Practical Application of the New IFRS for Insurance Contracts

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2 Practical Application of the New IFRS for Insurance Contracts John Nicholls 2017 Willis Towers Watson This presentation has been prepared for the Actuaries Institute 2017 Actuaries Summit. The Institute Council wishes it to be understood that opinions put forward herein are not necessarily those of the Institute and the Council is not responsible for those opinions.

3 Introduction John Nicholls Senior Consultant T E john.nicholls@willistowerswatson.com

4 Agenda Introduction to IFRS 17 How does it work? Implications

5 IFRS 17 Insurance Contracts Released by the IASB on 18 May 2017 Applicable from 1 January 2021

6 IFRS 17 Insurance Contracts Implementation Start of actuarial specifications and the implementation Implementation modification and testing, assess impact of IFRS 9 strategy Dry run 2018/9 IFRS 17 and publish 2018 IFRS 9 results 2021 IFRS P&L and BS according to full IFRS 9 and IFRS 17 and opening Balance Sheet for 2020 Final insurance contracts standard IFRS 9 Effective Dry Run Full BS needed IFRS 17 Effective IAS 39 and IFRS 4 IFRS 9 or/and IAS 39 and IFRS 4 IFRS 9 + new insurance standard IFRS 17 Option 1: Overlay approach Option 2: Deferral approach

7 General Measurement Model Fulfilment cash flows Cash-Flows Time Value Risk Adjustment Total Insurance Contract Liability Contractual service margin Risk adjustment Time value of money Cash-flows Explicit Unbiased Entity perspective Within contract boundary Reflect characteristics of cash-flows Consistent with observable market prices Exclude factors not relevant to the cash-flows Compensation the insurer requires for bearing uncertainty May reflect diversification within and between portfolios Top-down and bottom-up approaches may be used Fulfilment cash-flows: measured on a current basis

8 General Measurement Model Segmentation Initial measurement t=0 Loss through P&L Risk adjustment Present Value of Cash Inflows Present Value of Cash Outflows Present Value of Cash Inflows CSM Risk adjustment PV of Cash Outflows low risk of becoming onerous Group of onerous insurance contracts Profitable group of insurance contracts Group by portfolio Cannot group contracts issued more than one year apart other profitable contracts + more groups allowed

9 Variable Fee Approach Total Insurance Contract Liability Contractual service margin Risk adjustment Time value of money Cash flows Applies to contracts with direct participation features Initial measurement is identical to the general measurement model The fee is the entity s expected share of the returns on the underlying items less expected cash flows which do not vary directly with the underlying items Changes in the estimate of the fee adjust the CSM CSM recognized in profit or loss should be based on passage of time The entity does not have to hold the underlying items Approach is not applicable to reinsurance contracts issued or held If derivatives measured at FVPL are used to mitigate the guarantee embedded in the contract, the change in value of the guarantee can be recognized in profit or loss

10 Premium Allocation Approach Premium Acquisition Costs Initial Liability Simplified premium allocation approach for liability for remaining coverage Permitted but not required: If it is reasonable approximation to the core measurement; or The coverage period is one year or less Onerous contract test Adjust for time value of money If significant financing component Not required if coverage period is one year or less

11 Transition Retrospective application If impracticable, then two options: Default is retrospective application, as though IFRS 17 always applied Modified retrospective approach Fair value If reasonable and supportable information not available:

12 Financial statement example Statement of financial performance Year 1 Year 2 Year 3 Insurance revenue 32,575 29,621 26,989 Incurred claims and other expenses (22,126) (20,042) (18,192) Insurance service result 10,448 9,579 8,797 Investment income 1,896 3,754 5,725 Insurance finance expenses (1,655) (3,617) (5,434) Net financial result Profit or loss 10,689 9,715 9,088 Investment income 580 1, Insurance finance expenses (737) Other comprehensive income 944 1,942 (424) Comprehensive income 11,633 11,657 8,664 Statement of financial position Year 1 Year 2 Year 3 Assets 61, , ,879 Insurance contract liabilities 49, , ,215 Equity 11,633 11,657 8,664 Total liabilities and equity 61, , ,879 For illustration purposes only

13 Example: higher mortality claims Base results Higher claims yr 2 Statement of financial performance Statement of financial performance Year 1 Year 2 Year Year 1 3 Year 2 Year 3 Insurance revenue Insurance revenue 32,575 29,621 32,575 26,989 29,714 27,019 Incurred claims and other Incurred expenses claims and other (22,126) expenses (20,042) (22,126) (18,192) (24,099) (18,169) Insurance service result Insurance service result 10,448 9,579 10,448 8,797 5,615 8,850 Investment income Investment income 1,896 3,754 1,896 5,725 3,754 5,718 Insurance finance expenses Insurance finance expenses (1,655) (3,617) (1,655) (5,434) (3,617) (5,428) Net financial result Net financial result Profit or loss Profit or loss 10,689 9,715 10,689 9,088 5,752 9,140 Investment income Investment income 580 1, , Insurance finance expenses Insurance finance expenses (737) 575 (736) Other comprehensive income Other comprehensive income 944 1, (424) 1,940 (423) Comprehensive income Comprehensive income 11,633 11,657 11,633 8,664 7,691 8,717 Claim variation has second order flow on effects For illustration purposes only

14 Example: change mortality assumption Higher claims year 2 Lower assumption yr 3 Statement of financial performance Statement of financial performance Year 1 Year 2 Year Year 1 3 Year 2 Year 3 Insurance revenue Insurance revenue 32,575 29,714 32,575 27,019 29,714 28,371 Incurred claims and other Incurred expenses claims and other (22,126) expenses (24,099) (22,126) (18,169) (24,099) (18,168) Insurance service result Insurance service result 10,448 5,615 10,448 8,850 5,615 10,204 Investment income Investment income 1,896 3,754 1,896 5,718 3,754 5,718 Insurance finance expenses Insurance finance expenses (1,655) (3,617) (1,655) (5,428) (3,617) (5,428) Net financial result Net financial result Profit or loss Profit or loss 10,689 5,752 10,689 9,140 5,752 10,494 Investment income Investment income 580 1, , Insurance finance expenses Insurance finance expenses (736) 575 (739) Other comprehensive income Other comprehensive income 944 1, (423) 1,940 (427) Comprehensive income Comprehensive income 11,633 7,691 11,633 8,717 7,691 10,067 Assumption changes at the end of a period affect results for the period For illustration purposes only

15 Example: higher surrenders Base results Higher surrender yr 2 Statement of financial performance Statement of financial performance Year 1 Year 2 Year Year 1 3 Year 2 Year 3 Insurance revenue Insurance revenue 32,575 29,621 32,575 26,989 29,555 24,927 Incurred claims and other Incurred expenses claims and other (22,126) expenses (20,042) (22,126) (18,192) (20,639) (17,336) Insurance service result Insurance service result 10,448 9,579 10,448 8,797 8,915 7,590 Investment income Investment income 1,896 3,754 1,896 5,725 3,754 5,263 Insurance finance expenses Insurance finance expenses (1,655) (3,617) (1,655) (5,434) (3,617) (4,995) Net financial result Net financial result Profit or loss Profit or loss 10,689 9,715 10,689 9,088 9,052 7,858 Investment income Investment income 580 1, , Insurance finance expenses Insurance finance expenses (737) 507 (682) Other comprehensive income Other comprehensive income 944 1, (424) 1,872 (395) Comprehensive income Comprehensive income 11,633 11,657 11,633 8,664 10,924 7,464 Effects of surrender variation are spread over time For illustration purposes only

16 Example: components of revenue and claims/expenses Base results Higher surrender yr 2 Revenue/expense detail Revenue/expense detail Year 1 Year 2 Year 31 Year 2 Year 3 Expected claims Expected claims 1,999 1,958 1,919 1,999 1,958 1,776 Expected maintentance expenses Expected maintentance 8,000 expenses 7,203 6,486 8,000 7,203 6,003 CSM release CSM release 8,690 7,797 7,014 8,690 7,133 5,940 Change in RA Change in RA 1,758 1,782 1,783 1,758 1,782 1,651 Acquisition expense recovery Acquisition expense recovery 12,128 10,881 12,128 9,788 11,478 9,557 Loss recognition amortisation Loss recognition amortisation Insurance revenue Insurance revenue 32,575 29,621 26,989 32,575 29,555 24,927 Incurred claims Incurred claims 1,999 1,958 1,919 1,999 1,958 1,776 Maintenance expenses Maintenance expenses 8,000 7,203 6,486 8,000 7,203 6,003 Acquisition expense recovery Acquisition expense recovery 12,128 10,881 12,128 9,788 11,478 9,557 Insurance contract losses/reversals Insurance contract losses/reversals Loss recognition amortisation Loss recognition amortisation Incurred claims and other Incurred expenses claims and 22,126 other expenses 20,042 18,192 22,126 20,639 17,336 The behavior of the components leads to many nuances For illustration purposes only

17 CSM Progression General Measurement Model + + +/- +/- - CSM at start of period CSM for new contracts Interest at locked in rate Changes in cash flows Currency exchange CSM allocated to period CSM at end of period Experience adjustment for premium received Changes in estimates of cash flows relating to future service Difference between expected and actual investment component paid in the period Change in risk adjustment for future service CSM cannot be negative/loss reversal Allocation based on coverage units Profit not yet recognised

18 Example: higher mortality/change mortality assumption Source of profit - year Source of profit - year CSM - year CSM - year 3 For illustration purposes only

19 Example: higher surrender/change surrender assumption Source of profit - year Source of profit - year CSM - year CSM - year 3 For illustration purposes only

20 Implications Impact YRT becomes short term business Implication Different approach for YRT and level term Less volatility in profit or loss Principles based Range of methodology options Clear interpretations required Transition Material, one-time exercise Stakeholder expectations Performance metric impacts Volatility More groups for recognising losses Other comprehensive income Disclosure requirements Pressure to produce reliable numbers within the tight reporting APRA / ATO Implications not yet known

21 Opportunity to update practices Enterprise workflow process specific to your business linked into your overall architecture Lock down process, model and data through built-in security rights and roles Automatically maintain version history of models, assumptions, data and processes Repeat process consistently with automation and scheduling capability

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