IASB’s Project on Insurance Accounting

1. IASB’s Project on Insurance Accounting Wayne Upton Research Director International Accounting Standards Board

2. Disclaimer • EXPRESSIONS OF INDIVIDUAL VIEWS BY MEMBERS OF THE IASB AND ITS STAFF ARE ENCOURAGED. THE VIEWS EXPRESSED IN THIS SPEECH ARE THOSE OF THE SPEAKER. OFFICIAL POSITIONS OF THE IASB ON ACCOUNTING MATTERS ARE DETERMINED ONLY AFTER EXTENSIVE DUE PROCESS AND DELIBERATION.

3. Background • Insurance accounting in country X differs from • insurance accounting in country Y • accounting for other sectors in country X • Globalisation of markets and regulation • Developments in financial instruments accounting • Bancassurance • Transparency

4. Insurance Project • Timetable • Critical issues • Measurement objective • Renewal and cancellation options • Risk / market value margins • Field visits • Related IASB projects

5. Timetable • Issues Paper Nov 1999 • Draft Statement of Principles 2001 • internal report to the Board • Board discussions began 2001 • three chapters still to come • Exposure Draft 2002? • Final IAS 2003? • Implementation 2005?

6. Comments on Issues PaperSome common themes • Consistent measure of assets and liabilities • Concerns about fair value • Needs of regulators and policyholders • “Service” vs. “Financial” • Defer & Match vs. Asset & Liability • Cost, complexity, & guidance

7. Scope Insurance contracts (or groups of contracts) NOT All aspects of accounting by insurance enterprises

8. Not Insurance Contracts • Investment products • legal form of insurance but no insurance risk  • Self-insurance • retaining a risk that could have been covered by insurance  • Derivatives • payment does not depend on loss to holder

9. Recognition (1) • Recognise • contractual obligations that are liabilities • contractual rights that are assets • Income and expenses = changes in liabilities and assets

10. Recognition (2) • Do not recognise items that are not assets and liabilities • catastrophe and equalisation provisions • deferred premium revenue that differs from the insurer’s remaining exposure to claims and risks under the contract • deferred acquisition costs

11. Asset/Liability Interaction • Measurement basis for insurance liabilities • consistent with measurement basis for assets • Type of assets (or return on assets) should not affect actual measurement of liabilities • except participating and unit-linked contracts • fair value model: effect of future investment margins?

12. Measurement Objective • DSOP proposal • Entity-specific value or fair value • Board yet to conclude • Concern, profit on initial recognition • Concern, ability to measure risk margin • Concern, alternatives

13. Entity-specific Value • The value of an asset or liability to the enterprise that holds it • may reflect factors that are not available (or not relevant) to other market participants = market value of entity-specific cash flows

14. Fair Value Existing IAS Definition • Amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction = market value of cash flows for a typical market participant

15. ESV and FV – Possible Differences • Different expectations • cash flows (e.g. expenses) • emphasis - orderly settlement with policyholders over the life of the liability, not a hypothetical transaction • amount of risk  • BUT NOT different risk preferences, time preferences or knowledge • Own credit standing

16. Embedded Value? • Some similarity with ESV and FV, BUT • includes future investment returns • Capital lock-in

17. Renewal Options (1) • Include if: • they increase the liability; or • policyholders hold uncancellable renewal options that are potentially valuable • Can a written option be an asset? • Same issue for cancellation options

18. Renewal Options (2) • Parallels • bank deposit liabilities • credit card receivables • prepayable mortgage loans • cancellable leases • cancellable long-term supply contracts (e.g. pharmaceuticals)

19. Risk (1) • Market value margin: • as in price of arm's length transaction between knowledgeable, willing parties • reliability? • disclosure? • Option pricing

20. Risk (2) • Undiversifiable risk • clearly included • Diversifiable risk • more controversial • whose perspective?

21. Diversifiable Risk (1) • Arguments for including: • more intuitive • relevant for insurers and policyholders • basis for actual pricing in insurance market transactions

22. Diversifiable Risk (2) • Arguments for excluding: • finance theory says not relevant for capital market participants • harder to find market price for diversifiable risk • unit of account – level of aggregation becomes more critical

23. Field Visits • Key themes • cost of implementing a prospective approach – but may be justified by benefits • subjectivity of market value margins - need more guidance • stochastic models – most agree conceptually, but have implementation concerns • non-insurance contracts – need more guidance in IAS 39 • technical and human resources • Field testing – with ED?

24. Active IASB Projects(1) • Insurance Contracts • Improvements • IAS 39 • general • Financial Activities: Disclosure and Presentation

25. Active IASB Projects (2) • First-Time Application of IFRS • Performance Reporting • Business combinations (phase I) • Share-based payments

26. Potential IASB Projects • Liabilities and Revenue Recognition • Definitions of Elements of Financial Statements • Accounting Measurement • Financial Instruments • Intangible Assets • 11 others

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