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Session 8IFRS and Solvency Requirements
Regional Training Seminar IAIS-ASSAL-FIDES
25 November 2009, Lima Peru
Takao Miyamoto, IAIS Secretariat
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Agenda
1. Background– Accounting and Solvency– IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues– Measurement Approaches– Building Blocks– Margins– Day One Difference– Acquisition Costs– Own Credit Risk
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Two Uses of Financial Reporting
General purpose financial reporting
Regulatory purpose reporting & requirements
– Many resources (e.g. audit) were already used for accuracy & reliability
– Widely accepted
– Often in conservative direction– IAIS seeks to minimise
(Starting point) : Efficiency
(Prudential filter) : Adjustment for different purposes
Should reflect economics of businesses
Should serve to protect policyholders
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Key Principle
The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reports can be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements.
The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reports can be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements.
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IASB Project Schedule
2004
1997
Q2 2010
– Insurance Contracts Project start
New IFRS
May 2007 – Discussion Paper “Preliminary Views on Insurance Contracts” (DP)
Mid 2011
– Exposure Draft
IFRS 4
Phase II
Phase I
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Agenda
1. Background– Accounting and Solvency– IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues– Measurement Approaches– Building Blocks– Margins– Day One Difference– Acquisition Costs– Own Credit Risk
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Measurement Approaches – IASB
“Current Exit Value”• Amount insurer would expect to pay at reporting
date to transfer remaining contractual rights and obligations immediately to another entity
“Current Fulfillment Value”• Expected present value of cost of fulfilling
obligations to policyholder over time
“Updated IAS 37”• Amount entity would rationally pay at end of
reporting period to be relieved of present obligations– Given absence of active market for insurance contracts, this
may be close to fulfillment notion
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Measurement Approaches – IAIS
• Insurers generally do not transfer liabilities, given no active market for insurance contracts
• Insurers generally fulfill/settle obligations to policyholders over time
• Any transfer notion would be strongly influenced by settlement of obligations that transferee would undertake– Transfers would need to be made to entity capable of
accepting transfer– It implies that transferee would also need to be regulated
and capable of settling obligations to claimant/beneficiary
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Building Blocks – IASB
Three building blocks• Current estimate of expected (i.e. probability
weighted) present value of future cash flows• Time value of money (i.e. discounting)• Explicit margin
Rationale• Markets for trading insurance contract rarely exist• So, its value is rarely observable (i.e. Level 3
financial product)• So, its value has to be estimated somehow
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Comparison
IASB IAIS
Measurement Approaches
Current Exit Value
- Could work with any of views- Devil is in details
Updated IAS 37
Current Fulfillment Value
Building Blocks
- Current estimate of expected present value of CF- Time value of money- Explicit margin
- Agree with building blocks approach- Easy to say but difficult to implement…- Details to be developed
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Unearned Premium Approach
Exception• Pre-claims short-duration liabilities only• Permitted (not required) to use “Unearned
Premium” approach– Provide decision-useful information– Cost vs. Benefit
Measurement method• As insurer is released from risk, related part of
premium is earned and recognised as revenue• Unearned part of premium is recognised as liability
– Lock-in: allocate original price (premium) over periods– No explicit margin
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Agenda
1. Background– Accounting and Solvency– IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues– Measurement Approaches– Building Blocks– Margins– Day One Difference– Acquisition Costs– Own Credit Risk
13
Margins – IASB
Types of margins• Risk: compensation required for bearing risks• Service: compensation for assuming services other
than risk margin• Residual: remaining margin (calibrated to actual
premium)• Composite: inclusive of above three (calibrated to
actual premium)
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Comparison
IASB IAIS
Margins
Current Exit Value- Risk, Service, Residual
- Support explicit margins regardless whether/how they are classified- Initial measurement calibrated to zero profit on inception is supportable- Challenge is how to measure margins in subsequent periods
Updated IAS 37- Risk, Service, Residual
Current Fulfillment Value- Composite
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Agenda
1. Background– Accounting and Solvency– IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues– Measurement Approaches– Building Blocks– Margins– Day One Difference– Acquisition Costs– Own Credit Risk
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Day One Difference
What is “Day One Difference”?• When using exit price (whether transfer or
fulfillment) instead of entry price, day one difference could arise at inception
• It could be both positive (gain) or negative (loss)• Simple examples
– Insurance Company A enters into one-year term non-life contract. Premium for contract is 1,000 and is received at inception. Expected present value of future cash outflow is 800.
– What if expected present value of future cash outflow is 1,200?
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Day One Difference – IASB
Recognition• No profit at inception should be recognised in
profit/loss– Margin (either residual or composite) is recognised as
liabilities– They are calibrated to actual premiums
• Loss at inception should be recognised in profit/loss – onerous contracts– Asymmetry exists
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Acquisition Costs – IASB
Issues• Insurance companies incur initial acquisition costs
– Significant amount especially for long term contracts
• Are they expensed or deferred?• How about matching revenue?
IASB position• All acquisition costs should be expensed when
incurred• No revenue can be recognised to offset acquisition
costs expensed – October 2009 position– Day one loss on long term contracts (e.g. life insurance)
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Comparison
IASB IAISDay One Difference
No profit at inception Fine (except for below)Loss at inception – onerous
contracts
Acquisition Costs
All acquisition costs should be expensed when incurredNo recognition of revenue to offset acquisition costs
- It does not reflect economics (profitable business may incur losses at inception)- It would be disincentive for entering into profitable business
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Agenda
1. Background– Accounting and Solvency– IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues– Measurement Approaches– Building Blocks– Margins– Day One Difference– Acquisition Costs– Own Credit Risk
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Own Credit Risk
• Whether to include insurer’s own credit risk in valuation of insurance liabilities
• If included, decrease in liabilities for worsening of insurer’s credit standing
Liabilities
Assets
Surplus
AAA Insurer
Liabilities
Assets
Surplus
BBB Insurer
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Comparison
IASB IAIS
Own Credit Risk
Current Exit Value- Include own credit risk in technical provision
- Initial premium, agreed between relevant parties, may be presumed to incorporate own credit risk- However, remeasurement should never incorporate changes in credit risk(insurance contracts are not publicly traded)
Updated IAS 37- To be discussed (arguably implicit in residual margin at inception)
Current Fulfillment Value- To be discussed (arguably implicit in residual margin at inception)
