17: what to do now. Implications for Singapore insurers

Transcription

1 17: what to do now Implications for Singapore insurers

2 Executive summary

3 The International Accounting Standard Board (IASB or Board) has concluded its deliberations on the new Insurance Accounting Standard, formerly referred to as IFRS 4 Phase 2 and now referred to as IFRS 17 Insurance Contracts (the Standard). The Board is expected to issue the final Standard in May The final standard is to be first applied for reporting periods starting on or after 1 January The forthcoming Standard will represent the most significant change to accounting requirements ever taken by insurers in Singapore, requiring insurers to entirely overhaul their financial statements. Given the scale of this change, investors and other stakeholders will want to understand the likely impact as early as possible (see Exhibit 1). The Standard uses three measurement approaches: 1. (also referred to as the BBA) - for most long-term contracts 2. Premium Allocation Approach (PAA) - for most short-term contracts and 3. Variable Fee Approach (VFA) - for contracts with direct participation features The principles underlying these measurement approaches result in a fundamental change to current practice, particularly for long-duration contracts. The requirements are markedly different to the existing accounting in a number of critical aspects that will: Change profit emergence patterns Increase loss recognition Add complexity to valuation processes, data requirements, assumption setting and the requirements for analysing and communicating results. In the coming years, insurers will need to interpret, implement and apply the requirements to their insurance contracts and features a process involving significant time and effort. The major change program required will extend beyond finance and actuarial teams and its impacts will need to be communicated to a broad range of internal and external stakeholders. In addition to the Standard, insurers will need to adapt to a wave of other accounting and regulatory changes over the next five years, including: IFRS 9 Financial Instruments effective 1 Jan 2018 (unless deferred until 1 January 2021 based on the conditional deferral option in IFRS 4 Insurance Contracts) IFRS 15 Revenue from Contracts with Customers - effective 1 January 2018 IFRS 16 Leases effective 1 January Singapore RBC 2 expected effective date before 2021 Given the increasing certainty of the new Standard, the scale of its changes, and the complexity of the implementation task, insurers should start formally assessing impacts and mobilise their organisations now starting with these six actions Seven actions to Kick-start your implementation program: Conduct a gap analysis to understand key differences against current accounting / actuarial and reporting practices Educate the executive and board on the new requirements and implications. Understand interpretative issues and analyse the financial, operational and system implications of the new Standard on your organisation. Consider interaction with other new accounting standards. Draft budget and plan resourcing requirements. Assess implications for other current or planned programs of activity in the next 3-4 years. Assess strategic and product implications. Exhibit 1: IFRS 17 Timing (for December year-end) Disclosure of expected impacts of the issued but not yet effective Standard Possible revised IFRS 9 classification from IFRS 17 transition* First IFRS 17 compliant financial statements IFRS 17 issued IFRS 17 start of comparative period IFRS 17 effective 1 Jan 2021 * Unless IFRS 9 will be deferred based on the conditional deferral option IFRS 17 1

4 Proactive responses to IFRS 17 CFO Controllership Chief actuary Operations Underwriting Investing Communicate early to key stakeholders, including market analysts, regional or global headquarters or shareholders, providing clarity around the expected impacts to the financial statements and profit profiles Analyse current management reporting, key performance indicators and incentive frameworks for ongoing applicability and incorporate necessary changes for analysing margins and volatility Update volatility and asset-liability management frameworks for measurement changes under IFRS 17 and assets under IFRS 9 Monitor development of Singapore RBC 2 and other potential regulatory changes, and incorporate those as needed Discuss implementation options and potential consequences with industry peer group through share forum sessions and insurance seminars Liaise with local regulator and professional association on interpretation and implications of the new Standard and potential impacts on local regulatory reporting requirements Update the chart of accounts and account mappings to cover new disclosures Update the current balance sheet and Profit and Loss (P&L) formats to meet new presentation requirements Update accounting policies and practice manuals Analyse closing and reporting processes, including updated timelines and responsibilities Engage with taxation authorities to discuss implications and transition approaches if taxable income calculations are based on current accounting treatments Design specific controls to drive new process quality, robustness and integration into existing control frameworks Update process and controls documentation and operating procedures Create new or revise existing internal (e.g. forecasts and other management reports) and external (e.g. investor and analyst packs) reporting templates Build in additional time to design and complete increased disclosures for each reporting period Focus on the auditability of reported figures this will require a high level of interaction and consultation with the external auditor during the implementation process Allocate time and resources to projects to design, build and test new data, modelling, and systems capability Update methodology guidance for discount curve and assumption setting Create a new or revise the existing calculation engine for amortising and adjusting the contractual service margin Work with the finance team to estimate impacts on transition and design optimal approaches Assist in making sure the reported figures are auditable Assess current data availability against new data requirements for both model inputs and outputs as well as for transition Change the content and structure of data captured from business units to support group reporting Change the process for reporting that data to the group reporting team Enhance scrutiny of data quality, storage and archiving given the retrospective transition requirements, this should happen ahead of the date of implementation Enhance data reconciliation based on new data needs Enhance scrutiny of data governance and management Perform detailed reviews of product offerings and pricing strategy to adapt to changes in profit profiles to improve earnings for owners Review investment policies and ALM strategy based on the impacts of the new measurement models for both insurance contracts and financial instruments IFRS IFRS

5 Transition and implementation program In the next three years, insurers based in Singapore will need to implement significant technical and practical changes. EY is already working with major insurers in Europe, Australia and Asia as they assess the technical, commercial impacts of these changes, mobilise their implementation programs and, importantly, educate their stakeholders. In our experience, proactively maintaining market confidence in an insurer s ability to execute these programs is essential. As the Standard is finalised and the effective date approaches, external stakeholder interest will increase. Local insurers must be prepared to educate stakeholders on the expected impacts and communicate their execution plans. This will require a well-planned program and a clear organisational view of the effects of the new Standard. EY has the experience to help insurers assess these effects and design and implement a cohesive and tailored conversion program as illustrated in Exhibit 2. Exhibit 2. IFRS 17 Implementation program (illustrative) * Unless IFRS 9 will be deferred based on the conditional deferral option IFRS 17 3

6 Initial questions when analysing your contracts?????? See page 8 See page 10 See pages 15, 18 See pages 11,12,13,16 See pages 11,12,13,14 See page 17 Is this an insurance Do we have What additional What are the Which measurement Which transition contract? If non-insurance data do we need implications for model should approach should we so, what is its that for disclosures and our ALM, product we apply? What use? duration? must be separated? presentation? strategy, pricing changes do we and profit release need to make To what extent can we group individual contracts? Are any of the contracts onerous? patterns? to our valuation systems and processes? The three measurement models Default valuation approach Insurance contract valued using fulfilment cash flows the present expected future cash flows, plus a risk adjustment Offset by the contractual service margin, which represents unearned profit the insurer recognises as it provides services under the contract Premium Allocation Approach (PAA) Optional simplified approach for contracts with a duration of one year or less, or where it is a reasonable approximation to the General Model Many non-life, and some life, insurance contracts are expected to meet these criteria Insurance contract valued as a pre-claims coverage liability and an incurred claims liability Similar approach to existing non-life insurance contract measurement Variable Fee Approach (VFA) Applies to participating contracts, as defined by three criteria, based on policyholders having a significant share in the profit from a clearly identified pool of underlying items Insurance contract liability based on the obligation for the entity to pay the policyholder an amount equal to the value of the underlying items, net of a consideration charged for the contract a variable fee IFRS IFRS

7 Features and challenges of the expected Standard IFRS IFRS

8 A marathon accounting project The IASB s Insurance Contracts project has been a marathon not a sprint. However, we are now approaching the finish line. In 2013, the Board issued a revised exposure draft on the accounting for insurance contracts (the ED). The IASB received extensive feedback on the ED, including concerns that it would result in: Volatility in results that did not appropriately reflect the underlying performance A profit release pattern for participating contracts that did not reflect underlying performance Increased complexity that outweighed benefits In response to the industry s concerns, the IASB recognised the need to revisit many aspects of the proposed Standard. Its deliberations between 2014 and 2017 have led to extensive changes to the measurement model. On a number of topics the IASB appears to have accepted pragmatic solutions with the aim of developing a Standard acceptable to most in the international industry. In response to the industry s concerns, the Board recognized the need to revisit many aspects of the proposed Standard. Its deliberations led to a number of extensive changes to the measurement model. On a number of topics the IASB appears to have selected pragmatic solutions with the aim of developing a Standard acceptable to most in the international industry. Between September and November 2016 the IASB conducted targeted field testing with 12 insurance groups to further look into the impact of their proposals. The final Standard (IFRS 17) is now expected in May 2017, with 1 January 2021 as the mandatory effective date (with early adoption permitted). Given this timing, insurers expressed concern that the introduction of the new Standard will be aligned with IFRS 9 Financial Instruments, which becomes effective from 1 January In response, the IASB issued amendment to IFRS 4, providing conditional options to address the issue of different effective dates of IFRS 9 and IFRS 17 (see IFRS 9 section for more detail). These will mean that most insurers will be able to defer implementation of IFRS 9 until the date that IFRS 17 has become effective. IFRS IFRS

9 Variable Fee approach (see page 14) leading to a new accounting landscape The following sections take a deeper dive into the key features of the new accounting Standard (see Exhibit 3), their expected implications and implementation challenges they will present. Exhibit 3. Key focus areas of IFRS 17 Contractual service margin Definition and scope (see page 8) (see page 11) Risk adjustment Discount rate Expected value of future cash flows Presentation/ Disaggregation (see page 15) Reinsurance (see page 16) Disclosure (see page 18) Separation of (see page 10) Premium Allocation approach (see page 13) Liability for remaining coverage Risk Adjustment Discount Rate Cash Flows of claim liability Transition (see page 17) Financial instruments and other accounting changes (see page 19) IFRS 17 7

10 Premium Allocation approach Definition and scope Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes More granularity in contract groupings for valuation purposes will create additional complexity in the valuation models, process and data requirements. Variable Fee approach Disclosure The Liability Adequacy Test (LAT) will be replaced by an onerous contracts recognition test. This new test is expected to be measured at a more granular level than the current LAT, with the potential for certain contracts to enter into loss recognition.. Some life insurance contracts may be considered short-term, accelerating profit recognition and amortisation of acquisition costs. Some general insurance contracts will be considered long-term, becoming subject to a more complex valuation methodology. Additional guidance on the significant insurance risk test means contracts that are currently borderline or with deferred payment features may not meet the insurance contract definition. Exhibit 4.Illustrative schematic of proposed level of aggregation Definition of an insurance contract Since the definition of an insurance contract under the proposed standard is unchanged from current IFRS4, most contracts will not be affected. However, additional guidance on the significant insurance risk test states that it should be based on the present, rather than absolute, value of future potential cash flows of a particular contract. Contracts containing deferred payment features or currently borderline may be at risk of failing this revised test and may need to be measured using IFRS 9. Level of aggregation (unit of account) The level of aggregation is not merely an esoteric accounting concept. It directly affects insurers ability to aggregate contracts for valuation purposes and the onerous contract test. The guidance will state that entities should group together contracts: Which are issued in the same year (i.e., by cohort) Which are subject to similar risks, and are managed together as a pool (e.g., product lines) Split into three profitability buckets, being identified as contracts onerous at inception, contracts with no significant possibility of becoming onerous, and other contracts. When law or regulation constrains the entities ability to set a different price for policyholders with different characteristics, the entity may be able include those contracts in the same group. The Board clarified that entities will be allowed to divide their profitable portfolios into more than two groups, and to have cohorts covering a smaller period than one year. We expect these aggregation rules to result in more granular groupings than the current practice in Singapore, necessitating more complex modelling, valuation processes and data requirements. Insurers will have to assess from the pricing stage as more contracts are likely to be recognised as onerous because the lower level of aggregation means insurers will not always be able to offset individual loss-making contracts against profitable ones within the same product group. De-recognition and the contract boundary De-recognition timing and the contract boundary is critical as it determines which valuation approaches are available, the periods over which profits are released and which future cash flows should be included for valuation purposes. Cash flows are within the boundary of an insurance contract when the entity can compel the policyholder to pay the premiums or has a substantive obligation to provide the policyholder with coverage or other services. The insurer s substantive obligation ends when it can set a price or level of benefits that fully reflects the risks of the particular policyholder (or the portfolio of insurance contracts that contains that contract) and the pricing of the premiums for coverage up to the date when the risks are reassessed does not take into account the risks that relate to future period. This means insurers will need to assess contract boundaries for all their contracts. In Singapore there has been plenty of discussion particularly on Central Provident Fund (CPF) related products (e.g. Dependent Protection Scheme) and health products which have renewable features, but may lack the practical flexibility for insurers to reassess risks. The current approach adopted in Singapore differ across insurers due to lack of criteria set locally, insurers will have to reassess contract boundaries of these contracts taking practicability into consideration under IFRS 17. For contracts deemed to have a oneyear boundary, acquisition costs may cause them to fail the onerous contracts test in their first year, and will accelerate amortisation of their acquisition cash flows. Some general insurance contracts, such as engineering, construction or lenders mortgage insurance, will have a contract boundary greater than one year and therefore may need to apply a more complex valuation approach. They will need to change their models to adapt them to a life-time projection including discounting effect. IFRS 17 8

11 Premium Allocation approach Separation of (unbundling) Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Risk Adjustment Discount Rate Presentation/ Disaggregation Reinsurance Transition Cash Flows of claim liability Financial Instruments and other accounting changes Variable Fee approach Disclosure Current unbundling requirements Under the current Standard, in certain circumstances, embedded derivatives and deposit (investment) are unbundled from the host insurance contract and accounted for separately. Products with both insurance and investment, such as investment-linked products with life insurance rider benefits, are common in Singapore market. Implications The embedded derivative separation requirements are largely unchanged from current requirements. The investment component separation requirements are different, with no option to unbundle voluntarily, and separation and accounting under IFRS 9 required if the investment component is distinct from the insurance component. If a contract provides goods and services not related to insurance risk (e.g. preventative or lifestyle benefits), separation may be required and some allocated revenue recognized under IFRS 15. Contract features will require analysis. If separation is required this will add to the data requirements and accounting complexity. In other circumstances, insurer have the option to voluntarily unbundle deposit. As shown in Exhibit 4, the new Standard retains the concept of unbundling, described now as separation and disaggregation. However, the option to voluntarily separate has been removed and new have been added. Embedded derivatives The new Standard has retained the current requirements to unbundle (or separate) embedded derivatives, so no major changes are expected in this area. Investment Distinct investment should be separated and accounted for in accordance with IFRS 9. An investment component is distinct if a contract with equivalent terms is sold, or could be sold, separately in the same market or same jurisdiction, either by entities that issue insurance contracts or by other parties. However, it is not considered distinct if the investment and insurance are highly interrelated (i.e. if one cannot be measured without considering the other). Performance obligations to provide goods or services Distinct performance obligations to provide goods or services defined with reference to IFRS 15 as a promise in a contract with a customer to transfer a good or service to the customer must be separated from the host insurance contract. However, similar to the investment component, separation is not required if the cash flows and risks associated with the good or service are highly interrelated with the cash flows and risks associated with the insurance in the contract. Where goods and services are being provided outside of delivering a benefit related to insurance risk (preventative or lifestyle benefits for example), insurers may need to separate these and account for an allocated revenue component in accordance with IFRS 15. Exhibit 5. Separation and disaggregation Distinct investment Separation Insurance Embedded derivatives, which are not closely related Accounting under IFRS 17 Accounting under IFRS 9 Accounting under IFRS 15 Non-distinct investment Distinct performance obligation to provide goods and services Accounting under IFRS 17, disaggregation for presentation in income statement notes Disaggregation* * Disaggregation is the exclusion of an unseparated investment component from insurance co IFRS 17 9

12 Premium Allocation approach Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes Disclosure is considerably different from the current gross premium valuation used in Singapore. The methodology will result in different profit outcomes and require new modelling, data and process Contract aggregation at a cohort level will be much more granular than current practice. Combined with the need for probability-weighted expected cash flows, this will add significant effort and complexity to the valuation Calculating the discount rate and risk adjustment will require new techniques and application of considerable judgment The release of the contractual service margin (CSM), based on the passage of time and expected number of inforce contracts, will give some products unexpected profit emergence patterns Variable Fee approach (Building Block Approach, or BBA) will be the core measurement model, with the insurance contract liability comprising fulfilment cash flows and the CSM. The fulfilment cash flows include: The expected, probability-weighted, discounted cash flows within the contract boundary. The objective is to determine the expected value, or statistical mean, of the full range of possible scenarios, which will be discounted to present value at a discount rate that reflects the characteristics of those cash flows. This scenario-based approach is more complex than current best estimate approach adopted in Singapore. If the scenarios represent a symmetric distribution, then a more deterministic approach may still be possible. Although the discount rate may not be fully observable in the market, insurers may potentially adopt approach and applying judgement similar to what is required under RBC 2. The determination of the long-term discount rate, where instruments are not available on the market, will need to be strictly documented. A risk adjustment reflecting the level of compensation the insurer would demand for bearing the uncertainty about the amount and timing of cash flows. The technique used to determine the risk adjustment is not specified, but the result will need to be translated into a disclosed confidence level. This will be a new requirement for Singapore insurers as currently there is no explicit choice of confidence level, and insurers have chosen a provision for adverse deviation (PAD) level that is mid-way between best estimate and prescribed C1 level for local statutory reporting purposes. The CSM is the expected unearned contract profit in an insurance contract. At inception, it will be equal and opposite to the present value of fulfilment cash flows plus pre-coverage cash flows (i.e. acquisition costs). The concept of CSM is new to Singapore insurers. It is important to grasp good understanding of this earlier on as it is expected that the CSM will be one of the key metrics to measure profitability and performance of new business and in-force going forward. Discounting the fulfilment cash flows The Standard requires that, in determining the fulfilment cash flows, an insurer should discount the estimates of future cash flows to reflect the characteristics of those cash flows. The discount rate should be based on a methodology in accordance with the following principles: For liability measurement purposes, discount rates should be updated each reporting period (i.e., a current rate) Discount rates should be consistent with observable current market inputs for instruments with similar cash flow characteristics as the insurance contract liability Rates should exclude factors that are not relevant to the insurance contract liability To the extent that the amount, timing or uncertainty of the cash flows arising from an insurance contract depend wholly or partly on the returns from underlying items (e.g., financial instruments), the discount rate should reflect that dependency The Standard will propose two approaches that could be used to establish discount rates: a top-down approach and a bottom-up approach. The top-down approach starts at an expected rate of return on assets adjusted for items included in that rate that are not part of the characteristics of the liability (e.g., expected and unexpected defaults). The bottom-up approach starts by determining a risk-free rate and then adjusts that rate to reflect the characteristics of the insurance liability, which may include an illiquid component. The application and determination of the discount rate will be new for insurers in Singapore as life insurers have traditionally used the risk free rate, and no requirements for general insurers to apply discounting. Subsequent Measurement Interest will accrue on the CSM based on the discount rate locked in at inception. The rate may be a weighted average for each cohort, with an allowed averaging period of up to one year. Actuaries and accountants will have to think through the mechanics of averaging and the implications for accrual, e.g., the effect of averaging on forward accrual rates. At the November 2016 meeting the Board confirmed that the CSM for a group of contracts must be allocated over the current and expected remaining coverage period on the basis of the passage of time. The IFRS 17 10

13 allocation must be based on coverage units, reflecting the expected duration and size of the contracts in the group. Releasing CSM on this basis is likely to lead to some unexpected profit emergence patterns. The CSM mechanism means contracts are likely to be aggregated in annual cohorts. This is much more granular than current Singaporean practice. It will bring increased requirements for data and modelling, assumption setting and valuation processes, and the manner in which results are analysed and explained. When under the General Model an experience adjustment directly causes a change in the estimate of the present value of future cash flows (i.e., a direct effect on future coverage or other services), this direct effect on future cash flows should adjust the CSM, while the difference of estimated and actual cash flows of the current period (i.e., the experience adjustment) should be recognised in profit or loss as part of the insurance service expenses. Experience adjustments can be caused by several types of events, for example unexpected deaths Insurers will be able to choose whether the effect of changes in market discount rates are recognised fully in P&L or in Other Comprehensive Income, with interest accrued to the P&L at the locked-in discount rate at inception. Specific requirements for the presentation of insurance finance income or expense apply to participating contracts. Exhibit 6. The General Model and presentation of changes in the insurance liability Net contract asset or liability under the General Model Contractual service margin (Contract profit) Release of CSM Profit or loss: Underwriting result Change in estimates relating to future services Fulfilment cash flows Future cash flows: Expected cash flows from premiums and claims and benefits Risk adjustment: An assessment of the uncertainty about the amount of future cash flows Discounting: An adjustment that converts future cash flows into current amounts Change in CFs related to past and current periods Release of RA related to past and current periods Interest expense at locked in discount rate Effect of changes in discount rates Profit or loss: Investment Other comprehensive income IFRS 17 11

14 Premium Allocation approach Premium allocation approach (PAA) Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Risk Adjustment Discount Rate Presentation/ Disaggregation Reinsurance Transition Cash Flows of claim liability Financial Instruments and other accounting changes Variable Fee approach Disclosure The PAA, or simplified approach, may be used where: Contract coverage period (including premiums included in the contract boundary) is one year or less, or Use of the PAA produces a reasonable approximation of the General Model. A liability for incurred claims, which measures the insurer s present value obligation to investigate and pay that have already occurred whether reported or not. The liability for incurred claims will be calculated using the General Model methodology. Implications The PAA is similar to existing approaches for non-life insurance products. Defining the contract boundary is critical to analysing whether an insurer can use the PAA for some contracts either due to having a coverage period of one year or less, or because the PAA reasonably approximates the General Model results Some life insurance contracts currently using a long term valuation may qualify to be able to use the PAA approach (e.g. health contracts), which would simplify the modelling required but may also lead to unexpected results. Longer-term non-life contracts, such as construction, engineering and lenders mortgage insurance, may not meet the criteria. As a result, the insurer will face additional complexity in its valuation, modelling and associated processes. The first step to assess its use is to define the contract boundary and hence the coverage period. Many non-life insurance contracts meet the first criteria by having a coverage period of one year or less. However, contracts with longer coverage periods, such as engineering, construction or lenders mortgage insurance will need to demonstrate they meet the second criteria. If not, they will have to use the General Model instead. Non-life insurers in this scenario will need to develop more complex modelling than they currently apply, requiring more data and the development of long-term assumptions. This also means insurers will present financial statements with a mix of valuation techniques, complicating the way results are analysed and communicated. The PAA is similar to existing Singaporean non-life insurance accounting and incorporates two elements to measure the insurance contract liability: A liability for the remaining coverage, which measures the insurer s obligation to provide coverage to the policyholder during the coverage period. If the coverage period is less than one year, the insurer may choose to immediately expense directly attributable acquisition costs. The PAA measures the liability for remaining coverage by allocating the contract premiums over the coverage period, with revenue recognised either: On the basis of the passage of time, or If the expected pattern of release of risk differs significantly from the passage of time, then on the basis of expected timing of incurred claims and benefits. This revenue recognition allocation approach differs from the General Model, which is based on the passage of time and coverage units, and prima facie results in a more appropriate profit release pattern. For this reason, as well as the simplified measurement approach and reduced effort compared to the General Model, we expect many insurers, particularly non-life companies, will elect to apply the PAA if its criteria are met. Exhibit 7. The Premium Allocation Approach (PAA) Liability for remaining coverage Expected present value of future cash inflows CSM Risk adjustment Expected present value of future cash outflows Liability for remaining coverage premium allocation approach Premiums received (plus any additional onerous contract liability) Directly attributable acquisition costs Liability for remaining coverage Liability for incurred claims PAA Risk adjustment Present value of cash flows IFRS 17 12

15 Premium Allocation approach Variable Fee Approach (VFA) Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Variable Fee approach Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes VFA is to be used for contracts with direct participation features, representing an adaptation of the General Model Disclosure It will require judgment to determine whether participating contracts meet the criteria to apply this approach This approach has generally been welcomed by the industry as it appears to lead to a more appropriate measurement and profit emergence pattern than many alternatives The VFA limit the impact of market volatility in SCI as the movements in the shareholders share are absorbed by the CSM and therefore spread over the remaining coverage period The VFA is the measurement approach for direct participating contracts that meet three criteria: 1. The contractual terms specify that the policyholder participates in a share of a clearly identified pool of underlying items. 2. The entity expects to pay to the policyholder a substantial share of the fair value returns from the underlying items. 3. A substantial proportion of the cash flows that the entity expects to pay to the policyholder are expected to vary with the change in fair value of the underlying items. The VFA assumes that a participating contract creates an obligation for the entity to pay the policyholder an amount equal to the value of the underlying items, net of a consideration charged for the contract a variable fee. Accordingly, the entity s interest in the contract would represent a variable fee for the service of managing the underlying items on behalf of a policyholder. At inception, this fee comprises the entity s guaranteed minimum benefits and expenses: its expected share of returns on the underlying items to which the participating contracts have a participation right, less any expected cash flows that do not vary directly with the underlying items. This approach requires that changes to the estimate of the future fees an entity expects to earn from participating contract policyholders are adjusted against the CSM. The CSM on direct participating contracts would be recognised in profit or loss as part of the entity s underwriting results on the basis of the passage of time. Participating contracts which do not satisfy the criteria above will be accounted for using the General Model and are referred to as indirect participating contracts. Some key differences will arise between contracts measured under the VFA versus the General Model and are summarized in Exhibit 8 Differences General Model Variable fee approach Subsequent measurement Financial variables Accretion of interest on CSM Insurance investment expense PL or OCI, following the general model Locked-in rate Effective yield-based CSM (PL if risk-mitigated) Current rate Current period book yield (if investments are held) Some Insurers are concerned that the differences above will lead to a cliff effect, whereby two economically almost identical contracts may report quite different results if one does not qualify to use the variable fee approach. In Singapore, we do not expect this to be a significant issue. Given the styles of participating products sold, we expect they fall under the direct participating contracts bucket whilst the universal life products sold are likely to fall into the indirect participating bucket. Exhibit 8. The Variable Fee Approach Continuum of insurance contracts Type of contract Non participating Indirect participating Direct participating Measurement or PAA Variable fee model Interest expense effective yield Current period book yield IFRS 17 13

16 Premium Allocation approach Presentation and disaggregation Definition and scope Separation of Premium Allocation approach Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes Variable Fee approach Disclosure Premium revenue based on premiums written during the period will no longer appear on the face of the P&L, replaced by insurance contracts revenue. This is calculated based on movements in a number of different elements, requiring stakeholder education about its meaning and importance. There is a risk that, if the new format does not provide useful information to investors, further supplementary information outside the financial statements will proliferate. Insurers will need to implement reconciliation between the premiums and the revenue presented. The proposed Standard includes specific requirements for presenting insurancerelated balances in the financial statements. The biggest change for some insurers will Be seen in the Statement of comprehensive income, which will now separate investment performance explicitly from operating results. Exhibit 9 provides an illustrative simplified example of which line items certain income and expense items will be recognised in. An entity will be prohibited from presenting premium information in the statement of comprehensive income if that information is not consistent with the commonly understood notion of revenue. However, premium related information can still be disclosed in the notes to the financial statements. Rather than written premium revenue, insurance contracts revenue will be shown, comprising of the related shown in Exhibit 9. Claims and other expenses related to the insurance contracts will then be disclosed, leading to an underwriting result for the entity. Exhibit 9. Illustrative statement of comprehensive income Statement of comprehensive income Release in contractual service margin Change in risk adjustment Insurance contracts revenue Claims and expenses incurred Underwriting result Investment income Insurance finance expenses Investment result Other profit and loss Corporate tax Profit after tax Other comprehensive income Total comprehensive income X (X) X X (X) X X (X) X (X) X Expected claims (in fulfilment cash flows) Expected expenses (in fulfilment cash flows) Allocating premium relating to the recovery of directly attributable acquisition costs Excluding investment Actual claims incurred Actual expenses incurred Allocating premium relating to the recovery of directly attributable acquisition costs Onerous contracts Excluding investment Calculated using locked-in rates (if the OCI option is selected) Effect of discount rate changes on fulfilment cash flows (if the OCI option is selected) IFRS 17 14

17 Premium Allocation approach Reinsurance Definition and scope Separation of Premium Allocation approach Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes Reinsurers will measure insurance contracts issued under the Standard insurance contract models (the General Model or PAA). Variable Fee approach Disclosure Cedants have some additional specific areas of guidance. Prima facie, the reinsurance assets and underlying direct contracts should match as cedants will use the same inputs and assumptions in valuing the underlying contracts to value the reinsurance asset. However, some mismatches will still occur, as outlined below. Reinsurers will measure reinsurance contracts applying the same principles as those for all insurance contracts. As such, the requirements and observations made throughout this document apply to them as well. The exception is the VFA, which the Board has decided should not be applied to ceded business. This may have unintended consequences, or create opportunities for innovative reinsurance structures. On the other hand, cedants holding reinsurance contracts have particular requirements to consider: When measuring the reinsurance assets, cedants should use assumptions that are consistent with those used to measure the corresponding part of the underlying contracts reinsured. The recognition requirements for insurance contracts are modified such that ceded reinsurance business does not follow the onerous contracts guidance and instead, for retroactive contracts a negative day one difference (cost of reinsurance) must be recognised immediately in P&L if it relates to past events. The reinsurance asset will include an allowance for the reinsurer s default; whereas the direct contract will not. If the underlying direct contract is considered onerous at inception, even if the reinsurance arrangement is profitable for the direct insurer, the two cannot be offset. These requirements will lead to a number of accounting mismatches between measurement of the reinsurance contract and that of the related direct insurance contracts. To take an extreme example, an entity with 100% quota share reinsurance and no retained risk or profit share will still report an underwriting profit or loss due to accounting mismatches from one period to the next. Over the life of the contracts this will even out, but it will affect profits from one period to the next. Exhibit 10. Reinsurance measurement for cedants CSM Calibrated to the reinsured portion of the premium of the (direct) Risk adjustment CSM Present value of future cash flows Reinsured part of the cedant s liability Same inputs and assumptions plus reinsurance default Risk adjustment Expected future cash outflows Cedant s reinsurance asset CSM Calibrated to the reinsured portion of the premium of the (direct) insurance contract, IFRS 17 15

18 Premium Allocation approach Transition Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes Variable Fee approach Disclosure With 1 January 2021 as the effective date, the opening balance sheet for companies (mostly with December year end) will be 1 January 2020 which means it is less than three years away for insurers in Singapore Recognising the challenges that insurers, particularly life insurers, will face in sourcing reliable data to apply a full retrospective approach, a number of transition options have been provided to simplify the approach Nonetheless, preparing to apply and transition to the new Standard will be an enormous undertaking, affecting many parts of the organisation, particularly finance and actuarial resources Taxation implications, both on transition and for ongoing calculations, will need to be addressed In principle, the new Standard will need to be applied retrospectively, with entities required to restate comparative information about insurance contracts. For each portfolio, the cumulative effect of transition will be recognised in: Opening retained earnings Accumulated OCI for changes in interest rates since the beginning of the contract In addition, insurers will be able to make some limited re-designations of financial asset classifications previously made under IFRS 9 (see further discussion on the interaction with IFRS 9 on page 18). To the extent that taxable income is calculated by reference to accounting revenues or expenses, there will be: A transitional impact from the adjustment to opening retained earnings or OCI An ongoing impact on tax calculations It is not yet clear how the IRAS will respond to these changes. It will be important for the industry to engage with the IRAS to gain certainty prior to transition. To fully retrospectively apply the General Model, an insurer would need to determine the original fulfilment cash flows for each portfolio of insurance contracts including the inception discount rate and the original CSM and then roll this forward for each portfolio to the transition date. Apart from the difficulty of sourcing data for this exercise, it will be difficult to retrospectively determine the fulfilment cash flows as they would have been calculated at inception date without applying hindsight. This will be the case for many insurers, making full retrospective application impracticable. If it is impracticable, two alternative methods are allowed: Modified retrospective application (with specific modifications for direct participating contracts) Fair value approach Modified retrospective application Simplifications will be allowed for: Estimated cash flows Risk adjustment Discount rate at initial recognition Fair value approach CSM at initial application should be measured as: The total fair value of the underlying items, LESS The fulfilment cash flows, adjusted for past cash flows not related to the underlying items r, LESS The accumulated CSM for service provided in past periods Specific modifications for participating contracts CSM at the beginning of the earliest period presented equals the difference between the fair value of the insurance contract and the fulfilment cash flows IFRS 17 16

19 Premium Allocation approach Disclosures Definition and scope Separation of Contractual service margin Risk adjustment Discount rate Expected value of future cash flows Liability for remaining coverage Implications Risk Adjustment Discount Rate Cash Flows of claim liability Presentation/ Disaggregation Reinsurance Transition Financial Instruments and other accounting changes Some of the proposed disclosures are similar to the current disclosures insurers provide. However, the Standard will require extensive new disclosures showing how the of recognised amounts have moved during the period. Also, the nature of the measurement methodologies in the new Standard means these disclosures are likely to be more detailed and complex to prepare than current disclosures. Judgement will be needed to determine the appropriate level of disaggregation for the disclosures. Variable Fee approach Disclosure One of the primary objectives of the IASB s project on insurance contracts is to increase transparency in insurers financial statements. This include providing information about: how much risk the insurer has taken on; how much uncertainty is contained in the amounts reported; value of embedded options and guarantees. Although some of this information can be provided on the face of the financial statements, much will come in the form of more detailed disclosures in the footnotes. Exhibit 11 provides a summary of these new disclosure requirements. Prima facie, this looks similar to IFRS 4 and SFRS disclosure requirements. However, the guidance and discussion provided to date by the IASB suggests more granularity is expected than is currently the practice. The risk disclosures in particular will be expanded to cover all market risks and liquidity risk, and more detail will be required. Exhibit 11. Summary of disclosures The entity will need to determine the appropriate level of disaggregation of these disclosures, which might include: Type of contract (e.g. major product lines) Geographical area Reportable segment New business vs in force For example, for material measurements an insurer must disclose the methods used and the processes for estimating inputs. If practicable, the insurer would also provide quantitative information about the significant inputs used. These will include disclosures regarding the risk adjustment, discount rates and pattern of CSM recognition. The IASB provided an illustration of how these disclosures might look see Exhibit 12. Insurers will need to develop systems, source data and valuation models with these disclosure requirements in mind. Development of B/S items Balance sheet and P/L items Valuation methods and inputs used Reconciliation of booked premiums to insurance revenues Interest curve for discounting Type and extent of risks In general Insurance risks Other risks Risk appetite Exposure Exposure Risk management Concentrations Concentrations Regulatory law Claims settlement Maturity analysis Sensitivity analysis Exhibit 12. Illustrative input disclosure Sensitivity analysis Amount recognised on the balance sheet Product line 1 XXX Method 1 Method used Key inputs Range (weighted avg.) Method 2 Method 3 Product line 2 XXX Method 1 Total XXX Method 2 Method 3 Input X Input Y Input A Input B Input X Input L Input X Input Y Input A Input B Input X Input L X % Y % (Z%) A.X B.X (C.X) X % Y % (Z%) A.X B.X (C.X) X % Y % (Z%) A.X B.X (C.X) X % Y % (Z%) A.X B.X (C.X) X % Y % (Z%) A.X B.X (C.X) X % Y % (Z%) A.X B.X (C.X) Source: IASB Feedback on Disclosure Decisions (6 Dec. 2011) IFRS 17 17

20 IFRS 9 implementation IFRS

21 IFRS 9 implementation considerations Our point of view Singapore based insurers will need to reconsider financial asset classification and how the resulting measurement interacts with liability measurement under IFRS 17 Those firms holding equity instruments and certain types of complex debt instruments will experience volatile results once the new standards are in place Companies with large Universal Life blocks which fall outside the scope of the VFA in particular can expect more volatility in their P&L after the standards are implemented due to the mismatch between asset returns and liability and CSM movements Most insurers in Singapore are likely to qualify for the conditional deferral option, although a few significant bank-owned entities may choose not to do so as they will need to prepare for IFRS 9 as from 2018 for group reporting As shown in Exhibit 13, IFRS 9 Financial Instruments will become effective from 1 January 2018, with a comparative period starting from 1 January 2017 less than a year away. IFRS 9 comprises of three topics: Classification & measurement Hedge accounting (micro) Impairment Exhibit 13. IFRS 9 effective date compared to IFRS 17 Based on a business model test and cash flow characteristics test, financial instruments will be classified as one of the following: Debt instruments at amortised cost Debt instruments at FVOCI with gains and losses reclassified to P&L Debt instruments, derivatives and equity instruments at fair value through profit or loss Equity instruments designated at FVOCI (without gains and losses reclassified to P&L) The option of a conditional FV through P&L will still be available. Given the variety of treatments currently used in Singapore, it is not clear which combination of options will be chosen. Decisions will be driven by the interaction with IFRS 17 and application of the VFA, amongst other issues. For debt instruments not measured at FV through P&L, a new impairment recognition model will apply. This will be an expected loss model, re-assessed at each reporting period, in contrast to the current incurred loss model. Relief for insurers In September 2016, the IASB issued amendments to IFRS 4 to provide two options for insurers implementing IFRS The deferral approach or taking a temporary exemption from applying IFRS 9, provides the option to defer the implementation of IFRS 9 until either the earlier of the effective date of a new insurance Standard or This approach will be available automatically to reporting entities with a minimum predominance ratio of 90%, or 80% if there is no significant activity unrelated to insurance. The predominance ratio will be the ratio of liabilities arising from activities related to insurance plus investment contracts measured at FVPL, plus other liabilities related to these activities, divided by total liabilities. Specific disclosures will be required for entities electing the temporary exemption, the impact of which should not be underestimated as the implementation of some elements of IFRS 9 are necessary to prepare them. 2. The overlay approach provides the option to exclude from profit or loss, and recognise in OCI, the difference between amounts that would be recognised in profit or loss in accordance with IFRS 9 and the amounts recognised in profit or loss in accordance with IAS 39. This would reduce some of the accounting mismatches and temporary volatility in the P&L that could arise if IFRS 9 is implemented before the new insurance contracts Standard. However, it will still require insurers to designate eligible financial assets according to the new classification guidance upon implementation of IFRS 9. Both options also include significant disclosure requirements which will require investment in new systems and processes to prepare. IFRS 9 Start of IFRS 9 comparative period IFRS 9 effective date 1 Jan 2018 Possible revised IFRS 9 classification* from IFRS17 transition First IFRS 17 and 9 Compliant financial statements IFRS 17 Potential IFRS17 Final Standard Potential IFRS 17 start of comparative period Potential IFRS 17 effective date 1 Jan 2021 *Unless IFRS 9 will be deferred based on the conditional deferral option IFRS

22 How EY can help EY service offerings EY tools and accelerators Mobilize, analyze and evaluate Training, webcasts and workshops Assistance on key technical questions Develop operational impact assessment Conduct financial impact analysis Estimate of resource needs and costs Roadmap of activities for implementation IFRS 17 Operational Impact Analyzer IFRS 17/IFRS 9 training materials Gap analysis approach Roadmap and Costing templates Design smart tailored implementation program Pilot testing Design new Target Operating Model (TOM) and KPIs Run system impact assessment Prepare data analysis for transition IFRS 17 Prototype Tool () Financial impact analysis tool Data & System impact analysis tool System architecture examples Program implementation Investor and stakeholder education Run system tests Model accounts, data model and COA IFRS 17/IFRS 9 training materials Dry run Prepare transition data Implement new TOM Re-design of control frameworks and processes Populate proforma financial statements Conduct Board awareness sessions Model accounts, data model and COA Live reporting Investor and stakeholder education Project management on implementation Technical support IFRS 17 COA IFRS 17/IFRS 9 training materials EY tools and accelerators IFRS 17 Operational Impact Analyzer A web based tool to identify operational gaps from a micro and macro perspective on the insurer s existing processes, systems, data, models and policies, compared to the new requirements of IFRS 17. Gaps by dimension Systems 20 Processes 11 Policies 16 Models 22 Data 4 Gaps by topic Presentation and disclosure 13 Variable fee approach 8 Level of aggregation 21 Discounting 9 CSM 22 IFRS 17 Prototype Tool An actuarial model to identify the inputs needed from actuarial models to support IFRS 17 reporting. The tool demonstrates the impacts of changing assumptions and cash flows on reported results. It can also perform multiple model runs to produce Analysis of insurance liability and separate the impact of different assumption and experience changes. The tool is capable of calculating IFRS 17 insurance liabilities for a contract or a portfolio at inception and subsequent measurement dates. IFRS

23 Contacts Patrick Menard Partner Financial Service Office Tel: Sumit Narayanan Partner Actuarial Services Tel: Vanessa Lou Associate Director Actuarial Services (Life) Tel: Anthony Atkins Associate Director Actuarial Services (GI) Tel: IFRS 17 21