2008 General Meeting Assemblée générale 2008 Toronto, Ontario

1. Canadian Institute of Actuaries L’Institut canadien des actuaires 2008 General Meeting Assemblée générale 2008 Toronto, Ontario

2. Contract Classification Jim Doherty November 2008

3. Agenda • Contract Classification • A few odds and ends

4. Contract classification • Contract classification defines the accounting treatment. • i.e. How the liability will be measured on the balance sheet • Financial Instruments – IAS 39 • Amortized Cost or Fair Value • Insurance Contracts – IFRS 4 • Existing accounting measurement • Discretionary Participation Financial Instruments • Existing accounting measurement

5. Contract classification • The most significant impacts expected • Financial Instruments (Investment contracts) • Unbundling of contracts (embedded derivatives)

6. IFRS • Measurement • Current C GAAP - insurance enterprise level • IFRS 4 - at the contract level • Requires contracts to be classified • Insurance contracts (IFRS 4) • Financial Instruments (IAS 39 – IAS 32) • Service Contracts (IAS 18)

7. Definition of an insurance contract • 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. IFRS 4 Appendix A

8. Insurance Risk • Insurance risk is risk, other than financial risk, transferred from the holder of a contract to the issuers • Financial risk is the risk of a possible future change in one or more of a specified interest rate, financial instrument price, … or other variable • provided in the case of a non-financial variable, that the variable is not specific to a party to the contract. • If both financial risk and significant insurance risk are present, contract is classified as insurance. IFRS 4 Appendix A

9. Significant Insurance Risk • pays significant additional benefits in any scenario • even if the insured event is extremely unlikely • even if the expected (i.e. probability-weighted) present value of contingent cash flows is a small proportion of the expected present value of all the remaining contractual cash flows IFRS 4 Appendix B - B22-B28

10. Significant Insurance Risk • If an insurance contract is unbundled into a deposit component and an insurance component, the significance of insurance risk is assessed by reference to the insurance component. • The significance of insurance risk transferred by an embedded derivative is assessed by reference to the embedded derivative. • Not by reference to materiality in the financial statements

11. Significant insurance risk • Additional benefits include • Payments contingent on insurance risk • Term insurance • timing risk • Whole life contract (payment known, timing unknown) has additional benefits • Contract where death benefit is equivalent to maturity benefit (if the maturity benefit is adjusted for time value of money) does not have additional benefits

12. Quantitative measures • IASB has (and will) not provide quantitative guidance • Rules of thumb currently being adopted • Benefit paid on death exceeds benefits payable on survival by more than x% • Plausible scenario exists under which the death benefit exceeds the survival benefit by x% or more at any time during the policy term • Benefit payable on survival exceeds the benefit payable on death by more than x%

13. Significant Insurance Risk • Document your definition of significant • This is your value for “x%” • And the quantitative measures used • Obtain concurrence of auditor • Apply consistently across all contracts

14. Contract Classification • Tends to be a more complicated issue for Life and Health Insurance • a number of products may have been created primarily for investment purposes • However, due to the somewhat liberal definitions in IFRS 4 • most Life & Health Insurance contracts are expected to meet the insurance contract threshold • but an insurer still needs to conduct an analysis of it’s contracts!

15. Contract Classification • Remember that the classification is at a contract level and not at a product level. • Contracts entered into simultaneously with the same policyholder count as one contract • Classification is done as at the date of inception

16. Contract Classification • Homogeneous blocks • Contracts may be classified homogeneously on materiality grounds • Relatively homogeneous book known to consist of contracts that all transfer insurance risk • need not examine each contract

17. Contract Classification • Depends on the facts and circumstances of the contract terms • Document these and the rationale for the conclusion reached • Particularly for complex products or where judgement was required • Obtain auditor concurrence

18. Classification flowchart Are any elements of the benefit driven by discretionary participation Classified as an investment contract Product is an Investment Contract with discretionary participation features Yes No Deposit component Product is an Investment Contract without discretionary participation features No Is there significant insurance risk present in the contract? Insurance and deposit components of contract must, if not recognised, be unbundled and valued separately Insurance component Yes Yes Is there a deposit component to the contract? If so, is the deposit component independent of the insurance cash flows? Insurance features present in contract Product is an Insurance Contract No

19. Life Insurance Bifurcation or TBD? Insurance Not Insurance Variable Universal Life Individual Insurance Universal Life Term Par Fixed Payout Annuity Life Contingent Payout Annuities Annuities Fully Insured Plan Experience Rated Refund Administrative Services Only Group Insurance

20. Individual Insurance • Term Insurance • Whole Life • T 100 • CI • DI • LTC • Riders

21. Individual Insurance • UL • VUL • VL • Index Linked

22. Group L&H • Health • LTD • Life • Affinity • ASO • ERR • Hold Harmless agreements

23. Payout Annuities • Life • Settlement • Structured Settlement • Fixed • Index Linked

24. Seg Funds / VA • Group • Individual

25. Seg Funds / VA • GMDB • GMMB • GMDB + GMMB • GMWB • Fixed • Life • GMDB + GMWB

26. Seg Funds / VA • Normally a return of a % of premium on a unit-linked contract would classify the contract as insurance. • IFRS requires only a single scenario for the contract to be insurance. • A situation where this may be questioned is if the fund is cash or bonds (depending on duration) • Need to determine if there really is a chance that the death benefit would become significant.

27. Seg Funds / VA • GMDB combined with GMMB • Paragraph B27 • additional benefits can be the requirement to pay benefits earlier • if the insured event occurs earlier and • the payment is not adjusted for the time value of money

28. An aside • Seg funds are on balance sheet – one line for the assets and one for the liabilities • Treasury shares • where the segregated funds hold shares of the insurance company • these will probably have to be eliminated from the asset side as treasury shares, but kept on the liability side

29. Deferred Annuities • Individual • Annuitization benefit on a guaranteed basis • No MV adjustment on death • Group • Deposit Administration

30. Reinsurance • Life & Health • Financial

31. Another aside • Deferred Tax • CIA SOP • IAS 12

32. Contract Classification • IBNR • Claims in the course of payment • Dividends / Premiums / Proceeds on Deposit • Advance Premiums

33. Contract Classification • Facts and circumstances • Document these and the rationale for the conclusion reached • Particularly for complex contracts or where judgement was required • Obtain auditor concurrence

34. And another aside • If the contract is a financial instrument and measured at amortized cost under IAS 39 • Need to check for embedded derivatives

35. Discretionary Participation Feature • A contractual right to receive, as a supplement to guaranteed benefits, additional benefits: • (a) that are likely to be a significant portion of the total contractual benefits; • (b) whose amount or timing is contractually at the discretion of the issuer; and • (c) that are contractually based on: • (i) the performance of a specified pool of contracts or a specified type of contract; • (ii) realized and/or unrealized investment returns on a specified pool of assets held by the issuer; or • (iii) the profit or loss of the company, fund or other entity that issues the contract.

36. IAS 39 • If a Financial Instrument has a discretionary participation features (DPF) • The whole contract is valued using IFRS 4. • If the deposit element can be separated, then it may be accounted for under IAS 39 - but this is at the choice of the insurance company • There are requirements to check that the liability held is at least as big as that which would be held under IAS 39.

37. Questions

38. Canadian Institute of Actuaries L’Institut canadien des actuaires 2008 General Meeting Assemblée générale 2008 Toronto, Ontario