Session 8 IFRS and Solvency Requirements

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Session 8IFRS and Solvency Requirements

• Regional Training Seminar IAIS-ASSAL-FIDES
• 25 November 2009, Lima Peru
• Takao Miyamoto, IAIS Secretariat

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Agenda

• Background
• Accounting and Solvency
• IASB Insurance Contracts Project Overview
• IASB and IAIS Views on Main Issues
• Measurement Approaches
• Building Blocks
• Margins
• Day One Difference
• Acquisition Costs
• Own Credit Risk

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Two Uses of Financial Reporting
General purpose financial reporting
Should reflect economics of businesses
(Starting point) Efficiency

• Many resources (e.g. audit) were already used for
  accuracy reliability
• Widely accepted

(Prudential filter) Adjustment for different
purposes

• Often in conservative direction
• IAIS seeks to minimise

Regulatory purpose reporting requirements
Should serve to protect policyholders
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Key Principle
The IAIS believes that it is most desirable that
the methodologies for calculating items in
general purpose financial reports can be used
for, or are substantially consistent with, the
methodologies used for regulatory reporting
purposes, with as few changes as possible to
satisfy regulatory requirements.
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IASB Project Schedule
1997

• Insurance Contracts Project start

Phase I
IFRS 4
2004
Phase II
May 2007

• Discussion Paper Preliminary Views on Insurance
  Contracts (DP)

Q2 2010

• Exposure Draft

New IFRS
Mid 2011
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Agenda

• Background
• Accounting and Solvency
• IASB Insurance Contracts Project Overview
• IASB and IAIS Views on Main Issues
• Measurement Approaches
• Building Blocks
• Margins
• Day One Difference
• Acquisition Costs
• Own Credit Risk

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Measurement Approaches IASB

• Current Exit Value
• Amount insurer would expect to pay at reporting
  date to transfer remaining contractual rights and
  obligations immediately to another entity
• Current Fulfillment Value
• Expected present value of cost of fulfilling
  obligations to policyholder over time
• Updated IAS 37
• Amount entity would rationally pay at end of
  reporting period to be relieved of present
  obligations
• Given absence of active market for insurance
  contracts, this may be close to fulfillment notion

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Measurement Approaches IAIS

• Insurers generally do not transfer liabilities,
  given no active market for insurance contracts
• Insurers generally fulfill/settle obligations to
  policyholders over time
• Any transfer notion would be strongly influenced
  by settlement of obligations that transferee
  would undertake
• Transfers would need to be made to entity capable
  of accepting transfer
• It implies that transferee would also need to be
  regulated and capable of settling obligations to
  claimant/beneficiary

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Building Blocks IASB

• Three building blocks
• Current estimate of expected (i.e. probability
  weighted) present value of future cash flows
• Time value of money (i.e. discounting)
• Explicit margin
• Rationale
• Markets for trading insurance contract rarely
  exist
• So, its value is rarely observable (i.e. Level 3
  financial product)
• So, its value has to be estimated somehow

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Comparison
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Unearned Premium Approach

• Exception
• Pre-claims short-duration liabilities only
• Permitted (not required) to use Unearned
  Premium approach
• Provide decision-useful information
• Cost vs. Benefit
• Measurement method
• As insurer is released from risk, related part of
  premium is earned and recognised as revenue
• Unearned part of premium is recognised as
  liability
• Lock-in allocate original price (premium) over
  periods
• No explicit margin

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Agenda

• Background
• Accounting and Solvency
• IASB Insurance Contracts Project Overview
• IASB and IAIS Views on Main Issues
• Measurement Approaches
• Building Blocks
• Margins
• Day One Difference
• Acquisition Costs
• Own Credit Risk

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Margins IASB

• Types of margins
• Risk compensation required for bearing risks
• Service compensation for assuming services other
  than risk margin
• Residual remaining margin (calibrated to actual
  premium)
• Composite inclusive of above three (calibrated
  to actual premium)

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Comparison
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Agenda

• Background
• Accounting and Solvency
• IASB Insurance Contracts Project Overview
• IASB and IAIS Views on Main Issues
• Measurement Approaches
• Building Blocks
• Margins
• Day One Difference
• Acquisition Costs
• Own Credit Risk

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Day One Difference

• What is Day One Difference?
• When using exit price (whether transfer or
  fulfillment) instead of entry price, day one
  difference could arise at inception
• It could be both positive (gain) or negative
  (loss)
• Simple examples
• Insurance Company A enters into one-year term
  non-life contract. Premium for contract is 1,000
  and is received at inception. Expected present
  value of future cash outflow is 800.
• What if expected present value of future cash
  outflow is 1,200?

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Day One Difference IASB

• Recognition
• No profit at inception should be recognised in
  profit/loss
• Margin (either residual or composite) is
  recognised as liabilities
• They are calibrated to actual premiums
• Loss at inception should be recognised in
  profit/loss onerous contracts
• Asymmetry exists

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Acquisition Costs IASB

• Issues
• Insurance companies incur initial acquisition
  costs
• Significant amount especially for long term
  contracts
• Are they expensed or deferred?
• How about matching revenue?
• IASB position
• All acquisition costs should be expensed when
  incurred
• No revenue can be recognised to offset
  acquisition costs expensed October 2009
  position
• Day one loss on long term contracts (e.g. life
  insurance)

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Comparison
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Agenda

• Background
• Accounting and Solvency
• IASB Insurance Contracts Project Overview
• IASB and IAIS Views on Main Issues
• Measurement Approaches
• Building Blocks
• Margins
• Day One Difference
• Acquisition Costs
• Own Credit Risk

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Own Credit Risk

• Whether to include insurers own credit risk in
  valuation of insurance liabilities
• If included, decrease in liabilities for
  worsening of insurers credit standing

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Comparison
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Questions and Answers
Thank you very much!
www.iaisweb.org takao.miyamoto_at_bis.org