ifrs10 for the insurance

8/14/2019 IFRS10 for the Insurance

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Practical guide to IFRS IFRS 10 for the insurance industry 1

pwc.com/ifrs

Practical guide to IFRSIFRS 10 for the insurance industry

At a glance

IFRS 10, Consolidated financialstatements (IFRS 10 or the standard),introduces new guidance on control andconsolidation. This standard, whichcombines the concepts of power and

exposure to variable returns, is effectivefor financial years beginning on or after1 January 2013. Early adoption ispermitted.

The European Financial ReportingAdvisory Group (EFRAG) advised theEuropean Union (EU) in June 2012 toadopt IFRS 10 and the other standardsrelated to the consolidation project.However, their advice was to postponethe mandatory effective date to 1 January2014, although with early adoption

permitted. The EU has yet to decidewhether to adopt this recommendation; adecision is expected by the end of 2012.

The key principle in the new standard isthat control exists, and consolidation isrequired, only if the investor has powerover the investee, exposure to variablereturns from its involvement with theinvestee and the ability to use its powerover the investee to affect its returns.Management should reassess control if

facts and circumstances indicate changesto any of these three elements of control.

The standard will affect some entitiesmore than others. The consolidationconclusion is not expected to change formost straightforward entities. However,changes can result in complex cases.

Entities that are most likely to be affectedpotentially include investors in:

entities with a dominant investor thatdoes not possess a majority votinginterest, where the remaining votesare held by widely-dispersedshareholders (de facto control);

entities that issue or hold significantpotential voting rights;

structured entities (sometimesreferred to as special purpose entitiesor SPEs);

asset management entities; and

silos, which are ring-fenced parts of awider entity that are deemed separateentities for accounting purposes.

In difficult cases, the precise facts andcircumstances will affect the analysis

under IFRS 10. IFRS 10 does not providebright lines; management will need toconsider many factors.

A separate standard, IFRS 12, Disclosureof interests in other entities, sets outdisclosures for investor/investeerelationships.

We believe that insurance entities couldbe affected in particular, if they areinvolved in structured entities and asset

management activities or have silos.

This publication provides an overview ofthe elements of IFRS 10 that are, in ourview, most relevant to insurance entitieswith these types of structures, andprovides related examples. This papershould be used as a supplement to thePwC practical guide,Consolidatedfinancial statements redefiningcontrol.In addition, insurers may findthe PwC practical guide to IFRS 10,Applying IFRS 10 to asset management

activitiesuseful.

September 2012

Contents

At a glance 1

Overview of IFRS 10 2

IFRS 10 application

examples:

Deemed separateentities (silos) 7

Structured

entities

12

Investment

products

14

Unit-linked

contracts

variable returns

analysis

18

Lloyds structures

syndicates

20
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PwC: Practical guide to IFRS IFRS 10 for the insurance industry 2

Overview of IFRS 10

Applicability of IFRS 10

Only an entity can be consolidated

under IFRS 10, so it is important toidentify whether an entity exists. This isstraightforward in most cases. However,an entity may not always be a legal entityor it may be a ring-fenced portion of alarger entity. In some cases, it may bedifficult to ascertain if an entity existsand so whether IFRS 10 applies. IFRS 10does not define the word entity and asthere is little other guidance elsewhere inthe IFRS literature, management mightneed to use judgement to determine

whether an entity exists.

The principle of controlcontains three elements

IFRS 10 establishes control as the basisfor consolidation. Control requires threeelements to be present. An investor musthave all of the following:

power over the investee;

exposure or rights to variable returnsfrom its involvement with the investee;

andthe ability to use its power to affect theamount of returns.

The individual elements for assessingwhether one entity controls anotherentity are discussed below.

Purpose and design of theinvestee

The purpose and design of an investee

could affect the assessment of what therelevant activities are, how thoseactivities are decided, who can directthose activities, and who can receivereturns from those activities. Theconsideration of purpose and design maymake it clear that the entity is controlledby voting or potential voting rights.

In other cases, voting rights may notsignificantly affect an investees returns,and the investee may be controlled bycontractual arrangements. In those cases,the following should be considered in

assessing the purpose and design of anentity and who (if anyone) controls it:

(a) downside risks and upside potential

that the investee was designed tocreate;

(b) downside risks and upside potentialthat investee was designed to pass onto other parties in the transaction;and

(c) whether the investor is exposed tothose risks and upside potential.

Power

An investor has power over an investeewhen the investor has existingsubstantive rights that give it the currentability to direct the relevant activities.Where equity instruments clearlydetermine voting rights and powers tocontrol, the majority shareholder hascontrol in the absence of other factors.When two or more investors must acttogether to direct activities that affectreturns, neither investor has control. Aninsurer can have power over an investeeeither by voting rights or by contract.

Structured entities exist if voting rightsdo not have a significant effect on aninvestees return. In this case, votingrights are not the dominant factor indeciding who has control, but ratherrelevant activities are directed bycontractual rights. This is discussedfurther below.

Relevant activities

IFRS 10 defines relevant activities as

those activities of the investee thatsignificantly affect the investees returns.IFRS 10 offers a wide range of possiblerelevant activities including but notlimited to:

(a) sales and purchases of goods andservices;

(b) management of financial assetsbefore and after default;

(c) selection, acquisition and disposal ofassets;

(d) research and development; and(e) determining a funding structure

or obtaining funding.


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Decisions over relevant activities mayinclude operating, capital and budgetarydecisions; or the appointment,remuneration and termination of serviceproviders or key management.

Power over relevant activities

An investor must have rights that providethe current ability to direct relevantactivities in order to have power. Thisability can stem from a wide variety ofrights, including voting or potentialvoting rights, rights to appoint or removedecision-makers including keymanagement, veto rights and contractualrights. Generally, when the investee has arange of relevant activities that require

continuous substantive decisions, votingor similar rights will provide power. Inother cases, voting rights do not have asignificant effect on returns andstructured entities exist. The existence ofstructured entities requires considerationof further factors to determine who (ifanyone) has power.

Substantive and protective rights

IFRS 10 requires only substantive rightsto be considered in the assessment ofpower. Protective rights which aredesigned to protect the interest of theparty holding those rights without givingthat party power over the entity to whichthose rights relate are not considered.The standard provides guidance ondistinguishing between the two.

Voting and potential voting rights

An investor with more than half of thevoting rights has power when the

relevant activities are directed by themajority vote, the voting rights aresubstantive and they provide the currentability to direct the relevant activities. Aninvestor with less than a majority ofvoting rights can also gain power throughcontractual arrangements, through defacto control, by having potential votingrights or a combination of these.

De facto control

An investor with less than a majority of

the voting rights may hold the largestblock of voting rights with the remaining

voting rights widely-dispersed. Theinvestor may have the practical ability tounilaterally direct the investee unless asufficient number of the remainingdispersed investors act in concert tooppose the influential investor. Such

concerted action may be hard to organiseif it requires the collective action of alarge number of unrelated investors.

Potential voting rights

Potential voting rights are defined asrights to obtain voting rights of aninvestee, such as those arising fromconvertible instruments or options. Theissues to consider in determining if suchpotential voting rights give the holder ofthem power include:

(a)whether the potential voting rightsare substantive or protective;

(b)if there are other voting or decisionrights held by the investor; and

(c)the purpose and design of thepotential voting right instrumentand the purpose and design of anyother involvement the investor haswith the investee. This involvesbothan assessment of terms andconditions, and the investorsapparent expectations, motives andreasons for agreeing to those termsand conditions.

An important change under IFRS 10 isthe requirement to consider the financialposition of potential voting rights (that is,whether in or out of the money) as afactor in assessing control. Potentialvoting rights that are deeply out of themoney can result in those rights beingregarded as non-substantive in theabsence of a non-financial incentive for

the holder to exercise them.

Structured entities

Voting rights may not have a significanteffect on an investees returns. Forexample, voting rights might relate toadministrative tasks only and withcontractualarrangements dictating howthe investee should carry out itsactivities. These entities are described asstructured entities in IFRSs 10 and 12.

All substantive powers in such entitiesmay appear to have been surrendered


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to contracts that impose rigid controlover the entitys activities. None of theparties may appear to have power.However, such entities may beindirectly controlled by one of the

parties involved. Further analysis isrequired to determine if there is aparty with control. An investor shouldconsider the following factors whendetermining whether it has power.

Involvement and decisions made atthe investees inception as part ofits design

IFRS 10 requires management toconsider the involvement of variousparticipants in the design of the investeeat inception. Such involvement is notsufficient by itself to demonstratecontrol. However, participants who wereinvolved in the design may have theopportunity to obtain powerful rights.Decisions made at the investeesinception should be evaluated todetermine whether the transaction termsprovide any participant with rights thatare sufficient to constitute power.

Contractual arrangementsestablished at investees inception

The structured entity is often governednot only by its constitution documentsbut by contracts that bind the structuredentity to its original purpose. Theseinclude call rights, put rights, liquidationrights and other contractualarrangements that may provide investorswith power. When these contractual

arrangements involve activities that areclosely related to the investee, these areconsidered relevant activities. This is trueeven if the activities do not occur withinthe structured entity itself but in anotherentity.

Rights to direct relevant activitiesthat arise upon the occurrence ofcertain events

IFRS 10 requires management toconsider decision rights that take effectonly when particular circumstances ariseor events occur. An investor with theserights can have power even if thosecircumstances have not yet arisen.

Commitment to ensure thatinvestee operates as designed

Such an explicit or implicit commitmentby an investor may increase exposure tovariability of returns and heighten thelikelihood of control. However, this factoris insufficient by itself to demonstratepower or prevent other parties fromhaving power.

(a) Is investor exposed to downside risks and upside potential that investee wasdesigned to create and pass on (IFRS 10 B8)?

(b) Is investor involved in design of investee at inception (IFRS 10 B51 para 37)?Do the terms of decisions made at investees inception provide the investorwith rights that provide power? (IFRS 10 B51)

(c) Do contractual arrangements established at inception provide investor withrights over closely related activities (IFRS 10 B52 para 38)

(d) Does investor hold rights over relevant activities that arise only upon theoccurrence of contingent events (IFRS 10 B53 para 40)?

(e) Does investor have a commitment to ensure that investee operates asdesigned (IFRS 10 B54 para 41)?

(f) Do other factors indicate that investor has power (IFRS 10 B17)?

Indicatorofinvestor

ower

Yes


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Variable returns

Variable returns are defined as returnsthat are not fixed and have the potentialto vary as a result of the performance ofan investee. They can be positive,

negative or both. IFRS 10 identifies awide variety of possible returns, rangingfrom traditional dividends and interest toservicing fees, changes in the fair value ofan investment, exposures arising fromcredit or liquidity support, tax benefits,access to future liquidity, economies ofscale, cost savings and gainingproprietary knowledge.

Variability is assessed based on thesubstance of the arrangement, regardless

of legal form. For example, contractually-fixed interest payments could be highlyvariable if credit risk is high. Assetmanagement fees that are contractuallyfixed could nevertheless be subject tovariability if the investee has a high riskof non-performance.

Link between power andreturns principal versusagent

An agent is a party engaged to act onbehalf of another party (the principal).A principal may delegate some of itsdecision-making authority over theinvestee to the agent, but the agentdoes not control the investee when itexercises such powers on behalf of theprincipal. The decision-making rightsof the agent should be treated as beingheld by the principal directly inassessing control. Power resides withthe principal rather than the agent.

The overall relationship between thedecision-maker and other partiesinvolved with the investee must beassessed to determine whether thedecision-maker acts as an agent.

Analysis of principal-agencyrelationships under IFRS 10

Insurance groups often are assetmanagers and so must determinewhether they are an agent or a principal

in relation to the funds they manage. Thestandard sets out a number of specific

factors to consider; several aredeterminative, but the majority arejudgemental and need to be consideredtogether in assessing the overallrelationship. An agent is ...a partyprimarily engaged to act on behalf and

for the benefit of another party orparties (the principal(s)) and thereforedoes not control the investee when itexercises its decision-making authority.This means that if an asset manager isagent, it acts primarily on behalf ofothers (the investors in the fund) and sodoes not control the fund. However, if theasset manager acts primarily for itself, itwill be a principal and will thereforecontrol the fund.

The application guidance in IFRS 10states that a decision-maker (that is, theasset manager) should consider theoverall relationship between itself, theinvestee (that is, the fund) and otherparties involved with the investee (that is,third-party investors in the fund) indetermining whether it is acting as agent.Factors that management shouldconsider are:

1. scope of the asset managersdecision-making authority;

2. rights held by other parties;3. remuneration to which it is entitled;

and

4. exposure to variability of returns.

The first two factors deal with the extentof the asset managers power over thefund and the extent of any restrictions onthose powers. For example, an assetmanagement agreement gives the assetmanager power over the relevantactivities of the fund (day-to-day

management). However, if investors canremove the asset manager at any point intime without cause, by a majority vote,and there are only five investors in thefund, then the managers power over thefund seems to be limited throughsubstantive removal rights held by otherparties. In fact, IFRS 10 states that whena single party holds substantive removalrights and can remove the decision-maker without cause, this, in isolation, issufficient to conclude that the decision

maker is an agent. This is determinativerather than judgemental.


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The third and fourth factors relate to thereturns criterion; they require the assetmanager to consider the magnitude andvariability of the returns it gets (expectedand maximum) from the fund relative tothe total returns from the funds

activities. For example, a managersexposure to a funds variable returnsmight be limited to the on-marketmanagement fees it receives. Themanager might be an agent where thefees do not expose it sufficiently tomagnitude and variability of returns. Inother circumstances, the manager mightbe exposed to variable returns throughsome or all of: management fees,performance fees, carried interest andinvestments in the fund. Management

should analyse carefully whether allsources of returns in aggregate, alongwith consideration of the asset managerspower over the fund, are sufficient toindicate that the manager is a principal.

With regards to remuneration, indetermining whether the fund manager isa principal or agent, IFRS 10 requires thefund manager to consider whether thefollowing two conditions exist:

(a) the remuneration of the decision

maker is commensurate with theservices provided; and

(b) the remuneration agreementincludes only terms, conditions oramounts that are customarilypresent in arrangements for similarservices and level of skills negotiatedon an arms length basis.

The fund manager cannot be an agentunless these conditions are met.However, meeting those conditions inisolation is not sufficient to conclude thatthe fund manager is an agent.

We believe that insurance entities couldbe affected if they are involved in assetmanagement activities. The PwCpractical guide to IFRS 10, ApplyingIFRS 10 to asset management activitiesexplains the principles for these assetmanagement activities in detail andprovides a number of practical examples.

Silos

A portion of an investee is deemed tobe a separate entity for accountingpurposes (a silo) when, in substance:

(a) the specified assets and relatedcredit enhancements, if any, are theonly source of payment for specifiedliabilities of, or specified otherinterests in the investee; and

(b) parties other than those with thespecified liability do not have rightsor obligations over the specifiedassets and the cash flows from thoseassets.

So, in substance, all assets, liabilities andequity of that deemed separate entity arering-fenced from the rest of the investee.

If the assets, liabilities or other interestsconstitute a silo, the insurer must thendetermine whether it can control the silobased on the IFRS 10 criteria. If theinsurer controls the silo, the insurerconsolidates the silo. If a party other thanthe insurer controls the silo, the insurerwould exclude the silo from consolidationeven if it consolidated the rest of theinvestee.

Disclosures

The disclosure requirements forsubsidiaries as well as for an entitysinterests in associates, jointarrangements and unconsolidatedstructured entities are set out inIFRS 12, Disclosure of interests in otherentities.

The objective of IFRS 12 is to disclose

information that helps financialstatement readers to evaluate the nature,risks and financial effects associated withthe entitys interests in other entities.IFRS 12 allows reporting entities to judgethe level of detail required in thedisclosures and the emphasis of thedisclosures.

IFRS 12 disclosures only apply toinvolvements that meet the definition ofinterests in another entity. IFRS 12provides detailed guidance on what ismeant by interests in another entity.This question is particularly relevant for
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disclosures about unconsolidatedstructured entities, as it determines thescope of such disclosures. The purposeand design of a structured entity shouldbe considered in making a judgement asto when a relationship represents an

interest.

IFRS 12 requires a reporting entity todisclose significant judgements andassumptions made in determiningwhether it controls, jointly controls,significantly influences or has interests inother entities. This includes, for example,reassessment of control due to changes in

facts and circumstances, override ofpresumptions of control (or non-control)when voting rights exceed (or fall below)50% and assessment of principal-agentrelationships in consolidation. Inaddition to qualitative information, the

standard requires disclosure of certainquantitative information, includingsummarised financial informationdepending on the type of interest (e.g.subsidiary with non-controlling interest,unconsolidated structured entity).

IFRS 10 application examples

This section deals with a number ofexamples that could apply to aninsurance entity when interpreting IFRS10 either to determine whether controlexists or whether IFRS 10 applies at all toa certain structure. The examples give abrief background, example facts, ananalysis and a conclusion on how, if atall, IFRS 10 would apply in the specificexample.

Deemed separate entities(silos)

The following examples on cells and subfund structures as well as separateaccounts are aimed at clarifying whatconstitutes a silo or deemed separateentity under IFRS 10.

Cells and sub fund structures

Background

IFRS 10 requires certain criteria to bemet before a portion of an entity isdeemed to be a separate entity foraccounting purposes under IFRS 10. Theissue is the extent to which judgementand substance are relevant in applyingthese criteria in cases where there is nostrict legal separation of the specifiedassets and liabilities under allcircumstances.

Example 1Protected cell arrangement

Protected cell arrangements are typically

established for investors who wish to

undertake insurance business in certain

jurisdictions.

The investor pays a fee to a registered

insurer to set up and manage a protected

insurance cell. The investor (A) will specify

the type of insurance it wants to undertake

and the investments it wants to place in its

cell (Cell A). Cell A then writes insurance

policies that are backed by the assets that

Investor A has deposited in Cell A. The

liabilities from insurance policies written

within Cell A can only be met by assets in

Cell A. If the assets in Cell A are

insufficient, neither the policyholders nor

the Investor A have any recourse (even in

bankruptcy) to either the assets in other

cells managed by the registered insurer or

to the assets of the registered insurer itself.

None of the assets in Cell A are accessibleto the creditors of the registered insurer,

even in bankruptcy of the registered

insurer.

The registered insurer receives a fee for

managing the cell and performing

underwriting services, and is legally the

named holder of the assets and issuer of

the insurance policies written by the cell.


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Example 2Unprotected cell

arrangement

The cell arrangement is the same asabove, except that the cell structure is

unprotected. On a day-to-day basis,

only the assets of Cell A can be used to

settle the liabilities of Cell A. However, if

there is a shortfall in the assets of Cell A,

Cell A would in the first instance be

replenished by Investor A. Should

Investor A also be unable to make up the

shortfall, the assets of the registered

insurer and/or the other cells can be

used. This is the key difference from

Example 1. For example, accessingassets other than those in the relevant

cell could happen in the following

contractually agreed situation: when the

assets invested by investors into Cell A

are depleted and when the Cell A

investors are bankrupt and cannot pay

the insurance liabilities. In such a case,

any remaining insurance risk reverts

back to the registered insurer. The cells

are regarded as being ring fenced under

usual day-to-day situations, although

legally this is not the case in all possible

situations (that is, in an extreme situationsuch as bankruptcy of Investor A).

Example 3Umbrella fund

A fund manager establishes an umbrella

fund for retail investors, which has threeunitised sub funds. The sub-funds are not

separate legal entities but are all part of

one legal entitythe umbrella fund.

Investors can choose which sub-fund

they wish to acquire units in, and their

investment is in the relevant sub-fund

rather than the umbrella fund. Each sub-

fund holds different types of assets and

has a different investment mandate. On a

day-to-day basis, the assets of each sub-

fund are segregated from those of the

other sub-funds and from the umbrellafund, and support only the units of that

sub fund. If an investor redeems units

from a sub-fund, it receives only its

relative proportion of the assets held in

that sub fund. However, in certain remote

situations (for example, mis-selling fraud

or negligence), unit holders in the sub-

fund can access assets of the other sub-

funds and/or the umbrella fund.

Payments from other cells or from the

umbrella fund to a sub-fund to cover its

liabilities are seen as remote, as this

would only happen in very rare cases;payments from other funds or the

umbrella fund would not be made if the

assets decrease in value. The investment

risk of each sub fund is borne entirely by

the sub fund investor except for fraud or

negligence.

For the examples, the question is whetherthe cells or sub-funds are deemedseparate entities or silos for thepurposes of considering consolidation

under IFRS 10.

Cell A

Assets Liabilities

Cell B

Assets Liabilities

Cell C

Assets Liabilities

Investor A Investor B Investor C

Insurer


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Analysis

In all three examples, there is ringfencing of normal day-to-day activities.However, the examples differ in terms ofthe circumstances in which ring fencingmay be broken.

Example 1 appears to be a silo, as thereis ring fencing in all situations that is,specified assets are the only source ofpayments for specified liabilities in allcases. So the conditions for there to be asilo or deemed separate entity (asdescribed further below inIFRS 10 B77) are met.

Examples 2 and 3 require furtherconsideration, given that payments can

be required to be made from assets otherthan those of the specific cell or sub-fundin certain circumstances.

IFRS 10 B77 requires an investor to treata portion of an investee as a deemedseparate entity only if the followingcondition is met: Specified assets of theinvestee.are the only source ofpayment for specified liabilities of, orspecified other interests in, the investee.Parties other than those with the

specified liability do not have rights orobligations related to the specified assetsor to residual cash flows from thoseassets.In substancenone of thereturns from the specified assets can beused by the remaining investee and noneof the liabilities of the deemed separateentity are payable from the assets of theremaining investee. Thus, in substanceall the assets, liabilities and equity ofthat deemed separate entity are ring-fenced from the overall investee. Such adeemed separate entity is often called a

silo.

Note: The words in substance in IFRS 10B77 prevent any structuring around thesilo requirements by inserting a non-substantive clause to preclude a silo fromexisting. In addition, without thereference to substance, the guidancewould not converge with US GAAP. Theoverall aim of the IASB was to broadlymirror US GAAP on silos (see IFRS 10BC148).

Therefore, in our view, a non-substantiveclause allowing payment from other cellsor sub-funds would not preclude a silofrom existing under IFRS 10. On theother hand, if a remote but genuinesubstantive clause exists allowing

payment from other cells or sub-funds ina structure that would otherwise be a silo,the structure would not be a silo underIFRS 10. A substantive clause would beindicated, inter alia, if the presence ofthat clause was a factor that investorswould consider in making theirinvestment decision.

The ring fencing in example 2 can bebroken if the assets within the cell andthe assets of the investor are not

sufficient to cover the insured events. Webelieve that this would be an example of asubstantive clause that is significant to aninvestor. Hence the cell in example 2would not be a silo under IFRS 10. Withregards to example 3, the reporting entitywould have to use judgement indetermining whether the contractualclause to inject further funds into thesub-fund in case of fraud or negligence issubstantive. If such a clause was addedmerely for structuring reasons to avoidthe sub-fund being a deemed separateentity, the clause would be non-substantive and the sub-fund in example3 would be a silo. Conversely, in the morenormal case when the clause does havesubstance for example, there areoccasional instances of fraud or mis-selling and assets would have to beinjected into the affected sub-fund tocover for this then such a clause may besubstantive and the sub-fund would notbe a silo.

ConclusionExample 1 is a clear silo under IFRS 10,as there is ring fencing in all scenarios.Example 2 is not a silo, as there aresubstantive clauses in the unprotectedcell agreements that break the silo whenexisting assets are insufficient to meet allinsurance risks and the investors in thesilo became bankrupt. Example 3 may ormay not be a silo, depending onjudgement as to whether the contractualclauses are substantive or not.


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Separate accounts

Background

An insurer offering a separate accountinsurance product may need toconsider the application of IFRS 10 to

specified assets and liabilities of such astructure. IFRS 10 generally applies toentities but a portion of an investeemay be a deemed separate entity thatis, a silo if certain criteria are met. Ifa separate account contract structurewere to meet the silo criteria in IFRS10 and thus be a deemed separate

entity, the insurer offering such aproduct would have to analyse if itcontrols the separate account underIFRS 10. If it did not have control, theassets and liabilities of the silo wouldnot be included in the insurers

balance sheet. Conversely, if theseparate account structure is not anentity or a deemed separate entity, theinsurer would include the individualassets and liabilities arising from theseparate account in its balance sheet.

Example

A typical separate account structureis shown on the next page. The

following characteristics typically exist

in separate account arrangements:

The separate account

arrangement is recognised legally;

that is, the assets in the separate

account are held in a separate

investment account that is

established and maintained under

relevant regulations.

A separate account is not a

separate legal entity but is a legallyrestricted fund. The separate

account assets supporting the

contract liabilities are legally owned

by the insurer but are legally

insulated from the general account

liabilities of the insurer because

separate account assets are not

available to cover liabilities except

the liabilities to the separate

account policyholders.

The insurer must as a result of

contractual, statutory or regulatoryrequirements invest the

policyholders funds within the

separate account as directed by

the policyholder in any of the

designated investment alternatives

made available by the insurer, or in

accordance with specific

investment objectives or policies

established in the contract.

All investment performance, net of

contract fees and assessments,

must as a result of contractual,statutory or regulatory requirements

be passed through to the

individual policyholder. The

contract specifies conditions under

which there is a minimum

guarantee, but not a ceiling, as a

ceiling would prohibit all investment

performance from being passed

through to the policyholder.

The contract between the investor

and insurer creates an obligation of

the insurer that is not extinguishedby the segregation of funds in the

separate account.

The annuitisation option guarantee,

as well as any other minimum

guarantees and benefits provided

by the contract, are funded through

the insurers general account

assets and not the separate

account assets.

There is no provision in the

separate account contract that

prohibits settlement of the separateaccount liabilities using assets

from the insurance entitys general

accounts. For example, in the event

of a policyholder withdrawal, an

insurer can either sell the specified

assets supporting the policyholder

liability or it can choose to use

cash from the general account to

satisfy the obligation.


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Analysis

The separate account structure is not alegal entity. However, management needsto consider whether underIFRS 10 the specified separate accountassets and separate account liabilitiesare a deemed separate entity (that is, asilo). IFRS 10 B77 requires, as a conditionfor a deemed separate entity, thatspecified assets of the investee....are the

only source of payment for specifiedliabilities of.... the investee and that insubstance none of the returns from thespecified assets can be used by theremaining investee and none of theliabilities of the deemed separate entityare payable from the assets of theremaining investee.

In the example, which is typical of manyseparate account structures, there is noprovision in the separate account

contract that prohibits settlement of theseparate account liabilities using assetsfrom the insurance entitys generalaccounts. In addition, satisfaction ofsome of the liabilities to the policyholderwill be met from the insurers generalaccount, such as the annuitisation option,as well as any other guaranteedminimum benefits.

The separate account structure acts as aform of collateral for the insurers

promise to pass through the investmentperformance of the fund to thepolicyholder; however, the assets in theseparate account are not the only sourceof assets the insurer will use to servicethe policyholder liabilities. So theseparate account is not a deemedseparate entity under IFRS 10.

Conclusion

The separate account structure asdescribed above would not be a deemedseparate entity under IFRS 10. Theinsurer will therefore recognise on itsbalance sheet both the separate accountassets (for example, securities, loans, realestate) and the policyholder liabilities.

In other fact patterns where satisfactionof the liability to the policyholder is metexclusively using separate accountassets, further analysis would be required

to determine if the structure could be adeemed separate entity controlled by aparty other than the insurer. If thestructure is a deemed separate entity, theinsurer will need to analyse if it haspower over the structure as well asexposure to variability of returns that thestructure provides. Refer to the sectionUnit linked contracts variable returnsanalysis for relevant considerations onan insurers exposure to variability ofreturns.

Policyholder

Benefits to policyholder:Pass through ofinvestment returns ofspecified assets lessmortality and expense(M&E) fee.

Guaranteed annuitisationoption at guaranteedrates.

Some provide otherguaranteed minimumbenefits, such asminimum returns orminimum death benefits.

Insurer

Separate account assets Separate account liability

Cash invested intoseparate account assets;insurer subtracts periodicM&E fee.

Separate account assetsreturns are passed throughto investor less the M&E fee.

Guarantee liability

Insurer also providesguaranteed annuitisationoption at minimum guaranteedmortality and interest ratesand may provide otherguaranteed minimum benefits.

Cash

Benefits

Separate account structure


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Structured entities

Insurance entities often enter intoarrangements involving structuredentities. The insurer has to determinewhether to consolidate the structured

entity or not. This determination may becomplex. The following example providesa consolidation analysis for a structuredentity formed to issue catastrophe bonds.

Catastrophe bonds

Background

A catastrophe bond (cat bond) structure isan alternative way for an insurer to obtainreinsurance cover for catastrophe exposures

such as earthquakes and hurricanes. Catbonds are risk-linked securities that transfera specific risk from the insurance companyto investors, typically through a structuredentity sponsored by the insurer which thenissues the cat bonds. The issue is whetherthe insurer that transfers its catastrophe riskto the structured entity should consolidatethe entity.

Example

An insurer establishes a three-year limitedlife entity that issues catastrophe bonds

with a three-year maturity to a small group

of sophisticated investors. The bonds are

the only instruments issued by the entity,

and the insurer holds none of them. There

are no voting rights in the entity. The

agreement requires the funds received,

which act as collateral for the insurance

risk, to be invested in a high-quality money

market fund. Should there be a need for

any reinvestment (for example, a

downgrade of investments in the money

market fund that would trigger

reinvestment), a trustee, named in the debt

agreement, would execute the

reinvestment decisions based on

guidelines specified in the debt agreement.

The insurance company pays an annual

fee to the structured entity in exchange

for a promise by the structured entity that

if a specified risk event occurs (for

example, a hurricane hitting Florida), the

structured entity will pay the insurer a set

amount using a predetermined formula

(for example, based on the severity of the

hurricane, as determined by published

hurricane data). The maximum payout is

limited to the amount of principal on the

catastrophe bonds issued by the

structured entity. This agreement may

sometimes be in the form of a

reinsurance agreement between the

insurer and the structured entity. From the

standpoint of the investors in the

catastrophe bonds, in the case where

there is no loss event, they receive full

debt repayment after three years,

including a return equal to the three

annual insurer fee payments for bearing

the catastrophe risk plus the returnsearned on the money market fund. In the

case where there is a catastrophe event

covered by the agreement, the investors

repayment is limited to any amounts

remaining in the entity after claim

payments are made to the insurer.

The substance of the arrangement is that

the insurer is passing on a portion of its

catastrophe risk to the structured entity,

which in turn passes that risk along to the

investors. The following diagram gives an

overview of the structure.

Trustee

Insurance company

Threeannual feepayments

Paymentson triggereventsPre-agreed

investmentuidelines

Dividends +fee payments+ debtprincipal (if notrigger event)

Money marketfund

InvestorsSPVInvestments Debt principal

Dividendsand

investment


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Analysis

Purpose and design, and exposure orrights to variable returns

As described in the overview, whenassessing control, an investor considers

the purpose and design of the entity.When the entity is designed so thatvoting rights are not the dominant factorin deciding who controls it, considerationshould be given to (a) the downside risksand upside potential that the entity wasdesigned to create; (b) the downside risksand upside potential that the entity wasdesigned to pass on to other parties in thetransaction; and (c) whether the investor(the insurer) is exposed to those risks andupside potential.

The purpose and design of the structuredentity is to receive an attractive returnfrom the annual fee and fundinvestments (the upside potential) inexchange for taking on catastrophe riskof the sponsoring insurer (the downsiderisk). This upside potential and downsiderisk are then passed on to the bondinvestors in the form of the investorsreceipt of the fund returns and insurerfees, and absorption of the insurance riskand consequently the variability of the

payout of the cat bond residual afterpossible insurance losses.

The insurer therefore acts as a creator ofrisk to the structured entity rather thanan absorber of risk. The insurers upsidepotential and downside risk are theopposite of those of the structured entity.That is, while the insurer may receive avariable return in the form of variableclaim payments, the amount of whichare contingent on the occurrence of acatastrophe event, this does not represent

exposure to downside risk variability, butinstead the insurers rights to upsidepotential compensation.

The insurer is however exposed to thestructured entitys credit risk if thetrigger event occurs and the entity needsto make a payment. However, thisexposure is remote because it requiresboth the occurrence of the trigger eventand the default of the money market fundbefore it results in losses to the insurer.

Such an exposure to variability seemsinsignificant compared to the variability

contributed by the insurer to the entityrelating to the catastrophe risk.

Relevant activities and power

In terms of who exercises power over the

relevant activities of the entity, therelevant activities of the structured entityin this example are very limited;everything is pre-agreed in a contractbetween the insurer and the investorsexcept for reinvestment decisions. Theentity exists only for a fixed number ofyears, which cannot be extended, with athree-year contract specifying fixedcontract terms for the catastrophe cover.The catastrophe claim payment iscalculated based on a specified formulacomputed using external market derivedhurricane data, such that the insurer hasno influence (power) over the amount ofthe claim payment. The investment in thehigh-quality money market fund is pre-agreed and cannot be changed except ifthere is a downgrade of the investedfunds. In this case, the trustee makesreinvestment decisions in accordancewith investment guidelines; however,these are pre-agreed on a mutual basisbetween the insurer and investors atcontract inception. Therefore neither the

insurer nor the investors has power overthe trustee. The only relevant activity isreinvestment of funds, and the insurerhas no power to direct that activity andthus does not have power over the entity.

Conclusion

The insurer should not consolidate thestructured entity, as it does not havepower over the entity nor is it exposed tothe variable returns of the entity andtherefore does not control it.


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Investment products

An insurance group may offer a variety ofinvestment products to investors, whichmay not be insurance policies. Forexample, investments in retail funds

including money-market funds may beoffered. The insurance entity may alsoitself invest its own monies obtainedfrom insurance premiums into a fund.

An insurance entity has to determine howIFRS 10 applies to such investmentstructures and whether to consolidatecertain investment vehicles. We analysethe considerations for retail funds andspecific money market funds in thissection.

Retail funds

Background

The asset portfolio of an insurance group(the Group) is likely to includeinvestments in retail funds. Often suchgroups engage also in fund managingactivities. When determining whether afund should be consolidated into theGroup, the question arises whether theGroup acts in the capacity of a principal

or agent in relation to the fund. Aprincipal controls the fund andconsolidates; an agent does not.

Example

An insurance holding company and one

of its subsidiaries (Sub 1) hold shares or

units in Fund F, which is managed by

another subsidiary in the group. Sub 1

and the fund manager are both 100%subsidiaries of the holding company.

Third-party investors are able to, and do,

invest in the fund without being a

policyholder of the insurer. The fund

manager has set up the fund for relatively

unsophisticated investors, and the

investment mandate states it can invest

in any equities traded on the London

Stock Exchange. The direct holdings in

Fund F are as indicated below and there

is an on-market management fee of 1%

of net asset values (NAV) accruing to the

fund manager. The funds shareholders

have rights to remove the fund manager

without cause with a three-month notice

period. They can do so by voting in a

meeting that can be called at any time by

investors holding 10% or more of the

units in issue. However, the shareholders

are widely dispersed, with holdings of

less than 0.5% each, and have no

realistic means by which to organise

themselves. The units are immediately

puttable back to the fund.

In the Groups consolidated accounts,

would F be consolidated?

100%100%

35%

5%

60%

Fund F

Insurance holding company

Fund manager Sub 1 Dispersed third-

party holders

Fund F


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Analysis

The Group must determine whether itis an agent or a principal in relation toFund F. Factors to consider includethe:

1. scope of the fund managersdecision-making authority;

2. rights held by other parties;

3. remuneration to which it isentitled; and

4. exposure to variability of returnsfrom other interests.

The first two factors relate to assessingthe extent of the fund managers powerover the fund and the extent of anyrestrictions on those powers. The second

two factors relate to the returns criterionand require the fund manager to considerthe magnitude and variability of thereturns it gets from the fund relative tothe total returns from the fundsactivities.

Scope of the fund managers decision-making authority

Decision-making authority refers todecisions over the relevant activities ofthe fund. The relevant activities are the

ones affecting the funds returns. Theyare the asset selection decisions made,including holding, managing anddisposing of assets. Another relevantactivity is the determination of theinvestment mandate and parameters forinvesting. As the fund has been set up toprovide investment opportunities torelatively unsophisticated investors, thefund manager is realistically the onlyparty involved in determining thepurpose and design of the fund and in

outlining the investment mandate. Underthe mandate, the manager can invest inany equities traded on the London StockExchange. Within the context of IFRS 10,this represents sufficiently wide decision-making discretion; and correspondingwith example 14 in IFRS 10 B72, this mayindicate that the asset manager hassignificant power to direct the relevantactivities of the fund. This thereforeindicates that the fund manager (and theGroup through controlling the fundmanager) has power.

Rights held by other parties

IFRS 10 states that if a single party hasthe right to remove the fund managerwithout cause this has the effect that thefund manager is an agent (IFRS 10 B65).If such rights are not present, additionalconsiderations are needed to determinewhether the asset manager is principal oragent. These include how substantive theremoval rights are where agreement of anumber of investors is required toexercise them. The shareholders have inthis example rights to remove the fundmanager without cause with a three-month notice period. They can do so byvoting in a meeting that can be called atany time by investors holding 10% ormore of the units in issue. The unit

holders are so dispersed that, apart fromthe Group itself, none of them holds 10%or more and they have no realistic meansto organise themselves so as to achievethe required holding; so the rights toremove the fund manager are considerednon-substantive. In practice, it is veryunlikely that they would call a meetingspecifically to vote out the fund manager;rather unit holders would be more likelyto put back their units.

RemunerationThe fund managers fee is at arms lengthand a fixed percentage of the NAV. UnderIFRS 10 B69, this would be an indication,if taken on its own, that the fundmanager is an agent. However, the Groupin this case has other exposure to furthervariable returns through investments,which will also need to be taken intoaccount to determine if control exists.The fund manager on its own would nothave sufficient exposure to variable

returns, but the Group who controls thefund manager and also has a directinvestment may.

Exposure to variability of returns fromother interests

The greater the magnitude and variabilityof its exposure, the more likely the Groupis to control. IFRS 10 does not definebright lines as to what constitutessufficient exposure to variable returns togive control. The exposure must be

evaluated relative to the total variabilityof the funds returns. Here the Group hasa 35% investment. In addition, the Group


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controls a subsidiary, which has a further5% investment. The Group also receives afee of 1% of NAV. All of these expose theGroup to variable returns.

The examples 13-14 in IFRS 10 B72

indicate that the level of variable returnsmust be sufficiently high to conclude thatthe Group is acting as principal and soshould consolidate the fund, when theasset manager has power.Notwithstanding an analysis of the otherfactors, in example 14A the fundmanagers exposure comprises a 20%performance fee (manager earns 20% oftotal returns if hurdle is achieved), adirect investment of 2% plus amanagement fee of 1% of NAV. In that

example, it is concluded that the level ofexposure indicates no control. Inexample 14B, the same exposures exist asin 14A except that instead of a 2% directinvestment, there is now a 20% directinvestment (alongside with the sameperformance fee and management fee).Here it is concluded that the level ofexposure indicates control. In ourexample, the magnitude of exposure mayactually be higher than example 14B, asthe entity in 14B may not always reachthe performance target.

Conclusion

The Group controls Fund F because:

it has power over Fund Fs relevantactivities through controlling the fundmanager who has this power;

rights held by other parties to kick outthe manager are not sufficientlysubstantive to remove power; and

the Group has sufficient exposure to

variable returns of Fund F.

Money market fundsconsolidation reassessment

Background

In some cases, insurance groups may actas a fund manager of a money-marketfund (MMF) and not have a directinvestment in the fund. When there is nodirect investment and the fund manageris paid an on-market fee that is notexpected to absorb a significant amount

of the variability of the fund, under

normal circumstances the insurancegroup would not consolidate the MMF.

However, IFRS 10 requires a reassessmentof whether the group controls the fund iffacts and circumstances indicate that there

are changes to one or more of the elementsof control. IFRS 10 notes that the initialassessment of control including theinsurance companys status asprincipal/agent would not change simplybecause of a change in market conditions(for example, a change in the fundsreturns driven by market conditions),unless the change in market conditionschanges one of the control elements or theoverall principal/agent relationship.

The following is an example of a situationwhere poor economic conditions severelyreduce a MMFs return.

Example

A fund manager controlled by an insurer

has set up and manages an MMF. The

fund manager has decided on the

investment strategy, and it can choose

MMF investments from a wide pool. The

fund is an open-ended mutual fund

whose units are held by widely dispersed

investors. The unit holders do not havethe right to remove the fund manager, but

they can redeem the units they hold at

any time. As a result of poor market

conditions (for example, very low interest

rates), the performance of the fund is

below 1% per annum, and the fund

manager receives an annual fee of 0.5%

of the net asset value (NAV) of the fund.

The manager only earns this fee; it has

no other fees and no investment in the

fund. The fee at the time of set-up was

on-market. In prior periods, the MMF hasnot been consolidated by the insurer

because the magnitude of returns

compared to the total return of the fund

was not sufficiently high (annual fee of

0.5% of NAV).

What factors should the fund manager

consider in deciding whether a

consolidation reassessment is necessary

given the management fees now

represent more than 50% of the income

of the fund?


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Analysis

The core question is whether the currenteconomic conditions mean that thecontrol relationship needs to bereassessed. IFRS 10 para 8 would lead tothis, as it requires continuousreassessment of control and the changein economics indicates a change in one ofthe elements of control (exposure tovariability that in turn affects theprincipal/agent analysis).

The overall principle is therefore toestablish if the relationship of the fundmanager to the fund has changed andwhether the fund manager is still actingprincipally as an agent for the otherinvestors or whether it is now acting

principally on its own behalf and toprotect its own fee. Given the change inthe economic environment, areassessment is required, which meansthe analysis of principal versus agentshould be re-performed to establish if therelationship between the fund managerand the investors has now changed.

IFRS 10 requires a fund manager toconsolidate a fund if it controls the fund.The fund manager has to determine if the

overall relationship it has with the fundand the other parties is that of a principalor of an agent. If the fund manager is anagent, it does not control the fund. Thecriteria to take into account are:

1. scope of the fund managersdecision-making authority;

2. rights held by other parties;3. remuneration to which it is entitled;

and4. exposure to variability of returns

from other interests.

The fund manager has power over therelevant activities of the MMF as it setsthe investment strategy and can invest ina variety of money market instruments toachieve a return for the unit holders.There are no rights held by other partiesthat may restrict this power (that is, nokick out rights). Looking at these factorsonly, the manager would have power as it

selects investments and there are no kickout rights.

The fund manager is also exposed tovariable returns from the annualmanagement fee based on the funds

NAV. The remuneration was set atmarket and is commensurate with theservices provided. Off-market fees wouldindicate that the fund manager is aprincipal and a fund manager can only bean agent if remuneration is set at marketrates. In this example, the fund managerhas no other interest in the fund.Nevertheless, the remuneration in thecurrent poor market conditionsrepresents more than half of the incomeof the fund on an absolute basis. Is this

magnitude of exposure thereforesufficiently high to conclude power existsdespite the fee being on market?

Consideration of exposure to variabilityshould be performed over the fundslifetime rather than at a point in time. Inaddition, the fund manager considers thereturns that are expected from theinvestee (and its share), as well asmaximum and minimum exposure tovariability. The fund manager shouldconsider its absolute share of returns aswell as its exposure to variability from thefund (magnitude and variability (IFRS 10B72(a)).

In particular, the last criterion onexposure to variability of returns iscritical, as the other criteria are fairlyclear. Whether or not the consolidationanalysis produces a different outcomedepends on facts and circumstances. Ifthe fund manager now receives morethan half of the MMF returns through the

NAV management fee, the fund managerneeds to look carefully at the originaleconomics when setting up the fund, andany measures the fund manager mayemploy now to alleviate the poor market for example, fee waiver or redemptionsuspension. The following factors shouldtherefore be considered.


18/22


Factors Analysis to determine whether the fund manager now hascontrol

Expectedduration ofpoor

marketconditions /existence atMMF set up

If the current poor returns and length of time they are expected topersist are within the distribution of returns considered when theMMF was set up this indicates there is no overall change in the way

the fund manager manages the fund (as that of an agent).However, if the present poor conditions or length of time they areexpected to persist were not envisaged at the time of set up, theywould not have been included in the MMFs initial purpose anddesign. This could therefore indicate the fund manager now controlsthe fund and should consolidate it. This is because the fundmanager may now be approaching this fund with a different goal: toprotect its interest and therefore acting as principal.

Fee waiverimpliedfinancialsupport

In the case where the fund manager grants (either explicitly orimplicitly) financial support or puts in place a fee waiver, this ismore likely to indicate control for the fund manager, because itcreates more exposure to variability of returns. It may be that the

returns to the investors become fixed and downside variability isprimarily borne by the fund manager. This should be included in thevariability analysis.

Redemptionsuspension

It is also necessary to consider the effect of any right of the fundmanager to suspend redemptions in accordance with theprospectus. If the fund manager can suspend all redemptionswithout cause, then it is more likely that the fund manager is actingon its own behalf because it continues to earn its fee based on fundsthat the investors cannot access. Also investors are unable toexercise influence by redeeming their units (that is, by voting withtheir feet); so have given the fund manager more power.

Conclusion

There is a need for reassessment, but theoutcome of a re-performance of theoriginal analysis depends on facts andcircumstances. If a change in therelationship between the fund managerand the MMF has occurred, the MMFwould now need to be consolidated. Achange in relationship could arise forexample, if the poor conditions or theperiod for which they are expected to last

were not foreseen at the outset, or if thefund manager now waives its fee or nowsuspends redemptions. The reason whythese would point towards a change inrelationship is because such factorswould indicate that the fund managernow acts as a principal.

Unit linked contracts variable returns analysis

Background

Insurance companies may issue unit-linked insurance contracts topolicyholders. When assessing whetheror to what extent an insurer is exposed tovariable returns from an investmentfund, the question arises whether thereturn on investments in the fund that

back unit-linked insurance contractsshould be included in the variabilityanalysis or not. This assessment is part ofthe question whether the insurancecompany should consolidate the unitlinked fund in its consolidated financialstatements. The insurance company maycontemplate whether, despite possiblyhaving power over a unit-linked fund, itfails the exposure to variability criterion,as all the returns from the fund arepassed on to policyholders.


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Example

Insurance Co issues unit-linkedinsurance contracts to the policyholders.

Premiums are paid by the policyholder to

the insurance company, which forms the

basis of the policyholders account value.

Each policyholder decides on the profile

of investments that it would like its

premiums to be invested into; each

policyholder can change that investment

selection throughout the life of the policy.

In practice, the insurance group has set

up a number of funds with different

underlying portfolios of assets. Based on

the policyholders investment selection

and desired level of risk, the insurance

company purchases and allocates units

in the fund(s) to the policyholders

account value. The asset manager also

makes the decisions on the purchase

and sale of investments within the

underlying fund portfolio. All investment

decisions are therefore made by the

insurance group and not by the

policyholders. The insurance group

arguably has the power to affect variable

returns of the fund. The policyholders

account value is subsequently credited

with the return from those funds, suchthat the account value bears the up- and

down-side performance risk of the

underlying investments of those funds.

Upon termination (that is, on surrender,

death or maturity) the Insurance Co pays

the account value claim out to the

policyholder in cash.

The insurer is not contractually obliged to

invest in particular funds; instead an

obligation is created for the insurer to

generate and credit the account value

with returns that are similar to the returns

that the policyholder would have received

for their selected profile of investments.

In addition, even though the insurer has

invested monies received from the

policyholders, it is not obliged to sell

those investments on policy termination;

that is, the insurer can use its other liquid

resources to pay policyholders their

account value. Finally, the policyholders

account value is not ring fenced such that

on bankruptcy those assets may be used

to meet other obligations of the insurer.

Analysis

As described in the Example section,the insurance company has power. Thefocus and analysis in this example is onwhether the insurance company isexposed to variable returns. Theinsurance group receives variable returnsfrom the fund in the form of both assetmanagement fees and investment returns

from its investments in the fund.

Typically, the asset management feealone is unlikely to lead to the insurancegroup being exposed to sufficient variablereturns to trigger consolidation of thefund.

However, the question arises as towhether the insurance group is exposedto the variable returns from the fund

given that the return is credited to thepolicyholders account value and thus issubsequently paid out to the policyholder

Insuranceparent

Assetmanager

Unit-linked fund

InsuranceCo

Portfolio of assets

Policyholders

Premiums and claims

100% shares100% shares

100% units


20/22


when a claim is made. That is, somemight argue that the insurance group hasa minimal net exposure to variableinvestment returns. However, as theinsurance company has directlypurchased all of the units in the fund, the

insurance group is exposed to, andbenefits from, 100% of the risks andrewards from that fund. This includes100% exposure to the variableinvestment returns.

Conclusion

IFRS 10 requires investors to consolidateinvestees where they have power over theinvestee, exposure to variable returns andan ability to use their power to affect thevariable returns from the investee. As the

insurance group has power over the fundto affect investment returns and hasexposure to sufficient variable returns, itshould consolidate the investment fundin this example.

Lloyds structures syndicates

Background

The issue is whether the insuranceoperations of a Lloyds syndicatewould be required in certain instancesto be consolidated by either theManaging Agent that manages thesyndicate or a capital provider (aName).

Lloyds of London (Lloyds) is aninsurance and reinsurance market placewhere members mutually agree on thepooling and spreading of insurance risk.Members can be individuals (Names) orcorporate capital vehicles (CCVs) or a

combination of both. Lloyds syndicatesare associations formed by Members andthey operate as annual business ventureswhere members participate in aparticular year of account.

Each syndicate has a Managing Agentthat manages and oversees the

activities of the syndicate (for example,performs underwriting, investmentmanagement services, claimsoperations); a standard agencyagreement signed by each member setsout the relationship between the

managing agent and that member onan individual basis. If a member hasconcerns that an agent is not acting inaccordance with its fiduciary duties, itcan ask Lloyds to review the positionof the agent, although in practiceremoving a managing agent would be adifficult and drawn out process.

A Lloyds syndicate is not a separatelegal entity. It is simply a group ofNames who have joined a particular

syndicate for a particular underwritingyear. Each policy issued at Lloydsconsists of individual contracts madeon behalf of individual Names and thesyndicate does nothing on its ownbehalf. The syndicate cannot thereforecontract or be sued in its own name.Any legal action is taken in the namesof the members of the syndicate ratherthan the in the name of the syndicateitself.Syndicates do not hold bank accountsor investments in their own name;assets are instead held within apremium trust fund (PTF) in trust foreach member in accordance with adeed. Lloyds mandates the use ofPTFs to provide security to thepolicyholders that claims will be paid.The PTF is a therefore a fund intowhich all premiums due to themember are received, and from whichall claims and expenses are paid onbehalf of the member. Amounts aredistributed to the members at the end

of that syndicate year of accounts life(normally three years).

We now analyse if a Lloyds syndicateshould be consolidated under IFRS 10or if possibly IFRS 11 applies. Thelatter would be the case if the syndicatewas a joint arrangement.


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IndividualName A

IndividualName C

IndividualName B

15%

15%

Insurance company

Managing agent

Corporate capitalvehicle

Premium trustfund

Policyholder/assured Syndicate

Premiums andclaims

100%

100%

15%

55%

Analysis

IFRS 10

IFRS 10 only applies where the potentialsubsidiary is an entity (see IFRS 10 para 5and Appendix A). If the syndicate is not anentity, it would be out of scope ofIFRS 10. Entity is not defined in IFRS 10,and there is little other guidance elsewherein the current IFRS literature. Because thesyndicate is not a legal entity, cannotcontract or be sued in its own name, and

each policy issued at Lloyds consists ofindividual contracts made on behalf ofindividual Names, the syndicate is not anentity for purposes of IFRS 10.

As a Lloyds syndicate is not an entity, itis not in the scope of IFRS 10.

IFRS 11

IFRS 11 applies to joint arrangements,where the parties are bound by acontractual arrangement and that

arrangement gives two or more ofthose parties joint control of thearrangement. There must therefore bejoint control, which is thecontractually agreed sharing of controlof an arrangement, which exists whendecisions about the relevant activities

require the unanimous consent of theparties sharing control.

As the contractual agreements arebetween each member and the managingagent and not between the members,there is no contractual agreementbetween the members to share control ofthe syndicate. There is also norequirement for unanimous consentbetween the members; instead, eachmember delegates authority via theagency contract to the managing agent toact on each members behalf. As there isno joint control, the syndicate does notconstitute a joint arrangement underIFRS 11.

Conclusion

As the Lloydssyndicate arrangement isoutside the scope of IFRSs 10 and 11,entities that participate in syndicatesshould only account for the relevantproportion of the insurance orreinsurance contracts they have entered

into on their own behalf. This is oftenreferred to as the proprietary approach.

Examplestructure


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Concluding remarks

The examples above show thatinsurance or reinsurance groups may

enter into a variety of contractsinvolving structured entities,investment and insurance structures.These can be complex and tailored tospecific investors or client needs.

The purpose of this guide is not to coverall possible scenarios but to highlight thethought-process that insurance groupswill need to apply to analyse their ownstructures under IFRS 10. In our view,insurance entities should notunderestimate the tasks that lie ahead inimplementing IFRS 10 as the underlyingcontracts and the resulting analyses arelikely to be complex.

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. It does not take into account any objectives,financial situation or needs of any recipient; any recipient should not act upon the information contained in this publication without obtaining independent professional advice.No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted bylaw, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you oranyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

2012 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, eachof which is a separate and independent legal entity.

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