International Financial Reporting Standards Updates. Joint Regional Seminar on Financial Reporting, June 2006

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1 Actuarial Services International Financial Reporting Standards Updates Joint Regional Seminar on Financial Reporting, June 2006 Jonathan Zhao, FSA Bruce Moore, FSA 1

2 Agenda Background on IFRS Review experience & issues in the first year of IFRS 4 (Phase I) Progress on Phase II 2

3 Background IASB developing a single set of global accounting standards Many countries committed to the objective of global harmonisation Cross-border capital flows highlight the need for consistent, understandable financial information Drivers for fair value Historical cost accounting models lack relevance Solvency-based approaches don t provide an accurate picture 3

4 Key industry players 4 International Actuarial Association (IAA) Drafting Actuarial Guidance Insurance Advisory Committee European Financial Reporting Advisory Group (EFRAG) International Organization of Securities Commissions (IOSCO) International Association of Insurance Supervisors (IAIS) CFO Forum European Consultative Group

5 Phased approach for insurance There is now a phased approach to insurance contracts. Phase I Implement by 2005 IFRS INSURANCE PROJECT Phase II Implement Fair Value by 2010 / 11 (?) The Board s objective for Phase I is to implement some components of the insurance project by 2005, without delay to Phase II 5

6 Key standards for insurers Investments: Equities Fixed interest Mortgages Loans Property IAS 40 Investment Contract DAC Insurance Other assets IAS 39 IAS 18 Insurance Assets Phase I DAC IFRS 4 PVIF IFRS 4 Various Equity Insurance Liabilities & investment contracts with discretionary participation features Investment Insurance Liabilities contract Phase I liabilities Other liabilities Various IFRS 4 IAS 39 Various 6

7 Agenda Background on IFRS Review experience & issues in the first year of IFRS 4 (Phase I) Progress on Phase II 7

8 2005 Experience with IFRS 4 Issues in applying IFRS 4 Disclosure Local Adaptations of IFRS 4 8

9 IFRS 4 Basic Issues 1/2 Product Classification Companies inclined to classify as many products as possible into insurance contracts (or investment contracts with DPF) Liability Adequacy Test Quite a number of alternatives available Level of aggregation (i.e. testing block) is one of the concerns Valuation of investment contracts IAS 39 Amortised Cost or Fair Value Bifurcation Service contract 9

10 IFRS 4 Basic Issues 2/2 Policyholder Share of unallocated surplus Shadow accounting Policyholder share Loss recognition DAC Different Reporting Basis Local vs. Group Future Changes in Accounting Principles 10

11 Actuarial Disclosures under IFRS 4 Insurance risks Reserve movements IAS 32 requirements fair value disclosures Non-life disclosures 11

12 Local Adoptions of IFRS 4 Singapore From 2005: SFRS 104 with the existing RBC basis Hong Kong From 2005/12/31: HKFRS Existing accounting systems used varies: HK Statutory / US GAAP / Self-defined GAAP Australia AIFRS with the existing Australian MoS system Philippines Malaysia Taiwan 12

13 Agenda Background on IFRS Review experience & issues in the first year of IFRS 4 (Phase I) Progress on Phase II 13

14 Progress on Phase II - An Update as of 1 May 2006 Overview of the Insurance Project Phase II Topical discussion of accounting issues Related projects of the IASB Activities of other bodies Summary Observations Q&A 14

15 Overview of Insurance Project Phase II Priority project of the IASB Insurance Working Group to aid in deliberations Educational sessions from industry and the professions Fresh start restricted only by Framework and existing Standards Discussion paper Exposure draft Standard Possible FASB exposure of Discussion Paper 15

16 Phase II Expected Timetable Discussion Document IASB & IWG Meetings February - June 2006 First pre-ballot draft July 2006 Second pre-ballot draft September 2006 Ballot draft November 2006 Discussion Document Published December 2006 Exposure draft June 2008 Final Standard June 2009 Effective date

17 Insurance Working Group Twenty members accountants, actuaries, analysts North America 6 UK/Bermuda 4 Australia 1 Continental Europe 7 Japan 2 Official observers from IOSCO, EFRAG, IAIS, BCBS and participants from FASB, AASB In June the IWG will discuss the Board s decisions 17

18 Project Process Address critical issues by topic Make tentative decisions for each topic Reconsider decision in toto and as they relate to savings contracts, business combinations and other Standards Consider relevant FASB developments Produce draft discussion document 18

19 Measurement models Prospective approaches are being considered; i.e., based on current estimates of future cash flows, either current entry or current exit value The methods under consideration both: reflect unbiased estimates of future cash flows reflect time value of money (discounted at current rates) include adjustments to reflect risk (risk margins) Investments are measured under existing standards 19

20 Current entry vs. current exit value Current entry value The price today for a contract with the same remaining rights and obligations Defined to be current assumptions with margins calibrated at inception to the premium Risk margin basis locked in at inception Current exit value The amount today to transfer remaining rights and obligations May not equal premium at inception Margins re-measured each reporting date 20

21 Topical discussion of accounting issues 1. Policyholder behaviour 2. Acquisition costs 3. Liability adequacy test (LAT) 4. Gain/loss on issue 5. Non-life pre-claims 6. Participating contracts 7. Margins 8. Estimates 9. Discount rates 10. Embedded options 11. Discretionary features 12. Recognition 13. Unit of account 14. Life measurement attributes 15. Non-life claims liabilities 16. Linked contracts 17. Unbundling 18. Credit characteristics 19. Reinsurance 20. Salvage and subrogation 21

22 Board discussion topics The following slides present each topic and the issues as expressed by the staff of the Board, with some added commentary [ Comment ] As topics are discussed and decisions are made by the Board, these slides are updated This version is current as of 1 May

23 Topic 1: Policyholder behaviour Discussion date: February 2006 Should policyholder behaviour be considered in estimating cash flows; e.g., cancellations and payment of future premiums? Future premiums may relate to an intangible asset; namely, the contractual relationship with the customer Asset is recognised when there is guaranteed insurability The asset is not presented separately, the liability is net of the intangible asset. Separate disclosure of the asset may be required. 23

24 Topic 2: Acquisition costs Discussion date: February 2006 Should there be capitalised acquisition costs? What costs should be included? There is no deferred acquisition cost asset, rather For entry value model If already recovered from premiums received, that portion of premiums are excluded form measurement of the liability If expected to be recovered from future cash flows, that portion of cash flows is considered in measuring the customer relationship For exit value model, no direct role but may aid in model calibration If necessary, will consider if only incremental costs qualify 24

25 Topic 3: Liability adequacy test (LAT) Discussion date: February 2006 Is an LAT needed? What margins are included in measurement? Needed in the current entry approach. Not needed in current exit value approach Margin should be consistent with an exit value Shortfalls are subsequently released into income Undecided: If before or after reinsurance, and level of aggregation 25

26 Topic 4: Gain/loss on issue Discussion date: February 2006 Should the accounting model limit or prohibit the recognition of net profit or loss on initial recognition? Can a cedant recognise income when it buys reinsurance? Certain Board members noted that they would prefer to have no constraints on profit and loss, but rather would emphasise proper recognition and measurement of assets and liabilities In April, several Board members indicated a reluctance to allow gain on issue when the measurement of the liability was subjective. 26

27 Topic 6: Participating Contracts 1/2 Discussion date: March 2006 Are discretionary participation features a component of equity or are future dividends (bonuses) liabilities? Policyholders are not purchasing an equity instrument. Dividends are expenses, not distributions of equity. How should the feature be recognised, measured and presented? Liability is recognised when there is an unconditional obligation, consistent with Framework and IAS 37. Prior claim (e.g. 90/10 fund) is not an unconditional obligation. Constraint on equity to be disclosed. 27

28 Topic 6: Participating Contracts 2/2 Discussion date: March 2006 How to consider the effects of discretion and constraints (economic compulsion or constructive obligation)? Constructive obligation creates a liability. History of payments does not create future liability. Regulator approved dividend scale creates an obligation. Policyholder put option not discussed. Measurement of this may include expected rather than unconditional payments 28

29 Topic 7: Risk margins 1/2 Discussion date: March 2006 Should risk margins be a shock absorber or reflect the current price for risk? Risk margins should reflect the current price for risk. They are not shock absorbers or solvency margins. What level of guidance should be provided? Specific techniques will not be prescribed. Attributes of risk margins will be described (see next slide) 29

30 Topic 7: Risk margins 2/2 Discussion date: March 2006 Attributes of risk margins: Risk margins consistent with exit / entry value measurement Should be explicit and reflect all risks associated with liability. Investment risk / asset-mismatch risk should not be reflected as do not relate to uncertainty in liability cash flows Margin should be consistent with market price. Margin should be implementable in reasonable time, at reasonable cost and should be auditable. The tail risk should be considered in contracts with skewed payments Approach should allow comparability between companies Model risk and parameter risk should be included 30

31 Topic 8: Estimating cash flows 1/2 Discussion date: March 2006 Discuss the early draft guidance on estimating cash flows The following points were sent back for clarification Surprises should be included in risk margins, not cash flows Understand what changes to cash flows would occur on a company going into run-off Impact of the insurance price cycle should not be included. This will be covered in initial measurement Guidance should focus on measuring the contractual obligations, rather than reflecting intentions on settling 31

32 Topic 8: Estimating cash flows 2/2 Discussion date: March 2006 Guidance is provided around Uncertainty and the expected present value approach Consistency with current market prices Sources of estimates Using current estimates Future events Which cash flows Entity-specific cash flows Approximations 32

33 Topic 9: Discount rates 1/2 Discussion date: March 2006 What is the best benchmark for the time value of money; government securities or swap rates? Should a liquidity premium be used in liability measurement? Discount rates should be consistent with prices observable in the market place Adjusted to exclude factors that are not relevant to the liability 33

34 Topic 9: Discount rates 2/2 Discussion date: March 2006 Should there be guidance on determining risk-free rates in markets where benchmark rates are not available for all durations? The Board confirmed that it does not intend to provide guidance where benchmark rates are not available 34

35 Topic 11: Discretionary features Discussion date: March 2006 How should discretion given to policyholders, or retained by the insurer, be reflected in recognition and measurement of liabilities? Not explicitly discussed. Comment: Decisions for Participating contracts implies that discretionary elements are not liabilities until they are unconditional. Still not clear whether future discretionary deposits should be considered in measurement of liability 35

36 Topic 13: Unit of account Discussion date: April 2006 At what level should insurance contracts be aggregated for measurement and for LAT? Staff will investigate if diversification is within a portfolio of insurance contracts among different portfolios, or with other assets and liabilities 36

37 Topic 14: Life measurement attributes Discussion date: April 2006 The Board was asked to choose between current entry and current exit value. The Board favours exit value No prohibition on gain at inception Too early to conclude that exit value is fair value Recognised portion of customer relationship 37 Not recognised separately Uses same measurement attributes as the related liability

38 Topic 16: Linked contracts Discussion date: April 2006 Linked contracts are those invested in, or indexed to, internal or external investment funds. Specific topics include: How to measure liabilities; e.g. should the measurement be different from other insurance? How should assets invested in internal funds be measured and presented? (e.g. single-line or disaggregated) How should guarantees of unit prices be measured? This topic has been carried forward to the May meeting. 38

39 Topic 17: Unbundling Discussion date: April 2006 Should an insurer unbundle the individual elements of an insurance contract and measure them individually? Unbundling is not required, but the staff must investigate if it should be permitted. No decision on whether premiums should be unbundled into revenues versus deposits. No decision on not recognising linked liabilities related to linked assets not recognised (e.g., treasury shares). 39

40 Topic 18: Credit characteristics Discussion date: April 2006 Should the measurement of liabilities reflect the credit worthiness of the contracts? What is the effect, if any, of guarantee funds, or of the influence of regulators? Comment: It seems that, to be consistent with a fair-value measurement of other financial instruments, the credit worthiness of the insurance contracts would be reflected in the measure. This topic has been carried forward to the May meeting. 40

41 Related Topics Also to be decided in May are: Presentation of revenues and of the change in liabilities. Business combinations is there a need to provide guidance on acquisitions and portfolio transfers? Long-term savings contracts do any of the decision related to insurance contracts have implications to savings contracts? FASB projects are there implications to the Discussion document of the FASB projects? 41

42 Related Projects of the IASB Definition of Fair Value moving to exit value Conceptual Framework definitions of elements Revenue recognition customer consideration approach Performance reporting Financial Instruments Fresh start IAS 37 revisions measurement precedents 42

43 Relevant Projects of the FASB Risk transfer in insurance and reinsurance approaches to definition of insurance bifurcation of contracts Investments in life settlements Measurement of financial guarantee insurance contracts 43

44 Activities of other Bodies Insurance Accounting Committee of the International Actuarial Association International Association of Insurance Supervisors CFO Forum and GNAIE CRO Forum 44

45 Summary observations Much progress, and much further to go Conceptual development will extend into Discussion Paper Standards will be principles, leaving some details to reporting entities (e.g., margins) Professional bodies, like the IAA, may define best practices Disclosures will be key, although not addressed until the Exposure Draft 45

46 Thank you! Questions & Answers For additional details, please contact: Jonathan Zhao, FSA, (852) Bruce Moore, FSA, (8610)

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