Casualty Actuaries of New England (CANE)
September 26, 2008
Dispelling the Fog:
ERM, Solvency II & IFRS
PwC
FOG
A state of mental dimness and confusion.
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 2
ERM can provide a solid foundation for many key aspects of
IFRS implementation, as well as synergies to help ease the cost
of compliance with other forthcoming risk/capital management
directives, including Solvency II.
Regulatory challenges include overcoming the continuing
uncertainty with respect to insurance reporting under IFRS and
gearing up for the forthcoming Solvency II. Increased pressure
from regulators and rating agencies alike sees more focus on
ERM.
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 3
Agenda
 Introductions
 Overview of ERM
 Solvency II Update
 Overview of IFRS
 Linkages between ERM, Solvency II, and IFRS
 Company perspective
 Q&A
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 4
Navigating Through Fog
 Stay Calm
 Slow Down
 Avoid Braking Often
 Avoid Distractions
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 5
Section One
ERM Overview
Does ERM matter?
“Risk management adds value not only to individual companies,
but also supports overall economic growth by lowering the cost of
capital and reducing the uncertainty of commercial activities.”
James Lam
“Enterprise Risk Management – From Incentives to Controls”
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 7
Enterprise Risk Management
ERM Overview
The benefits of ERM are derived from integration:
1. an integrated organization, which often includes a centralized
risk management unit reporting to the board, CEO or CFO
with responsibility for broad risk policy setting across risk
taking activities;
2. an integration of risk transfer strategies (considering all risks,
and any diversification benefits between them); and
3. the integration of risk management into business processes,
optimizing performance through risk adjusted pricing,
resource allocation, and enhanced business decision making.
Source: James Lam – Enterprise Risk Management – From Incentives to Controls
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 8
Enterprise Risk Management
ERM Overview
An ERM infrastructure must be developed…
1. risk management governance;
2. risk management policies and procedures;
3. risk assessments and audits;
4. systems and financial models;
5. measures and reports; and
6. risk limits and exception processing.
Develop from the top down!
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 9
Enterprise Risk Management
ERM Overview
…however, ERM benefits will only be realized when companies:
1. build risk awareness through senior management
commitment;
2. create a culture for risk management;
3. facilitate open communication;
4. identify and/or develop talent; and
5. reinforce behavior.
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 10
Enterprise Risk Management
ERM Overview – An Illustrative Framework
Environment
Infrastructure
Process
Strategy
Validation/
re-assessment
Business mission
and strategy
Risk awareness/
Identification
Organisation
and people
Culture
Limits and
controls
Risk strategy
Risk assessment/
Response
Methodologies
& Models
Training
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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Value proposition
Operations
Systems
Communication
Risk appetite
Measurement
and Control
Data
Performance
measures
Reporting
Policies
Reporting
Reward
September 26, 2008
Slide 11
Enterprise Risk Management
Integration of Enterprise Risk Management
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 12
Enterprise Risk Management
ERM Infrastructure – Organization and people
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
• Centralized independent risk management function
• CRO or senior executive with risk role
• Oversight committees at the Board / senior management levels
• Risk awareness, culture and values
• Risk training
• Talent management
• Linkages between risk and compensation
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 13
Enterprise Risk Management
ERM Infrastructure – Limits and Controls
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
• Define corporate-wide and product-specific risk appetites
• Risk assessments
• Risk inventories
• Exposure limits and triggers
• Risk controls
• Risk escalation
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 14
Enterprise Risk Management
ERM Terminology
Risk Appetite
• A measure of the potential financial impact that the
company is willing to take in exchange for a targeted return
• ERM programs may have multiple definitions for risk
appetites
- Capital (Ruin focus)
- Earnings (Volatility focus)
- Rating (May be driver of probability choice)
• Alignment with product pricing
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 15
Enterprise Risk Management
ERM Terminology
Risk Tolerance
• Relates to management strategies
Risk Limits
• Defining risk limits - connection with the company-wide risk
appetite, approval processes
• Risk escalation processes
• Procedures used for monitoring and responding to limit
breaches
• Automatic triggers, risk dashboards
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 16
Enterprise Risk Management
Process in Place to Define Risk Appetite
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 17
Enterprise Risk Management
Process in Place to Deal with Breaches of Limits
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 18
Enterprise Risk Management
ERM Infrastructure – Methodologies & Models
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
• Insurance, market, credit and operational risk management
• Economic capital models & capital allocation
• Risk analytics, including scenario analysis, risk indicators, risk-
adjusted returns
• Risk transfer strategies
• Linkage of planning and risk strategy
• Linkages to product pricing
• Performance management
• Capital management
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 19
Enterprise Risk Management
Economic capital models
Key areas where survey
respondents identified benefits of
implementing an economic capital
model:
•
•
•
•
•
Better allocation of capital
than under a regulatory capital
model
Definition of risk appetite
Freeing up of capital for use in
the business
Changes in the pricing of
products to better reflect risk
Changes in strategic direction
after assessing risk-adjusted
performance
“Excess” Capital
Assets available
for required
capital
Economic Capital
Assets covering
liabilities
Liabilities
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 20
Enterprise Risk Management
Economic capital models (cont’d)
Aggregate Economic Capital Model
Inter-risk Diversification
Market
Risk
Inter-segment Diversification
BU 3
Credit
Risk
Operational
Risk

BU 1
BU 2
Insurance
Risk





Corporate &
Other
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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Types of models
• Factor based
• Stress tests
• Combination models (usually a
combination of factor based
models with either stress testing
or stochastic modeling)
• Fully stochastic models
Range of risks
• Insurance risks — typically
modeled using stress tests for life
business and stochastically for
non-life business
• Market risk and credit risk —
often modeled stochastically
• Operational risk — factor based
or “scenario driven models” are
common
September 26, 2008
Slide 21
Enterprise Risk Management
Economic capital models (cont’d)
Risk categories explicitly captured in economic capital models
Confidence level applied when managing VaR
Percentage of respondents
100%
95%
99.95%
90%
99%
80%
99.9%
70%
60%
50%
40%
99.7%
30%
99.5%
20%
10%
0%
Insurance
Credit
Market
Operational
Strategic
Risk measures managed within economic capital models
Risk category
90%
Percentage of respondents
80%
70%
60%
50%
40%
30%
20%
10%
0%
VaR
Source: 2008 PwC survey covering ERM in the global insurance industry
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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TVaR
CTE
Earnings at
Risk
Embedded
Value
Other
Risk measure
September 26, 2008
Slide 22
Enterprise Risk Management
Model Development Timeline
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 23
Enterprise Risk Management
Operational Risk
Traditional Operational Risk Management - Separate Silo
Risk Management for:
• IT Risks
• HR Risks
• Regulatory & Compliance Risks
• Fraud Risk
• Internal Controls
• Reputation Risk
• Business Continuity
• Distribution Risks
• Outsourcing/Vendor Risk
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 24
Enterprise Risk Management
Operational Risk Management
Enterprise ORM – leading to Strong ORM assessment by S&P
usually associated with:
• Comprehensive assessment of risks & control capabilities
• Identification of risks not adequately controlled by existing
programs
• Prioritization
• Development of key risk indicators, tracking process & problem
resolution system
Excellent ORM assessment usually associated with:
• Repeated application
• Refinements of controls & KRIs
• Response programs
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 25
Enterprise Risk Management
ERM Infrastructure - Systems
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
• ERM supporting technology
• System interface, mapping tools, middleware
• Risk registers
• Exposure analytics, drill-down capabilities
• Risk reporting tools
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 26
Enterprise Risk Management
ERM Infrastructure – Data
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
Risk and portfolio data requirements:
• Access
• Common definitions
• Quality assessments
• Cleansing
• Data warehouses
• Industry data
• Benchmarking data
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 27
Enterprise Risk Management
Rating Data Management Expenditures
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 28
Enterprise Risk Management
ERM Infrastructure – Policies
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
• Market, credit, insurance, operational risk policies and
procedures, including:
• Risk rating policies;
• Exposure management policies;
• Risk limit policies;
• Monitoring and review policies;
• Risk transfer policies;
• Management and board reporting policies.
• Overall risk policies
• Emerging risk policies
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 29
Enterprise Risk Management
ERM Infrastructure – Reporting
Organisation
and people
Limits and
controls
Methodologies
& Models
Systems
Data
Policies
Reporting
• Board reporting, including enterprise view on aggregate losses,
risk incidents, policy exceptions, key exposures, KRIs
• Key risk indicators that quantify major trends and risk
exposures
• Limit exception reporting
• Risk dashboards
• ERM disclosures
• Finance effectiveness – exploiting synergies between
requirements for financial reporting, ERM, Solvency II, and
IFRS
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 30
Enterprise Risk Management
Does ERM matter?
Through improved…
• Coordination
• Communication
• Financial discipline
• Transparency
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 31
Section Two
Solvency II Update
Solvency II
Solvency II – EU taking a global lead in insurance regulation
“This is an ambitious proposal that will completely overhaul the
way we ensure the financial soundness of our insurers. We are
setting a world-leading standard that requires insurers to focus
on managing all the risks they face and enables them to operate
much more efficiently.”
Charlie McCreevy
Internal Market and Services Commissioner
Speaking at the launch of the Solvency II draft Framework Directive
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 33
Solvency II
Is Solvency II likely to have Global impact?
•
•
•
Principles-based risk sensitive regulation is becoming the norm
- US led the way (RBC models) initially, then Canada (DCAT)
- More recently: Australia, UK (ICAS) and Switzerland (SST)
- Many other jurisdictions are looking at implementing Solvency II or
seeking “equivalent regime” status
• NAIC publicly-stated intention to consider options
• However, State-based US system adds significant complexity to
regulatory innovation/connectivity with other global regulators; e.g.
- Principles-based reserving discussions likely to take years to
finalise
- Policy forms and premium rates still needing regulatory approval
• The Optional Federal Charter solution?
IAIS has now got real traction
Global footprint of CFO and CRO Forum members
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 34
Solvency II
Economic capital – lies at the heart of Solvency II and at the core
of managing your business
Solvency &
Financial
Reporting
Rating
Agencies
Economic
Capital
Delivering
Shareholder
Value
Enterprise
Risk
Management
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
PricewaterhouseCoopers
September 26, 2008
Slide 35
Solvency II
Solvency II – Timescales
Solvency II system in
operation
(31 October 2012)
High Level Principles
Draft Framework
Directive published (Level I Directive) adopted
EU member states to transpose into law
2007
2008
2009
2010
2011
2012
Model pre-approval process
Quantitative
Impact Study v.3
Quantitative
Impact Study v.4
Detailed rules (Level II
implementing measures)
The above timeline corresponds closely to the current IFRS
timescale – but the two projects are not formally linked
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 36
Solvency II
Solvency II – Draft Framework Directive - overview
PILLAR I
Quantitative requirements
• Assets and Liabilities –
market consistent valuation
• Investments
• Solvency Capital
Requirement (SCR):
• European Standard
Formula; or
• Internal Model
• Minimum Capital
Requirement (MCR)
• Own Funds
PILLAR II
PILLAR III
Supervisor review
Disclosure
• System of governance
• Public Disclosure – annual
• Own risk and solvency
assessment (ORSA)
• Supervisory review
process
solvency & financial
condition report
• Information to be provided
for supervisory purposes
• Supervisory intervention
including capital add-on
GROUP SUPERVISION – all pillars applicable to solo entities and groups
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 37
Solvency II
Solvency II – Quantitative requirements
Proposed framework for Pillar I
Assets available
for SCR/ MCR
Solvency Capital Requirement (SCR)
MCR
Risk margin
for non-hedgeable risks
Best estimate
Assets covering
technical provisions
Assets at
Market Value
Technical Provisions
Market consistent valuation
for hedgeable risks
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 38
Solvency II
Current areas of contention within Solvency II/ outstanding
issues
•
•
•
•
•
•
•
•
Group supervision and group support
- role of lead versus country supervisor
- group support mechanism
- Treatment of 3rd countries (e.g. USA, Bermuda, Far East)
Design and calibration of MCR
Treatment of surplus funds (Germany), equities re: market risk (France)
Proportionality (e.g. should there be a de minimis threshold?)
Public disclosures – extent, timing
Captives and mutuals
Use of internal models
Role of audit (overlap with financial reporting)
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 39
Solvency II
Solvency II – Progression from Solvency I
Pillar 1
Solvency I
Solvency II
• Local GAAP/IFRS
• No internal model
• RMM
• Market consistent valuations
• MCR, SCR
• Internal model optional (use
subject to supervisory approval)
• Supervisory review
• No EU harmony
Pillar 2
• Group capital assessment
(post IGD) – no
diversification benefit
Pillar 3
• Public Disclosure
• FSA Return, IGD data
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• Supervisory review process
• Emphasis on governance
and risk management
• Capital add on: exceptional
• Group capital assessment with
diversification benefit
• ORSA
• Public Disclosure
September 26, 2008
Slide 40
Solvency II
Summary of possible implications of Solvency II
Multinational
•
•
•
•
Reconsideration of HO location
Diversification benefits / reduced capital req.
Reconsideration of operating structure
Acquisition opportunities (e.g. amongst
small players)
• Strategic re-evaluation of business lines
• Disposals or run-off of underperforming /
capital intensive books
• Capital fungibility challenges
Small
• Inability to meet SII requirements?
• Disproportionate compliance
costs
• Reconsideration of operating structure
• Seeking merger partners
• Industry roll up possibilities
• Discontinuation of business
• Insolvency
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Large
• Seek merger partners to obtain
diversification benefits
• Reconsideration of operating structure
• Acquisition opportunities (e.g. amongst
small players)
• Strategic re-evaluation of business lines
• Disposals of run-off/underperforming books
• Capital fungibility challenges
Domestic
September 26, 2008
Slide 41
Solvency II
What are we seeing European firms doing at present?
•
•
Broad EU industry support for the proposals
SII approach and level of engagement differs by country and segment
In Europe generally, what are companies typically doing:
• General education and awareness raising
• Companies taking a more proactive stance:
- Impact assessments/gap analyses (see below for typical themes)
- Setting up Solvency II project teams
- Examining specific aspects e.g. risk appetite/ERM framework
- Restructuring ahead of the final Directive wording
- Data warehouse set-up, model specification and build
- Projects covering economic capital, IFRS, MCEV
- Addressing broader finance transformation and actuarial integration
Outside EU, already some regulators and companies looking at same concepts
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 42
Solvency II
Market implications - Rating agency interaction with Solvency II
• Capital is just one element of ratings
• Rating agencies not all using DFA models – but moving in that direction
• Agencies stated intention to converge
-
Consider companies’ internal model (S&P launched limited EC
model review)
Still the option of qualitative add-on for other agency factors
Some major differences in approach (diversification benefits less
generous, no explicit discount for lack of fungibility of capital)
• Calibration differences (SCR is approximate to BBB)
• Agencies and indeed markets will react to any Pillar II add on
• Regulators may expect an integrated approach to calculating capital held
• Increased focus on ERM concepts
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 43
Solvency II
Link to ERM - Impact on organisations from the Solvency II risk
and governance requirements – Pillar II - ORSA
Management
Key Challenges
Strategy
• Integration of ORSA into the
business’ strategic management
• ORSA expected to serve multiple
purposes including regulatory
compliance
• Ability to have risk management
ORSA
systems that monitor, manage and
report risk on a continuous basis (at
individual and aggregate level)
Operations
• Use for allocation of capital,
Internal
consistency between pricing and
Models
capital decisions
EMBEDDING RISK MANAGEMENT
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 44
Solvency II
Draft Solvency II Directive:
Regulatory approval of an internal model will require an entity to
satisfy three broad tests:
• Test 1: Statistical Quality Test (Article 119) – Actuarial model
• Test 2: Use Test (Article 118) – Internal risk management
• Test 3: Calibration Test (Article 120) – Regulatory capital
In addition, entities must satisfy:
• Validation Standards (Article 122)
• Documentation Standards (Article 123)
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 45
Solvency II
Internal Models – External Review
Draft regulatory requirements for approval of internal models:
Review Element
Solvency II
FOPI
APRA
Partial or Full Models



Scope and granularity



Completeness and consistency



Calibration standards



Stresses and scenarios



Model “use” and linkages



Validation framework



Governance framework



Limitations and development plans



Documentation



CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 46
Solvency II
Pillar III - Public disclosure and link to IFRS
Public disclosure
• Annual disclosure of solvency and
financial condition report
• Subject to approval groups may
disclose only one report
• Systems/ structures required to
ensure ongoing appropriateness of
information disclosed
Link to IFRS
• Conceptually in line with IFRS
approach and timeline
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Solvency and financial condition
report to contain information on
• The nature and performance of the
business
• Governance systems
• Risk management approach and
risk profile
• Valuation basis for assets and
liabilities
• Capital management including
structure and quality of own funds,
MCR and SCR
• Non-compliance with MCR and SCR
during reporting period
September 26, 2008
Slide 47
Section Three
IFRS Update
International Financial Reporting Standards (IFRS)
What is IFRS?
SEC Roadmap
Insurance Contracts Today
Insurance Contracts Phase 2
What is IFRS?
Background
• IFRS—International Financial Reporting Standards
• Standard setter—International Accounting Standards Board (IASB)
founded in 2001 and based in London
• International Accounting Standards Committee (IASC) Foundation
- Appoint IASB members
- Exercise oversight
- Raise funds
- Similar to Financial Accounting Foundation (FAF)
• Predecessor organisation was International Accounting Standards
Committee (IASC) founded in 1973
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 50
What is IFRS?
Standard setting structure
Trustees
IASC
Foundation
22 trustees
Geographical break-down
Appoint
Govern
Fund
Europe
8
North America
6
Asia / Oceania
6
Rest of the world
2
Board
Geographical break-down
SAC
50 members
Advise
IASB
Chairman plus
12 members
Interpret
Create
IFRIC
12 members
Europe
6
North America
3
Asia / Oceania
3
Rest of the world
1
IFRS
High quality, enforceable and global
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 51
What is IFRS?
A simpler set of accounting guidance
IFRS
•
•
•
Standards
─ IFRS: 8
─ IAS: 29
Interpretations
─ IFRIC: 8
─ SIC: 11
Framework
US GAAP
•
2,500 pages
•
•
•
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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Standards:
25,000 pages
─ SFAS: 106
─ APB: 16
─ ARB: 4
Interpretations
─ FSP: 49
─ EITF: 108
─ FIN: 27
Concepts Statements: 6
Other
─ FTB: 32
─ AICPA Interpretations: 6
─ SOP: 51
─ AICPA Industry Audit and
Accounting Guides, SABs, DIGs…
September 26, 2008
Slide 52
What is IFRS?
IFRS Framework
Faithful presentation
of economic reality
Responsive to users’
needs for clarity
and transparency
Consistency with a
clear conceptual
framework
Criteria for
principles-based
standards
Based on an
appropriately
defined scope
Written in clear,
concise and plain
language
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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Allows for use of
reasonable judgment
September 26, 2008
Slide 53
International Financial Reporting Standards (IFRS)
What is IFRS?
SEC Roadmap
Insurance Contracts Today
Insurance Contracts Phase 2
SEC Roadmap
When might the transition to IFRS occur in the US?
Reasonable timeline for the US transition to IFRS
March 2007
SEC roundtable
on US GAAP
reconciliation for
IFRS filers
August 2007
SEC concept
release on use
of IFRS for US
registrants
2009
2007
2008
July 2007
SEC proposal
eliminating
US GAAP
reconciliation
for IFRS filers
August 27, 2008
Roadmap was issued
November 15, 2007
Reconciliation
eliminated for IFRS
filers
2011
January 2009-2014
Voluntary application of
IFRS permitted for
certain US registrants
2013
2010
2012
December 2007
SEC roundtable on
IFRS in the US
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2015
2014
January 2014
Proposed roadmap
targets potential
mandatory adoption
in 2014-2016?
During 2011
SEC will reconvene to
decide whether a
mandatory conversion
date should be set
September 26, 2008
Slide 55
SEC Roadmap
Proposed Roadmap
• Targets potential mandatory adoption of IFRS in the U.S.
beginning in 2014 (or 2014-2016)
• Lays out several milestones that would need to be achieved
prior to the SEC mandating use of IFRS for all U.S. issuers
• Proposed rule for certain qualifying domestic issuers to use
IFRS as early as 2009
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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Slide 56
SEC Roadmap
Requires Future SEC Action
SEC would reconvene in 2011 to decide whether:
• Milestones have been achieved
• Mandatory IFRS conversion date should be set for all issuers
• Option to early adopt IFRS should be expanded to a larger
population of issuers
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 57
SEC Roadmap
Milestones
• Continued improvements to IFRS accounting standards
• Independent funding of the IASC Foundation
• Enhanced ability for interactive data (XBRL) to accept IFRS
data
• Sufficient progress in IFRS education and training in the U.S.
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 58
SEC Roadmap
Optional Early Adoption of IFRS in the U.S.
• The SEC proposal would permit early adoption of IFRS by a
limited number of eligible U.S. issuers. The issuer would need
to meet the following two criteria in order to qualify for early
adoption of IFRS:
-
The issuer would need to be among the 20 largest companies,
measured by market capitalization, in their industry group and
IFRS must be used by the majority of the 20 largest companies,
measured by market capitalization, in that industry group
• Early adoption requires approval of the SEC Division of
Corporation Finance
• SEC estimates that at least 110 U.S. multinational companies
in 34 different industries would be eligible for early adoption
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 59
International Financial Reporting Standards (IFRS)
What is IFRS?
SEC Roadmap
Insurance Contracts Today
Insurance Contracts Phase 2
Insurance Contracts Today
IFRS 4 Measurement
Does contract contain
significant insurance
risk?
Yes
Does the contract
need to be
unbundled?
Yes
No
Insurance
Component
No
Are any discretionary
participation features
present?
No
Yes
Deposit
Component
Insurance Contract
Investment Contract
(IAS 39)
Use existing
valuation
Amortized Cost or FV
Investment Contract with
discretionary participation
features
Liability or equity
Insurance risk
= Risk other than financial risk transferred from the holder of the
contract to the issuer.
= No requirement for underwriting and timing risk.
Significant
= Where an insured event could cause an insurer to pay significant
additional benefits in any scenario, excluding scenarios that lack
commercial substance, irrespective of the likelihood of such event.
The “additional benefit” is measured in comparison to that which
would be paid if the insured event did not occur.
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 61
Insurance Contracts Today
IFRS 4 Disclosures
General disclosure principles
• Principle 1: Identify and explain significant amounts in financial statements
- Accounting policies and significant assumptions
- Changes in amounts and assumptions
• Principle 2: Help users understand future cash flows
- Objectives managing risks & policies for mitigating risks
- Terms and conditions and affect on cash flows
- Insurance risks - sensitivity analysis, concentrations, loss development
- Interest rate and credit risks
Sensitivity analysis
• Actual changes in financial results for changes in key assumptions
• Sensitivity of financial results for changes in all variables that have a material
impact on assets, liabilities, income and expenses (e.g. interest rates, inflation
rates, equity markets, mortality, persistency, frequency and severity )
• Companies have not historically not provided sensitivity analysis in audited
financial statements
< - Will need to determine data requirements
< - Will need to benchmark / emerging practice
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 62
International Financial Reporting Standards (IFRS)
What is IFRS?
SEC Roadmap
Insurance Contracts Today
Insurance Contracts Phase 2
Insurance Contracts Phase 2
Status Update
Current IFRS situation for accounting for insurance contracts is
inconsistent across jurisdictions
Results in too much diversity, less relevance and reliability
The IASB started with a clean slate to develop Phase 2
FASB may pursue joint project with IASB (IFRS/US GAAP
convergence)
Phase II
work begun
Jul 04
Discussion
Paper
published
May 07
Comment
period ends
Nov 07
Phase II
Exposure
Draft
published
Late 09?
Phase II
IFRS
published
2011?
FASB ITC
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
Aug 07
PricewaterhouseCoopers
We are here
Phase II
IFRS
effective
2013?
September 26, 2008
Slide 64
Insurance Contracts Phase 2
Technical Overview – key features
Single accounting
model
Exit Model
•Discounting for non-life business
•Strong opposition from US non-life industry
•Prospective cash flow model
•Controversial (inside and outside IASB)
•Possible day one gains
•Obligation may arise on contract signing
Exit vs. Entry value – illustration:
• 10 year single premium policy sold by insurer X for $1,000
• Insurer X expects to realize a profit of $250
• Insurer Y prepared to purchase policy from X for $900 (after allowing for risk)
Entry value liability = $1,000
Initial profit is $nil (before or after acq. costs?)
Exit value liability = $900
Initial profit is $100
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 65
Insurance Contracts Phase 2
Building blocks of the IASB current exit value
IASB rationale for current exit value:
•
•
•
•
•
•
More faithful representation of insurer obligations and rights
Conveys more useful information about amounts, timing, uncertainty of
cash flows
Current estimates and use of explicit rather than implicit assumptions
require insurer to actively consider whether circumstances have changed
Explicit rather than implicit risk margin
Avoids need for separate liability adequacy test
More coherent framework for complex contracts such as multi-year, multiline, or stop loss contracts, avoiding need for arbitrary rules
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 66
Insurance Contracts Phase 2
Building blocks of the IASB current exit value
IASB rationale for current exit value (cont):
• Eliminates need to separate embeddeds
• Consistent with IAS 37 and IAS 39 which require current
estimates of future cash flows
• Reduces motivation to use reinsurance to recognize
previously unrecognized gains
• No need for arbitrary criteria to distinguish amendments to
existing contracts from new contracts
• Reduces possible accounting mismatches between assets
and liabilities
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 67
Insurance Contracts Phase 2
Building blocks of the IASB current exit value
Opponents of exit value approach:
•
•
•
•
•
•
Exit value places too much reliance on hypothetical transactions that rarely
occur (i.e. transfers)
Entry value reflects real transaction – price charged to PH
No conceptual basis for Day 1 gains
Market-consistent cash flow assumptions and market-consistent risk
margins are not observable or attainable – introduces more subjectivity and
non-comparability into the estimates
Some believe discounting of non-life liabilities is not appropriate due to
unpredictable nature of cash flows
Current exit value inappropriately implies a greater measure of precision in
the estimate that just isn’t there
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 68
Insurance Contracts Phase 2
Technical Overview – key features cont’d
Core liability measurement
Current, unbiased, market
consistent, probability
weighted estimates of
contractual cash flows
Current market
discount rates
Current, not past conditions
• Market participant vs entity specific
• Modelling demands
• Expected mean value, not deterministic
most likely
– More complex (stochastic?) models
• What cash flows to include? Contractual?
• Liability moves with market rate changes
• Insurer’s investment strategy not relevant,
except for par business
• Estimate of market risk margin
Risk margin
• Limited guidance on calculation
• Controversial feature, due to lack of market
• Key driver of day one profit
Service margin
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• Amount of expected future market-based
service profits
September 26, 2008
Slide 69
Section Four
Linkages Between ERM, Solvency II, IFRS
Linkages Between ERM, Solvency II, and IFRS
Review of the Common Features
Company
Solvency II
ERM
ORSA
Economic Capital
Models
Internal (EC) Models
Public Disclosures
Public Disclosures
Public Disclosures
GAAP, Fair Value,
Market Consistent
Value
Market Consistent
Value
Exit Value
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IFRS
September 26, 2008
Slide 71
Section Five
Company Perspective
Company Perspective – ERM, Solvency II, IFRS
ERM & Capital Modeling
• ERM Stochastic Modeling
•
•
•
•
GAAP equity
Statutory surplus
Economic capital
Other measures
September 26, 2008
Slide 73
Company Perspective – ERM, Solvency II, IFRS
IFRS and GAAP Balance Sheet Accounting
• Key Difference
• GAAP  Full value loss reserves
• GAAP  Full value loss reserves
IFRS
Fair
September 26, 2008
Slide 74
Company Perspective – ERM, Solvency II, IFRS
IFRS & Solvency II – Two Sides of One Coin
• IFRS = Fair value = (Economic value) concept
• Convergence of economic and accounting values
• Aim: IFRS net assets = Available economic capital
• Solvency II = (Fair) value-at-risk concept
• One-year time horizon
• 99.5% confidence level
• Aim: (IFRS) Net Assets VaR99.5%  Required economic
capital
September 26, 2008
Slide 75
Questions
Do you have any questions
regarding what you have
learned in this session?
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
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September 26, 2008
Slide 76
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© 2008 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP
or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is
a separate and independent legal entity. The information contained in this document is provided 'as is', for general guidance on
matters of interest only. PricewaterhouseCoopers is not herein engaged in rendering legal, accounting, tax, or other
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ADDENDUM - IFRS
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 78
Insurance Contracts Phase 2
Premium Cash Flows –
Conceptual Framework
Definition of an asset per the Framework
• “…a resource controlled by the entity as a result of past events
and from which future economic benefits are expected to flow
to the entity”
Definition of a liability per the Framework
• “…a present obligation of the entity arising from past events,
the settlement of which is expected to result in an outflow from
the entity of resources embodying economic benefits.”
Internally developed intangible assets are generally not
recognized except in business combinations
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 79
Insurance Contracts Phase 2
Premium Cash Flows
Premiums relate to an intangible asset: portion of customer
relationship with the policyholder
IASB decided to present it together with insurance liability
Re-pricing the policy makes it a new contract from accounting
perspective and therefore not eligible for asset recognition
• e.g., short duration property/casualty contract
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 80
Insurance Contracts Phase 2
Premium Cash Flows
Future premiums on existing contracts recorded as part of
customer relationship if any of the following 3 criteria met:
• Policyholder must pay premium to retain guaranteed
insurability
- Guaranteed insurability = right that permits continued
coverage without reconfirmation of PH risk profile and at
price that is contractually constrained
• Insurer can compel policyholder to pay premium (rare)
• Including the premiums and resulting policyholder benefit will
increase the measurement of liability
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 81
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 1st
Determining expected present value:
• Identify each possible scenario
• PV cash flows in that scenario
• Make unbiased estimate of probability of that scenario
• Insurer might develop estimates of each scenario by:
- identifying individual scenarios
- developing a formula that reflects insurer estimate of shape
and width of probability distribution, or
- by random simulation
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 82
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 1st
Market-consistent vs. entity specific cash flows:
• Should not capture cash flows due to synergies between
insurance liability and other assets or liabilities
• But should capture specifics of portfolio being measured
• For unobserved variables (e.g., frequency/severity of claims,
mortality), rarely persuasive evidence that insurer’s own
estimates differ from estimates other market participants
would make
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 83
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 1st
Reflect market participant (not entity specific) efficiency
• Use servicing costs that market participants would incur
• Don’t use entity specific servicing costs that reflect synergies
others don’t have
• Don’t use costs reflecting inefficient servicing system (e.g.,
antiquated claims administration system)
But reflect characteristics of contract; strategy for handling
• Level and type of service provided
• Approach to claims management
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 84
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 2nd
Discount rates
• Consistent with observable current market prices
• For cash flows whose cash flows match those of insurance
liability in terms of:
- Duration
- Liquidity
- Currency
• Discount all liabilities (long and short duration)
• Not insurer’s investment yield rate
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 85
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 3rd
Risk Margin
• Explicit and unbiased estimate of margin that market
participants require as compensation for bearing risk
• Reflects uncertainty in timing and amount of estimated future
cash flows
- Not a “cushion”
• What a third party would require to assume risk
- Not calibrated to premium
- But premiums provide reasonableness check
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 86
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 3rd
Risk margin is portfolio rather than entity specific, reflecting
pooling of liabilities
• Unclear about market participant diversification across
portfolios or negative correlation that different portfolios could
provide
No specific method prescribed; example approaches provided
• Confidence level, CTE, TVaR, cost of capital
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 87
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 3rd
Characteristics of the risk margin will likely include the following:
• The less that is known about the current estimate and its
trend, the higher the risk margin
• Risks with low frequency and high severity will have higher
risk margins than risks with high frequency and low severity
• For similar risks, long duration contracts will have higher risk
margins than those of shorter duration
• Risks with a wide probability of distribution will have higher
risk margins than those risks with a narrower distribution
• To the extent that emerging experience reduces uncertainty,
risk margins will decrease, and vice versa
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 88
Insurance Contracts Phase 2
Building blocks of the IASB current exit value – 3rd
Service Margin
• Market consistent margins for rendering services
- e.g., investment management services
- Unit-linked and variable contracts, universal life
• Income (loss) recognition on Day 1 if insurer receives fee
higher (lower) than market participants would demand
• Differs from current revenue recognition under IAS 18 based
on stage of completion
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 89
Insurance Contracts Phase 2
Reinsurance – Cedent Perspective
•
•
•
•
Reinsurance asset follows same model as direct reinsured liability (exit
value approach)
Risk margin for reinsurance assets equals risk margins for corresponding
part of direct reinsured liability
- Because one can’t transfer rights of indemnification of reinsurance
contract without underlying liabilities’ rights and obligations
Reinsurance asset is adjusted for expected default and disputes
Recognize contractual right, if any, to obtain potentially favorable
reinsurance rates
- e.g., existing non-cancellable prospective reinsurance contract on future
negotiated direct contracts
CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS
September 26, 2008
Slide 90