Mr Hans Hoogervorst IFRS Foundation. 30 Cannon Street London EC4M 6XH United Kingdom

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1 Talanx AG Postfach Hannover Mr Hans Hoogervorst IFRS Foundation 30 Cannon Street London EC4M 6XH United Kingdom Your Talanx AG contacts: Dirk Tschirner Phone Your Hannover RE SE contact: Jens Chyba Phone Comment on IASB Exposure Draft 2015/11 Applying IFRS 9 financial Instruments with IFRS 4 Insurance Contracts Hannover, Dear Mr. Hoogervorst On behalf of Talanx AG and Hannover RE SE we welcome the opportunity to comment on IASB s Exposure Draft ED/2015/11 - Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts. Talanx Group offers high-quality insurance services in non-life and life insurance as well as reinsurance and also conducts business in the asset management sector. With premium income of EUR 29.0 billion (2014) and more than 21,300 employees, Talanx is one of the major European insurance groups. The Hannover-based Group is active in some 150 countries. Talanx operates as a multi-brand provider with a focus on B2B insurance. Hannover Re Group, being part of the Talanx Group, transacts all lines of property & casualty and life & health reinsurance. It is the third-largest reinsurer in the world based on gross written premium. We appreciate the IASB s acknowledgement in the current and previous exposure drafts of the significant issues faced by insurers due to the misalignment of the effective dates for IFRS 9 and the future standard for insurance contracts ( IFRS 4 Phase 2 ). We believe that the Exposure Draft s proposed Overlay Approach would not resolve the key issues related to the misalignment of dates. So we do not intend to use the Overlay Approach option, as we think that the Overlay Approach will result in costs which significantly exceed the limited benefits. As a result, we believe that a Temporary Exemption from applying IFRS 9 for insurers continues to be the only effective method to address all the key issues related to the misalignment of dates. For this reason, the Temporary Exemption must be available to all companies that are predominantly active on the insurance market. But at the same time we like to point out that we do not go along with the IASBs concept of the predominance test. To our opinion such a predominance test has to be more principle based than rule based. In the following paragraphs we will give you a short overview about the key messages we Talanx AG Riethorst Hannover Tel Fax Vorsitzender des Aufsichtsrats: Wolf-Dieter Baumgartl Vorstand: Herbert K. Haas (Vorsitzender), Dr. Christian Hinsch (stv. Vorsitzender), Torsten Leue, Dr. Immo Querner, Ulrich Wallin, Dr. Jan Wicke HR Hannover B 52546, Sitz Hannover USt-ID-Nr. DE

2 like to present within this comment letter followed by our detailed answers to the questions raised in the ED/2015/11: The Overlay Approach The Overlay Approach does not address all our key concerns. This approach will still result in multiple significant changes in a short period of time and the need to effectively implement IFRS 9 twice (once in 2018 and once when IFRS 4 Phase 2 is implemented). This dual implementation would be confusing to users. Implementing the Overlay Approach would result in significant incremental operational efforts and costs that would outweigh the limited benefits. Whereas we are not opposed to retaining the Overlay Approach as an option in addition to the Temporary Exemption, we intend to use the Temporary Exemption. Therefore our responses to the Exposure Draft are focused on the Temporary Exemption. The Temporary Exemption In general we agree to create a Temporary Exemption to the application of IFRS 9 until the application of IFRS 4 Phase 2 for companies that are predominantly active on insurance markets. To present meaningful and understandable financial information a financial statement has to stick to the principles of comparability and continuity. Regarding the exemption we identified three critical topics that have to be considered: - The design of a predominance testing - The timing of a predominance testing and its consequences - The expiry of the Temporary Exemption Regarding the design of a predominance test we believe that a principle-based approach would better represent the economic structure of the insurance business as a rules-based approach. In terms of comparability the design of the predominance test has to guarantee that companies that are predominantly active on the insurance market do not fail such a test just for the reason that their insurance business does not result in a high amount of insurance liabilities within the scope of IFRS 4. As we will elaborate in our detailed comments a lot of liabilities are directly connected to basic insurance activities but are outside of the IFRS 4 scope. If such liabilities would not be taken into account the liabilities used for testing would not be an adequate measure for the extent of the insurance business of a company. Due to these limitations of a rules-based testing we would propose a principlebased approach with the presumption that a regulated insurance company in most cases is predominantly active on insurance markets. Another critical issue is the timing of the predominance test. As implementing new systems and processes of a major standard as IFRS 9 would take some time it is not possible to start applying IFRS 9 overnight. Therefore there has to be an appropriate time between the test and its effects. We suggest that the test affecting the fiscal year beginning on January 1 st 2018 has to be performed in 2016 at the latest. For the case of a subsequent testing, which we think should only be performed if significant changes in the business of a company occur, the effects should become effective with at least one year delay. Nevertheless we recommend deleting the annual reassessment of eligibility for the deferral approach. With respect to the expiration of the Temporary Exemption we think that this should be only related to the implementation of IFRS 4 Phase 2. The concerns caused by the application of IFRS 9 are completely related to the timing misalignment between the implementation of IFRS 9 and IFRS Phase 2. We do not see any reason why time should change any of these 2

3 concerns. Therefore the exemption should not expire before IFRS 4 Phase 2 is implemented. Otherwise a company might have to apply three different accounting principles (from IAS 39 including disclosures, afterwards the overlay approach and finally IFRS 9) within less than five years. This definitely does not fit to the concepts of comparability and continuity and might confuse the readers of these financial statements. Based on our assessment in our view the deferral approach is the only approach that eliminates the difficulties due to a non-alignment of effective dates of IFRS 4 Phase 2 and IFRS 9. Nevertheless, we strongly recommend that the proposal in particular the design of the predominance test must be amended to ensure that all insurance groups can use the approach. Yours sincerely, Dirk Tschirner Head Accounting Policies & Reporting Talanx AG Jens Chyba Head of Competence Center International Accounting Group Accounting & Consolidation Hannover Re SE Riethorst 2 Karl-Wiechert-Allee Hannover Hannover Germany Germany 3

4 1. Question 1 Addressing the concerns raised 1.1. Question 1.2. Comment Yes. As we share this concerns also thinks that the IASB should address these very significant concerns. But there are further concerns that should be addressed by the IASB: Two major accounting changes in a short period of time noted in item (c) above would decrease the continuity of financial statements and could confuse users of the financial statements and undermine their confidence in the financial statements. The increased use of fair value in IFRS 9 without IFRS 4 Phase 2 will result in misleading financial reporting, as the accounting mismatch would be increased. Even if the net P&L impact is reversed (the Overlay Approach would only mitigate some of the net income statement impact but not the impact on equity or the balance sheet). 4

5 2. Question 2 Proposing both an overlay approach and a temporary exemption from applying IFRS Question 2.2. Comment From our point of view there is no need for the Overlay Approach but the Deferral Approach definitely addresses the concerns mentioned in Question 1. We believe that the Exposure Draft s proposed Overlay Approach would not solve the increase of the accounting mismatch. Further applying of the Overlay Approach does not seem to be cost efficient as the asset management systems would not only need to be able to present IFRS 9 figures but also the P&L effect IFRS 9 causes in comparison with IAS 39. The implementation of this feature would cause costs while this feature s use is limited until IFRS 9 would be implemented completely. So the Overlay Approach will result in multiple significant changes in a short period of time and the need to effectively implement IFRS 9 twice (once in 2018 and once when IFRS 4 Phase 2 is implemented). Therefore, it will be confusing to users. Implementing the Overlay Approach would result in significant incremental operational efforts and costs that would outweigh the limited benefits. Only a deferral of IFRS 9 for insurers could be an effective method to address all the key issues related to the misalignment of dates. Therefore the Temporal Exemption must be available to all insurers which engage predominantly in insurance activities. However, we are not opposed to retaining the Overlay Approach as an option in addition to the Temporary Exemption. 5

6 3. Question 3 The overlay approach 3.1. Question 3.2. Comment We do not believe that the Overlay Approach could address the concerns described in Question 1. As the reason for this is a methodic problem of the general concept and not a question of the scope of assets that are eligible, we do not have any comments regarding this scope or its presentation. 4. Question 4 The temporary exemption from applying IFRS Question 6

7 4.2. Comment a) Yes, we agree that eligibility for the Temporary Exemption should be based on the predominant criterion, as the concerns raised are primarily related to the accounting of insurance contracts. Non insurance companies might not share these concerns. b) No we do not agree. In our opinion the predominance test for the Temporary Exemption should be revised. Whilst we can support a principle of predominant insurance activities for the scope of the Temporary Exemption, predominance cannot be simplistically defined solely based on insurance contract liabilities within the scope of IFRS 4. Such an approach will lead to an exclusion of many insurance entities from the scope of the Temporary Exemption. The insurance business does differ between several countries. This includes different types of contracts as well as different business procedures. For example liabilities under written insurance business (such as to policyholder, to broker or reinsurance payables) are no insurance liabilities but are strongly related to the insurance business. Further some insurance products content insurance related derivatives, investment contract liabilities (e.g. unit linked products) accounted at fair value through profit 1 and loss or separable components (e.g. some life insurance contracts) that may not represent insurance contracts itself but are definitely highly connected to an insurance product and therefore part of the insurance business. The same applies to funds withheld under reinsurance business. Besides the basic insurance business there are regulatory rules that have to be fulfilled by regulated insurance companies, which could lead to insurance specific strategic liabilities (e.g. capitalization with subordinated capital). Hence all such liabilities mentioned in this paragraph or comparable items should definitely be taken into account to determine if a company is predominantly an insurer or not. Otherwise the insurance related liabilities taken into account would not be a good indicator of the size of insurance activities of a company. Further the asset management is an integral part of the insurance business. Some capital investments lead to non-controlling interest in consolidated investment funds or a consolidation of investment vehicles. If such investment vehicles also contain (non insurance) liabilities it would indirectly affect the predominance test even if it does not affect the characteristics of the business practiced by the insurance company. A rule based predominance test would ignore these facts. The design of the predominance test has to be principle based to prevent that the design of the test indirectly affects future business decisions of a company just trying to fulfill the rules of the test. For example the decision for investments in leveraged infrastructure projects would be influenced if the resulting liabilities would have a negative effect on the predominance test. We believe that predominance should be determined based on principles reflecting a range of qualitative and quantitative factors. There should be a presumption that a regulated insurance entity/(sub)group is engaged in predominantly insurance activities. This assessment should be done first at a group level. If needed, it could then be performed again at the next level down (sub-group/entity level). Utilizing a principles-based predominance criterion would be consistent with the principles-based nature of IFRS and would accommodate the different balance sheets of insurers around the globe. We are also concerned about the timing of the predominance test. In the field accounting regarding financial instruments is a very complex and highly automated process. Every fundamental change of this process (e.g. the introduction of IFRS 9) therefore needs an 1 Remark: for financial instruments accounted at fair value through profit or loss there is no difference between accounting under IFRS 9 or IAS 39. 7

8 appropriate preparation phase to be implemented. There is no chance that a company could stop the Temporary Exemption without enough time for implementation of IFRS 9. Consequently there has to be enough time between the predominance test and its consequences (i.e. stop of the exemption). If the predominance test is performed at the end of a fiscal period and a company that fails this test would have to stop the exemption already in the following fiscal period, every company using the exemption would be forced to have all IFRS 9 procedures running just for the case. Otherwise a company would risk not being IFRS compliant. But having both systems (the current IAS 39 accounting systems and the new IFRS accounting systems) available during the whole exemption phase would cause immense costs that could end up with no effective benefit. Therefore the predominance test for the fiscal year beginning on January 1 st 2018 has to be performed in 2016 at the latest. Given the temporary nature of the Temporary Exemption, we believe that reassessments should not be necessary. Anyways the consequences of a subsequent testing of the predominance criterion, if any, should become effective with at least one year delay (e.g. the test in 2017 should not affect fiscal years before 2019). Using a principles-based approach as described above may also help to deal with this timing issue. Besides the timing issue the effect of future IFRS changes has to be considered. E.g. the leasing liabilities that arise when IFRS 16 becomes effective, must not change the results of the predominance test, as no change of business occurs. Therefore we recommend that if a subsequent predominance test would be based on the currently applicable IFRS standards. (c) We support the IASB s proposed application of a predominance assessment at the reporting entity level for insurance groups. However, a specific solution is also needed to ensure that insurers that are part of a conglomerate (e.g. bancassurers) are able to elect to defer IFRS 9 until IFRS 4 Phase 2 is implemented. 5. Question 5 Should the overlay approach and the temporary exemption from applying IFRS 9 be optional? 5.1. Question 5.2. Comment (a+b) We do not see any reason why an insurance company should not be allowed to waive the temporal exemption and apply IFRS 9. So we think it should be optional and also possible to opt out of the temporal exemption or the Overlay approach. 8

9 6. Question 6 Expiry date for the temporary exemption from applying IFRS Question 6.2. Comment The concerns caused by the application of IFRS 9 are completely related to the misalignment of timing between the implementation of IFRS 9 and IFRS Phase 2. We do not see any reason why the passage of time should change any of these concerns. It is totally reasonable to limit the temporary exemption until the implementation of IFRS 4 Phase 2. If IFRS 4 Phase 2 is implemented before January 1 st 2021 there is no need for a fixed expiry date. But if IFRS 4 Phase 2 for any reason is implemented later, all reason for the implementation of a temporary exemption would still be valid and it would not be plausible to terminate the exemption until IFRS 4 Phase 2 is implemented. Otherwise a company might have to apply three different accounting principles within less than five years: 1) IAS 39 (after 2018 including additional disclosures) would apply until the expiration of the Temporary Exemption 2) After the expiration of the exemption the Overlay Approach would be applied 3) As soon as IFRS 4 Phase 2 is implemented IFRS 9 would be applied This would be an unnecessary break of the principle of continuity and would make it much harder to compare financial statements of different fiscal years. Instead of increasing the information value of financial statements this rapid changes would rather decrease comparability and trust into financial statements of insurance companies. 9