Canadian
Institute
of
Actuaries
L’Institut
canadien
des
actuaires
2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Canadian Institute of Actuaries
Appointed Actuary meeting
Financial Instruments – Toronto, 2006
pwc
2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
What are the new standards?
CICA 3855 Financial Instruments – Recognition and Measurement:
generally requires most financial assets to be measured at fair value;
policy liabilities are outside its scope
CICA 4211 Life Insurance Enterprises – Specific Items: eliminates the
moving-to-market model for investments other than real estate.
CICA 3861 Financial Instruments – Disclosure and Presentation:
requires some enhanced disclosures, mainly regarding fair values; P&C
policy liabilities are in scope, L&H policy liabilities are outside scope
CICA 3865 Hedges: provides rules for the application of hedge
accounting
CICA 1530 Comprehensive Income: establishes a new concept for
income
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Definitions
Financial instrument
•A contract that gives rise to a financial asset of one party
and a financial liability or equity instrument of another
party.
Financial asset
•Cash, a contractual right to receive cash, a contractual
right to exchange financial instruments with another party
under potentially favourable conditions or an equity
instrument of another entity.
Financial liability
•Any liability that is a contractual obligation to deliver cash
or another financial asset or to exchange financial
instruments with another party under potentially
unfavourable conditions
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
What is fair value?
 FAIR VALUE is the amount of consideration that would be
agreed upon in an arm's length transaction between
knowledgeable, willing parties who are under no compulsion
to act.
 Best evidence – quoted price in an active market
 Otherwise – use a valuation technique
 Investments are valued at the “bid” price vs “ask” or “closing”
prices
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Comprehensive income – a
new financial statement
Comprehensive
Income
=
All changes in net
assets other than
transactions with
investors
Net
Income
•Still the
focal point
of
performance
by Investors
+
Other
Comprehensive
Income
•Includes
unrealized
gains and
losses on some
investments
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Impact on insurance financial
assets
CATEGORY
EXAMPLES
ACCOUNTING TREATMENT
Loans and
receivables
Policy loans, receivables from Generally will continue to be
cedents, deposits with cedents, measured at cost unless the
retrocession recoverables
company elects that they should be
measured at fair value
Investments
Bonds and stocks
Accounting treatment is dependent
on how the company designates
these assets on purchase or initial
adoption of the new standards
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Designation of investments
Held to
maturity
Investments
Amortized value
Held for
trading
Market value
Available
for sale
Individual assets must be irrevocably designated on purchase or
on initial adoption of the new accounting standards
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Impact on net income and
other comprehensive income
Investments
Net Income
Other
Comprehensive
Income
Held to
maturity
Amortization
nil
Held for
trading
Change in
fair value
nil
Available
for sale
Amortization
Change in
fair value
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Held to maturity designation
 Can only be used where there is a history of holding investments to
maturity.
 Sales of more than an insignificant portion of “Held to maturity”
designated assets results in “tainting” of the entire portfolio and
immediate reclassification as “Held for trading”.
 Available for sale and Held for trading designation
 A matter of choice.
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Balance sheet extract –
Shareholders’ equity (new
P&C-1)
EQUITY
Shares issued and paid .........................................................................................
41
Contributed Surplus .........................................................................................................
42
.........................................................................................................................................
43
Retained Earnings .............................................................................................................
44
Reserves ............................................................................……………………..
45
Accumulated Other Comprehensive Income (Loss) …..
46
Total Equity ......................................................................................……………………
49
TOTAL LIABILITIES AND EQUITY …………………………………………………………………………
89
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Statement of Comprehensive
Income (New P&C-1)
COMPREHENSIVE INCOME (LOSS)
Net Income ...................................................................................................................
01
Other Comprehensive Income (Loss):
Available for Sale:
Change in Unrealized Gains and Losses:
- Loans..................................................................................................
02
- Bonds and Debentures …….....…......……………………....
03
- Equities..................................................................................................
04
Reclassification to Earnings of Gains/(Losses)……………
05
Derivatives Designated as Cash Flow Hedges
Change in Unrealized Gains and Losses ………………………………………..
06
Reclassification to Earnings of Gains/(Losses)……………
07
Foreign Currency Translation
Change in Unrealized Gains and Losses ……………………………………………………………………
08
Impact of Hedging ………………………………………………………
09
Total Other Comprehensive Income (Loss) …………………………………………………………..
21
39
Total Comprehensive Income (Loss) …………………………………………………………………………..
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Statements of Accumulated
Other Comprehensive Income
(New P&C-1)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Accumulated Gains/ (Losses) on:
Available for Sale:
- Loans ………………………………………………………………………………
42
- Bonds and Debentures ………………………………………………………………………………
43
- Equities ………………………………………………………………………………
44
Derivatives Designated as Cash Flow Hedges …………..
45
Foreign Currency (Net of Hedging Activities) …………………………………
46
Balance at end of Period ……………………………………………………………………………………….
59
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Transition rules
 New standards effective for fiscal years beginning on or after
October 31, 2006
 Prospective adoption with no restatement of comparatives
 Must have designations in place on first day
 Re-measure financial statement values on day one
 Adjustments to opening retained earnings and accumulated other
comprehensive income
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Comparison to US GAAP
and IFRS
 Similar but not identical to US GAAP and
IFRS
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Economic impact – interest
rates and asset values
Interest
Rate
Market Value
of Investments
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Economic impact – interest
rates, asset values and policy
liabilities
Interest
Rate
Market Value
of Investments
Actuarial
Liabilities
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Economic impact – P&C
companies
Interest
Rate
Market Value
of Investments
Actuarial
Liabilities
Increases in interest rates raise discount rates
and reduce actuarial liabilities.
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Economic impact – the potential
for mismatch
Changes in
actuarial
liabilities
•Changes in
•investment values
Net Income
Held to
maturity
Held for
trading
Amortization
Change in
market value
Other Comprehensive
Income
nil
nil
Change due
to amortization
Change due
to market
value change
M I S MATC H
Available
for sale
Amortization
Change in
market value
Change due
to market
value change
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Implications for earnings
management
Asset
supporting
liabilities
Held for
Trading
DESIGNATION
Assets
representing
surplus
Changes in
asset values
are offset by
changes in
liabilities
ACCOUNTING
RESULT
Available
for Sale
Changes in
asset values
reflected in
equity rather
than earnings
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Canadian GAAP – who cares
anyway?
Public Life Companies
…likely yes
Public P&C Companies
…depends on whether they discount
Private Insurers
…probably don’t care
Mutual Companies
…likely yes
Rating Agencies
…probably don’t care
FS Preparers
…like to limit GAAP differences
OSFI
…should have no capital impact, but…
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
OSFI Guideline D-10
OSFI is concerned with the reliability of fair values determined
using valuation techniques (rarely an issue for insurers) and wants
sound risk management.
D-10 limits the use of the Held for Trading designation unless:
1. it significantly reduces an accounting mismatch; or
2. the financial instruments are managed together and
evaluated on a fair value basis
Must maintain a documented risk management strategy and the
fair values must be reliable
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Tax implications
 Investments
 Reserves
 Others
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Taxation of investments
 Mark-to-market properties (“MTM”) for tax include:
– Equity investments if unrelated or held less than 10% votes
and value of shares;
– Specified debt obligations (“SDOs”) (i.e. bonds, mortgages,
etc.) that were carried at FMV on financial statements since
they were acquired.
 MTM gains or losses are taxed on an unrealized basis.
 SDOs which were not carried at FMV since they were acquired
are taxed on an amortized cost basis
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Investments – specified debt
obligations (“SDOs”)
 S.3855 classification of SDOs will affect
how the investments will be taxed
Accounting
Tax
Acquired
Pre-S.3855
Amortized Cost
(TD)
Acquired
Post-S.3855
FMV
Amortized Cost
(TD)
FMV
HFT
Pre-S.3855
Amortized Cost
Post-S.3855
FMV
AFS
Amortized Cost
FMV
HTM
Amortized Cost Amortized Cost Amortized Cost Amortized Cost
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Investments – portfolio equities
 Changes do not affect the taxation of “portfolio” equity investments
 Most previous temporary differences are eliminated
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Tax reserves
 P&C insurers
– IBC expects tax reserves to increase due to S.3855
– Recommendations to Finance to amortize tax reserve
increase over 3-4 years.
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Other tax implications
 Non-resident (Branch) insurers – any S.3855 impact in
TAAM could affect investment income for tax (through tax
attributed surplus calculation).
 Federal Part VI tax (a capital tax which affects large life
insurers) .
 Ontario and Quebec special additional capital taxes (a
provincial capital tax).
 Ontario corporate minimum tax calculated based on
accounting net income (presumably excludes OCI).
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2006 Seminar for the Appointed Actuary
Colloque pour l’actuaire désigné 2006
Thank you.
© 2006 PricewaterhouseCoopers LLP, Canada. “PricewaterhouseCoopers” refers to
PricewaterhouseCoopers LLP, Canada, an Ontario limited liability partnership, or, as
the context requires, the network of member firms of PricewaterhouseCoopers
International Limited, each of which is a separate and independent legal entity.
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PwC