Submission by the Canadian Institute of Actuaries to the Office of the Superintendant of Financial Institutions. IFRS Life after Phase II

Transcription

1 Submission Submission by the Canadian Institute of Actuaries to the Office of the Superintendant of Financial Institutions IFRS Life after Phase II January 2010 Document Ce document est disponible en français 2010 Canadian Institute of Actuaries

2 Desired End Result Submission by the Canadian Institute of Actuaries to the Office of the Superintendent of Financial Institutions IFRS Life after Phase II The Office of the Superintendent of Financial Institutions (OSFI) asked representatives of the Canadian actuarial profession to provide possible policy liability and capital framework options that might address OSFI s needs once the International Financial Reporting Standards (IFRS) are fully implemented in Canada. This paper presents four such options. In addition to identifying possible framework options, the Canadian Institute of Actuaries (CIA) was asked to identify key issues associated with each option and the major steps/tasks that would be required, and performed by whom, for the implementation of each option. Simplifying Assumptions This document considers only the valuation of insurance contracts. It does not address service contracts and other financial instruments. The focus on insurance contracts is in part due to our understanding that these represent the great majority of contracts written by insurance companies. When the preferred framework for insurance contracts is determined, then service contracts and other financial instruments will need to be considered. As with the framework for insurance contracts, it will be important to determine what actuarial Standards should apply to service contracts and other financial instruments. This document considers only Canadian insurance companies and not Canadian branches of foreign insurance companies. However, much of what is written in respect of Canadian companies would also likely apply to branches. The calculation of policy liabilities and required capital would likely be the same for both companies and branches, but the capital ratio calculations could be different, as is currently the case. General Considerations and Assumptions In all four options, a company s public statements will be prepared in accordance with IFRS. In particular, the amount reported as policy liabilities will be determined in accordance with IFRS. The International Accounting Standards Board (IASB) is working on a revision of IFRS 4 (Insurance Contracts). In this paper we refer to this as the revised IFRS 4. In this document, we have assumed the revised IFRS 4 will be accepted by all key players in Canada and that we will continue to have a single set of financial statements (i.e., Generally Accepted Accounting Principles (GAAP) (public statements) are prepared on the same basis as those filed with OSFI ( GAAP equals Statutory )). We assume that revised IFRS 4 will have the following features: Policy liabilities will equal the present value of future expected cash flows plus a risk margin. No profits will be allowed to be recognized at issue. 2

3 There will be some rules, or at least principles, about how the discount rate should be determined. Currently, it is unclear what these rules or principles will be, but the discount rate will not be based on the yields on a company s assets. We have serious concerns with two features that may be reflected (directly or indirectly) in the revised IFRS 4 - the determination of the discount rate to compute the present value of insurance contract liabilities, and a prohibition against taking any acquisition costs into account in establishing their value. This document does not address these two issues, and it assumes that these issues will be resolved satisfactorily. The International Actuarial Association (IAA) may not have high quality, enforceable standards (i.e., something equivalent in quality, completeness, and enforceability as the current Canadian actuarial Standards) in place by the effective date of the revised IFRS 4. Although we endorse and encourage the development by the IAA of high quality, enforceable standards, we are not confident that the IAA will be able to draft and adopt sufficiently detailed standards within the next five years. Furthermore, even if the IAA is able to develop such standards, the IAA does not currently have the power to enforce them. The IAA standards must be adopted and then enforced by the individual member organizations in each country. OSFI is looking to the Canadian actuarial profession to continue to provide the same level and type of support (e.g., high quality standards) as the profession has in the past. OSFI is currently working on numerous other issues that are related to the framework. This document does not address the following subjects: Stress testing/changes to Dynamic Capital Adequacy Testing (DCAT); Valuation of guarantees in segregated fund contracts; Valuation of policy liabilities using stochastic testing; Short-term changes to required capital to be effective before IFRS Phase II; and Any changes to required/available capital other than those that may result from new methods of determining policy liabilities. (See also Appendix on Background) 3

4 OPTION 1 Introduction It is our long-term vision that the international actuarial community will develop sufficiently strong standards of practice and accompanying educational notes (i.e., guidance). All companies would abide by these high quality and enforceable standards for insurance contracts, thus sufficiently narrowing financial reporting practices to promote reasonable comparisons between companies on a global basis. As noted previously, an underlying assumption of this paper is that the IAA may not have high quality, enforceable standards in place by the effective date of the revised IFRS 4. If international standards of sufficient quality and enforceability do not exist at the time of implementation of the revised IFRS 4, then we do not believe that Option 1 would be viable to OSFI. If such standards are in effect, Option 1 is essentially equivalent to Option 2 which is presented next. General Description In framework Option 1, policy liabilities would be calculated solely in accordance with the revised IFRS 4 and IAA guidance as adopted for practice in Canada. There would be no specific Canadian actuarial Standards of Practice related to the determination of policy liabilities for financial reporting. (This is similar to the situation that will exist in 2011 for service contracts and financial instruments other than insurance contracts under IFRS Phase I.) Benefits of this Option We note two benefits of Option 1. First, it would be simple to implement. Second, the option would likely entail the least amount of work for companies of all four options that are presented. Weaknesses of this Option We also note two weaknesses of Option 1. First, depending on the extent of detail provided for in the international actuarial standards of practice and educational notes, there could be a wide range of practice. Second, this could make it very difficult for OSFI to assess the financial health of a company. General Description OPTION 2 The primary difference between Options 1 and 2 is that in Option 2, Canadian-specific actuarial guidance bridges the gap until international guidance of sufficient quality and enforceability is available. We note that if the IAA were to develop high quality, enforceable standards by the effective date of the revised IFRS 4, there would be no need for supplemental Canadian actuarial Standards of Practice. In this situation, Options 1 and 2 would become essentially the same. We believe that this would be the optimal long-term solution; but, as noted earlier, we are not optimistic about its possibility over the short- to medium-term. 4

5 In Option 2, there would be a single set of financial statements for both GAAP and statutory purposes, which would also be applicable for capital purposes. Policy liabilities in a company s financial statements would be calculated in accordance with the revised IFRS 4 supplemented by Canadian actuarial Standards of Practice. We refer to this calculation as IFRS 4 (Canadian). The supplemental Canadian actuarial Standards would likely narrow the range of practice permitted under the revised IFRS 4 but would not be in conflict with the revised IFRS 4. In Option 2, the Actuarial Standards Board (ASB) and the CIA would commit to developing revised actuarial Standards of Practice, educational notes, and other guidance in connection with the IFRS 4 (Canadian) basis for calculating policy liabilities that would be similar in quality to current Canadian actuarial guidance. OSFI would develop a new basis for determining required and available capital, likely in consultation with the industry, actuaries, other regulators, and Assuris. In combination with IFRS 4 (Canadian) policy liabilities, this new basis would provide OSFI with sound measures for assessing the financial strength of a company. Reports to OSFI The following reports would need to be provided to OSFI: 1. An Appointed Actuary s (AA) report in respect of policy liabilities on IFRS 4 (Canadian) with the same contents and level of detail as at present; 2. An external review of item 1; 3. An audit sign off comparable to auditing guideline AuG-43; 4. DCAT/stress testing reports; 5. An analysis of earnings (based on IFRS 4 (Canadian) policy liabilities); and 6. To the extent that the new basis for determining required and available capital relied on the work of an actuary, the actuary would need to document his or her assumptions, justification, etc. (i.e., similar to the AA report on policy liabilities). All reports would be based on IFRS 4 (Canadian) policy liabilities. Benefits of this Option This option would maintain many of the benefits of the current Canadian framework (see Appendix). Option 2 provides for a single valuation of policy liabilities, which is backed up by high quality actuarial Standards of Practice, educational notes, and other actuarial guidance. Finally, there would be a narrowing of the range of calculation of policy liabilities as compared to what could happen under the revised IFRS 4 (i.e., without policy liabilities being calculated on the IFRS 4 (Canadian) basis). Weaknesses of this Option There is some question as to whether or not it is possible to have an IFRS 4 (Canadian). For example, would all the relevant parties (e.g., regulators, companies, auditors, accounting bodies, etc.) agree to it? IFRS 4 (Canadian) would require significant work by the CIA, ASB, and OSFI/Autorité des marchés financiers (AMF) (as well as other 5

6 provincial regulators), which would need to be completed before the implementation of the revised IFRS 4. Another weakness of Option 2 is that some of the benefits of the current method for valuing life and health insurance policy liabilities (i.e., Canadian Asset Liability Method (CALM)) would be lost, in particular the provision in the policy liabilities for the C-3 risk. The determination of required capital would need to reflect the C-3 risk. Actions Required 1. Obtain acceptance in principle of this option from the relevant parties, probably starting with the major auditing firms, followed by insurance companies, and the (Canadian) Accounting Standards Board. A key issue to discuss with the auditing firms would be whether or not the IFRS 4 (Canadian) basis for calculating policy liabilities would/might be considered to not be in compliance with the revised IFRS 4. As noted above, although IFRS 4 (Canadian) would likely narrow the range of practice permitted under the revised IFRS 4, it would not be in conflict with the revised IFRS 4. Nevertheless, the question remains as to what degree of narrowing of practice would be so great that it would not be considered acceptable. Conversely, we ask whether or not auditing firms would welcome the existence of actuarial guidance on the calculation of policy liabilities. 2. Major revisions to Canadian actuarial Standards of Practice, educational notes, and other actuarial guidance would be needed, particularly for life and health insurance. In some cases, research would need to precede the preparation of such guidance. Apart from recognizing a different valuation method (basically the Policy Premium Method (PPM) as opposed to CALM for life insurance), the revised guidance would need to address assumptions, margins, the run off of any profit at issue, and the discount rate. 3. Major revisions to capital requirements would be needed since IFRS 4 (Canadian) policy liabilities would be different from the current Canadian-basis policy liabilities. Although final decisions about capital requirements would be made by the regulators, the regulators would likely look to actuaries and others for assistance. 4. OSFI reporting requirements would need to be reviewed and modified where appropriate. Possible Longer-Term Modifications As noted earlier, we endorse and encourage the development by the IAA of high quality, enforceable standards. As and when such standards are developed by the IAA, these could replace any Canadian actuarial Standards of Practice as described in this option. 6

7 General Description OPTION 3 Similar to Options 1 and 2, there would continue to be one set of financial statements ( GAAP equals Statutory ) under Option 3. Policy liabilities would be calculated (solely) in accordance with the revised IFRS 4. A new basis for determining required and available capital would be developed by OSFI (likely in consultation with the industry, actuaries, other regulators and Assuris) that, in combination with IFRS 4 (Canadian) policy liabilities (see below), would provide OSFI with sound measures for assessing the financial strength of a company. For this new basis of determining required and available capital, companies would be required by OSFI to complete a second calculation of policy liabilities in accordance with revised IFRS 4 supplemented by Canadian actuarial Standards of Practice which would likely narrow the range of practice permitted under the revised IFRS 4. (We again refer to this second calculation as IFRS 4 (Canadian).) This second calculation would not be used to determine a company s GAAP net income or GAAP balance sheet but would only be used to determining its capital requirements. The second calculation of policy liabilities would result in a narrowing of the range of assumptions and margins permitted under the revised IFRS 4. This option might go a bit further than Option 2 (i.e., unlike Option 2, it might not be fully in compliance with the revised IFRS 4) depending on the IASB s final revised IFRS 4. The ASB and the CIA would commit to developing revised actuarial Standards of Practice, educational notes, and other guidance in connection with IFRS 4 (Canadian) that would be similar in quality to current Canadian actuarial guidance. Reports to OSFI Similar reports to those required for Option 2 would be required for Option 3. Benefits of this Option There are two primary benefits of this option. Although policy liabilities would need to be calculated on two bases, revised IFRS 4 and IFRS 4 (Canadian), the valuation method would generally be the same. The main difference would be in the assumptions and margins used. Thus, we expect that the additional work involved in the second valuation would be less than for Option 4 that requires two calculations. Second, we expect that there would be great consistency in this option with IFRS. Weaknesses of this Option There are several weaknesses of this option. First, this option would require policy liabilities to be calculated on two different (albeit similar) bases. This would require significant work to be completed by the CIA, ASB, and OSFI/AMF (and other provincial regulators) before the implementation of the revised IFRS 4. There may be industry opposition to any extra work that is required on top of the additional work, such as disclosures, that will be required simply as a result of the implementation of IFRS. 7

8 Finally, some of the benefits of the current method for valuing life and health insurance policy liabilities (i.e., CALM) would be lost, in particular the provision for the C-3 risk. Additional cash flow testing in connection with the determination of required capital would be required to compensate for this. Actions Required 1. Major revisions to Canadian actuarial Standards of Practice, educational notes, and other actuarial guidance would be needed, particularly for life and health insurance. In some cases, research would need to precede the preparation of such actuarial guidance. Apart from recognizing a different valuation method (basically the PPM as opposed to CALM for life insurance), the revised guidance would need to cover assumptions, margins, the run off of any profit at issue, and the discount rate. 2. Major revisions to capital requirements would be needed since IFRS 4 (Canadian) policy liabilities would be different from the current Canadian-basis policy liabilities. Although final decisions about capital requirements would be made by the regulators, the regulators will likely look to actuaries and others for assistance. 3. OSFI reporting requirements would need to be reviewed and modified where appropriate. General Description OPTION 4 There would continue to be one set of financial statements ( GAAP equals statutory ). Policy liabilities would be calculated (solely) in accordance with the revised IFRS 4. There would be no Canadian actuarial standards of practice in respect of the determination of policy liabilities under revised IFRS 4 for financial reporting purposes. OSFI would require capital to be calculated as at present. Thus, companies would be required to conduct a second calculation of policy liabilities using current Canadian actuarial Standards of Practice (e.g., CALM in the case of life and health insurance). This second calculation would not be used to determine a company s GAAP net income or GAAP balance sheet but would be used only to determine capital requirements. The ASB would continue to maintain/update actuarial Standards of Practice for the valuation of liabilities under current Canadian methods for capital purposes only. Reports to OSFI The following reports would need to be provided to OSFI: 1. An AA report in respect of policy liabilities on the current Canadian basis, with the same contents and level of detail as at present; 2. An external review of item 1; 3. An audit sign off comparable to AuG-43; 4. DCAT/stress testing reports; and 5. An analysis of earnings (based on revised IFRS 4 policy liabilities). 8

9 Benefits of this Option The current Canadian basis of calculating policy liabilities has been well tested over many years. It is widely understood and generally accepted in Canada. The focus of the CALM methodology on asset/liability matching and its asset adequacy aspects make it a sound approach in determining policy liabilities for solvency purposes. In addition to the long-standing acceptance of current methods, Option 4 offers two other advantages. There would be no material changes to the calculation of required and available capital, and there would be fewer transitional changes than for the other options. Weaknesses of this Option There are several weaknesses of Option 4. First, it would require policy liabilities to be calculated on two fairly different bases. We expect that there would be industry opposition to the additional work required for such calculations, particularly in light of the additional work (e.g., disclosures) that will be required simply as a result of the implementation of IFRS. Although the current Canadian basis for calculating policy liabilities is well understood at present, over time it would/could start to be seen, rightly or wrongly, as an old basis, unique to Canada. (For example, how many of today s practising actuaries could calculate policy liabilities on the 1978 Canadian basis?). Canadian actuarial Standards of Practice for calculating policy liabilities on the current basis (for the purpose of calculating capital) would still need to be maintained. Over time, these may diverge more and more from GAAP. Actions Required The actions required for this option are not as significant as for other options. Nevertheless, all existing actuarial Standards of Practice, educational notes, and other guidance, Minimum Continuing Capital and Surplus Requirements (MCCSR) rules, and OSFI reporting requirements would need to be reviewed and modified where appropriate Outstanding Questions What impact would this framework option have on the calculation of tax reserves? What would be the position of the Department of Finance? OTHER CONSIDERATIONS 1. In addition to discussions with auditors and insurance companies, discussions will also likely be required with the following: The AMF (and other provincial regulators); The Canadian Institute of Chartered Accountants (CICA)/the Accounting Standards Board (AcSB); and The Ontario Securities Commission (OSC). 9

10 2. In addition to the various reports that would need to be provided to OSFI, OSFI might find it helpful to request additional analysis, such as embedded value information, that companies perform (this applies to all options). 3. This report focused on the valuation of policy liabilities. Although it is beyond the scope of this report, we stress that the determination of required and available capital is critical. 10

11 APPENDIX - BACKGROUND The current framework in Canada, which has been in place for many years, has the following features. 1. GAAP (public) statements are prepared on the same basis as those filed with OSFI ( GAAP equals Statutory ). 2. Policy liabilities are determined by a company s Appointed Actuary, in accordance with actuarial Standards of Practice (originally developed by the CIA, now the responsibility of the ASB), educational notes, and other guidance. 3. Capital requirements (e.g., MCCSR) are calculated according to regulations prepared by the relevant regulators (e.g., OSFI and the AMF). 4. The role of the Appointed Actuary is defined in the Insurance Companies Act for federally licensed insurers, and the role of the valuation actuary is defined in the Loi des Assurances (Québec). In general, the current system is well accepted, and most stakeholders (OSFI, actuaries, insurers, accountants, shareholders, etc.) are believed to be satisfied with it. When IFRS is introduced in Canada (effective January 1, 2011), the initial changes to policy liabilities will be fairly small, even though the recent ASB exposure draft proposes to limit the scope (of the valuation of policy liabilities for financial reporting purposes) to insurance contracts. This is because most contracts issued by insurance companies will be classified as insurance contracts (as opposed to service contracts or financial instruments other than insurance contracts), and there will be no change in how the policy liabilities for insurance contracts are determined. A much more significant change will occur when the revised IFRS 4 (insurance contracts) becomes effective. The International Accounting Standards Board (IASB) has indicated that it plans to issue an exposure draft in early 2010 and a final standard in The effective date would probably not be before While the revised IFRS 4 is likely to describe the method for valuing insurance contracts, it is not expected to include details as to how assumptions and margins are determined. As indicated several times in our paper, we believe that it is unlikely that the IAA will have high quality, enforceable standards for the valuation of insurance contracts in place by the time the revised IFRS 4 becomes effective. If the ASB adopts the same approach for insurance contracts as it proposes to do for service contracts and financial instruments other than insurance contracts (i.e., have no actuarial Standards for the valuation of policy liabilities for financial reporting purposes), and no other elements of the current structure change, then OSFI will find it much more difficult to monitor the performance and financial health of insurance companies. 11