IFRS4 An Update. PwC. *connected thinking. Presented by Shu-Yen Liu 7 th November 2007

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1 IFRS4 An Update Presented by Shu-Yen Liu 7 th *connected thinking PwC

2 IFRS 4 Phase I Objectives Interim standard - focuses primarily on disclosures and classification of insurance contracts. Introduces a definition for an insurance contract based on the contract containing significant insurance risk. This standard however exempts insurers from changing their accounting policies to comply with the IFRS Hierarchy subject to limited required changes to existing accounting practices for insurance contracts and extensive disclosures. A principles-based framework that allows a high degree of discretion, even experimentation, in how it is presented. Slide 2

IFRS 4 Phase I Overview Product classification - A major exercise for insurance companies. - A hot topic for the future as product complexity increases.

3 IFRS 4 Phase I Overview Product classification - A major exercise for insurance companies. - A hot topic for the future as product complexity increases. - Solutions developed to address complex classification issues. Presentation and disclosure - Critical judgements and estimates applied. - Risk management disclosures. - PwC publication Rising to the challenge An analysis of Asia Pacific IFRS insurance annual reports provides examples of good practice. Slide 3

4 IFRS 4 Phase I - Key client questions Key client questions - What disclosure strategy should be chosen? - What are the key messages management wants to convey? - Is the required data available? Is it reliable? Is it auditable? - Is there an implementation plan? Slide 4

5 IFRS 4 Phase I Results Insurance contracts and participating contracts on existing accounting Investment contracts under IAS 39 (financial instruments)/ias 18 (revenue recognition) Minor modifications to some current accounting approaches Substantial qualitative and quantitative disclosure requirements Slide 5

6 Status of the Project Phase II Current situation for accounting for insurance contracts is a mixed model Resulted in too much diversity, less relevance and reliability, and inconsistency The IASB started with a clean slate to develop Phase II Modified joint project with FASB (US GAAP convergence) Phase II work started Jul 04 Discussion Paper published May 07 Comment period ends Nov 07 Phase II Draft IFRS published Late 08? Phase II IFRS published Late 09? Phase II IFRS effective 2011? We are here Slide 6

7 Scope of the discussion paper One model for all types Insurance contract definition Disclosures Policyholder accounting Input from industry and supervisors Slide 7

8 Get Set for IFRS Phase II IASB Discussion Paper Preliminary Views on Insurance Contracts Published on 3 May pages plus 83 pages of appendices 21 specific questions for comment by 16 Welcomed by UK Accounting Standards Board (ASB) as a starting point for an international debate US Financial Accounting Standards Board (FASB) has issued an Invitation to Comment on 2 August Comments are due by 16. Slide 8

9 Other IASB projects IAS 37 amendment Revenue Project Liabilities and equity project Insurance Contracts Fair Value discussion paper Conceptual Framework Phase II Financial Instruments due process document Performance reporting project Slide 9

10 High level financial impact assessment Phase I / II balance sheet overview Phase I Phase II Equity Equity Assets at mix of amortised cost / fair value Liabilities on IFRS 4 basis Assets at Market Value Risk margin for non-hedgeable risks Best estimate Technical Provisions Market consistent valuation for hedgeable risks Slide 10

11 Contentious areas for Phase II measurement Risk Margin Day one profit Guaranteed Insurability Service Margin Contentious areas Entity specific cash flows Solvency II Reconciliation Discounting Slide 11

12 What are the main contentious areas? + + Profit margin Risk and service margins Premium Unlocking of assumptions There is no market so how do you link to market? How does the service margin work? Guaranteed insurability Premium IASB view is that market reduces this to a small amount. Industry disagrees Retail vs wholesale Gain at recognition is unpopular - nothing earned yet Shock absorber for nonfinancial risks Best estimate of cash flows Discount rates Non-life discounting Cash flow definition Complexity Cost UPR proxy Own credit rating Other Financial statement presentation Linkages with other standards Linkages with solvency Is it worth it? Slide 12

13 Summary of the Main Features Basic model for core liability measurements current exit value Policyholder behaviour and acquisition expenses Participating contracts - Unit linked business Other measurement issues - Unbundling - Differences with IAS 39 Income statement presentation Slide 13

14 Current Exit Value Model Service margin Margins Risk margin Time value of money Discount rate Current unbiased probability weighted estimates of future cash flows Current estimates Amount an insurer would expect to pay to transfer its rights and obligations Slide 14

15 Estimates of Future Contractual Cash Flows Explicit Unbiased Market-consistent Probability-weighted Current Exclude entity specific Slide 15

16 Which Cash Flows? Include Policyholder claims Claims handling and maintenance expenses Direct and indirect costs of benefits in kind Option and guarantees Unfavourable policyholder behaviour Exclude Investment returns Reinsurance Income tax Entity specific Non-guaranteed insurability premiums Slide 16

17 Discounting Consistent with observable current market prices for cash flows whose characteristics market those of the insurance liability, in terms of, for example, timing, currency and liquidity Credit Characteristics Slide 17

18 How to Calculate the Risk Margin No prescribed technique Compensation for bearing risk Reference to what a market participant would require Not a shock absorber Possible methods Cost of capital Quantile Slide 18

19 Service Margins Compensation for providing other services Investment management services What else? Based on market price demanded by another party to assume the service obligation Different from IAS 18 Could have day one profit or loss Stage of completion is not the only driver to revenue reference to market prices must be taken into account Slide 19

20 Core liability measurement Current exit value Current unbiased probability weighted estimates of future cash flows Places more demands on estimates of cash flows than some current models, e.g. - Current conditions, not past conditions - Expected mean value, not 50/50 median - Market participant vs Entity specific Auditability of current models? More complex (stochastic) models? Current market discount rates Liability moves with market rate changes Insurer s investment strategy not relevant Impact on profit profile? Risk margin Service margin Unbiased estimate of market risk margin Limited guidance on calculation Key driver of day one profit arising Amounts required for future service provision Slide 20

21 Policyholder Behaviour and Acquisition Expenses Guaranteed insurability Future premiums offset liability Acquisition expenses Slide 21

22 Participating contracts Is there a present obligation IAS 37 Universal life contracts Legal Obligation Constructive Obligation IASB s view: Participating rights only create a liability when the insurer has an unconditional requirement to provide economic benefits Slide 22

23 Unit linked business Income statement and balance sheet mismatch Accounting mismatches - Treasury shares - Owner-occupied property - Deferred tax - Internally generated goodwill (eg. Venture capital unit-line not commonly found in the UK) Slide 23

24 Unbundling Interdependent so arbitrary measurement Interdependent but not arbitrary measurement Not interdependent Phase II for whole contract Phase II for whole contract, but IAS 39 for deposit IAS 39 for deposit, Phase II for insurance Slide 24

25 Differences with IAS 39 Contract Insurance Investment Liability Measurement No deposit floor Deposit floor Initial gains Possible day one gain Gains only if observable Non-incremental acquisition costs Guaranteed insurability Loss on inception Current assumptions Always Amortised cost possible Service fees Service margin As services provided Slide 25

26 Income statement presentation No preliminary views Margin approach Income statement preparation Non-life current approach Fee approach Life current approach Slide 26

The Actuarial Society of Hong Kong IFRS Insurance Contract Phase II Development

The Actuarial Society of Hong Kong IFRS Insurance Contract Phase II Development Jin Peng, PwC 6 November 2013 Agenda Introduction to 2013 Exposure Draft Key Industry Feedback Worldwide Feedback 2 Introduction