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Managing the Transition SLFRS – 4
© 2010 EYGM Limited Managing The Transition Slide 2 Managing The Transition 1) Identification of an Insurance Contract - Product Classification - Embedded Derivatives 2) Contemporary Issues - Unbundling of Deposit Component - Liability Adequacy Test - Shadow Accounting 3) Change In Accounting Policies 4) Business Consideration
© 2010 EYGM Limited Managing The Transition Slide 3 Insurance Liabilities – Phase I Investments equities fixed interest mortgages loans Other assets Other liabilities Equity Insurance contracts and investment contracts with DPF Investment contract liabilities Investment contract DAC Property LKAS 39 LKAS (16) 40 LKAS 18 Insurance DAC SLFRS 4 PVIF SLFRS 4 Various SLFRS 4 LKAS 39 Various LKAS 19 and others Key standards for insurers
Identification of an Insurance Contract Page 4
© 2010 EYGM Limited Managing The Transition Slide 5 Identification of an Insurance Contract Insurance Contract: 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 future event (the insured event) adversely affects the policyholder. Insurer as per SLFRS 4 is any entity that issues insurance contract, irrespective of whether the entity is considered an insurer for legal/ regulatory purposes. All reference in this SLFRS to insurance contracts also apply to reinsurance contracts.
© 2010 EYGM Limited Managing The Transition Slide 6 Once insurance – always insurance! Investment Contract Insurance Contract X
© 2010 EYGM Limited Managing The Transition Slide 7 Deposit accounting Deposit is not an insurance liability Financial instrument Premiums are not revenue Changes in deposits (balance sheet) Claims are not expenses Repayment of deposit (balance sheet) Movements in deposits not in P&L
© 2010 EYGM Limited Managing The Transition Slide 8 Discretionary Participation Feature A contractual right to receive, as a supplement to guaranteed benefits, additional benefits: (a) that are likely to be a significant portion of the total contractual benefits; (b) whose amount or timing is contractually at the discretion of the issuer; and (c) that are contractually based on: (i) the performance of a specified pool of contracts or a specified type of contract; (ii) realised and/or unrealised investment returns on a specified pool of assets held by the issuer; or (iii) the profit or loss of the company, fund or other entity that issues the contract. Guaranteed benefits- Payments or other benefits to which a particular Policyholder or investor has an unconditional right that is not subject to the contractual discretion of the issuer. Identification of an Insurance Contract
Product Classification Embedded Derivatives
© 2010 EYGM Limited Managing The Transition Slide 10 Product classification Product classification determines the accounting treatment for contracts during phase 1. Product Classification A major exercise for insurance companies A hot topic for the future as product complexity increases Solutions developed to address complex classification issues
© 2010 EYGM Limited Managing The Transition Slide 11 * Subject to certain modifications **Possibly with separate accounting for service component Product classification is very important as it defines the accounting treatment for the issued contracts by an insurer. The following chart provides an overview of the accounting treatment for different types of contracts as a result of product classification. Amortised Cost -or- Fair Value** Existing Accounting* SLFRS 4 Insurance contracts LKAS 32/39 Recognition and Measurement LKAS 32/39 Recognition and Measurement Existing Accounting* SLFRS 7 for Disclosure Discretionary Participation Investment contracts Product classification
© 2010 EYGM Limited Managing The Transition Slide 12 Impact On The Financial Statements If Contract qualify as Insurance Contract GWP Insurance Liability Deposit Liability GWP Investment Liability If Contract qualify as Investment Contract
© 2010 EYGM Limited Managing The Transition Slide 13 Flowchart of Product Classification Is there significant insurance risk present in the contract? Is there a deposit component to the contract? If so, is the deposit component independent of the insurance cash flows? Are any elements of the benefit driven by discretionary participation Insurance features present in contract Classified as an investment contract Deposit component Yes No Insurance and deposit components of contract must, if not recognised, be unbundled and valued separately Yes No Insurance component Product is an Investment Contract without discretionary participation features Product is an Insurance Contract Product is an Investment Contract with discretionary participation features Yes No SLFRS 4 LKAS 39
© 2010 EYGM Limited Managing The Transition Slide 14 Based on the definition of an insurance contract, an insurance contract must have all of the following three characteristics: Product classification 1.Uncertain future events (Insured event) 2.Transfers significant insurance risk from the policyholder to the insurer 3.Adverse effect on the policyholder
© 2010 EYGM Limited Managing The Transition Slide 15 Insurance product Analysis- scenario 01 Unit Link Product Maturity Value/ Surrender value Unit value/Fund value Death Benefit100.1% of the unit value Conclusion If the insured event affect adversely to the policyholder, Mortality risk is 0.1% of the unit value which is not significant means that contract does not transfers significant insurance risk from the policyholder to the insurer. This contract can be considered as an Investment Contract
© 2010 EYGM Limited Managing The Transition Slide 16 Insurance product Analysis- scenario 02 Unit Link Product Maturity Value/Surrender Value Unit value/Fund value Death Benefitgreater of: (a) unit value of an investment fund (equal to the amount payable on surrender or maturity); and (b) guaranteed minimum Conclusion Excess of guaranteed minimum over unit value is a death benefit This meets the definition of an insurance contract (unless the life- contingent payments are insignificant).
© 2010 EYGM Limited Managing The Transition Slide 17 Insurance product Analysis- scenario 03 bb Single Premium Contract Maturity Value/Surrender Value Fund value Death Benefit5 times of the initial premium Conclusion Insurer could suffer a significant loss on an individual contract if the policyholder dies early. This meets the definition of an insurance contract.
© 2010 EYGM Limited Managing The Transition Slide 18 Insurance product Analysis- scenario 04 bb Single Premium Contract Maturity Value/Surrender Value Initial Premium + 12% Interest per Annum Death BenefitInitial Premium + 12% per interest Annum + 2 times of the initial premium Conclusion Insurer could suffer a significant loss on an individual contract if the policyholder dies early. This meets the definition of an insurance contract.
© 2010 EYGM Limited Managing The Transition Slide 19 Insurance product Analysis- scenario 05 bb Single Premium Contract Maturity Value/Surrender Value No Death Benefit20 times of the initial premium Conclusion Insurer could suffer a significant loss on an individual contract if the policyholder dies early. This meets the definition of an insurance contract.
© 2010 EYGM Limited Managing The Transition Slide 20 Embedded Derivatives LKAS 39 require an entity to separate some embedded derivatives from their host contract, measure at fair value and include the changes in FV in the P&L. An insurer need not account for an embedded derivative separately at fair value if the embedded derivative meets the definition of an insurance contract. LKAS 39 will apply to all other instances- embedded derivative and are not closely related to the host contract need to be measured at fair value. Embedded Derivative A component of a hybrid instrument that includes both a derivative and a host contract – with the effect that some of the cash flows of the combined instrument vary in a similar way to a stand-alone derivative.
© 2010 EYGM Limited Managing The Transition Slide 21 IFRS 4 embedded derivative flow chart Yes No Yes Do not separate Does the feature meet the definition of Insurance Contract? No Do not separate Does the feature meet the definition of a derivative? Yes Do not separateclosely related? Separate and value at Fair Value No Host contract at FVTPL? Do not separate Yes Does it look and feel like an embedded derivative? No action No
© 2010 EYGM Limited Managing The Transition Slide 22 Embedded derivatives – examples Separate and fair value Examples: Equity index feature in fixed principles savings plan Guaranteed accumulation value in unit linked plan payable on death as well as maturity Fair value treatment not required Is it insurance? or fixed/cash surrender Examples: Unit-linked guaranteed minimum income benefits Guaranteed minimum death benefits (e.g., Ratchets) Guaranteed annuity options Yes 1.Is it an embedded derivative Value changes with underlying Little or no net investment Settled at future date 2.Is it not closely related to host Such as an equity index-link on a debt host instrument Create interest-rate risk and is leveraged 3.Is it not already at fair value Contract is at a mortised cost or accounted at measure other than fair value Examples: Interest rate floor in fixed interest rate contract Option to renew contract Separation criteria No
© 2010 EYGM Limited Managing The Transition Slide 24 Unbundling of deposit component So when do you unbundle? Unbundling is required only if both the following conditions are met : The insurers existing accounting policies do not require recognition of the deposit component and The insurer can independently measure the deposit component from the insurance component Unbundling is allowed but not required when the insurer only meets the second condition that the insurer can independently measure the deposit component from the insurance component. It means unbundling may be required when insurance benefit cash flows do not affect the deposit-like cash flows at all. If any grey areas exist, or if there are difficulties in unbundling, then do not unbundle. Unbundle- Account for the components of a contract as if they were separate contracts
© 2010 EYGM Limited Managing The Transition Slide 25 Unbundling of deposit component Impact On The Financial Statements If UnbundledIf not Unbundled GWP Insurance Liability Deposit Liability GWP Insurance Liability
© 2010 EYGM Limited Managing The Transition Slide 26 Liability Adequacy Testing Recognition of future losses required A deficiency is indicated when future cash flows exceed the net carrying amount For insurance contracts, existing liability adequacy tests apply unless they fail to meet the IFRS 4 minimum requirements, in which case an SLAS 36- Provisions, contingent assets and contingent liabilities measure apply Current Estimates of Futures Cash Flows Future Premiums Future Claims (including considering options & guarantees) related DAC related Intangibles Liability Adequacy Test- An assessment of whether the carrying amount of an insurance liability needs to be increased (or the carrying amount of related deferred acquisition costs or related intangible assets decreased), based on a review of future cash flows.
© 2010 EYGM Limited Managing The Transition Slide 27 Liability Adequacy Test - LAT Temporary First-Aid bandage In some countries the local tests might not be adequate Inverse impairment test Two routes Local test if SLFRS 4 minimum criteria are met: Use current estimates of all cash flows Current estimate is not discounting Consider options and guarantees consider is not measuring time value? What about New Money? Use LKAS 37 rules Discounting: what yield curve? Relation to local regulatory test
© 2010 EYGM Limited Managing The Transition Slide 28 In some accounting models, realised gains or losses on an insurer's assets have a direct effect on the measurement of some or all of its insurance liabilities, related deferred acquisition costs and related intangible assets, An insurer is permitted, but not required, to change its accounting policies so that a recognised but unrealised gain or loss on an asset affects those measurements in the same way that a realised gain or loss does. The related adjustment to the insurance liability (or deferred acquisition costs or intangible assets) shall be recognised in other comprehensive income if, and only if, the unrealised gains or losses are recognised in other comprehensive income. This practice is sometimes described as 'shadow accounting'. Shadow accounting
© 2010 EYGM Limited Managing The Transition Slide 29 Shadow accounting – Example at transition date, AXA Source: AXA
Changes in Accounting Policies.
© 2010 EYGM Limited Managing The Transition Slide 31 Changes in Accounting Policies An insurer may change its accounting policies for insurance contracts if, and only if, the change makes the financial statements more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs. An insurer shall judge relevance and reliability by the criteria in LKAS 8
© 2010 EYGM Limited Managing The Transition Slide 32 Prohibited in Phase I Phase 1 No catastrophe/equalisation reserves No Netting of reinsurance against gross numbers No change to less relevant/reliable So – DO NOT Stop discounting Introduce extra prudence Start to recognise future investment margins Start to use less uniform accounting in consolidation
© 2010 EYGM Limited Managing The Transition Slide 34 Business considerations Additional complexity in Finance processes and system calculations Better communication and alignment between the Investment function and Finance is required – the business activity should reflect the accounting classification and vice versa Certain funding instruments less attractive Greater balance sheet and potentially greater P&L volatility Actuaries and accountants need to work closer to source and calculate additional risk related disclosures Product development teams need to be aware of changes, in particular for product classification and guarantees
Page 35 Q&A
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2008 General Meeting Assemblée générale 2008 Toronto, Ontario 2008 General Meeting Assemblée générale 2008 Toronto, Ontario Canadian Institute of Actuaries.
International Accounting Standards Board ® May 2006 The IASB’s project on Insurance Contracts Peter Clark Senior Project Manager International Accounting.
International Financial Reporting Standards The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS.
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2008 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2008.
Serving the Cause of Public Interest Indian Actuarial Profession Impact of Ind AS 104 in Life Insurance Reporting Presented by: Jinal Sheth Ankur Goel.
Accounting for Financial Instruments 1. Accounting Standards on Financial Instruments LKAS 32 Financial Instruments: Presentation LKAS 39 Financial Instruments:
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*connectedthinking Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame.
IFRS 4 Phase II Insurance Contracts (Exposure Draft)
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1 Investments Sid Glandon, DBA, CPA Associate Professor of Accounting The University of Texas at El Paso.
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