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8/22/2019 AA Seminar 08 Presentation-PS 6 Handouts.ppt
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008Semin
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2008 Seminar for the Appointed Actuary
Colloque pour lactuaire dsign 2008
Canadian
Instituteof
Actuaries
LInstitut
canadiendes
actuaires
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Contract Classification
under IFRS
Johanne Papillon
September 25, 2008
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Presentation Outline
Background IFRS Contract Classification
Embedded Derivatives
Overview of IAS 39 Observations and Conclusion
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Background
Conversion to IFRS: Jan 1, 2011
Insurance contracts: IFRS 4; keep current basisof accounting until Phase II (effective 2012 or2013)
Investment contracts: IAS 39 FinancialInstruments
Service contracts: IAS 18 Revenue (similar toCGAAP)
Most signi f icant impact:
I nvestment contracts, and potentially
Embedded Derivatives
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InsuranceContracts: CALM
Insurance and InvestmentContracts: Actuarial Liabilities
InvestmentContracts: IAS 39
Phase IJanuary 1, 2011:
Phase IIJanuary 1, 2012,(or later):
Insurance Contracts:
new IFRS standards
(Discussion Paper)
Current CGAAP:
Embedded
Derivatives: IAS 39Fair Value option
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Contract classification under IFRS
IFRS definition of Insurance Contract:
contract under which one party (the insurer) accepts
signif icant insurance riskfrom another party (the
policyholder) by agreeing to compensate the
policyholder if a specified uncertain future event (theinsured event) adversely affects the policyholder.
Three key criteria:
1) Insured event must adversely affect policyholder2) Insured benefits must be significant
3) Insurance risk must be non-financial: mortality,
longevity, morbidity, P&C risks
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Contract classification (contd) Significance of insurance risk:
Insurance risk is significant if, and only if, an insuredevent could cause an insurer to pay significant additionalbenefits in any scenario, excluding scenarios that lackcommercial substance
Probability of insured event is not considered whenassessing significance of risk
Company determines what it considers as beingsignificant: 5%-10% additional benefits?
Risks that are created by the contract (lapse,expense) do not constitute Insurance Risk (i.e. riskmust be pre-existing)
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Does the insured event adversely affect the insured?
NoThe contract is not an
insurance contract; consider
Investment or Service contractYesIdentify scenario A, in which insured event
occurs: Example: Death of Pol icyholder
before end of insurance cov erage period
Insured event: Example:Death of po l icyho lder
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Decision tree (contd)
Determine the benefit payable by the insurer underScenario A: Example: Face Am ount o f $100,000
Identify scenario B, in which insured event does notoccur: Example: Surv ival of pol icyholder to the
end of th e coverage period
Determine the benefit available to policyholder
under Scenario B: Example: Surrender Value
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Is benefit payable under Scenario A significantly
greater than benefit available under Scenario B?
Compare benefits in Scenario A versus benefitsin Scenario B (ratio)
NoYesThe contract is aninsurance contract:
IFRS 4 applies.The contract is not aninsurance contract;
consider Investment
or Service contract
Decision tree (contd)
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Once Insurance, always Insurance
Assessment is made at contract inception
Contract is assessed as a whole: If significant
insurance risk is present in the contract, then thewhole contract is classified as Insurance.
Then, determine if contract contains:
Embedded derivative (separate fair valuemeasurement under IAS 39)
Deposit component (option to unbundle)
Discretionary participation feature
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Can assess at segment level for blocks that have
relatively homogeneous risk profiles
Lapse/expense risks do not constitute insurance risk
to the direct insurer, but do constitute insurance risk
to reinsurer assuming the risk Lapse/expense risk is pre-existing to the reinsurance
arrangement, and would adversely affect the direct
writer
Legal entity versus consolidated: Situations may exist for related-party reinsurance
arrangements, where a contract will be classified
differently at legal entity level versus consolidated
Other considerations (contd)
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Examples of insurance contracts
Insurance contracts:
Term plans, T100
Par Life, Whole life
Universal Life
Endowment products / Pure endowmentsCritical Illness/Health/Disability contracts
Long Term Care
Group Life and Health insurance (excluding ASO
contracts)
Reinsurance treaties with significant risk transfer
Payout immediate/deferred annuities (life contingent)
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2008 Insurance contracts (contd)
Insurance contracts:Seg fund/VA products with GMDB / GMIB /
For-life GMWB
GMDB, GMIB or for life GMWB constitute significant
insurance risk
Accumulation products/deferred annuities with
contractual guaranteed annuitization rates
Guaranteed annuitization rates, even if rarely exercised,
constitute significant insurance risk
Accumulation products/deferred annuities with BookValue Death Benefit in deferral period
If MVA surrender charge is waived on death and/or
disability, this constitutes significant insurance risk
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Examples of Investment contracts:
Investment contracts:Term certain contingent annuities
Fixed accummulation annuities which do not contain
guaranteed annuitization rates
Seg funds with no guaranteed minimum returnsGroup contracts with strong hold harmless
provisions (terminal/deficit accounting)
Mutual funds / banking products
IAS 39 applies:
Potential asset segmentation issues if commingled
with assets backing Insurance segments
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Examples of Service contracts
Service contracts:Group ASO
Financial Reinsurance with very limited risk transfers
Potentially: mutual funds where company acts asconduit / does not have ability to choose/replaceinvestment managers
Widely expected that IFRS treatment will besimilar to existing CGAAP
DAC implications for service componentsembedded in investment contracts
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2008 Embedded Derivatives
Embedded derivatives (EDs) withininsurance or investment contracts must be
separately measured at fair value if such
ED is:
not itself considered insurance, and
not closely related to the host insurance or
investment contract
EDs within Investment contracts do notneed to be separately fair valued if the
whole contract is measured at fair value
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2008 Embedded Derivatives: Definitions
IAS 39.9: A derivative is a financial instrumentwith all three of the following characteristics:
its value changes in response to the change in aspecified interest rate, financial instrument price,commodity price, foreign exchange rate, index of
prices or rates, credit rating or credit index, or othervariable, provided that the variable is not specific to a
party to the contract (sometimes called theunderlying);
it requires no initial net investment or an initial netinvestment that is smaller than would be required forother types of contracts; and
it is settled at a future date.
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2008 Embedded Derivatives (contd)
An embedded derivative is defined in IAS39.10 as follows:
is a part of a combined (hybrid) contract, which
also contains non-derivative components
combined contract includes an identifiable
condition to modify the cash flows otherwise
payable; and
modification of cash flows is in response to a
market factor or non-financial variable that is not
specific to a party to the contract
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ED that is itself Insurance:
If cashflows affected by the ED are only paid on a
insured/contingent event, then ED itself meets the
definition of an insurance contract;
IFRS 4 applies; exempt from separate FairValue measurement
Examples:
Seg fund GMDB, GMIB, for-life GMWB Seg fund GMAB, term certain GMWB?
CPI-indexing feature in disability contracts
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2008 Embedded Derivatives (contd)
Definition of closely related: An ED is closely related to its host contract
if the risks inherent in the ED and the host
contract are similar
An ED is considered closely related if ED and
host contract are so inter-dependent that the
ED cannot be measured without considering
the host contract
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2008 Embedded Derivatives (contd)
Examples closely related EDs: Unit-linked deposit components (where
policyholder AV is expressed in terms ofunits of underlying fund) are explicitly
listed in IFRS literature as being closelyrelated
Equity-linked UL deposit account?
UL account minimum return guarantees?
Refer to IAS 39 Appendix Aparagraphs AG30 and AG33
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2008 Embedded Derivatives (contd)
Other Embedded Derivatives at risk ofrequiring separate fair value
measurement:
Ceded / assumed GMIB: depending on specifics
of the contract, and whether actual reinsurance
recoveries can be viewed as being payable on
an insured event
Credit derivatives/ModCo Reinsurance treaties
(USGAAP DIG B36)
Surrender values based on external index or a
pool of equity investments
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Embedded Derivatives:
Measurement implications
For non-exempt EDs: ED is separately measured at Fair Value under IAS 39
similar to US GAAP FAS 133; change in value of ED
flows through earnings each quarter
Host contract is measured under IFRS 4 (Insurance), IAS
39 (Investment)
Insurance: CGAAP/CIA Standards require all
cashflows to be reflected in valuation (SoP 2130)
May argue that total measurement under IFRS =CALM, and ED separate measurement simply
affects where amounts are reported (ie. geography
issue, not earnings issue)
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High Level Overview of IAS 39:
Financial Instruments
CICA 3855 is based on IAS 39: liabilities wereexplicitly excluded from 3855
Elect either Amortized Cost or Fair Value option
Amortized cost: Effective rate of interest that exactly discounts future
cashflows to initial fair value;
must go back to contract inception; operationally
complex assets would have to be reclassified as AFS; issue if
some a given asset is partially allocated to Insurancesegment
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2008 Overview of IAS 39 (contd)
Fair value option: Similar to USGAAP fair value;
Maximum use of market inputs, margin forbearing risk, risk free rate + adjustment for owncredit and liquidity
DAC implications: No such concept under IAS 39
If service component embedded in contract, can
capitalize certain transaction costs only, providedthey are direct and incremental to contractissuance
Different rules will likely result in difference inwhat can be capitalized, and opening retained
earnings adjustment
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2008 Observations and Conclusions
Contract Classification exercise: Broad definition of insurance
Unlikely to have material amounts of InvestmentContracts;
For Investment contracts: need to understand
implications of IAS 39; potential asset segmentation issues
DAC differences
Embedded derivatives:
may find that most are exempt as either insurance orclosely related
Service contracts:
identify, but no significant accounting changes expected