Session 055 PD - IFRS 17: What to Expect When You re Expecting" Moderator: Kathleen Kelly Bachman, FSA, MAAA

Transcription

1 Session 055 PD - IFRS 17: What to Expect When You re Expecting" Moderator: Kathleen Kelly Bachman, FSA, MAAA Presenters: Kathleen Kelly Bachman, FSA, MAAA Laura S. Gray, FSA, MAAA Tara J. P. Hansen, FSA, MAAA Rebecca M. L. Rycroft, FSA, FCIA, MAAA SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer

2 2017 SOA Annual Meeting & Exhibit KATHY BACHMAN, FSA, MAAA WILLIS TOWERS WATSON REBECCA RYCROFT, FSA, FCIA, MAAA OLIVER WYMAN TARA HANSEN, FSA, MAAA EY LAURA GRAY, FSA, MAAA KPMG Session 55 IFRS 17 What to Expect When You re Expecting October 16, 2017

3 KATHY BACHMAN TARA HANSEN LAURA GRAY REBECCA RYCROFT WHAT TO EXPECT A NEW ACCOUNTING STANDARD 2

4 SOCIETY OF ACTUARIES Antitrust Compliance Guidelines Active participation in the Society of Actuaries is an important aspect of membership. While the positive contributions of professional societies and associations are well-recognized and encouraged, association activities are vulnerable to close antitrust scrutiny. By their very nature, associations bring together industry competitors and other market participants. The United States antitrust laws aim to protect consumers by preserving the free economy and prohibiting anti-competitive business practices; they promote competition. There are both state and federal antitrust laws, although state antitrust laws closely follow federal law. The Sherman Act, is the primary U.S. antitrust law pertaining to association activities. The Sherman Act prohibits every contract, combination or conspiracy that places an unreasonable restraint on trade. There are, however, some activities that are illegal under all circumstances, such as price fixing, market allocation and collusive bidding. There is no safe harbor under the antitrust law for professional association activities. Therefore, association meeting participants should refrain from discussing any activity that could potentially be construed as having an anti-competitive effect. Discussions relating to product or service pricing, market allocations, membership restrictions, product standardization or other conditions on trade could arguably be perceived as a restraint on trade and may expose the SOA and its members to antitrust enforcement procedures. While participating in all SOA in person meetings, webinars, teleconferences or side discussions, you should avoid discussing competitively sensitive information with competitors and follow these guidelines: Do not discuss prices for services or products or anything else that might affect prices Do not discuss what you or other entities plan to do in a particular geographic or product markets or with particular customers. Do not speak on behalf of the SOA or any of its committees unless specifically authorized to do so. Do leave a meeting where any anticompetitive pricing or market allocation discussion occurs. Do alert SOA staff and/or legal counsel to any concerning discussions Do consult with legal counsel before raising any matter or making a statement that may involve competitively sensitive information. Adherence to these guidelines involves not only avoidance of antitrust violations, but avoidance of behavior which might be so construed. These guidelines only provide an overview of prohibited activities. SOA legal counsel reviews meeting agenda and materials as deemed appropriate and any discussion that departs from the formal agenda should be scrutinized carefully. Antitrust compliance is everyone s responsibility; however, please seek legal counsel if you have any questions or concerns. 3

5 Presentation Disclaimer Presentations are intended for educational purposes only and do not replace independent professional judgment. Statements of fact and opinions expressed are those of the participants individually and, unless expressly stated to the contrary, are not the opinion or position of the Society of Actuaries, its cosponsors or its committees. The Society of Actuaries does not endorse or approve, and assumes no responsibility for, the content, accuracy or completeness of the information presented. Attendees should note that the sessions are audio-recorded and may be published in various media, including print, audio and video formats without further notice. 4

6 KATHY BACHMAN, FSA, MAAA WILLIS TOWERS WATSON

7 2017 SOA Annual Meeting IFRS 17 What to Expect When You re Expecting Kathy Bachman, FSA, MAAA October 16, 2017 willistowerswatson.com 2017 Willis Towers Watson. All rights reserved.

8 Agenda Timeline Definitions Measurement Models willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 7

9 The IFRS insurance contracts standard 20 years in the making The story so far now the interesting part really starts 1997 Kick-off IASC starts the Insurance Contracts project 2002 May Insurance project split into Phase 1 and Phase March IFRS 4 Insurance contracts Phase 1 issued 2007 May Discussion Paper: Preliminary views 2010 July Exposure Draft Insurance Contracts 2013 July Re-Exposure Draft Insurance Contracts 2017 May Publication of IFRS 17 Insurance Contracts Mandatory for annual periods beginning on or after 1 January 2021 Opening balance sheet required as of 1 January 2020 Early adoption possible willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 8

10 Reasons for issuing the standard Replaces IFRS 4 Comparability among companies across the globe Difficult to reflect the long-term nature and complexity of insurance products Hybrid insurance and investment contracts is challenging willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 9

11 Who is impacted? IFRS Preparers by region & world map Preparers by region Europe Asia Pacific Canada Africa, ME, LatAm willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 10

12 Scope An entity shall apply IFRS 17 to: Insurance contracts, including reinsurance contracts, it issues; Reinsurance contracts it holds; and Investment contracts with discretionary participation features it issues, provided the entity also issues insurance contracts. willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 11

13 Definitions Insurance Contract A contract under which an insurer accepts significant insurance risk by agreeing to compensate the policyholder if a specified uncertain future event (insured event) adversely affects the policyholder. Investment Contract with discretionary participation features A financial instrument that provides a particular investor with the contractual right to receive, as a supplement to an amount not subject to the discretion of the issuer, additional amounts: a) That are expected to be a significant portion of the total contractual benefits; b) The timing or amount of which are contractually at the discretion of the issuer; and c) That are contractually based on: i. The returns on a specified pool of contracts or a specified type of contract; ii. Realized and/or unrealized investment returns on a specified pool of assets held by the issuer; or iii. The profit or loss of the entity or fund that issues the contract. willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 12

14 Contract boundary Contract boundary is the time period during which premiums are paid and the insurance coverage is in place The contract boundary ends when the insurer can reassess the risks of policyholder and reset the premiums or level of benefits based on this new information. Examples: Term insurance that automatically renews (no new underwriting) Term conversion to whole life (no new underwriting) Replacement policy where there is new underwriting An entity shall not recognize as a liability/asset any amounts relating to expected premiums/claims outside the boundary of the insurance contract. Such amounts relate to future insurance contracts. willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 13

15 Onerous contracts At the date of initial recognition, an insurance contract is onerous if: fulfillment cash flows, plus any previously recognized acquisition cash flows, plus any cash flows arising from the contract at the date of initial recognition in total are a net outflow. willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 14

16 Grouping of contracts Contracts initially to be split into portfolios, meaning contracts that are subject to similar risks and managed together. Each portfolio is then divided into three groups: Contracts that at initial recognition have no significant possibility of becoming onerous subsequently Contracts that are onerous at initial recognition The remaining contracts in the portfolio Contracts in each group need to be sub-divided into annual cohorts willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 15

17 IFRS 17 The General Measurement Model Building Block Approach (BBA) Contractual service margin Risk adjustment Component representing unearned profit the insurer expects to earn as it fulfils the contract Total Insurance Contract Liability Time value of money Cash flows Fulfilment cash flows: Component representing the risk-adjusted present value of future cash flows needed to fulfil the contract willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 16

18 Discount rates Alternative approaches Illustrative Expected reference rate Illiquidity premium Expected defaults Residual credit risk Discount rate No single method prescribed to assess discount rate Should be consistent with observable current market prices for instruments with same characteristics as insurance liability Risk free rate Bottom up Top down Exclude effect of own credit risk and other factors not relevant to liability willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 17

19 Premium Allocation Approach (PAA) Simplified approach that can be applied if and only if: It is reasonably expected that such simplification would produce a measurement of the liability for the remaining coverage that would not differ materially from the one that would be produced using the building block approach. Coverage period is one year or less Option to reflect acquisition costs as an expense when incurred or as an asset to be amortized over time Liability = premiums received less acquisition costs Similar to unearned premium reserves Discounting is not required so long as coverage period is one year or less willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 18

20 Reinsurance contracts held Reinsurance contracts are divided into portfolios An onerous reinsurance contract is one which has a net gain on initial recognition Measurement Use consistent assumptions for the estimates of future cash flows of the reinsurance contracts and the estimates of the future cash flows of the underlying contracts Include the effect of any risk of non-performance of the reinsurer, including the effects of collateral and losses from disputes Risk adjustment for non-financial risk represents the amount of risk being transferred willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 19

21 Reinsurance contracts (cont d) Premium allocation approach Simplified approach can be used as if, at inception of the group: Resulting measurement would not differ materially Coverage period of each contract in the group is one year or less willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 20

22 IFRS 17 More complex than a fair value approach (MCEV, Solvency II) The principle based reporting standard is coming with little guidance & field testing. The standard document is comprised of 116 pages of text. 1. Granularity of measurement Grouping should ensure that cash-flows have similar sensitivity to key risks, but should not group contracts issued more than 1 year apart; 3 groups per portfolio 3. The CSM as an unknown animal Required to eliminate Day 1 profit. Is it deferred profit, shock absorber or simply a balancing number? Increased Complexity 2. Measurement depends on the cash-flow characteristics Different approaches depending on direct participation features and asset cash dependency; simplified P&C approach 4. Accounting options for P&L smoothing No methods prescribed to derive discount curves or risk adjustment. Accounting option to use OCI or not for a systematic split of investment result. The implementation of IFRS 17 is open to many interpretations and judgment, and a wide range of practices may develop willistowerswatson.com 2017 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 21

23 REBECCA RYCROFT, FSA, FCIA, MAAA OLIVER WYMAN

24 THE GENERAL MODEL Rebecca Rycroft, FSA, FCIA, MAAA Oliver Wyman

25 The basics of the General Model IFRS Insurance Contract Liability = PV of cash flows (current) Risk adjustment (current) Unearned profit (non-current) For contract types: Long-term and whole life insurance, protection business Life contingent annuities Universal life Reinsurance contracts Par/non-par not qualifying for Variable Fee Approach Oliver Wyman 24

26 General Model Default approach for most life insurance and longer duration Group or P&C contracts Contractual Service Margin (CSM) CSM eliminates Day 1 gain Total insurance contract liability Risk Adjustment (RA) Time value of money Future cash flows Probability weighted discounted future cash flows Fulfilment Cash flows: risk-adjusted, probability-weighted present value of future cash flows needed to fulfill the contract Oliver Wyman NYC-ADM

27 Estimates of future cash flows Components Objective and Scenario based Objective = Determine the expected value (mean) of possible outcomes most likely scenario (mode) more likely than not scenario a forecast Each scenario to include: Amount and timing of CF s (severity) Probability of that outcome (frequency) Include: tail events (catastrophes) Explicit assumptions or Fair Value Estimate separately: Risk adjustment (non-financial risk) Time value of money and financial risk adjustment IF (Using fair value of replicating portfolio technique) THEN exempt from explicit requirement ESTIMATE OF FUTURE CASH FLOWS Observable inputs/replicating Portfolio The entity shall: Maximize use of observable inputs NOT substitute internal estimates for observable market data IF (data not available and need to be estimated) THEN: be as consistent to market as possible Replicating Portfolio - An asset whose CF s match exactly those of the insurance contracts in question Regularly review and update estimates Review and update estimates made at end of previous reporting period. Consider whether: Updated estimates are faithful representations s to estimates faithfully represents s to conditions Use reasonable and supportable information available without undue cost or effort Oliver Wyman NYC-ADM

28 Estimate of future cash flows Contract boundary Inside boundary Include in measurement: Existing Insurance Contracts Insurer not able to reassess risk Reassess means: o Set a new price and/or o Re-underwrite Insurer required to provide coverage Policyholder may renew Outside boundary Exclude from measurement: Future Insurance Contracts Company no longer required to provide coverage Policyholder has no right of renewal Company has practical ability to reassess for the risk Essence of a contract is that it binds one or both parties BC160, excerpt Oliver Wyman NYC-ADM

29 General Model Discount rates Contractual Service Margin (CSM) Risk Adjustment (RA) Time value of money Future cash flows A discount rate that adjusts future cash flows for the time value of money Per paragraph 36(a) discount rates shall reflect 1. Time value of money Amount payable tomorrow has a value different from that of the same amount payable in 10 years time 2. Characteristics of cash flows Are cashflows dependent on: underlying returns? embedded options? 3. Liquidity characteristic of insurance contracts Entity cannot be forced to make payments earlier than occurrence of insured events, or dates specified in contract. Oliver Wyman NYC-ADM

30 General Model Discount rates IFRS 17 does not prescribe any particular discount rate estimation technique, but in applying any estimation technique, the entity shall: Maximize use of observable inputs Reflect all reasonable and supportable info on non-market variables Without undue cost / effort Both external and internal Discount rate shall not contradict available / relevant market data Non-market variable shall not contradict observable market variables ESTIMATION CONSIDERATIONS Reflect current market conditions - from the perspective of a market participant. Exercise judgment Especially for longer durations, past the observable market Oliver Wyman NYC-ADM

31 General Model Discount rates Top-down vs. Bottom-up For illustrative purposes only (Actual discount rates will have a term structure) Reference portfolio rate 4.5% Market risk premium for expected credit losses -1.0% Market Risk premium for unexpected credit losses -0.5% Insurance contract discount rate (Top-down) 3.0% Difference between the two methods need not be reconciled Insurance contract discount rate (Bottom-up) 2.5% Illiquidity premium 0.5% Risk free rate of return 2.0% Source: IFRS: Example of investor handout on IFRS 17 Insurance Contracts, July 2017 Oliver Wyman NYC-ADM

32 General Model Risk Adjustment Contractual Service Margin (CSM) Risk Adjustment (RA) Time value of money Future cash flows An explicit estimate of the effects of uncertainty about the amount and timing of future cash flows that arises from non-financial risk Compensation the entity would require to be indifferent between fulfilling a contract with a range of possible outcomes and fulfilling a contract with fixed cash flows of same expected value Determined at a level that reflects the degree of diversification benefit Only insurance contract risks included: No asset default risk (in discount rate) No asset-liability mismatch risk No prescribed approach (Confidence interval/cte, Cost of capital, Stress testing) Disclose confidence level Risk Adjustment will be separately disclosed, so separation of BE vs. RA is important Oliver Wyman NYC-ADM

33 General Model Risk Adjustment Higher when Risk Adjustment Is Lower when... Risks are low frequency, high severity Risks are high frequency, low severity Contracts have longer duration Contracts have shorter duration Risks have wide probability distributions Risks have narrower probability distributions Less is known about the current estimate and trends More is known about current estimate and trends Emerging experience does not decrease uncertainty Emerging experience decreases uncertainty Oliver Wyman NYC-ADM

34 General Model Contractual Service Margin Contractual Service Margin (CSM) Risk Adjustment (RA) Time value of money A margin that represents the unearned profit the insurer will recognize as it provides services under the insurance contract No front-ending of profit (front-ended loss for acquisition expenses not included) balancing item becomes: CSM, if positive P&L, if negative (onerous contract) Contractual Service Margin cannot be negative Must be tracked as notional loss component Future cash flows Need to track by group Oliver Wyman NYC-ADM

35 General Model Contractual Service Margin Accretion of interest P&L Insurance finance expenses CSM balance Changes in estimates that relate to future service Value of the new business Recognition in P&L as insurance service is provided P&L Insurance revenue Remaining unearned profit CSM balance Opening balance for group A Closing balance for group A Initial recognition Reporting period Reporting date Oliver Wyman NYC-ADM

36 General Model Unit of account (Level of aggregation) A portfolio of insurance contracts are divided into groups The standard requires at least 3 groups to be considered A group of contracts that are onerous at initial recognition, if any; A group of contracts that at initial recognition have no significant possibility of becoming onerous subsequently, if any; A group of the remaining contracts in the portfolio, if any; Oliver Wyman Onerous an insurance contract is onerous at the date of initial recognition if the fulfilment cash flows allocated to the contract, any previously recognized acquisition cash flows and any cash flows arising from the contract at the date of initial recognition in total are a net outflow 35

37 General Model Unit of account (Level of aggregation) Component Unit of account Contractual Service Margin (CSM) Risk Adjustment (RA) 3 groups per portfolio per year: a) onerous, b) profitable and unlikely to ever become onerous, c) other Objective to avoid commingling onerous contracts with profitable contracts, at issue and in future Same discount rate at issue ( locked-in rate) Higher than portfolio (could be legal entity) Incorporate diversification benefits to the extent that the entity considers those benefits in setting the amount of compensation it requires to bear risk Probability weighted discounted future cash flows Portfolio = Insurance contracts that are subject to similar risks and managed together as a single pool Need to be able to allocate to contract level Oliver Wyman NYC-ADM

38 TARA HANSEN, FSA, MAAA EY

39 Variable fee approach Discount rates for discretionary par products Separating components under IFRS Tara Hansen

40 Variable fee approach Page 39

41 Participating contracts Variable fee approach can be used if three criteria are met: The contract specifies a share in a clearly identifiable pool of underlying items (assets or other profit sources) The entity expects to pay an amount equal to a substantial share of the returns from the underlying items A substantial proportion of the expected payment should be expected to vary with the underlying items Will there be re-assessment after inception? What does specifies mean, when is a pool clearly identifiable? When is a share substantial, how to apply an entity s expectations? What is a substantial portion, how to evaluate the role of guarantees? Contracts meeting these requirements are called direct participating contracts. Participating contracts that do not meet the above are called indirect participating contracts Page 40

42 Participating contracts (continued) IASB views the shareholder s share in underlying items as a variable fee for investmentrelated services. Obligation under the contract to pay the policyholder an amount equal to the value of underlying items less a variable fee Variable fee = shareholder s share less any expected cash flows that do not vary directly with the underlying items (e.g., expenses, Options & Guarantees) Variable fee approach: Changes in the variable fee are not recognised immediately in other comprehensive income but included in CSM unlocking CSM updated for current interest rates and released on the basis of passage of time Risk mitigation: option to report changes in embedded guarantees in PL if certain criteria and documentation requirements are met If the insurer holds underlying items and uses OCI for reporting changes in market interest rates the P&L interest charge is equal to the P&L investment income on the underlying items. Page 41

43 Direct participating contracts Calculating the variable fee Variable fee inception plus the shareholder's expected share of returns on the underlying items to which the insurance contracts with participation feature have a participation right less any expected cash flows that do not vary directly with the underlying items (e.g., cost of guarantees, guaranteed minimum benefits and expenses). In March 2015, the IASB issued a series of simplified examples that give guidance on how to calculate a simplified variable fee in reality: Variable fee = plus Delta of the FV in the underlying asset (promised by the contract) less the Delta of the PV of the fulfillment cash flow Page 42

44 Impact on hedging As a result of feedback from preparers, the Board decided to permit an entity to exclude some or all of the changes in the effect of financial risk on the entity s share of the underlying items (i.e., unlocking of the CSM) if certain criteria are met, resulting in recognition of those effects in the income statement Criteria to be met to apply this option are: A previously documented risk management objective and strategy The entity uses a derivative to mitigate the financial risk arising from the group of insurance contracts An economic offset exists between the group of insurance contracts and the derivative Credit risk does not dominate the economic offset Page 43

45 Variable fee approach worked example Page 44

46 Product Description Variable annuity with a guaranteed minimum withdrawal benefit for life Product Information Initial premium $80,000 Issue date 4/17/2020 Issue age 51 Tax status Benefit base Withdrawal rates Surrender charge schedule Withdrawal status Page 45 Non-qualified contract Rollup at 5% simple interest for up to 20 years Tiered by attained age 6% grading down to 0% over 6 years Guaranteed withdrawals may begin after surrender charge period Assumptions Full surrenders Non-guaranteed partial withdrawals Withdrawal efficiency Withdrawal utilization 1% during surrender charge period 12% shock lapse 4% ultimate None assumed 95% until AV=0 15% at duration 7 20% at duration 10 20% at duration 15 15% at duration 20 30% never withdraw

47 Hedging Program Hedge target Delta Rho Vega Economic liability 100% hedged with equity futures 100% hedged with swaps 100% hedged with variance swaps The asset side of the balance sheet must be considered to get a more complete picture of the impacts IFRS 17 will have for variable annuities in the US. Hedging programs are commonly used to manage market risk associated with variable annuity living benefits. The primary focus of VA hedging programs is typically minimizing the volatility of an economic liability, i.e. a liability that is measured consistently with the liabilities. Page 46

48 Assumptions and simplifications The following slides represent a simplified example to demonstrate the mechanics of the variable fee approach General assumptions and simplifications include the following: Impact of discounting is not included Risk mitigation is 100% perfect Risk adjustment release is estimated No investment income or surplus assets reflected Only certain years are included within the presentation Page 47

49 Present Value of Cash Flows (PVCF) 12,000 10,000 8,000 6,000 4,000 Interest rates fall Average present value across 1,000 scenarios Risk neutral with liquidity adjustment Equities rally Cash flow projection: This presentation excludes the valuation of the separate account itself, which is equal to market value Includes both cash inflows and outflows that relate directly to the fulfilment of the portfolio of contracts Incorporates all available information in an unbiased manner (including trends) Includes all cash flows within the contract boundary Perspective of the entity (provided that market variables are consistent with observable prices) 2,000 Cash flow discounting: Curve is determined using the topdown or bottom-up approach Page 48

50 Risk Adjustment 12,000 10,000 8,000 6,000 Risk Adjustment PVCF This example sets the risk adjustment at time zero based on economic capital, and runs off proportionally to present value of claims No prescribed technique Represents compensation that an entity requires for bearing the uncertainty about the amount and timing of the cash flows that arise as the entity fulfils the insurance contract 4,000 PVCF Reflects both favorable and unfavorable outcomes in a way that reflects the entity s degree of risk aversion 2, Conveys the degree of diversification benefit that is considered when determining the compensation for bearing uncertainty Page 49

51 Contractual Service Margin (CSM) 12,000 10,000 8,000 6,000 CSM floored at zero CSM Risk Adjustment PVCF Time zero At initial recognition, the CSM is the net difference between the fulfilment cash flows, floored at zero The objective of the CSM is to report expected profitability from the contract over time, eliminating any day-one gain If CSM is floored at zero at inception, the insurance contract is onerous. Losses should be recognised in P&L immediately 4,000 Afterward CSM accrues interest and is amortized over time 2,000 CSM also offsets changes in PVCF due to assumption changes or unexpected inforce changes Page 50

52 Net Liability 12,000 10,000 If not for flooring, CSM would have absorbed almost all volatility in the liability CSM Risk Adjustment PVCF The CSM absorbs some of the volatility in the fulfilment cash flows over time. The effectiveness of the CSM in absorbing liability-side volatility is limited due to flooring at zero. 8,000 Liability (unfloored) Liability 6,000 4,000 2, Page 51

53 Balance Sheet 12,000 10,000 8,000 6,000 4,000 2,000 Liability Assets Net When the PVCF increases, the CSM absorbs most of the increase. However, the hedges offset the full change to PVCF, leading to a net accounting gain. Conversely, when the PVCF decreases, the CSM increases to offset the decrease. However, the hedges offset the full change to PVCF, leading to a net accounting loss. This accounting noise is temporary, and will run off with the CSM over the life of the contract. This is a poor outcome. - (2,000) (4,000) Page 52

54 Income Statement 2,000 1,500 1, (500) (1,000) (1,500) (2,000) Risk adjustment release Release of CSM into income (unhedged) Impact of onerous loss Since the CSM is floored at zero, market movements that cannot be captured in the CSM become a direct hit to income until the CSM is built back to a positive number and the losses are recovered Due to the change in interest rates, the contract becomes onerous in 2023 and the resulting loss is presented through income. The onerous loss is recovered in 2024 and 2025 with the remaining recovery in 2026 This simplified example assumes CSM is recovered at the beginning of the year in 2026 for the remaining CSM release Risk adjustment release is small throughout the years (difficult to see due to size of scale) Page 53

55 CSM With Hedge Carve-out 12,000 10,000 8,000 6,000 4,000 CSM does not absorb PVCF Changes CSM Risk Adjustment PVCF CSM does not absorb PVCF Changes A company may choose not to recognize changes in the CSM arising from changes in fulfilment cash flows if there exists a previously documented risk management objective and strategy for using derivatives : The derivatives are used to mitigate market risk in the fulfilment cash flows An economic offset exists between the specified fulfilment cash flows and the derivative Credit risk does not dominate the economic offset 2, Page 54

56 Liability With Hedge Carve-out 12,000 10,000 CSM Risk Adjustment PVCF Removing hedged changes from the CSM increases volatility of the net liability The liability is more sensitive to market impacts, which are managed through the hedging program 8,000 6,000 Liability without Carve-out Liability with Carveout 4,000 2, Page 55

57 Balance Sheet With Hedge Carve-out 12,000 10,000 8,000 6,000 4,000 Liability with Carve-out Assets Net Liability changes due to market risk are fully recognized in the liability and offset by changes in the hedging portfolio This example assumes a perfect offset; in reality there will be valuation differences between assets and liabilities, as well as basis risk Looking at the balance sheet holistically, removing hedged liability changes from the CSM results in a less volatile balance sheet 2, (2,000) (4,000) Page 56

58 Income Statement With Hedging Carve-out This example assumes perfect risk management matching and no changes to the expected pattern of CSM release and risk adjustment release. Both CSM and risk adjustment releases tail off in later years with less coverage along with a shock lapse increasing release of risk adjustment in The hedged carve-out results in a smoother pattern of CSM release into the income statement Risk adjustment release Release of CSM into income (hedged) Page 57

59 Discount rates for discretionary par products Page 58

60 Accounting for participating contracts vs. non participating contracts Continuum of insurance contracts Type of contract Non-participating Indirect participating Direct participating Measurement General model Variable fee model Interest expense General model Effective yield Current period book yield Differences General model Variable fee model Subsequent measurement PL or OCI, following the general model CSM Market variables Guarantees PL or OCI, following the general model CSM, if risk-mitigated PL Accretion of interest on CSM Locked-in rate Current rate Insurance investment expense Effective yield-based Current period book yield (if investments are held) Page 59

61 Effective yield example Indirect participating product priced to have profits of zero in each year (illustrative) Interest rates go down in the first year Crediting rates assumed to reduce slowly over time, producing lower cash flows 300 Projected Cash Flows No demographic changes have occurred, so no CSM unlocking applies If the locked in rate is used, there will be an immediate impact to income Net Income Baseline Revised Baseline Revised Page 60

62 Effective yield example (continued) Several options to adjusting the locked in rate were considered as illustrated here producing a more stable income emergence than simply using the locked-in rate Effective yield Net income 7.0% % 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Baseline Change in asset value Baseline Change in asset value Change in CF Flat Change in CF Flat Asset yield Asset yield Page 61

63 Separating components under IFRS Page 62

64 Separating components Separation Distinct investment components Accounting under IFRS 17 Insurance components Embedded derivatives, which are not closely related Accounting under IFRS 9 Non-distinct investment components Distinct performance obligation to provide goods and services Accounting under IFRS 15 Accounting under IFRS 17, disaggregation for presentation in income statement notes Disaggregation 1 1 Disaggregation is the exclusion of an unseparated investment component from insurance contracts revenue Page 63

65 LAURA GRAY, FSA, MAAA KPMG

66 Insurance Accounting Change for IFRS 17 Society of Actuaries Annual meeting October 2017

67 Agenda Transition Presentation and disclosure Potential impacts 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 66

68 Transition 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved.

69 Making the transition Comparative information is restated Limited ability to redesignate some financial assets on initial application 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 68

70 Full retrospective approach is required but expedients can be used Is it impracticable to use a full retrospective approach? No Yes Either Full retrospective approach Modified retrospective approach, if possible* Or Fair value approach A company can apply different approaches for different groups *If reasonable and supportable information cannot be obtained to apply the this approach, the fair value approach is applied KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 69

71 Modified retrospective approach The objective is to use reasonable and supportable information that is available without undue cost or effort to achieve the closest possible outcome to full retrospective application. Each modification is used only to the extent that an entity does not have reasonable and supportable information to apply a full retrospective approach KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 70

72 Fair value approach The CSM or loss component at the transition date is based on the difference between the fair value and the FCFs of the group at that date. In determining how to identify groups, reasonable and supportable information is used: Based on what an entity would have determined at the date of inception or initial recognition; or That is available at the transition date. When identifying groups of insurance contracts, an entity may group contracts issued more than one year apart. However, it may divide groups into those issued within a year if it has reasonable and supportable information to make the division KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 71

73 Presentation and disclosures 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved.

74 Presentation Investment components are excluded from insurance revenue and service expenses Entities can choose to present the effect of changes in discount rates and other financial risks in profit or loss or OCI to reduce volatility 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 73

75 Disclosures Information should be disclosed at a level of granularity that helps users assess the effects contracts have on Financial position Financial performance Cash flows New disclosures relate to expected profitability and attributes of new business 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 74

76 Level at which to disclose The disclosures are made at a level necessary to satisfy the general disclosure objective. Examples of the aggregation bases that may be appropriate are: Type of contract (e.g. major product lines) Geographic areas (e.g. country or region) Reportable segments (as defined in IFRS 8 Operating Segments) 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 75

77 Statement of financial position An entity presents separately: Groups of insurance contracts that are assets. Groups of insurance contracts that are liabilities. Reinsurance contracts held assets and liabilities are presented separately, and separately from insurance contract assets and liabilities KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 76

78 Statement of financial performance Investment components are excluded from insurance revenue and service expenses. Entities can choose to present the effect of changes in discount rates and other financial risks in profit or loss or OCI to reduce volatility. Separation of underwriting and finance results KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 77

79 What does it look like? IFRS 4 IFRS 17 Premiums X Insurance revenue X Investment income X Incurred service expenses (X) Incurred claims Change in insurance contract liabilities (X) (X) Insurance service result Investment result Insurance finance expenses X X (X) Profit or loss X Net finance result X Other comprehensive income Comprehensive income X X Profit or loss Other comprehensive income Comprehensive income X X X 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 78

80 Insurance revenue Reflects the consideration an entity expects to be entitled in exchange for services. As an entity provides services during the period, the liability for remaining coverage (LRC) decreases and is released in the form of revenue KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 79

81 Recognizing insurance revenue Insurance revenue is derived from the changes in the LRC for each reporting period, covering Expected insurance claims and expenses Risk adjustment for non-financial risk CSM allocation Acquisition cash flows These items represent a company s consideration for providing services KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 80

82 Operational impacts & potential impacts 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved.

83 Operational issues Fundamental operational challenges lie ahead and there isn t much time Actions to get started Completing an initial assessment Reviewing contracts Planning accounting policy decisions Determine needs for systems, processes and resources Effective date 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 82

84 The changes could significantly affect insurers Profitability patterns Volatility of financial results and equity Level of transparency about profit drivers Equity levels The magnitude of the accounting change for life and non-life insurers will be different 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 83

85 Life insurers Significant accounting changes are almost certain to occur under the new standard Sources of complexity include Use of current estimates Disaggregating changes in LRC Tracking the CSM at a group level 2017 KPMG IFRG Limited, a UK company limited by guarantee. All rights reserved. 84

86 Thank you 2017 KPMG IFRG Limited, a UK company limited by guarantee 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. The KPMG name and logo are registered trademarks or trademarks of KPMG International. 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.

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