IFRS Insurance Contracts. The state of play or, what is really going on?

Transcription

1 IFRS Insurance Contracts The state of play or, what is really going on? Sam Gutterman FSA, FCAS, MAAA, Hon FIA

2 Agenda Context Current status Key issues 2

3 Why Current IFRS 4 Other standards (IAS 18, IAS 32, IAS 37, IFRS 7, IFRS 9) cannot easily be applied to insurance contracts A wide range of accounting for different types of contracts No requirement for uniform accounting policies across a group - Or a relevant and reliable accounting policy for insurance contracts - Limits usefulness of consolidated financial statements Mostly a black box to insurance specialists and non-specialists - Resulting in lower share prices of insurers Why not just adopt US GAAP Too many measurement approaches, geared to U.S. products Some feel it is broken - Lock-in, DAC, lack of transparency, inconsistent discounting 3

4 Thoughts about measurement Transparency How best to remove the actuarial and insurance black boxes Current measurement best for liabilities But can be problematic for measurement of performance But not fair value Financial reporting challenges with respect to insurance Long-term bundled nature of insurance contracts - Usually contains elements of financial instruments and service Providing useful but not voluminous information Importance of consistency with other industries International convergence Importance of a level playing field 4

5 Project History X IASC starts project on insurance contracts IFRS 4 Insurance Contracts IASB Discussion Paper Preliminary Views on insurance contracts FASB joins project Not part of MoU IASB Exposure draft Insurance Contracts FASB Discussion Paper Preliminary Views on Insurance Contracts Likely IASB re-exposure Draft and FASB Exposure Draft Standard! 5

6 Positioning of Insurance Contracts measurement Insurance needs to be viewed in the context of financial instruments and service performance General liabilities (IAS 37, revision of which has been deferred) Measurement expected value, time value of money, risk adjustment Financial instruments IFRS 9 Replacement of IAS 39 Classification and measurement Choice of fair value through profit & loss and amortized cost Amortized cost only available if certain criteria are met Impairment rules Particularly controversial for loan loss liabilities Will likely apply to ceded reinsurance asset balances 6

7 Revenue recognition or Service performance For service contracts Currently being re-exposed Insurance contracts issues similar, but resolution may differ Primarily because base of insurance contracts is liability measurement For service contracts, all considerations are allocated over performance, while for insurance contracts just the residual margin Issues for insurance contracts Incremental acquisition cost (loss at issue for proposal) No discounting applied if longer than one year (thus the revenue to recognize), as a practical expedient Split multiple performance obligations by relative standalone actual or estimated selling price 7

8 IASB Measurement Building Block Model For longer duration insurance contracts, with four prospective building blocks The residual margin serves to allocate the initial amount to break-even over the coverage period The FASB prefers a combined risk adjustment and residual margin (right side below) For claims liability, only the first three blocks apply Cash flows Time value of money Risk adjustment Remaining Residual margin Total Liability Remaining single margin Time value of money Cash flows 8

9 IASB Measurement Premium Allocation Model For products such as property & casualty or group term Only relates to the coverage period Still struggling to determine the best rule for eligibility determination Allocation of premium (less initial acquisition costs) Over coverage period, similar to unearned premium approach An onerous contract Determine based on indicators, without need to check every contract every period If onerous, most likely revert to building block approach After claims incurral Based on the first three building blocks FASB, possibly just the first, except for long duration claims 9

10 Underlying issue Income volatility Primary sources of accounting income volatility Short-term changes in market interest rates Changes in non-market expectations Big industry issue Possible methods of reflecting these sources Other comprehensive income - Likely change in discount rate Corresponding changes in residual margins through remeasurement - Possibly change in non-financial estimates Disclosure - Needed in any event 10

11 Beginning and ending of contract Recognition Beginning of coverage period Unless onerous, in which case recognize loss when contract is entered into Contract boundary The current proposal being discussed attempts to reflect when The policyholder lacks substantive rights The insurer has the right or practical ability to reassess the risk of a particular policyholder and thus is able to set a price fully reflecting the risks involved and/or No prefunding exists Currently struggling with how to express, as a large range of possible rights and obligations exist 11

12 Expected cash flows What are expected cash flows Earlier in the project described as probability-weighted But never meant to require stochastic modeling all of the time Not necessarily a single best estimate Should capture the variability of the assumption For example, to reflect the cost associated with options and guarantees 12

13 Expected expense cash flows Initial acquisition costs Direct costs included, thus loss at issue equal to other initial costs IASB view includes cost associated with unsuccessful efforts FASB view excludes cost associated with unsuccessful efforts, except those reimbursed through commissions - Results in larger loss at issue Maintenance expenses Directly attributable cost of fulfilling obligations in expected cash flows Other expenses Treat overhead and other acquisition cost as period costs Result losses at issue and larger residual margins 13

14 Discount rates Time has value Basis is observed market prices of fixed income securities subject to supply and demand Market-based measurement of implied value of time can vary significantly from period-to-period Effect of changes in discount rates on asset and liability values can be significant Bottom-up and top-down approaches remain problematic For participating contracts details remain to be discussed Asset-liability management is a fundamental aspect of many life/annuity insurance contracts Inconsistent asset and liability measurement will contribute to difficult interpretations of insurers income Although not be as significant for most P&C insurance, investment income is still an important part of overall income 14

15 Risk adjustment A great deal of contention How should cost of uncertainty be reflected in accounting measures Lack of confidence by some in actuarial methods and assumptions FASB combines with residual margin to form a single margin Lack of recognition of uncertainty More people understand it in a context of market measurement - Participants are willing to pay a price to avoid or take on In determining the cost of fulfilling an obligation - Role important in managing business - But hasn t played an explicit role in many other accounting areas Many actuaries not used to measuring uncertainty in reporting Current approaches include cost of capital, VAR, tvar Concern that parameter level may not be comparable Disclosure important 15

16 Residual margin At issue, residual margin can serve a useful purpose Reduce incentive to use over-optimistic experience assumptions Nevertheless, its many elements reduce its usefulness - Includes part of initial acquisition cost, overhead, tax, expected profit, and difference between entity and market assessment of credit risk Re-measured on a prospective basis Uncertainty regarding when it should be re-measured At least when prospective non-financial assumptions change Single margin favored by the FASB suffers the same problems With added disadvantage of also including risk value implicitly 16

17 Unbundling or disaggregated presentation Conceptually appealing to facilitate comparisons of measurement of like components across entities Because of inconsistent measurement of components Designating an approach for one component may result in the reduction in useful information of other component(s) - For example, if the account value of a universal life contract, with residual being the insurance contract Bundled nature of insurance contracts Makes useful unbundling difficult in most cases Primarily because of inter-related and aggregated nature of components included Current move to Unbundle unrelated embedded derivatives and certain service elements Disaggregate most explicit account value contracts 17

18 Presentation Statement of comprehensive income How best to reflect short-term fluctuations Reopening discussion of use of Other Comprehensive Income (OCI) Format ED included a summarized margin approach, but not well liked - Inadequate to meet total user information needs, lacking key volume metrics Some type of expanded version likely still being discussed Building block approach possibly uses a premium due approach (traditional life model) Building blocks separately reported in balance sheet Premium allocation approach uses earned premium approach, not combined with BBA values Coverage and claims liability separately reported 18

19 Disclosure In a measurement model in which subjective inputs are used, effective communication of these inputs are needed P&C means effective loss development disclosures Life means effective actual to expected analysis Reconciliation of each measurement component Transparent description of risks and their management Level of aggregation and information overload always a concern 19

20 Differences between IASB and FASB Differences so far Acquisition costs Treatment of policyholder participation Explicit risk adjustment, therefore residual margin Scope financial guarantee contracts Further possible differences Other comprehensive income Short duration contracts Investment contracts with discretionary participation features 20

21 What is the IAA doing IASB standard development issues Involved in discussions Developing practice monographs emphasis on case studies Stochastic modeling (available) Discounting (expected to be exposed in the month or two) Risk adjustment (author contract being rewarded now, covering alternative methods) Standards of practice and actuarial notes In various stages of development 21

22 Questions Sam Gutterman, FSA, FCAS, MAAA, HonFIA Consulting Actuary & Director Chicago (1) This presentation has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon this information without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this presentation, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.