IFRS Developments and Product Challenges in Canada

1. Canadian Institute of Actuaries L’Institut canadien des actuaires 2007 General Meeting Assemblée générale 2007 Montréal, Québec

2. IFRS Developments and Product Specific Challenges Dan Doyle, FCIA Partner PricewaterhouseCoopers LLP Tim Deacon CA, CPA Vice President – Int’l Accounting & Policy Manulife Financial

3. Agenda • Solvency II – MAC Vision Paper • Overview of IFRS and Related Transition in Canada • Brief Overview of Insurance Accounting Under IFRS • IASB Discussion Paper – Insurance Contracts: • Overview • Key Framework Components • Comparison of Canadian GAAP vs. IFRS • Controversial Topics • How to Prepare for Double Conversion • Lessons learned from Europe • Questions

4. Solvency II and Economic Capital

5. Regulatory/Economic Capital

6. MCCSR- Current • Factor Based • No Correlation

7. Solvency II- Canadian Version • MCCSR Advisory Committee (MAC) Vision Paper • Principle based • Integrated asset Total Balance Sheet (TBS) • Two levels of capital • Minimum • Target

8. Solvency IIFocus on Total Asset Requirement Assets Liabilities & Capital required capital solvency buffer margins total asset requirement best estimate policy liability CGAAP policy liabilities expected asset requirement Required capital to be determined indirectly: Required = Total Asset - Reported GAAP Capital Requirement Liabilities

9. Solvency II- Canadian Version MAC Vision Paper • Target Asset Requirements • 99% Conditional Tail Expectations (CTE) • 1 year time horizon • Account for risk mitigation & risk dependencies • Standard or Advanced technique

10. Risk Classification Operational Risks Total Risk Liquidity Risks Group Risks Financial Risks Insurance Risks Credit Risks Market Risks Interest Rates P&C Life Defaults Capital Mobility Equity Migration Group Internal Risk Premium Risk Biometric Reinsurers Shares Group Behavior Risk Small Claims Real Estate Mortality Concentration Regulatory Risks Alt Invest. Longevity Large Claims Model Morbidity Catastrophes FX Reactivation Policyholder Reserve Risk Spreads Concentration Lapse quantitatively qualitatively Other options Model Cost

11. Economic Capital • “Sufficient surplus to cover potential losses at a given tolerance level over a specified time horizon” • Looks like Solvency II – Canada • 99% CTE • 1 Year • Terminal provisions

12. Banks - Basel lI • Banks have already developed EC/RC models • Expertise in a model building and stochastic processes exist

13. Bank Lessons • Lack of data to develop some correlations • Correlations behave differently under stress • OSFI will defer full benefits • Timelines are significant • Evolving process

14. IFRS

15. Overview of IFRS • International Financial Reporting Standards (IFRS) are a set of global accounting principles set by the International Accounting Standards Board (IASB). • More than 100 countries and most of the major stock exchanges (outside US) have mandated the use of IFRS for public companies. • Many global peers already report under IFRS. • Foreign subsidiaries (i.e. HK and Singapore) may already report under IFRS for local statutory purposes.

16. Transition to IFRS in Canada • Migration to IFRS over next 4 years – 2011 expected implementation date • Final CICA transition plan to be released by March 2008 • Numerous moving parts - need to watch the horizon: • Insurance contracts standard (double conversion) • Number of current IASB projects (derecognition, consolidation of VIE’s) will change existing standards • Joint FASB projects (Memorandum of Understanding) • CICA “Migration” plan • SEC rule to eliminate US GAAP reconciliation for foreign private issuers that file financial statements under IFRS. • SEC concept release regarding ability for domestic US registrants to file financial statements under IFRS.

17. Transition to IFRS in CanadaKey Milestones January 1, 2011 changeover to IFRS Dec 31-08 Dec 31-09 Dec 31-10 Mar 31-11 Dec 31-11 First annual IFRS-based financial statements Disclose IFRS convergence plan and anticipated effects Disclose IFRS convergence plan including quantification of anticipated effects and Opening Balance Sheet under IFRS (Jan 1, 2010) First comparative figures under IFRS First quarterly IFRS-based financial statements and First OSFI Filing under IFRS

18. Brief Overview of Insurance Accounting Under IFRS (Pre Discussion Paper) • Very limited guidance for insurance contracts available under current IFRS. • IFRS 4 – “Insurance Contracts” permits entities to retain previous basis of accounting (i.e. CALM) for contracts that are within scope. • If a contract is not in scope, an entity must follow other IFRS guidance (i.e. IAS 39). • IFRS 4 currently under revision – IASB issued Discussion Paper on recognition and measurement of insurance contracts – proposing use of “current exit value”

19. Brief Overview of Insurance Accounting Under IFRS • IFRS 4 has limited scope but does contain the following: • Definition of an insurance contract • Prohibits recognition of catastrophe and equalization provisions • Prescribes a liability adequacy test • Permits (not requires) unbundling and shadow accounting • Reinsurance balances (I/S and B/S) must be shown on gross basis • Addresses discretionary participation features • Embedded derivatives • Increased disclosure requirements

20. Brief Overview of Insurance Accounting Under IFRS – Some Definitions Insurance contract - ‘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 risk is significant if, and only if, an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance

21. Deposit Component Insurance Component Brief Overview of Insurance Accounting Under IFRS – Product Classification Flowchart Does contract contain significant insurance risk? Yes No Does the contract need to be unbundled? Are any discretionary participation features present? No Yes No Yes Investment Contract with discretionary participation features Insurance Contract Investment Contract (IAS 39) Amortized Cost or FV Use CALM Liability or equity

22. Brief Overview of Insurance Accounting Under IFRS – Deferred Acquisition Costs • Under IAS 39, Deferred Acquisition Costs must be expensed unless: • Amortized cost method used for valuing liability: • “Transaction Costs” must be incremental and directly attributable and does not include internal allocation of administrative expenses or allocation of overheads. • Effectively non-commission expenses are likely to be expensed unless they wouldn’t have been incurred if the contract was not issued. • Relate to securing right to receive Investment Mgmt fees: • Capitalised as an intangible asset representing the right to receive this revenue if can separately be measured. • Asset is amortized as entity provides the services and recognizes related revenue. • Difference to existing CGAAP and US GAAP.

23. IASB Discussion Paper – Insurance Contracts – Overview Phase II Draft IFRS published – Dec 08? IASB Discussion Paper published – May 07 Discussion Paper Comments – Due Nov 07 Phase II IFRS published –Dec 09? Phase II IFRS effective date – 1 Jan 2012? Phase II work begun – Jul 04 • CICA has stated it will adopt these standards for Canada once final standard approved by IASB • Under Insurance Companies Act in Canada, these GAAP standards would also become core policy liability standard for OSFI regulatory reporting We are here

24. IASB Discussion Paper- Key Framework Components Principle Comments • Single model for Life and Non-life • Valuation answers question “What are assets and liabilities?”, not “What assets are sufficient to discharge liabilities with sufficient assurance?” • Insurance liabilities made-up of three basis building blocks • expected future cashflows • margin • effect of time value of money (discounting) Similar accounting model for all insurance contracts Implications are assets and liabilities are valued independentlyAssumptions must be appropriate from 3rd party perspective All assumptions must be kept current, with changes capitalized in current period

25. IASB Discussion Paper - Key Framework Components Principle Comments Probability weighted requirement could mean significant model complexity if rigorously required Risk margins do not include asset related (C1 and C3) risks Method to get risk margins under debate (cost of capital, quantile) Expected to require current market risk free discount curve with perhaps some adjustment for liquidity premium No discounting of tax assets or liabilities in policy liabilities • Expected future cashflows should be explicit, current, market consistent and probability weighted • Margins include a risk margin and service margin and should be market consistent, current, and portfolio based • Discount rates are current market rates set independently of expected return on assets held

26. IASB Discussion Paper - Key Framework Components Principle Comments Approach described as “current exit value” under which valuation is intended to be consistent with cashflows/assumptions that a transferee would use in acquiring the block Practically, would expect a high hurdle to recognize profit at issue No explicit DAC asset Liability reduction from margins in premium/revenue capitalized in reserve Term for valuation ends at point at which insurer can cancel contract or adjust it in unconstrained way, unless extending term increases the liabilityMay not be all expected premiums, but just the minimums to keep policy in-force if there is a significant discretionary element (e.g. UL) Liability reduction from margins in premium/revenue capitalized in reserve • All assumptions, margins and discount rates must be kept current with impact of changes capitalized in current period • Gain/Loss permitted at contract inception • Acquisition expenses expensed immediately but offset by implicit liability reduction • Contracts valued over term to which insured has guaranteed insurability • Contractual cashflows include future premiums required to keep contract in-force

27. IASB Discussion Paper - Key Framework Components Comments Principle Definition of constructive obligation not yet clear – may be very restrictiveSame issue applies to adjustable contract elements such as credited interest rates Theoretically, value of liabilities reduced as company credit standing reduced – not expected to have material impact • Participation features (e.g. dividends) reflected only to extent there is a legal or constructive obligation to pay the dividends • Insurer own credit standing to be reflected in liability valuation

28. Comparison of CGAAP (CALM) vs IFRS • CGAAP and international models contain a number of similarities in basic framework with the exception of the approach to discounting and treatment of asset/liability mismatch • Canadian model is considered to be most similar to international model • There are a number of differences in details that could make application quite different

29. Comparison of CGAAP (CALM) vs. IFRS – Framework (third party perspective and different margin methods) (but no provision toextend term to offset acquisition expenses)

30. Comparison of CGAAP (CALM) vs. IFRS – Framework (cont’d) (more rigorous) (limits on discretionary premiums) (but potentially significant restrictions. Also classification liability vs. equity) (risk free) (insurance contracts only)

31. Comparison of CGAAP vs. IFRS – Profit Emergence Components

32. IASB Discussion Paper - Controversial Topics – Draft Framework • Discount rate approach • use of risk free discount rates will not allow companies to anticipate in the valuation earning positive spread on fixed income assets or yield premium on non-fixed income assets – disconnect from pricing and economic management • potential to cause significant earnings strain at issue • unclear how rates will be set where there is an observable curve (e.g. beyond 30 years) • a model where assets are held at fair value and liabilities discounted at current market curves will show significant volatility from spread changes, risk free rate movement for mismatch position and, movements in fair value of non-fixed income assets supporting liabilities

33. IASB Discussion Paper - Controversial Topics – Draft Framework

34. IASB Discussion Paper - Controversial Topics – Draft Framework • Elements that drive liability cashflows away from true best estimates • Potential exclusion of discretionary future premiums above those needed to keep contract in-force, even where those premiums expected • could be material impact for UL and distort earnings emergence • Requirement that policyholder dividends or other contract adjustment consistent with future expected assumptions can only be reflected if legally required or the result of a constructive obligation • unclear what is sufficient to be deemed a constructive obligation • Liability vs. equity classification • could materially distort earnings emergence • Valuation term limitations may limit revenue capitalization to offset acquisition expenses • deposit annuities could be most impacted

35. Universal Life ExampleMid & Max funded policies

36. IASB Discussion Paper - Controversial Topics – Draft Framework • Inclusion of own credit standing adjustment to discount rates • this concept has counter intuitive result of reducing liabilities as credit rating is lowered • Requirement that best estimate assumptions be probability weighted • if applied rigorously, could require advanced multi path modeling for all risks in all products • would be very significant development/implementation issue • Lack of clarity around methods to establish margins • significant uncertainty around profit emergence patterns, and what will be acceptable methods to set margins • “Cost of Capital” method is favoured • Lack of clarity around impact of “third party perspective” and how this will be measured • details of paper tend to suggest that assumptions would start with internal perspective and only be adjusted for evidence that they are not appropriate from market perspective

37. How to prepare for “Double Conversion” • Unlikely final insurance contract standard in place before transition to IFRS in 2011. • Will result in “double conversion” – once to implement IFRS 4 (phase I) in 2011 and second conversion once final standard in place. • Insurers will need to keep abreast of latest developments at IASB and assess proposals against existing reserves to ensure impacts on financial results, systems and processes are understood well in advance of adoption in order to implement in timely manner. • Take opportunity to provide comments on proposals to IASB. • Never been a better time to be an actuary (or an accountant!)

38. Experience of IFRS Conversions for insurers in Europe PwC Survey PwC Survey of 26 global insurers first annual report under IFRS (2005) resulted in the following key findings: • Enormous implementation challenges • Extensive new disclosure requirements • First internationally-agreed definition of an insurance contract • Little diversity in accounting policy beyond insurance contracts and investments • Use of alternative measures of profit – European Embedded Value (EEV)

39. Experience of IFRS Conversions for insurers in Europe Most challenging aspects of IFRS conversions Based on a survey of 47 insurers (spanning 17 countries), the accounting issues that were the most challenging within the IFRS conversion are: Source: KPMG survey ‘Implementing IFRS in the Insurance Industry’, 2006

40. 112% 210% 138% 14% 82% 67% 75% 59% 112 100 129 124 90 70 100 87 52 57 40 33 47 81 55 79 Experience of IFRS Conversions for insurers in Europe Increase in Size of Financial Statements Increase in length 2005 in IFRS 2004 in local GAAP 82% 60 33

41. Questions? ??