Solvency II and GAAP in the UK - Accounting and Other topical issues. 22 October 2015

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1 Solvency II and GAAP in the UK - Accounting and Other topical issues 22 October 2015

2 Agenda Using Solvency II for Accounts purposes Other topical issues Using UK GAAP for Solvency II Update on IFRS 4 Phase II and UK GAAP The Audit of Solvency II Pillar III reporting

3 USING SOLVENCY II FOR ACCOUNTS PURPOSES 3

4 Background For accounting periods beginning on or after 1 January 2015 UK insurers will prepare their accounts using FRS 102 and FRS 103; or IFRS and in particular IFRS 4 Phase I Solvency II is effective from 1 January 2016 Both IFRS 4 Phase I and FRS 103 (which replicates much of IFRS 4 Phase I) allow an insurer to continue using the accounting policies used prior to adoption of new standard Old UK GAAP for life insurers was based on PRA regulatory requirements that will no longer apply post 1 January 2016 MSSB and realistic capital regime

5 The issue for UK insurers Can we continue with our old accounting policies when Solvency II comes into force? Yes - FRC expected to issue an ED amending FRS 103 and making it clear that established accounting policies can continue to be applied - References to old pre-solvency II regulatory framework and PRA Handbook to be amended - No specific references to regulatory requirements Do we want to continue with our old accounting policies? Possibly What could we change to? (Modified) Solvency II basis Issue expected to be more pronounced for life insurers

6 Why might we want to change? Time and cost of preparing two sets of numbers One for accounts purposes, one for Solvency II purposes - Additional time and cost also incurred in reconciling and explaining differences A useful bridge to IFRS 4 Phase II Might become part of UK GAAP Understand what the incremental costs are Ensure cost v benefit analysis of change fully takes into account impact on - operating model - tax

7 Why might we not want to change? IFRS 4 Phase II when / if applicable will result in fundamental changes to insurance accounting Multiple restatements in a relatively short period may be difficult to explain to stakeholders Use of Solvency II transitional provisions affecting calculation of TP for solvency purposes means related accounting policies may have to change as these expire Transitional provisions require Solvency I calculations to continue Solvency II is new and KPI based on Solvency II might not be readily understood Non-availability of comparative information Loss of comparability with peers if they do not change

8 Criteria for change I May change policies but only if Change makes FS more relevant... and no less reliable OR more reliable and no less relevant (FRS 103 para 2.3 / IFRS 4 para 22) Relevance and reliability to be judged by criteria in FRS 102 para 10.4 and Section 2 or in IAS 8: Resulting FS - represent faithfully financial position, financial performance... - reflect economic substance rather than legal form - are neutral i.e. free from bias - are prudent - are complete in all material respects Information must be understandable, material, comparable, timely, cost effective

9 Criteria for change II Change cannot mean (FRS 103 para 2.6 / IFRS 4 para 25) measuring liabilities on an undiscounted basis measuring contractual rights to future investment management fees at > fair value making group accounting policies more diverse Change cannot introduce excessive prudence (FRS 103 para 2.7 / IFRS 4 para 26) Change cannot introduce future investment margins (FRS 103 para 2.8 / IFRS 4 para 27)) e.g. through use of discount rate based on estimated asset returns unless margins affect contractual payments a rebuttable presumption - Allowed if part of package of changes that overall meets criteria Change permitted if introduces shadow accounting recognised unrealised gains / losses treated in same way as realised ones

10 Criteria for change III Change should not contravene legal requirements in particular for UK GAAP preparers, Schedule 3 to The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410) ( the Regulations )

11 Could we change to Solvency II? More relevant? Arguably yes - Current regulatory basis - Used in management of business - Assets and Liabilities on a fair value basis Article 75 of Directive - Schedule 3 para 52 (3) requires LTBP to have due regard to actuarial principles laid down in Directive No less reliable? Less clear cut A new system, not yet bedded in Areas to consider - Prudence - Profit recognition - Future investment margins - Accounting mismatches - Solvency II transitional reliefs

12 Prudence Schedule 3 requires provisions to be sufficient to cover any liabilities arising out of insurance contracts as far as can reasonably be foreseen Will Solvency II TP including risk margin introduce excessive prudence? - Solvency II TP reflect all future cash flows not just reasonably foreseeable ones - Should risk margin be omitted or adjusted? - Is Solvency II cost of capital rate of 6% appropriate?

13 Profit recognition No P&L focus in Solvency II, no profit deferral mechanism Day 1 profits can be recognised Not consistent with general principles of FRS % completion method or IFRS 15 IFRS 4 Phase II will not allow recognition of Day 1 profits Consistency of approach needed re contract boundaries for BS and P&L account Less of an issue for mutuals than for insurers with shareholders

14 Future investment margins Standard approach under Solvency II is to discount using appropriate risk free rate but matching adjustment or volatility adjustment use rates based on returns on assets held

15 Accounting mismatches Will change increase volatility of results or mismatches between assets and liabilities? Will changes in asset strategies as a result of Solvency II increase accounting mismatches if liabilities are not accounted for on a Solvency II basis as well?

16 Solvency II transitional reliefs The unwinding of transitional reliefs may make consistency and comparability difficult to achieve

17 Other There are no deferred acquisition costs under Solvency II Unless a life insurer already uses, or elects to use, the realistic value of liabilities in its FS, FRS 103 para 3.8 states that except in certain circumstances acquisition costs shall be deferred Some accounting amendment may be necessary to Solvency II TP to gross them up for deferrable acquisition costs Similar to adjustment currently made under MSSB

18 Consideration for general insurers Same link does not exist between solvency requirements and accounting requirements as existed for life insurers Accounting basis for general insurance less broken than that for life insurance Premium allocation approach expected to be available to general insurers under IFRS 4 Phase II is more like old UK GAAP than Solvency II may be better to move straight to IFRS 4 Phase II basis Schedule 3 para 54 (1) restricts the use of discounting in particular, the expected average interval between the date for the settlement of claims being discounted and the accounting date must be at least four years Treatment of non-proportional reinsurance (may also impact some life insurers) Solvency II rules, as currently understood, effectively write off the cost of any reinsurance purchased before the year even if inwards policies yet to be written would be protected in due course Under old UK GAAP an asset would be recognised.

19 Summary Using Solvency II as the basis for the preparation for accounts may be a viable option for some insurers Arguments for and against need to be carefully weighed and discussions held with all interested stakeholders If a change is being considered, early consultations with the auditor are strongly recommended!

20 OTHER TOPICAL ISSUES 20

21 Using UK GAAP for Solvency II PRA SS38/15 Solvency II: consistency of UK generally accepted accounting principles with the Solvency II Directive sets out the PRA s expectations of firms wanting to use UK GAAP for the recognition and valuation of assets and liabilities for Solvency II purposes identifies those UK treatments which the PRA considers to be consistent, in full or in part, with Article 75 of the Directive

22 IFRS 4 Phase II Basic building blocks approach generally accepted unbiased estimate of future cash flows risk margin contractual service (profit) margin discount for time value of money Final standard delayed by continuing deliberations over performance reporting particularly in respect of contracts with a discretionary participation feature Another ED expected in year transition period between final standard and mandatory effective date EU approval FRC s position re introduction into UK GAAP unchanged No firm decision taken wait and see what final standard looks like and any implementation issues

23 Audit of Solvency II Pillar III reporting EIOPA position audit a good thing but not our problem! UK transitional audits ref to 31 December 2014 PRA consultation paper due in November 2015 on audit requirements iro live reporting from 1 January 2016 FRC to redraft PN20 Audit of Insurers in the United Kingdom gap period expected to arise between due date for first audited annual QRTs and issue date of revised PN20 Cost of audit proposals expected to be an issue!

24 QUESTIONS? 24 Titre de la présentation

Contact details Ray Tidbury: Tel: 020 7063 4447 ray.tidbury@mazars.co.

25 Contact details Ray Tidbury: Tel: Paul Bennett Tel: This presentation has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained herein without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information it contains. To the greatest extent permitted by law, Mazars LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act, in reliance on the information contained in this presentation or for any decision based on it.

CFO NETWORK 22 ND OCTOBER 2015

CFO NETWORK 22 ND OCTOBER 2015! CFO NETWORK HOST: JAMES BRENNAN, RATHBONES TODAY S CHAIR: MARTIN SHAW, AFM! TODAY S AGENDA Bond Market Update, Noelle Cazalis, Rathbones Solvency 2 calculation and reporting