IFRS 17 Insurance Contracts. SIAS, Salzburg, 5th and 6th of April, 2018 Dr. Johann Kronthaler

IFRS 17 Insurance Contracts SIAS, Salzburg, 5th and 6th of April, 2018 Dr. Johann Kronthaler

Timeline of IFRS 17 in the context of other standards IFRS 17 is effective for annual periods beginning on or after 1 January 2021. Earlier application is permitted. Deferral option: Start IFRS 9 for insurance companies Publication of IFRS 17 Start IFRS 15 Start IFRS 16 Comparatives IFRS 17 Start IFRS 17 2017 2018 2019 2020 2021! Qualitative and quantitative disclosure information in accordance with IFRS 9 has to be published as at 31.12.2018 when applying the deferral approach of IFRS 9.

The main documents of IFRS 17 IFRS 17 Standard Basis for Conclusions Illustrative Examples 116 pages 124 pages 82 pages

The content of IFRS 17 Paragraphs Introduction Objective Scope Level of aggregation of insurance contracts Recognition Measurement Modification and derecognition Presentation in the statement of financial position Recognition & presentation in the statement(s) of financial performance Disclosure IN1 IN8 1-2 3-13 14-24 25-28 29-71 72-77 78-79 80-92 93-132

What s the issue? Analysts currently have to adjust insurance companies financial positions and performance to be able to compare them IFRS 17 increases transparency about profitability and will add comparability 5

The changes could significantly affect insurers Profitability patterns Volatility of financial results and equity Level of transparency about profit drivers Equity levels The magnitude of the accounting change for life and non-life insurers will be different 6

A new, comprehensive accounting model IFRS 17 s general measurement model (GMM) is based on a fulfilment objective and uses current assumptions It introduces a single, revenue recognition principle to reflect services provided And is modified for certain contracts 7

Disclaimer There are many discussions going on with respect to IFRS 17. It may happen that the conclusions of such discussions is different to what is presented here. Number of open questions 8

Scope

Scope of IFRS 17 Insurance contracts Insurance contracts, including reinsurance contracts, issued Reinsurance contracts held Investment contracts with discretionary profit participation features (DPFs) issued (if issued by insurance company ) Optional: Financial guarantee contracts issued, if already accounted for as insurance contracts (otherwise: IFRS 9) Fixed fee service contracts issued, if they are calculated without risk assessment about an individual customer they are most likely fulfilled by providing services rather than cash payments the insurance risk arises primarily from the customer s use of services 10

What is an insurance contract? Characteristics Transfer of significant insurance risk Uncertain future event, that adversely affects the policyholder There has to be a scenario of commercial substance, in which the issuer has a possibility of a loss Significance of the insurance risk is to be evaluated on a present value basis 11

Separating components Identifying separate components Some components may be within the scope of another Standard Embedded derivatives Apply IFRS 9 Investment components Amounts that the insurance company has to repay to the policyholder even if an insured event does not occur Only if distinct (i.e.. not highly interrelated with insurance component Apply IFRS 9 Promise to transfer non-insurance services Assessment after separation of other components Apply IFRS 15 12

Measurement the core principles Three types of measurement depending on the type of contract General Measurement Model (GMM) Premium Allocation Approach (PAA) Variable Fee Approach (VFA) Measurement model that is applicable in general Optional, simplified approach, similar to current accounting principles Applicable for short term contracts (one year or less) Modification of the GMM with respect to the realization of revenue Mandatory to contracts with "direct participation features

The general measurement model

Initial recognition Key components Fulfilment cash flows Risk-adjusted present value of future cash flows e.g. premiums, claims 1 2 3 1 Future cash flows Inflows 2 Discounting 3 Risk adjustment Contractual service margin (CSM) Represents unearned profit results in no gain on initial recognition 4 Outflows 4 CSM 0 Net cash outflows result in no CSM a loss is recognized immediately Initial Recognition at the earliest of the following: Beginning of the coverage period Due date of the first payment from the policyholder As soon as a group of contracts becomes onerous 15

Cash flows to be considered Cash Flows to be considered: all future cash flows within the boundary of each contract in the group IFRS 17.33 Cash flows are within the boundary of an insurance contract if they arise from substantive rights and obligations that exist during the reporting period in which the entity can compel the policyholder to pay the premiums or in which the entity has a substantive obligation to provide the policyholder with services IFRS 17.34 A substantive obligation to provide services ends when the entity has the practical ability to reassess the risks of the particular policyholder and, as a result, can set a price or level of benefits that fully reflects those risks IFRS 17.34

Expected future cash flows All cash flows within the contract boundary, that are directly attributable to fulfilling the contract, have to be taken into account, and no other cash flows Premiums Payments Payments to a policyholder Payments to a policyholder that vary depending on returns on underlying items Payments to a policyholder resulting from embedded derivatives (i.e.. options and guarantees) Costs Insurance acquisition cash flows attributable to the portfolio Claim handling costs Policy administration and maintenance costs, including recurring commissions Fixed & variable overheads directly attributable to fulfilling the insurance contract Other costs specifically chargeable to the policyholder Others Transaction-based taxes Potential cash inflows from recoveries An expected value has to be determined (as opposed to a most-likely or a more-likely-than-not approach) 17

Expected future cash flows Cash flows not to be included: Investment returns Cash flows Cash flows arising from reinsurance contracts held Cash flows arising outside the contract boundaries Costs Costs that can not be directly attributed to the portfolio (i.e.. product development or training costs) Abnormal amounts of wasted labour or other resources used to fulfil the contracts Others Income tax payments 18

Discount rates The discount rates shall be consistent with the characteristics of the insurance contracts (i.e.. timing, currency, liquidity) Top-down or bottom-up approach Top-down approach: 3,35% Yield curve of a financial instrument 5,25% Risk premium for expected counterparty default (1%) Risk premium for unexpected counterparty default (0,9%) Illiquid risk-free discount rate Bottom-up approach: 3,5% Liquidity adjustment (0,5%) Risk-free liquid yield curve (3%) In theory both approaches should give the same result 19

Risk adjustment The risk adjustment shall cover the uncertainty about the cash flows arising from non-financial risks Company specific, making the entity indifferent between Fulfilling a liability that has a range of possible outcomes arising from non-financial risk; and Fulfilling a liability that will generate fixed cash flows with the same expected present value Fulfilment of insurance contract 50% 50% Fixed liability 100% 90 cash outflow 110 cash outflow 100 cash outflow Expected value: 100 Fixed liability: 100 20

Determination of the risk adjustment Characteristics of the underlying risk Risk adjustment Low frequency and high severity, i.e.. natural catastrophes Contracts with long duration Wide probability distribution Little knowledge about trends or current estimates High frequency and low severity Contracts with short duration Narrow probability distribution Knowledge about trends or current estimates Lower Higher 21

Subsequent measurement Composition Total liability of a group of insurance contracts Liability for remaining coverage (LRC) Fulfilment cash flows related to future services, plus CSM (unearned profit) remaining + Liability for incurred claims (LIC) Fulfilment cash flows for claims incurred, but not yet paid 22

Subsequent measurement of the CSM For insurance contracts without direct participation features, IFRS 17.44 CSM at the beginning of the period Effect of any new contracts added to the group CSM at the reporting date Interest accreted on the carrying amount of the CSM Changes in fulfilment cash flows relating to future service Effect of any currency exchange differences Amount recognized as insurance revenue For insurance contracts with direct participation features, where the Variable Fee Approach is applicable see IFRS 17.45

Subsequent measurement Changes in current estimates Fulfilment cash flows CSM Financial risk assumptions Past and current services Future services Adjust the CSM Either Or CSM allocation 24

Release of the CSM Release of the Contractual Service Margin by identifying the coverage units for the group of insurance contracts resp. the transfer of investment services for investment contracts with DPFs: Expected quantity of coverage Current Period Expected Coverage Contract #2 Contract #1 Contract #3 Coverage units have to be defined Measurement of contracts with direct participation features differs depending on the significance of their inherent insurance risk 25

Recognizing insurance revenue Insurance revenue is derived from the changes in the LRC for each reporting period, covering Expected insurance claims and expenses Risk adjustment CSM allocation Acquisition cash flows These items represent a company s consideration for providing services 26

Important remarks on presentation Insurance revenue and insurance service expenses presented in profit or loss shall exclude any investment components IFRS 17.85 Effect of changes in the discount rate may be presented in P&L or OCI, if the company chooses the accounting policy set out in paragraph 88(b) or in paragraph 89(b) to avoid accounting mismatch IFRS 17.90

Example

Example Initial recognition GMM Initial recognition of a portfolio of property insurance contracts: Coverage period 3 years, interest rate 4%, combined ratio 80% Expected premiums of 1,200 p.a. Risk Adjustment 15% of the expected present value of future premiums Measurement of the Contractual Service Margin (CSM) Fulfilment Cash Flows CSM LRC -79 519 280 0-3.600 2.880 Premiums Claims & Costs Discounting Adjustment Risk Adjustment Contractual Service Margin Liability for Remaining Coverage 29

Example Subsequent measurement Scenario after year one: Cash flows in Year 1 as expected Assumptions for Years 2 and 3 remain unchanged Calculation of the fulfilment cash flows: -190 CF Year 2-1200 -37-26 180 173 960 CF Year 3-1200 960 Cash Inflows Cash Outflows Disc. Adjustment Risk Adj. Fulfilment Cash Flows 30

Example Subsequent measurement Calculation of the contractual service margin (CSM): Opening balance 280 Effect of new contracts 0 Interest (4%) 11 Changes in the fulfilment cash flows 0 Effect of currency exchange 0 Allocation CSM -97 Closing balance 194-280+0+11+0+0 3 31

Example Subsequent measurement Liability for remaining coverage after Year 1: LRC results from summing up the building blocks 194 4-63 353-2.400 1.920 Premiums Claims & Costs Discounting Adjustment Risk Adjustment Contractual Service Margin Liability for Remaining Coverage 32

Example Subsequent measurement Reconciliation according to IFRS 17.101 for Year 1: PV of cash flows Risk Adj. CSM LRC Opening balance -799 519 280 0 Change in liab. due to cash inflows 1.200 0 0 1.200 Change in liab. due to cash outlows -960 0 0-960 Insurance finance income/expenses 16 0 11 27 Changes related to future service 0 0 0 0 Changes related to current service 0-166 -97-263 Closing balance -543 353 194 4 33

Example Subsequent measurement Financial statement Year 1 Cash 240 Liability for remaining coverage 4 Equity 236 Insurance revenue Year 1 Expected payments 960 Allocation risk adjustment 166 Allocation CSM 97 Total 1.223 IFRS 17 P&L Year 1 Insurance revenue 1.223 Insurance service expenses -960 Insurance finance income/expenses -27 Insurance service expenses from loss component of LRC 0 Profit / Loss 236 Conventional P&L Year 1 Premiums 1.200 Claims & Costs -960 Acquisition costs 0 Change in the liability -4 Profit / Loss 236 34

Example Scenario A: Favourable changes Scenario A at the end of Year 2: Actual expenses in Year 2: 600 instead of 960 Revised expectations for Year 3: Combined ratio of 70% instead of 80% (corresponding to expenses of 840) Risk adjustment of 12% instead of 15% of the expected PV of future premiums -248-32 144-1200 840 Cash Inflows Cash Outflows Disc. Adjustment Risk Adj. Fulfilment Cash Flows 35

Example Scenario A Measurement of the liability for remaining coverage: Change in the fulfilment cash flows for Year 3: Old assumptions: Cash inflows -1.200 Cash outflows 960 Discounting adjustment -37 Risk adjustment 180 Fulfilment cash flows -97 New assumptions: Cash inflows -1.200 Cash outflows 840 Discounting adjustment -32 Risk adjustment 144 Fulfilment cash flows -248 Contractual Service Margin (CSM): Opening balance 194 Effect of new contracts 0 Interest (4%) 8 Changes in the fulfilment cash flows 151 Effect of currency exchange 0 Allocation CSM -177 Closing balance 177 151-194+0+8+151+0 2 36

Example Scenario A Liability for remaining coverage after Year 1: 177-72 144-1.200 840-32 Negative LRC because of the order of the adjustments to the CSM: 1. Addition of changes of the FFCF 2. Allocation Premiums Claims & Costs Discounting Adjustment Risk Adjustment Contractual Service Margin Liability for Remaining Coverage 37

Example Scenario A Reconciliation according to IFRS 17.101 for Year 2: PV of cash flows Risk Adj. CSM LRC Opening balance -543 353 194 4 Change in liab. due to cash inflows 1.200 0 0 1.200 Change in liab. due to cash outlows -600 0 0-600 Insurance finance income/expenses 26 0 8 34 Changes related to future service -115-36 151 0 Changes related to current service -360-173 -177-710 Closing balance -392 144 177-72 38

Example Scenario A Financial statement Year 2 Cash 840 Liability for remaining coverage -72 Equity 912 Insurance revenue Year 2 Expected payments 960 Allocation risk adjustment 173 Allocation CSM 177 Total 1.310 IFRS 17 P&L Year 2 Insurance revenue 1.310 Insurance service expenses -600 Insurance finance income/expenses -34 Insurance service expenses from loss component of LRC 0 Profit / Loss 676 Conventional P&L Year 2 Premiums 1.200 Claims & Costs -600 Acquisition costs 0 Change in the liability 76 Profit / Loss 676 39

Example Scenario B: Unfavourable changes Scenario B at the end of Year 2: Actual expenses in Year 2: 1.260 instead of 960 Revised expectations for Year 3: Combined ratio of 95% instead of 80% (corresponding to expenses of 1.140) Risk adjustment of 20% instead of 15% of the expected PV of future premiums 240 136-44 -1200 1140 Cash Inflows Cash Outflows Discount. Adj. Risk Adj. Fulfilment Cash Flows 40

Example Scenario B Measurement of the liability for remaining coverage: Change in the fulfilment cash flows for Year 3: Old assumptions: Cash inflows -1.200 Cash outflows 960 Discounting adjustment -37 Risk adjustment 180 Fulfilment cash flows -97 New assumptions: Cash inflows -1.200 Cash outflows 1.140 Discounting adjustment -44 Risk adjustment 240 Fulfilment cash flows 136 Contractual Service Margin (CSM): Opening balance 194 Effect of new contracts 0 Interest (4%) 8 Changes in the fulfilment cash flows -202 Effect of currency exchange 0 Allocation CSM 0 Closing balance 0 202 31 Balance CSM Remainder Loss Component Profit & Loss 233 41

Example Scenario B Liability for remaining coverage after Year 2: 240 0 136-44 -1.200 1.140 Premiums Claims & Costs Discounting Adjustment Risk Adjustment Contractual Service Margin Liability for Remaining Coverage 42

Example Scenario B Reconciliation according to IFRS 17.101 for Year 2: PV of cash flows Risk Adj. CSM LRC Opening balance -543 353 194 4 Change in liab. due to cash inflows 1.200 0 0 1.200 Change in liab. due to cash outlows -1.260 0 0-1.260 Insurance finance income/expenses 26 0 8 34 Changes related to future service 173 60-202 31 Changes related to current service 300-173 0 127 Closing balance -104 240 0 136 43

Example Scenario B Financial statement Year 2 Cash 180 Liability for remaining coverage 136 Equity 44 Insurance revenue Year 2 Expected payments 960 Allocation risk adjustment 173 Allocation CSM 0 Total 1.133 IFRS 17 P&L Year 2 Insurance revenue 1.133 Insurance service expenses -1.260 Insurance finance income/expenses -34 Insurance service expenses from loss component of LRC -31 Profit / Loss -192 Conventional P&L Year 2 Premiums 1.200 Claims & Costs -1.260 Acquisition costs 0 Change in the liability -132 Profit / Loss -192 44

Example Scenario B Year 3: Cash flows as expected Reconciliation according to IFRS 17.101 for Year 2: PV of cash flows Risk Adj. CSM LRC Opening balance -104 240 0 136 Change in liab. due to cash inflows 1.200 0 0 1.200 Change in liab. due to cash outlows -1.140 0 0-1.140 Insurance finance income/expenses 44 0 0 44 Changes related to future service 0 0 0 0 Changes related to current service 0-240 0-240 Closing balance 0 0 0 0 45

Example Scenario B Financial statement Year 3 Cash 240 Liability for remaining coverage 0 Equity 240 Insurance revenue Year 3 Expected payments 1.116 Allocation risk adjustment 232 Allocation CSM 0 Total 1.348 IFRS 17 P&L Year 3 Insurance revenue 1.348 Insurance service expenses -1.140 Insurance finance income/expenses -44 Insurance service expenses from loss component of LRC 32 Profit / Loss 196 Conventional P&L Year 3 Premiums 1.200 Claims & Costs -1.140 Acquisition costs 0 Change in the liability 136 Profit / Loss 196 46

Example Comparison P&L (Scenario B) IFRS 17 Conventional Year 1 Year 2 Year 3 Total Year 1 Year 2 Year 3 Total Insurance revenue / premiums 1.223 1.133 1.348 3.704 1.200 1.200 1.200 3.600 Insurance service expenses / claims & costs -960-1.260-1.140-3.360-960 -1.260-1.140-3.360 Insurance finance expenses / interest expenses -27-34 -44-105 0 0 0 0 Insurance service expenses from loss component 0-31 32 1 0 0 0 0 Profit / Loss 236-192 196 240 240-60 60 240 Remarks: Under IFRS 17 interest expenses are allocated to insurance revenue. Therefore, the revenue exceeds the premiums received (this systematics has been confirmed explicitly by the IASB after consultation) In this example the interest expenses for the loss component are allocated to the insurance service expenses for the loss component, which leads to the difference in row three. 47

Level of Aggregation

Level of aggregation The CSM is determined for groups of insurance contracts Portfolio Insurance contracts with similar risks that are managed together (product line) Annual cohort Insurance contracts, that are issued more than one year apart, shall not be included in the same group Portfolio Annual cohort Group Group Portfolio shall be divided into a minimum of the following groups: Onerous at inception No significant possibility of becoming onerous Remaining contracts IFRS 17 limits offsetting of onerous contracts against profitable ones Fulfilment Cash Flows can be calculated at a higher level of aggregation 49

Mutualisation Situation IFRS 17.B67 Some insurance contracts affect the cash flows to policyholders of other contracts by requiring the policyholder to share with policyholders of other contracts the returns on the same specified pool of underlying items; Principle IFRS 17.B68 The fulfilment cash flows of each group reflect the extent to which the contracts in the group cause the entity to be affected by expected cash flows, whether to policyholders in that group or to policyholders in another group. Consequence IFRS 17.B68 The fulfilment cash flows for a group: include payments arising from the terms of existing contracts to policyholders of contracts in other groups, regardless of whether those payments are expected to be made to current or future policyholders; and exclude payments to policyholders in the group that, applying have been included in the fulfilment cash flows of another group.

A well known discussion about mutualisation An interpretation often heard Mutualisation has the consequence that annualization of the cohorts is not required for business fulfilling the criteria of mutualisation IFRS 17.BC138 [ ] the Board noted that the requirements specify the amounts to be reported, not the methodology to be used to arrive at those amounts. Therefore it may not be necessary for an entity to restrict groups in this way to achieve the same accounting outcome in some circumstances. This is still under discussion, however it is rather unlikely that annualization of cohorts is not obligatory

Level of aggregation for disclosures Level of aggregation IFRS 17.95 An entity shall aggregate or disaggregate information so that useful information is not obscured either by the inclusion of a large amount of insignificant detail or by the aggregation of items that have different characteristics. Examples type of contract (for example, major product lines) geographical area (for example, country or region) reportable segment, as defined in IFRS 8 Operating Segments Sales channel Disclosures do not necessarily have to mirror the groups of contracts

Premium Allocation Approach

Premium allocation approach (PAA) The PAA is an optional, simplified model for measuring the LRC Total liability of a group of insurance contracts Liability for remaining coverage (LRC) PAA replaces the GMM for short-duration contracts + Liability for incurred claims (LIC) May need to be discounted Premium is recognized over time as revenue unless release of risk follows a different pattern While unearned premium is a familiar concept, the revenue recognition pattern could differ 54

When is the PAA applicable? Length of the coverage period always at most one year (short term) more than one year if the measurement produced by the PAA does not differ materially from the one produced by the General Measurement Model (GMM) met if no significant variability of the fulfilment cash flows is expected before a claim is incurred Coverage period is determined by contract boundaries Multi-year contracts can be short term contracts too, if for example the insurance company has an annual right of cancellation, or an annual right to adjust the premiums/services to the risk 55

How to calculate applying the PAA Initial recognition IFRS 17.55(a) The premiums, if any, received at initial recognition minus any insurance acquisition cash flows at that date, unless the entity chooses to recognise the payments as an expense applying paragraph 59(a) plus or minus any amount arising from the derecognition at that date of the asset or liability recognised for insurance acquisition cash flows applying LRC on initial recognition

How to calculate applying the PAA Subsequent measurement IFRS 17.55(b) LRC on initial recognition plus the premiums received in the period minus insurance acquisition cash flows; unless the entity chooses to recognise the payments as an expense applying paragraph 59(a); plus any amounts relating to the amortisation of insurance acquisition cash flows recognised as an expense in the reporting period; (unless paragraph 59(a)); plus any adjustment to a financing component minus the amount recognised as insurance revenue for coverage provided in that period (see paragraph B126); and minus any investment component paid or transferred to the liability for incurred claims LRC at the end of the period

Onerous contracts in the light of the PAA Initial recognition For contracts issued to which an entity applies the premium allocation approach, the entity shall assume no contracts in the portfolio are onerous at initial recognition, unless facts and circumstances indicate otherwise. An entity shall assess whether contracts that are not onerous at initial recognition have no significant possibility of becoming onerous subsequently by assessing the likelihood of changes in applicable facts and circumstances. IFRS 17.18 Subsequent measurement IFRS 17.57 &.58 If at any time during the coverage period, facts and circumstances indicate that a group of insurance contracts is onerous, an entity shall calculate the difference between: a) the carrying amount of the liability for remaining coverage determined applying PAA; and b) the fulfilment cash flows that relate to remaining coverage of the group applying GMM. To the extent that the fulfilment cash flows described in (b) exceed the carrying amount described in (a), the entity shall recognise a loss in profit or loss and increase the liability for remaining coverage

Example (1/3) Illustrative Example 10 (IFRS 17.IE113-IE123) 1.7.20X1 31.12.20X1 30.6.20X2 31.8.20X2 Issue date 1.7. Duration (months) 10 Expected premiums (paid immediately) 1.220 Attributable acquisition costs (paid and expensed immediately) 20 LIC - Best Estimate 600 LIC - RM 36 LIC - Best Estimate 400 LIC - RM 24 Claims payments 1.070 PAA is applicable as duration less than one year Facts and circumstances do not indicate that the group of contracts is onerous Options are exercised as follows : The entity chooses to recognise the insurance acquisition cash flows as an expense when it incurs the relevant costs (IFRS 17.59 (a)) No discount effects of the LIC Further assumption: No investment component

Example (2/3) Initial recognition Premiums are paid directly after initial recognition LRC at initial recognition is 0 Subsequent measurement 6 10 1.220 LRC 31.12.20X1 30.6.20X2 31.12.20X2 LRC at the beginning of the period 0 488 0 Premiums received 1.220 0 0 Acquisition costs 0 0 0 Amortization of acquisition costs 0 0 0 Insurance Revenue -732-488 0 LRC at the end of the period 488 0 0 Liabilities 31.12.20X1 30.6.20X2 31.12.20X2 Liability for remaining coverage (LRC) 488 0 0 Liability for incurred claims (LIC) 636 1.060 0 Total 1.124 1.060 0 600 + 36 636 +400 + 24

Example (3/3) Balance sheet 31.12.20X1 30.6.20X2 31.12.20X2 Cash 1.200 1.200 130 Liabilities 1.124 1.060 0 Equity 76 140 130 Profit and Loss Insurance Service Expenses 31.12.20X1 30.6.20X2 31.12.20X2 Claims 636 424 10 Acquisition costs 20 0 0 Total 656 424 10 1.070 600 + 400 (36 + 24) P&L 31.12.20X1 30.6.20X2 31.12.20X2 Insurance Revenue 732 488 0 Insurance Service Expenses -656-424 -10 Profit / Loss 76 64-10

Variable Fee Approach

Variable fee approach (VFA) The approach considers the variable fee associated with direct participating contracts Obligation to policyholder = Obligation to pay fair value of underlying items - Variable fee Subsequent measurement Accounting for changes Recognised immediately Adjusts the CSM The application of the VFA is mandatory The VFA reduces the volatility of net results The general principal of the building blocks still holds The main difference arises in the subsequent measurement of the CSM 63

When is the VFA applicable? Insurance contracts with direct participation features: the contractual terms specify that the policyholder participates in a share of a clearly identified pool of underlying items the entity expects to pay to the policyholder an amount equal to a substantial share of the fair value returns on the underlying items; and the entity expects a substantial proportion of any change in the amounts to be paid to the policyholder to vary with the change in fair value of the underlying items Criteria have to be analysed at inception (no changes afterwards!) VFA is not applicable to reinsurance contracts! Examples, that could meet this definition: Traditional life insurance contracts Unit-linked life insurance contracts Long-term health insurance contracts The criteria have to be analysed carefully! 64

Remarks IFRS 17.B105 A share referred to in the definition does not preclude the existence of the entity s discretion to vary the amounts paid to the policyholder. However, the link to the underlying items must be enforceable IFRS 17.B107(a) An entity shall interpret the term substantial in both paragraphs in the context of being contracts under which the entity provides investmentrelated services and is compensated for the services by a fee that is determined by reference to the underlying items IFRS 17.B107(b) An entity shall assess the variability in the amounts in paragraphs: (i) over the duration of the group of insurance contracts; and (ii) on a present value probability-weighted average basis, not a best or worst outcome basis (see paragraphs B37 B38).

Measurement The following guideline might be of importance: IFRS 17.B104 [ ] insurance contracts with direct participation features are contracts under which the entity s obligation to the policyholder is the net of: (a) the obligation to pay the policyholder an amount equal to the fair value of the underlying items; and (b) a variable fee (see paragraphs B110 B118) that the entity will deduct from (a) in exchange for the future service provided by the insurance contract, comprising: (i) the entity s share of the fair value of the underlying items; less (ii) fulfilment cash flows that do not vary based on the returns on underlying items. It seems that the following order of measurement shall be applied: 1 2 Fair Value of the Underlying Items is allocated to the policyholder The variable fee is deducted afterwards!

Measurement ctd. Liability towards policyholder FV of Underlying Items Variable Fee Variable Fee Entity s share of the fair value of the Underlying Items fulfilment cash flows that do not vary based on the returns on Underlying Items

Measurement ctd. Liability to PH fulfilment cash flows that do not vary based on the returns on Underlying Items FV of Underlying Items Entity s share of the fair value of the Underlying Items

Comparison subsequent measurement General Measurement Model Variable Fee Approach CSM at the beginning of the period Effect of any new contracts added to the group Interest accreted on the carrying amount of the CSM Changes in fulfilment cash flows relating to future service (B96 B100) Effect of any currency exchange differences Amount recognised as insurance revenue CSM at the beginning of the period Effect of any new contracts added to the group Entity s share of the change in the fair value of the underlying items Changes in fulfilment cash flows relating to future service (B101 B118) Effect of any currency exchange differences Amount recognised as insurance revenue CSM at the end of the period CSM at the end of the period IFRS 17.44 IFRS 17.45

Subsequent measurement of CSM Measurement of CSM such that variability of the variable fee is accounted for IFRS 17.B110 B113 Source: KPMG first impressions on IFRS 17 If the CSM is not sufficient, a loss component is recognized

Similarities between GMM and VFA Principles of GMM Principles of VFA Initial Recognition Subsequent measurement Measurement of the CSM as excess of the Inflows over the risk-adjusted outflows CSM is adjusted for changes in estimates of service components relating to future service Changes in the estimates of nonfinancial assumptions Part of the service: relating to future service adjusts CSM relating to current and previous periods P&L Changes in the assumptions regarding future participation policy Regarded as non-financial assumptions treated as such Variable Fee Approach and General Measurement Model are based on the same principles

Differences between GMM and VFA The major difference arise in subsequently measuring the CSM Principles of GMM Principles of VFA Changes of estimates in financial assumptions Recognized in P&L or OCI Adjusts CSM Discounting rate for adapting the CSM Discounting rate at initial recognition Implicitly, and therefore current Simplification The adjustments to the CSM based on the changes in the variable fee do not have to be determined separately!

Illustrative Example 9 An entity issues 100 contracts that meet the criteria for insurance contracts with direct participation features. The coverage period is three years A single premium of CU150 Max of CU170, or the account balance, if the insured person dies Value of the account balance at the end of the coverage period if the insured person survives Account balance at the beginning of the period Premiums received Change of the FV of the Underlying Items an annual charge of 2% of the account at BoY plus change in FV the value of the remaining account balance in case of death or survival Account balance at the end of the period Assumption: The entity sells assets to collect annual charges and pay claims. Hence, the assets that the entity holds equal the underlying items

Illustrative Example 9 ctd. Assumptions at initial recognition FV of the assets will increase by 10% a year Risk Adjustment of CU25 Release of RA by CU12 / 8 / 5 from year 1 to 3 one insured person will die at the end of each year and claims will be settled immediately (no LIC) Actual FV of assets increase by 10% in year 1 FV of assets increase by 8% in year 2 FV of assets increase by 10% in year 3 All other assumptions occur as expected Remark: Some values cannot be recalculated (e.g. TVFOG)

Illustrative Example 9 Initial recognition Expected development of the Underlying Items: Account balance per contract Year 1 Year 2 Year 3 Account balance at BoP 0 162 174 Cash inflows: Premiums 150 0 0 Change FV of Underlying Items 15 16 17 Annual Charge (2%) -3-4 -4 Account balance EoP 162 174 188 Death benefits: Year 1 Year 2 Year 3 From PH s account 162 174 188 Difference to guaranteed amount 8 0 0 Claims paid 170 174 188

Illustrative Example 9 Initial recognition Situation in total PV of future cash inflows -15.000 PV of future cash outflows 14.180 Risk Adjustment 25 Fulfilment Cash Flows -795 = - 100 * 150 incl. TVFOG for guaranteed death benefit CSM 795 LRC 0

IE 9 Subsequent measurement Subsequent measurement in year 1: PV of future cash inflows 0 PV of future cash outflows 15.413 incl. TVFOG Risk Adjustment 13 Fulfilment Cash Flows 15.426 Reconciliation according to IFRS 17.101: = 15.413 (14.180 170) Fulfilment cash flows at BoP 0 Effects new contracts added to the group -795 Change in fair value 1.403 Current service: Release of Risk Adjustment -12 Cash inflows and outflows 14.830 Fulfilment Cash Flows 15.426

IE 9 Subsequent measurement Change in variable fee Adjustment of the CSM due to the change in the variable fee is calculated in total (according to simplification IFRS 17.B114) LRC year 1 CSM CSM at BoP 0 Effects of new contracts added to the group 795 Change in variable fee 97 = 1.500 1.403 Release CSM -300 = (0 + 795 + 97) * 100/(100+99+98) CSM EoP 592 Fulfilment Cash Flows 15.426 CSM 592 LRC year 1 16.018

IE 9 Development of the balance sheet Initial Recognition Assets 0 795 CSM SH Acc. 0-795 Fulf. CF Premium cash inflow, purchasing assets Assets 15.000 795 CSM SH Acc. 0 14.205 Fulf. CF Death benefit Assets 16.338 795 CSM SH Acc. -8 15.535 Fulf. CF Increase FV of assets Assets 16.500 795 CSM SH Acc. 0 15.705 Fulf. CF Accounting for entity s share of fair value Assets 16.008 892 CSM SH Acc. 322 15.438 Fulf. CF Release of CSM and Risk Adjustment Assets 16.008 592 CSM SH Acc. 322 15.426 Fulf. CF 312 P&L

IE 9 Development of the balance sheet Balance sheet end of year 1 IFRS 17 Assets 16.008 592 CSM SH Acc. 322 15.426 Fulf. CF 312 P&L vs. Traditional Assets 16.008 16.008 Liability SH Acc. 322 322 P&L

Illustrative Example 9 P&L Calculation of the insurance revenue Year 1 Insurance Service Expenses 8 Release Risk Adjustment 12 Release CSM 300 Insurance Revenue 320 P&L IFRS 17.B124 IFRS 17 Year 1 Insurance Revenue 320 Insurance Service Expenses -8 Insurance Finance Inc./Exp. -1.500 Investment Income 1.500 Insurance Service Expenses from Loss Component of LRC Profit / Loss 312 0 IFRS 17.B123 Year 1 Change LRC -16.018 Premiums 15.000 Insurance Finance Inc./Exp. 1.500 Payment Investment Component -162 Insurance Revenue 320 As death benefit is the max of account balance and 170, it is in our case the sum of account balance of 162 and 8 guaranteed benefit Payment of account balance is to be seen as a repayment of an investment component The other years are calculated accordingly

Reinsurance

For reinsurance contracts held The GMM and PAA still apply, with modifications The reinsurance contract held is accounted for separately from the underlying direct contract Reinsurance gain or loss is recognised as reinsurance services are received Counterparty default risk of the reinsurance company has to be accounted for 83

Presentation and disclosure

Presentation Investment components are excluded from insurance revenue and service expenses Entities can choose to present the effect of changes in discount rates and other financial risks in profit or loss or OCI to reduce volatility 85

Disclosure Information should be disclosed at a level of granularity that helps users assess the effects contracts have on Financial position Financial performance Cash flows New disclosures relate to expected profitability and attributes of new business 86

Important new disclosures Assets and Liabilities recognised Additional reconciliations in table format IFRS 17.98-.105 Input factors used for calculating the insurance revenue for the current period IFRS 17.106 Effects of contracts initially recognised in the current period IFRS 17.107 Analysis of the interest expenses IFRS 17.110 -.113 Additional disclosures regarding the transition to IFRS 17 IFRS 17.114 -.116 Significant judgements Detailed information about methods and processes used for estimating the inputs Effect of changes in the methods and processes, as well as the reason for each change Confidence level used to determine the risk adjustment for nonfinancial risk IFRS 17.119 Discount curves IFRS 17.117 -.118 IFRS 17.117 -.118 IFRS 17.120 Nature and extent of risks Sensitivities (insurance risk): quantitative information about the effects on P&L and own funds Comparison of actual claims with previous estimates of the claims Liquidity risk: Relationship between amounts that are payable on demand and the carrying amount of the related group of contracts Effect of regulatory framework IFRS 17.128 -.129 IFRS 17.126 IFRS 17.132 IFRS 17.130 87

Some more remarks Level of aggregation is not defined by the standard in more detail Examples of level of aggregation by the standard: type of contract (for example, major product lines); geographical area (for example, country or region); or reportable segment, as defined in IFRS 8 Operating Segments IFRS 17.96 Separate reconciliations shall be disclosed for insurance contracts issued and reinsurance contracts held. IFRS 17.98 An entity shall for each reconciliation, present the net carrying amounts at the beginning and at the end of the period, disaggregated into a total for groups of contracts that are assets and a total for groups of contracts that are liabilities IFRS 17.99(b)

Transition

Full retrospective approach is required but expedients can be used Full retrospective approach Is it impracticable to use a full retrospective approach? No Yes Either Modified retrospective approach, if possible Or Fair value approach A company can apply different approaches for different groups What is the meaning of impractical? 90

What the application of the full retrospective approach would mean 190 30 CSM 110 0 50 CSM 40 CSM 60 FFCF 160 FFCF -40 FFCF i.e. 31.12.2017 01.01.2020 i.e. 31.12.2013 To fully apply the retrospective approach & the subsequent measurement of the CSM all assumptions for the respective reporting day have to be determined retrospectively Practicability is at least questionable

Modified retrospective approach 110 170 10 CSM 0 40 CSM 50 60 CSM FFCF 160 FFCF -40 FFCF z.b. 31.12.2017 01.01.2020 z.b. 31.12.2013 When using the modified retrospective approach the CSM at initial recognition can be estimated and subsequently be updated on the first day of application using simplified methods. There will be deviations with overwhelming probability!

Fair value approach as a further simplification 200 160 Using the fair value approach, the CSM results as the residual from the fair value and the 40 current fulfilment cash flows. Fair Value FFCF CSM Obvious point for discussion How can the fair value and the FFCF differ? (compare the FV definition under Solvency II)

Analysts will take a very close look at the reported figures Fulfilment cash flows Discounting Risk adjustment CSM LRC Since all the building blocks strongly depend on estimates, the question of the margin arises inevitably. In particular the methods used for calculating the risk adjustment are not specified!

Potential accounting changes for insurers

Other things to think about Accounting mismatches may occur but accounting policy choices and transition provisions could reduce them More consistency and transparency for options and guarantees 96

The role of the actuary under IFRS 17 As in Solvency II the actuary will be an integral part of future accounting processes. Tasks under IFRS 17 where an actuary might be necessary: Generation of cash flows, including setting of assumptions Validation of CSM movement Validation of insurance revenue Etc. Though the main tasks are not too much different from today, the actuary will be involved much more into standardized accounting processes 97

Do not forget to have a closer look at the literature IFRS 17 Standard Basis for Conclusions Illustrative Examples 116 pages 124 pages 82 pages

And there is many more literature to come KPMG first impressions: Available online: https://home.kpmg.com/uk/en/home/insights/2017/07/ifrsnotesfirst-impressions-ifrs-17-insurance-contracts.html IFRS 17 Versicherungsverträge (Herausgeber: Kronthaler/Smrekar/Weinberger) 99

Questions?