author and presenter: rahul verma noca cpd …presented by: rahul verma institute and faculty of...

IFRS 17 Insurance ContractsAuthor and presenter: Rahul VermaNoCA CPD EventFriday 16 August 2019

• Methodology selection• Available options• Leveraging existing capabilities• Potential impacts on P&L and balance sheet• Consistency across industry

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Disclaimer

The information included in this pack should not be regarded as comprehensive, advisory, consultative or sufficient for making any decisions, nor should it be used in place of any professional advice.

Any data, charts, figures or worked examples included in this pack have been solely produced by the author as hypothetical examples for the purpose of communicating conceptual knowledge around the material presented in this pack and are not meant to reflect (or belong to) any actual insurance (or any other) company. This includes the hypothetical company name “LG Corp” and product name “For 30 OR 4 Life” - resemblance to any real (past and present) actual products or any firm is coincidental.

All concepts presented in this pack or discussed during the presentation are solely the views of the author on the subject and as such should not be considered advisory or views of any industry body or sector or any particular insurance or other firm.

If you require any further professional advice, explanations, or specific consultation on the subject matter, please contact us and we will be happy to discuss matters further.

Kind regards,

Rahul VermaE: [email protected]: +447581068880

IFRS17 presentation by: Rahul Verma. NoCA CPD event 16th August 2019

LG Corp board of directors

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mailto:[email protected]

Presented by: Rahul VermaInstitute and Faculty of Actuaries CPD EventFriday 16 August 2019Organised by NoCA

Intuitive understanding of what is new under IFRS17

At the point of sale (contract recognition), insurer receives premium and sets up three ‘bank accounts’. 1. Policyholder account – Best estimate reserves (BE) 2. Shareholder account – Contractual Service Margin (CSM) 3. Joint account between Policyholder and Shareholder – Risk Adjustment (RA)

As time goes by three things happen: Each of these accounts ‘earn’ some interest - accretion At the end of every period some money is paid out to the individual “account holders” – run off And – (just in case!) If some ‘original’ estimates used to divide premium across three accounts - prove to be

incorrect, accounts are ‘unlocked’ and money redistributed amongst them to (re)establish fairness.

Best Estimate Reserves (BE)

Risk Adjustment (RA)

CSM

Policyholder account£1446

Joint account - Shareholder and Policyholder

£126

Shareholder account£428


£2000IFRS4

account£1572

P&L£428

IFRS what?

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https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=2ahUKEwip4IH3-IHkAhV0AmMBHdXkBbAQjRx6BAgBEAQ&url=https://clipartpng.com/?1580,padlock-png-clip-art&psig=AOvVaw1WxVY9TZsQ_cqcKqaOOAWa&ust=1565857762915086

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=2ahUKEwip4IH3-IHkAhV0AmMBHdXkBbAQjRx6BAgBEAQ&url=https://clipartpng.com/?1580,padlock-png-clip-art&psig=AOvVaw1WxVY9TZsQ_cqcKqaOOAWa&ust=1565857762915086


Example

LG Corp. Insurance Company Limited

Pension specialist

New product offered – For 30 OR 4 Life For a single premium upfront – insurer pays its policyholder a regular annuity for 30 years OR until death within 30 year period Payments stop if policyholder dies before reaching age x+30 years (where x = age at policy issue) No changes in annuity rate post purchase No surrender benefit Non – profit, non - linked

Investment strategy Invests in a mix of

Corporate bonds Government bonds Illiquid assets (PPP/PFI/Infra etc.) Some long term assets (e.g. ER)

Needs to implement IFRS17Considering options and potential impacts

Company has just issued a ‘For 30 OR Life’ policy to a new customer. Received a premium of £2000 Invested all that money in line with its investment strategy Promised policyholder to pay £100 at the end of each year for next

30 years – provided policyholder is still alive at payment times.


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Example

Projected policyholder best estimate payments and income from the asset portfolio

What happened to “bank

accounts”?

LG Corp board meeting

Part I


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Discounting under IFRS17

In order to split the money – paid by the policyholder – and open three bank accounts required, LG Corp. board needs to estimatethe present value of two things: Present value of expected policyholder payments (BE), and Present value of risk adjustment ‘buffers’ (RA) Put rest of the money in the CSM locked account.

People across industry have been talking about two possible options - Top Down and Bottom Up. Which approach to take – Top Down or Bottom Up? How unique are these options? Are there variations in these options? IFRS17 will put a lock on CSM economics – will discount rate method selection impact release of our profits in future?

IFRS what?

Questions raised at the Board meeting


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Suppose we have estimated two types of economically equivalent yield curves for IFRS17 discounting Bottom Up – using some risk free (e.g. swaps) + Illiquidity premium Top down – using gross redemption yield curve adjusted for IFRS17 Financial Risk Adjustment

“Somehows”?Economically equivalent?

What about profit release??


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OK, I understand. But what

happened to Top Down v Bottom Up

choice?


Consider what happens to bank accounts with a periodic drawdown facility

£

1 2 3

Time (t)

CSM428

accretion

Run off - Service provided

CSM386

A

B

C

Profit release in 3 years = £42


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Impact on profit release pattern of Top Down vs Bottom Up – it may be a matter of shape going “forward” when locked-in

Top down approach in this case results in more optimised release of profits.

This is true even if the time zero balance sheets were ‘equivalent’. Differences may increase in real world.

In Top Down LG Corp. is able to release £10 more in profits by year 3, and £12 more by year 10 as compared to the bottom up approach.

The pattern reverses in later years. There is only so much money to be made, make it sooner or later!

OK, good for our UK division.But what about our business in

Asia?

This is likely to be true mainly for UK/European insurers. In Asian economies, where risk free rates are significantly higher (almost10% in some cases!), most ALM may be done using risk free assets.

Therefore, both approach will likely result similar profit patterns and bottom up might be more suitable in such companies.


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Discount rates

Consistency (or variance!) across the industry in discount rate approach

Possible variance in estimating Financial Risk Adjustment for Top Down approach Illiquidity premium for Bottom Up approach

Leveraging existing systems ALM and SAA systems for Top Down Solvency II MA platform for Bottom Up

Reference portfolios Swaps Gilts Other market standard platforms (iBoxx, Bloomberg) customised references Pricing portfolios Existing portfolio

Simplifications Weighted averages System developments Historical data requirements


BREAK TIME


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Risk Adjustment

What is the purpose?

Remember those bank accounts?

Financial risk is hedged by the asset side. IFRS17 discount rates took care of that. Insurance risk, hmm…not quite the same thing.

OK, this sounds like SII Risk Margin.

Is it?


Part II

Best Estimate Reserves (BE)

Risk Adjustment (RA)

CSM

Policyholder account

Joint account between Shareholder and Policyholder

Shareholder account

To reflect the compensation that the entity requires for bearing the uncertainty in respect of the amount and timing of the cash flows that arise from non-financial risks.


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Risk Adjustment

How can we measure this? Many ways. But three ‘Standard’ methods

1. Value at Risk method

Conditional tail expectation method

Cost of capital method

You actuaries had to bring out maths. My “confidence level”

for IFRS17 was already at risk

£𝑹𝑨𝑽𝒂𝑹 ∅,𝑪𝑳% = ∅ 𝑽𝒂𝑹 𝑪𝑳% , 𝒚 − ∅ 𝝁, 𝒚 ; 𝒔𝒖𝒄𝒉 𝒕𝒉𝒂𝒕

−∞

𝑽𝒂𝑹(𝑪𝑳%

𝒈 𝒚 .𝒅𝒚 = 𝑪𝑳%

£𝑹𝑨𝑪𝑻𝑬 ∅, 𝑪𝑻𝑬% = ∅ 𝑪𝑻𝑬 𝑪𝑳% ,𝒚 − ∅ 𝝁, 𝒚 ; 𝒔𝒖𝒄𝒉 𝒕𝒉𝒂𝒕

1

1 − 𝑪𝑻𝑬

𝑽𝒂𝑹(𝑪𝑻𝑬%

∞

𝒈 𝒚 .𝒅𝒚 = 𝑪𝑻𝑬%

£𝑹𝑨𝑪𝒐𝑪 ∅,𝑪𝐋%,𝑹 = 𝑹 ∗

𝒕≥0

∅𝒕 𝑽𝒂𝑹 𝑪𝑳% ,𝒚 − ∅𝒕 𝝁, 𝒚

1 + 𝒊𝒕𝒕


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Risk Adjustment

Regardless of what method you use – Standard wants you to disclose the confidence level underlying the £Risk Adjustment.

Leveraging Solvency II Internal Model Produce a full distribution of liabilities Make sure only drivers varying in the simulation are those in scope of IFRS17 risk adjustment

Mostly insurance risks and not hedged by asset side Produce a gazillion simulations Plot CDF Read off movement in liability = £Risk Adjustment to get probability of event That’s CL%

Hang on, I know Solvency II Internal Model. This 96% is

one on one year basis. Someone in

Australia got 75% on ultimate basis.

What about that?

100%

50%

0%

£RA = £126

96%

Pr(.)

∆ BE Liab (sim and fitted)IFRS17 presentation by: Rahul Verma. NoCA CPD event 16th August 2019

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Risk Adjustment

Extending the concept to ultimate horizon You can easily use your existing Solvency II simulation infrastructure to estimate any horizon, with some minor

customisation. No need to reinvent the Internal Model. There are three key parameters driving the VaR measure, i.e.

ℙ[.] : Probability measure cl% : Confidence level percentage for reported VaR, and h : time horizon.

Or, in a functional format:V𝑎𝑅 = 𝒇 ℙ[. ], 𝑐𝑙%, ℎ, Ω

You can keep varying the horizon parameter in above equation to any value >=0, to estimate VaR value, which can be inverted to get the entire confidence level surface.

𝑐𝑙(ℎ 𝑦𝑒𝑎𝑟 % = 𝒈−𝟏 £𝑉𝑎𝑅, ℙ[. ], ℎ, ΩOK, but what about our For 30

or 4 Life Product? Can you apply this maths?


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Risk Adjustment

1 year confidence level = 96%30 Year confidence level = 81%

What if we did not have the

luxury of Internal Model?

What about Standard Formula?


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Risk Adjustment

Confidence level of Risk Adjustment – Firms with Solvency II Internal Model in place

What if we don’t have an Internal Model to produce full simulations and only have Standard Formula spreadsheets? Can we estimate this metric somehow?

Does that math still apply? Yes. There may be a way! You may still leverage Solvency II techniques here.

Let us assume that the capital requirement under Standard Formula is calculated based on the premise that underlying risks are normally distributed and 1 year VaR (i.e. SCR) is 99.5%ile level of the loss, and the combined risk impact on BE is assumed to follow a multivariate Gaussian distribution.Given this, we can back solve for confidence levels.

In the presented case of For 30 OR 4 Life:BE of liabilities = £1446

And suppose our Standard Formula tells us thatBE + SCR (for non –hedgeable risks) is of = £1462RA under selected IFRS 17 method is = £126 (remember the bank account?)Then under Solvency II standard formula, the mean of the BE distribution is = £1446, with mean of the change in BE variable = £0Given that SII defines 99.5% as the confidence level. This means that SCR + BEL is sitting about 2.56 standard deviations away from the mean.This implies that the SD of the distribution is approximately = (1462-1446)/2.56 = 6.43Now we have a ∆BE ~ Normally distributed with 𝑵 𝝁 = 𝟎 , 𝝈 = 𝟔. 𝟒𝟑

This means that Risk Adjustment for non-financial risk is = Pr(∆BE<£126m | μ = 0 and 𝝈 =6.43) = c.94%

This gives us the one year confidence level estimate for the calculated Risk Adjustment using the Standard Formula instead, which can be converted to any ultimate duration as explained in the previous slide.

Please someone sayIts LG Corp board meeting

BREAK TIME


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Lets recap and consider potential industry wide variations in IFRS17 implementation

Life insurance is a very diverse market, e.g.• Annuity and protection• Endowments• Protection• Linked and non-linked…..and many more.

IFRS17 discount rates• Top down vs bottom up• Curve vs flat• Illiquidity premiums (how about MA style IP?); Financial risk adjustment using EIOPA,

CDS, credit risk indices. What about Inflation• Investment expense adjustments• Reference portfolio (own, actual, hypothetical, pricing) for TD & BU?• Risk free proxy (Gilts, Swaps, EIOPA)• Mismatch risk adjustments in TD?• Currency difference adjustments• Locked in assumptions? What about weighted averaging.• Point of sale – daily, monthly, quarterly• ……any many more.

IFRS17 risk adjustment• VaR, CoC, T-VaR…something else• Leveraging Solvency II – Internal Model, Standard Formula• What confidence levels to target? How about current IFRS?• One year, h year or some ultimate horizon?• Calculations at cohort level, contract level, UoA level?• What about operational risk (tricky? How about leave it?)• ……any many more.

IFRS17 Agenda for the next LG Corp. Board meeting

Transitions• What’s better higher IFRS Equity or More CSM? What would market analysts think?

LG Corp. seems very profitable, but doesn’t have much equity or the opposite? Too much CSM using Fair Value/Modified Retrospective/Fully Retrospective approaches? Where are we going to get the money to set up “bank accounts”?.....and many more!


TIME UP!AuditorInsurer


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If the reader has any question on the content presented or related to IFRS17 implementation, please contact the author.


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author and presenter: rahul verma noca cpd …presented by: rahul verma institute and faculty of...

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