Adoption of IFRS in the Insurance Sector Catherine Guttmann 15 March 2006

1. Adoption of IFRS in the Insurance SectorCatherine Guttmann15 March 2006 REPARIS Workshops on Accounting and Audit Regulation, Vienna, March 2006

2. What does IFRS 4 – Phase I mainly say

3. IFRS 4 – Phase I : Insurance Contracts Main features of the IFRS • The IFRS on insurance contracts applies to all insurance contracts (including reinsurance contracts) and only to insurance contracts Financial assets and liabilities of insurers are treated by IAS 39 • All IFRS standards apply to insurance companies • « Insurance contract » definition is a definition in substance and not a legal one : • The standard on insurance contracts should then be used for example in the banking industry

4. IFRS 4 – Phase I : Insurance Contracts Definition of an insurance contract • An insurance contract is a 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 futur event (the insured event) adversely affects the policyholder » • The « policyholder » is defined as : « a party that has a right to compensation under an insurance contract if an insured event occurs »

5. IFRS 4 – Phase I : Insurance Contracts Definition of financial risk • An insurance risk is a « risk , other that financial risk, transferred from the holder of a contract to the issuer » • A financial risk is « the risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract »

6. IFRS 4 – Phase I : Insurance Contracts Examples of insurance contracts

7. IFRS 4 – Phase I : Insurance Contracts First consequence : classification of the contracts and valuation principles • IAS 39 for the financial component and liability adequacy test • Local GAAP for the insurance component • No need to separate Significative insurance risk ? yes no yes Embedded derivative to separate Financial Component ? yes no Separate and Fair value the Embedded derivative Discretionary Participating Feature ? no • Local GAAP and Liability adequacy test Non discretionary discretionary IAS 39 IAS 39 / IFRS 4

8. Major changes with fair value orientation Local GAAP Second Consequence : an insurer balance sheet

9. Major changes with fair value orientation Local GAAP

10. Orientations for Phase II

11. IntroductionThe objectives of Phase II • By splitting the insurance project into 2 phases, the IASB board has postponed several key subjects : • Valuation of insurance contracts : keeping current accounting principles • Qualification and treatment of discretionary participating features (shadow accounting) • Embedded derivatives • Revenue recognition • Phase II will have to deal with all these issues with the following underlying purpose: • To get a better financial reporting • To reach a global consistency between all IAS standards (IAS 39, IAS 18, IAS 37, …) and the IFRS framework (comparability, reliability, substance over form,…)

12. Agenda of the Phase II project • A working group has been set up by the IASB board : • Meeting every 2 month • Participants : • CFO of major insurance groups : • Allianz • Axa • Prudential • AIG • Nippon Life • … • IASB board members • Members of IOSCO, IAIS,EFRAG • Actuaries (Chairman of IAA) • Analysts (Standard & Poors, DZ Bank AG) • Public debate • Regular publications

13. Agenda of the Phase II project Juillet 2005 2009/2010 2006 2008 • Agenda • A Working Paper should be published by the Working Group Phase II before year end 2006 • An Exposure Draft should be published in 2008 • Final standard could be published before year end 2008 Endorsement of phase II standard Working paper published ED published Working Group meetings

14. Some valuation approaches • Approach C – Current Entry Value • Principles : Approach C measures the insurance liability at the amount that the insurer would charge to a policyholder today for entering into a contract with the same remaining rights and obligations as the existing contract. • Initial measurement : • Discounting of future projected cash flows using current yield curve (best estimate value) • • Valuation of an implicit margin, equal to the difference between premiums and the best estimate value • Next measurements • Best estimate value is calculated on current assumptions (economic and non economic) • The initial margin is amortised among the duration of the contract with the release of the risk

15. Some valuation approaches • Approach D – Current Exit Value • Principles : Approach D measures the insurance liability at the amount that the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity. • Because there is no secondary market for most insurance liabilities, that amount would need to be estimated. • Specifically, approach D : • Measures the insurance liability as the present value of future cash flows arising from the contract (Uses a current risk-free discount rate). • Does not defer acquisition costs as a separate asset. • The measurement of the liability includes the margin that market participants would require for contractually assuming risks and providing services : • Margin for risks and uncertainty AND • Margin for the servicing part included in the insurance contract (servicing margin) • Profit at inception is limited : • by the level of the MRI and • by the level of the Servicing margin

16. Some valuation approaches • Approaches C & D Approach C – "Business to Customers” Approach D – "Business to Business” Asset Net equity Asset Net equity No gain at inception Some gain at inception but limited by the SM and the MRI Global Margin Servicing margin • Separation and valuation of the 3 parts of the contracts : • exit value "best estimate" • Margin for risks • Servicing margin MRU Global margin = Premiums – Exit Value best estimate Exit Value best-estimate Exit Value best-estimate

17. Some valuation approaches • IAIS is working on a similar model so that the same valuation for liabilities could be taken for solvency purposes and accounting • Questions still to be solved : • Definition of the MRU (level of confidence ; Cost of capital), or pattern of amortisation • Definition and level of the servicing margin (market reference ?) • Policyholder behaviour ? • Paragraph 49 of IAS 39 for investment contracts