ifrs 4 phase ii & solvency ii maximising the synergy benefits€¦ · effective 1/1/15? q4 2012...

© 2012 Deloitte MCS Limited. Private and confidential

IFRS 4 Phase II & Solvency IIMaximising the synergy benefits3 October 2012Marylène Lanari-Boisclair Rakesh B Patel

© 2012 Deloitte MCS Limited. All rights reserved.2

Introduction

© 2012 Deloitte MCS Limited. Private and confidential© 2012 Deloitte MCS Limited. Private and confidential

Contents

3 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits

The IFRS 4 Phase II landscape

IFRS 4 Phase II alignment with Solvency II

Wider impacts of IFRS 4 Phase II

Questions

© 2012 Deloitte MCS Limited. Private and confidential4

The IFRS 4 Phase II landscape


The IFRS 4 Phase II landscape Timeline of wider IASB projects

Solvency IIEffective 1/1/15?

Q4 2012 2013 2014

Insurance contracts Effective date 1/1/17?

Insurance contractsIFRS 4 Phase II

Re-exposure and timing ?

IAS37 LiabilitiesAmended IFRS

IFRS 9 Financial InstrumentsReplacement of IAS 39

Effective 1/1/15

IFRS 13 Fair Value measurementEffective 1/1/13

2015+


Revenue Recognition(replacement of IAS 18)

New IFRS

IAS19 post employment benefits

Effective 1/1/13


Re-exposure of the Insurance StandardA new exposure draft announced by the IASB

• The exposure draft will ask questions on a limited number of topics:

1. the decision that participating contracts will be measured on the same basis as the backing assets;

2. the requirement for premiums to be presented in the statement of comprehensive income;

3. the “unlocking” of the residual margin;

4. the use of the OCI solution for changes in the discount rate;

5. the proposed transition requirements.

• The exposure draft is expected in Q1 2013

• Comment period between 3 to 4 months

• The European Commission demanded a 3 years gap between publication of the Phase II final requirements and effective date



The IFRS 4 Phase II landscapeIFRS Phase II – insurance contracts liability

Block 1:

Present Value of Best Estimate Fulfilment CFs

Block 3:Residual Margin

Block 2:Risk Adjustment

Total IFRSInsurance Liability

Amounts the insurer expects to collect from premiums and pay out as

it acquires, services and settles the contract

Quantifies the amount between a certain and an uncertain liability (similar

concept to a Solvency II risk margin)

Quantifies the unearned profit the insurer expects to earn as it fulfils the contracts

(e.g. Premiums less BEL less Risk Adjustment)

Principles

• Measurement model uses a “building block” approach

• Measurement is current i.e. no locking-in of assumptions

• Measurement objective based on a “fulfillment of obligations” notion

• Discounting done using either a “top down” or “bottom up” approach



The IFRS 4 Phase II landscapeSummary of the current tentative decisions

• Current IFRS 4 definition of “insurance” carried forward, with some scope changes

• Single prospective measurement model for all insurance and reinsurance contracts, as well as financial instruments with Discretionary Participating Features issued by insurers (e.g. with-profits investment contracts)

• Premium allocation approach for short term contracts

• Prohibition of accounting profit on sale => residual margin defers expected profit

• Day-one losses recognised immediately through income

• Acquisition costs included in contractual cash flows if incremental and directly attributable

• Presentation and disclosures still being discussed

• Impact of assumption changes:

• arising from changes to discount rate => will go through Other Comprehensive Income

• arising from changes to non-economic assumptions => will be offset by a change to residual margin


© 2012 Deloitte MCS Limited. All rights reserved.9

IFRS 4 Phase II alignment with Solvency II


IFRS Phase 4 alignment with Solvency IIBalance Sheet components

Typical Solvency IIBalance Sheet

Assets

Excess of assets over liabilities

Subordinatedliabilities

Best estimate liability

Other liabilities

Risk margin

Basic ownfunds

Tangible assets

Shareholder equity

Other liabilities


Goodwill / Intangibles

Residual margin

Risk adjustment

Proposed IFRSBalance Sheet

Ancillary ownfunds

Value of m

arket consistent liabilities

Callable capital instruments

Technical Provisions

Insurance contracts

Investment contracts (e.g.

unit-linked pure savings

contracts)



Component Challenge Key Areas of Impact

IFRS 4 Phase II alignment with Solvency II Key challenges

Residual Margin There is no concept of residual margin under Solvency IIData, systems /

Reporting

Risk Adjustment The measurement under IFRS4 is governed by principles rather than rules; additional disclosure of equivalent confidence interval requirement

Data and systems / Methodology / Assumptions

DiscountingUnlike Solvency II, the discounting under IFRS4 is governed by principles rather than rules

Assumptions / Systems

Best estimate cashflows Some cash flows may differ e.g. costs & contract boundaries

Assumptions / Methodology

ReportingP&L attribution process needs to be developedBalance sheet reconciliation between IFRS and SII

Data and systems / Methodology /

Reporting

Tax Tax implications need to be fully understoodAssumptions / Methodology

To establish a single common regulatory framework to maintain capital adequacy and risk management standards

To improve transparency and comparability of insurers’ financial statements, regardless of sector, geography or products.

IFRS4 “portfolio” level measurement for certain components may require different data segmentation, and investment contracts measurement is done under IFRS 9

Scope & unit of measurement

Data and systems / Assumptions / Inputs

to ICM / reporting

Tar

get O

pera

ting

Mod

el

Solvency II IFRS 4 Phase IIDiffering

Goals


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IFRS 4 Phase II alignment with Solvency IIScope consequences

12

Focuses on regulated entities and their regulated activities

Transactions that fall within the business follow the Solvency II valuation rules

Focuses on transactions – “insurance” contract irrespective of regulatory status of issuer

Absence of transfer of insurance risk does not scope liabilities out of Solvency II

IFRS 4 applies to “insurance” contracts as individual transactions

Deals with both sides of the balance sheetIFRS 4 only deals with the liability side of the balance sheet

Applies to the entire business of insurance undertakings

Insurers selling non “insurance” contracts use different IFRSs.

For example:Unit-linked pure savings contracts are accounted for as deposits (IAS 39 / IFRS 9); andAsset management services will be accounted for as service contracts (IAS 18).

Solvency II IFRS 4 Phase II

IFRS 4 Phase II & Solvency II: Maximising the synergy benefits


IFRS 4 Phase II alignment with Solvency IIRisk margin versus Risk adjustment

13

Objective Technical provisions sufficient to meet the insurer’s obligations

A margin to reflect uncertainty in the estimate of fulfilment cash flows

Scope Assumes whole portfolio is transferred to another insurance company

Defined as “The compensation the insurer requires for bearing the uncertainty inherent in the cash flows that arise as the insurer fulfils the insurance contracts”.

Methods Cost of capital approach with the charge varying between Pillar 1 and Pillar 2

Following approaches can be used (but not limited to): confidence interval, conditional tail expectation and cost of capital.

Diversification Diversification across portfolio segments and legal entities

Unit of account not prescribed as long as objective met => potential for similar diversification benefits.

Risks coveredTypically, includes non-hedgeable risks such as underwriting, counterparty and operational risks. All market risks are typically assumed to be hedgeable.

Includes market risks (to the extent that they affect the payments to the policyholders only) and underwriting risks.

Reporting

Re-measured at each reporting period and explicitly reported at the same level of granularity as the best estimate liability.

Re-measured at each reporting period and explicitly reported in the financial statements as part of the insurance liability. Equivalent confidence disclosure requirements.




IFRS 4 Phase II alignment with Solvency II Residual Margin

• Day 1 measurement:

• Eliminates gains at inception of a contract i.e. premiums less BEL less risk adjustment; and

• Measured at “portfolio” level, and within a portfolio, by similar date of inception / coverage period leading to additional data requirements.

• Subsequent measurement:

• Adjust for favourable and unfavourable changes in estimates (excluding economic);

• Residual margin can increase or decrease, but cannot become negative;

• Experience adjustments recognised in P&L account to the extent that there is no residual margin left;

• The release of the RM should be over the coverage period, on a systematic basis that is consistent with the pattern of transfer of services provided under the contracts (still under debate); and

• Accretes interest on carrying amount of residual margin using discount rate at inception.



IFRS 4 Phase II alignment with Solvency IIDiscounting

15

Principles

Consistent with current market prices.

Risk-free interest rate term structures will be the sum of:

a. basic risk-free interest rate term structure;

b. counter-cyclical premium (if applicable); and

c. Matching adjustment (if applicable).

This is still subject to debate between the industry and EIOPA.

Consistent with current market pricesExclude factors not relevant to the insurance contract.

Only reflect risks not included elsewhere in the measurement.

Yield curve may be determined using “top down” or “bottom up”.

Method

Highly prescriptive method published by EIOPA.

No prescribed method.

Guidance to be provided.

Non Participating

contracts

Reflect the characteristics of the insurance contract liability.

Participating contracts

The discount rate should also reflect the dependence between the assets and liabilities.




Reconciling balance sheet components

Assets• Differences due to measurement

differences (FV versus MV)

• Assets category differences (e.g. goodwill, DAC and intangibles)

16

IFRS Phase 4 alignment with Solvency II

Liabilities• Scope differences mean that UL liabilities are measured

differently (e.g. SV floor and DIR)

• Scope differences mean there is no risk adjustment for investment contracts, unlike SII

• Risk adjustment in IFRS is measured differently to risk margin under SII

• Differences caused by possible different discount rates

• Difference caused by the residual margin in IFRS which is not a component of the SII technical liability

Typical Solvency IIBalance Sheet

Assets

Excess of assets over liabilities

Subordinatedliabilities


Other liabilities

Risk margin

Basic ownfunds

Tangible assets

Shareholder equity

Other liabilities


Goodwill

Residual margin

Risk adjustment

Proposed IFRSBalance Sheet

Ancillary ownfunds

Value of m

arket consistent liabilities

Callable capital instruments

Technical Provisions

Insurance contracts

Investment contracts



Significant investment by companies in

embedding Solvency II

Many potential synergies between

Solvency II and IFRS Insurance, but also some differences

Alignment between Solvency II and IFRS

Insurance is critical to maximising the strategic

synergy benefits from your Solvency II

investmentCompanies are investing

in understanding all aspects of IFRS now

before Solvency II becomes too “locked

down”

18

Maximising synergies with Solvency II




An integrated or closely aligned approach to the implementation of the two projects is likely to minimise implementation costs and maximise benefits.

The key challenges that insurers will face Focus area

19

Wider impacts of IFRS 4 Phase IIKey challenges

Business impacts analysisUnderstand the business impacts

Target Operating ModelIntegration with the existing TOM and WDT

Finance TransformationNeed for greater efficiency and cost savings

Programme management structure and designReadiness for IFRS implementation

Organisation structure review – tax efficiencyTax efficiency implications

Help the investment analysts understand business dynamicsManaging external

stakeholder relations

Management Information: Financial planning and

analysis

Providing accurate and fully explained reconciliations between IFRS and Solvency II

Benefits realisationDelivering the identified synergy benefits

Maximising the capability across Actuarial / Technol ogy / Accounting



Systems

Policy administration

systems, general ledger cost

hierarchies and cost allocation

systems will need to be updated.

Data

Data requirements for IFRS and SII are

similar.

Process

Mixed presentation model that requires multiple data feeds.

Performance management

The primary focus for SII is capital adequacy.

Approach will be familiar to insurers

already using embedded value.

People and culture

Incentivisation

Remuneration

Education

Strategy and governance

Market-consistent measurement basis

will lead to an increased focus on matching between

assets and liabilities.

Complianceactivities

Homogeneous valuations required

within the same group.

Increased documentation and

disclosure requirements.

External financial and regulatory

reporting

The proposed margin-based income statement is a

significant departure from traditional revenue account presentation.

Wider impacts of IFRS 4 Phase IIKey factors and issues to consider

External financial and

regulatory reporting

Compliance activities

Strategy and governance

People and culture

Performance management Process Data Systems

20

Maximising the capability across Actuarial / Technol ogy / Accounting



Questions


Key Contacts

Marylène Lanari-Boisclair

Senior ManagerActuarial & Insurance Solutions

Tel: 020 7303 3227Email: [email protected]

David Hare

PartnerActuarial & Insurance Solutions


Rakesh B Patel

DirectorActuarial & Insurance Solutions


Tamsin Abbey

PartnerActuarial & Insurance Solutions




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Deloitte MCS Limited is a subsidiary of Deloitte LLP, the United Kingdom member firm of DTTL.

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