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Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame. PwC. *connectedthinking. Agenda. History of the IASB Insurance Project Summary of the Discussion Paper. History of the IASB Insurance Project. History of the IASB Insurance Project. 1998. 1999. 2000. 2001. 2002.
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Discussion Paper Preliminary Views on Insurance ContractsSabine Wuiame PwC *connectedthinking
Agenda • History of the IASB Insurance Project • Summary of the Discussion Paper
History of the IASB Insurance Project 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1997 • IASC starts insurance project in 1997 • “Issue Paper” published in 1999 – followed by issuance of a “Draft Statement Of Principles” • Not feasible to complete a project on insurance contracts before 2005. • Phase I = IFRS4 = Wide variety of accounting practices • DP issued on 3rd May 2007 • Comment period : 16 November • Will be used to develop Exposure Draft (? End 2008/2009) • Final Standard should be published in +/- End 2009/2010? • Effective transition date more than one year later (Jan. 2011?) Start of insurance project December: Issue Paper /DSOP Project split in two phases March: IFRS4 May: D.P. ED? IFRS?
Principles of Phase I – IFRS4 • Contract classification and measurement: • Insurance contracts and investment contracts with dpf : IFRS4 • Investment contracts with no dpf: IAS39 • Phase I of the insurance project (IFRS4) is an interim phase • Continuation of local accounting policies with amendments: • Elimination of equalisation reserves • Liability adequacy test • Reinsurance impairment test • Change in accounting policies permitted: • Aimed at eliminating accounting mismatch • Shadow accounting • Use of current interest rates • Extensive disclosure requirements
Convergence with other projects • Convergence project with US GAAP • Convergence with other IASB projects • Revenue recognition • Fair value measurement • Financial instruments • IAS37 • Framework • Definitions of liability and equity • Financial statements presentation • Convergence with Solvency II
Summary of the Discussion Paper • Published in May 2007 • 7 Chapters: • 1-Scope • 2-Recognition and Derecognition • 3-Measurement - core issues • 4-Policyholder behaviour, customer relationship and acquisition costs • 5-Measurement- other issues • 6-Policyholder participation • 7-Changes in insurance liabilities
Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities
Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities
Scope • Definition of an insurance contract in IFRS4: • “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” • Insurance liability = insurer’s obligations under an insurance contract • Insurance asset = insurer’s rights under an insurance contract • Applies to all types of contracts (life, non life, accepted reinsurance)
Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities
Measurement • Concept of “current exit value” • Based on building blocks Service Margin Risk Margin Current exit value Best estimate of future cash-flows Discount Rate
Measurement • Best estimate of future cash-flows (1) • No detailed guidance • Explicit • Consistent with observable market prices • If observable: direct inputs without adjustments • Not observable : • All available data, external and internal • Should not contradict market data • Include – in an unbiased way- information about amount, timing and uncertainty of all cash flows • Full range of possible outcomes and their probabilities
Measurement • Best estimate of future cash-flows (2) • Current • >< “locked-in” assumptions • Exclude entity-specific cash-flows • Economic characteristics of the liability • Do not capture CF arising from synergy with other assets and liabilities • Do not capture CF that are specific to the insurer and would not arise for other market participants with the same obligations • Portfolio specific vs entity specific
Measurement • Discount rate • Applies to all types of contracts • Including non life • Should not reflect the characteristics of the assets • Consistent with observable current market prices for cash flows whose characteristics match those of the insurance liability • No detailed guidance
Measurement • Risk margin (1) • Effects of uncertainty • Liability with fixed cash flows vs liability with uncertain cash flows • “Explicit and unbiased measurement of the compensation that entities demand for bearing risk” • NOT a shock absorber • Captures all risks associated with liability • List of compliant actuarial methods • Should not reflect the benefits of diversification between portfolios and negative correlation between portfolios
Measurement • Risk margin (2) • Calibrating the risk margin per unit of risk • Two approaches: • Implementation A : calibrates at inception directly to actual premium charged (less relevant acquisition costs) • Need to define acquisition cost, liability adequacy test • Implementation B: use actual premium only as reasonableness check • Profit at inception • Majority of Board Members in favor of implementation B
Measurement • Service margin • Insurer might provide other services as well • Should be included if market participants require such a margin
Measurement • Future premiums • Future premiums (+ related benefits) included if any of the following criteria is met: • Policyholder must pay premium to retain guaranteed insurability • The insurer can compel the policyholder to pay the premium • Including the premiums and the resulting policyholder benefits will increase the measurement of the liability
Measurement • Acquisition costs • Should be recognized as an expense • Not as the cost of an asset
Measurement • Assets backing insurance contracts • Phase I: accounting mismatches • Existing options to avoid accounting mismatches • Assets at fair value through P&L • Fair value model for investment property • These are not required • Shadow accounting • Shadow accounting no longer relevant for non-participating insurance liabilities • For participating business • Could be considered if assets classified as “available for sale”
Measurement • Reinsurance assets • No offset • Current exit value • Risk of default (or disputes) of the reinsurer should be considered based on the expected loss model
Measurement • Unbundling • Preliminary view based on interdependence : • If components so interdependent that can be measured only on an arbitrary basis, Phase II should apply to the whole contract • If components not interdependent, Phase II applies to insurance component and IAS39 applies to the deposit component • If components interdependent but can be measured on basis that is not arbitrary, then insurance component = measurement of whole contract under Phase II less IAS39 measurement of deposit component
Measurement • Other • Current exit value should reflect liability’s credit characteristics • Unit of account does not affect the expected PV of future cash flows • No specific proposals for investment contracts
Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities
Participating contracts • Discretion (with constraints) over amount or timing of distribution to policyholders • Definition of DPF is not discussed • Is such right creating a liability? • Include in each scenario policyholder dividends that satisfy a legal or constructive obligation at the reporting date • Applies to participating insurance and investment contracts
Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities
Changes in Insurance Liabilities • Are insurance premiums revenue or deposits? • No preliminary view yet • No preliminary view yet on separate presentation of specified components of the changes in insurance liabilities: • Income or expense at inception of new contracts • Cash flows • Expected changes • Changes in circumstances • Policyholder participation • Income or expense from reinsurance held • Effects of business combinations and changes in foreign exchange rates
Changes in Insurance Liabilities • Profit or loss should include all changes in the carrying amount of insurance liabilities