*connectedthinking Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame

*connectedthinking

Discussion Paper Preliminary Views on Insurance Contracts

Sabine Wuiame

Agenda

History of the IASB Insurance Project Summary of the Discussion Paper

History of the IASB Insurance Project

Page 4PricewaterhouseCoopers

History of the IASB Insurance Project

• IASC starts insurance project in 1997

• “Issue Paper” published in 1999 – followed by issuance of a “Draft Statement Of Principles”

• Not feasible to complete a project on insurance contracts before 2005.

• Phase I = IFRS4 = Wide variety of accounting practices

• DP issued on 3rd May 2007- Comment period : 16 November

- Will be used to develop Exposure Draft (? End 2008/2009)

- Final Standard should be published in +/- End 2009/2010?

- Effective transition date more than one year later (Jan. 2011?)

Start of insurance project

1997 1998 1999

December: Issue Paper

/DSOP

2000 2001 2002 2003 2004

Project split in

two phases

March:

IFRS4

2005 2006

May:

D.P.

2007 2008

ED?

2009

IFRS?


Principles of Phase I – IFRS4

• Contract classification and measurement:- Insurance contracts and investment contracts with dpf : IFRS4

- Investment contracts with no dpf: IAS39

• Phase I of the insurance project (IFRS4) is an interim phase- Continuation of local accounting policies with amendments:

• Elimination of equalisation reserves

• Liability adequacy test

• Reinsurance impairment test

• Change in accounting policies permitted:

- Aimed at eliminating accounting mismatch

- Shadow accounting

- Use of current interest rates

- Extensive disclosure requirements


Convergence with other projects

• Convergence project with US GAAP• Convergence with other IASB projects

- Revenue recognition

- Fair value measurement

- Financial instruments

- IAS37

- Framework

- Definitions of liability and equity

- Financial statements presentation

• Convergence with Solvency II

Summary of the Discussion Paper


Published in May 2007

7 Chapters:• 1-Scope• 2-Recognition and Derecognition• 3-Measurement - core issues• 4-Policyholder behaviour, customer relationship and

acquisition costs• 5-Measurement- other issues• 6-Policyholder participation• 7-Changes in insurance liabilities



Scope

Measurement

Policyholder Participation

Changes in insurance liabilities



Scope

Measurement




Scope


Scope

• Definition of an insurance contract in IFRS4:- “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”

• Insurance liability = insurer’s obligations under an insurance contract

• Insurance asset = insurer’s rights under an insurance contract

• Applies to all types of contracts (life, non life, accepted reinsurance)


Scope

Measurement




Measurement


Measurement

• Concept of “current exit value”• Based on building blocks

Best estimate of future

cash-flows

Discount Rate

Risk Margin

Service Margin


Measurement

Best estimate of future cash-flows (1)

•No detailed guidance

•Explicit

•Consistent with observable market prices• If observable: direct inputs without adjustments• Not observable :

• All available data, external and internal• Should not contradict market data

•Include – in an unbiased way- information about amount, timing and uncertainty of all cash flows

• Full range of possible outcomes and their probabilities


Measurement

Best estimate of future cash-flows (2)

•Current• >< “locked-in” assumptions

•Exclude entity-specific cash-flows• Economic characteristics of the liability• Do not capture CF arising from synergy with other assets and

liabilities• Do not capture CF that are specific to the insurer and would not

arise for other market participants with the same obligations• Portfolio specific vs entity specific


Measurement

Discount rate

• Applies to all types of contracts• Including non life

• Should not reflect the characteristics of the assets

• Consistent with observable current market prices for cash flows whose characteristics match those of the insurance liability

•No detailed guidance


Measurement

Risk margin (1)

• Effects of uncertainty• Liability with fixed cash flows vs liability with uncertain cash flows

•“Explicit and unbiased measurement of the compensation that entities demand for bearing risk”

• NOT a shock absorber

• Captures all risks associated with liability

• List of compliant actuarial methods

• Should not reflect the benefits of diversification between portfolios and negative correlation between portfolios


Measurement

Risk margin (2)

• Calibrating the risk margin per unit of risk

• Two approaches:• Implementation A : calibrates at inception directly to actual premium

charged (less relevant acquisition costs)- Need to define acquisition cost, liability adequacy test

• Implementation B: use actual premium only as reasonableness check - Profit at inception

• Majority of Board Members in favor of implementation B


Measurement

Service margin

• Insurer might provide other services as well• Should be included if market participants require such a margin


Measurement

Future premiums

• Future premiums (+ related benefits) included if any of the following criteria is met:

a)Policyholder must pay premium to retain guaranteed insurabilityb)The insurer can compel the policyholder to pay the premiumc)Including the premiums and the resulting policyholder benefits will

increase the measurement of the liability


Measurement

Acquisition costs

• Should be recognized as an expense• Not as the cost of an asset


Measurement

Assets backing insurance contracts

• Phase I: accounting mismatches

• Existing options to avoid accounting mismatches• Assets at fair value through P&L• Fair value model for investment property • These are not required

• Shadow accounting• Shadow accounting no longer relevant for non-participating insurance

liabilities• For participating business

- Could be considered if assets classified as “available for sale”


Measurement

Reinsurance assets

• No offset• Current exit value• Risk of default (or disputes) of the reinsurer should be considered based on the expected loss model


Measurement

Unbundling

•Preliminary view based on interdependence :• If components so interdependent that can be measured only on an

arbitrary basis, Phase II should apply to the whole contract

• If components not interdependent, Phase II applies to insurance component and IAS39 applies to the deposit component

• If components interdependent but can be measured on basis that is not arbitrary, then insurance component = measurement of whole contract under Phase II less IAS39 measurement of deposit component


Measurement

Other

• Current exit value should reflect liability’s credit characteristics

• Unit of account does not affect the expected PV of future cash flows

• No specific proposals for investment contracts


Scope

Measurement






• Discretion (with constraints) over amount or timing of distribution to policyholders

• Definition of DPF is not discussed

• Is such right creating a liability?• Include in each scenario policyholder dividends that satisfy a

legal or constructive obligation at the reporting date

• Applies to participating insurance and investment contracts

Participating contracts


Scope

Measurement






Changes in Insurance Liabilities

• Are insurance premiums revenue or deposits?• No preliminary view yet

• No preliminary view yet on separate presentation of specified components of the changes in insurance liabilities:

• Income or expense at inception of new contracts

• Cash flows

• Expected changes

• Changes in circumstances

• Policyholder participation

• Income or expense from reinsurance held

• Effects of business combinations and changes in foreign exchange rates


Changes in Insurance Liabilities

• Profit or loss should include all changes in the carrying amount of insurance liabilities

Questions?

Documents

*connectedthinking Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame