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

Transcription

1 The Actuarial Society of Hong Kong IFRS Insurance Contract Phase II Development Jin Peng, PwC 6 November 2013

2 Agenda Introduction to 2013 Exposure Draft Key Industry Feedback Worldwide Feedback 2

3 Introduction to 2013 Exposure Draft 3

4 What has happened so far and what might happen? 4

5 What is wrong with current insurance accounting? 5

6 Overview of Building Block Approach BBA One model for all insurance contracts. Explicit margins as part of liability. Day 1 loss in income statement, no day 1 gain. Combination of rights and obligations (considers cash inflows and outflows). Optional simplified model for pre-claim liabilities based on the unearned premium. Contractual service margin Risk adjustment Discounting Best estimate of fulfilment cash flows Unearned profits recognised over life of contract Reflect compensation for uncertainty. Quantifies the value difference between certain and uncertain liability. Discounting future cash flows using top-down or bottom-up approach to reflect characteristics of the liabilities Best estimate cash flows explicit, unbiased and probability weighted estimate of fulfilment cash flows 6

7 Key changes from the previous ED Changes have been made to address the artificial earnings volatility in the original model 7

8 Key changes from the previous ED Revised ED focuses on five key targeted areas of change, which are highlighted below and included in slides with coloured background: Topic Discount rate and OCI Contractual service margin Contracts that require an entity to hold underlying items and specify a link to these items. Presentation Transition Changes from previous ED Introduction of OCI for changes in discount rates Top-down or bottom-up approach (not in targeted areas) Unlocking of contractual service margin Amortise in line with services (not in targeted areas) Splitting cash flows in different types Mirroring approach for certain cash flows Insurance contracts revenue approach Disaggregate non-distinct investment components Modified retrospective application Simplifications for cash flows, discount rate and risk adjustment 8

9 Other areas of change Topic Definition and scope Changes from previous ED Carried forward the option for financial guarantees if entity previously asserted these as insurance contracts Clarified fixed-fee service contracts and combining insurance contracts Separating components Clarified only distinct investment components separated from insurance contracts Recognition Cash flows Risk adjustment Modifications Reinsurance Simplified approach (also known as premium allocation approach) Disclosures Recognition point in non-onerous contracts beginning of coverage Acquisition costs included at portfolio level Cash flows outside contract boundary if able to re-price at portfolio level Unit of account not prescribed Not restricted to specified techniques New requirements included No day 1 gains for cedants, but day 1 loss for reinsurance for past events OCI equally applies to cedants Optional Proxy for building block model Level of aggregation no longer specified 9

10 IASB Field Test Comments by 25 October 2013 IASB will re-deliberate in 2014 Invitation to comment will focus on smaller number of questions Adjusting the contractual service margin Mirroring approach Presentation of revenue and expenses Interest expense in P&L Transition Cost and benefit of the revised proposal Clarity of drafting 10

11 Key Industry Feedback 11

12 Hong Kong Response The Process A questionnaire was sent to key stakeholders operating from Hong Kong Responses were collected by 15 th Oct Out of a total of 24 requests sent out, 10 responses were received from around the industry 12

13 The Responses Question part Response 1 Response 2 Response 3 Response 4 Response 5 Response 6 Response 7 Response 8 Response 9 Response 10 Average (0.8) (0.6) (1.3) (1.9) (1.0) (1.0) (0.6) (0.3) (0.2) (1.0) (0.4) (0.6) (0.3) (1.0) (1.0) A wide range of answers Focused on questions where there are stronger indications of agreeing or disagreeing Considered the response in other comment letters -3: strongly disagree; -1 disagree; 1 agree; 3 strongly agree 13

14 Key Feedbacks From Insurance Industry 14

15 Different CSM Drivers impact Future Profit Pattern Unit Linked Example Amount IFRS Phase II Profit with Different Contractual Service Margin Carriers Sum Assured Net Amount at Risk Premium Number of Policy Account Value Policy Year 15

16 Reducing Volatilities - OCI is used to absorb the interest rate impact It is assumed that risk free discount rate is increased by 0.5% while the best estimate investment rate stays unchanged. Therefore, profit under USGAAP is not affected because its valuation interest rate is locked-in, unless it is unlocked. Amount (100) (200) Amount 450 Profit/Loss - Baseline vs Higher Interest Rate Scenario (interest rate increased by 0.5% starting from year 5) IFRS Phase II Baseline IFRS Phase II Interest Shock US GAAP Baseline US GAAP Interest Rate Shock Other Comprehensive under Higher Interest Rate Scenario (interest rate increased by 0.5% starting from year 5) Policy Year (50) Policy Year 16

17 Reducing Volatilities CSM is used to absorb changes in estimate of future cash flows Amount 400 Profit/Loss - Baseline vs Mortality Worsening Scenario (mortality increased by 10% starting from the end of year 5) (100) (200) Policy Year IFRS Phase II Baseline IFRS Phase II Mortality Shock US GAAP Baseline US GAAP Mortality Shock Profit signatures under both two bases are not significantly affected by the 10% shock on mortality experience. 17

18 Question 1 from IASB Adjusting the Contractual Service Margin IASB Question 1: Do you agree if the Contractual Service Margin should be adjusted for differences between the current and previous estimates of the present value of future cash flows? Our response: We agree that the CSM should be adjusted for changes of estimate of future cash flows. However, we believe the definition of what is a future cash flow is unclear. The current Exposure Draft is also unclear about the level of aggregation for adjusting the CSM. We believe the adjustment should be made at a level that is consistent with how insurers manage their business. 18

19 Definition of level of aggregation for Contractual Service Margin and Risk Adjustment Why is this an issue The latest Exposure Draft lacks clarity on the level of aggregation of Contractual Service Margin and Risk Adjustment. BCA113 suggests aggregating at the cohort level. This may lead to higher volatility in Profit and Loss due to higher chance of contractual service margin depletion. If the above suggestion is the intended requirement by IASB, the following issues may be raised: Volatility of Profit & Loss Less offsetting would increase the likelihood of depleting the CSM, leading to potential profit and loss volatility Practicality Issue Higher maintenance cost is expected for valuation system as the contractual service margin of each cohort must be tracked 19

20 Questions 2 from IASB Mirroring Approach IASB Question 2: Do you agree the Mirroring approach would faithfully represents the entity s financial position and performance for contracts that require the entity to hold underlying items and specify a link to returns on those underlying items? Our response: Our members have overwhelming concern with the guidance for insurance contracts that meet the requirements for mirroring as outlined in paragraph 33 of the ED. This includes the requirement to split the cash flows as well as the differing treatment of those cash flows. Our constituents also have concern with the expected volatility caused by this guidance that they believe is not appropriate given the nature of the risk. 20

21 Why this is an issue? Increased Volatility to P&L A percentage of of assets are unhedged. However, the same volatility exists in current reporting Change in the value of options and guarantees books P&L. This is new and will increase volatility to P&L Inconsistent accounting treatment on same product type in dif f erent territories Practicality Issues Splitting of cash flows into direct, indirect and fixed are difficult to implement in practice. For example, premium incomes need to be split between what serve the guaranteed portion of the liabilities and those serve the f uture dividends In practice, the asset linked liability is not simply a fixed percentage of the Participating fund asset due to the undistributed surplus. A careful analysis is required to quantify the percentage belonging to the current generation of policyholders and shareholders Quantification of value of options and guarantees typically requires stochastic valuation, which leads to operational dif f iculties 21

22 Questions 3 from IASB Presentation of Revenues and Expenses IASB Question 3: Do you agree with presenting insurance contract revenue and expenses, rather than the changes in the components of the insurance contracts? Our response: We understand that the presentation of revenue and expenses will align the accounting for insurance industry with other industries. We understand the benefit of excluding deposit elements from revenue. However, based on our understanding of the analyst community and other users of these financial statements, we question the benefit of such consistency 22

23 The new format of presentation Contractual service margin 20XX 20XX Risk adjustment Insurance contracts revenue X X Incurred claims and expenses (X) (X) Current unbiased probability weighted estimates of present value of future cash flows ~ ~ Underwriting result X X Investment income X X Interest insurance liability (X) (X) Net interest and investment income X X Profit or loss X X Effect of discount rate changes on insurance liability (X) (X) Total comprehensive income X X A considerable amount of effort and cost will need to be invested on system and methodology so that a reliable income statement can be derived. 23

24 Why is this an issue? Comparability Issues Operational Difficulties The new format may not be meaningful It may not be appropriate to align the new format with that of other industries,. It requires additional judgements that may lead to less comparability No clear instruction on how to book the impact from the experience variance The requirement of spreading the acquisition expenses in line with the service profile leads to reconciliation issue between balance sheet and profit and loss Back solving profits into each components would increase the operational difficulties 24

25 Question 4 from IASB Interest Expense in Profit and Loss IASB Question 4: Do you agree with segregating the effects of the underwriting performance from the effects of the changes in the discount rate in the Other Comprehensive Income? Our response: Our members support the proposal in the ED to segregate the effect of changing discount rates in OCI. However, given the mixed measurement model in IFRS 9 we do not believe that recognizing changes in discount rates in OCI would provide relevant information in all circumstances. We therefore suggest that the presentation be optional and considered by preparers only when volatility is actually reduced. 25

26 The Use of Other Comprehensive Income (OCI) Why is this a key issue and our proposed alternative solution Illustration: Impact from change in risk free rate for BBA will hit OCI but the underlying asset may hit P&L (e.g. equity) depending on its asset class ED approach impact on liability through OCI is mandatory Alternative approach: Impact on liability through OCI is optional P&L Impact P&L Impact Under the alternative approach, the net impact on profit and loss from the change in economic environment will be smaller. * OCI refers to the impact on liability caused by the change in economic environment. Under the Exposure Draft approach, such impact will be allocated to other comprehensive income. Therefore, it will not impact profit and loss. 26

27 Question 5 from IASB Effective Date and Transition IASB Question 5: Do you agree that the proposed approach to transition appropriately balances comparability with verifiability? Our response: Our members welcome the change to transition since the 2010 ED and believe the simplifications offered are helpful. However, we also note that transition will require a significant amount of judgment so recommend that this should be a focus on any further field testing. As a main benefit of the ED is greater consistency between insurers, the board to make every effort that such consistency is realized though transition. 27

28 Why is this an issue Negative Spread Business For business with negative spread, the need to hold contractual service margin is contradictory to the real remaining profitability CSM Surplus Asset Asset OCI* Liability BEL* & RA Before Transition After Transition * OCI refers to the additional liability held as the result of lower risk free rate in the time of transition as compared to inception; * BEL refers to the best estimate liability derived based on the discount rate as of inception; Equity on book may be wiped out and dividend capacity may be impacted 28

29 Other Key Item Contract Boundary Why is this an issue With the requirement of the current Exposure Draft, some health products will be treated as 1 year contracts as companies have the right or the practical ability to re-price. Such treatment will lead to significant loss in the first year due to the commission from acquiring the business. What is the alternative solution Assume premiums will not be re-priced and suggest experience analysis on continuance be used in determining the contract boundary The argument for not treating the product as short term is that these contracts are regarded as long term in their pricing. Accounting for these as short term is not consistent with the management of this type of contract 29

30 Worldwide Feedback 30

31 Consistent with Worldwide Feedback Mirroring Mirroring, on the face of it, looks like a really good idea. Concern about complexity of splitting different types of cash flows Questions about how widely or narrowly the proposals apply OCI Concern about accounting mismatches, strongly expressed in some jurisdictions, leading to call for an option to present all changes in profit and loss 31

32 Consistent with Worldwide Feedback Revenue Some believe that unique nature of insurance justifies a different presentation Doubt about whether insurance contract revenue would provide useful information Transition Widespread agreement that proposals are an improvement from 2010 proposals Concern than insurers will have to implement IFRS 9 and the insurance contracts standard at different times Disagreements about disaggregating deposits 32

33 The End Any questions? 33