2009 Washington Freedman 11a

7/25/2019 2009 Washington Freedman 11a

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U.S. GAAP, From Basic Application to Current

Topics Seminar

August 31 September 1, 2009

11A: IFRS for Insurance Contracts; IFRS 4

(Intermediate)

Mark Freedman


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IFRS 4, Insurance Contracts

Mark Freedman

Ernst & Young

August 31 September 1, 2009

Society of Actuaries GAAP Seminar

Page 2

Background

Product classification

Insurance contract measurement

Agenda


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IFRS guidance for an insurance company balance sheet

Investments:Equities,

fixed interest,

loans

Insurance

Liabilities PhaseI

Other assets Other liabilities

Insurance

liabilities and

investment

contracts with

discretionary

participation

features

Investment

contract

liabilities

Investment

contract DAC

IAS 39

IAS 40

IAS 18

Insurance DAC IFRS 4

PVIF IFRS 4

Various

IFRS 4

IAS 39

Various

Various

Property

Equity

Page 4

There is a phased approach to insurance contracts.

IFRS

INSURANCE

PROJECT

Phase I Implemented 2005

Phase II

Uniform, likely new, insurance

measurement standard

Phased approach for insurance


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Exemption from IAS 8

Absent a specific relevant standard, reporting entities look to IAS 8Accounting Policies, Changes in Accounting Estimates and Errors forguidance on adopting accounting policies.

IFRS 4 exempts insurance and investment contracts withdiscretionary participation features, but not other investmentcontracts, from IAS 8, effectively allowing insurers to continue existingaccounting policies, with certain limitations and modifications.

Insurers are also given relief from the strict requirements of IAS 8 ifthey wish to change accounting policies for insurance contracts,either at the time of adopting IFRS or later. They can make a change

to a policy that is more relevant but not less reliable or more reliablebut not less relevant than the current policy.

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Key requirements under IFRS 4

Changes in IFRS 4 accounting policies

An i nsu rer may change its account ing pol ici es fo r in sur ance cont ract s if , and onl y if , thechange makes the financial statements:

more relevant and no less reliable, or

more reliable and no less relevant

An i nsu rer shall j udge relevance and rel iabi lit y by the c ri teri a in IAS 8.

Relevance economic decision-making needs of users

Reliability

represent faithfully the financial positions, financial performance and cash flows of theentity

reflect the economic substance of transactions, other events and conditions, and notmerely the legal form

are neutral, ie free from bias are prudent; and

are complete in all material respect


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Background



Agenda

Page 8

Product Classification defines accounting treatment

Phase I

Investment contracts

Discretionary Participation

Investment contracts

Insurance contracts

*Subject to certain modifications

Existing

Accounting*

Existing

Accounting*

Existing

Accounting*

Existing

Accounting* Amortised Cost

-or-Fair Value**

Amortised Cost

-or-Fair Value**

Product classification - Why is it important?

**Possibly with separate accounting

for service component


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Is there significant

insurance risk present

in the contract?

Is there a

deposit component to thecontract? If so, is the deposit component

independent of the insurance

cash flows?

Are any elements of

the benefit driven by discretionary

participation

Insurancefeatures present

in contract

Classified as an

investment contract

Deposit component

Yes

No

Insurance and deposit

components of contract must, if

not recognised, be unbundled

and valued separately

Yes

No

Insurance

component

Product is an Investment

Contract without discretionary

participation features

Product is anInsurance Contract


Contract with discretionary

participation featuresYes

No

Classification flowchart

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A contract under which one party (the insurer) accepts significant

insurance risk from another party (the policyholder) by

agreeing to compensate the policyholder if a specified uncertain

future event (the insured event) adversely affects the

policyholder.IFRS 4.Appendix A

The same definition and tests apply to reinsurance.

Definition of insurance


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Financial risk is the risk of a possible future change in one or moreof a specified interest rate, financial instrument price, commodityprice, foreign exchange rate, index of prices or rates, credit ratingor credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to thecontract.

Insurance risk is risk, other than financial risk, transferred from theholder of a contract to the issuers

If both financial risk and significant insurance risk are present,contract is classified as insurance.

IFRS 4.Appendix A

Considered over life of the contract including option periods

Insurance versus financial risk

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Significant if, and only if, an insured event could cause an

insurer to pay significant additional benefits in any scenario,

excluding scenarios that lack commercial substance.

Additional benefits must be for pre-existing risk and do not

include:

Charges that would be made on cancellation or surrender

Loss of ability to charge policyholder for future services (e.g., if a

contract terminates on death)

Possible reinsurance recoveries as these are classified separately

IFRS 4.Appendix B22 - B28

Significant insurance risk


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Additional benefits include timing risk Whole life contract (payment known, timing unknown) has additional

benefits

Contract where death benefit is equivalent to maturity benefit (i.e.,maturity benefit adjusted for time value of money) does not haveadditional benefits

Classification on a contract by contract basis Contracts entered into simultaneously with the same policyholder count as

one contract

Products may be classified homogeneously on materiality grounds

IFRS 4.Appendix B22 - B28

Significant insurance risk

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No quantitative guidance given.

Rules of thumb currently being adopted for internal consistency Benefit paid on death exceeds benefits payable on survival by more than

x% (term assurance)

Plausible scenario exists under which the death benefit exceeds thesurvival benefit by x% or more at any time during the policy term(guaranteed minimum death benefit in unit-linked contract)

Benefit payable on survival exceeds the benefit payable on death by morethan x% (pure endowment, life contingent annuity)

The ultimate result on reinsurance may exceed x% of premium earned byreinsurer.

Quanti tative measures


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Examples of significant insurance risks

Significant Insurance Risk?Insured Event Occurrence and Cost

YESCostly and feasible event in scenario of commercial substance

even if it is extremely unlikely

NOContingent amount to be paid is insignificant in all scenarios of

commercial substance

NOLoss of ability to charge for future services

NOWaiver on death of surrender charges

NOUnfeasible event in any scenario of commercial substance

YESSignificant additional benefits payable under insured event

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Comparison to US GAAP

SFAS 60, SFAS 97 Limited

Payment, SFAS 120

SFAS 60, SFAS 97 Limited

Payment, SFAS 120

SFAS 97 Universal LifeSFAS 97 Universal Life

SFAS 91, SFAS 97 InvestmentSFAS 91, SFAS 97 Investment

InsuranceInsurance

Generally InsuranceGenerally Insurance

Insurance or Investment(depending on significance of insurance risk)

Insurance or Investment(depending on significance of insurance risk)

US GAAP classification IFRS classification


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Page 17

Examples of insurance and financial risks

Insurance - significant insurance risk

Most property/casualty insurance contracts

Term assurance and pure endowment assurance

Life contingent annuities

Whole life contracts

Variable annuities with significant death benefit

Fixed or variable (unit-linked) with significant life contingent annuity

guarantee

Most reinsurance contracts

Financial guarantees of specific third party debts

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Examples of insurance and financial risks

Investment - insignificant insurance risk Reinsurance contracts that do not transfer any significant reinsurance

risks

Short-term endowment contracts

Variable or unit-linked without significant death benefit (e.g. 101% valueof units)

Pension accumulation contracts without significant death benefits

Contract exposed to lapse or expense risk only

Financial derivatives

Deferred annuity with no life contingency or insurance guarantee

Guaranteed investment contract or bond

Product warranties issued directly by manufacturer

Reinsurance catastrophe bonds with triggers not directly related to theissuers losses

Financial guarantees linked to credit index


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in the contract?

Is there a

deposit component to thecontract? If so, is the deposit component


cash flows?

Are any elements of


participation

Insurancefeatures present

in contract

Classified as an

investment contract

Deposit component

Yes

No





Yes

No

Insurance

component

Yes

No

Unbundling




Product is an

Insurance Contract



participation features.*

*Likely none in North America

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Unbundling seperate presentation and measurement of insurance and investmentcomponent.

Some insurance contracts contain both an insurance component and a deposit component.In some cases, an insurer is required or permitted to unbundle those components:

Unbundling is required when: The insurers existing accounting policies do not require recognition of the deposit

component and

The insurer can independently measure the deposit component from the insurancecomponent

Unbundling is allowed when the insurer can independently measure thedeposit component from the insurance component

IFRS 4.10 12

Unbundling is intended to require recognition of deposit elements of contractsthat in some accounting regimes were not reflected, such as in somecatastrophic reinsurance arrangements. Given the requirements of US GAAP,this will have little effect on US insurers.

When do you unbundle?


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Unbundling examples

Some riders interact with underlying contract. Some riders do not.

Rule of thumb:

If premium is from fund do not unbundle

If separate premium unbundle - really treat as separate contractsIf the rider benefit is insurance and the underlying contract is insurance, then there is

no need to unbundle.

Riderbenefits

Cost of life cover made through charges to fund. Unbundling is complex and

therefore would not be required

Where separate risk premium for fixed death benefit, then unbundling required.

Unit-linked

contracts

Insurance cash flows are integrated with deposit cash f lows and contract should not

be unbundledWhere term assurance is attached and premium is recorded for joint contract and

practicably inseparable, then contract will not be unbundled.

Where term assurance is attached and premium is recorded separately, thencontract will be unbundled.

Traditional

insurancecontracts

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in the contract?

Is there a

deposit component to the

contract? If so, is the deposit component


cash flows?

Are any elements of


participation

Insurance

features present

in contract

Classified as an

investment contract

Deposit component

Yes

No





Yes

No

Insurance

component

Yes

No

Discretionary participation features (DPF)




Product is an

Insurance Contract





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Contractual right to additional payments as a supplement to

guaranteed minimum payments

Likely to be a significant portion of the total contractual payments.

Amount or timing is contractually at the discretion of the issuer

Contractually based on

Performance of a specified pool of contracts or a specified type of contract

Realised and / or unrealised investment returns on a specified pool of

assets held by the issuer

Profit or loss of the company, fund or other entity that issues the contract

IFRS 4.Appendix A

Defini tion of DPF

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Investment contracts with discretionary participation features aremeasured under IFRS 4

Investment contracts without discretionary participation featuresare measured under IAS 39 Investment management services separated and measured under IAS 18

IFRS 4.2

Measurement of DPF


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Background



Agenda

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During Phase I, existing accounting policies apply with certainmodifications

Prohibited certain accounting policies are prohibited as they do not meetthe IFRS framework

Mandated certain accounting policies must be implemented if they are notalready in the existing accounting policies

Al lowed to continue, but not start certain accounting policies that do notmeet the IFRS framework can continue, but cannot be implemented.

Can be started certain accounting policies can be introduced.



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The following accounting policies are prohibited Amounts for catastrophe provisions for potential claims beyond the term

of existing contracts

Amounts for claims equalisation provisions

Offsetting of reinsurance assets and direct liabilities

IFRS 4.14

This is no different from US GAAP.

Prohibited policies

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The following accounting policies are mandated if they are not

already present

Liability adequacy testing

Impairment of reinsurance assets

IFRS 4.14

Mandated pol icies


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Current liability adequacy test applies if Test at each reporting date using current estimates of future cash flows

(including guarantees and options)

If these are greater than current liability, liability is increased anddeficiency flows through profit and loss

Otherwise Liability Adequacy Test under IAS 37 Provisions,Contingent Assets and Contingent Liabilities Fair value like calculations

IFRS 4.15-19

US companies may have to change loss recognition policies fordeferred annuities that are insurance contracts under IFRS butinvestment contracts under US GAAP to avoid having them fall under

IAS 37.

Mandated Policies:Liability adequacy test

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Reinsurance asset is reduced and reduction flows through income

statement if it is impaired

Reinsurance asset is impaired if:

Objective evidence of an event after initial inception that the cedant may

not receive all amounts due to it

The impact of the event can be reliably measured

Impairment may be reversedIFRS 4.20

This guidance is similar to US GAAP.

Mandated Policies:

Impairment of reinsurance assets


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The following accounting policies may continue but companies

may not switch to these where they are not already applied

Using an undiscounted liability basis

Measuring future investment management fees at a value greater than the

acquisition costs

Using non-uniform accounting policies for subsidiaries

Using excessive prudence in the valuation of liabilities

IFRS 4.25

Policies that may continue

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The following accounting policies can be started subject to certainrestrictions Use of current market discount rates and use of other current variables for

selected liabilities

Use of shadow accounting

Use of asset based discount rates

Only if part of a comprehensive accounting po licy which makesfinancial statements more relevant and reliable

An example is the adoption of FAS 60 for the

measurement of liabilities for traditional policies. If FAS60 is more relevant or more reliable than the existingaccounting policy, then discounting at asset yields isacceptable.

Policies that may be started


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Measure liabilities using current market interest rates

Current market interest rates Can include investment spreads only if already included

Otherwise presumably risk free rates

Can move to using current assumptions for other variables at the same

time

Can be performed for any designated liabilities

All changes in liabilities must flow through income statement

IFRS 4.24

The ability to use current assumptions for variables that are locked in

under current accounting policies is intended to allow for movement

in liabilities that is more consistent with movement in investments, asassets are generally measured at fair value.

Current market interest rates

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Shadow accounting

Quantify impact of realising gains on liability and related assets

If unrealised gains flow through P&L the effect on the measurement of

liabilities and related assets flows through P&L

If unrealised gains flow through equity as OCI the effect on the

measurement of liabilities and related assets flows through equity as OCI

IFRS 4.30

The use of shadow accounting is new to many companies not using US GAAP. The point

that the treatment of shadow movement follows the treatment of unrealized gains and

losses (ie, through P&L or in OCI) is the common application of the guidance in IFRS 4.

Shadow accounting


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Distributable surplus must be classified as liability or equity

Disclosure of movement in statement of equity if any distributable surplus

classified as equity

Distributable surplus classified as liability taken into account in liability

adequacy test

IFRS 4.34

This means, for example, that a PDO associated with a closed block

of contracts from a demutualized company could be reported as a

component of equity rather than as a liability. Few insurers in Europe

took the alternative to classify distributable surplus as equity and it is

doubtful that US insurers will find this attractive.

Insurance contracts with DPF

Documents

2009 Washington Freedman 11a