1. Adoption of IFRS in the Insurance Sector Catherine Guttmann 15 March 2006 REPARIS Workshops on Accounting and Audit Regulation, Vienna, March 2006

2. What does IFRS 4 – Phase I mainly say

3. 3 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte IFRS 4 – Phase I : Insurance Contracts Main features of the IFRS lThe IFRS on insurance contracts applies to all insurance contracts (including reinsurance contracts) and only to insurance contracts Financial assets and liabilities of insurers are treated by IAS 39 lAll IFRS standards apply to insurance companies l« Insurance contract » definition is a definition in substance and not a legal one :  The standard on insurance contracts should then be used for example in the banking industry

4. 4 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte IFRS 4 – Phase I : Insurance Contracts Definition of an insurance contract lAn insurance contract is 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 futur event (the insured event) adversely affects the policyholder »  The « policyholder » is defined as : « a party that has a right to compensation under an insurance contract if an insured event occurs »

5. 5 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte IFRS 4 – Phase I : Insurance Contracts Definition of financial risk lAn insurance risk is a « risk, other that financial risk, transferred from the holder of a contract to the issuer » lA financial risk is « the risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract »

6. 6 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte IFRS 4 – Phase I : Insurance Contracts Examples of insurance contracts Are insurance contracts:Are not insurance contracts: - Insurance against theft or damage to property - Insurance against product liability, professional liability, civil liability - Disability and medical cover - Life contingent annuities - Death benefit -Catastrophe bond if the triggering event includes a condition that the issuer of the bond suffered a specified loss -Financial contracts which don’t expose the insurer to significant insurance risk (investment contracts, financial reinsurance) -Fronting -Own insurance :  for example : product warranty is issued directly by a manufacturer dealer or retailer -Catastrophe bond triggered by an external event for which the issuer doesn’t incure a specific loss

7. 7 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte IFRS 4 – Phase I : Insurance Contracts First consequence : classification of the contracts and valuation principles Significative insurance risk ? IAS 39 / IFRS 4 Embedded derivative to separate IAS 39 yes Discretionary Participating Feature ? discretionary Non discretionary no IAS 39 for the financial component and liability adequacy test Local GAAP for the insurance component No need to separate Local GAAP and Liability adequacy test Financial Component ? Separate and Fair value the Embedded derivative yes no

8. 8 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte Second Consequence : an insurer balance sheet Major changes with fair value orientation Local GAAP

9. 9 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte Major changes with fair value orientation Local GAAP

10. Orientations for Phase II

11. 11 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte Introduction The objectives of Phase II lBy splitting the insurance project into 2 phases, the IASB board has postponed several key subjects : nValuation of insurance contracts : keeping current accounting principles nQualification and treatment of discretionary participating features (shadow accounting) nEmbedded derivatives nRevenue recognition lPhase II will have to deal with all these issues with the following underlying purpose: nTo get a better financial reporting nTo reach a global consistency between all IAS standards (IAS 39, IAS 18, IAS 37, …) and the IFRS framework (comparability, reliability, substance over form,…)

12. 12 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte Agenda of the Phase II project lA working group has been set up by the IASB board : nMeeting every 2 month nParticipants :  CFO of major insurance groups : – Allianz – Axa – Prudential – AIG – Nippon Life – …  IASB board members  Members of IOSCO, IAIS,EFRAG  Actuaries (Chairman of IAA)  Analysts (Standard & Poors, DZ Bank AG) nPublic debate nRegular publications

13. 13 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte Agenda of the Phase II project lAgenda nA Working Paper should be published by the Working Group Phase II before year end 2006 nAn Exposure Draft should be published in 2008 nFinal standard could be published before year end 2008 Juillet 2005200620082009/2010 Working Group meetings Working paper published ED published Endorsement of phase II standard

14. 14 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte lApproach C – Current Entry Value Principles : Approach C measures the insurance liability at the amount that the insurer would charge to a policyholder today for entering into a contract with the same remaining rights and obligations as the existing contract. Initial measurement : Discounting of future projected cash flows using current yield curve (best estimate value) Valuation of an implicit margin, equal to the difference between premiums and the best estimate value Next measurements Best estimate value is calculated on current assumptions (economic and non economic) The initial margin is amortised among the duration of the contract with the release of the risk Some valuation approaches

15. 15 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte lApproach D – Current Exit Value Principles : Approach D measures the insurance liability at the amount that the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity. Because there is no secondary market for most insurance liabilities, that amount would need to be estimated. Specifically, approach D : Measures the insurance liability as the present value of future cash flows arising from the contract (Uses a current risk-free discount rate). Does not defer acquisition costs as a separate asset. The measurement of the liability includes the margin that market participants would require for contractually assuming risks and providing services : Margin for risks and uncertainty AND Margin for the servicing part included in the insurance contract (servicing margin) Profit at inception is limited : by the level of the MRI and by the level of the Servicing margin Some valuation approaches

16. 16 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte lApproaches C & D Some valuation approaches Asset Approach D – "Business to Business” Asset Approach C – "Business to Customers” Global margin = Premiums – Exit Value best estimate Net equity Servicing margin MRU Exit Value best- estimate Net equity Global Margin Exit Value best- estimate Some gain at inception but limited by the SM and the MRI No gain at inception Separation and valuation of the 3 parts of the contracts : - exit value "best estimate" - Margin for risks - Servicing margin

17. 17 REPARIS Workshops on Accounting and Audit Regulation, Vienna – « Adoption of IFRS in the Insurance Sector » - 15 March 2006 © 2006 Deloitte lIAIS is working on a similar model so that the same valuation for liabilities could be taken for solvency purposes and accounting Questions still to be solved : Definition of the MRU (level of confidence ; Cost of capital), or pattern of amortisation Definition and level of the servicing margin (market reference ?) Policyholder behaviour ? Paragraph 49 of IAS 39 for investment contracts Some valuation approaches