NEW EXPOSURE DRAFT IFRS 4 - PHASE , Novembre 7

Transcription

1 NEW EXPOSURE DRAFT IFRS 4 - PHASE , Novembre 7

2 OVERVIEW 1. Background to the project 2. Key points of the new ED and their impact 3. Conclusion 2

3 01 BACKGROUND TO THE PROJECT 3

4 BACKGROUND The insurance standard has been in the pipeline for more than 15 years Volatility in profit or loss 2002: Draft Statement of Principles (DSOP) Strong emphasis on fair value of liabilities 2007: Publication of the DP Preliminary Views on Insurance Contracts Proposals based on transfer value 2008: FASB decides to collaborate on IASB project Different views throughout the project 2013: New exposure draft 1997: Discussions begin 2004: Publication of IFRS 4 Phase I Insurance contracts with phase 2 scheduled for 2007 Compromise / Temporary solution Local accounting methods remain (with a few exceptions) Asset-liability mismatch partially addressed by shadow accounting Liability Adequacy Test (LAT) needed Did not achieve its goals of convergence and comparability 2010: Publication of exposure draft Measurement of the liability using a building block apprach (3 blocks) with immediate recognition of experience adjustments and changes in estimates in P&L.?

5 DIFFICULTIES ENCOUNTERED IFRS Transversal standards which aim to comply with the fundamental principles of transparency, comparability and relevance Insurance sector A wide variety of insurance contracts and business models Various different accounting approaches existing Response to the July 2010 ED A model based on a fair value approach which introduces volatility into the statement of profit or loss that does not reflect insurers performance => Need to look for alternative solutions Various IFRS projects have affected and delayed the Phase II project: - IFRS 9 - Convergence with the FASB - Revenue recognition project - Revision of IAS 37 on liabilities - Solvency II 5

6 2017: comparative year PROVISIONAL TIMETABLE Effective application date of IFRS 4 Phase II: probably no earlier than January 1, 2018 The timelag between IFRS 4 and IFRS 9: an issue for insurers Effective date of IFRS 9: 1 January 2015? Effective date of IFRS 4 phase II: 1 January 2018? Exposure draft IASB/ FASB discussion New exposure draft Final standard: H2 2014? QIS 5 LTGA project Consultation "Preparatory guidelines" Discussions on Pillar 1 technical provisions Preparation for Pillars 2 and 3 Effective date of Solvency II: 1 January 2016? 6

7 02 KEY POINTS OF THE NEW EXPOSURE DRAFT AND THEIR IMPACTS 7

8 NEW EXPOSURE DRAFT 2013 New ED published on June 20, 2013 Limited re-exposure covering the following issues: - Presentation in OCI of the impact of changes in the discount rate used to measure insurance liabilities; - Accounting treatment of participating contracts; - Treatment of the Contractual Service Margins (previously named residual margins); - Presentation of revenues and expenses in profit or loss; - Effective date and transition. Comment period open until 25 October 2013 Scope of the standard The definition of an insurance contract is similar to that presented in IFRS 4 Phase I - Some service contracts are explicitly excluded - The accounting treatment for financial guarantee contracts remains unchanged - Investment contracts with a discretionary participation feature, which were covered by IFRS 4 phase I, remain within the scope of the standard as long as they are issued by an insurer. 8

9 MEASUREMENT OF LIABILITIES Several alternatives for measuring liabilities were discussed. The Fulfilment value has been chosen in the 2010 ED. Current entry value Calibrated to the premium paid by the policyholder Fair value Fulfilment value Embedded value) Current value Use of OCI Current exit value Calibrated to the amount payable to transfer rights & obligations DP Simplified approach ED 2013: a more complex approach, with some exceptions. Mirroring approach 9

10 MEASUREMENT OF LIABILITIES Present value calculated using a building block approach: IFRS - Phase I Life Shadow PB PB Reserve Mathem atical reserve Non Life UPR Claims Reserve 1 Best Estimate (including time value of options and guarantee s) IFRS - Phase II Life and Non Life Discounted Best Estimate Contractual Service Margin Risk Adjustment Discounted Best Estimate 1 Best Estimate of existing contracts: An explicit, unbiased and probability-weighted estimate of the future cash outflows less future cash inflows that will arise as the insurer fulfils the insurance contract. 2 A discount rate to adjust for the time value of money. 3 Risk Adjustment: The margin that a market player would ask to manage the risk. 4 Contractual service margin: Calibrated to the premium paid by the policyholder, such that the insurer does not recognise a gain at inception (although if it is a loss, it is recognised immediately through P&L) 10

11 MEASUREMENT OF LIABILITIES Best Estimate The best estimate is the first of the building blocks and includes all cash flows (premiums, losses, expenses, etc.) relating to existing insurance contracts: - It is calculated at the portfolio level (contracts subject to similar risks, managed together and priced similarly); - Cash flows relating to options on existing contracts are taken into account, in line with the probability that the option will be exercised; - Future cash flows arising from contracts with participation features; - The boundary between an existing contract and a future contract is defined as the moment when the insurer no longer has any substantial obligation to provide coverage (or has the ability to reassess or reprice to reflect the risk of a policyholder s contract or a portfolio of contracts). The best estimate is a mathematical calculation which must take account of a sufficient number of scenarios, but which is not required to take account of all possible scenarios (so in practice, there is no need to use stochastic modelling) 11

12 MEASUREMENT OF LIABILITIES A summary of the cash flows to be included in the model for calculating the best estimate Source: IASB presentation, Overview of the insurance contract project, March

13 MEASUREMENT OF LIABILITIES Discount rate This is a current rate (updated at each year-end) which must be consistent with: - observable market prices for instruments with cash flows whose characteristics are similar to those of the liability in terms of timing, liquidity and so on; - the risks relating to insurance contracts to reflect only the characteristics of the insurance contract liability. Are the insurance contract s cash flows expected to vary directly with returns of underlying assets? no yes The discount rate only needs to reflect the characteristics of the liability. The measurement of the liability must take this link into account. => no specific guidance is given Two different methods can be used to calculate the discount rate: Bottom-up approach ~ MCEV Top-down approach ~ expected rate of return on assets, adjusted for the credit risk, the asset/liability duration gap, and other non-relevant elements no need to adjust for liquidity differences 13

14 MEASUREMENT OF LIABILITIES Risk adjustment The compensation required by the insurer for bearing the uncertainties related to the liability - Recalculated at each closing and maintained throughout the coverage period - Changes presented in profit or loss No specific guidance on the methodology to be used, but disclosures must be presented on the confidence level using a quantile approach Diversification effect between portfolios is permitted. What level of comparability can be expected? Potential arbitrage on the best estimate: some changes could be presented/absorbed in other sections of financial statement and not impact income statement. What is the point of disclosing the quantile approach? 14

15 MEASUREMENT OF LIABILITIES Contractual service margin (formerly residual margin) This margin corresponds to the margin expected at inception - If the portfolio of contracts has a negative margin at inception, the corresponding loss has to be recognized. It can be calculated at the portfolio level - The level of aggregation should be defined such that the margin on a contract is fully amortized in profit or loss at the end of the coverage period. The margin is not fixed at inception, although it may not become negative at any point: - This margin should be adjusted to absorb changes in estimated cash flow relating to future insurance coverage, except for cash flows that depend on the performance of specific assets, for which changes should be recognised through profit or loss. - A change in the estimated cost of a claims that have already occurred shall be recognised in profit or loss. 15

16 MEASUREMENT OF LIABILITIES Changes in the BE: recognized in the contractual service margin or in P&L? Contractual service margin Margin expected at inception Changes in estimated future cash flows relating to a future coverage period P&L Losses on completion Changes in estimated future cash flows which do not relate to a future coverage period or which exceed the service margin Changes in the contractual service margin relating to services provided Examples 16 Scenario 1 Scenario 2 t0 31/12/N 31/12/N+1 31/12/N+2 t0 31/12/N 31/12/N+1 31/12/N+2 Premium 900 Premium 900 Claims Claims Central Scenario Central Scenario Scenario Scenario Central scenario t0 31/12/N 31/12/N+1 31/12/N+2 Central scenario t0 31/12/N 31/12/N+1 31/12/N+2 Cont. Service Margin Cont. Service Margin Insurance Liabilities Insurance Liabilities P&L P&L Scenario 1 t0 31/12/N 31/12/N+1 31/12/N+2 Scenario 2 t0 31/12/N 31/12/N+1 31/12/N+2 Cont. Service Margin Cont. Service Margin Insurance Liabilities Insurance Liabilities P&L P&L as CSM can not be < 0

17 MEASUREMENT OF LIABILITIES 17

18 CHANGES IN LIABILITIES LINKED TO THE DISCOUNT RATE Compulsory use of OCI for changes in the discount rate (linked to the reexamination of IFRS 9) Discrepancy between the current rate and the rate as originally defined Changes in the liabilities measurement related to the discount rate Impact of changes in the discount rate Accretion calculated using the discount rate initially determined (or the adjusted rate when the liability cash flows depend on the performance of assets) OCI P&L This is a major step forward, but it is felt to be insufficient. Limitation of the volatility in profit or loss resulting from changes in interest rates Exception which negates the progress made on participating contracts (complex mirroring approach) The use of OCI is compulsory without taking into consideration the classification of related assets under IFRS 9. Cash flows which are sensitive to changes in interest rates will still be recognised in profit or loss 18

19 MIRRORING APPROACH FOR CONTRACTS WITH PARTICIPATION FEATURE If using this approach, you need to distinguish: Cash flows that vary directly with underlying items The discount rate must reflect the fact that cash flows are dependent on specific assets Changes in estimates are recognised consistently with changes in the underlying assets Interest expense is recognised in profit or loss using the asset s rate of return The non-participating component The impact of changes in the discount rate on cash flows which are not dependent on assets is recognised in OCI Asymmetrical risks (i.e. options and guarantees) are recognised through profit and loss. 19

20 MIRRORING APPROACH FOR CONTRACTS WITH PARTICIPATION FEATURE A more complexe model and introduction of subjective concepts A potential structural example in the Basis for Conclusions on the calculation of the time value of options and guarantees 20

21 PRESENTATION IN PROFIT OR LOSS Key points to note concerning presentation in profit or loss: Volume measures for premiums, technical charges and expenses to be presented in P&L - Investment component of insurance premiums excluded Recycling of OCI and impact of the accretion of the liability using the original discount rate to be presented in profit or loss Impact on liabilities of changes in the discount rate to be presented in OCI Additional disclosures on changes in liabilities: A disclosure in the notes will be required on changes in the following items, distinguishing between items recognised in P&L and other changes: - Present value of future cash flows - Risk adjustment - Contractual service margin Separate reconciliations shall be presented for insurance and reinsurance contracts OCI Contractual Service Margin Risk Adjustment Discounted Best Estimate P&L 21

22 PRESENTATION IN PROFIT OR LOSS P&L presentation Focus on revenues Investment component excluded Recognised in line with expected cash outflows Examples t0 31/12/N 31/12/N+1 31/12/N+2 Premium 900 Incl. Investment component Claims Central scenario Scenario Scenario Insurance liabilities evolution Scenario 1 Total 31/12/N 31/12/N+1 31/12/N+2 Scenario 1 31/12/N 31/12/N+1 31/12/N+2 Revenue Insurance liabilities opening Claims Revenue Loss recognized at inception Investment component Loss reserve reversal Loss recognized at inception P&L Insurance liabilities closing Scenario 2 Total 31/12/N 31/12/N+1 31/12/N+2 Scenario 2 31/12/N 31/12/N+1 31/12/N+2 Revenue Insurance liabilities opening Claims Revenue Loss recognized at inception 150 Investment component Loss reserve reversal -150 Loss recognized at inception P&L Insurance liabilities closing

23 TRANSITION REQUIREMENTS Derecognition of all insurance assets and liabilities (including DAC, VBI, etc.) Recognise insurance assets and liabilities in accordance with IFRS 4 Phase 2: Applicable retrospectively, if possible (in accordance with IAS 8) Otherwise, use the best information available to measure the following components at the beginning of the earliest period presented: contractual service margin, risk adjustment and best estimate. The difference between the best estimate at the original discount rate and the best estimate at the current discount rate (at the beginning of the earliest period presented) is recognised in a separate component of shareholders equity. 23

24 03 CONCLUSION 24

25 COMPARISON OF IFRS 4 PHASE II AND IFRS 4 PHASE I Comparison of presentation in the balance sheet: IFRS - Phase I IFRS - Phase II FV P&L Equity FV P&L Equity HTM Amortised cost Contractual service margin Risk adjustment FV OCI Reserves FV OCI Best Estimate 25

26 COMPARISON OF IFRS 4 PHASE II AND IFRS 4 PHASE II Measurement of liabilities: IFRS 4 Phase I Most of the contracts were included in the scope of IFRS 4 Liabilities generally measured under local standards, except equalization reserves For life insurance, assumptions were generally set at the subscription date (table, rate) Implementation of a Liability Adequacy Test, and the shadow accounting for life insurance The security margin is currently implicitly incorporated in reserves (calculated using a prudent approach) IFRS 4 Phase II Use of so-called market-consistent techniques for financial variables Stochastic valuation of options and guarantees Financial and non-financial parameters updated at each year-end 26

27 COMPARISON OF IFRS 4 PHASE II AND IFRS 4 PHASE II Profit or loss profile: IFRS 4 Phase I: profit or loss profile Profit or loss profile in line with local standards smoothed over the life of the contract IFRS 4 Phase II: profit or loss profile Amortization method (Contractual service margin, OCI) to be tested For life insurance The updating of parameters at each closing is likely to result in increased volatility (thus, users will need more education in analysing the results) The economic asset-liability mismatch is likely to become more visible, particularly concerning the time value of options and guarantees For non-life insurance The asset-liability mismatch will be reduced in OCI Issues around the management of the security margin (to reduce the volatility of profit or loss) Potentially significant synergies with S2 27

28 IFRS 4 PHASE 1 / PHASE 2 Key observations Increased volatility for company A under IFRS phase II, due to changes in the value of options and guarantees. Phases 1 and 2 sometimes give rise to contrasting trends Absolute value comparison is not appropriate due to the unavoidable short cuts of our study Field tests are necessary. 28

29 COMPARISON OF IFRS 4 PHASE II / SOLVENCY II Theme IFRS 4 Phase II Solvency II Comparison Contract boundaries End of the coverage period or when the insurer is able to reprice the contract Premiums taken into account until the point where they can no longer be refused or repriced Possible harmonisation Best Estimate Discount rate Cash flows related to current contracts are taken into account in line with the probability that they will occur. They include: -payment of participation benefits to policyholders -cash flows generated by the exercise of options or contractual guarantees -direct expenses A rate consistent with the market price of instruments with similar characteristics to the liability The same, except that acquisition costs are not taken into account Discussions ongoing (matching premium CCP) Risk adjustment Explicit The Solvency II project requires to use the cost of capital approach Service margin The service margin eliminates all profits at the date when the contract is issued N/A Similar approaches, except for issues around the mirroring approach and simplified approach Uncertainties remain IFRS 4 Phase II is quite flexible and will permit the use of the cost of capital approach as long as the corresponding quantile is also provided in the disclosures. No contractual service margin in Solvency II Short-term contracts Special accounting treatment N/A No special accounting treatment for short-term contracts under Solvency II 29

30 04 QUESTIONS & ANSWERS 30

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