By: FARRUKH REHMAN Partner, A.F. Ferguson & Co. a member firm of the PwC network

1. A PRESENTATION ON MODIFIED ACCOUNTING REGULATIONS FOR INSURANCE COMPANIES By: FARRUKH REHMAN Partner, A.F. Ferguson & Co. a member firm of the PwC network Date: 20 August 2013

2. Scope • Draft Insurance Accounting Regulations, 2012 were issued by SECP on 19 November 2012 • Therefore, this presentation covers the applicability and changes applied through these regulations.

3. Session to cover: • Developments in respect of Accounting Regulations for insurance companies in Pakistan • Some concerns in existing Accounting Regulations • Changes in presentation of Published Financial Statements • Presentation of Insurance Liabilities for life insurers • Applicability of IAS-27, IAS-39 & IAS-40 • Recognition of Cover Note in the books of accounts • Explanation of management and other expenses – non-life insurers • Change in premium deficiency requirement • Key issues identified in modified regulations

4. Prior to the Insurance Ordinance, 2000 the concept of Accounting Regulations alongwith the prescribed format of financial statements was also given in Insurance Act, 1938. The Accounting Regulations were basic and the formats of financial statements were not keeping pace with the changes happening in the world with respect to the International Accounting standards. • The Insurance Ordinance, 2000 brought about number of changes for the insurance industry and there under the new Accounting Regulations & formats of financial statements were introduced in 2002. The accounting regulations both for life and non life segments were detailed enough to address all aspects of the insurance transactions. The financial statements formats were also largely brought in line with International Accounting Standards. • Some of the major changes included method of premium income, recognition of IBNR claims, creation of separate statutory funds for life business, introduction of premium deficiency etc. This was considered a major change at that time. Developments in respect of Accounting regulation for Insurance companies 4

5. Developments in respect of Accounting regulation for Insurance companies – contd. With the passage of almost 10 years now there have been further developments in the International Accounting Standards relating to insurance. In 2004, the first Insurance specific IFRS-4 was issued and SECP made this applicable for insurance companies from period commencing from 1 January 2009. IFRS -4 did not change the existing accounting practices in any substantive way. It catered more of disclosure requirements than recognition and measurement. Recently the IASB has issued exposure draft of IFRS-4 as part of its phase II for developing insurance specific standard. This is expected to change significantly the recognition and measurement requirements of insurance industry. 5

6. Some concerns in existing regulations • Difference in Financial Statements for Insurers and Other Sectors under the International Financial Reporting Standards (IFRS) • Total earnings of the Life Insurer not reflected completely • Consolidated financial statements are not required for investment by statutory funds • Applicability of IAS 39 and IAS 40 • Issues relating to calculation and classification of incurred but not reported claims – IBNR • Correct classification / allocation of Management Expenses • Recognition of Cover Note in the books of accounts • No basis of preparation for Statement of Exposures 6

7. Changes in presentation of Published Financial Statements • The modified accounting regulations now prescribes format of Financial Statements in accordance with International Accounting Standards. • A complete and detailed illustrative accounts have now been provided in Published Financial Statements format by SECP. This has been done to provide consistency across the insurance sector as done in banking sector. • A comparison of existing and revised Statements comprising Financial Statements is given in the following slide.

8. Changes in presentation of Published Financial Statements - contd . • Statement of financial position • Statement of comprehensive income • Statement of cash flows • Statement of changes in equity • Notes to the accounts • Balance sheet • Profit and loss account • Statement of cash flows • Revenue account - • (for life insurers only) • Statement of premiums • Statement of claims • Statement of expenses • Statement of investment income • Notes to the accounts

9. Comparison of balance sheet (Life insurers)

10. Comparison of balance sheet (Life insurers) – contd.

11. Comparison of profit and loss (Life insurers)

12. Comparison of balance sheet (Non - life insurers)

13. Comparison of profit and loss (Non - life insurers)

14. Change in presentation of Financial Statements - contd . Segmental information to be disclosed • The segment information which at present is given on the face of the profit and loss account and the information in the statements of premiums, claims, investment income and expenses have now been presented in the note Segment Information. • Revenue Account in the life insurers financial statements now also forms part of the Segment Information. Additionally Segmental results by line of business are now to be disclosed: • an analysis between group life, group health, individual life distributed through direct sales force, individual life distributed through banks; • an analysis between business written in Pakistan and business written outside Pakistan. 14

15. Presentation of insurance liabilities • One of the major changes in the modified accounting regulations for life insurers relates to the classification of insurance liabilities: • Balance of statutory funds • Previously, retained earnings accounts A to D were part of balance of statutory funds which was disclosed after the Shareholders’ Equity. • In the modified accounting regulations retained earnings accounts C and D, which are effectively arising out of surplus of the statutory funds attributable to the shareholders are therefore made part of shareholders’ equity.

16. Presentation of insurance liabilities – contd. • Incurred But Not Reported Claims (IBNR) • IBNRs were previously made part of Policyholder Liabilities on the basis that these are determined by actuaries and payable to policyholders. However, the nature of IBNR is different from policyholder liabilities in that IBNR is something where the claim event has actually happened but yet to be reported to the insurer. Whereas, policyholder liability is in respect of future event. The revised format of Financial Statements includes IBNR as insurance liabilities after outstanding claims.

17. Presentation of insurance liabilities – contd. • POST CHANGE BALANCE SHEET LINE ITEMS • Insurance Liabilities • Unappropriated Profit / (Loss) • Insurance Liabilities include: • Outstanding claims • IBNR • Policyholder liabilities • Balance in ledger account A • Balance in ledger account B EXISTING BALANCE SHEET LINE ITEMS • Outstanding Claims • Balance of statutory fund Balance of statutory fund includes: • Policyholder liabilities (including IBNR) • Balance in ledger account A • Balance in ledger account B • Balance in ledger account C • Balance in ledger account D

18. Applicability of IAS 27, IAS 39 and IAS 40 • As per existing regulations, insurers are given certain exemptions from IAS 27, IAS 39 and IAS 40. • However, revised regulations have encouraged compliance with IFRS, therefore these exemptions have been withdrawn. • These are presented in next slides.

19. Applicability of IAS 27, IAS 39 and IAS 40 – contd. • Applicability of IAS 27 • As per existing regulations, consolidated published financial statements in respect of investments made through statutory funds is not required to be presented. However, this exemption has been withdrawn in modified regulations.

20. Applicability of IAS 27, IAS 39 and IAS 40 – contd. • Applicability of IAS 39 • The existing regulations requires available for sale investments to be valued at lower of cost or market value. • Now the accounting regulations adopts the requirements of IAS 39 completely and all investments requiring marked to market will be valued accordingly.

21. Applicability of IAS 27, IAS 39 and IAS 40 – contd. • Applicability of IAS 40 • Under IAS 40 companies have the option to select accounting policy of valuing investment property either on cost or fair value basis. The existing regulations however provides restriction and do not allow the use of fair value option. The revised accounting regulation removes this restriction.

22. Recognition of Cover Note in the books of accounts • In non-life insurance business, particularly in Marine Insurance there is a practice of issuing cover notes for temporary period which remain in force until the insurance policy is issued. It was observed that the insurance companies start recognising the accounting for such transactions only when the insurance policy is issued. However, it was viewed that the company needs to record the transaction since its inception. • The existing and revised requirements of the accounting regulations are in the next slide:

23. Recognition of Cover Note in the books of accounts- contd. • EXISTING • Premium receivable under a policy shall be recognised as written from the date of attachment of the policy to which it relates. REVISED Premium receivable under a policy / cover note shall be recognised as written from the date of attachment of risk of the policy /cover note.

24. Explanation of management and other expenses – non-life insurers • Previously, there was no explanation of ‘expenses’ and ‘general and administrative expenses’ for non-life insurers. However, in modified accounting format ‘management expenses’ and ‘other expenses’ have been identified. • Following are included in other expenses in modified format: • Legal and professional fee other than business related • Auditors’ remuneration • Subscription • Registration fee • Expenses of bonus issue • Donations • Workers Welfare Fund

25. Change in premium deficiency requirement Revised The provision for premium deficiency (liability adequacy test) shall be recognised in accordance with the requirements given in International Financial Reporting Standard 4 – Insurance Contracts. • Existing • Where the unearned premium liability for any class of business is not adequate to meet the expected future liability, after reinsurance, from claims and other expenses, including reinsurance expense, commissions and other underwriting expenses, expected to be incurred after balance date in respect of policies in that class of business in force at balance date, a premium deficiency reserve shall be recognised to meet the deficit.

26. Change in premium deficiency requirement– contd. Liability adequacy test If an insurer's liability adequacy test meets the minimum requirements as above, the test is applied at the level of aggregation specified in that test. Liability less related deferred acquisition cost and intangible assets Current estimates of future contractual cash flows IF • then recognise deficiency in profit and loss

27. Key issues highlighted in modified regulations – life insurance • Possible adverse impact of taxation • The taxability of life insurers is computed as per the provisions of Fourth Schedule of Income Tax Ordinance, 2001. As per the Fourth Schedule only the amount of surplus transferred from revenue account to profit and loss account is subject to taxation. • The existing regulations present separate revenue account and profit and loss account in which the transfer of surplus from revenue account to profit and loss account is separately disclosed. 27

28. Key issues highlighted in modified regulations – life insurance – contd. • Possible adverse impact of taxation • In the modified accounting regulations there will be no revenue account and profit and loss account is prepared on a combined basis for all statutory funds and shareholders fund therefore, the transfer of surplus would not be separately identifiable on the face of profit and loss account. • The life insurance industry strongly feels that unless the requirements of Income Tax Ordinance are changed to reflect the new accounting regulations, taxation authorities may create huge demands on the insurance companies. 28

29. n Key issues highlighted in modified regulations – life insurance – contd. • The amount representing solvency margin in account D shall not be taken as equity. • The surplus of any statutory fund which is not yet transferred to profit and loss account is disclosed as ledger account D relating to non participating business. This amount may be held in view of solvency margins. It is viewed that since there is a restriction on transfer such amount should be treated as liability. 29

30. n • Thank you