The Coming IFRS for
Insurance Accounting
Michael G. McCarter, FCAS, MAAA
Vice President, AIG
CAMAR, Philadelphia
June 5, 2008
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Introduction
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Prelude – the rise of the standards setters
The perfect storm for international accounting
standards
IASB Insurance Contracts Phase II
FASB, the SEC, and you
EU Solvency II, the IAIS, and the NAIC
Conclusion: Brave new world, or the Emperor’s
new clothes?
A little about GNAIE
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Prelude – the rise of the standards
setters
Old style standards setter: FASB
 FASB is delegated its authority to set
standards for U.S. GAAP by the SEC
 SEC retains practical authority over some
significant areas of U.S. GAAP
 SEC is in Washington, DC and may be
influenced by Congress and the President
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3
Prelude – the rise of the standards
setters
New style standards setter: (surprise) the
NAIC
 The NAIC had no authority to be a
standards setter. It is not a regulator, but
a trade association for regulators.
 However, in the accounting codification
project it took the status of insurance
regulatory accounting standard setter from
the states who had responsibility
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Prelude – the rise of the standards
setters
The NAIC demonstrates the power of
“agreeing to agree”
 It is now the most important U.S.
regulatory accounting standards setter
 Since it is not a part of government, it has
problematic standards of due process
 Through the accreditation process, it can
exercise influence over state governments
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Prelude – the rise of the standards
setters
Another new style standards setter: the
IASB
 Descended from old IASC founded in 1973
(older than FASB)
 No official delegated authority from any
government (to start with)
 Acted with alacrity to take advantage of
perceived need for international standards
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The perfect storm
Asian financial crisis 1998
 Caused G8 to issue ritual call for improved
accounting standards and reporting
 Old IASC recognized an opportunity
 Old IASC “standards” merely collected
more commonly used national options for
various accounting standards
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The perfect storm
New IASC project to revise its standards
to select the best, “principles-based”
approach
 Project coincided with EU need for EUwide accounting standards
 IASC reorganized itself into the IASB to
meet U.S. (FASB and SEC) objections as to
its process and funding
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The perfect storm
Once the IASC/IASB had done what the
U.S. said it should, the U.S. was
committed to work with the IASB towards
the obvious goal of a single world-wide set
of high quality accounting standards
 Another example of the power of
“agreeing to agree”
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The perfect storm
EU agrees to adopt IASB IFRS effective
January 1, 2005 (even though no
complete set of IFRS existed when
adopted, when implemented, or even
today)
 “Norwalk Agreement” in 2002 commits
FASB and the IASB to work towards
“convergence” of U.S. GAAP and IFRS
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The perfect storm
IASB lauded itself on its “principles-based”
standards that would not be subject to the
abuses of the “rules-based” FASB
approach
 Multiple major projects (Conceptual
Framework, Revenue Recognition,
Financial Statement Presentation) amount
to re-building car while racing around the
track
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The perfect storm
Breaking News!
 FASB, SEC no longer interested in
“converging” U.S. GAAP and IFRS
 Instead they are working to have the U.S.
adopt IFRS on a date certain, probably
January 1, 2013
 More on this later
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IASB Insurance Contracts Phase II
Old IASC had never completed an
insurance contracts accounting standard
 Recognized as a major need, but the new
IASB could not complete an insurance
accounting standard in time for the EU
IFRS implementation
 IASB developed IFRS 4 (Insurance
Contracts Phase I) as a placeholder
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IASB Insurance Contracts Phase II
IASB issued “Discussion Paper: Preliminary
views on insurance contracts” in May 2007
 Comments were due November 16, 2007
 FASB also issued the discussion paper with
a “wraparound” asking for comments as to
whether FASB should take up the
insurance contracts accounting project as
well
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IASB Insurance Contracts Phase II
Over 160 comment letters filed, many with
serious concerns
 Following are some of the major issues
covered by the “DP”
 Note: The “DP” approach is based on
“principles” that have nothing to do with
the ideas underlying current U.S. GAAP (or
SAP either) for insurance
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IASB Insurance Contracts Phase II
Measurement of insurance liabilities is to
be on a “market consistent” basis using a
“current exit value” (CEV) approach
 CEV may not be the same as “fair value”,
but to date no difference between CEV
and “fair value” has been identified
 CEV based on three “building blocks”:
current estimates, time value of money,
market risk and service margins
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IASB Insurance Contracts Phase II
Current estimates: explicit, unbiased,
market-consistent, probability-weighted
current estimate of contractual cash flows
 Discount rates based on current market
interest rates to apply to these cash flows
 Explicit and unbiased estimates of margins
that market participants would require to
bear risk (risk margin) and to provide
services, if any (service margin)
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IASB Insurance Contracts Phase II
Margins are not “entity specific” – they are
to reflect a market participant, not the
specific insurer being accounted for
 Margins reflect the pooling of similar risks
in a portfolio, but not the diversification
benefits of other portfolios of the insurer
 Insurance liabilities should reflect their
own credit standing (as assets)
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IASB Insurance Contracts Phase II
Question: Liabilities don’t trade – they are
settled. Why is “market-consistent” a
relevant consideration for liabilities?
 Question: There is no benchmark for ever
verifying the correct “market risk margin”
for a liability. How does this “mark-tounverifiable-model” add reliable
information for investors?
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IASB Insurance Contracts Phase II
Question: Insurers are obliged to settle claims in
accordance with contract terms. Why should
liability valuations be reduced by the “own credit
stance” when the insurer cannot benefit from
that haircut?
 Question: If we accept “market consistent” for
argument’s sake, why is no diversification credit
allowed when markets, rating agencies, and
even solvency regulators recognize the validity
of the concept in many circumstances?
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IASB Insurance Contracts Phase II
Question: Why should an insurer use a “market
participant” service margin lower than its actual
costs that generates an artificial day one profit
at inception only to reverse as the actual service
costs emerge?
 Question: Why are life and non-life insurance
presumed to use the same accounting treatment
when no existing accounting system treats them
together and the relative underwriting and
investment risks are very different?
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IASB Insurance Contracts Phase II
Question: Why is the whole discussion focused
on balance sheets when management and
investors are at least equally concerned with
performance measurement (notably for non-life
underwriting results and combined ratios)?
 Question: Why is there no plan for serious
testing of these proposals before simply
requiring them for one of the world’s major
industries?
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IASB Insurance Contracts Phase II
Question: Why allow Day One Gains on
insurance contracts when there has been
no release from risk and the services
promised have not been provided?
 Insurance Working Group met in April
2008 to begin providing the IASB with its
advice on these questions
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IASB Insurance Contracts Phase II
Industry wants increased field testing and
communications
 May cause exposure draft to be pushed
from 2009 to 2010 or later
 Comments and final standard 2010 or
later
 Will set insurance reporting framework for
decades
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FASB, the SEC, and you
“I only do business in the U.S., so I don’t
have to worry about the IASB IFRS for
insurance contracts”
 Incorrect. FASB and the SEC are now
working to replace U.S. GAAP with IFRS
 “But I’m a mutual and don’t use U.S.
GAAP”
 What happens to SAP if U.S. GAAP
disappears?
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FASB, the SEC, and you
FASB will reduce itself from 7 to 5
members as of July 1, 2008
 The FASB Chair will gain agenda setting
authority at that time
 FASB will decide whether to participate in
the Insurance Contracts Phase II project
during the third quarter of 2008
 The IASB wants FASB’s participation
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FASB, the SEC, and you
SEC Proposed Rule released July 2, 2007
 “Acceptance from Foreign Private Issuers
of Financial Statements Prepared in
Accordance with International Financial
Reporting Standards without
Reconciliation to U.S. GAAP”
 Adopted! Reconciliations no longer
required
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FASB, the SEC, and you
SEC Concept Release on August 7, 2007
 “Concept Release on Allowing U.S. Issuers
to Prepare Financial Statements in
Accordance with International Financial
Reporting Standards”
 Decision expected in the near future
 Might be affected by potential for U.S.
switch to IFRS
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FASB, the SEC, and you
Semi-annual joint IASB/FASB meeting in
April 2008
 Discussed “mandatory adoption of IFRS in
all major capital markets” by 2013
 Considered what accounting standards
should be completed before mid-2011
“quiet period” starts
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FASB, the SEC, and you
Most important issues include Revenue
Recognition, Fair Value Measurement, and
Financial Statement Presentation (not
Insurance Contracts)
 But IASB continues to work on Insurance
Contracts project since they are in the
middle of it and they have no real current
Insurance Contracts standard
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FASB, the SEC, and you
SEC Chair Cox now chairs IOSCO Technical
Committee
 Developing revised governance structure
for IASB to give worldwide securities
regulators (including the SEC) a role
 Chairman Cox appears to see replacement
of U.S. GAAP with IFRS as a major
“legacy” of his chairmanship
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FASB, the SEC, and you
U.S. GAAP likely to be replaced by IFRS by
2013 (with option for sooner)
 Most likely there will be a new IFRS for
Insurance Contracts for implementation by
that time
 If not, EU insurers may develop their own
“improved” insurance contracts standard
for use with Solvency II
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EU Solvency II, the IAIS, and the
NAIC
As the EU adopted (mostly) the IASB’s IFRS to
unify accounting standards across its member
states, it is now adopting the Solvency II
directive to unify insurance regulation
 Solvency II is designed around the three pillars
of capital requirements, regulatory
examinations, and disclosure requirements that
were pioneered for banks under Basel II
 Solvency II is designed to provide EU insurers
with competitive regulatory advantages over
non-EU insurers
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EU Solvency II, the IAIS, and the
NAIC
Solvency II has two required capital calculations,
the Solvency Capital Requirement (SCR) and the
Minimum Capital Requirement (MCR)
 SCR tends to be based on internal models that
use concepts similar to the IASB’s CEV concept
 SCR is intended to represent the amount of
capital required to make the probability of failure
0.5% or 1 in 200 years.
 MCR is intended to be a simpler formula
approach
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EU Solvency II, the IAIS, and the
NAIC
Issue: Should solvency measurements and
financial reporting measurements be the same?
 Not necessarily – “different horses for different
courses”
 Accounting makes entities comparable across
industries, while solvency focuses on insurance
 Solvency considers cat exposure, accounting
only cats that have happened
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EU Solvency II, the IAIS, and the
NAIC
Issue: Should equally secure insurers be treated
the same way, no matter where they are
located?
 Yes, if you are interested in market competition
to serve consumers
 EU Solvency II may disadvantage U.S. insurers
by claiming U.S. insurance regulation does not
meet their standards
 Implication: Less diversification credit for U.S.
insurers
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EU Solvency II, the IAIS, and the
NAIC
The IAIS is developing international
standards and best practices for insurance
regulation
 It appears to be largely modeling its
approach on that of the EU
 The NAIC participates on IAIS committees
 The NAIC may be helping to build
standards that will come back to haunt it
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EU Solvency II, the IAIS, and the
NAIC
No country but the U.S. has a separate
regulatory accounting system for insurance
 Other countries use general purpose accounting
for insurance regulatory purposes
 Thus, the IAIS has taken an active interest in
the IASB insurance contracts project as likely to
affect reports used by their members
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EU Solvency II, the IAIS, and the
NAIC
The IAIS develops comments on various
IASB proposals
 The NAIC provides comments to the IAIS
to influence the development of those
comments
 The NAIC is being encouraged to also
comment directly to the IASB since the
NAIC represents regulators of the world’s
largest insurance marketplace
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EU Solvency II, the IAIS, and the
NAIC
When FASB and the IASB agree on an insurance
contracts accounting standard, that standard will
become the de facto global insurance regulatory
standard, even if it confuses solvency regulation
 Accordingly, the pressure for U.S. insurance
regulators to adopt it will be intense
 Therefore, it is important to fix the IASB
proposal now if you’re going to be unhappy with
it as either a general purpose or regulatory
accounting standard
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Brave new world, or the Emperor’s
new clothes?
Standard setters not responsible to anyone save
themselves have increasing roles in the global
marketplace
 The IASB has embraced the untested “mark to
model” CEV version of fair value as the right
means of accounting for insurance liabilities,
even though they’ve made no attempt to verify
that it is an effective accounting approach for
insurance
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Brave new world, or the Emperor’s
new clothes?
What is the value of “market consistency”
when insurance liabilities do not trade?
 Why is no attention paid to key
management measures of non-life
insurance performance such as
underwriting profit or combined ratio?
 Why is there no plan for testing and
validating these proposals before
implementing them?
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Brave new world, or the Emperor’s
new clothes?
The result of the Insurance Contracts
Phase II project will be coming to financial
statements near you, probably through
U.S. adoption of IFRS to replace U.S.
GAAP
 When that happens, it is likely insurance
regulatory accounting will move the same
way
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Brave new world, or the Emperor’s
new clothes?
Insurance solvency regulation need not
follow insurance accounting standards, but
right now they are running in parallel
 The CEV approach to liability valuation has
serious issues when applied to solvency
 If you care, comment! Now is the time!
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GNAIE Strategies
Support development of a single set of
high quality international accounting
standards for insurance contracts
 Work to inform and educate interested
parties and encourage active participation
and comment on these issues
 Work to build bridges and encourage
common action to better communicate the
importance of these issues
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GNAIE Strategies
Example GNAIE action: Provided 5
discussion papers to IASB IWG after its
April meeting. The topics were:
 Settlement Value – Life and Non-Life
 Field Testing
 Day One Profit
 Risk Margins
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WWW.GNAIE.NET
News of significant international
accounting standards and solvency
regulation developments
 Comment letters submitted by GNAIE to
various bodies
 Reports and studies prepared by or on
behalf of GNAIE in regard to international
accounting and solvency issues
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GNAIE Member Companies
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ACE
AIG
Allstate
AXIS Capital
Genworth Financial
The Hartford
Lincoln Financial
Manulife Financial
MetLife
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New York Life
PartnerRe Ltd.
Principal Financial
Prudential Financial
RenaissanceRe
Sun Life Financial
Travelers
XL Capital
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