IFRS For Captives Practicalities

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IFRS For Captives - Practicalities
GICMA GSCCA

• GICMA / GSCCA Captive Training Session
• 12.30pm Friday 9th December 2005
• Les Cotils

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IFRS For Captives - Practicalities

• Agenda
• Introduction
  Vanessa Pipe
• IFRS 4 Insurance Contracts
• IAS 21 The Effects of Changes in
  Debbie Smith
• Foreign Exchange Rates
• IAS 24 Related Party Disclosures
• IFRS / UK GAAP convergence
  Andrew Weatherburn
• FRS 21 / IAS 10 Events After the Balance Sheet
  Date
• FRS 25 / IAS 32 Financial Instruments
• Disclosure and
  Presentation Summary

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IFRS For Captives - Practicalities

• Working party members
• Aon Marsh
• Deloitte Prism
• EY PWC
• GFSC Willis
• KPMG

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IFRS For Captives - Practicalities

• Scope and disclaimer
• Focus is on key issues in the application of IFRS
  to Guernsey captive insurance companies
• General guidance only and does not constitute
  advice
• Case by case basis
• Specific queries should be raised with the
  auditors of the client in question
• Not covering the transition to IFRS

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IFRS For Captives - Practicalities

• IFRS 4
• IFRS 4 (Phase 1) applies to periods beginning on
  or after 1 January 2005
• IASB Insurance Project (Phase 2) Expecting a
  draft in 2008
• Paragraphs 36, 37, 38 and 39 cover the disclosure
  requirements of the standard

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IFRS For Captives - Practicalities

• Disclosure
• The two main principles are
• Explanation of Recognised Amounts
• Para 36 An insurer shall disclose information
  that identifies and explains the amounts in its
  financial statements arising from insurance
  contracts
• Amount, timing and uncertainty of cash flows
• Para 38 An insurer shall disclose information
  that helps users to understand the amount, timing
  and uncertainty of future cash flows from
  insurance contracts

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• IFRS 4 Insurance Contracts Disclosure
• To comply with paragraph 36, an insurer shall
  disclose (Para 37)-
• accounting policies
• notes to the financial statements
• The level of detail and disclosure is extensive,
  much higher than under UK GAAP for both.

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• IFRS 4 Insurance Contracts Disclosure
• Accounting policies
• Not new but increased disclosure
• For example
• premium recognition
• product classification
• reserving policies
• reinsurance assets
• insurance assets
• assumptions, judgements and estimates
• fees and commission income

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• IFRS 4 Insurance Contracts
• Key Assumptions
• Disclose the key assumptions that have the
  greatest effect on the measurement of amounts in
  the financial statements
• Use of actuaries
• Standard is not prescriptive as to level of
  disclosure or indeed the use of actuaries
• Interpretation is that use of a qualified actuary
  and/or actuarial methods should be disclosed in
  the accounting policies or within the notes
• Not necessary to mention who or reproduce their
  report

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• IFRS 4 Insurance Contracts
• Sensitivity Analysis
• For general business the narrative could
  include
• Uncertainty of estimation process
• Delays that arise between occurrence,
  notification and eventual settlement of claims
• Liabilities will vary as a result of
  subsequent developments
• If aggregates breached or reinsurance has cut in
  then this may be included in a brief narrative

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• IFRS 4 Insurance Contracts
• Discounting
• Existing companies under UK GAAP that discount
  on conversion to IFRS must still discount
• Existing companies under the UK GAAP that do NOT
  discount - on conversion to IFRS continue to NOT
  discount
• New companies post 1 January 2005 adopting IFRS
  have the choice whether to discount
• Where a company currently discounts under UK
  GAAP then increased disclosure will include
  sensitivity analysis of
• Claims settlement pattern
• Rate of return

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• IFRS 4 Insurance Contracts
• Reconciliation of Changes in Insurance
  liabilities and reinsurance assets
• Interpretation of this for most captives is
  tables for premiums and claims
• This should be shown gross and net
• Example of Premiums
• Unearned Premium Reserve at start of year
• Premiums Written in year
• Premiums Earned movement in year
• Other movements (e.g. Novations)
• Foreign Exchange
• Unearned Premium Reserve at end of year

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• IFRS 4 Insurance Contracts
• Example of claims
• O/S claims and IBNR at start of year
• Claims incurred in year
• IBNR movement in year
• Claims Paid
• Foreign Exchange
• O/S claims and IBNR at end of year
• In respect of some captives with no reinsurance
  or foreign exchange then the reconciliation might
  be covered by the technical account (but
  reference elsewhere).

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• IFRS 4 Insurance Contracts
• To comply with paragraph 38 an insurer shall
  disclose the following (Para 39)-
• Insurance Risk
• Narrative needs to explain to the user of the
  accounts the types of risk underwritten and any
  particular concentration
• Can aggregate similar policies together and
  explain the insurance risk
• If limits are used to restrict exposure then this
  fact should be disclosed
• Possible to provide disclosure in a tabular
  format
• Gross and net

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• IFRS 4 Insurance Contracts
• Concentrations of insurance risk
• Only write business of the parent
• Explain the concentration or lack of it
• Examples-
• Geographic
• Industry
• Policy type
• Possible to provide disclosure in a tabular
  format
• Gross and net basis
• Standard not prescriptive premiums/insured
  values?

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• IFRS 4 Insurance Contracts
• Claims development disclosure
• Disclosure required to show actual claims
  compared with previous estimates
• Earliest year of material uncertainty (value or
  timing)
• 5 years of data required from adoption of IFRS
• Build to 10 years of data over time
• No disclosure required for claims expected to be
• resolved within one year (eg life insurers)
• Can have a single table (gross and net) but may
  require additional narrative disclosure or an
  additional table

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• IFRS 4 Insurance Contracts
• Claims development disclosure
• Table to show
• Cumulative claims incurred i.e. paid, o/s and
  IBNR
• Cumulative payments
• Balance sheet reserves
• This is significant additional work for the
  insurance manager to obtain in year 1 and for
  the auditor to verify
• Example given in IG 61

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IFRS 4 Insurance Contracts
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• IFRS 4 Insurance Contracts
• Information about interest rate risk and credit
  risk (same as IAS 32)
• Need to disclose how this is actively being
  managed
• Ongoing issues
• Speak to relevant auditors

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IFRS For Captives - Practicalities

• IAS 21 The Effects of Changes in
  Debbie Smith
• Foreign Exchange Rates
• IAS 24 Related Party Disclosures

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IAS 21 The Effects of Changes in Foreign Exchange
Rates

• Requirements
• Company must determine its functional currency
  and maintain its books and records in this
  currency
• Translate from source to functional currency
• Income and expenses to be translated at rate
  ruling at date of transaction
• Monetary balance sheet items to be translated at
  closing balance sheet rate
• Non-monetary balance sheet items to be translated
  at
• Historic rate if held at historic cost
• Rate prevailing when fair value was determined if
  held at fair value
• Any FX gains/losses arising will go to the Income
  Statement

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IAS 21 The Effects of Changes in Foreign Exchange
Rates

• Requirements (cont)
• Company must choose a presentation currency which
  can be different to the functional currency
• Translate to presentation currency as follows
• Assets and liabilities to be translated at
  closing balance sheet rate
• Income and expenses to be translated at rate
  ruling at date of transaction (or average if
  appropriate)
• Any FX gains/losses arising will go to Equity

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IAS 21 The Effects of Changes in Foreign Exchange
Rates

• Key considerations
• Company does not have a free choice of functional
  currency. The functional currency is the currency
  of the primary economic environment in which the
  company operates.
• Presentation currency is a matter of choice. If
  the company decides to change its presentation
  currency then it must
• - re-state comparatives at prior year rates
• -re-state share capital at the original historic
  rate or the rate on the date of change and
  disclose

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IAS 21 The Effects of Changes in Foreign Exchange
Rates

• Key considerations PCCs
• The company needs to determine the functional
  currency for each individual cell and then choose
  a presentation currency
• - disclose the functional currency of core and
  note that each cell has its own functional
  currency
• - disclose the presentation currency

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IAS 21 The Effects of Changes in Foreign Exchange
Rates

• Disclosures
• Amount of exchange differences included in
• - Income Statement
• - Equity (with a reconciliation)
• Reasons (if applicable)
• - Why the presentation currency is different
  from the functional currency
• - Why there has been a change in functional
  currency

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• IAS 24 Related Party Disclosures
• No exemption
• Under UK GAAP and FRS 8 there was an exemption
  for wholly owned subsidiaries from disclosing
  transaction with related parties where the
  amounts involved were ultimately consolidated
• This exemption is not present in IAS 24

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• IAS 24 Related Party Disclosures
• Disclosures
• Separate disclosure for each type of related
  party
• Amount of the transactions
• Amount of outstanding balances, including
  guarantees
• Provisions for doubtful debts on the outstanding
  balance and the expense recognised during the
  period
• Key management compensation

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• IAS 24 Related Party Disclosures
• Considerations
• In principle a narrative disclosure (for pure
  captives) of the fact that transactions are
  effectively driven by related parties would be
  necessary
• In practical terms direct and fronted policies
  would be treated the same under this disclosure
• If the captive provides third party cover then
  there would be the need for some form of tabular
  disclosure

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• IAS 24 Related Party Disclosures
• Considerations contd.
• If the captive writes a material policy for a
  sole subsidiary then this may need to be
  disclosed
• If the captive purchases DO cover for the
  protection of the Directors then this would need
  to be disclosed
• In respect of PCCs there is an argument that Cell
  owners are not related parties to the PCC and
  hence there is no need to consider IAS 24
  disclosures
• This could be challenged if there is a dominantly
  large cell in a PCC

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IFRS For Captives - Practicalities

• IFRS / UK GAAP convergence
  Andrew Weatherburn
• FRS 21 / IAS 10 Events After the Balance Sheet
  Date
• FRS 25 / IAS 32 Financial Instruments
• Disclosure and
  Presentation Summary

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• IFRS / UK GAAP Convergence
• 31 December 2005
• The ASB has issued a number of new accounting
  standards designed to converge UK GAAP with IFRS
  over coming years.
• Two of these new standards include elements which
  must be implemented with effect from 31 December
  2005.
• FRS 25 (IAS 32) Financial instruments
  disclosure and presentation
• FRS 21 (IAS 10) Events after the balance sheet
  date

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• FRS 25 (IAS 32) Financial Instruments
  Disclosure and Presentation
• Debt / equity analysis
• FRS 25 embodies IAS 32
• Financial instruments (or their component parts)
  shall be classified as
• a financial asset,
• a financial liability or
• an equity instrument
• in accordance with the substance of the
  contractual arrangement and the definitions of
  these terms.

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• FRS 25 (IAS 32) Financial Instruments
  Disclosure and Presentation
• Debt / equity analysis
• A financial liability is a liability that is a
  contractual obligation
• to deliver cash or another financial asset to
  another entity, or
• to exchange financial assets or financial
  liabilities with another entity under conditions
  that are potentially unfavourable to the entity
• An equity instrument is any contract that
  evidences a residual interest in the assets of an
  entity after deducting all of its liabilities

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• FRS 25 (IAS 32) Financial Instruments
  Disclosure and Presentation
• Debt / equity analysis
• A critical feature in distinguishing a liability
  from equity is the existence of a contractual
  obligation on the issuer to deliver cash of
  another financial asset to the holder, or to
  exchange financial assets or liabilities with the
  holder under conditions that are potentially
  unfavourable to the issuer
• Although the holder of equity may be entitled to
  receive a pro rata share of dividends or other
  distributions of equity the issuer does not have
  a contractual obligation to make such
  distributions
• A financial instrument that gives the holder the
  right to put it back to the issuer for cash or
  assets (a puttable instrument) is a financial
  liability
• The substance rather than the legal form governs
  the classification

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• FRS 25 (IAS 32) Financial Instruments
  Disclosure and Presentation
• Debt / equity analysis
• Implementation guidance (paras 25 26)
• First consider if the redemption rights are
• at the option of the holder debt
• only at the discretion of the issuer equity
• If non redeemable consider other rights
• contractual distributions debt
• distributions only at the discretion of the
  issuer equity

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• FRS 25 (IAS 32) Financial Instruments
  Disclosure and Presentation
• Status of PCC cellular share capital
• Does the cell shareholder have the ability to
  force dividends or redemption liability
• Does the cell shareholder have no entitlement to
  force dividends, redemption or distribution of
  any kind equity
• This will need to be looked at on a case by case
  basis and will be determined by Memorandum and
  Articles of Association and Cell Operating
  Agreements

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• FRS 21 (IAS 10) Events After the Balance Sheet
  Date
• Provision for proposed / declared dividends
• FRS 21 embodies IAS 10
• Applies to accounting periods beginning on or
  after 1 January 2005
• Prior year adjustment required for comparatives

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• FRS 21 (IAS 10) Events After the Balance Sheet
  Date
• Provision for proposed / declared dividends
• Equity dividends only become a present
  obligation (FRS12 Provisions, Contingent Assets
  and Contingent Liabilities) and are no longer at
  the discretion of the entity, when they have been
  approved by the shareholders
• FRS 21 para 12 dividends declared after the
  balance sheet date shall not be recognised as a
  liability at the balance sheet date (whether
  approved by the shareholders or not)
• Interim dividends proposed by the board of
  directors after the balance sheet date are not a
  present obligation and cannot therefore be
  recognised as a liability (as they have been in
  the past)
• Interim dividends proposed by the board of
  directors before the balance sheet date are not
  an obligation (contractual) and cannot be
  recognised as a liability.

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• FRS 21 (IAS 10) Events After the Balance Sheet
  Date
• Provision for proposed / declared dividends
• Options
• Continue as before but
• final dividends appear in the accounts for the
  year in which they are approved by the
  shareholders
• interim dividends appear in the accounts for the
  year in which they are paid (effectively a cash
  basis)
• Where a contractual obligation exists prior to
  the year end (shareholder approval) can include
  in balance sheet but
• Care with distributable profits
• Converting equity to debt by customary approval
  of dividends

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IFRS For Captives - Practicalities

• Summary and conclusions
• IFRS 4 - expanded accounting policies
• - expanded disclosures in notes
• IAS 21 - functional currency considerations
• IAS 24 - no group exemptions from related
• party disclosures
• IAS 7 - no exemptions from cash flow
• statements either
• FRS 25 (IAS 10) - debt/equity analysis
• FRS 21 (IAS 32) - revised treatment of
  dividends

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IFRS For Captives - Practicalities

• Summary and conclusions
• Conversion hurdle setting up the new requirements
  and disclosures in the first year.
• Additional work on disclosures each year.
• Significant input from insurance personnel not
  just accounting issues (claims development
  tables, reinsurer credit risk etc).
• Captives in 3 states
• UK GAAP as now
• UK GAAP plus IFRS reporting to group
• IFRS full conversion
• Still new concept, few captives on IFRS yet,
  still some differing views, should bed down over
  the next year.