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© 2013 Deloitte LLP The last chance to have your say! IFRS 4 Phase II Francesco Nagari Deloitte Global IFRS Insurance Lead Partner 26 June 2013
© 2013 Deloitte LLP Agenda Background Five key topics for public comments Update on timetable and next steps IFRS 4 Phase II – Webcast (June 2013) 1
© 2013 Deloitte LLP After nearly three year since it published its draft IFRS on insurance contract the IASB made significant changes in five key topics which are now re-exposed. The revised Exposure Draft relates to the proposed requirements for: Adjusting the unearned profit from insurance contracts (‘Unlocking of contractual service margin’) Presentation of interest expense between profit or loss and the other comprehensive income (‘OCI’) (‘OCI solution’) Accounting for contracts that specify a link to the returns on underlying items that the entity is required to hold (‘Mirroring Approach’ for participating contracts) Presentation of insurance contract revenue and expenses (‘Earned premium approach’) Effective date and transition (‘Retrospective application’) IASB does not intend to revisit other aspects of the proposed standard. These are deemed final following the IASB deliberations, the associated outreach and field testing Background IFRS 4 Phase II – Webcast (June 2013) 2
© 2013 Deloitte LLP Unlocking of contractual service margin Initial recognition – the CSM is calculated as an amount equal and opposite to the sum of all cash flows included in the measurement of the insurance contract at initial recognition. The unearned profit on the contract Subsequent measurement – CSM reduces to earn profit and is adjusted for certain changes Adjust prospectively for changes in estimates for cash flows related to future coverage and/or services. If due to favourable changes, no limit on the amount the CSM can increase. If due to unfavourable changes, impact of change in excess of carrying amount of CSM as at date of change will be recognised immediately in profit of loss. The CSM cannot be negative 3IFRS 4 Phase II – Webcast (June 2013) RA changes always through earnings
© 2013 Deloitte LLP Changes that will trigger unlocking Experience differences on premiums that refer to future coverage. This affects all regular premium contracts where actual collection higher/lower than expected would increase/decrease CSM for future coverage/benefits (lapse experience). Delay or acceleration of repayment of investment components (e.g. fixed surrender values) when it affects cash flows associated with future coverage or other services Changes in the estimate of asset-dependent cash flows would trigger adjustment if they relate to benefits/claims expected in future periods Changes that will NOT trigger unlocking Changes in estimates of incurred claims – expired coverage Changes in risk adjustment – rule-based decision Changes in expected credit losses the cedant estimates on its reinsurance assets – consistency with impairment of financial assets Unlocking of contractual service margin (cont.) IFRS 4 Phase II – Webcast (June 2013) 4
© 2013 Deloitte LLP Other Comprehensive Income (OCI) solution Dealing with interest rate fluctuations and insurers performance The principle of the OCI solution is to faithfully reflect the performance of insurance contracts and the assets backing them recognising that the illiquidity of the former should not bring in insurer’s profits the impact of market interest rate fluctuations because they will unwind over time In parallel, IFRS 9 will introduce a new category ‘fair value through OCI’ for debt instruments Changes in the insurance liability arising from changes in the discount rate caused by current interest rates will be presented in OCI. Income statement expense will be based on historical discount rates In practice insurers will need to maintain two sets of balance sheet data: one at current interest rates and one at a locked-in rate For participating contracts the “mirroring approach” has precedence over the OCI solution Derivatives would not be allowed to be accounted for under the OCI solution in IFRS 9 and IFRS 4 Phase II – this remains a material unresolved problem 5IFRS 4 Phase II – Webcast (June 2013)
© 2013 Deloitte LLP Other Comprehensive Income (OCI) solution (cont.) Fair Value-OCI available for debt instruments, but accounting mismatches may not be entirely eliminated ‒ Assets at Amortised Cost or Fair Value through Net Income ‒ Impairment impacts on assets Changes in interest sensitive assumptions recorded in earnings Impacts on post claim liabilities for PAA contracts Tracking layers and rate changes is potentially demanding IFRS 4 Phase II – Webcast (June 2013) 6 R CFs t0t0 t0t0 t1t1 t1t1 ∆ Rates (to OCI) ∆ CFs (to earnings/CSM) ∆ R x ∆ CFs This “layer” is a new cohort. t2t2 t2t2
© 2013 Deloitte LLP Participating contract ‘mirroring approach’ IFRS 4 Phase II – Webcast (June 2013) Participating contracts These are contracts that specify a link to the returns on underlying items. With-profit, unit-linked and many others Measurement and presentation where cash flows vary directly with the underlying asset Measure and present fulfilment cash flows by reference to the assets carrying amount (‘mirroring’ approach) No adjustment to CSM where cash flows vary indirectly with the underlying asset measure fulfilment cash flows at risk-adjusted present value discounted at current rate No OCI solution applies – all interest-related changes will go through earnings Adjust CSM prospectively where cash flows do not vary with the underlying asset measure fulfilment cash flows at risk-adjusted present value OCI solution applies Adjust CSM prospectively Risk adjustment is common across and changes always go through earnings 7
© 2013 Deloitte LLP Participating contracts ‘mirroring approach’ (cont.) Need to ‘decompose’ the different sets of cash flows in a contract to identify those cash flows that vary directly with the underlying assets Illustrative example 5-year contract with a single premium of CU2,000 received at inception. Surrender and maturity values are 90 per cent of the value of a specified pool of assets held by the company where his premium was invested Death before the end of 5 years triggers a fixed death benefit of CU4,000 Maturity value is guaranteed to be at least CU2,000 CF2: 90% of the value of underlying assets CF3: Value of the option to maturity CF1: death benefit of CU 4,000 IFRS 4 Phase II – Webcast (June 2013) 8
© 2013 Deloitte LLP Presentation of insurance revenue and expenses IASB wanted to take on board critics of the summarised margin and absence of a revenue figure from the 2010 presentation proposals The IASB concluded that the presentation of insurance contracts under the Premium Allocation Approach (PAA) already satisfied these critics and did not change it The IASB decided to produce a revenue presentation approach for the Building Blocks Approach (BBA) – no changes to profit recognition principles Deposit components are disaggregated from the period’s movements in the BBA liability The BBA outflows are split between those relating to future coverage and services and those beyond the expiry of that period (settlement cash flows) Outflows experience variances for the first sub-set are grossed up: expected cash flows are taken to the insurance revenue line whilst actual cash outflows (benefits and expenses) are reported as insurance expenses IFRS 4 Phase II – Webcast (June 2013) 9
© 2013 Deloitte LLP Presentation of insurance revenue and expenses (cont.) Net experience variances on inflows (premiums) that relate to future coverage are added to the revenue together in line with the changes in CSM recognised through earnings and the changes in the risk adjustment related to future coverage net cash flows Amounts derived from the CSM are grossed up for direct acquisition costs which are presented as an expense using an amortisation pattern that mirrors the release of the CSM through earnings. Other presentation requirements: Offsetting insurance and reinsurance revenue/expenses is prohibited Offsetting of ‘mirroring approach’ revenue/expenses with the expenses/revenue of the underlying items is prohibited Insurers are required to disclose inputs into the determination of the revenue recognised in the period, i.e. expected cash flows; change in risk adjustment; and change in CSM and implicit amortisation of acquisition costs IFRS 4 Phase II – Webcast (June 2013) 10
© 2013 Deloitte LLP Presentation of insurance revenue and expenses (cont.) Linking the liability movements to revenue and expenses IFRS 4 Phase II – Webcast (June 2013) CSM RA EPV FCF Gross up for acquisition costs Adjust for FCF inflows experience variances Split RA between coverage part and settlement part Split FCF between inflows/outflows and coverage/settlement Collect actual coverage and settlement FCF outflow data (insurance expenses) Disaggregate deposit component FCF Adjust for FCF change in assumptions (coverage)
© 2013 Deloitte LLP Liability for remaining coverage Presentation of insurance revenue and expenses (cont.) IFRS 4 Phase II – Webcast (June 2013) 12 Linking the liability movements to revenue and expenses (cont.)
© 2013 Deloitte LLP Approach to transition Modified retrospective restatement for all prior periods to calculate the opening CSM If CSM restatement is not practicable because of lack of objective data, the use of estimates based on objective information that are reasonably available is permitted Determining the locked-in discount rates retrospectively should be based on adjusting a market-observable interest rate yield curve for at least the past three years If there is not a market-observable yield curve, the discount rates can be determined using the closest market-observable yield curve The same market-observable reference point must be used to determine the locked-in discount yield curve for each of the years in the retrospective period Use the yield curve determined above for recognising interest expense on the accretion of the discount rates Cumulative effect of the difference between those yield curves and the discount rate yield curve determined at the transition date goes to accumulated OCI IFRS 4 Phase II – Webcast (June 2013) 13
© 2013 Deloitte LLP Approach to transition (cont.) Use of hindsight is required for this transition Re-designation of financial assets At the beginning of the earliest period presented, an insurer is permitted but not required, to re-designate financial assets to be measured at FVTPL if to do so would eliminate or significantly reduce an accounting mismatch. An insurer is required to revoke previous designations at FVTPL if the accounting mismatch that led to previous designation is now eliminated. If the entity has already applied IFRS 9, it is permitted to designate an investment in an equity instrument at FVOCI and revoke a previous election to use OCI to present changes in the fair value of some or all of its equity securities that are not held for trading. In applying the transitional provisions to in-force contracts previously acquired through business combination, the insurer shall use: The date of the business combination as the inception date of the contract. The fair value of the contract at the date of business combination as premium received. Reduced disclosures on claims development and other areas Early adoption is permitted IFRS 4 Phase II – Webcast (June 2013) 14
© 2013 Deloitte LLP Update on timetable and next steps Exposure Draft released July 2010 Effective date: Revised Exposure Draft released June 2013 Final Standard 2HY Comment period ends 25 October 2013 Target date of publication for the final standard is H Effective date of the standard is “approximately three years from date of publication of the final IFRS” ED: Expected Credit Losses released March 2013 ED: Limited Amendments: Classification and Measurement released Nov 2012 IFRS 9 IFRS 4 1 January or 1 January 2015? 2016? 1 January or 1 January 2017? 2018? Effective date: IFRS 4 Phase II – Webcast (June 2013) Final Standard 2HY 2014 IFRS 9 for assets and liabilities published October 2010
© 2013 Deloitte LLP. Contact details Francesco Nagari Deloitte Global IFRS Insurance Lead Partner Deloitte Insights into IFRS Insurance (i2ii) Insurance Centre of Excellence: IFRS 4 Phase II – Webcast (June 2013) 16
This seminar and the accompanying hand-outs cover topics only in general terms and are intended to give a wide audience an outline understanding of issues relating to accounting applicable to entities in the insurance sector, and therefore cannot be relied on to cover specific situations; applications of the principles set out will depend on the particular circumstances involved. Furthermore, responses given in the seminar to questions are based on only an outline understanding of the facts and circumstances of the cases and therefore do not form an appropriate substitute for considered specific advice tailored to your circumstances. We recommend that you obtain professional advice before acting or refraining from acting on any of its contents. We would be pleased to advise you on the application of the principles demonstrated at the seminar and other matters to your specific circumstances but in the absence of such specific advice cannot be responsible or liable. Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Deloitte LLP is the United Kingdom member firm of Deloitte Touche Tohmatsu ('DTT'), a Swiss Verein, whose member firms are legally separate and independent entities. Please see for a detailed description of the legal structure of DTT and its member firms. © 2013 Deloitte LLP.
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