Presentation Workshop Insurance IFRS Seminar December 2, 2016 Darryl Wagner Session 25

Objectives To build the Statement of Comprehensive Income using the Exposure Draft approach For simplification purposes, we only calculate the following: Underwriting margin Gains and losses at initial recognition Acquisition costs that are not incremental There are 2 cases: Base Case & Mortality Sensitivity with extra 25% loading Spreadsheet provided has 4 tabs: Assumptions Base Case Mortality Sensitivity 2001 CSO

Case Study Product: 10 year Level Term Life Insurance Insured Characteristics Male, age 45 Face Amount of $50K Fixed level annual premium - $4.5 per $1,000 face Commission on premium is 75% in year 1 and 5% thereafter Non-commission acquisition expenses of $75 per policy (Assume 75% of $75 is directly attributable & successful) Annual maintenance expenses of $10 per policy Investment yield is 6% annually Inflation is 3% per annum Experience Mortality – 75% of 2001 CSO Table Experience Lapse – 8% for years 1-9, and 100% for year 10

Illustrative modeling approach Block 1: Fulfillment Cash Flows We assume a pricing-type model for single policy New business model for liability Cash flows include: Projected premium incomes Directly attributable acquisition expenses Projected future maintenance expenses Projected death benefit payments Single scenario only – no probability weighting of multiple scenarios

Illustrative modeling approach (cont.) Block 2: Interest Discount Rates For simplification, we assume fixed interest discount rates are used to discount all cash flows Flat yield curve with risk-free rate of 2.28% annually Estimated liquidity premium is 0.37% annually

Illustrative modeling approach (cont.) Block 3 (IASB): Margins - Risk Adjustment We assume Cost of Capital approach Future annual economic capital values estimated using proxy factors 0.18% of Face amount 6.16% of Premium Risk adjustment at valuation date is 6% of PV of future annual economic capital values

Illustrative modeling approach (cont.) Block 3 (IASB): Margins – Contractual Service Margin At initial measurement, contractual service margin is a plug item measured as [PV of cash inflows] – [PV of cash outflows with Risk Adjustment] Then amortized in proportion to change in PV of expected future benefit cash flows

Statement of comprehensive income IASB Exposure Draft Insurance contract revenue X Claims and benefits incurred (X) Amortization of acquisition costs Changes in estimates for future claims Unwind of previous changes in estimates Total Underwriting Margin Investment income Interest accreted on insurance contracts Profit Components of other comprehensive income Total comprehensive income Block 1 Current, unbiased and probability weighted estimates of the contractual cash flows The future cash flows are re-estimated every period with changes reflected in the SCI The difference between the expected vs. actual cash flows during the period are reflected in the SCI

Statement of comprehensive income IASB Exposure Draft Insurance contract revenue X Claims and benefits incurred (X) Amortization of acquisition costs Changes in estimates for future claims Unwind of previous changes in estimates Total Underwriting Margin Investment income Interest accreted on insurance contracts Profit Components of other comprehensive income Total comprehensive income Block 2 Discounting of cash flows The interest expense from the discount unwinding is recognized in the SCI The discount rates are re-estimated every period with changes recognized in the SCI

Statement of comprehensive income IASB Exposure Draft Insurance contract revenue X Claims and benefits incurred (X) Amortization of acquisition costs Changes in estimates for future claims Unwind of previous changes in estimates Total Underwriting Margin Investment income Interest accreted on insurance contracts Profit Components of other comprehensive income Total comprehensive income The risk adjustment is re-measured at each reporting period and the movement is recognised in the SCI Block 3 Risk adjustment

Statement of comprehensive income IASB Exposure Draft Insurance contract revenue X Claims and benefits incurred (X) Amortization of acquisition costs Changes in estimates for future claims Unwind of previous changes in estimates Total Underwriting Margin Investment income Interest accreted on insurance contracts Profit Components of other comprehensive income Total comprehensive income The contractual service margin is released ON a systematic basis that reflects the remaining transfer of services that are provided under the contract Block 3 Contractual service margin

Exercise Objective: Build the Statement of Comprehensive Income using the Exposure Draft approach For both Base Case and Mortality Sensitivity: Calculate the IASB contractual service margins Calculate the underwriting margin, gains and losses at initial recognition, and acquisition costs that are not directly attributable

Assumptions/Calculation Methods Answer Key Underwriting margin Assumptions/Calculation Methods Change in risk adjustment Risk adjustment (t) – Risk adjustment (t+1) Release of contractual service margin Contractual service margin (t) – Contractual service margin (t+1) Gains/losses at initial recognition Losses at initial recognition of an insurance contract Max (Risk adjustment + NPV of fulfillment CFs, 0) Acquisition costs that are directly attributable 75% of total acquisition costs, plus the incremental 1st year commission

Answer Key Base Case IASB Year 1 Year 2 Year 3 Year 4 Year 5 Year 6   Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total (a) Underwriting margin Insurance contract revenue Release of contractual service margin 15 17 18 19 21 22 24 26 197 Change in risk adjustment 5 4 43 Period expected cash outflows 104 108 110 109 112 116 121 127 134 1,150 Acquisition cost period allocation 6 7 56 Claims and benefits incurred (104) (108) (110) (109) (112) (116) (121) (127) (134) (1,150) Amortization of acquisition costs (181) (5) (6) (7) (233)

Answer Key Mortality Sensitivity IASB   Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total (a) Underwriting margin Insurance contract revenue Release of contractual service margin - Change in risk adjustment 5 4 43 Period expected cash outflows 130 135 137 136 140 144 150 158 167 1,433 Acquisition cost period allocation 6 7 56 Claims and benefits incurred (130) (135) (137) (136) (140) (144) (150) (158) (167) (1,433) Amortization of acquisition costs (181) (5) (6) (7) (233)

Questions to consider In the Mortality Sensitivity case, what if the mortality shock comes after year 1 (in a valuation-type model)? What considerations need to be made when unlocking the CSM? Can there be negative reserves? What is the significance of a negative reserve result? How would the asset side of the balance sheet be represented if this scenario was to arise?

Thank You