IFRS Phase II Accounting Issues

Transcription

1 IFRS Phase II Accounting Issues Session CIA Annual Conference Neil Parkinson, FCA Toronto, June 21, 2012

2 Our agenda 1. IFRS adoption in 2011 what changed and what didn t 2. Future IFRS changes for insurers overview of progress to date a) Key decisions reached in 2012 b) U.S. (non) convergence 3. Details of expected standards - IFRS 4 and IFRS 9 1

3 IFRS adoption in 2011

4 What changed with IFRS and what didn t Insurance accounting little change IFRS 4 allows insurers to continue with their previous basis of accounting for insurance contracts Some difference in the definition of insurance contracts Some savings contracts with little or no risk were reclassified as deposits (life insurance) Some service contracts without insurance risk could be reclassified as service arrangements (few if any examples) Reinsurance reported gross rather than net for life insurers OSFI discouraged (effectively prohibited) optional changes in basis of accounting upon adoption of IFRS 3

5 What changed with IFRS and what didn t Investment accounting little change, Canadian GAAP (CICA 3855) was already aligned with IFRS (IAS 39), with only minor differences Re-designation between financial instrument categories permitted under IFRS Some reclassification between AFS and FV through income has resulted Measurement differences, elections and exemptions in other areas, such as property assets, post-employment benefits accounting Revaluation of fixed assets Componentization of depreciable assets Charge of pension and benefit deficits to retained earnings 4

6 IFRS 1 (first time adoption) - Exemptions and Exceptions A look at Canadian insurance companies Company Bus Com Employee Benefits CTA Designation of FI Share-based payments Insurance Contracts Deemed Cost Borrowing Costs Manulife Yes Yes Yes Sun Life Yes Yes Yes Yes Yes Yes GWL Yes Yes Yes Yes Yes Intact Yes Yes Fairfax Yes Yes Yes Genworth Yes Yes

7 IFRS 1- Adjustments A look at adjustments by Canadian insurance companies Company Employee Benefits Consolidation Financial Instruments Stock-based Compensation Insurance Contracts Manulife Yes Yes Yes Yes Yes Sun Life Yes Yes Yes GWL Yes Yes Intact Yes Yes Yes Fairfax Yes Genworth Yes Yes

8 FUTURE IFRS CHANGES FOR INSURERS - PROGRESS - KEY DECISIONS TO DATE - US (NON) CONVERGENCE

9 IASB project to replace IFRS 4 Progress to date Project Phases IASB Discussion paper Preliminary Views on Insurance Contracts (May 2007) Current Exit Value Approach FASB invitation to Comment wrapping IASB paper (August 2007) FASB joins IASB project (October 2008) IASB Exposure Draft (July 2010) FASB Discussion Paper (September 2010) Final IFRS re-exposure draft is not expected before late in 2012 FASB Exposure Draft also targeted for late 2012 but being reconsidered First time application to be established (Boards intent was to align effective date with IFRS 9 Financial Instruments 2015? 2016?) 8

10 Insurance contracts Key decisions reached in 2012 Issue Tentative decisions to May 31, 2012 Discount rate No linkage between assets actually held and the discount rate used for liabilities This has been the most controversial issue for Canadian life insurers, less so for non-life Volatility No linkage between assets and liabilities can lead to unrealistic short term volatility Reconfirmation of key aspects of the model 4 building blocks model Measurement at portfolio (vs. contract) level Premium allocation approach (unearned premium) -approximates building blocks model Allow either a top down approach, starting with an asset rate, or a bottom up approach starting with a yield curve IASB has tried to address some industry concerns, but largely confirmed its positions Two sided OCI interest rate changes in liability measurement to be recorded in other comprehensive income (OCI) as would FV changes in certain assets The above requires changes in IFRS 9 to reintroduce something similar to the old AFS Separately determined risk margins Acquisition costs at portfolio level (not successful efforts only as in US GAAP) Use of premium allocation approach permitted for short term business, but is not required 9

11 IFRS and US GAAP the outlook for (non) convergence June 5 and 7 statements by FASB Chair Leslie Seidman seem to rule out converged standards in the near future: Despite attempts to reach agreement with IASB on several issues, FASB has been unable to do so - areas cited in particular: Separately determined risk margins in the IASB model Treatment of certain policy acquisition costs Timing and classification of changes in liability assumptions FASB will issue an ED but it won t look like IASB s proposals FASB is not dropping the project, and will continue to work with IASB 10

12 DETAILS OF EXPECTED STANDARDS - IFRS 4 - IFRS 9

13 IASB Stage II Insurance contracts update Measurement Model 3 or 4 Building Blocks? Four Building Blocks IASB Preference (modified to exclude day one gains) Expected future cash flows explicit, unbiased and probability-weighted estimates of future cash outflows less future cash inflows Time value of money discounted using current rates to reflect the time value of money Risk adjustment to adjust for the effects of uncertainty about the amount and timing of future cash flows Residual margin to remove any profit at inception and released over time Three Building Blocks FASB Preference (modified to exclude day one gains) Expected future cash flows explicit, unbiased and probability-weighted estimates of future cash outflows less future cash inflows Time value of money discounted using current rates to reflect the time value of money Composite margin to remove any profit at inception and released over time 12

14 Building Block 1 Identification and treatment of acquisition costs Identification - IASB tentative decision is that acquisitions costs are to be identified on a portfolio basis allows inclusion of variable but indirect costs of selling and originating new business (decision confirmed in May 2012) US FASB implemented a change in US GAAP to a narrower definition of acquisition costs effective 2012, and has voted against the IASB approach Limits acquisition costs to those directly identifiable with the sale of a specific policy, and only for successful efforts (EITF 07-G) Given the recent change in US GAAP, it is hard for FASB to reverse themselves and align with IASB New US GAAP change aligns with non-insurance IFRS approach to revenue recognition and acquisition costs Treatment Acquisition costs are part of fulfilment cash flows, and not an asset In the building blocks model, ACs reduce the residual margin required In the Premium Allocation approach, ACs reduced the pre-claims liability (unearned premium) 13

15 Building Block 2 Time value of money In principle, not a change in Canada, for either life or P&C insurance. However, discounting is the exception for P&C insurers outside of Canada and Australia. Existing IFRS 4 permits but does not require discounting - but does not allow a change from discounting to undiscounted insurance liabilities permits but does not require the continued use of a discount rate including future investment margins but does not allow moving to adopt such a rate The original ED proposals had two points of controversy for Canadian insurers: 1. Breaking the linkage between the discount rate used for liabilities, and the return expected from the investments held resulting in unrealistic volatility in income (and capital) 2. Proposing the use of low or no-risk discount rates, typically well below the rates built into life insurance product pricing resulting in unrealistic profit recognition and liability valuation 14

16 Building Block 2 Discount rate alternative approaches Asset rate > Liquidity premium Risk- free rate? Top down alternative Credit risk Tentative decisions of the IASB: Reflect the characteristics of the liability; no linkage to assets No locking in of the rate Allow a top down approach as an alternative, starting with an asset rate The top down alternative Deduct risks not present in the liability, e.g. investment risks that can t be passed to the policyholder (expected and unexpected credit defaults) IASB: bottom up and top down should get to the same place but in practice? ED: Bottom up approach Might reduce but not eliminate problems of volatility and losses at inception What asset rate can you use as a starting point? IASB prefers debt securities only 15

17 Building Block 2 Discount rate applying the top down approach Asset rate > Top down alternative Credit risk Deducting credit risk Expected and unexpected credit defaults can be determined using the insurer s own methodology, not market credit spreads? Why would there be a gap between bottom up and top down in practice? Liquidity premium Risk- free rate Market yields tend to include premiums related to sentiment, inefficiencies, frictional costs Methods for long durations? ED: Bottom up approach Need other approaches where insurance contracts have durations beyond those that are reliable and observable. E.g. moving average, mean reversion for interest rates, and use of non-fixed instruments. 16

18 Building Block 2 Use of OCI to address volatility: the Two-sided OCI solution May 2012 decision by IASB to introduce a 2-sided OCI approach to keep some short-term volatilities and mis-matches out the income statement a. Re-measurement differences in insurance liabilities from changes in discount rate (from that established at contract inception) would be required to be presented in Other Comprehensive Income (OCI) regardless of treatment of supporting assets b. Market value change in eligible debt instruments would also go through OCI (see IFRS 9 slides below) Approach would reduce P&L volatility from interest rate changes but not necessarily in capital Also, this approach would not eliminate mis-matches in many circumstances; for example where an insurer uses NFI (non-financial instruments) as backing assets 17

19 Premium Allocation approach IASB considers the Premium Allocation approach to be a short cut or simplification of the four building blocks model not a different model (FASB sees as a separate model) The approach uses an unearned premium calculation to establish a pre claim liability Eligibility of contracts for the approach: Insurance contracts with a coverage period of approximately12 months or less, if there are no embedded options or derivatives that significantly affect cash flows If a reasonable approximation of the building block approach results IASB would permit but not require use of Premium Allocation 18

20 Premium Allocation approach measurement details Pre-claims liability Unearned premium, pro rata calculation Reduced by acquisition costs and no deferred acquisition cost asset Discounting may be required practical expedient to ignore discounting of pre-claims liability if coverage period after premium is paid is one year or less Onerous contract test - similar to premium deficiency test today Claims liabilities Discounted cash flows, with an express risk margin similar to current practice Outlook Premium allocation will be available and will likely be selected for most P&C insurance; it could be used for some life insurance business, but is not mandatory 19

21 Financial Instruments IFRS 9 IAS 39 is the standard adopted as part of IFRS in was very similar to previous Canadian GAAP IFRS 9 will replace IAS 39 in a three phased approach; Classification and Measurement The current IFRS 9 largely deletes the AFS (available for sale) category, leaving amortized cost in some cases, and fair value through profit and loss (FVTPL) otherwise amortized cost could be used for debt securities held with the objective of collecting contractual cash flows - however FVTPL would likely still be preferable for assets backing insurance Impairment to be issued; impairment model is expected loss, and would recognize losses earlier for amortized cost assets Hedge accounting 20

22 Financial Instruments IFRS 9 FVOCI fair value through other comprehensive income IFRS 9 will need changes to accommodate a 2-sided OCI solution to insurance contract volatility - in effect, to reintroduce a form of available-for-sale (AFS) category to allow asset market volatility to be recorded in Other Comprehensive Income (OCI) IASB proposes to introduce a FVOCI (fair value through OCI) category, for eligible debt instruments Eligible debt instruments would be those held within a business model whose objective is to hold financial assets to collect principal and interest, and to sell financial assets Same impairment tests as would apply to amortized cost assets Recycling of FVOCI to profit and loss would occur on derecognition 21

23 Financial Instruments IFRS 9: change and implementation IASB plans to consider other targeted improvements to IFRS 9 The IASB deferred the mandatory effective date of IFRS 9 to years beginning on or after January 1, a 2 year delay. Early adoption is permitted under the standard, but OSFI has ruled out early adoption. It was intended that the new insurance contracts standard would have the same effective date, so that both standards could be implemented together which has always been IASB s stated intention but the new IFRS 4 may not be ready. 22

24 Effective date current outlook? Little or no formal guidance, but IASB board members have indicated not before 2015 Expect IASB to issue a re-exposure draft of the standard in late 2012 final standard sometime in 2013 Other indicator timing of IFRS 9 Financial Instruments IASB has consistently expressed desire for IFRS 9 and the new Insurance Contracts standard to be available at the same time postponement of mandatory effective date from 2013 to 2015 as mentioned above, targeted improvements in IFRS 9 are to be considered to address interactions with the insurance project Prognosis effective date in 2015 is still technically possible but 2016 (or later) is far more likely 23

25 Neil Parkinson Partner, National Insurance Sector Leader (416) The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. The KPMG name, logo and "cutting through complexity" are registered trademarks or trademarks of KPMG International.