Session 8
IFRS and Solvency Requirements
Regional Training Seminar IAIS-ASSAL-FIDES
25 November 2009, Lima Peru
Takao Miyamoto, IAIS Secretariat
Agenda
1. Background
–
Accounting and Solvency
–
IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues
–
Measurement Approaches
–
Building Blocks
–
Margins
–
Day One Difference
–
Acquisition Costs
–
Own Credit Risk
1
Two Uses of Financial Reporting
General purpose
financial reporting
(Starting point)
Should reflect economics
of businesses
: Efficiency
–
Many resources (e.g. audit) were
already used for accuracy & reliability
–
Widely accepted
(Prudential filter) : Adjustment for different purposes
–
Often in conservative direction
–
IAIS seeks to minimise
Regulatory purpose
reporting & requirements
Should serve to protect
policyholders
2
Key Principle
The IAIS believes that it is most desirable that the
methodologies for calculating items in general
purpose financial reports can be used for, or are
substantially consistent with, the methodologies used
for regulatory reporting purposes, with as few changes
as possible to satisfy regulatory requirements.
3
IASB Project Schedule
1997
–
Insurance Contracts Project start
Phase I
IFRS 4
2004
Phase II
May 2007
–
Discussion Paper “Preliminary Views
on Insurance Contracts” (DP)
Q2 2010
–
Exposure Draft
Mid 2011
New IFRS
4
Agenda
1. Background
–
Accounting and Solvency
–
IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues
–
Measurement Approaches
–
Building Blocks
–
Margins
–
Day One Difference
–
Acquisition Costs
–
Own Credit Risk
5
Measurement Approaches – IASB
“Current Exit Value”
• Amount insurer would expect to pay at reporting
date to transfer remaining contractual rights and
obligations immediately to another entity
“Current Fulfillment Value”
• Expected present value of cost of fulfilling
obligations to policyholder over time
“Updated IAS 37”
• Amount entity would rationally pay at end of
reporting period to be relieved of present obligations
–
Given absence of active market for insurance contracts, this
may be close to fulfillment notion
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Measurement Approaches – IAIS
•
•
•
Insurers generally do not transfer liabilities, given
no active market for insurance contracts
Insurers generally fulfill/settle obligations to
policyholders over time
Any transfer notion would be strongly influenced by
settlement of obligations that transferee would
undertake
–
–
Transfers would need to be made to entity capable of
accepting transfer
It implies that transferee would also need to be regulated
and capable of settling obligations to claimant/beneficiary
7
Building Blocks – IASB
Three building blocks
• Current estimate of expected (i.e. probability
weighted) present value of future cash flows
• Time value of money (i.e. discounting)
• Explicit margin
Rationale
• Markets for trading insurance contract rarely exist
• So, its value is rarely observable (i.e. Level 3
financial product)
• So, its value has to be estimated somehow
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Comparison
IASB
IAIS
Measurement Approaches
Current Exit Value
- Could work with any of views
- Devil is in details
Updated IAS 37
Current Fulfillment Value
Building Blocks
- Current estimate of expected
present value of CF
- Time value of money
- Explicit margin
- Agree with building blocks
approach
- Easy to say but difficult to
implement…
- Details to be developed
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Unearned Premium Approach
Exception
• Pre-claims short-duration liabilities only
• Permitted (not required) to use “Unearned
Premium” approach
–
–
Provide decision-useful information
Cost vs. Benefit
Measurement method
• As insurer is released from risk, related part of
premium is earned and recognised as revenue
• Unearned part of premium is recognised as liability
–
–
Lock-in: allocate original price (premium) over periods
No explicit margin
10
Agenda
1. Background
–
Accounting and Solvency
–
IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues
–
Measurement Approaches
–
Building Blocks
–
Margins
–
Day One Difference
–
Acquisition Costs
–
Own Credit Risk
11
Margins – IASB
Types of margins
• Risk: compensation required for bearing risks
• Service: compensation for assuming services other
than risk margin
• Residual: remaining margin (calibrated to actual
premium)
• Composite: inclusive of above three (calibrated to
actual premium)
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Comparison
IASB
IAIS
Margins
Current Exit Value
- Risk, Service, Residual
Updated IAS 37
- Risk, Service, Residual
Current Fulfillment Value
- Composite
- Support explicit margins
regardless whether/how they
are classified
- Initial measurement calibrated
to zero profit on inception is
supportable
- Challenge is how to measure
margins in subsequent periods
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Agenda
1. Background
–
Accounting and Solvency
–
IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues
–
Measurement Approaches
–
Building Blocks
–
Margins
–
Day One Difference
–
Acquisition Costs
–
Own Credit Risk
14
Day One Difference
What is “Day One Difference”?
• When using exit price (whether transfer or
fulfillment) instead of entry price, day one difference
could arise at inception
• It could be both positive (gain) or negative (loss)
• Simple examples
–
–
Insurance Company A enters into one-year term non-life
contract. Premium for contract is 1,000 and is received at
inception. Expected present value of future cash outflow is
800.
What if expected present value of future cash outflow is
1,200?
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Day One Difference – IASB
Recognition
• No profit at inception should be recognised in
profit/loss
–
–
•
Margin (either residual or composite) is recognised as
liabilities
They are calibrated to actual premiums
Loss at inception should be recognised in
profit/loss – onerous contracts
–
Asymmetry exists
16
Acquisition Costs – IASB
Issues
• Insurance companies incur initial acquisition costs
–
•
•
Significant amount especially for long term contracts
Are they expensed or deferred?
How about matching revenue?
IASB position
• All acquisition costs should be expensed when
incurred
• No revenue can be recognised to offset acquisition
costs expensed – October 2009 position
–
Day one loss on long term contracts (e.g. life insurance)
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Comparison
IASB
IAIS
Day One Difference
No profit at inception
Loss at inception – onerous
contracts
Fine (except for below)
Acquisition Costs
All acquisition costs should be
expensed when incurred
No recognition of revenue to
offset acquisition costs
- It does not reflect economics
(profitable business may incur
losses at inception)
- It would be disincentive for
entering into profitable
business
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Agenda
1. Background
–
Accounting and Solvency
–
IASB Insurance Contracts Project Overview
2. IASB and IAIS Views on Main Issues
–
Measurement Approaches
–
Building Blocks
–
Margins
–
Day One Difference
–
Acquisition Costs
–
Own Credit Risk
19
Own Credit Risk
•
•
Whether to include insurer’s own credit risk in
valuation of insurance liabilities
If included, decrease in liabilities for worsening of
insurer’s credit standing
Liabilities
Assets
Liabilities
Assets
Surplus
AAA Insurer
Surplus
BBB Insurer
20
Comparison
IASB
IAIS
Own Credit Risk
Current Exit Value
- Include own credit risk in
technical provision
Updated IAS 37
- To be discussed (arguably
implicit in residual margin at
inception)
Current Fulfillment Value
- To be discussed (arguably
implicit in residual margin at
inception)
- Initial premium, agreed
between relevant parties, may
be presumed to incorporate
own credit risk
- However, remeasurement
should never incorporate
changes in credit risk
(insurance contracts are not
publicly traded)
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Questions and Answers
Thank you very much!
www.iaisweb.org
takao.miyamoto@bis.org
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