Agenda Paper 4 IFRS 4 Insurance Contracts Jeong-Hyeok, Park
1. Members of Insurance Working Group (IWG) Members Australia China Hong Kong Japan Korea Macau Malaysia Nepal New Zealand Pakistan Sri Lanka Thailand Leader Co- Leader 1
2. IWG s proposals regarding IFRS 4 Phase II IWG s proposals, which are developed through discussions among IWG members, have been reflected in IASB s tentative decisions. OCI solution (P/L or OCI) CSM unlocking for par contracts Fresh Start (AOCI=0 at transition) 2010 1 st ED 2013 2 nd ED Insurance Revenue Fair value measurement of CSM Deferral of IFRS9 2
3. Developments of IFRS 4 Phase II and expected effective date IASB plans to complete the remaining technical decisions on IFRS 4 phase II in 2015 and issue the new Standard on Insurance Contracts in 2016. Comparative presentation OR Implementation Comparative presentation Implementation 2015 2016 2017 2018 2019 2020 2021?? Completion of the remaining topics - Unit of Account - Transition - Disclosures, etc. Expected date of issuing IFRS 4 Phase II - Second half of 2016 After the due process Expected Effective date - 3 years from the publication - Deferral of IFRS 9 - Early application 3
Issues to be discussed 3
Issue 1: Unit of Account IASB s intention is deemed that the measurement of CSM is based on a single contract level. Nevertheless, higher unit of account could be applied for CSM measurement purpose if certain criteria are met. Contracts Non Par Indirect Par Direct Par Accounting Model BBA BBA VFA* IASB tentative decision Lower unit of account (e.g. individual contract) Higher unit of account if mutualisation effect exists Unit of Account for CSM Alternative view Higher unit of account (*)VFA: Variable Fee Approach 4
Issue 1: Unit of Account - Consideration (1) : Premium differentiation Insurers cannot use premium differentiation to reflect differences in expected claims costs due to the following : - Regulatory constraints on pricing (e.g. unisex tariffs) - Ethical / Reputation considerations : Insurers often decide not to consider credit score, occupation, education level, etc. on pricing due to the fear of negative reputation / ethical considerations. - Cost Vs. Benefit consideration : Cost of price differentiation (e.g. health checks) often outweighs the benefit (e.g. travel health insurance) In such cases, CSM will vary depending on unit of account for CSM since the fulfilment cash flows capture the differences in expected claims costs even though the premium is uniformly applied. 5
Issue 1: Unit of Account - Consideration (2) : Mutualisation IASB permits the aggregation of contracts for the measurement of CSM only when a group of contracts is accounted for as VFA and the mutualisation effect exists among the contracts However, regardless of a certain accounting model, cash flows from contracts (*) are deemed to be closely interrelated in the following situations : (*) Assumed that all the contracts are managed in a single pool (e.g. general fund) - For Par contracts where the dividends to policyholders are calculated based on an entity s net earnings, losses from A group of par contracts have an impact on B group s dividend cash flows. - For Renewal premium contracts where the renewal premium is calculated based on costs of claims made by whole policyholders at the expiration, losses from A group of policyholders have impact on B group s renewal rates. - For ISP where the accretion rate is based on an entity s portfolio earning rates, investment losses from A group have an impact on B group s accretion rate. 6
Issue 1: Unit of Account - Consideration (3.1) : Nature of insurance business In some jurisdictions where insurance liabilities are measured on a cost basis, Insurance liabilities will significantly increase at transition due to the future profits (CSM) from in-force contracts, which results in a decrease in net assets. - In a worst case, the encroachment of net assets will occur at transition - However, for a new business after the transition, the corresponding CSM at inception will not affect an entity s net assets since the same amount of CSM is recorded in the debit side ( BEL) However, per the Statutory Accounting Principals (e.g. Solvency II) and Embedded Value calculation, CSM is regarded as a component of net assets in order to reflect the nature of insurance business. Therefore, in order to provide the economic substance of insurers to stakeholders, insurers have no choice but to rely on other non-gaap measures such as Solvency II and EV reporting. 7
Issue 1: Unit of Account - Consideration (3.2) : Nature of insurance business At transition, a change in measurement basis of insurance liabilities from cost to fair value will result in the following : The impact of adoption of IFRS 4 Phase II <Current > Insurance Liabilities 100 Net Premium Reserve Increase by 20 <IFRS 4 Phase II> Insurance Liabilities under IFRS 4 Phase II 120 Net Assets 30 Decrease by 20 Net Assets 10 An increase in liabilities due to future profits (CSM) A decrease in net assets due to future losses Therefore, an insurer, which measures its liabilities on a cost basis, will be double penalized due to the adoption of IFRS4 Phase II. 8
Issue 1: Unit of Account Discussion point Discussion point 1. CSM measured based on Lower unit of account Vs. Higher unit of account: Which one does properly represent the contracts profitability? 2. Does the definition of mutualisation proposed by IASB properly capture the nature of insurance business? 3. What is a possible solution to reflect the economic substance of insurers on the financial statements? 4. Do you think the IASB should consider an additional transition relief in order to alleviate the entity s burdens arising from the transition? 9
Issue 2: Implementation period IASB proposed 3-year implementation period after the publication. Many grey areas require analysis, quantification of impact and careful consideration of consequences - Unit of Account i.e. Level of Aggregation into Portfolios? - What are directly attributable expenses? - How will discount curves be determined? - How frequently are discount curves updated? - Which simplifications will be made in cash flow projections? - How will management action be modeled? - How will the Risk Adjustment be determined and allocated? - Which products will be considered in scope of the Variable Fee approach? - Which options will be taken for Transition? 10
Issue 2: Implementation period Discussion point Discussion point 1. Considering each AOSSG member country s situation, 3-year implementation period is deemed to be enough? 10
Issue 3: IWG s future plan Discussion point Discussion point 1. IWG s future plan after the completion of remaining technical decision on IFRS4 Phase II? 12
Thank you 13