Overview

1. Implications of International Financial Reporting Standards onProperty/Casualty Insurance Companies Mary Frances Miller, FCAS, MAAAPresident, Casualty Actuarial SocietyandPrincipal, Select Actuarial ServicesNashville, Tennesseemaryfrances.miller@selectactuarial.com

2. Overview • Terminology • Current practice • IASB insurance project • Phase I changes (IFRS 4) • Phase II potential changes

3. Terminology • Unpaid claim liability, same as -loss reserves • Reserves, same as -technical provisions • Discount – time value of money • Insurance supervisor, same as -insurance regulator • Regulatory accounting, same as -“Statutory” accounting (at least in U.S.)

4. Current practice • No consistency across countries • Some countries have • Equalization reserves • Catastrophe reserves • Some countries have neither • A few allow discounting, but most don’t • Some countries require loss reserves to be set using a fixed rule or formula

5. Current practice(cont.) • Some countries allow management to instead book their “best estimate” • Some let regulator and solvency-related public policy concerns determine local GAAP • Some have separate accounting rules for separate regulator financial reports • Some show reserves net of reinsurance • Some show reserves gross of reinsurance, with ceded amounts as an asset

6. IASB Insurance Project • IASB made the insurance project a priority • Why? -No consistency across the world -No single standard viewed as ideal or preferred -No current IAS standard on insurance -EU wanted to adopt IAS by 2005 -Hence, an opportunity for IASB to provide leadership, and -Needed to meet EU objective

7. IASB Insurance Project • How structured? -Tried to get done in one step -Raced to meet 2005 deadline -Decided it couldn’t make the 2005 deadline *Why? *Fair value *Several issues that are predominately life insurance oriented --Asset/liability consistency --Deposit floor --Renewal premiums -Solution: Break it up into two pieces *Phase I – pieces it could do by 2005 *Phase II – pieces that would take longer

8. Phase I changes (IFRS 4) • IFRS 4 issued 30 March 2004 • Steps that could be taken by 2005: - Limited improvements that could be madewithout risking major reversals in phase II - Enhanced disclosure requirements • Definition of insurance contract

9. Major phase I components affecting P&C insurers • Follow current local GAAP until phase II is issued, except: • No more catastrophe or equalization reserves (for GAAP) • Reserves must be shown gross of reinsurance Ceded reinsurance balances are now a separate asset

10. Major phase I components affecting P&C insurers (cont.) • Follow current local GAAP until phase II is issued, except: • Reserves must be tested (“assessed”) for adequacy at each reporting date No “lock-in” of old assumptions Any “rule” under current GAAP superceded by this test Non-issue for those under U.S. GAAP

11. Major phase I components affecting P&C insurers(cont.) • Follow current local GAAP until phase II is issued, except: • Ceded reinsurance balances must undergo an impairment test “Reinsurance collectibility” test Should be a non-issue for those under U.S. GAAP, but not all may follow this practice

12. Major phase I components affecting P&C insurers(cont.) • Follow current local GAAP until phase II is issued, except: • Unbundling of deposit features required if deposit is both a.) Separable from rest of the contract, and b.) “the insurer’s accounting policies do not otherwise require it to recognize all obligations and rights arising from the deposit component” Example given in the standard that focuses specifically on reinsurance.

13. Major phase I components affecting P&C insurers(cont.) • Follow current local GAAP until phase II is issued, except: • Insurer can decide to discount “designated insurance liabilities” at current market rates Intended to satisfy those worried about assets at market but liabilities not at market If elected, insurer must continue updating those liabilities so “designated” at all future report dates to reflect changes in market interest rates

14. Major phase I components affecting P&C insurers(cont.) • Follow current local GAAP until phase II is issued, except: • Reserves acquired through a “business combination” must be measured at fair value Can split the fair value into two pieces Acquired reserve under local GAAP Adjustment to bring to fair value (“intangible asset”) “The subsequent measurement of this asset shall be consistent with the measurement of the related insurance liability” Not clear what this means. No guidance provided.

15. IFRS 4 – Required Disclosures • “36. An insurer shall disclose information that identifies and explains the amounts in its financial statements arising from insurance contracts”

16. IFRS 4 – Required Disclosures (cont.) • “37. To comply with paragraph 36, an insurer shall disclose: … • (d) the effect of changes in assumptions used to measure insurance assets and insurance liabilities, showing separately the effect of each change that has a material effect on the financial statements.”

17. IFRS 4 – Required Disclosures (cont.) • “38 An insurer shall disclose information that helps users to understand the amount, timing and uncertainty of future cash flows from insurance contracts”

18. IFRS 4 – Required Disclosures (cont.) • “39 To comply with paragraph 38, an insurer shall disclose … • (c ) information about insurance risk (both before and after risk mitigation by reinsurance), including information about: (i) … sensitivity … (ii) concentrations of insurance risk. (iii) … claims development” Item (i) requires sensitivity analysis Item (ii) requires disclosures about concentration Item (iii) requires claim development triangle disclosures

19. IFRS 4 – Required Disclosures (cont.) • Claims development triangles - Q. How many years of development? - A. The number of years that claim uncertainty lasts *But need not be more than 10 *And need not show data prior to 5 years before effective date • The IAA is developing actuarial standards of practice for these disclosure requirements.

20. Phase II potential changes • Asset – Liability approach (and not deferral-matching) No deferred acquisition cost asset Revenue recognized as written Unearned Premium reserve replaced by liability for unexpired portion of policy • Discounted reserves

21. Phase II potential changes(cont.) • Fair value, if “workable in practice” • Fair value would add Risk margins (or “market value margins”) Credit risk adjustment after reflecting government guarantees, etc. • Not yet clear if a fair value standard would be practical in the “real world” • Planned exposure draft – mid 2005.