Indian Actuarial Profession Serving the Cause of Public Interest 28th India Fellowship Seminar Topic: IFRS 17- Introduction, History, Features and Implications on Insurers Guide Name: Kamlesh Gupta Presenters Name: 1. Jimmy Jacob 2. Rohit Mall 3. Subhasree Nigamma 4. Nandan Nadkarni Date: November 10, 2017 Venue: Mumbai Indian Actuarial Profession Serving the Cause of Public Interest

Coverage Aspects Paras Content Level of Aggregation 14-24 Minimum criteria for grouping Recognition 25-28 The contract recognition date Measurement ---Initial Measurement 32-38 Estimation of fulfilment cash flows and contractual service margin ---Subsequent Measurement 40-43 The measurement of subsequent carrying amount and the impact on P&L ---Onerous Contracts 47-52 Treatment of onerous contracts www.actuariesindia.org Source: IFRS 17

Coverage (Contd…) Aspects Paras Content ---PAA approach 53-59 An alternate measurement approach ---Reinsurance Contracts held 60-69 Recognition and Measurement of Reinsurance contracts ---Investment Contracts with DPF 71 Modified requirements for these contracts Modification and Derecognition 72-74 The conditions for modification and de-recognition Presentation 78-87 Presentation Requirements Disclosure 97-114 Disclosure requirements www.actuariesindia.org Source: IFRS 17

Introduction and History Areas to be addressed Introduction and History Timelines and Scope History Features Three valuation methods Aggregation Level General Measurement Model Onerous Contracts Implications Life Insurance General Insurance Common www.actuariesindia.org

Time Lines and Scope 2017 2022 2021 2020 2019 2018 IFRS 17 applies to: Disclosure of expected impacts of the issued but not yet effective standard Revised IFRS 9 classification from IFRS 17 implementation First IFRS 17-compliant financial statements IFRS 17 start of comparative period IFRS 17 effective 1 January 2021 IFRS 17 issued IFRS 17 applies to: Insurance and reinsurance contracts that an entity issues Reinsurance contracts that it holds Investment contracts with DPF (provided entity issues Insurance contracts) Applicable for annual periods starting on or after 1st Jan, 2021, comparative reporting through 2020 Early application permitted for entities that apply IFRS 9 and IFRS 15 www.actuariesindia.org Source: EY IFRS 17 report

History IFRS 4 permitted wide latitude in a/c practice Hampered comparability of financial statements Some a/c practices under IFRS 4 did not reflect true financial position Non-marketability of an insurance contract posed measurement issues Need for a common global insurance standard IFRS 17 focuses on transparency and consistency of accounting practice! www.actuariesindia.org Source: IFRS 17

Introduction and History Areas to be addressed Introduction and History Timelines and Scope History Features Three valuation methods Aggregation Level General Measurement Model Onerous Contracts Implications Life Insurance General Insurance Common www.actuariesindia.org

Three valuation methods General Measurement (GM) Model (Building block Approach-BBA) Insurance Contracts (without Direct Participating feature) Unearned profit over the coverage period Estimates of Future cash flows Long term contracts PAA Approach Short term contracts (< than 1 year) Stable cash flows Simplified GM model Similar to ‘Unearned premium approach’ Variable Fee Approach (VFA) Direct Participating Contracts and Investment Contracts with DPF Variant of GM model Long term Contract with Investment Component www.actuariesindia.org

Level of Aggregation Onerous contracts are loss making contracts! Contracts with similar risks to be grouped together Minimum Grouping at inception Nature Profitable and unlikely to be onerous Onerous Remaining Duration Issue dates- Maximum one year apart Onerous contracts are loss making contracts! “Profitable and unlikely to be onerous”?? ..Judgment?? www.actuariesindia.org

IFRS 17 and the valuation methods IFRS 17 Aim/Intention Focus on Profit drivers Three valuation methods General Measurement Model- Deviation from current practice?? www.actuariesindia.org

General Measurement (GM) Model -Building Block approach (BBA) Liability for future coverage Contractual Service Margin(CSM) Risk Adjustment Probability weighted discounted EPV Unearned profit amortized over coverage period Eliminates gain at contract inception Liability for Incurred claims Risk Adjustment Probability weighted discounted EPV For non-financial risks + Best Estimate Liability at a liability discount rate Risk Adjustment + Probability weighted discounted EPV=Fulfilment Cash flows www.actuariesindia.org

Subsequent Measurement- BBA P&L Release post this reassessment OCI CSM P&L Subsequent Measurement- BBA Risk Adjustment Probability weighted discounted EPV Risk Adjustment Probability weighted discounted EPV Estimated cash flow changes + Reassessment of fulfilment cash flows Release through P&L/OCI www.actuariesindia.org

BBA- CSM Impact of changes for future coverage P&L (CSM Release) Risk Adjustment Estimated changes related to future service Probability weighted cash flows P&L Discount rate changes Other Comprehensive Income Why through CSM?? www.actuariesindia.org

GM Model- New components Liability for future coverage Contractual Service Margin(CSM) Risk Adjustment Unearned profit amortized over coverage period Eliminates gain at contract inception Liability for Incurred claims Risk Adjustment + For non-financial risks Risk adjustment /CSM at the portfolio level?? Judgment in allocation IFRS guidance for Risk Adjustment estimation Cash flow characteristics; Probability distribution of cash flows Confidence Interval Components to be tracked www.actuariesindia.org

Key Aspects of GM Model Subsequent Measurement Initial Recognition Pricing equation… CT5! Initial Recognition Quantifying the CSM Liability at inception is NIL. CSM ensures that the Income/Expense in NIL Subsequent Measurement ---Reevaluate the fulfilment cash flows ---P&L/OCI impact The change in cash flows impact either the CSM or the P&L/OCI Cash Flow Changes Flow through P&L Absorbed in Balance sheet(CSM) Flow to OCI www.actuariesindia.org

Insurance Contract (without Direct Participating Features) General Measurement Model (BBA) -Illustration Insurance Contract (without Direct Participating Features) Values Comments Coverage period (years) 4 Total premium at inception(in Rs.) 1500 Initial acquisition cost (in Rs.) 100 Expected claims and expenses (in Rs.) 800 Incurred evenly over 4 years No lapse assumed Risk adjustment for non-financial risk (in Rs.) 80 Assumed even release Discount rate Negligible Actual Experience Same as expected & no assumption changes www.actuariesindia.org Source: KPMG, July 2017

-Illustration (Contd..) GM Model (BBA) -Illustration (Contd..) Years Cash flow description Initial recognition 1 2 3 4 EPV of cash inflows Premium 1500 EPV of cash outflows Expected claims and expenses (incl. acquisition cost) -900 -600 -400 -200 Risk adjustment Non-fin risk adj -80 -60 -40 -20 Fulfilment cashflows 520 -660 -440 -220 Contractual service margin -520 -390 -260 -130 Insurance contract liability -1050 -700 -350 www.actuariesindia.org Source: KPMG, July 2017

GM Model (BBA)-P&L Impact Change in liability for remaining coverage Years 1 2 3 4 Opening balance -1050 -700 -350 Premiums received -1500 Acquisition cash flow 100 Expected claims 200 Risk adjustment recognised 20 CSM allocation 130 Closing balance P &L impact 1 2 3 4 Expected claims 200 Risk adjustment recognised 20 CSM allocation 130 Revenue for services provided 350 Revenue to cover acquisition cash flows 25 Insurance revenue 375 Service expenses -200 -25 Insurance service expenses -225 Insurance service result 150 www.actuariesindia.org Source: KPMG, July 2017

GM Model (BBA)-Balance Sheet Impact Years 1 2 3 4 Asset Cash 1500-100-200= 1200 1200-200 = 1000 1000-200 = 800 800-200 = 600 Liability and Equity Insurance contract Liability 1050 700 350 Equity 150 300 450 600 Total Liability and Equity 1200 1000 800 www.actuariesindia.org

Balance sheet measurement General Measurement Model- Macro Perspective (Contd..) CSM Risk Adjustment Estimated changes related to future service Probability discounted cash flows Flow to Income/OCI Balance sheet measurement Source: PWC, March 2, 2017 www.actuariesindia.org

Balance sheet measurement General Measurement Model- Macro Perspective (Contd..) CSM CSM Release Risk Adjustment Release of Risk Adjustment Estimated changes related to future service Probability discounted cash flows Interest on Insurance liability at inception rate (unwind of discount rate) Discount Rate changes (update current market rates) Changes in cash flows related to past and current service period Flow to Income/OCI Balance sheet measurement Source: PWC, March 2, 2017 www.actuariesindia.org

Balance sheet measurement General Measurement Model- Macro Perspective (Contd..) CSM CSM Release P&L (Underwriting Result) Risk Adjustment Release of Risk Adjustment P&L (Investment Result) Estimated changes related to future service Probability discounted cash flows Interest on Insurance liability at inception rate (unwind of discount rate) Discount Rate changes (update current market rates) Changes in cash flows related to past and current service period Other Comprehensive Income (Equity) Flow to Income/OCI Balance sheet measurement Source: PWC, March 2, 2017 www.actuariesindia.org

Onerous Contracts Definition When? CSM Impact Treatment Total fulfilment cash flows are a net outflow Loss making contracts When? Initial Recognition; or Subsequent Measurement CSM Impact Wipes out the CSM Treatment Immediate recognition of the liability P&L Management judgment to identify profitable contracts that could turn onerous! www.actuariesindia.org

Introduction and History Areas to be addressed Introduction and History Timelines and Scope History Features Three valuation methods Aggregation Level General Measurement Model Onerous Contracts Implications Life Insurance General Insurance Common www.actuariesindia.org

Life Insurers: Likely Impact on Segment Mix Business Mix for life Insurance Industry [for 6 months ended 30th Sep 2017 (FYP)] Category Business Mix Individual Single Premium 14% Individual Non-Single Premium 26% Group Single Premium 57% Group Non-Single Premium 2% Group Yearly Renewable Premium Key Aspects IFRS 17 amends the way revenue is measured and disclosed. Likely to Impact Single premium mix; since it will not contribute to immediate top line growth Aggressive sale of ULIP/Group fund based products may not translate in to top line growth www.actuariesindia.org

Life Insurers: Likely Impact on Segment Mix Key results disclosed in Income statement Underwriting result Net Interest and Investment income Profit/ Loss Total comprehensive income Key Performance indicators likely to change. Likely that Insurers will focus on more Profitable segments like Protection Products. www.actuariesindia.org

Life Insurers: Measurement Approach for different Segments Need for the Approach Types of contract (Illustrative list) General Measurement Approach (Building Block Approach) Default model for all Insurance contracts. Applicable for contracts without direct participating features. Term / Whole life / Endowment Long term health Other protection business Certain annuities Immediate annuities Premium Allocation Approach (PAA) Simplified approach for Short term contracts Short term life contracts Variable fee approach (VFA) To deal with Participating business, where payments to policy holders are linked to underlying items like assets. Applicable for contracts with direct participating feature. Variable Insurance contracts Unit linked contracts www.actuariesindia.org

Variable fee Approach : Illustration Facts for ULIP contract Values Coverage period (years) 3 Single premium (payable at inception) (in Rs.) 150 Number of Policies issued 100 Benefit payable -Account balance, if the policy holder survives -In case of death, higher of guaranteed death benefit of 170 or Account balance. Expected claims One Policy holder will die at the end of each year. Return on underlying assets (p.a.) 10% Service charge levied by Insurer(p.a.) 2% Risk free interest rate (p.a.) 6% Risk adjustment for non-financial risk 25 (12 to be recognized in profit statement in year 1) www.actuariesindia.org Source: KPMG, July 2017

Variable fee Approach : Illustration Estimate of CSM Estimate of Present value of cash inflows (100 Policies*150) 15,000 Estimate of Present value of cash outflows *Factors in the current discount rate as well the time value of guarantee in providing a minimum death benefit (14,180)* Risk adjustment (25) Fulfillment cash flows 795 CSM to be recognized (795) www.actuariesindia.org Source: KPMG, July 2017

Variable Fee Approach : Illustration Fair value of Underlying assets at end of year 1 Premium received on inception 15,000 Investment return at 10% 1,500 Annual charge [16,500 * 0.02] (330) Payment for death [(16,500-330)*1/100] (162) Fair value at end of year 1 16,008 CSM at end of year 1 Opening balance (795) Company’s share of change in fair value of underlying items (increase of 1500*.02) (30) Effect of time value of money and other financial risk (67) CSM before Allocation (892) CSM to be allocated for year 1(892*percentage of service provided in year 1) Percentage of service provided in Year 1: (100/(100+99+98)) =34%. 300 (592) www.actuariesindia.org Source: KPMG, July 2017

Variable fee Approach : Illustration Results for Year 1 Expected claims and other expenses (Guaranteed amount of 170 minus account balance of 162) 8 Changes to risk adjustment for the non-financial risk 12 CSM allocation during the period 300 Insurance Revenue 320 Insurance service expenses Insurance service result 312 Investment income 1500 Insurance finance expenses (1500) Finance result Profit www.actuariesindia.org Source: KPMG, July 2017

Life Insurers: Acquisition cash flows IFRS 17 :Insurance Acquisition cash flows to be included in determining CSM on initial recognition. :Insurance Acquisition cash flows eventually affect profit or loss through the CSM release process (So in effect we defer acquisition cost). Current Practice : Expense all Acquisition cash flows at inception. Implication of implementing IFRS 17 :Smaller losses at inception (less year one strain) :Lower profit in Year 2 & later. www.actuariesindia.org

Implications – General Insurance Aspect Implication Method Expectation – PAA Long tailed LoB – application of PAA – doubtful Judgments – Regarding Onerous Cash flow Determination, risk adjustment Non availability – Year wise High volatility – more judgment Same implications as BBA approach Acquisition cost Realised year after year Long term contracts may be affected www.actuariesindia.org

Actuaries will have a greater role! Implications-General Insurance Aspect Implication Recognition of incurred claims Different from current practice Not - (Paid + Changes in O/S & IBNR Claims) Key metrics Review of Combined ratio, Incurred claims ratio required Actuaries will have a greater role! www.actuariesindia.org

Common Implications – Cost/Data Aspect Implication Aggregation (Grouping) By inception dates and nature (Onerous, profitable,etc) implies large storage requirements CSM/Risk Adjustment release Allocation methodology to be devised e.g could depend upon the number of contracts, coverage offered, etc. Risk Adjustment An explicit adjustment; No specific IFRS guidance; Impact on comparability Confidence Interval www.actuariesindia.org

Common Implications – Cost/Data Aspect Implication Reconciliation E.g. CSM and Risk Adjustment Cash flows Information on cash flows (Historical and Future), discount rates and risk adjustments for each contract group to be stored Adverse circumstances Methodology to monitor circumstances indicating onerous contracts ‘Facts and Circumstances’ for onerous under PAA e.g CSM margin at inception, sensitivity of cash flows to assumption changes etc. www.actuariesindia.org

Common Implications – Cost/Data Aspect Implication Discount rates Two set of discount rates to be stored Performance Appraisal New benchmarks to be developed; incentives around new KPIs Data, Systems Human Talent Upgradation of legacy systems New controls and increased interaction of actuaries and accountants Indeterminate Impacts Tax authorities and Regulators www.actuariesindia.org

More time and effort Common Implications – Disclosures Disclosure Requirement Insurance risk Sensitivity to changes in risk exposure, claim development Credit risk, Liquidity risk, Market risk Exposure to risk, Policies and process to manage the risk More time and effort Working group by IRDA for reviewing and early adoption of IFRS 17 www.actuariesindia.org

Thank you www.actuariesindia.org