International Financial Reporting Standards Risks and Rewards 4 October Mark R. Shumway, CFA Guy Carpenter & Co Global Business Intelligence

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1 International Financial Reporting Standards Risks and Rewards 4 October 2012 Mark R. Shumway, CFA Guy Carpenter & Co Global Business Intelligence

2 Agenda Risks and rewards of implementing IFRS Disclaimer and Introduction Risks associated with IFRS implementation Potential benefits of IFRS for Indonesia 1

3 Disclaimer This presentation is for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Guy Carpenter & Company, LLC makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. Please consult your insurance/reinsurance advisors with respect to individual coverage issues. Statements concerning tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or regulatory advice, which we are not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas. Readers are cautioned not to place undue reliance on any historical, current or forward-looking statements. Guy Carpenter & Company, LLC undertakes no obligation to update or revise publicly any historical, current or forward-looking statements, whether as a result of new information, research, future events or otherwise. This document or any portion of the information it contains may not be copied or reproduced in any form without the permission of Guy Carpenter & Company, LLC, except that clients of Guy Carpenter & Company, LLC need not obtain such permission when using this presentation for their internal purposes. 2

4 Introduction My perspective Userof financial statements Over fifteen years analysing insurance company financial statements in a professional capacity: - KPMG consultant to insurance and banking clients - A.M. Best insurance credit analyst - Guy Carpenter (re)insurance industry analyst and advisor Fully agree with CFA Institute: It is in the best interests of investors and for global financial markets generally for the differing standards to be harmonized and complete convergence to be achieved at the earliest possible time. But, there are fundamental problems with IFRS that should be addressed 3

5 Risks of IFRS Implementation Costs, volatility, information risk

6 Risks of IFRS Compliance costs Implementation may require a material increase in resources to deal with technical accounting challenges Median increase in staffing among insurance companies: >10%¹ Greater need for actuarial resources Using untrained staff increases information risk Potentially major increase in technology costs Much more impact on life insurers relative to general insurers ¹ KPMG, 2006 survey of global insurance companies implementing IFRS 5

7 Risks of IFRS Greater volatility A more precise measure is more uncertain (volatile) Under fair value accounting, there is much more variance in the reported value of assets and liabilities, and thus net assets and regulatory capital, between periods This is accounting volatility, not reflective of economic fundamentals, so may lessen the value that stakeholders place on reported numbers Jakarta Stock Exchange Composite Index Jakarta Stock Exchange Composite Index

8 Risks of IFRS Information risk Information risk = the risk that investors or other stakeholders rely on materially misstated information, or misinterpret vague information, when making decisions Decision-useful financial information is: ² Relevant Representationally faithful Verifiable Timely Understandable Comparable Where information does not meet all of these standards, stakeholders bear information risk ² Statement of Financial Accounting Concepts No. 2, Financial Accounting Standards Board (FASB) 7

Risks of IFRS Information risk Sources of information risk associated with IFRS include: The illusion of similarity - Comparability of standards comparability of practice - Differences in economic

9 Risks of IFRS Information risk Sources of information risk associated with IFRS include: The illusion of similarity - Comparability of standards comparability of practice - Differences in economic factors and application - The European Union s crisis illustrates the difficulties of true convergence across different cultures, economies, and politics - Indonesian IFRS will not be strictly comparable with Singaporean IFRS, etc. 8

10 Risks of IFRS Information risk Managerial discretion - Low industry-specific guidance under IFRS gives managers extensive discretion over disclosures - Make inter-industry comparisons at your own risk Overuse of footnotes - To improve comparability across industries and countries, IFRS sacrifices recognition (information conveyed by the numbers) - Increased footnote disclosure potentially material information ignored / information overload 9

11 Benefits of IFRS Implementation for Indonesia Opportunity to improve, reduced costs of capital

12 Rewards of IFRS The accepted benefits Comparability - More attractive to foreign investors Transparency - Reduce cost of capital, improve valuation Intra-group convergence - Improve efficiency among global groups 11

13 Rewards of IFRS Opportunity? Not just a compliance challenge, but also an opportunity to strengthen governance and risk controls - Conversion to IFRS entails extensive changes to many internal systems and processes - Many required changes are supportive of or even require a more robust risk management processes - Systems not just for financial reporting -ALM - Product design and pricing - Reinsurance - Documented assumptions - Sensitivity analyses 12

14 Rewards of IFRS Cost of capital Contributors of capital demand a reward. This reward is the cost of capital Value is created only when profitability (return on economic capital) is greater than the cost of capital Return on Economic Capital > Cost of Capital 13

15 Rewards of IFRS Cost of capital Transparency is a value driver Value Driver Strategy Reduce Capital Increase Returns Value Creation Lower Shareholder Demands 14

Rewards of IFRS Cost of capital Managing Transparency Despite its drawbacks, IFRS represents improved transparency over Indonesian GAAP - Insurers can further improve transparency by clearly

16 Rewards of IFRS Cost of capital Managing Transparency Despite its drawbacks, IFRS represents improved transparency over Indonesian GAAP - Insurers can further improve transparency by clearly communicating risk preferences and comparative advantages as part of the IFRS disclosure - We have evidence that firms with clearly communicated risk preferences, and persistent results in line with those preferences, are rewarded by the market with higher valuation 15

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