Phase 2
                 Most likely a combination of International Actuarial Standards of Practice and International Actuarial
          Have almost completed IAA book on Stochastic Modeling
                 In process of discussing what other technical education material should be developed at an
                  international level
     Has served as informal advisor to IASB (and in 2009 FASB) staff on many insurance
      contracts related issues
November 2009                                                                                                         Page 21

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