Valuation of Assets and other Liabilities (Life and Non-Life) Nicos Stavrou Senior Manager Assurance

Valuation of Assets and other Liabilities (Life and Non-Life) Nicos Stavrou Senior Manager Assurance P C

Valuation approach key points Framework Solvency II Directive => economic, marketconsistent approach: Assets : valued at the amount for which they could be exchanged between knowledgeable, willing parties in an arm s length transaction. Liabilities : valued at the amount for which they could be transferred, or settled, between knowledgeable, willing parties in an arm s length transaction. International Accounting Standards as endorsed by the European Commission => suitable proxy to Solvency II valuation principles Guidance issued by the IASB can be taken into account, as long as no deviation from the economic valuation results. Slide 2

Valuation approach general principles I. Going concern principle II. Materiality principle Omissions or misstatements of items are material if they could, by their size or nature, individually or collectively, influence the economic decisions of users taken on the basis of Solvency II financial reports Materiality depends on the size and nature of the omissions or misstatement judged in the surrounding circumstances. The size, nature, or potential size of the item, or a combination of those, could be the determining factor. III. No valuation discrimination Growth by acquisition vs organic Treatment of Goodwill see later Slide 3

Valuation approach general principles IV. Mark to market approach The default approach Based on readily available prices in orderly transactions that are sourced independently V. Mark to model techniques To be used when marking to market is not possible Any valuation technique which has to be benchmarked, extrapolated or otherwise calculated from a market input The use of relevant observable inputs to be maximised, use of unobservable inputs to be minimised. Entities to document and disclose transparently the characteristics of the models used and the nature of the inputs used when marking to model. Slide 4

Goodwill (IFRS 3) IFRS treatment: Measured at cost excess of the cost of the business combination over the acquirer s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities QIS5 treatment: Economic value of goodwill for solvency purposes is NIL. Avoids difference in basic own funds between two entities with similar tangible assets/liabilities which have grown differently (organic vs by acquisition) Slide 5

Intangible Assets (IAS 38) IFRS treatment: Initially at cost and subsequently using the cost model or the fair value model QIS5 treatment: Fair value if: - separable - evidence of exchange transactions => saleable in market place. If a fair value measurement is not possible => NIL value Slide 6

Property, plant and equipment (IAS 16) IFRS treatment: Cost model (cost less depreciation) or revaluation model (fair value at date of revaluation less any subsequent accumulated depreciation) QIS5 treatment: Revaluation model under IFRS on PPE => reasonable proxy for solvency purposes Slide 7

Investment Property (IAS 40) IFRS treatment: Initially at cost, subsequently either under fair value or cost model QIS5 treatment: Investment properties re-measured at fair value for solvency purposes if the cost model is used for the purposes of the general purpose financial statements. Fair value model under IAS 40 considered to be a good proxy. Slide 8

Subsidiaries, Associates and Joint Ventures IFRS treatment: In accordance with IAS 27, IAS 28 and IAS 31 respectively. QIS5 treatment: i) Holdings in related undertakings => valued using quoted market prices in active markets. ii) For subsidiaries, where the requirements for a market consistent valuation are not satisfied, an adjusted equity method should be used. iii) For all other undertakings, an adjusted equity method should be used, with mark to model as a last option, provided observable market inputs are maximised and entity-specific inputs avoided. Adjusted equity method => entities value holdings based on their share of the excess of assets over liabilities (at fair value) Slide 9

Deferred Tax Assets/Liabilities (IAS 12) IFRS treatment: DTL/DTA recognised for all taxable temporary differences. DTA recognised only if probable that taxable profit will be available against which a deductible temporary difference can be utilised. QIS5 treatment: > DTL/DTA => difference between SII values and tax values > For DTA => need to demonstrate that future taxable profits are probable and that realisation of the DTA is probable within a reasonable timeframe Slide 10

Financial Assets and Financial Liabilities (IAS 39) IFRS treatment: At fair value or at amortised cost QIS5 treatment: Financial assets - measured at fair value for solvency purposes even when they are recognised at cost on an IFRS balance sheet. Financial liabilities -Upon initial recognition, should be valued in conformity with IFRSs as endorsed by the EC. Subsequent valuation has to be at fair value: i) No subsequent adjustments to take account of a change in own credit standing. ii) Adjustments for changes in the risk-free rate to be accounted for. Slide 11

Contingent Liabilities (IAS 37) IFRS treatment: Should not be recognised (but disclosed and continuously assessed) QIS5 treatment: Contingent liabilities that are material should be recognised. Valuation based on probability-weighted average of future cash flows required to settle the contingent liability, discounted at the relevant risk-free interest rate term structure. Slide 12

Employee Benefits (IAS 19) IFRS treatment: as defined by IAS 19 full recognition of actuarial differences either in equity or in the income statement. IAS 19 also offers the option of deferring the recognition of actuarial differences by spreading them through the income statement (corridor method) QIS5: The application of IAS 19 is recommended. Smoothing (the corridor method) must not be utilised to prevent incomparability across entities. Internal economic models for post-employment benefits calculations can be used, provided that these are based on Solvency II valuation principles(documentation would need to be provided) Slide 13

Valuations systems of governance I. External, independent verification at least every three years (or more frequently if significant change in market conditions) a) Assets and liabilities valued using mark to model b) Property II. Documentation of policies and procedures for the process of valuations (roles, responsibilities of personnel, models/sources of information etc) Slide 14

Valuations systems of governance III. Explicitly identify assets/liabilities marked to market Vs marked to model. IV. Mark to model => justify and document underlying assumptions. Assessment of any resulting valuation uncertainty to be submitted to supervisor. V. Establish internal control processes, including independent review and verification on periodic basis of valuation inputs, outputs and suitability => sign-off process to be clearly described. Slide 15

Concluding remarks As part of QIS5 outputs, entities should highlight any particular problem areas in the application of IFRS valuation requirements for Solvency II purposes, and in particular, bring to supervisors attention any material effects on capital figures/calculations Slide 16