IFRS 4 Phase 2 Insurance contracts Update on the industry s response. December 2, 2010

Transcription

1 IFRS 4 Phase 2 Insurance contracts Update on the industry s response December 2, 2010

2 Contents Introduction Jacques Tremblay 3 Goal of IFRS Phase 2 Timeline Overview building blocks of the measurement model Global industry general response and expected impact - Jacques Tremblay 7 Industry response Expected Impact on the Industry Sources of guidance Five focus areas of debate with Canada s comments to IASB Micheline Dionne 17 Review building blocks of the measurement model Discount rate Risk adjustment Residual margin Unbundling Expenses Key takeaways and potential Impact on the Caribbean industry Michelle Chong Tai-Bell 23 2

3 Introduction to IFRS 4 and Global Industry response Jacques Tremblay, FSA, FCIA, CERA Partner Oliver Wyman December 2, 2010

4 The aim of IFRS Phase 2 is develop a high quality global standard to correct many of the deficiencies of the various practices used The change we are seeking in our financial statements and how it will benefit users and other stakeholders Better reflection of economic reality Understandability Comparability Transparency and consistency of accounts Convergence of global insurance accounting Relevance Reliability Level playing field for companies With the increasing adoption of IFRS globally this proposed standard could fundamentally change the way insurers measure, report, and evaluate performance of their contracts worldwide 4

5 The IFRS II Exposure draft is a product of other IASB initiatives Performance reporting Conceptual framework IFRS II Exposure Draft Revenue recognition Financial instruments 5

6 With the underlying goals and desire for consistency with other IASB initiatives the key principles for IFRS Phase II were developed A single model for life and non-life Reflect the insurance business model Profit recognized in line with release from risk Nil gain or loss at inception unless economic loss (Liability Adequacy Test) Market consistent valuation of liabilities Present value of future cash flows with allowance for risk and uncertainty Risk free discount rate allowing for liquidity Recognition of options and guarantees Active unlocking of assumptions Reflect how insurance companies manage risk Liabilities measured on a portfolio basis reflecting policyholder behaviour Assets and liabilities measured on a consistent basis 6

7 IFRS Insurance Contract Exposure Draft (ED) Timeline and important dates ED comments period Final revisions to IFRS 4 Implementation Effective date? July 2010 IFRS Insurance Contract ED November 30, 2010 Comments on ED must be received Exposure Draft published July 2010 Mid 2011 Expected Final IFRS on insurance contracts Final standard, is not expected to be published before the second half of 2011, and not expected to be implemented before 2013 Joint FASB/IASB project creates global convergence Principles based approach with certain additional guidance 7

8 Overview of Proposed Phase II Measurement model Fulfilment objective rather than exit value objective A 5 building block measurement model Block 5 Unbundled elements Fund values Embedded derivatives Block 4 Residual margin Block 3 Risk adjustment A mechanism (plug) to ensure no Day 1 gain is possible but allows for a Day 1 loss Locked-in and amortized over coverage period at cohort level Reflects of uncertainty about amount/timing of future cash flows Insurer perspective; not market participant Block 2 Time value of money Discount rate is risk free plus a liquidity premium Liquidity premium to reflect non-credit element of current market spreads over risk free Block 1 Current unbiased probability weighted estimates of future cash flows Re-measured each period using current estimates reflecting a combination of rights and obligations (inflows and outflows) Insurer perspective 8

9 Section 2 Global industry responses/intentions

10 Global industry supports the development of an international standard for insurance contracts but the response to the building blocks varies by region Europe (CFO forum) major influence on development of draft supports the motivation of most building blocks some concerns on the interpretation of the standard A 5 building block (BB) measurement model Block 4 Residual margin Block 3 Risk adjustment Canada (CIA): building blocks 1 and 3 similar to CALM/PPM, but has fundamental concerns regarding BB 2 and BB 4: OSFI returns also to be on IFRS basis requiring change to MCCSR UK: (Faculty/Institute) Supports the change in paradigm Emerging markets: how will this work in our environment? Block 2 Time value of money Block 1 Current estimates of future cash flows Block 5 Unbundled elements US Industry: has concerns on the implications on the design of building block 2 FASB 1 : proposing a similar approach but with a single combined margin (block 3 and 4) Areas of great debate 1. For a more detailed comparison of the IASB s to FASB s proposal See CIA AA 2010 presentation-: Session 18 Doherty 2. CFO Forum Viewpoint: See Elaborated principles document at 10

11 What will Phase II mean for companies? Significant change!! Business dynamics/kpis Economics won t change but results will Presentation format of results Key measures Management of volatility People Communication Training Performance targets Established measures under current accounting no longer apply Not just accountants, but the whole business IT Automate underlying changes to business models Changes to underlying business systems as well as financial systems Processes Pricing dynamics Asset/liability matching Discounting of General Insurance reserves Restatement of prior year numbers Regulatory solvency compatibility Investment for no economic return in the business Will impact all areas of the business 11

12 The global industry does have concerns on the impact on the industry In Canada, the impact on earnings and balance sheet requirements will be significant Absolute impact on day 1 earnings IFRS Phase II will not allow for recognition of any day 1 profits and will require immediate expensing of nonincremental acquisition costs Current CGAAP standard currently allows for explicit deferral and amortization for VAs and segregated funds, negative reserves for other products In addition, IFRS Phase II valuation rates could potentially be lower than those under current CGAAP regime, further increasing pressure on day 1 earnings (balance sheet strain) Absolute impact on earnings volatility For long-term fixed business without risk sharing features, the impact will be strongest Widening credit spreads will reduce asset values without an offset in liability values Credit spread volatility will drive earnings volatility, particularly in times of stress For long-term fixed business with risk-sharing features, the impact will be more muted Widening credit spreads will reduce the value of liabilities in tandem with assets Predicated on the ability to share future credit losses with shareholders Absolute impact on total balance sheet requirements A significant increase in the total balance sheet requirements for long-term fixed businesses could be driven by Higher capital requirements for credit risk Higher reserve requirements caused by lower valuation rates OSFI s recent Quantitative Impact Study (QIS) implied a material increase in capital requirements for credit risk Reserve requirements are also likely to increase (assuming OSFI maintains a single balance sheet for solvency and accounting) 12

13 Likely outcomes in Canada if IFRS 4 Phase II goes through in current form Solvency regime Some actuaries believe that current Canadian GAAP framework should be retained as solvency regime but OSFI is very reluctant to de-link GAAP and Solvency Regimes Volatility issues need to be addressed Some Appointed Actuaries believe this would be the preferred approach An asset adequacy based method such as current Canadian GAAP is a logical way to assess adequacy of balance sheet resources GAAP reporting Use of non-gaap measures to explain results Solvency (MCCSR) Pressure to absorb GAAP balance sheet volatility in solvency regime Perhaps a total balance sheet approach Products Growth of adjustable products with minimal guarantees De-emphasize long duration guaranteed products 13

14 Some of the negative effects could be mitigated through product repositioning and management action Pass-through or adjustable long-term products E.g. Current assumption or index-linked UL, participating-like products, etc. Earnings and solvency volatility largely mitigated by linkages between credit spreads and liability valuations Risk sharing or adjustable features should ensure no large increases in either insurance liabilities or capital requirements, assuming timely management action Short term protection E.g. Most group insurance, renewal term, etc. Some group products, such as long term disability ( LTD ) and long term care ( LTC ), would be affected similarly to non passthrough, long-term individual policies once in disabled life status Generally, short term group contracts are not sensitive to changes in the economic environment (interest rates and spreads) No material impact on earnings or solvency volatility Variable annuities E.g. Individual retail with living benefit guarantees, group DC products Sensitive to interest rates and capital markets due the degree of in-the-moneyness of the policyholder investments Companies are de-risking the product design by reducing benefits (e.g. guaranteed returns, number of resets) Also globally, industry players have been increasing fees, reducing withdrawal percentages, imposing more asset allocation restrictions and offering less generous deferral incentives Risk is partially mitigated through hedging programs (cost is partially passed on to consumer) mostly for new business Market has experienced some withdrawal from new offerings 14

15 and everyone is looking for further guidance on how to get it done! Many areas in the ED lack the clarity required for implementation, such as the discount rate, liquidity premiums..etc The CIA presented a few options to OSFI with respect to guidance, including Option 1 : pure reliance on the IAA for guidance - CIA endorses and encourages the development by the IAA of high quality, enforceable standards - However, the CIA is not confident that IAA will be able to develop sufficiently detailed guidance in time for conversion - There is also still the question of enforceability Option 2 :CIA provides Canadian specific guidance to bridge the gap - CIA provides detailed guidance to bridge the gap until international guidance of sufficient quality and enforceability is available - Will require significant work to be completed by the CIA and ASB - Will require the OK from the auditing firms Most likely outcome will be for the IAA to provide global standards and local actuarial bodies to provide more specificity with respect to local products etc 15

16 Section 3 Five focus areas of debate with the CIA s comments to IASB Micheline Dionne, FSA, FCIA, CERA President of the CIA December 2, 2010

17 Overview of Proposed Phase II Measurement model Fulfilment objective rather than exit value objective A 5 building block measurement model Block 5 Unbundled elements Fund values Embedded derivatives Block 4 Residual margin Block 3 Risk adjustment A mechanism (plug) to ensure no Day 1 gain is possible but allows for a Day 1 loss Locked-in and amortized over coverage period at cohort level Reflects of uncertainty about amount/timing of future cash flows Insurer perspective; not market participant Block 2 Time value of money Discount rate is risk free plus a liquidity premium Liquidity premium to reflect non-credit element of current market spreads over risk free Block 1 Current unbiased probability weighted estimates of future cash flows Areas of great debate Re-measured each period using current estimates reflecting a combination of rights and obligations (inflows and outflows) Insurer perspective 17

18 Time value of money CIA proposal using a discount rate based on the credit characteristics of a portfolio of high quality corporate debt obligations (Corporate AA, in Canada) Description/Motivation for Discount rate Reflect a fair valuation of the liabilities independent of the assets held Risk free (in the appropriate currency) + liquidity adjustment No up-fronting of credit spreads reflected Reflects investment cash flows if liability cash flows contractually dependent Liquidity consistent with characteristics of liability cash flows No consideration for risk of non-performance by the insurer Issues/CIA Response to IASB Proposal Q3. Do you agree that the discount rate used by the insurer for non-par contracts should reflect the characteristics of the insurance contract liability and not those of the assets backing that liability? We do not agree that the discount rate should ignore the assets supporting the obligation. The de-link from assets held leads to disconnect from current business model and will not reflect a company s ALM mismatch risk The lack of a generally accepted approach to measuring the liquidity premium will lead to inconsistencies and less useful financial results Comments on Implementation Guidance needed for the specification of the liquidity premium CIA is suggesting an indirect approach by subtracting a provision for pure credit risk (estimated from credit default swaps) Guidance needed for the extrapolation beyond last duration of observable bond yields leads to undue volatility CIA is suggesting the use approach to URR like CALM Further guidance needed on the use of risk neutral stochastic methods for guarantees 18

19 Time value of money (cont d) Other implications of the proposed discounting approach The Level of Actuarial Liabilities The concept behind the liquidity premium and the expected CALM based spreads are different Corporate AA will be closer to CALM rates but behaviour will be different Will the liquidity spread be large enough for companies to offer long duration products at current prices (strain issue)? The volatility of the actuarial liabilities The lack of a smoothed URR will increase the interest rate volatility Significant basis risk volatility as spreads on diversified fixed income portfolio move differently than liability reference curves Both impacts are material when capitalised each period on long duration blocks of business Anticipated impact on industry Increased earnings volatility ALM more transparent in results Product changes/repricing Increased new business strain if the liquidity premium concept is retained, less so if Corporate AA is adopted 19

20 Risk adjustment (RA) The CIA supports the basic concept of an explicit risk adjustment the concerns surround some of the proposed principles of application Description/Motivation for Risk Adjustment RA represents the maximum amount the insurer would rationally pay to be relieved of the risk that ultimate fulfilment cash flows exceed expected Estimated at the portfolio level no inter-portfolio diversification Re-measured each period based on current estimate Only risks associated with the contract no investment risk (unless affects p/h cash flows), A/L mismatch or operational risk A choice of 3 methods have been given Conditional Tail Expectation, Percentile, Cost of Capital Issues/CIA Response to IASB Proposal Q5b. ED limits the choice of techniques for estimating RA to 3 methods. Do you agree that these three techniques should be allowed and no others? Why or why not? The Board should set out the objective of the risk adjustment and the principles for choosing it and then let reporting entities, with the assistance of professionals, determine how best to apply the principles Ignores possibility that, improved approaches could be developed in future Other comments: the word maximum should be removed, can be interpreted as introducing a bias Comments on Implementation If the Board s decision stands to limit the permitted techniques then the Board should provide additional guidance on CoC definition of capital and rate of the cost of capital Confidence Level, if disclosure is required guidance should be given on how to treat situation where there is no distribution 20

21 Residual margin (RM) release from risk approach CIA fundamentally disagrees with the need for a residual margin Motivation for a residual margin Accounting profit should be recognised in line with release from risk. That is, when the service is provided and hence it is inappropriate to recognise anticipated profit at outset The initial profit margin is akin to deferred income The risk profile of a policy determines the pattern of profit recognition. For short-duration policies, the release from risk approach may be approximated by the unearned premium reserve approach. Economic losses should be reflected both on initial and subsequent measurement Residual margin is the method to synchronise the release of profit with release from risk CIA Response to IASB Proposal Q6. Do you agree that an insurer should not recognise any gain/loss at initial recognition of an insurance contract? No, we do not agree The proposed RM is an artificial device that distorts the measurement Two contracts identical in every way except that one has a higher premium will be measured at the same initial value Presents opportunities for manipulation of income The question of which acquisition expenses should, and should not, be included would become moot in the absence of a residual margin Comments on Implementation The proposed approach for implementation and amortisation is overly complex 21

22 Unbundling CIA response unbundling components adds a significant amount of complexity for little, or no, additional value Description/motivation for Unbundling Components are unbundled and measured under other appropriate IFRS if not closely related to insurance coverage provided No definition of closely related Most common examples Account balance credited with explicit return or based on the full investment performance of underlying investments (e.g. indexed-linked, unit-linked, general account) Embedded Derivatives Goods and services combined with the insurance coverage for reasons without commercial substance risk Issues/CIA Response to IASB Proposal Q12. Do you think it is appropriate to unbundle some components of an insurance contract Ideally, unbundling would be unnecessary as different types of contracts would be measured using consistent principles Unbundling components adds a significant amount of complexity for little, or no, additional benefit to users It would seem Canadian UL contracts would qualify but the account balance is merely a reference measure and not directly available to the policyholder Comments on implementation Need more guidance on the definition of closely related Crediting rate used in determining the account balance reflects crediting rate after eliminating cross-subsidy between that rate and the charges and fees however in many cases there will be cross-subsidies with other contract elements that would need to be extricated. This could require maintaining a completely artificial shadow account 22

23 Expenses CIA response Expenses should include more than just direct expenses Description for Expenses Limit expenses to direct costs Exclude accounting, human resources, systems, overhead Exclude taxes Issues/CIA Response to IASB Proposal Some non-direct expenses are essential to be able to run the operations Limiting expenses to direct ones will cause inappropriate front-ending of profits Will be offset by the residual margin but with a different pattern of recognition (accounting mismatch) Should include taxes too. Their impact is material for long duration insurance contracts Comments on implementation Direct expenses should be assessed at a portfolio level not at the individual policy level. The inclusion of non-direct expenses necessary to run the operation would apply to both acquisition and maintenance expenses. 23

24 Section 4 Key takeaways and potential impact on the Caribbean industry Michelle Chong-Tai Bell, FSA, FCIA, CERA Executive Vice President, Resident Actuary Sagicor Life December 2, 2010

25 KEY TAKEAWAYS WE ARE NOT IN THIS ALONE WE ARE NOT YET ABLE TO ASSESS THE SIZE OF THE IMPACT THE IMPACT IS WIDE-RANGING IN SCOPE THIS IS NOT SIMPLY AN ACCOUNTING OR ACTUARIAL MATTER WE MUST START OUR PREPARATIONS NOW 25

26 WE ARE NOT YET ABLE TO ASSESS THE SIZE OF THE IMPACT MANY QUESTIONS AT THIS STAGE DISCOUNT RATE??? LIQUIDITY PREMIUMS??? UNBUNDLING??? TREATMENT OF EXPENSES??? METHODS FOR THE RISK ADJUSTMENT??? RESIDUAL MARGIN??? TRANSITION REQUIREMENTS??? GUIDANCE WILL BE REQUIRED 26

27 FUNDAMENTALLY CHANGES HOW PROFITS EMERGE THIS IS NOT JUST AN ACCOUNTING OR ACTUARIAL MATTER INVESTORS SHAREHOLDERS BOARDS OF DIRECTORS MANAGEMENT EMPLOYEES CUSTOMERS DISTRIBUTION REGULATORS 27

28 THIS IS NOT JUST AN ACCOUNTING OR ACTUARIAL MATTER INDUSTRY COMPETITIVENESS ABILITY TO RAISE CAPITAL COST OF CAPITAL COMPANY COMPETITIVENESS QUARTERLY EARNINGS DIVIDEND DISTRIBUTION MANAGEMENT AND STAFF BONUSES PRODUCT PRICING & DESIGN SYSTEMS & IT COMPANY TAX CAPITAL ADEQUACY REGIMES AGENT COMPENSATION STRUCTURES PERFORMANCE MANAGEMENT 28

29 BEGIN TO PREPARE NOW THIS IS NOT JUST AN ACCOUNTING OR ACTUARIAL MATTER 29