ifrs 4 implementation issues workshop - actuaries.org.hk · may cause the contract to be classified...
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IFRS 4 Implementation Issues WorkshopJoint Regional Seminar on Financial Reporting, 22 -30 June 2006
Bruce Moore, FSA, Jonathan Zhao, FSA
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Product Classification
Embedded Derivatives
Insurance Contract Accounting
Investment Contract Liability Measurement
- IAS 39
- IAS 18
Liability Adequacy Testing
Disclosure Requirements
Agenda
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Product Classification
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Product Classification defines accounting treatment
Phase I
Investment contracts
Discretionary Participation Investment
contractsInsurance contracts
*Subject to certain modifications
ExistingAccounting*
ExistingAccounting*
ExistingAccounting*
ExistingAccounting* Amortised Cost
-or-Fair Value
Amortised Cost-or-
Fair Value
Product Classification- Why is it important?
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Classification Flowchart
Is there significantinsurance risk present
in the contract?
Is there adeposit component to the
contract? If so, is the deposit componentindependent of the insurance
cash flows?
Are any elements ofthe benefit driven by discretionary
participation
Insurancefeatures present
in contract
Classified as aninvestment contract
Deposit component
Yes
No
Insurance and depositcomponents of contract must, ifnot recognised, be unbundled
and valued separately
Yes
No
Insurancecomponent
Product is an InvestmentContract without discretionary
participation features
Product is anInsurance Contract
Product is an InvestmentContract with discretionary
participation featuresYes
No
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Insurance Risk
Is there significantinsurance risk present
in the contract?
Is there adeposit component to the
contract? If so, is the deposit componentindependent of the insurance
cash flows?
Insurancefeatures present
in contract
Yes
No Product is anInsurance Contract
Are any elements ofthe benefit driven by discretionary
participation
Classified as aninvestment contract
Deposit componentNo
Insurance and depositcomponents of contract must, ifnot recognised, be unbundled
and valued separately
YesInsurance
component
Product is an InvestmentContract without discretionary
participation features
Product is an InvestmentContract with discretionary
participation featuresYes
No
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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.”
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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 thecase 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.
Insurance versus Financial Risk
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‘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
Possible reinsurance recoveries (these are classified separately)
Significant Insurance Risk
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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 haveadditional benefits
Classification on a contract by contract basis
Contracts entered into simultaneously with the same policyholder are counted as one contract
Products may be classified homogeneously on materiality grounds
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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)
Quantitative Measures
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Testing for SignificantInsurance Risk
Feature Significant
Significant additional benefits payable on insured event
Costly and feasible event in scenario of commercial substance even if it is extremely unlikely
Waiver on death of surrender charges
Loss of ability to charge for future services
Unfeasible event in any scenario
Contingent amount is insignificant in all scenarios of commercial substance
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Term assurance
Life annuity in payment
Whole life contract
Mortgage endowment assurance
Pension pure endowment
Permanent health insurance
Pension endowment assurance return with interest
Yes
Yes
Yes
Yes
Yes
Yes
Probably
Quiz – Traditional products
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Regular premium UL savings contract (101% DB)
Regular premium UL mortgage endowment
Single premium UL bond with return of premium
Single premium UWP Whole Life
Regular premium UWP Pension
Persistency bonuses
Contract with rider benefits
No
Yes
Yes
Yes
No
Possibly
Yes – assuming they are significant
Quiz – Unitised products
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Once insurance, always insurance, but can go from investment to insurance
Investment may change to insurance through:Changes in regulation, law
Switch between funds, first fund has no insurance risk – second fund has insurance risk.
Previously underestimated risks in investment contracts
INVESTMENT INSURANCE
Change in level ofinsurance risk
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SFAS 60, SFAS 97 Limited Payment, SFAS 120
SFAS 97 Universal Life
SFAS 91, SFAS 97 Investment
Insurance
Insurance
Insurance or Investment(depending on significance of insurance
risk)
US GAAP Classification IAS Classification
Comparison to US GAAP
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Unbundling
Is there significantinsurance risk present
in the contract?
Is there adeposit component to the
contract? If so, is the deposit componentindependent of the insurance
cash flows?
Are any elements ofthe benefit driven by discretionary
participation
Insurancefeatures present
in contract
Classified as aninvestment contract
Deposit component
Yes
No
Insurance and depositcomponents of contract must, ifnot recognised, be unbundled
and valued separately
Yes
No
Insurancecomponent
Product is an InvestmentContract without discretionary
participation features
Product is anInsurance Contract
Product is an InvestmentContract with discretionary
participation featuresYes
No
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When do you unbundle?
Unbundling is required when:
The insurer’s existing accounting policies do not require recognition of thedeposit component
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
Consistent treatment of unit-linked products where some contracts have rider benefits
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Discretionary ParticipationFeatures (DPF)
Is there significantinsurance risk present
in the contract?
Is there adeposit component to the
contract? If so, is the deposit componentindependent of the insurance
cash flows?
Are any elements ofthe benefit driven by discretionary
participation
Insurancefeatures present
in contract
Classified as aninvestment contract
Deposit component
Yes
No
Insurance and depositcomponents of contract must, ifnot recognised, be unbundled
and valued separately
Yes
No
Insurancecomponent
Product is an InvestmentContract without discretionary
participation features
Product is anInsurance Contract
Product is an InvestmentContract with discretionary
participation featuresYes
No
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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
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Measurement of DiscretionaryParticipation Features
Investment contracts with discretionary participation features are measured under IFRS 4
Probably subject to IAS 39 in Phase II of the insurance contract project
Investment contracts without discretionary participation features are measured under IAS 39
Service elements may need to be separated and valued under IAS 18
All contracts subject to IAS 32 disclosures
Fair value disclosure will be an issue for contracts with discretionary participation features
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Key learning points
Product classification will affect measurement basis, profit emergence and disclosures
Contracts with significant insurance risk will be insurance
Contracts without significant insurance risk will be investment
Contracts with discretionary participation features are exempt from IAS 39 during Phase I but not from IAS 32 disclosures
Contracts may need to be unbundled, with the deposit features valued under IAS 39
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Embedded Derivatives
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Measurement of embeddedderivatives
Certain embedded derivatives have to be separated from insurance contracts, investment contracts with DPF and investment contracts without DPF measured at amortised cost
If separated, measured under IAS 39:
Fair value
Changes in fair value through profit and loss
Similar to US GAAP requirements
Settled rather than net settled
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Embedded derivativeflowchart
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Value changes in response to the change in 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 (underlying).
No initial investment or initial investment is lower than required for another contracts that behaves similarly.
It is settled at a future date.
Definition of a derivative
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Economic characteristics of derivative are similar to those of the host contract, the derivative is closely related
Mainly defined by use of examples
Unit-linked contract measured at fair value of underlying units
Interest rate floor or cap out of the money at issue, unless leveraged, is closely related
Surrender option is closely related if surrender value is similar to carrying value of liability
If so interrelated to insurance host contract that cannot be measured separately
Definition of closely related
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Contract at fair value
If the whole contract is at fair value with movements in the fair value flowing through the income statement, there is no requirement to separate the contract as embedded derivative already measured
Unlikely to apply to insurance contracts as not at fair value
If embedded derivative is already at fair value, then no requirement to separate (e.g. structured products)
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If a derivative meets the definition of an insurance contract then it does not need to be separated in Phase I. Examples include:
The presence of an embedded derivative with insurance risk may cause the contract to be classified as insurance.This exemption also applies if meets the definition of DPF
If a derivative meets the definition of an insurance contract then it does not need to be separated in Phase I. Examples include:
The presence of an embedded derivative with insurance risk may cause the contract to be classified as insurance.This exemption also applies if meets the definition of DPF
Occurs only on Insurance Event
Form of an insurance contract
Guaranteed minimum death benefit
Guaranteed minimum maturity value
Guaranteed annuity option
Meets definition of insurancecontract
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Some surrender options do not require separation.
Surrender options in insurance contracts or contracts with discretionary participation features are exempt if:
Surrender value is a fixed amount
Surrender value is a fixed amount and an interest rate
Exemption does not apply if the surrender value is based on financial variable (equity prices or index)
Surrender option exemption
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How many do we expect?
Most contracts contain significant numbers of guarantees and options
These tend to only be payable on insured events
Guaranteed minimum death benefits
Guaranteed minimum maturity values
Therefore very few do not meet the definition of insurance and are exempt from separation
Specific disclosures are therefore required
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Key learning points
Guarantee must meet the definition of a derivative to be an embedded derivative.
If an embedded derivative is closely related to the host contract it does not need to be separated.
If the host contract is at fair value, there is no requirement to separate any embedded derivatives.
Some surrender values on insurance contracts, and embedded derivatives that meet the definition of insurance do not require be separation.
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Insurance Contracts and Contracts with DPF – Accounting Treatment
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Insurance contracts
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 notalready 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.
Existing accounting policies are those in the primary financial statements
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Prohibited policies
The following accounting policies are prohibited
Setting up catastrophe provisions
Setting up claims equalisation provisions
Offsetting of reinsurance assets and direct liabilities
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Mandated policies
The following accounting policies are mandated if they are not already present
Liability adequacy testing
Impairment of reinsurance assets
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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
Fair value like calculations
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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
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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
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Phase I measurement concerns
Liabilities and backing assets may not move together
Liabilities are fixed or at amortised cost, but
Assets are AFS with unrealised gains/losses in equity
Assets are trading with changes in fair value in income
Therefore some policies were allowed to start
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Policies that may be started
The following accounting policies can be started subject to certain restrictions
Use of current market discount rates
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
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Current market interest rates
Measure liabilities using current market interest rates
Current market interest rates
Can include investment spreads only if already included
Otherwise risk free rates
Can move to using current assumptions at the same time
Can be performed for any designated liabilities
All changes in liabilities must flow through income statement
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Shadow accounting
Shadow accounting
Quantify impact of realising gains on liability and related assets
If unrealised gains flow through income statement additional amount must be held as liability
If unrealised gains flow through Equity additional amount canbe held as Equity
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Asset based discount rates
Measure liabilities using discount rates based on asset returns
Only as part of move to a new accounting policy system which is more relevant and reliable
Rebuttable presumption that this will not be the case
Must be applied consistently to all insurance contracts
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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
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Investment contracts with DPF
Like insurance contracts, continue existing accounting with additional modifications:
Premiums can still be recognised as revenue
If distributable surplus is classified as equityMinimum liability for investment contracts is IAS 39 liability for guaranteed benefits
If distributable surplus is all classified as liability, need to include this in the liability adequacy testing
Fair value disclosure under IAS 32 still applies
If impracticable – disclose this fact, nature of the risks and range in which the fair value is likely to sit
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Business combinations -insurance phase I
Closed Book Basis
Intangible Asset Insurance
Liability(based on original
accounting policies)
Subsequently test for liability
adequacy
Net Fair Value
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Business combinations -insurance phase I
Reserves on local basis
VIF = difference between local basis reserves and fair value at purchase date – can be presented as net liabilities
VIF amortised
Prior acquisitions – continue existing accounting policies
Recognise other intangibles acquired, such as a controlled sales force
Derecognise other not allowed, such as client lists
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Key Learning Points
Catastrophe and equalisation reserves prohibited
Liabilities adequacy testing and impairment of reinsurance assets mandated
Gross presentation – reinsurance shown separately
Investment contracts with discretionary participation features temporarily under IFRS 4 – subject to disclosure requirements of IAS 32
Business Combinations allow separate presentation of intangible asset
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IAS 39 Calculation Methodologies for Investment Contracts
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Asset liability matching
Matching would reduce volatility of earnings
Matching through consistent measurement principles for assets and liabilities
Asset classification follows IAS 39
Fair Value through income statement – elective (subject to exposure draft)
Available for Sale: Fair value through equity – elective
Held to Maturity: amortised cost – restrictions
Loans and receivables: amortised cost – restrictions
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No
+
Amortised Cost
Fair ValueEntire Contract
Method of
valuation
ContainsEmbeddedDerivatives
Yes
Host at Amortised Cost
Derivative at Fair Value
Amortised Cost
Liability measurement options
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Fair value option in Europe
Exposure draft issued in response to Central European Bank worries
Fair value must be verifiable
Limit the use of fair value to:Contracts that contain embedded derivatives
Financial liabilities contractually linked to assets (unit-linked)
Financial liabilities whose exposure is substantially offset by changes in another financial instrument
Financial assets that are not loans or receivables
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“Incremental”excludes allocated costs or overhead
“External”excludes salaries and
possibly employee commissions
“Directly Attributable”must be acquisition
related
More restrictive than most existing GAAP
Transaction costs
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“Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”
(IAS 32 paragraph 11)
Fair value definition
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Active Market – quoted price
Bid price for asset
Offer price for liability
No Active Market – use valuation techniques
Reference to the current fair value of another instrument that is substantially the same
Valuation technique commonly used by market participants which has been shown to reliably price actual transactions
Makes maximum use of market inputs
Fair value considerations
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Fair value limitations
Demand deposit floor
The minimum fair value liability is the amount payable on demand –surrender value
Limits liability to a minimum of zero
Calibration at issue
Best evidence of fair value at inception is the premium paid
Calibration required – ongoing calibration to new contracts
No gain or loss at issue – except for initial expenses
Grandfathering may be allowed
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Fair value components
IAS 39 states the following components should be considered
Time value of money (basic or risk free)
Swap curve can be used for practical reasons – adjustment for risk must be made
Credit risk
Foreign currency exchange prices
Commodity price
Equity prices
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Fair value components
Volatility
Surrender riskMinimum liability is demand deposit floor
Servicing costs / feesCosts can be estimated by looking at fees charged by other market participants
Likely that present value of fees equals origination costs – unless evidence charging more than the market
Renewal PremiumsNot clear whether these should be included – pragmatically they are being included
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Methodology
Liability is the discounted value of future cash flows
Future cash flows include:
Payments to policyholders
Premiums received from policyholders (?)
Policy administration and maintenance costs
Transaction based taxes and levies relating to existing contracts
Future policy loans and repayments of these by the policyholder
All guarantees and options
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Assumptions
Discount rate is the risk free rate adjusted for credit standing
Credit standing is claims paying ability of insurance company
Assumptions should be best estimate with allowance for risk (MVMs)
Lapses
Expense inflation
Etc.
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Unit-linked example
Discounted cash flows
Investment management fees limited to transaction costs
Therefore liability at inception equals premium minus transaction costs
But how does this tie up with IAS 39 requirements?
Demand deposit floor – Surrender value may be greater, therefore limits the liability
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Fair value exceeds best estimate
Fair value exceeds premium minus transaction costs, creating loss at issue
Fair value probably requires a margin (“MVM”) on cash flows
Positive MVMs needed to calibrate to initial premium
Addition to discount rate for credit risk would reduce liability
Fair value observations
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“… the amount at which the financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount ….”
(IAS 39 paragraph 9 paraphrased)
Amortised cost definition
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The effective interest method gives a liability where the initial amount is grown by the effective interest rate to the maturity period.
The effective interest rate exactly discounts the estimatedfuture cash payments or receipts through maturity to the initial amount.
If cash flows cannot be reliably measured – contractual cash flows are used
Effective interest method
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Initial amount
The initial amount is made up of:
Fair value at issue – initial premium
Minus
Transaction costs
Implicitly creates deferred acquisition cost
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Premium = 1000
Commission = 50
IA = 950
Maturity value in one year = 1100
Effective interest rate grows 950 in one year to 1100
Effective interest rate = 15.9%
Traditional contract example
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Surrender options in contracts create the requirement for estimation
Use the best estimate surrender assumptions and expected surrender payments
Calculate the effective interest rate on a cohort of policiesCohort to be product / inception year or lower
Surrender options
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Premium = 1000
Commission = 50
IA = 950
Assume 10% of policyholder surrender half way through the year
Surrender value at mid year = 1020
Maturity value in one year = 1100
Effective interest rate = 15.76%
Estimated cash flows
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MethodologyEffective interest rate remains the same
Update assumptions for current expectations
Recalculate liability as discounted future cash flows
Changes in liability flow through income statementAmortisation of liability
Changes due to experience being different from expected
Changes due to changing expectation of the future
Re-measurement
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Amortised cost or fair value
Issue Fair Value Amortised CostFair value disclosure requirement fulfilledEmbedded derivatives already fair valuedConsistent with Phase II expectation for insurance Consistent with trading assetsConsistent with AFS assets ½Minimal implementation effort
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Key learning points
Asset and liability classification should be consistent
Decision on fair value or amortised cost is elective
Fair value calculated using discounted cash flows
Amortised cost calculated using effective interest method
If amortised cost is used, then embedded derivatives need to be separated and fair value disclosed
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Investment Contract revenue recognition –IAS 18
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Background
Guidance for investment contracts with investment management services is found in IAS 18: Revenue
Unit-linked
Applies to revenue recognition & acquisition cost recognition
IAS 18 amended by IFRS 4
Requirements are included inIAS 1: Presentation of Financial Statements, paragraphs 32 - 35
IAS 18 paragraphs 20 - 28
IAS 18 Appendix paragraph 14 (b) (iii)
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Practical
IAS 1 & 18 key words:
Shall not be offset unless required or permitted by a standard or interpretation
Fees recognised as services are provided – stage of completion
Transaction costs (as defined in IAS 39) recognised in line withrevenue
Recoverability performed on portfolio basis
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Stage of Completion
Defined asServices provided to date
total services over life of the contractServices measured by costs, or by other approaches
Applies to all service contractsSimilar to Construction contracts
Requires reliable cost accountingStraight-line methodology can be used where:
Indeterminate number of acts
There is no evidence that another methodology would not better represent the stage of completion
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Questions
1. The initial fees and initial expenses are designed to offset each other. Deferral of both initial fees and initial expenses will not impact the profitability. Can this be done?
2. We currently amortise DAC using US GAAP methodologies. Can this be continued? If not, what methods can we use?
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Conclusions
1. The initial fees and initial expenses are designed to offset each other. Deferral of both initial fees and initial expenses will not impact the profitability. Can this be done?
AnswerIAS 1 states that no items should not be offset.
IAS 18 states that revenue for a significant act should be recognised when that act is performed.
Is payment of commission to an IFA a significant actThe conclusion is no:
The payment of commission forms part of a contract between the insurance company and the IFAThis is not part of the contract between the insurance company and the policyholderTherefore it is not a significant act in the context of the contract between the insurance company and the policyholder
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Conclusions
2. We currently amortise DAC using US GAAP methodologies. Can this be continued? If not, what methods can we use?
AnswerUS GAAP has the following features
Retrospective cumulative catch-up on change in assumptionsAmortisation is in line with discounted gross profits (fees less expenses)Amortisation with interest
IAS 8 only allows effect of changes in estimates to be prospective.Therefore no retrospective cumulative catch-up
IAS 18 states amortisation as revenue is recognisedNo discounting as do not recognise revenue on discounted basis
Service contracts are not financial instrumentsMethods for financial instruments do not workDAC is really an intangible – common analogy is depreciation
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So what methods can be used?
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One example – in line with policies (straight-line)
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So what methods can be used?
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Straight LineRP AMCSP AMC
Another example – in line with AMC
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Liability Adequacy Test
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Background
Liability adequacy testing applies to NET CARRYING AMOUNTS of insurance contracts and investments contract with Discretionary Participation features
Net carrying amount is gross liability minus intangibles such as DAC / PVFP
Requirements for liability adequacy testing IFRS 4.15-4.19
IFRS 4.35 (investment contracts with DPFs)
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Practical
IFRS 4.15 key words:Each reporting date
Current estimates of future cash flows under its insurance contracts
If inadequate in the light of future cash flows, entire deficiency shall be recognized in P&L
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Minimum requirements for local testsContinuation of local test if the following two criteria are met:
Current estimates of all contractual cash flows, related cash flows (claims costs) and cash flows resulting from embedded options and guarantees
If the test shows that the liability is inadequate, entire deficiency is recognised in P&L
If the existing test does not meet the requirements, application of approach found in IAS 37
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Example
Applied test is as followsCash flows are determined including cash flows from guaranteesFor unit linked products with interest guarantees, actual fund values are taken into account
Investment returns are based on actual investments and reinvestments based on actual yield with a floor of
4% for production until August 19993% for production as from August 1999
Discounting based on 3% or 4% Investment returns and discounting are regulatory requirements (from 1999!!!)Regulator does not require taking the value of guarantees into consideration.
Intrinsic value of guarantees (shortfall of available assets in relation to the guaranteed amounts) is deducted from marginProvision related to guarantees is included in margin
Calculated as discounted value of future shortfalls according to a stochastic model
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Example
To come to an IFRS test the applied test is corrected for:Market Value for assets
Elimination of deferred realized gains
Potential issuesA mandated regulatory yield may overlook a yield deficiency
Need to consider aggregation policies and make sure these are consistent
May be possible to ‘improve’ current test to meet IFRS 4 requirements
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Our questions
1. Does this test meet the minimum IFRS 4 requirements?
2. Should the provision for guarantees be treated as an available margin in the adequacy test or should this be considered as the market value of the costs of the guarantees that you need for future estimated shortfalls?
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Our conclusions
1. Does this test meet the minimum IFRS 4 requirements?
AnswerThe Dutch liability adequacy test takes into consideration deficits (if any) of available assets in relation to the guaranteed policyholders benefits up to balance sheet date only. IFRS 4.16 requires that all cash flows from options and guarantees until expiration of the relating policies are taken into consideration.
At this moment, there are no rules that explicitly require measuring these cash flows on a stochastic basis; a deterministic approach is still acceptable. However, the Dutch Liability Adequacy Test as described in this memo only qualifies for IFRS when there is documented proof that a discount rate based upon a realistic investment scenario does not result in higher policyholders’ liabilities than the present approach where the regulatory interest of 3% and 4% is used as estimated future investment yield.
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2. Should the provision for guarantees be treated as an available margin in the adequacy test or should this be considered as the market value of the costs of the guarantees that you need for future estimated shortfalls?
AnswerThe provision for guarantees has been based by the insurer upon a stochastic scenario. The analysis above implies that under the present rules, nothing prevents the insurer from considering the excess of these provisions above the deterministic estimate as an available margin in the adequacy test for IFRS.
Should the insurer decide that options and guarantees should be measured based upon a stochastic scenario in the IFRS LAT, this would be an acceptable approach, provided that it would be applied consistently.
Our conclusions
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Phase I – Disclosure Requirements
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Insurance disclosurerequirements
IFRS 4 Two high level principles:
Principle 1 – Explanation of recognised amountsPrinciple 1 – Explanation of recognised amounts
Principle 2 –Amount, timing and uncertainty of cash flowsPrinciple 2 –Amount, timing and uncertainty of cash flows
Implementation guidance - runs to 61 paragraphs – but does not create additional requirements!
Fair Value Disclosure for insurance contract assets and liabilitiesFair Value Disclosure for insurance contract assets and liabilities
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Materiality
Specific disclosure requirement need not be satisfied if the information is not material
Specific disclosure requirement need not be satisfied if the information is not materialIAS 1IAS 1
“Omissions or misstatements of terms are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.”
“Omissions or misstatements of terms are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.”
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Reinsurance
All disclosures are required to be gross / ceded
Follows on from requirements not to offset reinsurance against insurance
Bear this in mind when looking at the number of required disclosures
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Principle 1 disclosures
Accounting policies forInsurance contracts
Related assets
Related liabilities
Related income and expense
Amounts ofKey assets
Key liabilities
Key income, expense and cash flows
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Principle 1 disclosures
AssumptionsSignificant assumptions and their derivationOther sources of measurement or uncertaintyChanges in assumptions
Changes in liabilities – reconciliations requiredInsurance liabilitiesDeferred acquisition costsIntangible assets from
Business combinationsPortfolio transfer
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Principle 1 disclosures
Gain or loss on buying reinsurance
If accounting policies amortise this gain or loss then
Starting position
Amortisation over period
End position
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Principle 2 disclosures
Risk managementObjectivesPolicies for mitigating risk
Asset/liability matchingUnderwriting
Terms and conditionsSignificant effect on the amount, timing and certainty of future cash flows
Nature of risks coveredConcentrations of riskSummary of material guaranteesParticipation features and methods for crediting interest
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Principle 2 disclosures
Monitoring insurance riskExposures reported gross and net of reinsurance
Analysis of liabilities by time of expected maturity
Sensitivity analysis
Areas of concentration of risk
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Principle 2 disclosures
Run off triangles (claims development)Only claims where amount or timing of payment is unknown
Only claims where settlement takes longer than 1 year.Unlikely to affect Life Insurance
Back to earliest material incurred claim aroseMaximum of 10 years
Maximum of 5 years required on transition
If impracticable, then not historic years not required
Can be based on accident year / underwriting year
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Guarantees and options
Information about material exposures to interest and credit risk for guarantees and options which are not held at fair value
This is expected to coverGAO – Guaranteed annuity options
GMDB – Guaranteed minimum death benefits
GMIB – Guaranteed minimum income benefits
GMMV – Guaranteed minimum maturity values
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Investment contract disclosures
Similar to insurance disclosures
Plus fair value disclosures for contracts not held at fair value
Investment contracts measured at amortised cost
Investment contracts with discretionary participation features
Reconciliation required for IAS 18 DAC and DIR
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Risks to level / natureof disclosure
Disclosures based on IAS 32 and other standards
Current project – Financial Risks and Other Amendments to Financial Instruments Disclosures
Recommendations from this project will probably affect disclosures for Insurance
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Key learning points
Significant disclosure requirements
Disclosures to be informative rather than voluminous
Gross / reinsurance presentation in all disclosures
Analysis of movement in reserves required
Disclosure of amortisation of reinsurance gains or losses
Disclosures of material guarantees and options
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Thank you for your time
Any questions?
For additional details, please contact:Jonathan Zhao, FSA, [email protected], (852) 2846-9023Bruce Moore, FSA, [email protected], (8610) 5815-3364