Canadian L’Institut Institute canadien of des Actuaries...
Transcript of Canadian L’Institut Institute canadien of des Actuaries...
2007 General MeetingAssemblée générale 2007
Montréal, Québec
Canadian Institute
of Actuaries
L’Institutcanadiendesactuaires
IFRS Developments and Product Specific Challenges
Dan Doyle, FCIA Partner
PricewaterhouseCoopers LLP
Tim Deacon CA, CPA Vice President – Int’l Accounting & Policy
Manulife Financial
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Agenda
Solvency II – MAC Vision Paper
Overview of IFRS and Related Transition in CanadaBrief Overview of Insurance Accounting Under IFRSIASB Discussion Paper – Insurance Contracts:
OverviewKey Framework ComponentsComparison of Canadian GAAP vs. IFRSControversial Topics
How to Prepare for Double ConversionLessons learned from EuropeQuestions
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Solvency II- Canadian Version
• MCCSR Advisory Committee (MAC) Vision Paper
• Principle based• Integrated asset Total Balance Sheet (TBS)• Two levels of capital
– Minimum– Target
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Required capital to be determined indirectly:
Required = Total Asset - Reported GAAP Capital Requirement Liabilities
Assets Liabilities & Capital
solvencybuffer
expected asset requirement
margins
required capital
CGAAP policy liabilities
best estimate policy liability
total asset requirement
Solvency IIFocus on Total Asset Requirement
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Solvency II- Canadian Version
MAC Vision Paper• Target Asset Requirements• 99% Conditional Tail Expectations (CTE)• 1 year time horizon • Account for risk mitigation & risk dependencies• Standard or Advanced technique
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Risk Classification
Insurance Risks
Credit Risks
Total Risk
Market Risks
Interest Rates
Equity
FX
Real Estate
Alt Invest.
Concentration
Model
Migration
Reinsurers
Concentration
Model
Operational Risks
qualitatively
Financial Risks
quantitatively
Liquidity Risks
Group Risks
Regulatory Risks
Group Behavior Risk
Capital Mobility
Group Internal Risk
Spreads
Shares
Defaults P&C
Premium Risk
Reserve Risk
Small Claims
Large Claims
Catastrophes
Life
Biometric
Policyholder
Mortality
Longevity
Morbidity
Reactivation
Lapse
Other options
Cost
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Economic Capital
• “Sufficient surplus to cover potential losses at a given tolerance level over a specified time horizon”
• Looks like Solvency II – Canada– 99% CTE – 1 Year– Terminal provisions
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Banks - Basel lI
• Banks have already developed EC/RC models• Expertise in a model building and stochastic
processes exist
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Bank Lessons• Lack of data to develop some correlations• Correlations behave differently under stress• OSFI will defer full benefits• Timelines are significant• Evolving process
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Overview of IFRS
International Financial Reporting Standards (IFRS) are a set of global accounting principles set by the International Accounting Standards Board (IASB).
More than 100 countries and most of the major stock exchanges (outside US) have mandated the use of IFRS for public companies.
Many global peers already report under IFRS.
Foreign subsidiaries (i.e. HK and Singapore) may already report under IFRS for local statutory purposes.
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Transition to IFRS in Canada
• Migration to IFRS over next 4 years – 2011 expected implementation date
• Final CICA transition plan to be released by March 2008
• Numerous moving parts - need to watch the horizon:– Insurance contracts standard (double conversion)– Number of current IASB projects (derecognition,
consolidation of VIE’s) will change existing standards
– Joint FASB projects (Memorandum of Understanding)
– CICA “Migration” plan
• SEC rule to eliminate US GAAP reconciliation for foreign private issuers that file financial statements under IFRS.
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Transition to IFRS in CanadaKey Milestones
Disclose IFRS convergence plan including quantification of anticipated effectsandOpening Balance Sheet under IFRS (Jan 1, 2010)
Dec 31-08 Dec 31-09 Dec 31-10 Mar 31-11 Dec 31-11
Disclose IFRSconvergence plan and anticipated effects
First quarterly IFRS-based financial statementsandFirst OSFI Filing under IFRS
First annual IFRS-based financial statements
January 1, 2011 changeover to
IFRS
First comparative figures under IFRS
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Very limited guidance for insurance contracts available under current IFRS.
IFRS 4 – “Insurance Contracts” permits entities to retain previous basis of accounting (i.e. CALM) for contracts that are within scope.
If a contract is not in scope, an entity must follow other IFRS guidance (i.e. IAS 39).
IFRS 4 currently under revision – IASB issued Discussion Paper on recognition and measurement of insurance contracts – proposing use of “current exit value”
Brief Overview of Insurance Accounting Under IFRS (Pre Discussion Paper)
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Brief Overview of Insurance Accounting Under IFRS
IFRS 4 has limited scope but does contain the following:
Definition of an insurance contract
Prohibits recognition of catastrophe and equalization provisions
Prescribes a liability adequacy test
Permits (not requires) unbundling and shadow accounting
Reinsurance balances (I/S and B/S) must be shown on gross basis
Addresses discretionary participation features
Embedded derivatives
Increased disclosure requirements
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Insurance contract - ‘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 future event (the insured event) adversely affects the policyholder.’
Brief Overview of Insurance Accounting Under IFRS – Some Definitions
“Insurance risk is significant if, and only if, an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Does the contract need to be unbundled?
Are any discretionary participation features
present?
Insurance Component Deposit Component
Yes YesNo
Does contract contain significant
insurance risk?
Investment Contract(IAS 39)
Investment Contract with discretionary participation
features
Insurance Contract
No
NoYes
Brief Overview of Insurance Accounting Under IFRS – Product Classification Flowchart
Use CALM Amortized Cost or FVLiability or equity
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
• Under IAS 39, Deferred Acquisition Costs must be expensed unless:
• Amortized cost method used for valuing liability:– “Transaction Costs” must be incremental and directly
attributable and does not include internal allocation of administrative expenses or allocation of overheads.
– Effectively non-commission expenses are likely to be expensed unless they wouldn’t have been incurred if the contract was not issued.
• Relate to securing right to receive Investment Mgmt fees:– Capitalised as an intangible asset representing the right to
receive this revenue if can separately be measured.– Asset is amortized as entity provides the services and
recognizes related revenue.
• Difference to existing CGAAP and US GAAP.
Brief Overview of Insurance Accounting Under IFRS –Deferred Acquisition Costs
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07IASB Discussion Paper – Insurance Contracts – Overview
CICA has stated it will adopt these standards for Canada once final standard approved by IASB
Under Insurance Companies Act in Canada, these GAAP standards would also become core policy liability standard for OSFI regulatory reporting
Phase II work
begun –Jul 04
IASB Discussion
Paper published – May 07
Phase II Draft IFRS published – Dec 08?
Phase II IFRS
published –Dec 09?
Phase II IFRS
effective date – 1
Jan 2012?
We are here
Discussion Paper
Comments – Due Nov
07
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper- Key Framework Components
Principle Comments1. Single model for Life and Non-life
2. Valuation answers question “What are assets and liabilities?”, not “What assets are sufficient to discharge liabilities with sufficient assurance?”
3. Insurance liabilities made-up of three basis building blocksa. expected future cashflowsb. marginc. effect of time value of money
(discounting)
Similar accounting model for all insurance contracts
Implications are assets and liabilities are valued independently
Assumptions must be appropriate from 3rd party perspective
All assumptions must be kept current, with changes capitalized in current period
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Key Framework Components
Principle Comments
4. Expected future cashflows should be explicit, current, market consistent and probability weighted
5. Margins include a risk margin and service margin and should be market consistent, current, and portfolio based
6. Discount rates are current market rates set independently of expected return on assets held
Probability weighted requirement could mean significant model complexity if rigorously required
Risk margins do not include asset related (C1 and C3) risks
Method to get risk margins under debate (cost of capital, quantile)
Expected to require current market risk free discount curve with perhaps some adjustment for liquidity premium
No discounting of tax assets or liabilities in policy liabilities
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Key Framework Components
Principle Comments
7. All assumptions, margins and discount rates must be kept current with impact of changes capitalized in current period
8. Gain/Loss permitted at contract inception
9. Acquisition expenses expensed immediately but offset by implicit liability reduction
10. Contracts valued over term to which insured has guaranteed insurability
11. Contractual cashflows include future premiums required to keep contract in-force
Approach described as “current exit value”under which valuation is intended to be consistent with cashflows/assumptions that a transferee would use in acquiring the block
Practically, would expect a high hurdle to recognize profit at issue
No explicit DAC assetLiability reduction from margins in premium/revenue capitalized in reserve
Term for valuation ends at point at which insurer can cancel contract or adjust it in unconstrained way, unless extending term increases the liability
May not be all expected premiums, but just the minimums to keep policy in-force if there is a significant discretionary element (e.g. UL)
Liability reduction from margins in premium/revenue capitalized in reserve
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Key Framework Components
Principle Comments
12. Participation features (e.g. dividends) reflected only to extent there is a legal or constructive obligation to pay the dividends
13. Insurer own credit standing to be reflected in liability valuation
Definition of constructive obligation not yet clear – may be very restrictiveSame issue applies to adjustable contract elements such as credited interest rates
Theoretically, value of liabilities reducedas company credit standing reduced – not expected to have material impact
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Comparison of CGAAP (CALM) vs IFRS
CGAAP and international models contain a number of similarities in basic framework with the exception of the approach to discounting and treatment of asset/liability mismatch
Canadian model is considered to be most similar to international model
There are a number of differences in details that could make application quite different
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Comparison of CGAAP (CALM) vs. IFRS – Framework
√√No cash value floors
√√Acquisition costs expensed with reserve offset to extent recoverable over valuation term
√√Gain/Loss permitted at contract inception
√√Best estimate cashflows and margins unlock and are kept current with changes capitalized in current income
√√Based on best estimate cashflows plus margins
√√Prospective cashflow valuation√√Principle not rules based
IFRSCGAAP
(third party perspective and different margin
methods)
(but no provision toextend term to offset acquisition expenses)
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Comparison of CGAAP (CALM) vs. IFRS – Framework (cont’d)
√xOwn credit standing adjustment to liabilities
x√Standard applies to all policy liabilities of insurance company
x√Liabilities include asset/liability mismatch risk
x√Discount rates based on actual assets held
√√Incorporate par dividends and contract adjustment features
√√Policyholder behaviour reflected
√√Cost of options/guarantees reflected
IFRSCGAAP
(more rigorous)
(limits on discretionary premiums)
(but potentially significant restrictions.
Also classification liability vs. equity)
(risk free)
(insurance contracts only)
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Comparison of CGAAP vs. IFRS – Profit Emergence Components
√
X
√
√
√
√
X
X
MarginsInsurance margins
Mismatch, market and credit margins
Service margins
Expected Investment Returns – risk free
√
√(IAS 39)
√
√
Actual – Expected Insurance Assumptions
Actual – Expected Investment Returns
Experience Gains
IFRSCGAAP
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Controversial Topics– Draft Framework
Discount rate approachuse of risk free discount rates will not allow companies to anticipate in the valuation earning positive spread on fixed income assets or yield premium on non-fixed income assets – disconnect from pricing and economic managementpotential to cause significant earnings strain at issueunclear how rates will be set where there is an observable curve (e.g. beyond 30 years)a model where assets are held at fair value and liabilities discounted at current market curves will show significant volatility from spread changes, risk free rate movement for mismatch position and, movements in fair value of non-fixed income assets supporting liabilities
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Controversial Topics– Draft Framework
Alternatives focus on minimizing capitalization volatility One alternative would increase/decrease margins to “re-spread” capitalization impacts over contract lifetimesAnother alternative would ignore unlocking unless “loss recognition” (i.e. reserve inadequate on current best estimate assumption basis without MfADs
Full contract unlocking ofassumptions, margins and discount rates each periodwith change impactcapitalized to earnings incurrent period
Should liability valuation be calibrated to the premium?No gain could be achieved by increasing margins to offset potential inception gains
Gains/losses permitted atcontract inception
DiscussionCurrent Exit ValueModel Proposal
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Controversial Topics– Draft Framework
Elements that drive liability cashflows away from true best estimates1. Potential exclusion of discretionary future premiums above
those needed to keep contract in-force, even where those premiums expected
could be material impact for UL and distort earnings emergence
2. Requirement that policyholder dividends or other contract adjustment consistent with future expected assumptions can only be reflected if legally required or the result of a constructive obligation
unclear what is sufficient to be deemed a constructive obligationLiability vs. equity classificationcould materially distort earnings emergence
3. Valuation term limitations may limit revenue capitalization to offset acquisition expenses
deposit annuities could be most impacted
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07Universal Life Example
Mid & Max funded policies
-150%9%Lower premiums
15%Adjust MCCSR
-42%10%Risk Free
4%16%Base
FY Income/ Premiums
ROE
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
IASB Discussion Paper - Controversial Topics– Draft Framework
Inclusion of own credit standing adjustment to discount ratesthis concept has counter intuitive result of reducing liabilities as credit rating is lowered
Requirement that best estimate assumptions be probability weighted
if applied rigorously, could require advanced multi path modeling for all risks in all productswould be very significant development/implementation issue
Lack of clarity around methods to establish marginssignificant uncertainty around profit emergence patterns, and what will be acceptable methods to set margins“Cost of Capital” method is favoured
Lack of clarity around impact of “third party perspective” and how this will be measured
details of paper tend to suggest that assumptions would start with internal perspective and only be adjusted for evidence that they are not appropriate from market perspective
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07How to prepare for “Double Conversion”
Unlikely final insurance contract standard in place before transition to IFRS in 2011.
Will result in “double conversion” – once to implement IFRS 4 (phase I) in 2011 and second conversion once final standard in place.
Insurers will need to keep abreast of latest developments at IASB and assess proposals against existing reserves to ensure impacts on financial results, systems and processes are understood well in advance of adoption in order to implement in timely manner.
Take opportunity to provide comments on proposals to IASB.
Never been a better time to be an actuary (or an accountant!)
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
PwC Survey of 26 global insurers first annual report under IFRS (2005) resulted in the following key findings:
•Enormous implementation challenges
•Extensive new disclosure requirements
•First internationally-agreed definition of an insurance contract
•Little diversity in accounting policy beyond insurance contracts and investments
•Use of alternative measures of profit – European Embedded Value (EEV)
Experience of IFRS Conversions for insurers in Europe PwC Survey
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Experience of IFRS Conversions for insurers in Europe Most challenging aspects of IFRS conversions
Based on a survey of 47 insurers (spanning 17 countries), the accounting issues that were the most challenging within the IFRS conversion are:
26.1%Insurance technical: unbundling 26.7%Insurance technical: shadow accounting 30.4%Insurance technical: DPF accounting 35.6%Insurance technical: embedded derivatives 39.1%Taxes (including deferred taxes) 50%Disclosures: other disclosures
52.2%Financial instruments (without hedging and derivatives)
53.3%Financial instruments (hedging and derivatives) 54.3%Insurance: contract classification 71.7%Disclosures: insurance-related disclosures
Source: KPMG survey ‘Implementing IFRS in the Insurance Industry’, 2006
2007
Gen
eral
Mee
ting
Ass
embl
éegé
néra
le20
07
Experience of IFRS Conversions for insurers in Europe Increase inSize of Financial Statements
Increase in length 2005 in IFRS 2004 in local GAAP
138% 112 47
82% 100 55
75% 100 57
67% 87 52
14% 90 79
112% 70 33
59% 129 81
210% 124 40
82% 60 33