financial REporting changes 2012 and beyond
Agenda 1. IFRS today how did the adoption of IFRS impact the insurance industry? 2. Developments in IFRS Standards 2012 and Beyond more changes coming 3. Standards in motion fundamental changes expected in the long term 4. Update on US convergence to IFRS
IFRS today 2011 first year of adoption of IFRS What was the impact? Impact on financial results Impact on capital Impact on analysts/investors
IFRS today Impact on the Canadian Public Insurance Industry Impact on Opening Equity Impact on Net lncome Impact on Balance Sheet Response from Regulator/Investors
IFRS 2012 and beyond IAS 1 IAS 12 IFRS 7 IAS 19 IFRS 10 IFRS 11 IFRS 12 IFRS 13 Presentation of financial statements Deferred taxes for investment properties Transfers of financial assets Employee benefits Consolidated Financial statements Joint Arrangements Disclosure of Interests in Other entities Fair value measurement and disclosure requirements
IAS 1 Presentation of financial statements Effective January 1, 2012 Scope: All entities with items of other comprehensive income. Previous IFRS: Amendments to IAS 1: Statement of comprehensive income Statement of profit or loss (P&L) and other comprehensive income (OCI) Single statement or separate P & L No grouping of OCI items Single statement in 2 sections or separate P&L Group OCI items into those that are recycled to P&L and those that never hit P&L Will I be impacted? Expect changes to be minimal.
IAS 12 Deferred taxes for investment properties Effective January 1, 2012 Scope: Investment properties carried at fair value. Previous IFRS: Amendments to IAS 12: Deferred taxes calculation: based on the expected manner of recovery whether through sale, use or both. Deferred taxes, including those arising on a business combination, are calculated based on presumption that value is recovered through sale. Presumption can be rebutted for depreciable property if the business model supports this. Will I be impacted? Only if you have investment property carried at fair value and only for jurisdictions where capital gains are taxed at a different rate from business income (as in Canada).
IFRS 7 Transfers of financial assets Effective January 1, 2012 Scope: Transfers of financial assets both when sale recognition is achieved and when de-recognition fails. Previous IFRS: Amendments to IFRS 7: Requires disclosure of transfers only Enhances disclosures and when transfer fails de-recognition. transparency for transfers that: Do not result in derecognition; and Result in derecognition, but there is continuing involvement Will I be impacted? If you sell, factor, securitize, lend or otherwise transfer financial assets to other parties you will have to consider if additional disclosures are required.
IAS 19 Employee benefits Effective January 1, 2013 Scope: All entities with defined benefit plans. Previous IFRS: Amendments to IAS 19: Options to recognize actuarial gains/losses: Delayed recognition in P/L corridor approach Immediate recognition in P/L Immediate recognition in OCI Amortization of unvested past service costs Actuarial gains and losses renamed re-measurements No longer any options: recognition directly in OCI Past service costs recognized in profit or loss immediately Interest cost on the defined benefit obligation and the expected return on plan assets calculated separately Net interest expense/income calculated by applying the discount rate to the net deficit or net surplus in the plan Will I be impacted? All defined benefit plans will be impacted. Even more disclosures will be required.
IFRS 10 Consolidation Effective January 1, 2013 Scope: Applies to all who have involvement with other entities to determine which are subsidiaries. Previous IFRS: Amendments to IFRS 10: Consolidation of entities that are controlled Control concept under IAS27/SIC12 Based on potential voting rights Must be currently exercisable or convertible No consideration of management s intention or financial ability to exercise or convert Special purpose entities Separate guidance under SIC 12 Principles of consolidation remains Definition of control has changed Substantive potential voting rights can give the holder power Determining whether potential voting rights are substantive requires judgment No risk and rewards approach Will I be impacted? You will need to reconsider all existing relationships. Greatest impact is expected on complex SPE structures.
IFRS 11 Joint arrangements Effective January 1, 2013 Scope: All joint arrangements which are contractual arrangements where joint control exists. Previous IFRS under IAS 31: IFRS 11: Policy choice between proportionate consolidation and equity method Elimination of proportionate consolidation Accounting for total interest in a jointly controlled entity either according to proportionate consolidation or equity method Look at activities of the Joint Arrangement (JA):Joint Operation (JO) or Joint Venture (JV) Will I be impacted? You will need to assess all existing relationships. Classification between JO and JV will become an issue in practice.
IFRS 12 Disclosure of interests in other entities Effective January 1, 2013 Scope: New disclosure standard puts disclosure requirements for interests in entities all in one place. Sets out the disclosure requirements for entities reporting under IFRS 10 and IFRS 11, and replaces the disclosure requirements currently found in IAS 28, Investments in Associates. Will I be impacted? Even more disclosures will be required.
IFRS 13 Fair value measurement and disclosure requirements Effective January 1, 2013 Scope: All fair value measurements in financial statements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date at an exit price. Previous IFRS: Amendments to IFRS 13: Fair value measurement guidance provided in each relevant standard Standards such as IAS 39 contain more guidance and disclosures than other standards that also require fair value measurements, such as IAS 36 on impairments Supersedes all other fair value guidance in IFRS Single source for guidance on measuring and disclosing fair values provides more guidance in an inactive market Will I be impacted? Even more disclosures will be required.
Standards in motion IFRS 9 IAS 17 IFRS 4 Financial instruments Leases Insurance contracts
IFRS 9 Financial instruments IASB recently delayed IFRS 9 mandatory adoption date until 2015. Issued in 2009/2010 originally effective 2013 Not yet final Not yet final 1 2 3 Classification and measurement Impairment Hedging Micro & Macro
IFRS 9 Financial instruments - classification and measurement Scope: All insurance and reinsurance entities. Previous IFRS: Amendments to IFRS 9: Four categories for assets: Fair value through P/L Available for sale Held to maturity Loans and receivables Two primary categories: Amortized cost Fair value Reclassification limited AFS option available for debt & equity AFS option to recycle FV changes from OCI Reclassification prohibited Only recognize FV changes within OCI for certain equity investments No recycling Will I be impacted? Unless all investments are currently classified as fair value through profit and loss, you will be impacted.
IAS 17 Leases Scope: All entities with leased assets. Previous IAS: Amendments to IAS 17: Risk and Reward model Right-of-use model Classification of leases as operating or finance leases Classification only once at inception of the lease Leases are accounted for as acquisition (lessee) / disposal (lessor) of a right-of-use asset Eliminated Will I be impacted? All insurance companies expected to see a gross-up of their assets and liabilities.
IFRS 4 Insurance contracts Exposure Draft (ED) Background and timetable Definition and scope Measurement model Specific guidance Summary of status today
Insurance contracts ED Background and timetable FASB joins project FASB DP FASB ED 2004 2005 2006 2007 2008 2009 2010 2011/12 2012-2015 2015 July 2004 Phase II is born Discussion Phase II Phase II IFRS paper exposure published draft reexposure or review draft Phase II final IASB standard and effective date?
Insurance contracts ED Background and timetable Insurance contract accounting under current IFRS is driven by IFRS 4 Insurance Contracts (phase I) Classified products into 3 main categories: Insurance products (IFRS 4) Investment contracts with DPF (IFRS 4/IAS 39) Other investment contracts (IAS 39)
Insurance contracts ED Definition Retain IFRS 4 definition: A contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. Significance measured using present values Underwriting or timing risk but additional guidance that timing delays may reduce uncertainty Requires a scenario in which present value of cash outflows exceeds present value of premiums IASB deliberation status: The IASB has reaffirmed the ED position 22
Insurance contracts ED Scope of Standard - specific matters Included Financial guarantees Certain DPF contracts Excluded Manufacturer/dealer/ retailer warranties Fixed fee service contracts Residual value guarantees in leases Policyholder accounting IASB deliberation status: The IASB has changed position from the ED stating that the contract classifications for financial guarantees that are currently being used by the industry i.e. banks and insurers will continue (IFRS 4 /IAS 39). Scope exclusions have been reaffirmed Reaffirmed inclusion of DPF contracts within scope but limited to contracts issued by insurers 23
Insurance contracts ED Measurement Model - Building Block Approach Re-exposure draft is expected mid to end of 2012. Application date expected to be no earlier than Jan 1, 2015. Single measurement model for life and P&C Fulfillment rather than exit objective Risk free discount rate + liquidity adjustment Explicit risk adjustment Residual margin: Day 1 loss no day 1 gain Short term duration contracts get some relief
Insurance contracts ED Measurement model - IASB deliberation status No gains at inception Adjust prospectively for changes in estimates of cashflows Include independently measured and updated risk adjustment Discount rate that reflects characteristics of the liabilities Expected value considering all relevant information Include all costs directly attributable Fulfilment rather than an exit objective IASB deliberation status: The IASB has reaffirmed the concept of a building block model using expected value and a discount rate to incorporate the time value of money
Insurance contracts ED Measurement model - Short duration contract model Unearned premium (UEP) method required for pre-claims liabilities of short-duration contracts Applies when: Coverage period approximately 12 months or less No embedded options or other derivatives that would significantly affect the variability of cash flows Claims liabilities (once claim is reported) measured at present value of fulfilment cash flows (including risk adjustment) IASB deliberation status: The IASB will include an overall principle that the Premium Allocation Approach (PAA) can be used as long as the results approximate that of the building block approach IASB propose that the eligibility criteria be included as application guidance only (subject to some rewording)
Insurance contracts ED Measurement model - Short duration contract model Initial recognition Premium (plus present value of any future premiums within the contract boundary) less any incremental acquisition costs Onerous contract test (includes risk margin) Subsequent measurement Reduce the initial liability in a systematic way Passage of time; or Expected timing of claims and benefits if different Onerous contract test Accrete interest at current interest rate IASB deliberation status: Reaffirmed measurement model Agreed on practical expedient whereby the insurer need not apply discounting or interest accretion for subsequent measurement if period between payment and satisfying obligation shorter than 12 months
Insurance contracts ED Specific guidance Discount rate Acquisition costs Risk and residual margin Presentation Transition
Insurance contracts ED Specific guidance - Discount rate A discount rate that adjusts for the time value of money. Reflects characteristics of the liability If liability independent of supporting asset, discount rate is risk free with adjustment for illiquidity If liability linked to supporting assets then discount rate reflects that linkage No adjustment for non-performance risk Current rate updated each reporting period Significant concerns for the Canadian Market IASB deliberation status: Reaffirmed discount rate and decision that discount rates will not be prescribed - top down and bottom up acceptable. No prescribed rate and will not allow lock in of discount rate. 29
Insurance contracts ED Specific guidance - Acquisition costs Incremental acquisition costs at the contract level are included in the contract cash flows Reduces residual margin or unearned premium All other acquisition costs are expensed Business model will impact the profitability of your operations- in-house sales force vs external sales advisors Concerns in the Canadian market have been alleviated somewhat by re-deliberations IASB deliberation status: IASB changed position from ED and have decided that acquisition costs can be deferred at the portfolio rather than contract level. IASB would include direct costs for both successful and unsuccessful efforts
Insurance contracts ED Specific guidance - Risk & Residual margin Objective of risk margin to reflect the maximum amount that an insurer would rationally pay to be relieved of the risk that the ultimate fulfilment cash flows exceed those expected Diversification at the portfolio level: Subject to broadly similar risks and managed together as a single pool Residual margin amortized in systematic way over coverage period Passage of time; or Expected timing of claims and benefits if different Residual margin cannot be negative Reinsurance industry concerned about the ability to take credit for risk diversification. Result could be an overstatement of liabilities. IASB deliberation status: Reaffirmed explicit risk adjustment / residual margin approach. No restrictions on permitted techniques for calculation of the risk margin 31
Insurance contracts ED Specific guidance - Presentation (no UEP model) Income statement consistent with measurement model OCI not used for insurance liabilities Summarized margin approach: Underwriting margin (risk adjustment and residual margin) Gains/losses at initial recognition Non-incremental acquisition costs Experience adjustments and changes in estimates Interest on insurance contract liabilities IASB deliberation status: IASB decided that an insurer should present premiums, claims, benefits, and the gross underwriting margin in the statement of comprehensive income
Insurance contracts ED Specific guidance - Presentation (UEP model) Disaggregate underwriting margin into: Premium revenue (earned and gross of acquisition costs) Claims incurred (not defined - initial estimate or updated for changes?) Expenses incurred Amortization of incremental acquisition costs Change in onerous contract liabilities Other relevant items Gains/losses at initial recognition Non-incremental acquisition costs Experience adjustments / changes in estimates to extent not in claims incurred IASB deliberation status: IASB still to consider whether contracts measured using the buildingblock approach and the premium allocation approach should be separately presented.
Insurance contracts ED Specific guidance - Presentation (no UEP model) Inception 1 January Six month to 30 June Six months to 31 December Change in risk margin 21 26 Residual margin 13 13 Underwriting margin - 34 39 Non-incremental acquisition costs 10 - - Experience adjustments (10) (10) Changes in estimates (20) 0 Gains / losses at inception - 0 0 Investment income 40 38 Interest on insurance liability - (25) (23) Profit/(Loss) (10) 19 44
Insurance contracts ED Other specific guidance - Presentation (UEP model) Inception 1 January Six month to 30 June Six months to 31 December Premium revenue - 500 500 Claims and benefits incurred - (350) (400) Expenses - (40) (40) Amortization of acquisition costs - (25) (25) Underwriting margin - 85 35 Change in onerous contract liability - - - Non-incremental acquisition costs (10) - - Experience adjustments? - (10) (10) Changes in estimates? - - 10 Gains / losses at inception - - - Investment income - 18 7 Interest on insurance liability - (15) (5) Profit/(Loss) (10) 85 37
Insurance contracts ED Other specific guidance - Disclosures Extensive disclosure requirements based on existing IFRS 4 and IFRS 7 disclosure requirements, with some enhancements, including: Reconciliation from opening to closing balance of each major component of contract balances, including: insurance contract liabilities insurance contract assets and the risk adjustment and residual margin included in each similar information for reinsurance contracts Methods and inputs used to develop measurements that have the most material effect, and when practicable, quantitative information about those inputs Includes methods and inputs used to measure risk adjustment, and confidence level used
Insurance contracts ED Other specific guidance - Disclosures Extensive disclosure requirements based on existing IFRS 4 and IFRS 7 disclosure requirements, with some enhancements (continued): Confidence level to which the risk adjustment corresponds (regardless of method used to calculate it) Measurement uncertainty analysis of inputs that have a material effect on the measurement Nature and extent of risk arising from insurance contracts, including insurance risk, market risk, liquidity risk, and credit risk IASB deliberation status: IASB decided to retain disclosures in the proposal, with a number of changes including: eliminate the minimum reportable segment disaggregation requirement, and use disclosure principles, but retain reportable segments as one example of disaggregation.
Insurance contracts ED Other specific guidance - Transition IASB proposal Difference from current carrying value True retrospective adoption Difference from current carrying value Residual Risk Margin Current unbiased probability weight estimates of future cash flows Risk Margin Current unbiased probability weight estimates of future cash flows Each portfolio measured using building block approach but with no residual margin Difference between this amount and the existing net insurance liability recorded under the previous GAAP is reflected in opening retained earnings.
Insurance contracts ED Other specific guidance - Transition Proposed effective date not included in ED Ability to re-designate financial assets at FVTPL Not required to disclose previously unpublished claims development information earlier than first five years before end of first year it applies the standard IASB deliberation status: IASB deliberation status: Effective date will be determined taking into account the significance of the changes required and methods of transition. IASB noted during re-deliberations that effective date likely to be 3 years from issuance date of final standard.
Insurance contracts ED How has the market responded? Significant divergence in views depending on country and products offered General insurers pleased with the introduction of the PAA- short cut method. The concept of risk adjustments and residual margin vs. composite margin key area of debate between Europe and North America Basis of calculating risk adjustment too restrictive Without proper guidance consistency and comparability will be difficult General insurers would like more volume information on the face of the income statement i.e. GPW, NEP Life industry concerned about write off of profits on transition, general insurers want some grandfathering for short duration contracts
Insurance contracts ED Summary of tentative decisions through re-deliberation Scope Discount rate The ISAB changed position stating that the contract classifications for financial guarantees that are currently being used by the industry i.e. banks and insurers will continue Discounting will not be required where it is considered immaterial Decision that discount rates will not be prescribed top down and bottom up is acceptable Reaffirmed the discount rate is based on characteristic of liabilities Expected to explore OCI treatment for changes in discount rate Risk adjustment Residual margin IASB reaffirmed their support for explicit risk adjustment Clarified that the risk margin is the compensation the insurer requires to bear the risk No methods will be prescribed IASB and FASB have not reached a consensus IASB changed position stating that residual margin should not be locked in
Insurance contracts ED Summary of tentative decisions through re-deliberation Contract boundary and recognition Recognize contract at start of coverage period Onerous contracts recognized in pre-coverage period Tentative change to definition of contract boundary Reinsurance Acquisition costs Premium Allocation Approach Presentation Recognize day one losses but defer day one gains Recognition follows underlying insurance contract Acquisition costs to be determined at the portfolio level with no distinction between successful/unsuccessful efforts FASB only includes cost relating to successful acquisition efforts Viewed as a reasonable estimate of BBA Discounting not required if immaterial Tentative decision to present premium, claims and gross underwriting margin in the statement of comprehensive income Considering separate presentation of BBA and PPA contracts
Effective dates of New IFRS standards IAS 1 OCI presentation IAS 12 Deferred income taxes for investment properties measured at fair value IFRS 7 Disclosures of risk exposures arising from asset transfers IAS 19 Pensions and other postemployment benefits and terminations benefits IFRS 10 Consolidation IFRS 11 Joint ventures and arrangements IFRS 12 Disclosure of interests in other entities IFRS 13 Fair value measurement and disclosure IFRS 9 Financial instruments classification and measurement IAS 17 Leases IFRS 4 Insurance contracts 2012 2013 2014 2015 and beyond
Update on US convergence to IFRS Will the US ever convert to IFRS? Status of IASB-FASB convergence project
Update on US convergence to IFRS 2002 IASB FASB convergence project began 2008 with financial crisis, the boards agreed to a speedy completion Successfully converged some standards: for business combinations and non-controlling interest, fair value, measurement and other comprehensive income Continue to work on key projects: revenue recognition, leasing, insurance, investment entities and loan impairment Significant differences continue to exist and develop Don t expect convergence any time soon but what about condorsement?
In conclusion Don t expect any period of calm Standards continue to evolve and develop The Insurance contracts ED could fundamentally change the Canadian Life insurance/reinsurance markets Could we really see accounting standards drive business Could we really see accounting standards drive business decisions?
Questions?