View
216
Download
0
Category
Tags:
Preview:
Citation preview
Casualty Actuaries of New England (CANE) September 26, 2008
Dispelling the Fog: ERM, Solvency II & IFRS
Slide 2
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
FOG
A state of mental dimness and confusion.
PricewaterhouseCoopers
Slide 3
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM can provide a solid foundation for many key aspects of IFRS implementation, as well as synergies to help ease the cost of compliance with other forthcoming risk/capital management directives, including Solvency II.
Regulatory challenges include overcoming the continuing uncertainty with respect to insurance reporting under IFRS and gearing up for the forthcoming Solvency II. Increased pressure from regulators and rating agencies alike sees more focus on ERM.
PricewaterhouseCoopers
Slide 4
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Agenda
Introductions
Overview of ERM
Solvency II Update
Overview of IFRS
Linkages between ERM, Solvency II, and IFRS
Company perspective
Q&A
PricewaterhouseCoopers
Slide 5
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Navigating Through Fog
Stay Calm
Slow Down
Avoid Braking Often
Avoid Distractions
PricewaterhouseCoopers
Section One
ERM Overview
Slide 7
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Does ERM matter?
“Risk management adds value not only to individual companies, but also supports overall economic growth by lowering the cost of capital and reducing the uncertainty of commercial activities.”
James Lam“Enterprise Risk Management – From Incentives to Controls”
PricewaterhouseCoopers
Slide 8
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Overview
The benefits of ERM are derived from integration:
1. an integrated organization, which often includes a centralized risk management unit reporting to the board, CEO or CFO with responsibility for broad risk policy setting across risk taking activities;
2. an integration of risk transfer strategies (considering all risks, and any diversification benefits between them); and
3. the integration of risk management into business processes, optimizing performance through risk adjusted pricing, resource allocation, and enhanced business decision making.
Enterprise Risk Management
Source: James Lam – Enterprise Risk Management – From Incentives to Controls
PricewaterhouseCoopers
Slide 9
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Overview
An ERM infrastructure must be developed…
1. risk management governance;
2. risk management policies and procedures;
3. risk assessments and audits;
4. systems and financial models;
5. measures and reports; and
6. risk limits and exception processing.
Develop from the top down!
Enterprise Risk Management
PricewaterhouseCoopers
Slide 10
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Overview
…however, ERM benefits will only be realized when companies:
1. build risk awareness through senior management commitment;
2. create a culture for risk management;
3. facilitate open communication;
4. identify and/or develop talent; and
5. reinforce behavior.
Enterprise Risk Management
PricewaterhouseCoopers
Slide 11
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Reporting Measurement
and ControlOperations
Risk assessment/Response
Business mission and strategy
Risk strategy Value proposition Risk appetite
Risk awareness/Identification
Organisation and people
Limits and controls
Methodologies & Models Systems Data Policies Reporting
Culture Training CommunicationPerformance
measuresReward
StrategyProcess
Infrastructure
Environment
Validation/re-assessment
ERM Overview – An Illustrative Framework
Enterprise Risk Management
PricewaterhouseCoopers
Slide 12
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Integration of Enterprise Risk Management
Enterprise Risk Management
PricewaterhouseCoopers
Slide 13
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure – Organization and people
• Centralized independent risk management function• CRO or senior executive with risk role• Oversight committees at the Board / senior management levels• Risk awareness, culture and values• Risk training• Talent management• Linkages between risk and compensation
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 14
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure – Limits and Controls
• Define corporate-wide and product-specific risk appetites• Risk assessments• Risk inventories• Exposure limits and triggers• Risk controls• Risk escalation
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 15
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Risk Appetite• A measure of the potential financial impact that the
company is willing to take in exchange for a targeted return• ERM programs may have multiple definitions for risk
appetites- Capital (Ruin focus)- Earnings (Volatility focus)- Rating (May be driver of probability choice)
• Alignment with product pricing
ERM Terminology
Enterprise Risk Management
PricewaterhouseCoopers
Slide 16
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Risk Tolerance• Relates to management strategies
Risk Limits• Defining risk limits - connection with the company-wide risk
appetite, approval processes• Risk escalation processes• Procedures used for monitoring and responding to limit
breaches• Automatic triggers, risk dashboards
Enterprise Risk Management
ERM Terminology
PricewaterhouseCoopers
Slide 17
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Process in Place to Define Risk Appetite
Enterprise Risk Management
PricewaterhouseCoopers
Slide 18
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Process in Place to Deal with Breaches of Limits
Enterprise Risk Management
PricewaterhouseCoopers
Slide 19
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure – Methodologies & Models
• Insurance, market, credit and operational risk management
• Economic capital models & capital allocation
• Risk analytics, including scenario analysis, risk indicators, risk-adjusted returns
• Risk transfer strategies
• Linkage of planning and risk strategy
• Linkages to product pricing
• Performance management
• Capital management
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 20
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Economic capital models
Economic Capital
Liabilities
Assets available for required
capital
Assets covering liabilities
“Excess” Capital
Key areas where survey respondents identified benefits of implementing an economic capital model:
• Better allocation of capital than under a regulatory capital model
• Definition of risk appetite
• Freeing up of capital for use in the business
• Changes in the pricing of products to better reflect risk
• Changes in strategic direction after assessing risk-adjusted performance
Enterprise Risk Management
PricewaterhouseCoopers
Slide 21
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Economic capital models (cont’d)
Aggregate Economic Capital Model
Market Risk
Insurance Risk
Credit Risk
Operational Risk
Inte
r-se
gm
en
t D
ive
rsifi
catio
n
Inter-risk Diversification
BU 1
BU 2
BU 3
Corporate & Other
Types of models • Factor based• Stress tests• Combination models (usually a
combination of factor based models with either stress testing or stochastic modeling)
• Fully stochastic models
Range of risks• Insurance risks — typically
modeled using stress tests for life business and stochastically for non-life business
• Market risk and credit risk — often modeled stochastically
• Operational risk — factor based or “scenario driven models” are common
Enterprise Risk Management
PricewaterhouseCoopers
Slide 22
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Source: 2008 PwC survey covering ERM in the global insurance industry
Risk categories explicitly captured in economic capital models
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Insurance Credit Market Operational Strategic
Risk category
Per
cen
tag
e o
f re
spo
nd
ents
Confidence level applied when managing VaR
95%
99%
99.5%
99.7%
99.9%
99.95%
Risk measures managed within economic capital models
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
VaR TVaR CTE Earnings atRisk
EmbeddedValue
Other
Risk measureP
erc
en
tag
e o
f re
sp
on
de
nts
Economic capital models (cont’d)
Enterprise Risk Management
PricewaterhouseCoopers
Slide 23
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Model Development Timeline
Enterprise Risk Management
PricewaterhouseCoopers
Slide 24
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Traditional Operational Risk Management - Separate Silo Risk Management for:• IT Risks• HR Risks• Regulatory & Compliance Risks• Fraud Risk• Internal Controls• Reputation Risk• Business Continuity• Distribution Risks• Outsourcing/Vendor Risk
Operational Risk
Enterprise Risk Management
PricewaterhouseCoopers
Slide 25
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Enterprise ORM – leading to Strong ORM assessment by S&P usually associated with:• Comprehensive assessment of risks & control capabilities• Identification of risks not adequately controlled by existing
programs• Prioritization• Development of key risk indicators, tracking process & problem
resolution system
Excellent ORM assessment usually associated with: • Repeated application• Refinements of controls & KRIs • Response programs
Operational Risk Management
Enterprise Risk Management
PricewaterhouseCoopers
Slide 26
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure - Systems
• ERM supporting technology
• System interface, mapping tools, middleware
• Risk registers
• Exposure analytics, drill-down capabilities
• Risk reporting tools
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 27
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure – Data
Risk and portfolio data requirements:• Access• Common definitions• Quality assessments • Cleansing
• Data warehouses
• Industry data
• Benchmarking data
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 28
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Rating Data Management Expenditures
Enterprise Risk Management
PricewaterhouseCoopers
Slide 29
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure – Policies
• Market, credit, insurance, operational risk policies and procedures, including:
• Risk rating policies;• Exposure management policies;• Risk limit policies;• Monitoring and review policies;• Risk transfer policies;• Management and board reporting policies.
• Overall risk policies• Emerging risk policies
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 30
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ERM Infrastructure – Reporting
• Board reporting, including enterprise view on aggregate losses, risk incidents, policy exceptions, key exposures, KRIs
• Key risk indicators that quantify major trends and risk exposures
• Limit exception reporting
• Risk dashboards
• ERM disclosures
• Finance effectiveness – exploiting synergies between requirements for financial reporting, ERM, Solvency II, and IFRS
Organisation and people
Limits and controls
Methodologies & Models
Systems Data Policies Reporting
Enterprise Risk Management
PricewaterhouseCoopers
Slide 31
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Does ERM matter?
Through improved…• Coordination• Communication• Financial discipline• Transparency
Enterprise Risk Management
PricewaterhouseCoopers
Section Two
Solvency II Update
Slide 33
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Solvency II – EU taking a global lead in insurance regulation
“This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers. We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently.”
Charlie McCreevyInternal Market and Services Commissioner
Speaking at the launch of the Solvency II draft Framework Directive
Solvency II
PricewaterhouseCoopers
Slide 34
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Is Solvency II likely to have Global impact?
• Principles-based risk sensitive regulation is becoming the norm
- US led the way (RBC models) initially, then Canada (DCAT)
- More recently: Australia, UK (ICAS) and Switzerland (SST)
- Many other jurisdictions are looking at implementing Solvency II or seeking “equivalent regime” status
• NAIC publicly-stated intention to consider options
• However, State-based US system adds significant complexity to regulatory innovation/connectivity with other global regulators; e.g.
- Principles-based reserving discussions likely to take years to finalise
- Policy forms and premium rates still needing regulatory approval
• The Optional Federal Charter solution?
• IAIS has now got real traction
• Global footprint of CFO and CRO Forum members
Solvency II
PricewaterhouseCoopers
Slide 35
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Solvency &Financial Reporting
EconomicCapital
Economic capital – lies at the heart of Solvency II and at the core of managing your business
Delivering Shareholder
Value
EnterpriseRisk
Management
Rating Agencies
Solvency II
PricewaterhouseCoopers
Slide 36
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Solvency II – Timescales
Draft Framework Directive published
2007 2008 2009 2010 2011 2012
High Level Principles (Level I Directive) adopted
Solvency II system in operation
(31 October 2012)
Quantitative Impact Study v.3
Quantitative Impact Study v.4
Detailed rules (Level II implementing measures)
EU member states to transpose into law
The above timeline corresponds closely to the current IFRS timescale – but the two projects are not formally linked
Model pre-approval process
Solvency II
PricewaterhouseCoopers
Slide 37
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
PILLAR IQuantitative requirements• Assets and Liabilities –
market consistent valuation • Investments• Solvency Capital
Requirement (SCR):• European Standard
Formula; or• Internal Model
• Minimum Capital Requirement (MCR)
• Own Funds
PILLAR IISupervisor review
• System of governance
• Own risk and solvency assessment (ORSA)
• Supervisory review process
• Supervisory intervention including capital add-on
PILLAR IIIDisclosure
• Public Disclosure – annual solvency & financial condition report
• Information to be provided for supervisory purposes
GROUP SUPERVISION – all pillars applicable to solo entities and groups
Solvency II – Draft Framework Directive - overview
Solvency II
PricewaterhouseCoopers
Slide 38
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Solvency II – Quantitative requirements
Assets at Market Value
MCR
Solvency Capital Requirement (SCR)
Technical Provisions
Assets available for SCR/ MCR
Market consistent valuation for hedgeable risks
Best estimate
Risk margin
for non-hedgeable risks
Assets covering technical provisions
Proposed framework for Pillar I
Solvency II
PricewaterhouseCoopers
Slide 39
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Current areas of contention within Solvency II/ outstanding issues
• Group supervision and group support- role of lead versus country supervisor- group support mechanism- Treatment of 3rd countries (e.g. USA, Bermuda, Far East)
• Design and calibration of MCR• Treatment of surplus funds (Germany), equities re: market risk (France)• Proportionality (e.g. should there be a de minimis threshold?)• Public disclosures – extent, timing• Captives and mutuals• Use of internal models• Role of audit (overlap with financial reporting)
Solvency II
PricewaterhouseCoopers
Slide 40
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Solvency II – Progression from Solvency I
Solvency I Solvency II
Pillar 1
Pillar 2
Pillar 3
• Local GAAP/IFRS• No internal model• RMM
• Supervisory review• No EU harmony
• Group capital assessment (post IGD) – no diversification benefit
• Public Disclosure • FSA Return, IGD data
• Market consistent valuations• MCR, SCR• Internal model optional (use
subject to supervisory approval)
• Supervisory review process• Emphasis on governance and risk management• Capital add on: exceptional• Group capital assessment with diversification benefit • ORSA
• Public Disclosure
Solvency II
PricewaterhouseCoopers
Slide 41
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Summary of possible implications of Solvency II
Small Large
Multinational
Domestic
• Inability to meet SII requirements?• Disproportionate compliance costs• Reconsideration of operating structure• Seeking merger partners• Industry roll up possibilities• Discontinuation of business• Insolvency
• Reconsideration of HO location• Diversification benefits / reduced capital req.• Reconsideration of operating structure• Acquisition opportunities (e.g. amongst small players)• Strategic re-evaluation of business lines• Disposals or run-off of underperforming / capital intensive books• Capital fungibility challenges
• Seek merger partners to obtain diversification benefits• Reconsideration of operating structure• Acquisition opportunities (e.g. amongst small players)• Strategic re-evaluation of business lines• Disposals of run-off/underperforming books• Capital fungibility challenges
Solvency II
PricewaterhouseCoopers
Slide 42
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
What are we seeing European firms doing at present?• Broad EU industry support for the proposals
• SII approach and level of engagement differs by country and segment
In Europe generally, what are companies typically doing:
• General education and awareness raising
• Companies taking a more proactive stance:
- Impact assessments/gap analyses (see below for typical themes)
- Setting up Solvency II project teams
- Examining specific aspects e.g. risk appetite/ERM framework
- Restructuring ahead of the final Directive wording
- Data warehouse set-up, model specification and build
- Projects covering economic capital, IFRS, MCEV
- Addressing broader finance transformation and actuarial integration
Outside EU, already some regulators and companies looking at same concepts
Solvency II
PricewaterhouseCoopers
Slide 43
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Market implications - Rating agency interaction with Solvency II
• Capital is just one element of ratings
• Rating agencies not all using DFA models – but moving in that direction
• Agencies stated intention to converge- Consider companies’ internal model (S&P launched limited EC model
review)- Still the option of qualitative add-on for other agency factors- Some major differences in approach (diversification benefits less
generous, no explicit discount for lack of fungibility of capital)
• Calibration differences (SCR is approximate to BBB)
• Agencies and indeed markets will react to any Pillar II add on
• Regulators may expect an integrated approach to calculating capital held
• Increased focus on ERM concepts
Solvency II
PricewaterhouseCoopers
Slide 44
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Link to ERM - Impact on organisations from the Solvency II risk and governance requirements – Pillar II - ORSA
Key Challenges
• Integration of ORSA into the business’ strategic management
• ORSA expected to serve multiple purposes including regulatory compliance
• Ability to have risk management systems that monitor, manage and report risk on a continuous basis (at individual and aggregate level)
• Use for allocation of capital, consistency between pricing and capital decisions
Solvency II
ORSA
ManagementStrategy
Operations InternalModels
EMBEDDING RISK MANAGEMENT
PricewaterhouseCoopers
Slide 45
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Regulatory approval of an internal model will require an entity to satisfy three broad tests:• Test 1: Statistical Quality Test (Article 119) – Actuarial model• Test 2: Use Test (Article 118) – Internal risk management• Test 3: Calibration Test (Article 120) – Regulatory capital
In addition, entities must satisfy:• Validation Standards (Article 122)• Documentation Standards (Article 123)
Draft Solvency II Directive:
Solvency II
PricewaterhouseCoopers
Slide 46
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Internal Models – External Review
Review Element Solvency II FOPI APRA
Partial or Full Models
Scope and granularity
Completeness and consistency
Calibration standards
Stresses and scenarios
Model “use” and linkages
Validation framework
Governance framework
Limitations and development plans
Documentation
Draft regulatory requirements for approval of internal models:
Solvency II
PricewaterhouseCoopers
Slide 47
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Pillar III - Public disclosure and link to IFRS
Public disclosure
• Annual disclosure of solvency and financial condition report
• Subject to approval groups may disclose only one report
• Systems/ structures required to ensure ongoing appropriateness of information disclosed
Link to IFRS
• Conceptually in line with IFRS approach and timeline
Solvency and financial condition
report to contain information on
• The nature and performance of the business
• Governance systems
• Risk management approach and risk profile
• Valuation basis for assets and liabilities
• Capital management including structure and quality of own funds, MCR and SCR
• Non-compliance with MCR and SCR during reporting period
Solvency II
PricewaterhouseCoopers
Section Three
IFRS Update
International Financial Reporting Standards (IFRS)
What is IFRS?SEC RoadmapInsurance Contracts TodayInsurance Contracts Phase 2
Slide 50
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Background
• IFRS—International Financial Reporting Standards• Standard setter—International Accounting Standards Board (IASB)
founded in 2001 and based in London• International Accounting Standards Committee (IASC) Foundation
- Appoint IASB members- Exercise oversight- Raise funds- Similar to Financial Accounting Foundation (FAF)
• Predecessor organisation was International Accounting Standards Committee (IASC) founded in 1973
What is IFRS?
PricewaterhouseCoopers
Slide 51
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Geographical break-down
Europe 6
North America 3
Asia / Oceania 3
Rest of the world 1
IASCFoundation22 trustees
SAC50 members
IFRSHigh quality, enforceable and global
IASBChairman plus
12 members
IFRIC12 members
AppointGovernFund
AppointAppoint
InterpretAdvise
Create
Trustees
Board
Geographical break-down
Europe 8
North America 6
Asia / Oceania 6
Rest of the world 2
Standard setting structure
What is IFRS?
PricewaterhouseCoopers
Slide 52
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
A simpler set of accounting guidance
IFRS • Standards
─ IFRS: 8─ IAS: 29
• Interpretations─ IFRIC: 8─ SIC: 11
• Framework
US GAAP • Standards:
─ SFAS: 106─ APB: 16─ ARB: 4
• Interpretations ─ FSP: 49─ EITF: 108─ FIN: 27
• Concepts Statements: 6• Other
─ FTB: 32─ AICPA Interpretations: 6─ SOP: 51─ AICPA Industry Audit and
Accounting Guides, SABs, DIGs…
2,500 pages 25,000 pages
What is IFRS?
PricewaterhouseCoopers
Slide 53
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Criteria for
principles-based
standards
Faithful presentationof economic reality
Responsive to users’needs for clarity and transparency
Consistency with aclear conceptual
framework
Based on an appropriately defined scope
Written in clear, concise and plain
language
Allows for use ofreasonable judgment
IFRS Framework
What is IFRS?
PricewaterhouseCoopers
International Financial Reporting Standards (IFRS)
What is IFRS?SEC RoadmapInsurance Contracts TodayInsurance Contracts Phase 2
Slide 55
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
When might the transition to IFRS occur in the US?
2008 2010
2009
2012 2014
2007 2011 2013 2015
March 2007 SEC roundtable on US GAAP reconciliation for IFRS filers
July 2007 SEC proposal eliminating US GAAP reconciliation for IFRS filers
August 2007 SEC concept release on use of IFRS for US registrants
November 15, 2007Reconciliation eliminated for IFRS filers
January 2009-2014Voluntary application of IFRS permitted for certain US registrants
January 2014Proposed roadmap targets potential mandatory adoption in 2014-2016?
Reasonable timeline for the US transition to IFRS
December 2007SEC roundtable on IFRS in the US
August 27, 2008Roadmap was issued
During 2011SEC will reconvene to decide whether a mandatory conversion date should be set
SEC Roadmap
PricewaterhouseCoopers
Slide 56
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Proposed Roadmap
• Targets potential mandatory adoption of IFRS in the U.S. beginning in 2014 (or 2014-2016)
• Lays out several milestones that would need to be achieved prior to the SEC mandating use of IFRS for all U.S. issuers
• Proposed rule for certain qualifying domestic issuers to use IFRS as early as 2009
SEC Roadmap
PricewaterhouseCoopers
Slide 57
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Requires Future SEC Action
SEC would reconvene in 2011 to decide whether:• Milestones have been achieved• Mandatory IFRS conversion date should be set for all issuers• Option to early adopt IFRS should be expanded to a larger
population of issuers
SEC Roadmap
PricewaterhouseCoopers
Slide 58
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Milestones
• Continued improvements to IFRS accounting standards• Independent funding of the IASC Foundation • Enhanced ability for interactive data (XBRL) to accept IFRS
data• Sufficient progress in IFRS education and training in the U.S.
SEC Roadmap
PricewaterhouseCoopers
Slide 59
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Optional Early Adoption of IFRS in the U.S.
• The SEC proposal would permit early adoption of IFRS by a limited number of eligible U.S. issuers. The issuer would need to meet the following two criteria in order to qualify for early adoption of IFRS:- The issuer would need to be among the 20 largest companies,
measured by market capitalization, in their industry group and- IFRS must be used by the majority of the 20 largest companies,
measured by market capitalization, in that industry group
• Early adoption requires approval of the SEC Division of Corporation Finance
• SEC estimates that at least 110 U.S. multinational companies in 34 different industries would be eligible for early adoption
SEC Roadmap
PricewaterhouseCoopers
International Financial Reporting Standards (IFRS)
What is IFRS?SEC RoadmapInsurance Contracts TodayInsurance Contracts Phase 2
Slide 61
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
IFRS 4 Measurement
Does the contract need to be unbundled?
Are any discretionary participation features
present?
Insurance Component
Deposit Component
Yes YesNo
Does contract contain significant insurance
risk?
Investment Contract(IAS 39)
Investment Contract with discretionary participation
features
Insurance Contract
No
NoYes
Use existing valuation
Amortized Cost or FVLiability or equity
Insurance risk = Risk other than financial risk transferred from the holder of the contract to the issuer.
= No requirement for underwriting and timing risk.
Significant = Where an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance, irrespective of the likelihood of such event.The “additional benefit” is measured in comparison to that whichwould be paid if the insured event did not occur.
Insurance Contracts Today
PricewaterhouseCoopers
Slide 62
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
IFRS 4 Disclosures
General disclosure principles• Principle 1: Identify and explain significant amounts in financial statements
- Accounting policies and significant assumptions- Changes in amounts and assumptions
• Principle 2: Help users understand future cash flows - Objectives managing risks & policies for mitigating risks- Terms and conditions and affect on cash flows- Insurance risks - sensitivity analysis, concentrations, loss development- Interest rate and credit risks
Sensitivity analysis • Actual changes in financial results for changes in key assumptions• Sensitivity of financial results for changes in all variables that have a material
impact on assets, liabilities, income and expenses (e.g. interest rates, inflation rates, equity markets, mortality, persistency, frequency and severity )
• Companies have not historically not provided sensitivity analysis in audited financial statements
< - Will need to determine data requirements < - Will need to benchmark / emerging practice
Insurance Contracts Today
PricewaterhouseCoopers
International Financial Reporting Standards (IFRS)
What is IFRS?SEC RoadmapInsurance Contracts TodayInsurance Contracts Phase 2
Slide 64
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Status Update
Current IFRS situation for accounting for insurance contracts is inconsistent across jurisdictions
Results in too much diversity, less relevance and reliability
The IASB started with a clean slate to develop Phase 2
FASB may pursue joint project with IASB (IFRS/US GAAP convergence)
Phase II work begun
Jul 04
Discussion Paper
published May 07
Comment period ends
Nov 07
Phase II Exposure
Draft published Late 09?
Phase II IFRS
published 2011?
Phase II IFRS
effective 2013?
We are hereFASB ITC
Aug 07
Insurance Contracts Phase 2
PricewaterhouseCoopers
Slide 65
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Technical Overview – key features
Exit vs. Entry value – illustration:
• 10 year single premium policy sold by insurer X for $1,000 • Insurer X expects to realize a profit of $250• Insurer Y prepared to purchase policy from X for $900 (after allowing for risk)
Entry value liability = $1,000 Initial profit is $nil (before or after acq. costs?)
Exit value liability = $900 Initial profit is $100
Single accounting model
Exit Model
•Discounting for non-life business•Strong opposition from US non-life industry•Prospective cash flow model
•Controversial (inside and outside IASB)•Possible day one gains•Obligation may arise on contract signing
Insurance Contracts Phase 2
PricewaterhouseCoopers
Slide 66
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value
IASB rationale for current exit value:• More faithful representation of insurer obligations and rights• Conveys more useful information about amounts, timing, uncertainty of
cash flows • Current estimates and use of explicit rather than implicit assumptions
require insurer to actively consider whether circumstances have changed• Explicit rather than implicit risk margin• Avoids need for separate liability adequacy test• More coherent framework for complex contracts such as multi-year, multi-
line, or stop loss contracts, avoiding need for arbitrary rules
Insurance Contracts Phase 2
PricewaterhouseCoopers
Slide 67
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value
IASB rationale for current exit value (cont):• Eliminates need to separate embeddeds• Consistent with IAS 37 and IAS 39 which require current
estimates of future cash flows• Reduces motivation to use reinsurance to recognize
previously unrecognized gains• No need for arbitrary criteria to distinguish amendments to
existing contracts from new contracts• Reduces possible accounting mismatches between assets
and liabilities
Insurance Contracts Phase 2
PricewaterhouseCoopers
Slide 68
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value
Opponents of exit value approach:• Exit value places too much reliance on hypothetical transactions that rarely
occur (i.e. transfers)• Entry value reflects real transaction – price charged to PH• No conceptual basis for Day 1 gains• Market-consistent cash flow assumptions and market-consistent risk
margins are not observable or attainable – introduces more subjectivity and non-comparability into the estimates
• Some believe discounting of non-life liabilities is not appropriate due to unpredictable nature of cash flows
• Current exit value inappropriately implies a greater measure of precision in the estimate that just isn’t there
Insurance Contracts Phase 2
PricewaterhouseCoopers
Slide 69
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Technical Overview – key features cont’d
Core liability measurement
Current, unbiased, market consistent, probability weighted estimates of contractual cash flows
Current, not past conditions• Market participant vs entity specific• Modelling demands • Expected mean value, not deterministic
most likely– More complex (stochastic?) models
• What cash flows to include? Contractual?
Current marketdiscount rates
Risk margin
• Liability moves with market rate changes• Insurer’s investment strategy not relevant,
except for par business
• Estimate of market risk margin• Limited guidance on calculation• Controversial feature, due to lack of market• Key driver of day one profit
Service margin • Amount of expected future market-based service profits
Insurance Contracts Phase 2
PricewaterhouseCoopers
Section Four
Linkages Between ERM, Solvency II, IFRS
Slide 71
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Review of the Common Features
Linkages Between ERM, Solvency II, and IFRS
Company Solvency II IFRS
ERM ORSA
Economic Capital Models
Internal (EC) Models
Public Disclosures Public Disclosures Public Disclosures
GAAP, Fair Value, Market Consistent
ValueMarket Consistent
ValueExit Value
PricewaterhouseCoopers
Section Five
Company Perspective
Slide 73September 26, 2008
ERM & Capital Modeling
• ERM Stochastic Modeling
• GAAP equity
• Statutory surplus
• Economic capital
• Other measures
Company Perspective – ERM, Solvency II, IFRS
Slide 74September 26, 2008
IFRS and GAAP Balance Sheet Accounting
• Key Difference
• GAAP Full value loss reserves
• GAAP Full value loss reservesIFRS Fair
Company Perspective – ERM, Solvency II, IFRS
Slide 75September 26, 2008
IFRS & Solvency II – Two Sides of One Coin
• IFRS = Fair value = (Economic value) concept• Convergence of economic and accounting values• Aim: IFRS net assets = Available economic capital
• Solvency II = (Fair) value-at-risk concept• One-year time horizon• 99.5% confidence level
• Aim: (IFRS) Net Assets VaR99.5% Required economic capital
Company Perspective – ERM, Solvency II, IFRS
Slide 76
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Questions
Do you have any questions regarding what you have learned in this session?
PricewaterhouseCoopers
www.pwc.com
© 2008 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. The information contained in this document is provided 'as is', for general guidance on matters of interest only. PricewaterhouseCoopers is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional adviser. Although we believe that the information contained in this document has been obtained from reliable sources, PricewaterhouseCoopers is not responsible for any errors or omissions contained herein or for the results obtained from the use of this information.
Slide 78
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
ADDENDUM - IFRS
Slide 79
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Premium Cash Flows – Conceptual Framework
Definition of an asset per the Framework• “…a resource controlled by the entity as a result of past events
and from which future economic benefits are expected to flow to the entity”
Definition of a liability per the Framework• “…a present obligation of the entity arising from past events,
the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.”
Internally developed intangible assets are generally not recognized except in business combinations
Insurance Contracts Phase 2
Slide 80
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Premium Cash Flows
Premiums relate to an intangible asset: portion of customer relationship with the policyholder
IASB decided to present it together with insurance liability
Re-pricing the policy makes it a new contract from accounting perspective and therefore not eligible for asset recognition• e.g., short duration property/casualty contract
Insurance Contracts Phase 2
Slide 81
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Premium Cash Flows
Future premiums on existing contracts recorded as part of customer relationship if any of the following 3 criteria met: • Policyholder must pay premium to retain guaranteed
insurability - Guaranteed insurability = right that permits continued
coverage without reconfirmation of PH risk profile and at price that is contractually constrained
• Insurer can compel policyholder to pay premium (rare)• Including the premiums and resulting policyholder benefit will
increase the measurement of liability
Insurance Contracts Phase 2
Slide 82
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 1st
Determining expected present value: • Identify each possible scenario• PV cash flows in that scenario• Make unbiased estimate of probability of that scenario• Insurer might develop estimates of each scenario by:
- identifying individual scenarios- developing a formula that reflects insurer estimate of shape
and width of probability distribution, or - by random simulation
Insurance Contracts Phase 2
Slide 83
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 1st
Market-consistent vs. entity specific cash flows:• Should not capture cash flows due to synergies between
insurance liability and other assets or liabilities• But should capture specifics of portfolio being measured• For unobserved variables (e.g., frequency/severity of claims,
mortality), rarely persuasive evidence that insurer’s own estimates differ from estimates other market participants would make
Insurance Contracts Phase 2
Slide 84
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 1st
Reflect market participant (not entity specific) efficiency• Use servicing costs that market participants would incur• Don’t use entity specific servicing costs that reflect synergies
others don’t have• Don’t use costs reflecting inefficient servicing system (e.g.,
antiquated claims administration system)
But reflect characteristics of contract; strategy for handling• Level and type of service provided• Approach to claims management
Insurance Contracts Phase 2
Slide 85
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 2nd
Discount rates• Consistent with observable current market prices• For cash flows whose cash flows match those of insurance
liability in terms of:- Duration- Liquidity- Currency
• Discount all liabilities (long and short duration)• Not insurer’s investment yield rate
Insurance Contracts Phase 2
Slide 86
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 3rd
Risk Margin• Explicit and unbiased estimate of margin that market
participants require as compensation for bearing risk • Reflects uncertainty in timing and amount of estimated future
cash flows- Not a “cushion”
• What a third party would require to assume risk- Not calibrated to premium- But premiums provide reasonableness check
Insurance Contracts Phase 2
Slide 87
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 3rd
Risk margin is portfolio rather than entity specific, reflecting pooling of liabilities• Unclear about market participant diversification across
portfolios or negative correlation that different portfolios could provide
No specific method prescribed; example approaches provided• Confidence level, CTE, TVaR, cost of capital
Insurance Contracts Phase 2
Slide 88
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 3rd
Characteristics of the risk margin will likely include the following:• The less that is known about the current estimate and its
trend, the higher the risk margin• Risks with low frequency and high severity will have higher
risk margins than risks with high frequency and low severity• For similar risks, long duration contracts will have higher risk
margins than those of shorter duration• Risks with a wide probability of distribution will have higher risk
margins than those risks with a narrower distribution• To the extent that emerging experience reduces uncertainty,
risk margins will decrease, and vice versa
Insurance Contracts Phase 2
Slide 89
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Building blocks of the IASB current exit value – 3rd
Service Margin• Market consistent margins for rendering services
- e.g., investment management services- Unit-linked and variable contracts, universal life
• Income (loss) recognition on Day 1 if insurer receives fee higher (lower) than market participants would demand
• Differs from current revenue recognition under IAS 18 based on stage of completion
Insurance Contracts Phase 2
Slide 90
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008
Reinsurance – Cedent Perspective
• Reinsurance asset follows same model as direct reinsured liability (exit value approach)
• Risk margin for reinsurance assets equals risk margins for corresponding part of direct reinsured liability- Because one can’t transfer rights of indemnification of reinsurance
contract without underlying liabilities’ rights and obligations • Reinsurance asset is adjusted for expected default and disputes• Recognize contractual right, if any, to obtain potentially favorable
reinsurance rates- e.g., existing non-cancellable prospective reinsurance contract on
future negotiated direct contracts
Insurance Contracts Phase 2
Recommended