International Accounting Standards Board ® May 2006 The IASB’s project on Insurance Contracts Peter Clark Senior Project Manager International Accounting

International Accounting Standards Board

®

May 2006May 2006

The IASB’s project on The IASB’s project on Insurance ContractsInsurance Contracts

Peter ClarkPeter Clark

Senior Senior ProjectProject Manager Manager

International Accounting Standards BoardInternational Accounting Standards Board

www.iasb.org.ukwww.iasb.org.uk

®International Accounting

Standards Board

May 2006May 2006

OverviewOverview

Insurance contracts phase IInsurance contracts phase I IFRS 4 Insurance contractsIFRS 4 Insurance contracts

IAS 39IAS 39 Insurance contracts phase IIInsurance contracts phase II ConvergenceConvergence


Standards Board

May 2006May 2006

IFRS 4 IFRS 4 Insurance ContractsInsurance Contracts

ObjectivesObjectives ScopeScope Definition of insurance contractDefinition of insurance contract Recognition and measurementRecognition and measurement DisclosureDisclosure


Standards Board

May 2006May 2006

IFRS 4 objectivesIFRS 4 objectives

Limited improvements for 2005Limited improvements for 2005 Avoid Avoid

delay to phase IIdelay to phase II changes that phase II might reversechanges that phase II might reverse


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May 2006May 2006

ScopeScope

Insurance and reinsurance Insurance and reinsurance contracts issuedcontracts issued

Reinsurance contracts heldReinsurance contracts held No exemption from other IFRSsNo exemption from other IFRSs

IAS 39 covers financial assets, IAS 39 covers financial assets, financial liabilities (‘investment financial liabilities (‘investment contracts’) and derivativescontracts’) and derivatives


Standards Board

May 2006May 2006

Definition of Definition of insurance contract insurance contract (1)(1)

AA contract under which one party contract under which one party (the insurer) accepts (the insurer) accepts significantsignificant insurance riskinsurance risk from another party from another party (the policyholder) by agreeing to (the policyholder) by agreeing to compensate the policyholder if a compensate the policyholder if a specified uncertain future event specified uncertain future event adverselyadversely affectsaffects the policyholder the policyholder


Standards Board

May 2006May 2006

Definition of Definition of insurance contract insurance contract (2)(2)

Significant insurance riskSignificant insurance risk Significant additional benefits in any Significant additional benefits in any

scenario (that has commercial scenario (that has commercial substance)substance)

Not a percentage testNot a percentage test Contract by contractContract by contract

Unbundling a deposit componentUnbundling a deposit component


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May 2006May 2006

Recognition and Recognition and measurementmeasurement

Exemption from hierarchy in IAS 8Exemption from hierarchy in IAS 8 ReinsuranceReinsurance Discretionary participation featuresDiscretionary participation features


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May 2006May 2006

IAS 8 IAS 8 hierarchy (1)hierarchy (1)

Criteria to use in developing an Criteria to use in developing an accounting policy if no IFRS or accounting policy if no IFRS or Interpretation applies specificallyInterpretation applies specifically RelevanceRelevance ReliabilityReliability Other IFRSsOther IFRSs FrameworkFramework


Standards Board

May 2006May 2006

IAS 8 IAS 8 hierarchy (2)hierarchy (2)

Temporary exemption in phase I for:Temporary exemption in phase I for: insurance (or reinsurance) contracts issued insurance (or reinsurance) contracts issued reinsurance contracts heldreinsurance contracts held

BUTBUT Do not change accounting policy unless Do not change accounting policy unless

result is more relevant and reliableresult is more relevant and reliable Limited changes required (due to hierarchy) Limited changes required (due to hierarchy) May continue some existing practices, but not May continue some existing practices, but not

introduce themintroduce them


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May 2006May 2006

Limited changesLimited changes

No catastrophe or equalisation No catastrophe or equalisation provisionsprovisions

Liability adequacy testLiability adequacy test ReinsuranceReinsurance Derecognition of insurance liabilitiesDerecognition of insurance liabilities

Only when the obligation is discharged or Only when the obligation is discharged or cancelled or expirescancelled or expires


Standards Board

May 2006May 2006

Limited changes: Limited changes: ReinsuranceReinsurance

Reinsurance contractReinsurance contract No special definition No special definition

(insurance between two insurers)(insurance between two insurers) No offsettingNo offsetting Impairment testImpairment test

Incurred loss model (as in IAS 39)Incurred loss model (as in IAS 39) Disclose gains at inceptionDisclose gains at inception


Standards Board

May 2006May 2006

Some existing Some existing practices may practices may continuecontinue

May continue, but not introduce:May continue, but not introduce: non-discounting of insurance liabilitiesnon-discounting of insurance liabilities off-market measurement of contractual off-market measurement of contractual

rights to investment management fees rights to investment management fees non-uniform accounting policies for non-uniform accounting policies for

insurance liabilities of subsidiariesinsurance liabilities of subsidiaries excessive prudenceexcessive prudence future investment spreads (rebuttable future investment spreads (rebuttable

presumption)presumption)


Standards Board

May 2006May 2006

Discretionary Discretionary participation features participation features (1)(1)

What are discretionary participation What are discretionary participation features (DPF)? features (DPF)?

Insurance contracts with DPFInsurance contracts with DPF Investment contracts with DPFInvestment contracts with DPF PremiumsPremiums Profit or loss attributable to DPFProfit or loss attributable to DPF


Standards Board

May 2006May 2006

Discretionary Discretionary participation features participation features (2)(2)

Contractual right to additional benefits:Contractual right to additional benefits: likely to be significant portion of total likely to be significant portion of total

benefitsbenefits amount or timing contractually at the amount or timing contractually at the

discretion of the issuer, anddiscretion of the issuer, and contractually based on:contractually based on:

performance of specified contractsperformance of specified contracts returns on specified assets, orreturns on specified assets, or profit or lossprofit or loss


Standards Board

May 2006May 2006

Insurance contracts Insurance contracts with DPFwith DPF

Guaranteed elementGuaranteed element Policyholder has unconditional rightPolicyholder has unconditional right Must classify as liabilityMust classify as liability

Discretionary participation featureDiscretionary participation feature May classify as liability, equity or splitMay classify as liability, equity or split Do not show as mezzanineDo not show as mezzanine


Standards Board

May 2006May 2006

Investment Investment contracts with DPFcontracts with DPF

May classify whole contract as May classify whole contract as liabilityliability If so, apply liability adequacy testIf so, apply liability adequacy test

May classify part or all of DPF in May classify part or all of DPF in equityequity Reported liability not less than IAS 39 Reported liability not less than IAS 39

measurement of guaranteed element measurement of guaranteed element


Standards Board

May 2006May 2006

Contracts with DPF: Contracts with DPF: PremiumsPremiums

May report the whole premium as May report the whole premium as revenuerevenue Even for investment contracts Even for investment contracts Even if part or all DPF is classified in Even if part or all DPF is classified in

equityequity Portion of profit or loss attributable Portion of profit or loss attributable

to equity portion (if any) of DPFto equity portion (if any) of DPF not expense, but allocation of profitnot expense, but allocation of profit


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Profit or loss Profit or loss attributable to DPFattributable to DPF

Profit for the periodProfit for the period XXXXXX

Attributable to:Attributable to:

Equity holders of the parentEquity holders of the parent XXXXXX

Equity component of DPFEquity component of DPF XXXXXX

Minority interestMinority interest XXXXXX

XXXXXX


Standards Board

May 2006May 2006

DisclosureDisclosure

Reported amountsReported amounts Amount, timing and uncertainty of Amount, timing and uncertainty of

cash flows, egcash flows, eg Sensitivity analysisSensitivity analysis Claims developmentClaims development


Standards Board

May 2006May 2006

Financial Financial Instruments: IAS 39 Instruments: IAS 39

Financial assetsFinancial assets Financial liabilitiesFinancial liabilities

‘‘investment contracts’investment contracts’


Standards Board

May 2006May 2006

Financial assetsFinancial assets

Economic mismatch or accounting Economic mismatch or accounting mismatch?mismatch? NB disclosure implicationsNB disclosure implications

May reclassify some or all financial May reclassify some or all financial assets as ‘at fair value through P&L’assets as ‘at fair value through P&L’

May switch to current discount rates for May switch to current discount rates for some or all insurance liabilitiessome or all insurance liabilities

‘‘Shadow accounting’Shadow accounting’


Standards Board

May 2006May 2006

‘‘Investment’ Investment’ contractscontracts

IAS 39 appliesIAS 39 applies Premiums = deposit receipt, not revenuePremiums = deposit receipt, not revenue Asset cash flows do not affect liability Asset cash flows do not affect liability

measurementmeasurement Service fee revenue (see IAS 18 Revenue)Service fee revenue (see IAS 18 Revenue)Measure at:Measure at: Fair value, orFair value, or Amortised costAmortised cost


Standards Board

May 2006May 2006

Phase IIPhase IIKey objectivesKey objectives

up to date estimates of:up to date estimates of: cash flowscash flows an appropriate price for those cash flowsan appropriate price for those cash flows

use observable market inputs, where they use observable market inputs, where they existexist

a measurement attribute that users can a measurement attribute that users can understand, as a basis for economic understand, as a basis for economic decisionsdecisions not just a computationnot just a computation


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May 2006May 2006

Ingredients to meet Ingredients to meet those objectivesthose objectives

estimates of future cash flowsestimates of future cash flows time value of moneytime value of money a margina margin


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May 2006May 2006

Future cash flowsFuture cash flows

Current estimatesCurrent estimates Unbiased Unbiased Probability-weighted (expected Probability-weighted (expected

value) value) Principles, not detailed guidancePrinciples, not detailed guidance


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May 2006May 2006

Time value of moneyTime value of money

Even for non-lifeEven for non-life Current market discount ratesCurrent market discount rates Expected returns on actual assets Expected returns on actual assets

are not relevant (unless they affect are not relevant (unless they affect the liability cash flows)the liability cash flows)


Standards Board

May 2006May 2006

MarginMargin

As required by market participants, As required by market participants, forfor bearing risk (risk margin)bearing risk (risk margin) other services (profit margin)other services (profit margin)

Not intended as a shock absorberNot intended as a shock absorber How calibrated?How calibrated?

Gain or loss at inception?Gain or loss at inception?


Standards Board

May 2006May 2006

A measurement A measurement attribute users can attribute users can understand? understand?

Current exit value:Current exit value: amount the insurer would expect to amount the insurer would expect to

have to pay today to another entity if have to pay today to another entity if it transferred all its remaining it transferred all its remaining contractual rights and obligations contractual rights and obligations immediately to that entity immediately to that entity

… … excluding any payment for other excluding any payment for other rights and obligationsrights and obligations


Standards Board

May 2006May 2006

Current exit valueCurrent exit value

Best meets the objectives discussed Best meets the objectives discussed earlierearlier

Relevant and reliable information to help Relevant and reliable information to help users with economic decisionsusers with economic decisions

Does not imply that an insurer can, will or Does not imply that an insurer can, will or should actually transfer the liability to a should actually transfer the liability to a third partythird party

In most cases, insurers cannot transfer In most cases, insurers cannot transfer the liabilities and do not want to do so the liabilities and do not want to do so


Standards Board

May 2006May 2006

Advantages of the Advantages of the approachapproach

information on amount, timing and information on amount, timing and uncertainty of contractual cash flowsuncertainty of contractual cash flows

consistent approach to changing estimates consistent approach to changing estimates of cash flowsof cash flows

coherent way to resolve new issuescoherent way to resolve new issues consistency with IFRSs on other liabilities consistency with IFRSs on other liabilities

(especially IAS 37)(especially IAS 37) margins are explicit and reflect margins are explicit and reflect release from release from

riskrisk clear reporting of economic mismatchesclear reporting of economic mismatches


Standards Board

May 2006May 2006

Other points (1)Other points (1)

Unearned premium:Unearned premium: sometimes a reasonable proxysometimes a reasonable proxy

Acquisition costsAcquisition costs Expense (deferral would be double Expense (deferral would be double

counting)counting) Unit of account?Unit of account?


Standards Board

May 2006May 2006

Other points (2)Other points (2)

Focus on contractual rights and Focus on contractual rights and obligationsobligations

Embedded options and guarantees Embedded options and guarantees Policyholder cancellation optionsPolicyholder cancellation options Participating contractsParticipating contracts Investment contractsInvestment contracts


Standards Board

May 2006May 2006

Embedded Value?Embedded Value?

Increasingly common (life)Increasingly common (life) Largely unregulatedLargely unregulated

Some similarity with current exit value Some similarity with current exit value BUTBUT includes future investment returnsincludes future investment returns capital lock-incapital lock-in off-market measurement of contractual rights off-market measurement of contractual rights

to investment management feesto investment management fees


Standards Board

May 2006May 2006

Other relevant Other relevant projectsprojects

Conceptual FrameworkConceptual Framework RevenueRevenue Liabilities / equityLiabilities / equity Performance reportingPerformance reporting Financial instrumentsFinancial instruments


Standards Board

May 2006May 2006

Phase II timetablePhase II timetable

Discussion paperDiscussion paper Q4 2006Q4 2006

Exposure DraftExposure Draft 20082008

StandardStandard 20092009

ImplementationImplementation ??


Standards Board

May 2006May 2006

Convergence – Convergence – generalgeneral

A high priorityA high priority SEC ‘roadmap’SEC ‘roadmap’

eliminate reconciliation to US GAAP?eliminate reconciliation to US GAAP? Memorandum of Understanding Memorandum of Understanding

between the IASB and FASBbetween the IASB and FASB A two-way processA two-way process


Standards Board

May 2006May 2006

Convergence – Convergence – insurance contractsinsurance contracts

A ‘modified joint’ project. FASB expects :A ‘modified joint’ project. FASB expects : to issue Discussion Paper (not deliberated)to issue Discussion Paper (not deliberated) to review the responses in assessing whether to review the responses in assessing whether

to join in a joint project to join in a joint project US mini projects on insurance:US mini projects on insurance:

Risk transferRisk transfer Financial guaranteesFinancial guarantees Life settlementsLife settlements


Standards Board

May 2006May 2006

Convergence – Convergence – insurance contractsinsurance contracts

A ‘modified joint’ project. FASB expects:A ‘modified joint’ project. FASB expects: to issue Discussion Paper (not deliberated)to issue Discussion Paper (not deliberated) to review the responses in assessing whether to review the responses in assessing whether

to join in a joint project to join in a joint project US mini projects on insurance:US mini projects on insurance:

Risk transferRisk transfer Financial guaranteesFinancial guarantees Life settlementsLife settlements


Standards Board

May 2006May 2006

Know More about Know More about IASBIASB

Our website Our website www.iasb.orgwww.iasb.org includes news and project summariesincludes news and project summaries and much more…and much more…

Newsletters:Newsletters: IASB Insight (quarterly)IASB Insight (quarterly) IASB Update (after each Board meeting)IASB Update (after each Board meeting) IFRIC Update (after each IFRIC meeting)IFRIC Update (after each IFRIC meeting)

Documents

International Accounting Standards Board ® May 2006 The IASB’s project on Insurance Contracts Peter Clark Senior Project Manager International Accounting