Challenges in Construction, FISIM, and Insurance

1. 5. Focus on difficult areas – Construction, FISIM, Insurance THE CONTRACTOR ISACTING UNDER A FRAMEWORK CONTRACT CONCLUDED WITH THE COMMISSION

2. Compilation challenges • Construction • FISIM • Insurance

3. Construction - Definition and coverage • Construction services cover « the work performed on construction projects and installation, by employees of an enterprise in locations outside the economic territory of the enterprise ». • A clear distinction to be made between: • Construction abroad: construction works for NR by R enterprises in the compiling economy. • Construction in the reporting economy: construction works for R by NR enterprises. • Establishing the residency of the construction company is the first step

4. BOP recording – gross flows • Construction abroad • Comprises construction work for NR by enterprises R in the compiling economy (exports), • With an offset by goods and services purchased in the host country / abroad (imports). • Construction in the reporting economy • Comprises construction work provided to R in the compiling economy by NR construction enterprises (imports) • With an offset by goods and services purchased in the host country / compiling economy (exports).

5. Construction services example • A company from economy A wins a contract to renovate a building in economy B for a less than one year period. The total value of the project is 100 and the costs as parts of the work involved are: • Purchases of goods in the economy A of the contractor (10) • Purchases of goods from economy B (30). • Purchases of goods from economy C (10). • Purchases of services from economy B (10) • Wages paid to residents of economy B (20) • Wages paid to residents of economy A (10) • The total cost of inputs is 90 (whatever their origin) and the gross operating surplus accruing to the construction company is 10. How do we record the transactions in the countries A and B balance of payments?

6. Construction services example

7. Construction: services or FDI? • Construction as trade in services • Construction abroad: transactions made by a resident enterprise without a centre of economic interest in the host economy. • The resident construction company ensures plans and supervises the work to be done. • Usually under one year but not always. • Construction as Foreign Direct Investment • « If certain criteria are met, the work undertaken is treated as having involved the creation of a separate institutional unit –a branch - resident in the economy where the activity is being carried out, which is a direct investment enterprise » • In that case the BOP records the transactions between the affiliates and the mother company and the activity of the branch is recorded under FATS.

8. Construction: services or FDI? • Construction as FDI • These criteria can be summarised as follows: • The construction enterprise operates in the host economy for > 1 year. • The enterprise maintains a separate set of financial acounts (income statement, balance sheet, transactions with the parent company…). • Payment of income tax in the host economy • Existence of a substantial physical presence • Even if the central office retains normally all general functions (planning, contracting, financing, choice of the local suppliers…). • If met, BOP records the flows between a mother company and its affiliate (a FDI relationship). • Constructions activities involving major projects extending over a period of several years (bridges, dams, power stations…) generally meet these criteria

9. Construction as FDI – BPM6 12.1 • The total value of the project is 34,500 • Materials purchased from residents of economy A 18,000 • Materials purchased from residents of economy B 1,000 • Acquisition of materials from residents of economy C 2,000 • Services procured in economy B (inc. rental) 3,000 • Wages and salaries paid to residents of economy A 4,500 • Wages and salaries paid to residents of economy B 1,000 • Total cost of inputs 29,500 • Gross operating surplus accruing (profit) 5,000 • Total gross value of construction work 34,500

11. Data collection • The central office of the contractor should record all transactions linked to a specific project. • A direct reporting or survey collection system is the more appropriate solution (compared to a banks ITRS). • Contractors are often big building, engineering or architectural companies limiting the number to be surveyed. • The number of customers may be larger. They can be companies in all the sectors of the economy.

12. The IMF questionnaire

13. Construction recording in Italy • Information collected from quarterly SITS surveys • A dedicated section devoted to construction where construction abroad and construction in Italy are distinguished • Construction item compilation based on a general purpose sample • Estimation of the duration of the work • If less than one year: recorded as services construction • If more than one year: recorded as foreign direct investment • FDI: 98% of construction abroad and 80% of construction in Italy

14. Construction recording in Italy • Recording as a service • Questionnaire includes data on: • Project start and end data, counterpart country, • Gross value of the construction project, • Goods, services and labour acquired abroad and in Italy, • Simplified information to limit the burden • No split between goods acquired in the host and third economies • Information provided includes labour cost (recorded as construction and not as compensation of employees). • Goods purchased in Italy: a corresponding amount is deducted from merchandise exports • Gross construction value considered as uniformly distributed throughout the duration of the work

15. Introduction • Financial intermediation: process where a financial institution (FI) accepts deposits from units in order to lend these funds to other units. • Intermediation is a service that is provided to depositors and borrowers (and adds to GDP). • Need data on both explicit and implicit charges to get a complete picture of financial services. • Services explicitly charged and other financial services: • Fees and commissions • Require no special calculation but only an appropriate data collection.

16. Introduction • Financial intermediation service charges indirectly measured (FISIM): • Instead of a direct charge, loan and deposit services provided by FIs are paid for by the interest differential between borrowers and lenders: • FISIM used to offset FIs expenses and to provide an operating surplus (without FISIM, banks would make a loss on fee income alone). • FISIM needs to be calculated (indirectly measured) from the partitioning of relevant interest flows between the service and the property income components.

17. FISIM definition • Actual interest includes both an income element and a charge for a service.  • FIs charge an additional amount of interest on loans that represents the value of a service delivered to the borrower • A service charge is deducted from the interest paid on the deposits held with the FIs. • The reference rate used for the partitioning between « pure interest » and service charge should contain no service element Loans Deposits Reference rate Interest on deposits Interest on loans Reference rate FISIM to depositors FISIM to borrowers

18. FISIM example Reference rate = 3% Stockon Loan of 100 € Interest receivable by FI of 6 % So FISIM on Loan = 100 € x (6% - 3 %) = 3 € Stock of Deposit of 100 € Interest payable by FI of 2 % So FISIM on Deposit= 100 € x (3% - 2%) = 1 € Total FISIM output = 4 € Rate on loan % Ref rate Margin loan Rate on dep. Margin deposit time t

19. FISIM export and import • FISIM may be payable by both depositors and borrowers • Households, businesses, government, rest of the world • Depositors and borrowers may be residents or nonresidents. • We find in the BOP (and the RoW) FISIM exports on the credit side and FISIM imports on the debit side. • FISIM on loans and deposits involving NR customers are services exported by R banks to their NR clients. • FISIM on loans and deposits provided by NR banks are imports of services for the compiling economy. The R clients can belong to all resident institutional sectors.

20. The reference rate • FISIM is calculated by using an appropriate reference rate, but what is it? • It is a rate of interest somewhere between bank interest rates on deposits and loans. • Reference rate should contain no service element and reflect the risk and maturity structure of deposits and loans. • «Represents the pure cost of borrowing funds, that is a rate from which the risk premium has been eliminated to the greatest extent possible and which does not include any intermediation services ». • Usually refer to the interbank rate

21. The reference rate • Different reference rates may be needed for domestic and foreign financial institutions • A single reference rate may be used for transactions in domestic currency. • Several reference rates may be used for international trade in FISIM as several currencies may be involved • Should be calculated by at least two groups of currencies (national and foreign currency).

22. FISIM allocation:in cross-border relationships Now when FISIM is recoded as Trade in Services, it must be eliminated from interest (D.41). In other words, D.41 must be recorded at the ref. rate level. D.41rec. on loan € Ref. rate FISIM on Loan = 3 € D.41 receivable by banks = 6€ D.41 adj. receivable by banks = 3€ THUS: FISIM adj.= -3€ FISIM on Deposit= 1 € D.41 payable by banks = 2€ D.41 adj. Payable by banks = 3 € THUS: FISIM adj.= +1€ D.41pay. on dep. time t

23. Source data requirements STOCKS of deposits & loans of FIs by counterparts to construct “from whom to whom” matrix • Balance sheets of resident FI with the following counterparts • Resident sectors: S.11, S.124, S.125, S.13, S.14 UB + DW, S.15 – to calculate FISIM intermediate consumption; • Resident sector: S.14 consumers – to calculate FISIM final consumption • Non-residents – to calculate FISIM exports • Balance sheets of non-resident FIs with as detailed as possible counterparts - to calculate FISIM imports. In practice, availability of detailed data is problematic; BIS data are helpful, but not detailed. 23

24. Source data requirements INTEREST of deposits & loans of FIs by counterparts to construct “from whom to whom” matrix • Profit and Loss Accounts or Income statements of resident FIs with the analogous counterparts as in point 1, namely: • Resident sectors: S.11, S.124, S.125, S.13, S.14 UB + DW, S.15 – to calculate FISIM intermediate consumption; • Resident sector: S.14 consumers – to calculate FISIM final consumption • Non-residents: – to calculate FISIM exports • Interest data of non-resident FIs with analogous counterparts as in point 2 - to calculate FISIM imports . In practice, availability of detailed data is problematic; IMF rates, ECB (MFI statistics) may be helpful, and assumptions necessary. • Reference rate. Interbank rate is often used.

25. Conclusion • A growing attention has been put on the measurement of financial services since the beginning of the financial crisis. • New developments of international standards including FISIM in the balance of payments. • Measurement difficulties, as FISIM calculation depends on the choice of the reference rate: the issue continues to be debatable. • Need of a collaboration between the BOP compilers and national accountants.

26. Insurance - introduction • Insurance and pension services in the BOP cover the provision to NR of various types of insurance by R insurance enterprises and vice-versa. • The classifications and the concepts adopted in the BOP are very similar to those of national accounts: premiums, premium supplements, technical reserves, claims. • Measurement of cross-border insurance activities and the calculation of insurance services may suffer from a lack of data, especially for imports of insurance services from non-resident companies.

27. Insurance in EBOPS 6. Insurance and pension services • 6.1 Direct insurance • Life insurance • Freight insurance • Other direct insurance (accident and health, motor vehicle, fire, other property…) • 6.2 Reinsurance • 6.3 Auxiliary insurance services • Insurance brokerage • Actuarial services… • 6.4 Pension and standardized guarantee services

28. EBOPS memorandum items Gross insurance premiums for: • Life insurance • Freight insurance • Other direct insurance Gross insurance claims for: • Life insurance • Freight insurance • Other direct insurance

29. Defining insurance service charge • The output of the insurance corporation represents the service provided to the policyholders • Financial protection against risk and financial intermediation services. • Not explicitly charged to policyholders: undifferentiated component of premiums. • To be derived from amounts accruing to insurers and policyholders. • Based on the principle of adding premiums and premiums supplements and deducting claims incurred. • Service charge = Gross premiums earned + premium supplements - claims due (adjusted from claims volatility, if needed).

30. Defining insurance service charge • Calculation of insurance service charge should take into account claims volatility • Observed claims can be volatile: fluctuations in the rate of claims and major catastrophes are not considered as normal business (earthquakes, tsunami, hurricanes…). • Measurement of the service charge should not be affected by the volatility of the occurrence of the risk. • A negative service charge is a concept that makes no economic sense. 2008 SNA recommends the use of adjusted claims incurred when measuring the output of insurance companies

31. Towards expected claims • Adjustment for claims volatility show the difference between actual claims in a particular period and a normally expected level of claims, calculated according to three methods: • Expectation approach: use of smoothed past figures of gross claims incurred, or smoothed past ratios of gross claims incurred over premiums, applied to current premium (recommended). • Accounting approach: based on changes in insurers’ equalization provision to account for claims volatility. • Sum of costs plus “normal” profit approach • Service charge = Gross premiums earned + premium supplements - adjusted (expected) claims incurred

32. Exports of insurance services • The calculation is straightforward for R insurers with separate data on NR policy holders (premium, premium supplement, claims are all known). • Gross premiums earned from abroad = 100 • Claims payable abroad = 95 • Income attributable to policy holders from investment income (premium supplements) = 20 • Imputed service charge is 25: (100 + 20 – 95) (Source: BPM6 box 10.4)

33. Exports of insurance services • For incomplete information: R insurers with separate data on NR policyholders for premiums only, and using domestic information. • Total insurance services (to residents and non-residents) = 50 • Total premiums = 200 • Of which premiums from residents = 120 • Premiums from non-residents = 80 • Ratio of services charge to premiums: 50/200 = 25% • Service charge estimated by multiplying the gross premiums earned from NR by the ratio of service charge to gross premium earned for all nonlife insurance operations • Imputed service charge is 20: (80 x 25%).

34. Exports of insurance services • With averaging • Premiums earned from abroad =100 • 3 year ratio of service charge to total premiums = 20% (based on national accounts: domestic insurance data). • Imputed service charge earned from abroad = 20.

35. Imports of insurance service • More complicated • Available information less complete than that for exports (relate to NR insurers: importers which are R policyholders are generally not in a position to determine the proportion of services charges attributable to them). • Use of ratios of large international insurance companies from other economies. • Ratios from the R insurance industry (assuming strong competition between domestic and international companies). • Alternatively BOP compilers in the NR exporting country could be contacted.

36. Imports of insurance service • Could also use ratios based on premiums payable abroad and claims payable from abroad over a medium term period plus an adjustment for the premium supplement. • Premiums from residents to NR insurance companies =40 • Ratio of service charge to premiums (average from data on insurers abroad) = 25% • Estimated insurance services from NR = 10 (40*0.25)

37. Accounting entries in the BOP • Services: insurance service charge • Primary income: income attributable to policyholders • Current transfers: net premiums receivable (premiums + supplement – service charge) • Current transfers: claims payable • Financial account: increase in technical reserves

38. Accounting entries in the BOP • The case of a resident insurer • Premiums earned from abroad: 100 (premiums received 105) • Claims payable abroad: 95 (claims paid 85) • Technical reserves (beginning of period: 200) • Income attributable to policy holders (premium supplements): 20 • Premiums payable minus the estimated service charge and claims receivable are regarded as transfers.

39. The accounting entries in the BOP

40. Reinsurance • A policy between two insurance companies. Used to offset risks and minimise losses in the event of large numbers of claims. • Reinsurance services should be estimated separately: the direct insurance company is fully liable vis-à-vis the policyholder, regardless of whether part of the risks are reinsured. • Reinsurance accounting uses using the same principles as direct insurance (expected claims, removing volatility…) with some peculiar payments (ceding commission, profit commission). • Value of the reinsurance service: Gross premiums earned less commission payable + net income from investments (premium supplements) – claims due (adjusted from claim volatility, if necessary) and profit commission payable.

41. Life insurance • Payments of premiums are viewed by the policyholder as savings, and claims as withdrawal of these savings: the policyholder is considered to have a claim on the insurance enterprise. • The service element in life insurance is calculated on the same basis as the service element associated with nonlife insurance. • Investment in life insurance is recorded in the financial account and the IIP under “other investment-other assets/liabilities” item.

42. Data collection - BPM6 • Calculation of service charge needs the knowledge of: • Premiums earned, • Claims due, • Insurance technical reserves, • And income earned on those reserves. • Countries often derive the data from payments reported by the transactors(directly or indirectly): • Premiums and claims actually paid • Premiums supplements and changes in technical reserves must be derived from other sources (insurance companies balance sheets and profit and loss account provided by supervisory institutions).

43. Conclusions – round table discussion on country practice