Dynamics in Accounting and Auditing related to Insurance Supervision

1. Dynamics in Accounting and Auditing related to Insurance Supervision Peter Cooke, Member of Secretariat International Association of Insurance Supervisors 16 May 2006 IAIS Overview and Activities related to Accounting

2. Outline of Presentation • Introduction to IAIS and its working parties on accounting issues • Insurance Core Principles • IFRS from perspective of insurance supervisors • Insurance Contracts Phase I • Insurance Contracts Phase II • Supervisory Framework and roadmap for solvency assessment IAIS Overview and Activities related to Accounting

3. International Association of Insurance Supervisors IAIS objectives: • cooperate to contribute to improved supervision of the insurance industry on a domestic and international level in order to maintain efficient, fair, safe and stable insurance markets and for the benefit and protection of policyholders • promote development of well regulated insurance markets • contribute to global stability IAIS Overview and Activities related to Accounting

4. IAIS Primary Activities • Develop international standards for insurance supervision • Assist supervisors in implementation of standards • Promote cooperation between insurance supervisors • Coordinate with other financial sector and international organisations IAIS Overview and Activities related to Accounting

5. IAIS organisation chart(as of April 2006) General Meeting Executive Committee Secretariat Budget Committee Financial Outlook Task Force Technical Committee Implementation Committee Regional Coordination Subcommittee Solvency & Actuarial Issues Subcommittee Insurance Laws, Regulations, Practices & Standards Subcommittee Enhanced Disclosure Subcommittee Task Force on Insurance Core Curriculum Financial Conglomerates Subcommittee Insurance Fraud Subcommittee Pension Coordination Group Reinsurance and Other Forms of Risk Transfer Subcommittee ACCOUNTING SUBCOMMITTEE INSURANCE CONTRACTS SUBCOMMITTEE Reinsurance Transparency Group IAIS Overview and Activities related to Accounting

6. IAIS working parties on accounting Insurance Contracts Subcommittee • IASB projects: • Insurance Contracts (Phase II - valuation of insurance liabilities for general purpose accounting) • Financial instruments • Revenue recognition • Chaired by Rob Esson (US) IAIS Overview and Activities related to Accounting

7. IAIS working parties on accounting Accounting Subcommittee • IASB projects not covered by Insurance Contracts Subcommittee • Currently undertaking survey on impact of IFRS 4 implementation upon supervisors • Auditing • Liaison with other bodies, and any other accounting-related issues • Chaired by Tomoko Amaya (Japan) IAIS Overview and Activities related to Accounting

8. IAIS Standard Setting Process • Two tier approach Core Principles Principles Supervisory Standards Guidance & Issues Papers IAIS Overview and Activities related to Accounting

9. Insurance Core Principles Most relevant to Accounting: • ICP 20: Liabilities • ICP 21: Investments • ICP 23: Capital adequacy & solvency • ICP 26: Information, disclosure & transparency towards the market IAIS Overview and Activities related to Accounting

10. Insurance Core Principles ICP 20: Liabilities • The supervisory authority requires insurers to comply with standards for establishing adequate technical provisions and other liabilities, and making allowance for reinsurance recoverables. • The supervisory authority has both the authority and the ability to assess the adequacy of the technical provisions and to require these provisions be increased, if necessary. ICP 21: Investments • The supervisory authority requires insurers to comply with standards on investment activities. • These standards include requirements on investment policy, asset mix, valuation, diversification, asset-liability matching, and risk management IAIS Overview and Activities related to Accounting

11. Insurance Core Principles (cont) ICP 23: Capital adequacy & solvency • The supervisory authority requires insurers to comply with the prescribed solvency regime. • This regime includes capital adequacy requirements and requires suitable forms of capital that enable the insurer to absorb significant unforeseen losses ICP 26: Information, disclosure & transparency towards the market • The supervisory authority requires insurers to disclose relevant information on a timely basis in order to give stakeholders a clear view of their business activities and financial position and to facilitate the understanding of the risks to which they are exposed IAIS Overview and Activities related to Accounting

12. IAIS input to IASB IAIS representation on IASB working groups: • Standards Advisory Council – member (Tomoko Amaya) • Insurance Working Group – 2 seats as official observer (Tomoko Amaya & Rob Esson) • Financial Instruments Working Group – official observer (Rob Esson) Comment letters and papers IAIS Overview and Activities related to Accounting

13. IAIS views on IASB standards • IAIS supports harmonised accounting principles • Consistent approach to measurement of assets and liabilities is essential to meaningful disclosure • IAIS would prefer consistent methodologies for regulatory and general-purpose financial reporting • IAIS is concerned about the possible mismatch in accounting models in phase I of IFRS 4 • IAIS members unanimously against the use of own credit rating in measurement of liabilities IAIS Overview and Activities related to Accounting

14. IFRS 4 – IAIS survey on implementation • Qualitative study by Accounting Subcommittee • Impact on supervisors of implementation of IFRS 4 • Due for publication Q2 2006 • Main themes from survey responses: • Definition of an insurance contract • ‘Mismatch’ between assets and liabilities IAIS Overview and Activities related to Accounting

15. IFRS 4 – IAIS survey on implementation • Main themes from survey responses (cont): • Catastrophe and equalisation provisions • Discretionary participation features • Impact of application of IAS 39 IAIS Overview and Activities related to Accounting

16. Insurance Contracts Phase II First ‘Liabilities Paper’ issued May 2005: • Preferable if the methodologies for financial and regulatory reporting are substantially consistent • Inappropriate for prudential regulatory purposes to require total financial resources (net liability plus equity) backing an insurance contract at less than its current surrender value • Allowing for own credit worthiness is inconsistent with the valuation of insurance liabilities in a going concern and unacceptable for both regulatory and general purpose financial reporting IAIS Overview and Activities related to Accounting

17. Insurance Contracts Phase II First ‘Liabilities Paper’ (cont): • Asset / Liability measurement consistency is especially important in the insurance sector • A bottom up approach is preferable but profit should only be recognised where an appropriate and sufficiently reliable risk margin has been provided for in the value of liabilities • Risk free discount rate utilising the entire yield curve is appropriate, except where the benefits are contractually dependent upon the performance of the underlying assets. For prudential purposes, expected earning rate should be verified against the discount rate IAIS Overview and Activities related to Accounting

18. Insurance Contracts Phase II Second ‘Liabilities Paper’ – draft under consultation, expected to be issued end May 2006. Key principles and observations: • Measurement of an insurance liability should be based upon the future cash flows relating to full settlement with the claimant/beneficiary • The IAIS supports an approach to modelling whereby observable market inputs are used to the fullest extent possible, and the remaining elements are modelled. • A common framework is appropriate to model non-observable inputs as objectively as possible. • Where the amount or timing of future cash flows in uncertain, probability is a crucial factor in measuring the cash flows relating to the contract. IAIS Overview and Activities related to Accounting

19. IASB Insurance Contracts Project - Phase II • An exit model is preferable but profit on inception should be recognised only where an appropriate and sufficiently reliable risk margin in the liability measurement. • Similar obligations with similar risk profiles should redult in similar liabilities. • Any methodology for calculating the margin should share certain characteristics. • The margin should determined in such a way as to promote transparency and comparability between different insurers in an objective manner. • Probabilities which reflect policyholder behaviour regarding the contracts as a whole are needed to achieve meaningful results. • No requirement for application of surrender value floor to insurance liabilities for general purpose accounting. IAIS Overview and Activities related to Accounting

20. Insurance Contracts Phase II • Future cash inflows should be taken into account in the measurement, if integral to the obligations under the contract. • Cash inflows should be offset against outflows • The IAIS would prefer full expensing of acquisition costs at inception with allowance for the future income to recover the costs taken into the measurement. • Discretionary benefits should be treated as liabilities based upon expected future cash flows, as treatment as equity would misrepresentthe financial position. • Derivatives embedded in insurance contracts should be taken into account in the valuation methodology. • The credit standing of an insurer is not relevant to the valuation of insurance liabilities. IAIS Overview and Activities related to Accounting

21. IAIS Framework for Insurance Supervision A new framework for insurance supervision: Towards a common structure and common standards for the assessment of insurer solvency (Framework paper) IAIS Overview and Activities related to Accounting

22. Supervisory action supervisory assessment and intervention LEVEL 3 Regulatory requirements financial governance market conduct LEVEL 2 basic conditions for the effective functioning of the insurance supervisory authority LEVEL 1 Preconditions the insurance sector and insurance supervision IAIS Framework for Insurance Supervision IAIS Overview and Activities related to Accounting

23. IAIS Common structure for solvency assessment ‘Cornerstones Paper’ • Sets out key ‘cornerstones’ for regulatory financial requirements of supervisory framework (October 2005) ‘Roadmap Paper’ • Workplan for the IAIS Solvency project (February 2006) ‘Structure Paper’ (in progress) • Outlines a more detailed philosophy on assessment of insurer solvency, and analysis of main aspects and elements IAIS Overview and Activities related to Accounting

24. International Association of Insurance Supervisors Sources of Information • Website www.iaisweb.org • Newsletter (quarterly) • IAIS published papers • Working party meetings • IAIS annual conference • Training seminars • Contact IAIS iais@bis.org IAIS Overview and Activities related to Accounting

25. IAIS papers most relevant to accounting and financial assessment IAIS Overview and Activities related to Accounting

26. IAIS Standard Setting Activities Questions??? Thank you!! peter.cooke@bis.org IAIS Overview and Activities related to Accounting