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CIA PD 30: 3855 Implementation: SLF View Chris Christaki

CIA PD 30: 3855 Implementation: SLF View Chris Christaki. Introduction. 3855 = FIAC = Financial Instruments Accounting Changes Sun Life world wide project Main areas of Canadian impact: Investment Accounting Tax Actuarial Reserving Impact to quarterly close period Lesson Learned:

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CIA PD 30: 3855 Implementation: SLF View Chris Christaki

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  1. CIA PD 30: 3855 Implementation:SLF ViewChris Christaki

  2. Introduction • 3855 = FIAC = Financial Instruments Accounting Changes • Sun Life world wide project • Main areas of Canadian impact: • Investment Accounting • Tax • Actuarial Reserving • Impact to quarterly close period • Lesson Learned: • knew International GAAP was on the horizon • Took simplest approach possible that was acceptable under CSOP • Could have made this more complicated – but shelf life is short (4-5years)

  3. Accounting Mismatch, Term of Liability>0 • Under CALM, Actuarial Liabilities are equal to the Statement Value of the assets that back them. • Both AFS and HFT assets use market value on balance sheet. • Impact of Unrealized Gains and Losses on Actuarial Liabilities always flows through Income via change in Actuarial Liabilities. (i.e., don’t get USGAAP shadow treatment) HFT: Unrealized Gains and Losses in Income Stable Income AFS: Unrealized Gains and Losses in OCI Unstable Income

  4. Accounting Mismatch, Term of Liability>0 Conclusion • Choose HFT whenever possible • Opposite of USGAAP • Lesson Learned: it is troublesome to have the same asset designated 2 ways for 2 different bases. Lack of shadow accounting on the liabilities has created this.

  5. Accounting Mismatch, Term of Liability=0 • Under CSOP, Actuarial Liability is equal to the Account Value or undiscounted value (e.g., IBNR) • Unrealized Gains and Losses do not impact Actuarial Liabilities and never flow through Income via change in Actuarial Liabilities HFT: Unrealized Gains and Losses in Income Unstable Income AFS: Unrealized Gains and Losses in OCI Stable Income

  6. Accounting Mismatch, Term of Liability=0 Conclusion: • Choose AFS whenever possible • Same as USGAAP

  7. Valuation Goals • Maintain existing control processes • Minimize inappropriate volatility of income Issues • Deferred Tax Accounting

  8. Four Valuation Methods • CFVM (Cash Flow Valuation Method) • PPM + Fair Value Adjustment • Modified Account Value (some participating products) • Account Value for term 0 liabilities

  9. PPM + Fair Value Adjustment • Use for portfolio segments • Maintain Pre-3855 accounting and reserving • Keep existing controls • Stable base for SOE and MCCSR (e.g. Negative Reserves) • Maintain Policyholder Reasonable Expectations (PRE) in Group and Individual Life • Lessons Learned: • double work for Investment accounting, • Investment Accounting was not preserved perfectly, • must carefully consider what is included in ratio (surplus, goodwill, short term liabilities).

  10. CFVM (Cash Flow Valuation Method) • Use for CFVM segments (Individual Wealth and GRS) • Manage under Discounted Values • Keep existing controls • Keep existing SOE

  11. Modified Account Value • Applies to Dividends on Deposit (DOD) • Demand liability, but credited rates are tied to portfolio rates on Pre-3855 basis • Because of PRE cannot change credited rate strategy quickly • If Post-3855 Asset Value> Pre-3855 Asset Value, need reserve larger than account value to support future credited rates Term of Liability>0

  12. Modified Account Value cont’d • If Post-3855 Asset Value < Pre-3855 Asset Value, Term of Liability=0, since extending the term of the liability lowers the reserve below the account value Account Value Floor

  13. Account Value • Use for liabilities with Term of Liability=0 • In theory should be backed with AFS assets to get stable Net Income • Use HFT as liabilities are small and income volatility from accounting mismatch is small

  14. Deferred Tax Accounting • Do CALM on a no-tax basis • Remove best estimate timing differences and calculate Discounted Deferred Tax Liability (DDTL) • Some 3855 adjustments are not taxed because they are permanent differences: • Changes flow directly to after tax income

  15. December 28 2006 Proposals • Mark-to-Market Properties • Gains/losses realized before 2007 continue to be spread over the remaining term to maturity • All debt obligations carried at fair market value for accounting purposes will be mark-to-market for tax (Under current rules only new debt obligations were mark-to-market for tax) • Unrealized gains/losses of these investments as at January 1, 2007 will be spread evenly over a 5-year period • Changes in Policy Reserves • Post-1995 Tax Reserves • Increase or decrease in reserves as of January 1, 2007 spread over 5 years starting with 2007 • Pre-1996 Tax Reserves • Beginning January 1, 2007 tax reserves for pre-96 policies (but not health) will be based upon statement reserves (i.e. the rules that currently apply to post-1995 tax reserves will apply to ALL reserves). The one time change in pre-1996 tax reserves will be spread over 5 years starting with 2007 • Capital Tax • Excess of statement policy reserves over tax policy reserves no longer in base

  16. December 28 2006 Proposals • GOOD NEWS – simpler! • BAD NEWS • so late, no time to react • No real law, no guidance – essentially no one knew what to do • CLIFR letter was distributed in April 13 (after quarter end!) • Lesson Learned: If possible, try to start lobbying the Department of Finance earlier to ensure there is enough time to implement appropriately.

  17. Accounting Issues • Should the Tax proposals be considered in the restatement under 3855 of the opening balance sheet for 2007? • Tax proposals are not substantively enacted and may not be for some time: • Debt Obligation and Capital tax proposals require changes to Income Tax Act. Requires passing 3rd reading to be substantively enacted under minority government • Reserve proposals require changes to regulations. To be substantively enacted, the Privy Council must pass an order (called an "Order in Council"). This process takes considerable time ..sometimes years • Result – tax had to use current rules for all their calculations • Are the changes to the pre-’96 reserves separate from the 3855 changes and does the change flow through income? • agreement that it is not part of 3855 and that it will flow through income

  18. Actuarial Concerns and Issues • CLIFR letter: • No adjustment to 2006 year-end liabilities • Adjustments to opening balance sheet: • Caution should be used in projecting any favourable tax timing changes as a result of the accounting changes • If liabilities reduce, ignore impact until proposal is substantively enacted • If liabilities increase, assume that proposed rules are a reasonable best estimate of future tax regulations • Evaluation is in aggregate, but done separately for shareholders and policyholders • Result: • For Actuarial Liabilities we used Proposed Rules (Dec 28th) • Set up additional tax PfAD in case of changes to proposed rules • Similar approach in par blocks

  19. Implementation Challenges and Issues • CRA (Canada Revenue Agency) likely will administrate as if rules were in place for 2007 • Implication: • After-tax actuarial liabilities are done on proposed rules. • Tax accounting done on current rules • Use carve-out to preserve impact of proposed rules by looking at what Tax department has actually booked • Lesson Learned: Work needs to be done twice • Accounting rules do not permit you to do anything else (Current rules) • Actuarial Rules allow you to do what is reasonable (Proposed rules) (CSOP 1130.10) • Some asset segments did not line up with liability segments – this created a host of issues

  20. Other 3855 related Impacts • SOE – preserved pre-3855 SOE and created new source called 3855 (plan to drill down into more detail if needed). • Lesson Learned: optimal solution is to apply 3855 appropriately to each source. • EV – Changes were minimal • Only real impact is cost of capital due to increase in MCCSR • CALM – CALM is essentially 3855 blind • Essentially a cashflow is a cashflow • Need alternative base for any assumption that is based on statement value of reserves e.g. defaults, investment expenses, etc… • Lesson Learned: less 3855 impact in segments that are better matched

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