Risk and Accounting. Insurance Accounting. Giovanni Rago 16 th of March 2018

Transcription

1 Risk and Accounting Insurance Accounting Giovanni Rago 16 th of March 2018

2 Agenda Introduction on Insurance & Accounting Accounting framework for Italian insurers Local gaap versus IAS/IFRS Individual financial statements Consolidated financial statements Other source of information Annex 2

3 Introduction on Insurance (1/3) Insurance allows individuals & corporates to transfer the risks and their potentially costly financial outcome: Insurance is a contract whereby the insurer, against payment of a premium, undertakes to repay the insured, within the agreed limits, the damage caused to him from an event, or to pay a principal or an annuity upon the occurrence of an event relating to human life (art Civil Code) Inverted production cycle: policyholders pay premiums upfront, and payments by insurers only if/when an insured event has occurred stable cash flows to insurers (no liquidity risk) loss sharing (mutualism): many people pay to cover the losses of few law of large numbers: when the pool of risks increase, it is more likely that actual loss is equal the expected loss (i.e. correct pricing) 3 hypothesis for pricing: demographic, financial and expenses components The insurance sector plays an important role in the EU economy (i.e. growth, stability) by taking on risks and mobilising savings. 3

4 Introduction on Insurance (2/3) 2 main products: 1) non-life (P&C): the insurer indemnifies the policyholders from loss or damage caused by specific risks purpose: compensation/indemnity examples: car insurance, fire, aviation/marine, travel, health, etc 2) life: the insurer pays the beneficiary a sum of money (the benefit) in exchange for a premium, upon the death of an insured person purpose: investment/saving examples: term insurance, with-profits contracts, unit/index linked 3 categories: term life insurance, whole life and endowment subject involved: insurer, beneficiary, insured person and policyholder. 2 main items in the insurer s balance sheet (annex 1): - Investments: funded by premiums and held-to-match liabilities (ALM) - Technical provisions: estimates of future obligations (expected losses) Insurers are highly regulated (Solvency II in EU annex 2): they are required to hold - among other things - eligible own funds (equity) to cover capital requirements (on top of TP) to cover unexpected losses ALM = Asset-Liability Management 4

5 Introduction on Insurance (3/3) Premiums (2016)* Global = $ 4,732 bn EU = 1,189 bn (=7% of GDP) IT = 138 bn (=8% of GDP) Breakdown of premiums in EU (2016)* Life ( 696bn) Non-Life ( 363bn) Breakdown of Investments in EU (2016)* Total Investments = 10,112 bn (=62% of EU GDP) Market structure in EU (2016)* insurance companies (IT: 108) direct employees - Distribution channel: Bancassurance in life Agents and brokers in non-life * European Insurance in Figures: 2016 data, February

6 Introduction on Accounting (1/2) Objective: to provide information about the financial position and financial performance of an entity that is useful to a wide range of users in making economic decisions (IAS 1 & CF) Structure: FS comprises a statement of (IAS1+art cc): - Financial position - assets, liabilities & equity - Profit or loss (incl. OCI) Info about - incomes & expenses - Changes in equity entity s: - contribution by/to owners - Cash flows - cash flows - Notes General features (IAS1): - Fair presentation - Materiality & aggregation - Going concern - offsetting - Accrual basis - Frequency of reporting - comparability - consistency Pros & Cons of FS: (+): info on amount/timing/uncertainty of future cash flows (-): no all info, no value of an entity, no exact figures but estimates FS = Financial Statements CP = Conceptual Framework cc = Civil Code OCI = Other Comprehensive Income 6

7 Introduction on Accounting (2/2) The financial analysis of FS depends on the objectives of users USERS Shareholders Investors Financial analyst Supervisory Authorities Policyholders Management OBJECTIVES Risk analysis Return on investments Value creation Solvency Protection of policyholders Prudent management Stewardship or accountability of management Internal planning 7

8 Accounting framework for Italian insurers In accordance to the options provided by IAS Regulation (Reg. 1606/2002) and differently from banking, Italian insurance undertakings prepare their financial statements in accordance to two different accounting principles: Individual financial statements Italian/local gaap [1] Consolidated accounts IAS/IFRS Legal framework: Primary laws: - Civil code OIC principles - Insurance code (2) : artt artt D Lgs 173/1997 (transposition of Directive 91/674/EEC) Secondary provisions: - Regolamento ISVAP n. 22/2008 (3) Legal framework: Primary laws: - D Lgs 38/2005: art. 3 Insurance code (2) ): artt artt Regulation (EC) No 1606/2002 and endorsing regulations Secondary provisions: - Regolamento ISVAP n. 7/2007 (3) (1) IAS/IFFRS not permitted with the only exclusion of Italian Insurance undertakings listed on the market with no consolidated accounts (2) Legislative Decree n. 209 of 09/07/ (3) As modified by IVASS Orders n. 53 of 6 December 2016

9 Local gaap versus IAS/IFRS (1/2) The two frameworks (i.e. local gaap and IAS/IFRS) are based on different underlying principles: Local gaap Information to lenders Historical cost Prudence Form over substance Realized gains and losses IAS/IFRS Information to (actual and potential) investors Fair value Mark to market Substance over form Unrealized gains and losses 9

10 Local gaap versus IAS/IFRS (2/2) in relation to insurance accounting the main differences are: Local gaap IAS/IFRS Structure of layouts Separately for Life (L) & Non-Life (NL) No separation L/NL + segment reporting Goodwill Properties Investments Derivatives Amortised (over 5 years) Cost + depretiation Current portfolio: lower cost & market value Fixed ptf: cost + permanent write-down Off-balance sheet P&L: matching principle for hedging At cost less impairment losses (no amortisation) Own use (IAS 16) or Investment (IAS40) Cost or fair value HTM : amortised cost (+ impairments to P&L) LR: amortised cost AFS: FV to OCI (+ impairments to P&L) HFT: FV to P&L On-balance sheet Hedge accounting Technical provisions (TP) Additional provisions Life Technical provisions: shadow accounting Premiums from Life investments contracts* Prudent valuation Equalisation and catastrophe provisions N.A. P&L: Written premiums BS: insurance liabilities (item D) at FV IFRS 4 allows the use of local gaap with minor amendments (LAT) Equalisation and catastrophe provisions are derecognised Applied to par contracts to reduce accounting mismatch between assets, valued at FV, and TP, valued at cost with local gaap. No premiums + Financial liabilities (IAS 39) FV = fair value par contracts = participating contracts (contracts with discretionary participation features ) * With no significant insurance risk 10

11 Individual financial statements (1/3) Based on local gaap Regolamento ISVAP 22/2008: valuation principles, layouts (BS and P&L), chart of accounts, public disclosure & supervisory data Balance sheet: - Layout from Insurance Accounting Directive* + new items - No split by current/fixed portfolio and life/non-life portfolio which is available in the notes (templates) - Investments split by «item C» (risk borne by insurer) and «item D» (unit/index linked risk borne by the policyholders) [Annex 3] - Technical provisions split by item C/item D (class III & VI) [Annex 2] - Separate line for Equity Profit & loss: - 3 sections: non-life/life technical accounts and non technical account - Financial results: Life: gains & losses recognised in technical account (TA) + % in non TA Non-life: gains & losses in non-technical account (TA) + % in TA * Directive 91/674/EEC, transposed by D Lgs 173/

12 Individual financial statements (2/3) Framework for the valuation of technical provisions (TP): legal framework: D Lgs 173/1997+ Regolamento ISVAP 22/2008* Principles for non-life reserving: - TP sufficient to face the obligations towards policyholders (reserve risk) - TP gross of reinsurance (recoverables from reinsurance) - Prudent valuation method based on analytical evaluation of each claim + verification applying statistic/actuarial methodology - 2 main provisions: 1) provisions for unearned premiums. It includes: - provisions for unearned premiums: part of gross written premiums which is to be allocated to the following financial year(s) - provisions for unexpired risks: to cover the risk of mis-pricing (expected losses > provisions for UP + future premiums) 2) provisions for claims outstanding: provisions for insurance claims which have been reported and not yet settled (RBNS) or which have been incurred but not yet reported (IBNR). * Annex 14, 15, and 16 12

13 Individual financial statements (3/3) Framework for the valuation of technical provisions (TP) con t Principles for life reserving: - Mathematical provisions is the most important provisions - TP gross of reinsurance (recoverables from reinsurance) - Valuation per each single contract but possible to aggregate similar risks - Calculation methods: 1) Prospective actuarial method (default) to estimate all future and expected cash out flows by the insurer (payments to policyholders), net of cash in-flows (future premiums by policyholders) 2) Retrospective actuarial method (at certain condition) - Type of demographic/financial assumptions used to estimate TP: Technical basis of 1 st order: same assumptions used for pricing + additional reserve for demographic and financial risks ( pricing vs experience) Technical basis of 2 nd order: most up-dated assumptions - TP for unit/index linked valued in accordance with close matching principle 13

14 Consolidated financial statements (1/3) Based on IAS/IFRS legal framework: Regolamento ISVAP 7/2007: NO valuation principles but layouts (BS and P&L) and public disclosure Balance sheet: Assets - 7 macro-items - Split of investments & reinsurance (TP & receivables) Liabilities - 6 macro-items - Insurance liabilities (IFRS 4) and financial liabilities (IAS 39) - Insurance and reinsurance playbles - equity Assets Balance sheet Liabilities 14

15 Consolidated financial statements (2/3) Income statement Other Comprehensive Income 15

16 Consolidated financial statements (3/3) Investments (BS/assets) are mostly valued at fair value (IAS 39): Technical provisions (BS/liabilities) are mostly valued at cost (IFRS 4: local gaap), excluding unit/index linked: 816,721 /mln (2015) Accounting mismatch between assets and liabilities Shadow accounting: mitigates the accounting mismatch for insurance/investment contracts with DPF splitting the unrealised gain (losses) from investments by the policyholders share increase(decrease, subject to the guarantee rate) of TP and the insurer s share (see example in annex 4). 16

17 Other source of information (1/2) The financial statements include: - the Notes to accounts which includes information on: Part A: summary of significant accounting policies Part B: information on the Balance Sheet and Profit and Loss Part C: other information Detailed quantitative templates with breakdown of BS/P&L items - the management report with information about the performance of the company, the principal risks/uncertainties faced by the undertaking and the compliance with of capital requirements - Risk report with information on: Risk management system The solvency position The risk profile: underwriting risk (life and non-life) financial risk (market and credit risk) operational risk other risks: liquidity, strategic, reputational, contagion, emerging risk. 17

18 Since January 2016, EU insurers have to comply with Solvency II regulation which requires among other things to disclosure the Solvency and Financial Condition (SFCR) report with info on: - Business and performance: qualifying shareholders, material line of business, significant operations, info on source of performance (underwriting, investments, other activities) - System of governance: Structure of the Board, remuneration policy, fit & proper policy, risk management system, internal control system, etc. - Risk profile: Other source of information (2/2) underwriting risk, market risk, credit risk, liquidity risk, operational risk, other material risks; use and effect of risk mitigation techniques; stress testing; etc. - Valuation for solvency purposes (TP and investments) - Capital management Capital management policy, eligible own funds to cover capital requirements with reconciliation with account equity, info on capital requirements (standard formula vs internal model) and use of simplifications, etc. 18

19 Annex 1 Synthetic balance sheet for European life/non-life insurance groups Source: Insurance and Financial Stability, IAIS, November

20 Annex 2 20

21 Annex 3 (Consolidated data as of 2013 year-end source IVASS) 21

22 Annex 4 Let consider an Available-for-Sale assets (whose change of fair value is recognised in Equity/OCI), included in the segregated fund related to a participating contract, with a fair value of 100 CU at t and a fair value of 80 CU a t+1. At t+1, the unrealised loss of 20 CU (80-100) is split - assuming a share of 85% of returns distributed to policyholders between the insurer s share (4 CU=20%*20 CU) e the policyholders share (16 CU=80%*20 CU): 22