IAS/IFRSIAS/IFRS

Insurers and IAS / IFRSInsurers and IAS / IFRS

Frank Helsloot (AXA Group Belgium)Frank Helsloot (AXA Group Belgium)Luxembourg 23 February 2005Luxembourg 23 February 2005

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Table of Contents

IAS - IFRS --> some principles

Classification of Assets and Liabilities ---> some industry related

principlesConclusions

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IAS - IFRSIAS - IFRSSome principlesSome principles

IAS/IFRSIAS/IFRS

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IAS / IFRS

Framework

IAS (International Accounting Standard)

SIC (Standard Interpretations Committee)

IFRS (International Financial Reporting Standard)

– Standard

– Implementation Guidance

– Basis for Conclusions

Exposure Draft (Standard in preparation)

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Some Principles

Accounting (recognition and derecognition)• economic reality prevails legal reality• activity based instead of industry based• component approach• asset / liability approach instead of deferral and matching

Presentation• in / out balance• cash flow statement• Statement of changes in equity

Measurement• amortised cost• fair value

Disclosures• detailed information• management information

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Classification of Assets and Liabilities Classification of Assets and Liabilities Some Industry Related PrinciplesSome Industry Related Principles

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ConferenceConference Classification of assets and liabilities

Financial Instruments (IAS 39 - IAS 32)– Measurement categories– Amortised Cost and Fair Value– Impairment – Embedded derivatives– Hedges– Trade date versus settlement date

Real Estate (IAS 40 and IAS 16) Insurance

– Insurance contract – Discretionary participation– IAS 39 <---> IFRS 4

Comparison Local GAAP and IFRS: Impact P/L and Phase 1 and 2 Insurance contracts

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ConferenceConference Classification of assets and liabilities

Financial Instruments (IAS 39 - IAS 32)– Measurement categories – Amortised Cost and Fair Value– Impairment – Embedded derivatives– Hedges– Trade date versus settlement date

Real Estate (IAS 40 and IAS 16) Insurance

– Insurance contract – Discretionary participation– IAS 39 <---> IFRS 4

Comparison Local GAAP and IFRS: Impact P/L and Phase 1 and 2 Insurance contracts

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ConferenceConference Financial Instruments: Measurement Categories

• Strict use of HTM• Limited use of FV designated (under discussion)• Derivatives and embedded derivatives are at trading

Portfolio Assets Measurement Differences FV toTrading Fair Value P/LHeld to maturity Amortised Cost -Loans originated Amortised Cost -Available for sale Fair Value EquityTrading designated Fair Value P/L

Portfolio Liabilities Measurement Differences FV toTrading Fair Value P/LAmortised Cost Amortised Cost -Trading designated Fair Value P/L

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ConferenceConference Financial Instruments: Measurement Rules

Amortised Cost: (assets and liabilities)– Add all fees and points paid or received between parties to the

contract that are an integral part of the effective interest rate (IAS 18), transaction costs and other premiums or discounts

----> Cash flow schema----> Internal administrative costs are excluded

– Calculate the Effective Interest Rate: rate that discounts the estimated future cash payments or receipts through the expected life of the financial instrument

– Carrying amount based on Effective Interest Rate– Contractual book value (cash flow based)– Changes in applications needed (IT budget!)

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ConferenceConference Measurement Rules:Amortised Cost: simpl.example

Investment or deposit: 3 year 10.000 EUR Payment of Fee: 100 EUR (front end)Rate 5%

Cash Flows Capital Interest Fee TotalYear 0: 10000 -100 9900Year 1: -500 -500Year 2: -500 -500Year 3: -10000 -500 -10500

Effective Yield: 5,36976%

IAS Book value

Liability (start)

Effective Yield

Cost (effective

yield)

Interest Payment

FeeBook value

Liability (end)

Year 0: 9900,00Year 1: 9900,00 5,37% -531,61 -500,00 -31,61 9931,61Year 2: 9931,61 5,37% -533,30 -500,00 -33,30 9964,91Year 3: 9964,91 5,37% -535,09 -500,00 -35,09 0,00

10000,00 -100,00

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ConferenceConference Financial Instruments: Measurement Rules

Fair Value: (assets and liabilities)– incorporate all embedded derivatives in the product (mortgages:

cap and floor, prepayment option,….)– changes in fair value are reported in either P/L (volatility!!) or

Equity (depends on portfolio) – deferred acquisition cost not recognised (immediately in P/L)– fair value can not be lower than amount payable on demand) – when there is no market: fair value will largely equate to a mark-

to-model system– measurement is contract by contract– either accounting or disclosures– changes in applications needed (IT budget!)

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ConferenceConference Financial Instruments: Measurement Rules

Impairment

Type of financial asset Basis for Impairment P/L charge reversibleAmortised Cost Recoverable amount Yes

Available for sale Equity securities Market amount No Debt securities Recoverable amount Yes

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ConferenceConference Financial Instruments: Derivatives

Definition of a derivative: 3 characteristics:– its value changes in response to the change in a specified ‘underlying’

• interest rate• security price• foreign exchange rate• index of prices or rates• credit rating

– it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors

– it is settled at a future date

Can be contained explicit (guaranteed interest rate) or even implicit (prepayment option) in a contract: ---> embedded derivative

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ConferenceConference Financial Instruments: Embedded derivatives

Identification of embedded derivatives in – Assets:

• Financial instruments IAS 39

– Liabilities:• Insurance investments IAS 39• Insurance contracts

Test for separation – no separation

• if feature does not meet the definition of derivative• if host at fair value (trading or trading designated)• if closely related • feature meets definition of insurance contract

Measurement at Fair value

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Financial Instruments: Hedges

Fair-value hedges Cash-flow hedges Hedges of a Net Investment in a Foreign

Operation Portfolio hedge of interest rate risk Hedge Disclosures Effectiveness test Alternative: ? Use of ‘Fair Value through P/L

designated’ portfolio

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ConferenceConference Financial Instruments: Trade date versus Settlement date

Assets: Trade date or Settlement date accounting– no difference on impact on P/L by purchases– difference on impact on P/L by sale (immediate

recognition of P/L by trade date)– trade date will increase assets

Liabilities: Settlement date

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ConferenceConference Classification of assets and liabilities

Financial Instruments (IAS 39 - IAS 32)– Measurement categories – Amortised Cost and Fair Value– Impairment – Embedded derivatives– Hedges– Trade date versus settlement date

Real Estate (IAS 40 and IAS 16) Insurance

– Insurance contract – Discretionary participation– IAS 39 <---> IFRS 4

Comparison Local GAAP and IFRS: Impact P/L and Phase 1 and 2 Insurance contracts

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Real Estate

IAS 40: Investment property– Either Cost or Fair Value for all investment property

• Cost depreciation based on its useful life (IAS 16): – split of the property in separate items – residual value

• Fair Value: volatility ?• Impact on P/L

IAS 16: Property, Plant and Equipment– Cost model (benchmark) or Revaluation model

(alternative treatment, positive valuation = equity)– When an item is revaluated: entire class should be

revaluated

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ConferenceConference Classification of assets and liabilities

Financial Instruments (IAS 39 - IAS 32)– Measurement categories – Amortised Cost and Fair Value– Impairment – Embedded derivatives– Hedges– Trade date versus settlement date

Real Estate (IAS 40 and IAS 16) Insurance

– Insurance contract – Discretionary participation– IAS 39 <---> IFRS 4

Comparison Local GAAP and IFRS: Impact P/L and Phase 1 and 2 Insurance contracts

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Insurance Contracts

Definitions:– Insurance contract:

• A contract under which one party (the insurer) accepts significant insurance risk (other than financial risk from another party) (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (whether an insured event will occur, when it will occur or how much the insures will need to pay if it occurs) (the insured event) adversely affects the policyholder.

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Insurance ContractsDefinitions:

– Discretionary participation: • A contractual right to receive, as a supplement to guaranteed

benefits, additional benefits:– (a) that are likely to be a significant portion of the total contractual benefits;

– (b) whose amount or timing is contractually at the discretion of the issuer; and

– (c) that are contractually based on:

• (i) the performance of a specified pool of contracts or a specified type of contract;

• (ii) realised and/or unrealised investment returns on a specified pool of assets held by the issuer; or

• (iii) the profit or loss of the company, fund or other entity that issues the contract.

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Insurance Risk

Investment Contract Insurance Contract

Discretionary Participation

IFRS 4

IFRS 4

IFRS 4

IAS 32

IAS 39

IAS 32

Measurement / Accounting

Disclosures / Presentation

Yes

Yes

No

No

Insurance Contracts

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Insurance Contracts

Phase 1:– Investments:

• See IAS 39 - IAS 32: Financial Instruments– Amortised Cost– Fair Value

– Insurance contracts: • Phase 1: Local GAAP• Embedded derivatives (IAS 39)

Phase 2: 2007?

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ConferenceConference Classification of assets and liabilities

Financial Instruments (IAS 39 - IAS 32)– Measurement categories – Amortised Cost and Fair Value– Impairment – Embedded derivatives– Hedges– Trade date versus settlement date

Real Estate (IAS 40 and IAS 16) Insurance

– Insurance contract – Discretionary participation– IAS 39 <---> IFRS 4

Comparison Local GAAP and IFRS: Impact P/L and Phase 1 and 2 Insurance contracts

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ConferenceConference Comparison Local GAAP versus IAS

(simplified) Assets

Local IAS Changes in FV

Trading and (emb) derivatives Fair Value Trading P/LCost (hedging) Trading P/L

Trading P/LTreasury

Premium/discount

AFS EquityFair Value P/L

Investments HTM (debt / equity based) AFS Equity

Fair Value P/L

Loans Cost Loans and receivables

Fair Value P/L

Real estate (IAS 40) Cost CostFair Value P/L

Premium/discount

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ConferenceConference Comparison Local GAAP versus IAS(simplified)

LiabilitiesLocal IAS Changes in FV

Trading and (emb) derivatives Fair Value Trading P/LCost (hedging) Trading P/L

Deposits Cost Amortised CostFair Value P/L

Investment Contracts Reserve Phase 1: Fair Value P/L (Insurance IAS 39) Phase 1: Amortised Cost

Insurance Contracts (Life) Reserve Phase 1: Local GAAPPhase 2: FV ? P/L ?

Insurance Contracts (Non Life) Reserve Phase 1: Local GAAPPhase 2: FV ? P/L ?

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ConclusionsConclusions

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Conclusions

How to manage classification of assets and liabilities on Opening Balance IFRS ?– Define strategy about volatility in P/L and in Equity– Use of ‘Fair Value designated through P/L’ (under

discussion)– Use of hedge accounting (under discussion)

How to manage P/L and Equity under IFRS?– Phase 1– Phase 1 2

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Thank you for your attention