Presidents Forum / Insurance Accounting Committee IASB Insurance Contracts Phase 2 Status and IAA Role -- Hyderabad Sam Gutterman Page 0
Agenda Background International accounting convergence Insurance Contracts Phase 2 status IAA Role and Activities Page 1
Background International Accounting Convergence Objectives: One single set of high-quality financial reporting standards for companies world-wide No surprises with full transparency The whole objective of the International Accounting Standards Board is to boost transparency by having one single set of high-quality standards for companies worldwide. The real secret for confidence in the markets is: no surprises and full transparency that s going to mean some pretty uncomfortable standards coming in the future. It s silly having a different rule in the UK or Australia or the US when we should just see who s got the better rule and let s do it worldwide. Sir David Tweedie, Chairman IASB Page 2
Background International Accounting Convergence IFRS International Financial Reporting Standards Standard setter International Accounting Standards Board (IASB) Founded in 2001. Based in London Replaced the International Accounting Standards Committee (IASC), which previously published financial reporting standards referred to as International Accounting Standards (IAS), used in countries without their own accounting standards setter Impetus came from the G7 after the Asian Financial Crisis in the 1990s Current convergence efforts given further push by the G20 this year IASC Foundation s Trustees have oversight responsibility, with a Standards Advisory Council (SAC) that provides advice regarding the IASB agenda The IASB develops IFRS and the International Financial Reporting Interpretations Committee (IFRIC) provides interpretations of IFRS Main functions of IASC Foundation trustees include Appointing IASB members Exercising oversight Raising funds Monitoring Board, recently formed, made up of international regulators, provides oversight to the IASC Foundation Page 3
Background International Accounting Convergence Standard setting structure Monitoring Group 5 members IASC Foundation 22 trustees Trustees Geographical break-down Europe 8 North America 6 Appoint Govern Fund Asia / Oceania 6 Rest of the world 2 SAC 46 members Advise IASB Chairman plus 14 members Interpret IFRIC 12 members Board Geographical break-down Create Europe 4 North America 5 IFRS High quality, enforceable and global Asia / Oceania 4 Rest of the world 2 Page 4
Background International Accounting Convergence More than 100 countries require or permit the use of IFRS, or are converting Top 10 Global Capital Markets US Japan US GAAP Converting to IFRS UK France Canada IFRS IFRS Converting to IFRS Germany Hong Kong Spain Switzerland IFRS IFRS IFRS IFRS or US GAAP Australia IFRS Countries seeking convergence with the IASB or pursuing adoption of IFRSs Countries that require or permit IFRSs Countries with no current plans to convert to IFRS Page 5
Background International Accounting Convergence SEC Roadmap When might the transition to IFRS occur in the US? March 2007 SEC roundtable on US GAAP reconciliation for IFRS filers August 2007 SEC concept release on use of IFRS for US registrants August 2008 Roadmap was issued January 2009-2014 Voluntary application of IFRS permitted for certain US registrants 2007 2009 2011 2013 2015 2008 2010 2012 2014 July 2007 SEC proposal eliminating US GAAP reconciliation for IFRS filers November 2007 Reconciliation eliminated for IFRS filers December 2007 SEC roundtable on IFRS in the US During 2011 SEC will reconvene to decide whether a mandatory conversion date should be set January 2014 Proposed roadmap targets potential mandatory adoption in 2014-2016? Page 6
Background - IASB and IFRS Current IFRS 4 Insurance Contracts IFRS 4 in its current form Adopted in 2004 Applies to Insurance Contracts, not Insurance Companies Originally designed as an interim solution (2 years) Primarily relies on local standards (e.g. US GAAP in the US) A great deal of diversity in practice Starting with current local standards Eliminates liabilities for future claims (e.g. catastrophe reserves) Requires a liability adequacy test (type depending on prior or newly adopted test) Measuring liabilities on an undiscounted basis can be continued, but not introduced No netting for reinsurance Can make a subsequent change to entity s accounting policy as long as it is more reliable and no less relevant, or more relevant and no less reliable Page 7
Background - IASB and IFRS Current IFRS 4 Insurance Contracts Definition of an Insurance Contract (not expected to change in Phase 2) 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 Insurance risk Risk other than financial risk transferred from the holder of the contract to the issuer. Financial risk includes a change in interest rate, security price Lapse, persistency or expense risk not insurance risk in a direct contract Must relate to an uncertain future event that adversely affects the policyholder Must be a pre-existing risk, rather than risk created by a contract (e.g., a gambling contract) No requirement for underwriting and timing risk. Significant Where an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance (i.e., have no discernable effect on the economics of the transaction), irrespective of the likelihood of such event. The additional benefit is compared to that which would be paid if the insured event did not occur. Page 8
Background - IASB and IFRS Current IFRS 4 and IFRS 7 Insurance Contracts General disclosure principles Principle 1: Identify and explain significant amounts in financial statements Accounting policies and significant assumptions Changes in amounts and assumptions Principle 2: Help users understand future cash flows Objectives in managing risks and policies for mitigating risks Effect on cash flows of contractual terms and conditions Insurance risks - sensitivity analysis, concentrations, loss development Interest rate and credit risks Risk oriented disclosure requirements Sensitivity analysis Page 9
Insurance Contracts Phase 2 Insurance Contracts Discussion Paper (2007) Current IFRS method used in the accounting for insurance contracts is inconsistent across jurisdictions Results in too much diversity, less relevance and less reliability The IASB started with a clean slate to develop Phase 2 The FASB agreed to pursue a joint project with IASB (will result in IFRS/US GAAP convergence on the financial reporting standard for Insurance Contracts) because of overlap with most of their other joint projects Phase 2 work begun Jul 04 Discussion Paper published May 07 Comment period ended Nov 07 Phase 2 Exposure Draft published February 10 Phase 2 IFRS published June 2011? Phase 2 IFRS effective 2013? FASB IToC Aug 07 We are here Page 10
Insurance Contracts Phase 2 Insurance Contracts Discussion Paper (2007) IASB Discussion Paper Preliminary Views on Insurance Contracts Published May 2007 US Financial Accounting Standard Board (FASB) issued an Invitation to Comment Included ideas for financial reporting of insurance contracts: Basic model current exit value Reflected policyholder behavior and acquisition expenses Other measurement issues Reinsurance Unbundling Guaranteed insurability as the basis for recognizing renewal premiums Gain at issue possible, although expected to be small Page 11
Insurance Contracts Phase 2 Insurance Contracts Discussion Paper (2007) Many responses to the insurance contracts discussion paper were received; some themes: Respondents expressed general support for: A single model for life and non-life 3 building block approach, but many differences in opinion about each block Discount rate should not be asset-based Premiums as revenue Expensing of acquisition costs Were generally against: Including own credit characteristics Unbundling Service margins Guaranteed insurability test for future premium recognition And had mixed views on: Day 1 Profit Discounting loss reserves (non-life insurers in US generally against) Page 12
Insurance Contracts Phase 2 Joint Project of FASB/IASB It is expected that the outcome of Phase 2 will become US GAAP irrespective of if and when there is overall convergence between US GAAP and IFRS FASB joined project in late 2008 Joint staff project as well Single Approach for all life and non-life insurance and reinsurance contracts Though a tentative decision by the IASB may lead to a distinction for pre-claims liability between short-duration and long-duration contracts (although no definition of distinction yet decided) Three basic building blocks of measuring liabilities are Expected future cash flows Time value of money Margin Page 13
Insurance Contracts Phase 2 Overall Measurement Objectives Methods currently being considered for valuing liabilities: Fulfillment approach FASB had tentatively agreed to this approach through October 2009 Expected present value necessary to fulfill obligations over time Expected cost based Reasonably consistent with proposed revenue recognition (customer consideration model) Revenue recognized with performance of service Single margin calibrated to premiums, although in included explicit risk margin Modified IAS 37 approach (currently being developed, to be re-exposed in December, applicable to non-contractual obligations) IASB leaning toward this approach Modifications being made to apply to contracts No gain at issue Transfer notion as in settlement, yet not fair value Explicit risk and service margin Through October had initial incremental acquisition expense recognized as revenue For short-duration contracts an unearned premium approach IASB agreed to mandate, although may discuss the mandatory nature in December FASB hasn t discussed yet No separate building blocks Staffs currently reexpressing description of objectives Current exit value (transfer price as assessed by third party) is no longer being discussed Page 14
Insurance Contracts Phase 2 Building Block 1 Expected Value of Future Cash Flows Determining expected value: Identify each possible scenario Estimate the cash flows under each scenario Make unbiased estimate of probability of each scenario Treatment of administrative expenses here or in margins? Expected not to require stochastic modeling Open application question for claims liability: Will insurers need to develop estimates of each possible scenario by identifying individual scenarios, estimating the cash flows for those scenarios, and then weigh them together in a probability weighted manner? OR Would current P&C non-life actuarial approaches be suitable for Building Block 1? Page 15
Insurance Contracts Phase 2 Building Block 2 Discount Time Value of Money Discount rates Consistent with observable current market prices Apply to cash flows whose characteristics match those of insurance liability (not matching assets) in terms of: Duration Liquidity Currency Discount all liabilities Including claims liability Coverage period Explicitly for long-duration contracts Implicitly for short duration contracts through unearned premium approach Possible interest rates being considered: Risk free or similar rate IASB considering whether liquidity adjustment appropriate Waiting for field testing results relating practicality concerns Not insurer s investment yield rate Page 16
Insurance Contracts Phase 2 Building Block 3 - Margins Subsequent margin measurement (other than for claims liability) Contract fulfillment approach with composite margin Depends on whether composite margin is remeasured If not remeasured If allowed to be a shock absorber, to what extent deviations in actual experience affect level of composite margin If not a shock absorber, most likely consistent with release of insurance risk, as that is primary risk driver, but there are other possibilities If remeasured, in a manner similar to risk margin Requires allocation of risk to each period or Prospective measurement based on assessment of uncertainty Revised IAS 37 model with two or three types of margins Risk margin consistent with previous slides Service margin no one quite sure what it is for (possibly administrative cost or markup of internal expenses) Residual margin same issues as for composite margin above Residual margin would be equal to difference between present value of premiums and present value of benefits/losses and relevant expenses, less risk margin Key issue for long-duration contracts to the extent different margins (residual, risk and composite) released in a different manner Page 17
Insurance Contracts Phase 2 Building Block 3 Risk Margins Families of risk margin methods as given in IAA Risk Margins paper: Quantile methods Cost of capital Explicit assumptions (related to specific risk factors) Discount rate related Implicit Examples of approaches in current practice Cost of capital method Switzerland regulatory: Swiss Solvency Test using 6% cost and regulatory capital Solvency II in Europe 6% cost on regulatory capital, which is defined at a 99.5% chance of a loss in one year Quantile method Australian property & casualty claims liability Minimum of 75% CTE Explicit method Canada, with strict ranges for each risk determined by the actuarial profession, accompanied by peer review Page 18
Insurance Contracts Phase 2 Other Outstanding Issues Recognition of renewal premiums The IASB has now bought into recognizing fixed and determinable premiums Not yet discussed flexible premiums, e.g., for universal life insurance Contract boundaries Treatment of non-guaranteed features Policyholder dividends Where charges or credits different than those guaranteed What is revenue All premium, no premium, sometimes premium Unbundling Especially if a contract has a deposit component Minimum cash value floor Currently none Own credit standing adjustment When a contract is recognized Made important since no-gain at issue requirement Reinsurance issues Many related overall IASB projects, including revenue, presentation, liabilities, financial instruments, fair values Page 19
IAA Role Insurance Accounting Committee Formed as committee of IFAA in 1996 In response to IASC Insurance Contracts project Chair, Sam Gutterman Vice Chairs Francis Ruygt, Paul McCrossan (through 2006), David Congram (from 2005) Represented on IASC Present Value Steering Committee (Gutterman) IASC Insurance Steering Committee (McCrossan) IASB Standards Advisory Group (McCrossan 2001-2006, Ruygt from 2009) IASB Insurance Working Group (Gutterman) IASB Financial Instruments Working Group (Ruygt) IAASB Consultative Advisory Group (Gutterman) IASB Employee Benefits Working Group (Jim Verlautz, with other actuaries) Taken part in Four IASB Education Sessions (2006-2008) Two FASB Education Sessions (2009) Commented on Each IASB Insurance Contracts Discussion Papers and Exposure Drafts Many other IASB papers and drafts Page 20
IAA Activities Established general insurance listserve for currently about 315 interested parties Research papers Two joint research papers with American Council of Life Insurance Principle sponsor of IAA ad hoc Risk Margins Working Group Measurement of Insurance Liabilities: Current Estimates and Risk Margins (2009) Committee meetings Extensive meetings in conjunction with each IAA Council meeting Several standalone meetings Employee benefits begun meetings and significant effort on a revised IAS 19 Work with IAIS Attended many IAIS Insurance Contracts Subcommittee meeting Assisted in their development of several papers and comment letters Actuarial standards and education Developed 11 International Actuarial Standards of Practice related to Phase 1 Has served as educational guidance for actuaries around the world Beginning to discuss what guidance is needed to support Phase 2 Most likely a combination of International Actuarial Standards of Practice and International Actuarial Notes Have almost completed IAA book on Stochastic Modeling In process of discussing what other technical education material should be developed at an international level Has served as informal advisor to IASB (and in 2009 FASB) staff on many insurance contracts related issues Page 21