Introduction to IFRS 17 Pawel Wozniak, Agnieszka Hupert

Transcription

1 Introduction to IFRS 17 Pawel Wozniak, Agnieszka Hupert 11 March 2018

2 Agenda Background 3 Building Blocks. 8 Premium Allocation. 21 Variable Fee.. 25 Reporting. 28 Onerous Contracts Retrospective Approach Fair Value Approach Mod. Retrospective Approach Unbundling. 66 IFRS 17 vs Solvency II Example Wrap-up Illustrative Examples Standard Basis for Conclusions 2

3 Background Background 3

4 What is wrong with IFRS 4 Insurance Contracts IFRS Phase I (2005) Phase II (2021) IFRS 4 IFRS 17 IFRS 4 allows for a wide range of insurance liabilities modelling methods that can be applied as long as they satisfy the Liability Adequacy Test. Lack of comparability between countries Lack of comparability between companies Different levels of safety embedded in insurance liabilities calculations Valuation of insurance liabilities does not have to be cash flow based Discounting is not always required, typically non-life TPs valued on undiscounted basis Results may be distorted by not adequately deferred acquisition expenses 4

5 Timeline First Exposure aft IFRS 17 publication Transition date First IFRS 17 fin. statements Second Exposure aft Effective date Initial application afting the new standard Implementation IFRS 17 reporting Retrospective implementation 5

6 Measurement models overview Method Building Blocks BBA VFA PAA Variable Fee Premium Allocation Overview Risk adjusted present value of future cash flows plus service margin Equal to underlying assets Similar to unearned premium reserve Application Default approach Contracts linked to underlying assets Short term contracts (1 year), pre-claim period Examples Incurred claims, Endowments, Term, Whole Life Unit Links, Unitized With Profits 1-year non-life, health or life insurance 6

7 Level of aggregation Recognition and measurement applied at the insurance contracts group level. Insurance contracts have to be grouped across three dimensions: [1] Portfolio [2] Profitability (*) [3] Underwriting period Insurance Portfolio Subject to similar risks Managed together Within the same product line Onerous at initial recognition Category not applicable to the PPA. At initial recognition no significant possibility of becoming onerous Remaining contracts Contracts issued more than one year apart should not be included in the same group. [Cohorts] Groups established at initial recognition and their composition should not be changed Groups may be smaller that that prescribed above e.g. quarterly instead of yearly cohorts, different groups for different levels for profitability, Sub-portfolios (*) - for reinsurance contracts held the reference to the onerous should be replaced with the net gain - onerous contract group may be identified by measuring the set of contracts instead of on the individual basis - regulatory pricing restrictions (e.g. Gender Directive) driven profitability differentiation may be ignored 7

8 Measurement Measurement Building Blocks Approach (BBA) 8

9 CSM Fulfilment Cashflows Introduction to IFRS 17 Building Blocks Technical Provisions Sign convention: Building Blocks Approach is a default IFRS 17 insurance liabilities measurement method Future cash flows Time value of money + for inflows - for outflows + or - dep. on the CF sign & struc The same approach for the initial and subsequent measurement Risk Adjustment +, Risk Adj. increases the TP Contractual Service Margin +, CSM increases the TP Initial and subsequent measurement methods are different 9

10 Building Blocks - Cashflows Technical Provisions Future cash flows Time value of money Best estimate cash flows Expenses Claims Acquisition Premium Best estimate of cashflows Reassessed at each reporting date Assumptions based on experience Reflect conditions existing at the measurement date Within boundary of the contract Unbundle distinct components: investments, derivatives or service Can be done at portfolio level and allocated to insurance groups Risk Adjustment Contractual Service Margin Recognition The earliest of the following beginning of the coverage period date when the first premium becomes due when the group becomes onerous Cashflow boundary Ability to reassess the risk and change the premiums or benefits Possibility to do the reassessment at the portfolio level 10

11 Bottom up Top Down Introduction to IFRS 17 Building Blocks Discounting [1] Technical Provisions Ins. cashflows are not directly linked to assets Bottom-up Top-down Risk free + Liquidity premium - Gov. Bonds Default Adjustment - - Cost of Downgrade Future cash flows Ins. cashflows directly linked to assets Yield on the underlying assets Adj. yield on the underlying assets B74(b) Cash flows that vary based on the returns on any financial underlying items shall be: discounted using rates that reflect that variability; or adjusted for the effect of that variability and discounted at a rate that reflects the adjustment made. Time value of money 8% 7% Gov. bonds curve Expected Losses (Probability of Default) Risk Adjustment Contractual Service Margin 6% 5% 4% 3% 2% 1% 0% Risk free curve Unexpected Losses (Cost of Downgrade) Liquidity Premium 11

12 Building Blocks Discounting [2] Technical Provisions Future cash flows Negative Basis method: Interest Rate Spread Liquidity Premium Probability of default Cost of Downgrade Expected losses Unexpected losses Time value of money Liquidity Premium Gov. bonds = curve + Credit Risk Swap - Swap rate curve Risk Adjustment Contractual Service Margin Manufactured credit risk free bond constructed by combining a government bond and Credit Risk Swap Interest Rate Swap rate represent a risk free reference rate that excludes both credit and liquidity risk 12

13 Building Blocks Discounting [3] Technical Provisions Future cash flows Time value of money Risk Adjustment Contractual Service Margin Examples Surrender risk Other liquidity indicators Bottom-up approach Top-down approach Not-liquid liabilities Only u/w risks are longevity risk and expense risk Premiums have been paid Semi-liquid liabilities Liquid liabilities e.g. Annuities, Single P. Terms e.g. Endowments, Terms e.g. Unit Links No surrender risk Some surrender risk Substantial surrender risk The swap yield curve plus the liquidity premium. Mortality, longevity, morbidity, expense risk Not all premiums paid The swap yield curve plus some portion of the liquidity premium. No longevity risk The swap yield curve appropriate to the currency of the related cash flows. [Swap Rate] + [Liq Prem] [Swap Rate] + F x [Liq Prem] [Swap Rate] Government Bonds curve less credit risk (Prob. of Default and Cost of Downgrade) Top-Down = Bottom-Up [Gov Bond Rate] - [PD] - [CoD] Top-Down Bottom-Up 13

14 Building Blocks Risk Adjustment [1] Technical Provisions Future cash flows Insurance contracts Compensation for bearing the uncertainty about the amount and timing of the cash flows that arises from non-financial risk. Reinsurance contracts held Represents the risk being transferred by the holder of the group of reinsurance contracts to the issuer of those contracts. Assets Liabilities Assets Liabilities Time value of money RA RA Risk Adjustment Contractual Service Margin RA RA 14

15 Building Blocks Risk Adjustment [1] Technical Provisions Future cash flows Risk Adjustment calculation method not specified in the standard but it should follow the fallowing principles: - longer duration - higher severity - wider distribution - less is known Higher risk Greater Risk Adjustment Time value of money Confidence level based methods Risk Adjustment Contractual Service Margin 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Mean Value at Risk Conditional Tail Expectation 15

16 Risk Adjustment Introduction to IFRS 17 Building Blocks Risk Adjustment [2] Technical Provisions Cost of Capital method Future cash flows Time value of money Risk Adjustment = Discounted Cost of Capital at risk free rate Cost of Capital = SCR x [CoCRate] Risk Adjustment Risk Adjustment to Tech. Prov. = Projection of SCR for non-hedgable risk excluding the reins. risk mitigation effects x CoC rate Contractual Service Margin Risk Adjustment to Reins. Recoverables = Projection of SCR for non-hedgable risk x CoC rate Risk Adjustment to Tech. Prov. 16

17 Initial measurement Introduction to IFRS 17 Building Blocks CSM - Initial measurement [1] Technical Provisions Discount (*) Risk Adj. Recognise Day 1 gainas the CSM Future cash flows Future cashflows DAC CSM Time value of money Risk Adjustment Contractual Service Margin Future cashflows Recognise Day 1 loss in P&L Discount Risk Adj. P&L (*) In some special cases discounting may work in the other direction. For example for single premium products, at the inception discounted cashflow will be greater than undiscounted cashflows. DAC 17

18 Initial measurement Introduction to IFRS 17 Building Blocks CSM - Initial measurement [2] Technical Provisions Insurance contracts Reinsurance contracts held Future cash flows Day 1 Gain recognised in the BS as the CSM. Day 1 Loss recognised as an expense in the Income Statement. Both Day 1 Gains and Day 1 Loss recognised in the BS as the CSM. Time value of money CSM P&L CSM CSM Risk Adjustment Contractual Service Margin Day 1 Gain (CSM) Day 1 Loss Day 1 Gain (CSM) Day 1 Loss (CSM) 18

19 Subsequent measurement Introduction to IFRS 17 Building Blocks CSM - Subsequent measurement Technical Provisions Discount (*) Contractual Service Margin Future cash flows CSM [opening] Release to revenue Estimates variance CSM [closing] Time value of money Opening balance Accreted interest Release to revenue Fulfilment CF variances Closing balance Risk Adjustment Contractual Service Margin Interest accrete at the locked-in discount rate (*) see the comment on the slide 16 Release to revenue in proportion to coverage units e.g. number of policies in-force Future fulfilment cashflows estimate variance measured at locked-in discount rate CSM cannot be negative 19

20 Subsequent measurement Introduction to IFRS 17 Building Blocks CSM - Subsequent measurement Technical Provisions New contracts Discount (*) Contractual Service Margin Future cash flows CSM [opening] Release to revenue Estimates variance CSM [closing] Time value of money Opening balance Additions to the group Accreted interest Release to revenue Fulfilment CF variances Closing balance Risk Adjustment Contractual Service Margin The effect of any new contracts added to the group in case the group has not be closed yet. (*) see the comment on the slide 16 Interest accrete at the locked-in discount rate Release to revenue in proportion to coverage units e.g. number of policies in-force Future fulfilment cashflows estimate variance measured at locked-in discount rate 20

21 Measurement Measurement Premium Allocation Approach (PAA) 21

22 Initial measurement Introduction to IFRS 17 Premium Allocation Initial measurement Technical Provisions Premium received Acquisition costs DAC Building Blocks Premium Allocation CSM RA Discounting Future cashflows PPA Liability Estimate Premium Allocation Approach No cashflow projection required No calculation of the RA and CSM BBA default, PAA optional Allowed if: - is a reasonable approximation of BBA - coverage period is one year or less 22

23 Fulfilment Cashflows PPA Measurement Introduction to IFRS 17 Premium Allocation Subsequent measurement [1] Subsequent measurement Unexpired Risk (Remaining Coverage) Non-Loss Component PPA Liability Estimate Insurance Liability Liability for Incurred Claims (Past Coverage) Loss Component RA Disc. Future cashflows Discounting not required if the settlement is expected in no more than 1 year 23

24 Subsequent measurement Introduction to IFRS 17 Premium Allocation Subsequent measurement [2] Premiums Acquisition cashflows DAC amort. Investment component Interest Release to revenue TP [opening] TP [closing] Opening balance Premiums received Acquisition exp. CF Amortisation of DAC Investment component Accreted interest Release to revenue Closing balance DAC amortisation recognised as acquisition expense At the same the corresponding revenue is released The amounts that an insurance contract requires the entity to repay to a policyholder even if an insured event does not occur. Accreting the interest depends on materiality of financing component Interest accrete at the discount rate at the inception Release to revenue in proportion to coverage units Includes revenue corresponding to the DAC amortisation. 24

25 Measurement Measurement Variable Fee Approach (VFA) 25

26 Variable Fee Approach Variable Fee Approach Clearly identified pool of underlying items Substantial portion of cashflows will vary with changes in the fair value of the underlying assets The policyholder will receive a substantial share of the returns from the underlying assets Initial measurement The same as under the BBA Subsequent measurement Variable Fee Technical Provisions Fair value of underlying assets Share of FV of underlying assets Fulfilment CF that do not vary on returns Risk Adjustment CSM 26

27 Variable Fee Approach CSM [closing] CSM [opening] Entity s share in the FV change Change in future estimates Release to revenue Technical Provisions Fair value of underlying assets Share of FV of underlying assets Fulfilment CF that do not vary on returns Risk Adjustment CSM P&L CSM BBA rules CSM/P&L BBA rules CSM/P&L 27

28 Reporting Reporting 28

29 Initial CSM Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Initial CSM Initial accounting for the CSM Balance Sheet Income Statement OCI Initial acq. cost before the TP recognition Cr [A] Derecognition of the initial DAC asset Cr Premiums future cashflows Cr Claims future cashflows Expenses future cashflows Cr Cr Acquisition cost future cashflows Cr Risk Adjustment Cr Losses on initial recognition Cr [B] [A] [B] An entity shall recognise DAC asset for any insurance acquisition cash flows relating to a group of issued insurance contracts that the entity pays or receives before the group is recognised. An entity shall derecognise this DAC asset when the group of insurance contracts to which this DAC relates is recognised. The CSM cannot have the debit balance so in case of the initial loss the balance should be debited to Operating Costs in Income Statement instead of being recognised in the Balance Sheet. 29

30 Revenue Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Revenue & RA [1] Revenue under the BBA Balance Sheet Income Statement OCI Claims - Projected Cr Expenses - Projected Cr Acquisition Cost Systematic Recognition Cr Risk Adjustment Release to Revenue Cr [D] CSM Release to Revenue Cr DAC - Amortization Cr [C] RA Risk Adjustment Change of Estimate D/C C/D [C] [D] B125, BC179 An entity shall determine insurance revenue related to insurance acquisition cash flows by allocating the portion of the premiums that relate to recovering those cash flows to each reporting period in a systematic way on the basis of the passage of time. An entity shall recognise the same amount as insurance service expenses. Unlike other elements of revenue, release of the risk adjustment to revenue includes discount unwinding effect. Similarly release of the Risk Adjustment to the CSM also includes the discount unwinding effects. 30

31 Building Blocks Revenue & RA [2] Accounting for Acquisition Costs Part 1 : DAC Part 2 : Projected Acquisition Costs Acquisition Costs Cashflows Insurance liability recognition date Initial Measurement Cr CSM DAC Cr CSM Fulfilment Cashflows Subsequent Measurement Cr Acq. Costs (P&L) Revenue (P&L) Cr Fulfilment Cashflows Revenue (P&L) Cr Acq. Costs (P&L) Cash at Bank 31

32 Premiums and Acquisition Costs Current Period Future Periods Introduction to IFRS 17 Building Blocks Premiums and Acquisition Costs Projected Actual CSM P&L 32

33 Premiums Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Premium Premiums under the BBA Balance Sheet Income Statement OCI Projected Premiums - Current Service Cr [E] Actual Premiums Current Service Cr Projected Premiums Future Service Cr [F] Actual Premiums Future Service Cr Future Premiums Changes in Estimates D/C D/C [E] [F] B123(a)(i) states that insurance revenue excludes changes in the liability resulting from premiums received cashflow. Consequently premium variances related to the current period cannot be included in revenue but should be recognized as operating income or expense. B96(a) stipulates that the experience adjustments arising from premiums received in the period that relate to future service, adjusts the CSM. 33

34 Acquisition Costs Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Acquisition costs Acquisition Costs under the BBA Balance Sheet Income Statement OCI Actual Acquisition Costs Current Service Cr DAC amortization - Current Service Cr Acquisition Cost Accrual Current Service Cr [L] Projected Acquisition Costs - Current Service Cr Projected Acquisition Costs Future Service Cr [M] Actual Acquisition Costs Future Service Cr Acquisition Costs Changes in Estimates D/C C/D [L] [M] If there are some acquisition expense that should recognized in the period but has not been paid the entity should follow the standard accounting rules for expenses by accruing for them to ensure completeness of expenses in the given period. B96(a) stipulates that the experience adjustments arising from the acquisition expenses paid in the period that relate to future service, adjust the CSM. 34

35 Expenses Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Expenses Expenses under the BBA Balance Sheet Income Statement OCI Paid Expenses Current Service Cr [I] Expenses Accrual. Current Service Cr Projected Expenses Future Service Cr Paid Expenses Future Service Cr [J] Other Paid Expense Future Service Cr [K] Expenses Changes in Estimates D/C C/D [I] [J] [K] If there are some operating expenses that should recognized in the period but has not been paid the entity should follow the standard accounting rules for expenses by accruing for them to ensure completeness of expenses in the given period. B96(a) stipulates that the experience adjustments arising from the premium based expenses paid in the period that relate to future service, adjust the CSM. If there are some operating expenses paid in the period that do no fall under article B96(a) but relate to future period. They should follow the standard accounting rules by being deferred to ensure that expense recognized in the period are not overstated. 35

36 Claims Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Claims Accounting under the BBA Balance Sheet Income Statement OCI Claims Paid Cr Claims Incurred but not Paid Cr [G] Incurred claims - Changes in Estimates D/C C/D Future claims Changes in Estimates D/C C/D [H] [G] [H] 40(b) stipulates that the liability for incurred claims is measured at the related fulfilment cash flows value regardless whether the underlying contract have been initially measured under the PPA or not. Changes in future claims estimate represent the change is future fulfilment cashflows estimates and adjust the CSM in accordance with the Article 44 (c) 36

37 Interest Fulfilment Cashflows CSM Bank Account Deferred Costs Accruals Revenue Account Incurred Claims Incurred Expenses Acquisition expenses Operating Inc/Exp Financial Inc/Exp OCI Introduction to IFRS 17 Building Blocks Interest Interest under the BBA Balance Sheet Income Statement OCI Interest on fulfillment CF Income Statement D/C C/D [N] Interest on fulfillment CF - OCI D/C C/D Interest on CSM at locked-in rate Cr [N] Changes in financial assumptions do not have a substantial effect on the amounts paid to policyholders Discount rates determined at the date of initial recognition of a group of contracts i.e. locked-in rate Changes in financial assumptions do have a substantial effect on the amounts paid to policyholders Discount rates that allocate the remaining revised expected finance income or expenses over the remaining duration of the group of contracts at a constant rate; T=0 PV 0 (Curr Curve)=PV 0 (5%) T=1 PV 1 (Curr Curve) = PV 1 (3%) P&L : PV 1 (5%) - PV 0 (5%) OCI : PV 1 (3%) - PV 1 (5%) T=2 PV 2 (Curr Curve) = PV 2 (1%) P&L : PV 2 (3%) - PV 1 (3%) OCI : PV 2 (1%) - PV 2 (3%) 37

38 Based on the weighted-average discount rates over the period that contracts in the group are issued Introduction to IFRS 17 Interest Accounting for insurance finance expenses and income Portion recognized in P&L Locked-In rate Systematic allocation rate Changes in financial assumptions do not have a substantial effect on the amounts paid to policyholders Interest accreted on the CSM Rate at the claim incurred date Locked-in rate Changes in financial assumptions do have a substantial effect on the amounts paid to policyholders Incurred claims under PPA Changes to the CSM Locked-in rate Interest accreted under PAA Locked-in rate Fulfilment Cashflows Current discount rates 38

39 Oth Op result Net financial result Ins. service result Introduction to IFRS 17 Income Statement Income Statement layout based on the sources of income that have to be separated: - Insurance Service Result - Financial Result - Other Operating Result 39

40 Presentation driven by the unit of accounting (insurance contacts group) Introduction to IFRS 17 Balance Sheet BEFORE AFTER Assets Assets Reinsurance recoverables X Reinsurance contracts assets X Policyholders debtors X Insurance contracts assets X Policyholders loans X Reinsurance commission X Value of business acquired X Salvages and subrogations X Liabilities Liabilities Unearned premium reserve X Insurance contracts liabilities X Mathematical reserve X Reinsurance contracts liabilities X Unit Links X Claims reserve X Liability Experience Adj. X 40

41 Onerous contracts Onerous Contracts 41

42 Onerous contracts Income Statement Loss component Cash outflows Split between loss and non-loss component Loss component Cash outflows DAC Reversal of losses on onerous contracts Risk Adj. Cash inflows DAC Cash inflows Cash outflows Revenue Risk Adj. DAC Risk Adj. 42

43 Full retrospective approach Full Retrospective Approach 43

44 Transitional provisions - Introduction Transition Date Effective Date Initial Application First IFRS 17 Fin. Stat IAS 8 Article 19(b) CSM Transitional Provisions: 1 Modified Retrospective Approach 2 Fair Value Approach IAS 8 Article 19(b) Changes an accounting policy upon initial application of a Standard or an Interpretation that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, it shall apply the change retrospectively 44

45 Application of transitional provisions FV Approach A B C Modified Retrospective D E F Full Ret. XXXX-XXXX P P2 Different generations may be covered by different sets of transitional provisions P3 P P2 P3 P1 P2 P3 Different portfolios may be covered by different sets of transitional provisions P1 A B C P2 P3 There may be different sets of modifications within the given transitional approach 45

46 CSM Fulfilment Cashflows Calculation of cashflows at each reporting date Determination of discount rates at each reporting date Risk margin calculation at each reporting date Introduction to IFRS 17 Historical values calculations Technical Provisions Recurrence formula Past periods calculations Future cash flows Time value of money Risk Adjustment Contractual Service Margin Fulfilment cashflows estimate variance 46

47 Other Assets Assets Introduction to IFRS 17 Full retrospective approach steps IFRS 4 Equity Other Liab. A B 1 Derecognize any existing balances that would not exist had IFRS 17 always applied For example - Non pre-recognition acq. costs related DAC asset - Unbundling of investment components - Reinsurance assets/liabilities presentation IFRS 17 Equity Other Liab. CSM Risk Adj. B 3 2 Recognize any resulting net difference in equity Identify, recognize and measure each group of insurance contracts as if IFRS 17 had always applied DAC C C 47

48 Fair value approach Fair Value Approach 48

49 VIF Introduction to IFRS 17 Fair value concept Fair Value Definition (IFRS 13, Art 24) Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (not forced) in the principal (or most advantageous) market at the measurement date under current market conditions (ie an exit price) regardless of whether that price is directly observable or estimated using another valuation technique Estimating Fair Value with MCEV approach Fair value of insurance liabilities can be estimated as the TP adjusted for VIF (Value in Force) PVFP TVOG FCRC CRNHR Present Value of Future Profits Time Value of Options & Guarantees Frictional Cost of Required capital Cost of Residual Non-Hedgeable Risks IFRS 13 Art 47 floor deposit not applicable for IFRS 17 measurement (IFRS 17, Art C20) The fair value of a financial liability with a demand feature (eg a demand deposit) is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid 49

50 Fulfilment Cashflows vs Fair Value Fulfillment Cashflows Fair Value Contract Boundaries Outside contact boundary if the entity has the practical ability to reassess the risks of the particular policyholder and, as a result, can set a price or level of benefits that fully reflects those risks Includes renewals even when the a has an ability to reassess the risk or terminate the contract Different types of risk taken into account i.e. it does not have to be a policyholder risk Discount Rates Insurance cashflows directly linked to assets discounted using the yield of the related assets Insurance cashflows not linked directly to assets discounted using the discount rates determined with the top-down or bottom up approach Risk Neutral or Real Word discount rates No distinction between cashflows directly linked to asset and not directly linked to assets No prescribed methods to determine discount rates Risk Adjustment (CRNHR) No prescribed method for the RA calculation Only non-financial risk covered by the RA No prescribed level of risk to be covered Cost of capital method, no CoC rate is prescribed All residual non-hedgeable risk covered by the CRNHR Diversification effects to be taken into account FCRC Not taken into account Included in the valuation 50

51 Fair value approach - Introduction Fair Value Fulfillment Cashflows CSM CSM or Loss Component at the Transition Date calculated as the difference between the fair value of a group of insurance contracts and the fulfilment cash flows Fair Value PV of Future Cashflows Risk Adj. Fair Value PV of Future Cashflows CSM Risk Adj. Loss Comp. 51

52 PVCF PVCF PVCF TP PVCF PVCF Introduction to IFRS 17 VFA - Insurance contracts issued FV RA Loss RA TP FV CSM Loss FV TP RA FV RA CSM TP FV RA TP Loss For insurance contracts issued: RA CSM Risk Adjustment has always credit balance CSM has always credit balance 52

53 PVCF PVCF PVCF PVCF PVCF Introduction to IFRS 17 FVA - Reinsurance contracts held CSM FV RA Re FV CSM Re RA CSM RA FV Re FV RA Re FV CSM Re For reinsurance contracts held: RA Risk Adjustment has always debit balance CSM RA CSM CSM CSM may have both credit or debit balance 53

54 Fulfilment Cashflows CSM Equity IFRS 17 TP PVCF IFRS 4 TP/DAC Introduction to IFRS 17 Accounting for the fair value approach [1] Balance Sheet FV RA CSM Eq Premiums future cashflows Cr Claims future cashflows Expenses future cashflows Cr Cr Acquisition cost future cashflows Cr Risk Adjustment Cr Fair Value Cr IFRS 4 Technical Provisions Cr 54

55 Fulfilment Cashflows CSM Equity PVCF IFRS 17 TP IFRS 4 TP/DAC Introduction to IFRS 17 Accounting for the fair value approach [2] Balance Sheet FV Eq Premiums future cashflows Cr Claims future cashflows Cr RA Loss Expenses future cashflows Cr Acquisition cost future cashflows Cr Risk Adjustment Cr Fair Value Cr IFRS 4 Technical Provisions Cr Loss component Cr 55

56 Fulfilment Cashflows CSM Revenue Account Acquisition Costs Introduction to IFRS 17 DAC under the fair value approach Balance Sheet Income Statement Revenue Components Expected claims payments Expected expenses payments Release of acquisition cost to revenue DAC amortization Risk Adjustment release to revenue CSM amortization Cr Cr Cr Cr Cr Cr Treatment of the implicit/quasi DAC under the FV Approach This element does not exist under the fair value approach because past acquisition costs and the related revenue has been already reflected in the FV measurement and recognized in equity 56

57 FVA - Other modifications Default Treatment FV Approach Modification Identification of insurance groups Determined at the insurance group initial recognition date Determined at the transition date Size of cohorts Contract issued within 1-year or less Cohorts can cover periods exceeding 1-year locked-in Discount Rate Determined at the insurance group initial recognition date Determined at the transition date Interest recognized in P&L (PPA claims incurred) Based on discount rates determined at the claims incurred date Based on discount rates determined at the transition date Discount rates variances recognised in OCI Calculated at each reporting date Cumulative effect calculated at the transition date 57

58 Modified retrospective approach Modified Retrospective Approach 58

59 MRA - Introduction 16 = 1 The objective of the modified retrospective approach is to achieve the closest outcome to retrospective 64 4 application possible without undue cost or effort Risk Adjustment Cashflows Discount Rates A D B E C F CSM Use of the actual cashflows vs projected cashflows Ins. contracts identification and classification date Cohorts with duration exceeding 1 year Approximate discount rates curve vs exact calculation Two methods to determine the approximate discount rates curve Use the Risk Adjustment at the Transition Date adjusted for estimated Risk Adjustment releases Contracts without DPF: calculation of cumulative effect of CSM movements Contracts with DPF: calculation based on the fair value at the transition date 59

60 MODIFIED Retrospective Approach FULL Retrospective Approach Introduction to IFRS 17 MRA - Cashflows modification Projection Transition date or earlier Actual Projection Transition date or earlier 60

61 MODIFIED Retrospective Approach FULL Retrospective Approach Introduction to IFRS 17 MRA - Risk margin modification Transition date or earlier Transition date Estimated releases of the Risk Adjustment Transition date or earlier Transition date 61

62 MRA - Discount rates modification T-1 Average [A]-[B] spread Based on T-1, T-2, T-3 IFRS 17 yield curve [A] Observable yield curve [B] Average A-B spread [C] Yield curve B adj. for C T-2 Use observable curve yield curve if it approximates well IFRS 17 yield curve Use observable yield curve adjusted for the average spread in relation to the IFRS 17 yield curve T-3 62

63 MRA - CSM modification Contracts without DPF CSM 0 (Initial) CSM T (Transition) Coverage Units provided since the inception date Accreted interest CSM 0 Release to Revenue CSM 0 x [CU Provided] [CU Provided] + [CU Remaining] CSM 0 x { [1+r(0,1)] x [1+r(0,2)] x. x [1+r(0,T)] -1 } or CSM 0 x { [1+r(T,1)] x [1+r(T,2)] x. x [1+r(T,T)] -1 } Coverage Units remaining at the transition date allowed if the cohorts modification applied 63

64 MRA - CSM modification Contracts with DPF Fair Value of underlying items Fulfillment Cashflows Charges to the policyholder prior to the transition (including amounts deducted from underlying items) Payments made prior to transition that would not have varied with the underlying items Estimated reduction in the Risk Adjustment prior to the transition Deduct Add Deduct Deduct CSM at the Inception Date CSM that relates to the period before the transition date Deduct CSM at the Transition Date 64

65 MRA - Other modifications Modified Retrospective Fair Value Approach Insurance groups identification at transition date Contract classification at transition date Cohorts size can exceed 1-year period locked-in discount rates at the inception date (no cohorts simp.) locked-in discount rates at the transition date (cohorts simplification) OCI option - possibility to set the OCI element at Nil (cohorts simplification) Some modifications are contingent on the application of the cohorts size option DPF Cont.: Equal to amount recog. in OCI on underl. assets (cohorts simp.) OCI option calculation at transition date 65

66 Unbundling Unbundling 66

67 IFRS 15 Revenue IFRS 9 Financial Inc/Exp or Other Comp. Income IFRS 9 Financial Inc/Exp Introduction to IFRS 17 Unbundling Embedded derivatives Separate an embedded derivative if it is not closely related and a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; Account for the separated embedded derivative under IFRS 9 (FVTPL) Investment components Separate a distinct investment component The component is distinct if it is not highly interrelated and could be sold separately in the same market The component is highly interrelated if it cannot be measured without considering the other and the policyholder is unable to benefit from only one component. Account for the separated investment component under IFRS 9 (FVTPL, FVTOCI, Amortised Costs) Service component Separate a distinct service component i.e. promise to transfer goods or non-insurance services to a policyholder. The component is distinct if it is not highly interrelated and a policyholder can benefit from the good or service on its own. Account for the separated service component under IFRS 15 (allocate revenue to the service component and recognize it when the service is rendered) 67

68 IFRS4 Phase II vs Solvency II IFRS 17 vs Solvency II 68

69 Solvency II and IFRS 17 Differences [1] Solvency II IFRS 17 Goal Scope Contracts covered Geographical coverage Acquisition cost Capital Adequacy and Risk Management framework Assets and liabilities, Own Funds, Capital Requirements All contracts giving rise to asset or liabilities EEE i.e. the European Union plus Iceland, Liechtenstein and Norway Recognized immediately Show financial position and result for the reporting period. Recognition, measurement, presentation and disclosure of insurance liabilities (Re)insurance contracts issued, Reinsurance contracts held, investments with DPF All insurance and reinsurance companies in the world reporting under IFRS. Recognized over the insurance service period Discounting Initial gain Risk free rate with adjustments: matching adj., volatility adj., discount rate transitional Recognized (negative Technical Provisions allowed) Risk free rate plus illiquidity adjustment Initial gain recognized over contract term (negative Technical Provisions not allowed) 69

70 Solvency II and IFRS 17 Differences [2] Solvency II IFRS 17 Contract beginning Contract end Short-term contracts The date the insurance company becomes a party to the contract Unilateral right to terminate contract, amend premiums or benefits No special treatment of short-term contracts Earlier of coverage period, first premium due, the group becomes onerous Similar as SII plus possibility to make the risk reassessment of the portfolio level Simplification allowed for short term contracts Grouping Homogeneous Risk Groups Groups based on portfolio, profitability and underwriting period Risk Adjustment Cost of Capital method, applied to TPs No method prescribed. Risk Adjustment applied to both TPs and reinsurance held. Unbundling Not required Distinct derivative, investment or service components should be unbundled Expenses Cashflows models include overhead expenses Cashflow models include only expenses that relate directly to the ins. contract fulfilment 70

71 Solvency II and IFRS 17 Differences [3] Solvency II IFRS 17 Reinsurance modeling Future acquisition costs Transition Disclosures Contracts with DPF Effective date Reinsurance modelling mirrors modelling of the direct contract Future acquisition cost included in the cashflow projection models Possible simplifications in relation to the CSM on existing business. Disclosures focused on the solvency position and risk management (QRT, SFCR, ORSA) Surplus Funds defined the UK regulations excluded from the TPs 1 January 2016 Reinsurance held and the related direct contract are modelled independently Acquisition cost including future acquisition cost recognized in a systematic way Possibility to apply transitional measures on TP or TP discount rates Disclosures focused on explain the result for the period and the financial position Does not regulate the country specific elements, IFRS are principle based 1 January 2021 with an earlier implementation option 71

72 Solvency II vs IFRS 17 Balance Sheet Solvency II IFRS 17 Spot the difference Free Surplus MCR SCR Own Funds Shareholder equity Other Liabilities Assets Risk Margin Other Liabilities Assets Contractual Service Margin Risk Adjustment Best Estimate Liability Technical Provisions Best Estimate Liability Technical Provisions 72

73 Example Example 73

74 Thousand EUR Introduction to IFRS 17 Example - Assumptions Portfolio of 1000 policies: Policy Assumptions Non-market assumptions Expense assumptions Market assumptions Term Insurance with Single Premium 5 year term insurance Mortality rate 0.1% annually Acquisition expenses 10% of premium Discount rate 2% Single premium 100 EUR Lapse rate 0% Maintenance expenses per policy - 5 EUR 40 Best estimate cash flows 20 Sum assured 10,000 EUR Expenses Claims Acquisition Premium 74

75 Thousands EUR Thousands EUR Thousand EUR Introduction to IFRS 17 Example Base scenario 5.0 Profit & Loss elements 20 Impact of Service Margin on Profit & Loss Profit or loss Service Margin release Risk Adjustment releaase Investment result Profit or loss (without Contractual service margin) Liability Liability BEL Risk adjustment Service Margin The CSM eliminates Day 1 gain and smooths the profit:

76 Thousand EUR Introduction to IFRS 17 Example Base scenario 40 Balance Sheet Liability movement Profit or loss impact End of Year3 Cash flows Interest Release of Risk adjustment Release of Contractual service margin End of Year4 76

77 Thousands EUR Thousands EUR Thousand EUR Introduction to IFRS 17 Example Shock scenario 1 Profit & Loss elements Impact of shock scenario on Profit & Loss Profit or loss Service Margin release Risk Adjustment release Investment result Profit or loss (shock) Profit or loss (base) Liability Liability BEL Risk Adjustment Service Margin Shock scenario: negative mortality variance in year 2 (no change in future cash flows). Small decrease of liability due to portfolio size reduction. Negative variance hits P&L in 2nd year. 77

78 Thousands EUR Thousands EUR Thousand EUR Introduction to IFRS 17 Example Shock scenario 2 Profit & Loss elements Impact of shock scenario on Profit or loss Profit or loss Service Margin release Risk Adjustment release Investment result Profit or loss (shock) Profit or loss (base) Liability Liability BEL Risk Adjustment Service Margin Shock scenario: increase of mortality by 30% for future cash flows at the end of year 2. Increase of BEL compensated by decrease of Contractual Service margin no change in total liability Decrease of 3rd, 4th, 5th year profit due to decreased releases of contractual service margin

79 Thousands EUR Thousands EUR Thousand EUR Introduction to IFRS 17 Example Shock scenario 3 Profit or loss elements Impact of shock scenario on Profit or loss Profit or loss Service Margin release Risk Adjustment release 3 Profit or loss (shock) 2.0 Investment result 2 Profit or loss (base) Liability Balance Sheet Liability BEL Risk Adjustment Service Margin Shock scenario: increase of mortality by 50% for future cash flows at the end of year 2. Increase of BEL not fully compensated by decrease of service margin (cap). Negative impact on P&L in year 2. Decrease of 3rd, 4th, 5th year profit due to decreased releases of Contractual service margin. 79

80 Wrap-up Wrap-up 80

81 Questions & Answers That s the CSM What s that? 81

82 Thank you Pawel Wozniak Director tel London [UK] Agnieszka Hupert Manager tel Warsaw [Poland] 82