Adoption of IFRS in the Insurance Sector Catherine Guttmann 15 March 2006

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Adoption of IFRS in the Insurance
SectorCatherine Guttmann15 March 2006

• REPARIS Workshops on Accounting and Audit
  Regulation, Vienna, March 2006

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What does IFRS 4 Phase I mainly say
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IFRS 4 Phase I Insurance Contracts

• Main features of the IFRS
• The 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
• All IFRS standards apply to insurance companies
•  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

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IFRS 4 Phase I Insurance Contracts

• Definition of an insurance contract
• An 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 

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IFRS 4 Phase I Insurance Contracts

• Definition of financial risk
• An insurance risk is a  risk , other that
  financial risk, transferred from the holder of a
  contract to the issuer 
• A 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 

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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 dont 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 doesnt incure a specific loss
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IFRS 4 Phase I Insurance Contracts
First consequence classification of the
contracts and valuation principles

• IAS 39 for the financial component and liability
  adequacy test
• Local GAAP for the insurance component
• No need to separate

Significative insurance risk ?
yes
yes
no
Embedded derivative to separate
Financial Component ?
yes
no
Separate and Fair value the Embedded derivative
Discretionary Participating Feature ?
no

• Local GAAP and Liability adequacy test

Non discretionary
discretionary
IAS 39 / IFRS 4
IAS 39
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Second Consequence an insurer balance sheet
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Orientations for Phase II
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IntroductionThe objectives of Phase II

• By splitting the insurance project into 2 phases,
  the IASB board has postponed several key subjects
  
• Valuation of insurance contracts keeping
  current accounting principles
• Qualification and treatment of discretionary
  participating features (shadow accounting)
• Embedded derivatives
• Revenue recognition
• Phase II will have to deal with all these issues
  with the following underlying purpose
• To get a better financial reporting
• To reach a global consistency between all IAS
  standards (IAS 39, IAS 18, IAS 37, ) and the
  IFRS framework (comparability, reliability,
  substance over form,)

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Agenda of the Phase II project

• A working group has been set up by the IASB board
  
• Meeting every 2 month
• Participants
• 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)
• Public debate
• Regular publications

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Agenda of the Phase II project

• Agenda
• A Working Paper should be published by the
  Working Group Phase II before year end 2006
• An Exposure Draft should be published in 2008
• Final standard could be published before year end
  2008

Endorsement of phase II standard
Working paper published
ED published
Working Group meetings
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Some valuation approaches

• Approach 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

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Some valuation approaches

• Approach 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

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Some valuation approaches

• Approaches C D

Approach C "Business to Customers
Approach D "Business to Business
Asset
Asset
Net equity
Net equity
No gain at inception
Some gain at inception but limited by the SM and
the MRI
Global Margin
Servicing margin

• Separation and valuation of the 3 parts of the
  contracts
• exit value "best estimate"
• Margin for risks
• Servicing margin

MRU
Global margin Premiums Exit Value best
estimate
Exit Value best-estimate
Exit Value best-estimate
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Some valuation approaches

• IAIS 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

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