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Page 0November 2009
Presidents Forum / Insurance Accounting Committee
IASB Insurance Contracts Phase 2Status and IAA Role
November 2009 -- Hyderabad
Sam Gutterman
Page 1November 2009
Agenda Background
International accounting convergence
Insurance Contracts Phase 2 status
IAA Role and Activities
Page 2November 2009
BackgroundInternational Accounting Convergence
Objectives:One single set of high-quality financial reporting standards for
companies world-wideNo surprises with full transparency
“The whole objective of the International Accounting Standards Board is to boost transparency by having one single set of high-quality standards for companies world-wide. The real secret for confidence in the markets is: no surprises and full transparency—that’s going to mean some pretty uncomfortable standards coming in the future.”
“It’s silly having a different rule in the UK or Australia or the US when we should just see who’s got the better rule and let’s do it worldwide.”
Sir David Tweedie, Chairman IASB
Page 3November 2009
BackgroundInternational Accounting Convergence
IFRS—International Financial Reporting Standards Standard setter—International Accounting Standards Board (IASB) Founded in 2001. Based in London
Replaced the International Accounting Standards Committee (IASC), which previously published financial reporting standards referred to as International Accounting Standards (IAS), used in countries without their own accounting standards setter
Impetus came from the G7 after the Asian Financial Crisis in the 1990s Current convergence efforts given further push by the G20 this year
IASC Foundation’s Trustees have oversight responsibility, with a Standards Advisory Council (SAC) that provides advice regarding the IASB agenda The IASB develops IFRS and the International Financial Reporting Interpretations
Committee (IFRIC) provides interpretations of IFRS Main functions of IASC Foundation trustees include
– Appointing IASB members– Exercising oversight– Raising funds
Monitoring Board, recently formed, made up of international regulators, provides oversight to the IASC Foundation
Page 4November 2009
BackgroundInternational Accounting Convergence
Standard setting structureMonitoring Group5 members
Geographical break-down
Europe 8
North America 6
Asia / Oceania 6
Rest of the world 2
IASCFoundation22 trustees
SAC46 members
IFRSHigh quality, enforceable and global
IASBChairman plus
14 members
IFRIC12 members
AppointGovernFund
InterpretAdvise
Create
Trustees
Board
Geographical break-down
Europe 4
North America 5
Asia / Oceania 4
Rest of the world 2
Page 5November 2009
BackgroundInternational Accounting Convergence
More than 100 countries require or permit the use of IFRS, or are converting
Top 10 Global Capital Markets
US US GAAP
Japan Converting to IFRS
UK IFRS
France IFRS
Canada Converting to IFRS
Germany IFRS
Hong Kong IFRS
Spain IFRS
Switzerland IFRS or US GAAP
Australia IFRS
Countries seeking convergence with the IASB or pursuing adoption of IFRSs
Countries that require or permit IFRSs
Countries with no current plans to convert to IFRS
Page 6November 2009
BackgroundInternational Accounting Convergence – SEC Roadmap
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 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?
December 2007SEC roundtable on IFRS in the US
August 2008Roadmap was issued
During 2011SEC will reconvene to decide whether a mandatory conversion date should be set
Page 7November 2009
Background - IASB and IFRSCurrent IFRS 4 – Insurance Contracts
IFRS 4 in its current form Adopted in 2004 Applies to Insurance Contracts, not Insurance Companies Originally designed as an interim solution (2 years) Primarily relies on local standards (e.g. US GAAP in the US) A great deal of diversity in practice
Starting with current local standards Eliminates liabilities for future claims (e.g. catastrophe reserves) Requires a liability adequacy test (type depending on prior or newly adopted test) Measuring liabilities on an undiscounted basis can be continued, but not introduced No netting for reinsurance Can make a subsequent change to entity’s accounting policy as long as it is more
reliable and no less relevant, or more relevant and no less reliable
Page 8November 2009
Background - IASB and IFRSCurrent IFRS 4 – Insurance Contracts
Definition of an Insurance Contract (not expected to change in Phase 2) “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”
Insurance risk Risk other than financial risk transferred from the holder of the contract to the issuer.
Financial risk includes a change in interest rate, security price Lapse, persistency or expense risk not insurance risk in a direct contract Must relate to an uncertain future event that adversely affects the policyholder Must be a pre-existing risk, rather than risk created by a contract (e.g., a gambling contract)
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 (i.e., have no discernable effect on the economics of the transaction), irrespective of the likelihood of such event.
The “additional benefit” is compared to that which would be paid if the insured event did not occur.
Page 9November 2009
Background - IASB and IFRSCurrent IFRS 4 and IFRS 7 – Insurance Contracts
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 in managing risks and policies for mitigating risks Effect on cash flows of contractual terms and conditions Insurance risks - sensitivity analysis, concentrations, loss development Interest rate and credit risks
Risk–oriented disclosure requirements
Sensitivity analysis
Page 10November 2009
Insurance Contracts Phase 2Insurance Contracts Discussion Paper (2007)
Current IFRS method used in the accounting for insurance contracts is inconsistent across jurisdictions
Results in too much diversity, less relevance and less reliability The IASB started with a clean slate to develop Phase 2 The FASB agreed to pursue a joint project with IASB (will result in IFRS/US GAAP
convergence on the financial reporting standard for Insurance Contracts) because of overlap with most of their other joint projects
Phase 2 work begun
Jul 04
Discussion Paper
published May 07
Comment period endedNov 07
Phase 2 Exposure Draft
published February 10
Phase 2 IFRS
published June 2011?
We are hereFASB IToC
Aug 07
Phase 2 IFRS
effective 2013?
Page 11November 2009
Insurance Contracts Phase 2Insurance Contracts Discussion Paper (2007)
IASB Discussion Paper “Preliminary Views on Insurance Contracts” Published May 2007 US Financial Accounting Standard Board (FASB) issued an Invitation to Comment
Included ideas for financial reporting of insurance contracts: Basic model – current exit value Reflected policyholder behavior and acquisition expenses Other measurement issues
Reinsurance Unbundling Guaranteed insurability as the basis for recognizing renewal premiums
Gain at issue possible, although expected to be small
Page 12November 2009
Insurance Contracts Phase 2Insurance Contracts Discussion Paper (2007)
Many responses to the insurance contracts discussion paper were received; some themes:
Respondents expressed general support for: A single model for life and non-life 3 building block approach, but many differences in opinion about each block Discount rate should not be asset-based Premiums as revenue Expensing of acquisition costs
Were generally against: Including own credit characteristics Unbundling Service margins Guaranteed insurability test for future premium recognition
And had mixed views on: Day 1 Profit Discounting loss reserves (non-life insurers in US generally against)
Page 13November 2009
Insurance Contracts Phase 2Joint Project of FASB/IASB
It is expected that the outcome of Phase 2 will become US GAAP irrespective of if and when there is overall convergence between US GAAP and IFRS
FASB joined project in late 2008 Joint staff project as well
Single Approach for all life and non-life insurance and reinsurance contracts Though a tentative decision by the IASB may lead to a distinction for pre-claims liability
between short-duration and long-duration contracts (although no definition of distinction yet decided)
Three basic building blocks of measuring liabilities are Expected future cash flows Time value of money Margin
Page 14November 2009
Insurance Contracts Phase 2Overall Measurement Objectives
Methods currently being considered for valuing liabilities: Fulfillment approach
FASB had tentatively agreed to this approach through October 2009 Expected present value necessary to fulfill obligations over time
– Expected cost based Reasonably consistent with proposed revenue recognition (customer consideration model)
– Revenue recognized with performance of service Single margin calibrated to premiums, although in November 2009 included explicit risk margin
Modified IAS 37 approach (currently being developed, to be re-exposed in December, applicable to non-contractual obligations) IASB leaning toward this approach Modifications being made to apply to contracts
– No gain at issue Transfer notion as in settlement, yet not fair value
– Explicit risk and service margin Through October had initial incremental acquisition expense recognized as revenue
For short-duration contracts an unearned premium approach IASB agreed to mandate, although may discuss the mandatory nature in December FASB hasn’t discussed yet No separate building blocks
Staffs currently reexpressing description of objectives
Current exit value (transfer price as assessed by third party) is no longer being discussed
Page 15November 2009
Insurance Contracts Phase 2Building Block 1 – Expected Value of Future Cash Flows
Determining expected value: Identify each possible scenario Estimate the cash flows under each scenario Make unbiased estimate of probability of each scenario Treatment of administrative expenses – here or in margins? Expected not to require stochastic modeling
Open application question for claims liability: Will insurers need to develop estimates of each possible scenario by identifying
individual scenarios, estimating the cash flows for those scenarios, and then weigh them together in a probability weighted manner?OR
Would current P&C non-life actuarial approaches be suitable for Building Block 1?
Page 16November 2009
Insurance Contracts Phase 2Building Block 2 – Discount – Time Value of Money
Discount rates Consistent with observable current market prices Apply to cash flows whose characteristics match those of insurance liability (not
matching assets) in terms of: Duration Liquidity Currency
Discount all liabilities Including claims liability Coverage period
– Explicitly for long-duration contracts– Implicitly for short duration contracts through unearned premium approach
Possible interest rates being considered: Risk free or similar rate IASB considering whether liquidity adjustment appropriate
– Waiting for field testing results relating practicality concerns Not insurer’s investment yield rate
Page 17November 2009
Insurance Contracts Phase 2Building Block 3 - Margins
Subsequent margin measurement (other than for claims liability) Contract fulfillment approach with composite margin
Depends on whether composite margin is remeasured If not remeasured
– If allowed to be a shock absorber, to what extent deviations in actual experience affect level of composite margin
– If not a shock absorber, most likely consistent with release of insurance risk, as that is primary risk driver, but there are other possibilities
If remeasured, in a manner similar to risk margin– Requires allocation of risk to each period or– Prospective measurement based on assessment of uncertainty
Revised IAS 37 model with two or three types of margins Risk margin – consistent with previous slides Service margin – no one quite sure what it is for (possibly administrative cost or markup
of internal expenses) Residual margin – same issues as for composite margin above
Residual margin would be equal to difference between present value of premiums and present value of benefits/losses and relevant expenses, less risk margin Key issue for long-duration contracts to the extent different margins (residual, risk and
composite) released in a different manner
Page 18November 2009
Insurance Contracts Phase 2Building Block 3 – Risk Margins
Families of risk margin methods as given in IAA Risk Margins paper: Quantile methods Cost of capital Explicit assumptions (related to specific risk factors) Discount rate related Implicit
Examples of approaches in current practice Cost of capital method
Switzerland regulatory: Swiss Solvency Test using 6% cost and regulatory capital Solvency II in Europe
6% cost on regulatory capital, which is defined at a 99.5% chance of a loss in one year
Quantile method Australian property & casualty claims liability
Minimum of 75% CTE
Explicit method Canada, with strict ranges for each risk determined by the actuarial profession,
accompanied by peer review
Page 19November 2009
Insurance Contracts Phase 2Other Outstanding Issues Recognition of renewal premiums The IASB has now bought into recognizing fixed and determinable premiums Not yet discussed – flexible premiums, e.g., for universal life insurance
Contract boundaries Treatment of non-guaranteed features Policyholder dividends Where charges or credits different than those guaranteed
What is revenue All premium, no premium, sometimes premium
Unbundling Especially if a contract has a deposit component
Minimum cash value floor Currently none
Own credit standing adjustment When a contract is recognized Made important since no-gain at issue requirement
Reinsurance issues Many related overall IASB projects, including revenue, presentation, liabilities,
financial instruments, fair values
Page 20November 2009
IAA Role Insurance Accounting Committee
Formed as committee of IFAA in 1996 In response to IASC Insurance Contracts project Chair, Sam Gutterman Vice Chairs – Francis Ruygt, Paul McCrossan (through 2006), David Congram (from 2005)
Represented on IASC Present Value Steering Committee (Gutterman) IASC Insurance Steering Committee (McCrossan) IASB Standards Advisory Group (McCrossan 2001-2006, Ruygt from 2009) IASB Insurance Working Group (Gutterman) IASB Financial Instruments Working Group (Ruygt) IAASB Consultative Advisory Group (Gutterman) IASB Employee Benefits Working Group (Jim Verlautz, with other actuaries)
Taken part in Four IASB Education Sessions (2006-2008) Two FASB Education Sessions (2009)
Commented on Each IASB Insurance Contracts Discussion Papers and Exposure Drafts Many other IASB papers and drafts
Page 21November 2009
IAA Activities Established general insurance listserve for currently about 315 interested parties Research papers
Two joint research papers with American Council of Life Insurance Principle sponsor of IAA ad hoc Risk Margins Working Group Measurement of Insurance
Liabilities: Current Estimates and Risk Margins (2009) Committee meetings
Extensive meetings in conjunction with each IAA Council meeting Several standalone meetings
Employee benefits – begun meetings and significant effort on a revised IAS 19 Work with IAIS
Attended many IAIS Insurance Contracts Subcommittee meeting Assisted in their development of several papers and comment letters
Actuarial standards and education Developed 11 International Actuarial Standards of Practice related to Phase 1
Has served as educational guidance for actuaries around the world Beginning to discuss what guidance is needed to support Phase 2
Most likely a combination of International Actuarial Standards of Practice and International Actuarial Notes
Have almost completed IAA book on Stochastic Modeling In process of discussing what other technical education material should be developed at an
international level Has served as informal advisor to IASB (and in 2009 FASB) staff on many insurance
contracts related issues
Presidents Forum / Insurance Accounting Committee�AgendaBackground�International Accounting ConvergenceBackground�International Accounting ConvergenceBackground�International Accounting ConvergenceBackground�International Accounting ConvergenceBackground�International Accounting Convergence – SEC RoadmapBackground - IASB and IFRS�Current IFRS 4 – Insurance ContractsBackground - IASB and IFRS�Current IFRS 4 – Insurance ContractsBackground - IASB and IFRS�Current IFRS 4 and IFRS 7 – Insurance ContractsInsurance Contracts Phase 2�Insurance Contracts Discussion Paper (2007)Insurance Contracts Phase 2�Insurance Contracts Discussion Paper (2007)Insurance Contracts Phase 2�Insurance Contracts Discussion Paper (2007)Insurance Contracts Phase 2�Joint Project of FASB/IASBInsurance Contracts Phase 2�Overall Measurement ObjectivesInsurance Contracts Phase 2�Building Block 1 – Expected Value of Future Cash FlowsInsurance Contracts Phase 2�Building Block 2 – Discount – Time Value of MoneyInsurance Contracts Phase 2�Building Block 3 - MarginsInsurance Contracts Phase 2�Building Block 3 – Risk MarginsInsurance Contracts Phase 2�Other Outstanding IssuesIAA RoleIAA Activities