Canadian Institute of Actuaries PD-6 Update on International Standards CIA Seminar for the Appointed Actuary 2004 Montréal, September 20, 2004

IFRS 4 and IAA Proposed Guidance David Congram Good afternoon Well it is one year later and we are meeting again to address this topic When I spoke last year I alerted you to start getting prepared I am glad I did that as the train has left the station as I predicted. I will not be repeating the review of the IASB standard as I did last year but will focus on the IAA guidance.

Adoption of IFRS/IAS EU – publicly traded companies must apply IFRS/IAS for financial reporting in 2005 Major concerns with IAS 39 among banks (not approved by EU yet) Insurers concerns through CFO forum Regulators concerned about “fair value” Affects Canadian branches/subs of European companies US – FASB committed to working with IASB to achieve convergence So first lets step back and ask who is affected? Review slide EU-listed companies and the Caribbean. Australia - possible early adoption So those in Canada with foreign parents reporting under IFRS, mostly the European parents I would guess, you will be reporting first quarter 2005 The expectation is with convergence the CICA will move Canada to IFRS in 2007/8. So for the rest of us who are responsible to perform DCAT this is now expected within the testing horizon as I mentioned last year. I am looking forward to hearing how this topic was addressed. I suspect a number of us last year indicated the basis was not clear enough to get a good assessment. With some of us now reporting on this basis we will need to consider how best to address this topic. The implications of this change on the financial status of your business needs to be understood and I believe Management will want to know how it will affect their potential competitive position.

Target Implementation timetable Those adopting IFRS 2005 2007 IAS 39 Report results Report results IFRS 4 Report results Report results Phase 2 - Report results So for first time application of International Financial Reporting Standards this is the timetable in the top half I included a similar slide with my presentation at the last AA seminar here in 2003. Interestingly the only thing that has changed is I have replaced ED5 with IFRS 4. Usually we expect some slippage. I expect 2007 will slip into 2008. Normally you have to include a one year comparative so that means income statements for 2004 and 2005. The implication of that is you need to construct an opening balance sheet December 2003.

IFRS/IAS for “Insurance” IASB has published: IFRS 4 – Insurance Contracts Significant insurance risk (e.g., term insurance) IAS 32&39 – Financial Instruments (e.g., certain annuities) IAS 18 – Service Contracts (e.g., ASO and Service components) Contracts written by Canadian insurers would primarily fall under these three accounting standards This definition will be used throughout all standards (IFRSs). A contract is insurance if the insurer accepts significant insurance risk by agreeing to compensate the beneficiary if the insured event adversely affects the policyholder or beneficiary. Significant means at least one scenario with payment of commercial substance with an amount that is not trivial Contracts issued by insurers are generally financial instruments. So, if a contract does not meet the definition of insurance, it will likely be an investment contract, to be measured under IAS 39. However for investment contracts they need to be divided between their financial instrument component and the servicing component. Lets take a variable annuity backed by segregated fund. The management fee for the investment management is viewed as a service contract and would be viewed as a separate component from the assets in the fund which would be the financial instrument component.

Primary Provisions of IFRS 4 IFRS 4 allows insurance contracts to be accounted under local GAAP, with certain restrictions Liability adequacy tests required Certain existing practices may continue in Phase 1 Restrictions No catastrophe provisions No Claims equalization provisions No offsetting of reinsurance assets or liabilities Tests Required if accounting policies do not include Liability adequacy, Impairment of reinsurance and recover-ability of deferred acquisitions costs Most classic that if your existing policy is not to discount this can be continued

IAS 32&39 – Financial Instruments Covers measurement of asset side of the balance sheet Covers financial instrument component of investment contracts GICs, term certain annuities Election as “held for trading” or not Held for trading measured at fair value; others measured at amortized cost Any embedded derivatives at fair value Amortized cost based on effective interest rate DAC prohibited Review the slide

IAS 18 – Service Contracts Covers contracts service component of investment contracts and other contracts that are not financial instruments ASO contracts etc Matching of revenue and expense DAC allowed but more restrictive definition than US GAAP Claim service contracts (ASOs) Self insurance (basic risk financing) Deductibles Note this is the manner in which acquisition costs can be deferred

IAA Insurance Standards Practice Guideline (IAA Class 4) - Exposure Drafts Actuarial Practice Contract Classification Measurement Liability Adequacy Testing Changes in Accounting policy Embedded Derivatives Discretionary Participating Features Current Estimates Disclosure Reinsurance Stochastic Models So What Guidance has the IAA provided First three exposure drafts in accordance with the IAA due process was published September 14, 2004, last Thursday. (I might add finally) The balance other than Reinsurance and Stochastic Models are in the final review and voting by the Committee. I have provided the URL where you can obtain these documents http://www.actuaries.org/members/en/committees/INSSTD/documents/PG_Actuarial_Practice_09-14-04.pdf

IAA Insurance Standards - Actuarial Practice Specific guidance Disclosures Scope and adequacy of Professional Services Accounting requirements Classification Measurement Participation Liability Adequacy Test Accounting Disclosure Relevant Knowledge Material Inconsistencies General guidance Disclosure in accordance with what IASP Measurement includes unit of account, unbundled, service components Material Inconsistencies Aware of information not in conformity with accounting policy errors Management may select measurement bases potential for misleading income

IAA Insurance Standards - Classification IAS 18 Service Contract Measurement Significant insurance risk Create financial assets or liabilities? No No Yes Yes Service Element IFRS 4 Insurance Contains Discretionary Participation Feature? Yes No Contains service elements Tests Financial Instrument Go through the slide Embedded Derivative Test Tests IAS 39 Financial Instrument Measurement Deposit Component Financial Instrument

International Actuarial Practice Guideline Measurement Measurement approaches addressed Amortised Cost model Fair Value model Stage of completion Structure Approach Models and assumptions Updating Accounting Requirements

Revised IAS 39: Measurement Valuation Technique Market Calibration Fair Value Entire Contract Options and Guarantees considered Option Pricing Models Financial Markets YES Election Held for Trading Financial Instrument Fair Value Option Pricing Models Derivative Host YES NO Contains Embedded Derivatives Amortized Cost Amortised Cost NO

Liability Adequacy Testing Insurance Contracts and Investment contracts with Discretionary Participation Features (DPF) IAS 37 applies if accounting policy does not meet minimum requirements Application to pre tax/direct business Where Investment Contracts with DPF classified as only liabilities. (When partially assigned to surplus additional requirements) Service Contracts IAS 16 Asset Recoverability IAS 37 Onerous contracts Does not apply to If IAS 37 applies then margins for risk and uncertainty required

Other Practice Guidelines Changes in Accounting policy Embedded Derivatives Discretionary Participating Features Current Estimates Disclosure Reinsurance Stochastic Models