Acumen Conference IFRS 9 for insurers

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1 Acumen Conference IFRS 9 for insurers December 9, 2015

2 Agenda Insurer deliberations and implications of IFRS 9 Asset classification: evaluation of business model Impairment model Interplay of IFRS 9 and IFRS 4 phase II Mitigants 2

3 IFRS 9 asset classification Deloitte LLP and affiliated entities. 3

4 Business model Key considerations for insurance business: Levels of aggregation of portfolio? e.g. Business Group Business Unit products liability segment asset classes Reflects how groups of financial assets are managed together to achieve a particular business objective How is performance reported? How are managers compensated? How is risk managed? What level is the investment strategy defined at? At what level are asset target mix being defined at? Can liability segment have more than one business model? Insignificant value or infrequent sale of assets when business model is hold to collect contractual cash flows? Deloitte LLP and affiliated entities. 4

5 IFRS 9 classification of financial instruments Summary of key considerations for classification of assets in insurance business under current IFRS 4 / CALM: IAS 39 Asset classes Key considerations IFRS 9 Held to maturity Mortgages and loans Depends on Business model & SPPI Amortized cost Expected loss model applies Loans and receivables Debt backing surplus Debt securities depends on Business model & SPPI Fair value through OCI Expected loss model applies Available for sale Fair value through profit and loss Equities backing surplus Equities backing liabilities Derivatives Bonds backing liabilities Debt securities FVO if accounting mismatch FVTPL unless elect FVTOCI option Fair value through profit or loss Deloitte LLP and affiliated entities. 16

6 Contractual cash flow characteristics (cont d) Examples of non solely payments of principal and interest on the principal amount outstanding ( SPPI ) Non SPPI = no FVTOCI option Examples Key considerations Not SPPI Convertible bonds convertible to fixed equity instruments of issuer Inverse floating interest rate debt Return inconsistent with basic lending arrangement Return is linked to value of equity of issuer Return not reflective of time value of money Commodity linked loan Inconsistent with basic lending arrangement Return is linked to commodity Debt instrument that pays LIBOR plus 100 bps, except when LIBOR is above 6%, LIBOR is multiplied by 1.5 (i.e., when LIBOR is 7% the contractual rate will be 10%) Dual currency bond where principal is to be paid at a fixed Euro amount but floating interest is denominated and paid in USD Interest payments derived from specific assets of the issuer Not SPPI due to leverage of LIBOR Not SPPI as the return is not consistent with basic lending arrangement Depends on underlying assets and whether performance could result in payments that are compensation for time value (e.g., if the underlying are financial instruments themselves) Deloitte LLP and affiliated entities. 6

7 Contractual cash flow characteristics (cont d) Examples of SPPI, (ie FVTOCI option) Examples Interest at a fixed rate that adjusts annually for changes in credit risk Lender can demand repayment if borrower s credit quality slips Fixed rate instrument that can be prepaid by the issuer at par plus accrued interest Fixed rate instrument that can be prepaid by the issuer at par plus accrued interest plus a penalty Fixed rate loan that the issuer can prepay at a variable amount depending on changes in interest rate since issuance (e.g., Canada Yield calls common in many bonds) Investor can demand repayment if the issuer is acquired by a company of lesser credit quality Issuer can extend the term and choose either the then fixed market rate of interest or 3 month LIBOR plus 100 bps SPPI not violated If variable credit margin can be considered consistent with basic lending arrangements Since the contingent event causing repayment is linked to credit risk, not inconsistent with a basic lending arrangement Since prepayment simply accelerates the payment of principal and accrued interest As long as the penalty represents reasonable compensation for the investor s investment risk Providing the variable amount is compensation for decreases in market interest rates since inception Since the prepayment option contingent on change in control seeks to protect the investor from adverse changes in credit quality Since payments after the extension will still be consistent with basic lending arrangements Deloitte LLP and affiliated entities. 7

8 IFRS 9 impairment and life insurance CALM Deloitte LLP and affiliated entities. 8

9 Insurer deliberations and implications of IFRS 9 Impairment model Potential duplication with future expected loss impairment model and actuarial policyholder reserving inclusive of asset default charge 9

10 IFRS 9 vs CALM asset default assumption Under CALM, value of liabilities = value of matching set of asset cash flows. Asset cash flows used in the actuarial CALM process are typically reduced to allow for asset depreciation (i.e. default risk). Impact is: need more assets to cover any shortfall in liability cash flow, hence higher liabilities. Need to consider asset depreciation on impaired assets and non-impaired assets (i.e. potential future impairments). I.e. forward looking lifetime expected loss Deloitte LLP and affiliated entities. 10

11 IFRS 9 vs CALM asset default assumption IFRS 9 Impairment required on FVTOCI and Amortized cost assets (FVTPL already makes allowance) At initiation: 12-month expected credit loss If significant increase in credit risk: lifetime expected loss Actuarial asset default Asset default assumption required on all assets backing liabilities e.g. including bonds FVTPL Best estimate (BE) represents PV of lifetime expected loss on valuation date; AND MfAD set as a % of BE assumption BE and MfAD varies by credit rating (mortgages based on internal ratings); rating downgrade results in higher projected default losses Unbiased, probability-weighted based on range of possible outcomes, taking into account time value of money Best estimate based on average yearly calculation of default cost / exposure Need to consider at least 2 outcomes, probability of credit loss i) occurs and ii) does not occur Based on reasonable and supportable information available re: past, current and future events Intended to be a long-term average assumption over full economic cycle, would not necessarily be overly influenced by recent economic downturn Mortgage default assumption primarily based on historical default study based on commercial/residential mortgages Canada and US Assumptions updated annually Deloitte LLP and affiliated entities. 11

12 IFRS 9 vs CALM asset default assumption (cont d) Key considerations: Ensure no double counting with asset default and IFRS 9 future expected loss impairment model and pre IFRS 4 Phase II e.g. carve out for any impairment provision already set up under IFRS 9 Internal consistency of source data and key considerations in setting assumptions by Investment Finance and Actuarial Important to define triggers for significant deterioration in credit quality Align internal information and monitoring used by Investments; Actuaries; Risk Management Possible refinements to actuarial asset default BE assumption model to better align with IFRS 9 and leverage these models Deloitte LLP and affiliated entities. 12

13 Interplay of IFRS 9 with IFRS 4, Phase II Deloitte LLP and affiliated entities. 13

14 Insurer deliberations and implications of IFRS 9 Accounting mismatch with IFRS 4 Phase II Different effective dates 14

15 Interaction with IFRS 4, Phase II IFRS 4: accounting policy choice to recognize impact of changes in discount rates in OCI (OCI solution) Complicated if IFRS 9 classifications in 2018 are not consistent with intended classifications under IFRS 4 Phase II Ability to refresh IFRS 9 decisions Deloitte LLP and affiliated entities. 15

1 Earnings from Insurance Contracts updated version of an IASB presentation Statement of Comprehensive Income Contractual service margin: Expected contract profit Fulfilment cash flows 20XX Insurance

16 1 Earnings from Insurance Contracts updated version of an IASB presentation Statement of Comprehensive Income Contractual service margin: Expected contract profit Fulfilment cash flows 20XX Insurance contract revenue $$ Incurred claims and expenses ($) Future cash flows 2 Operating result $ Investment income $ Risk adjustment 3 Interest on insurance liability ($) Investment result $ Profit or loss $ Discounting 4 Effect of discount rate changes on insurance liability ($) Total comprehensive income $$ IFRS 9 FVOCI ONLY ON IMPLEMENTATION OF IFRS 4 Phase II option, in 2019 / 2020? Deloitte LLP and affiliated entities. 1. Changes in estimates relating to future services 2. All other expected cash flow changes 3. Based on a cost view 4. Based on a current view

17 Expected IASB and insurer timeline IFRS 9: 2018 IFRS 4 Phase II: 2020/2021? IASB Complete IFRS 4 Phase II deliberations Expected timing for issue of new IFRS 4 Phase II standard IFRS 9 effective date IFRS 4 effective dates? New IFRS 4 Implementation period /2021? IFRS 9 compliance IFRS 4 compliance Insurer Dec 10 IFRS 4 ED to defer IFRS 9 two options 60 day consultation period Expected timing for issue of amended IFRS 4 Disclosures of impact of new issued standards 2016 to 2019 year end financial statements Q1 Q2 Q3 2020/2021 quarterly reporting IFRS 4 restated comparatives Q1 Q2 Q3 2019/2020 year end financial statements IFRS 4 Phase II Transition date Restated comparatives Year end reporting Illustrative December year end Deloitte LLP and affiliated entities. 17

18 IFRS 4 ED: deferral of IFRS 9 by qualifying insurers (December 10, 2015) Deloitte LLP and affiliated entities. 18

19 IFRS 4 ED Insurers can opt to defer IFRS 9: Overlay approach Defer IFRS 9 implementation date up to 2021 Overlay Approach Defer IFRS 9 Only applies to financial assets backing insurance business ONLY for qualifying insurers: Predominance test = 75% of total liabilities are insurance liabilities Implement IFRS 9 on January 1, 2018 Implement IFRS 9 when IFRS 4 Phase II implemented or in 2021 ONLY where recognition and measurement of financial assets has changed from Amortised Cost or FVOCI to FVPL under IFRS 9 Disclose financial assets which would not qualify as SPPI Determine effect of IFRS 9 compared to IAS 39 and recognize IFRS 9 impact in OCI (ie remove impact from P&L) Deloitte LLP and affiliated entities. 19

20 IFRS 9 implication mitigants Deloitte LLP and affiliated entities. 20

21 Mitigants Align assets and liabilities as far as possible: OCI/OCI and FV/FV Investment strategy but consider business / product objectives IFRS 9 deferral? Begin IFRS 9 and IFRS 4 Phase II assessments and requirements Deloitte LLP and affiliated entities. 21

22 Q&A Deloitte LLP and affiliated entities. 22

23 Contact Elaine Hultzer (416) (647) Deloitte, one of Canada's leading professional services firms, provides audit, tax, consulting, and financial advisory services. Deloitte LLP, an Ontario limited liability partnership, is the Canadian member firm of Deloitte Touche Tohmatsu Limited. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. The information contained herein is not intended to substitute for competent professional advice. Deloitte LLP and affiliated entities.

IFRS 9 AND IFRS 17 INTERACTION

The Actuarial Society of Hong Kong IFRS 9 AND IFRS 17 INTERACTION 2017 Insurance IFRS Seminar David Ogloza Session 23 IFRS 17 Transition Interaction with IFRS 9 IFRS 9 is effective for periods beginning