International Accounting Standards
for
Insurance Contracts
Implications
for
Property/Casualty Insurance
in the United States
Robert Miccolis, FCAS, MAAA
CAS Representative to IAA Insurance Accounting Committee’s
Subcommittee on International Actuarial Standards
Casualty Loss Reserve Seminar
Session 7 – International Reserving Issues
September 8-9, 2003
Questions
 What is the IASB? (International Accounting Standards Board)
 What is an IFRS? (International Financial Reporting Standard)
 What is an IAS? (International Accounting Standard)
 Why is this important?
 What is the role of the FASB?
 Will US GAAP change?
 What will happen to regulatory STAT?
 What impact will this have on US actuarial work?
 When does this all happen?
IASB
 The body that sets accounting standards for all
companies permitted or required to follow its standards
 The European Community, as agreed by the EU
Parliament, will require all “listed” companies in the EC
to adhere to accounting standards set by the IASB
starting in 2005.
 A few countries currently are using IAS as their local
accounting standard (with exceptions)
IAS & IFRS
 Currently, standards promulgated by the IASB are designated as
an IAS, for example IAS 39.
 IRFS will become the new designation, as a better description of
what these standards are to be used for, i.e., financial reporting.
Current IAS designations have not been changed.
 IAS 39 has had the most attention for insurance. It’s application
has excluded “insurance” contracts, but the IASB has proposed a
more precise definition of an insurance contract vs. a “financial
instrument” (or investment contract) which would be valued
differently than currently allowed for insurance contracts.
IAS 39
 The main concern about IAS 39 is that it requires
contracts (assets and liabilities) to be valued at market
 In the absence of a market value, fair value is to be
used, based on a valuation using appropriate methods
 Many life & annuity insurance contracts contain both
pure insurance and investment (“financial”) components
 Some P/C contracts, e.g. financial/finite reinsurance,
can also have both components
Accounting for Insurance Contracts
 The IASB has been working on many aspects of
reconciling accounting differences and advancing a
consistent approach across industries
 The IASB Insurance Project was started over 2 years
ago with the issuance of a DSOP – Draft Statement of
Principles regarding accounting for insurance contracts
 Notice that the focus is specifically on insurance
contracts and not on insurance companies
Why is an insurance standard required?
 Insurance contracts are now excluded from most IFRS
 Globally no common insurance accounting practice and
the differences are material
 There are many features unique to insurance, for
example, the discretion that management have in
designing some contracts
History and Looking Forward
 1997 Steering committee set up by the IASC
 1999 Issues paper
 2001 DSOP developed as precursor to Exposure Draft
 May 2002 Project splits into 2 Phases
 Phase 1 Exposure Draft issued July 31, 2003
 Final Phase 1 standard issued in 2004 for 2005 financials
 Fair Value “disclosures” in year end 2006 financials
 Phase 2 implementation by 2007 (sunset)
Revised IASB Insurance Proposals:
The Two Phase Approach
 Phase 1 - interim solution - quick fixes to be in place by 2005
• common definition of insurance
• limited and temporary dispensation from existing IFRS
• guidance on IAS 39
• significant disclosures required
 Phase 2 – a standard covering recognition and
measurement issues for insurance contracts, including fair
value
Phase 1 – Insurance Contracts
Phase 1 is expected to result in a new standard which will:
 Introduce a common definition of insurance across all standards;
 Include guidance on the implementation of IAS 32 and 39 for
insurance;
 Specify disclosures required for insurance (very significant);
 Avoid the need for implementing major changes to accounting
systems for insurance contracts prior to completion of phase 2.
This involves a temporary dispensation from certain existing IFRS.
The timetable for Phase 1:
 31 July 2003 exposure draft - comments due 31 Oct 2003 and,
 a standard published in the first half of 2004.
Phase 1 Dispensation from IAS/IFRS
 IAS 8 – Covers what to do when there is no Accounting
Standard
 Dispensation from IAS 8 for Insurance Contracts to allow the
use of local GAAP, and including:
• Deferred acquisition costs
• Unearned premium reserves (pro rata basis)
• Embedded value measurement
 Allow companies to adopt accounting changes, but only if
the change is more relevant and reliable (closer to fair value)
Phase 1 Dispensation from IAS/IFRS
 No further dispensation for insurers
• e.g. from the requirements of IFRS 39 for contracts that do not
meet the definition of insurance
 Why allow dispensation?
• Avoids major changes to accounting systems prior to final
standard on insurance (in phase 2)
• Allows investors familiar with embedded values (DAC, UPR,
etc.) to continue to rely on them
IASB New Definition of Insurance Contract
The Phase I proposes a definition of an insurance contract as:
“a contract under which one party (the insurer) accepts significant
insurance risk by agreeing with another party (the policyholder) to
compensate the policyholder or other beneficiary if a specified
uncertain future event (the insured event) adversely affects the
policyholder or other beneficiary”
(other than an event that is only a change in one or more of a specified interest rate, security price,
commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index or
similar other variable).
A reinsurance contract is defined as:
“an insurance contract issued by one insurer (the reinsurer) to
indemnify another insurer (the cedant) against losses on an insurance
contract issued by the cedant”
Common Definition of Insurance
 The definition is required for identifying:
• Which insurance products fall within existing standards (IAS),
for example, IAS 39 - those products that are more akin to
savings than protection (investment risk as opposed to
insurance risk)
• The scope of temporary dispensation in Phase 1
Guidance on the Definition of Insurance
 The meaning of “significant” insurance risk
• If, and only if, it is plausible that an insured event will cause a
significant change in present value of insurer’s net cash flows
• Even if the insured event is extremely unlikely
• Even if the contingent cash flows (for insured events) is a small
proportion of the expected (probability-wtd) PV of all cash flows
• However, there needs to be a plausible scenario that produces
a non-trivial change in the PV of contract cash flows
 For most property/casualty insurance contracts, there should
not be an issue regarding this definition.
• Lack of risk transfer would be problem (not just reinsurance)
What is included in Phase 1?
 Financial contracts written as “insurance” (or reinsurance)
 IAS 39 applies to insurance products failing definition of insurance but
exposed to financial risk (not insurance or financial, then service contract)
 Changes to the valuation of “insurance” contracts are excluded
from Phase 1
 Ceded reinsurance – must be reported as an asset
• Insurance Liabilities – Direct plus Assumed
• Assets – include All Ceded Reinsurance Recoverables
• Prepare for Phase 2 – Fair Value measurement
Phase 2 – Insurance Contracts
 Phase 2 will then lead to a comprehensive standard
on the recognition and measurement for insurance
contracts.
 This standard would replace temporary dispensations
and the Phase 1 interim accounting standards.
 This final Phase 2 standard is expected to be published
in time for full implementation by 2007.
(Exposure Draft planned for 2004.)
Phase 2 decisions
 Phase 2 to be developed upon these principles:
• Definition of insurance – no change from phase 1
• Asset & Liability approach rather than Deferral and Matching
• Deferral and Matching is replaced
– UPR no longer a liability (replace with unexpired risk reserve)
– DAC no longer an asset
• Fair Value measurement
– Independent valuation of Assets vs. Liabilities
– Profit “at inception” likely to be no greater than zero
Impact on US P/C Companies
 Pressure from financial regulators (SEC) and financial
markets for a common global financial accounting
reporting standards
 Commitment of FASB and other accounting bodies for
“convergence” of accounting standards
 Europe & Australia will be first, then others (US) will
follow due to global business and financial markets
 Time to comment on technical issues is right now
Changes to P/C Actuarial Practice
 Fair Value will be difficult to avoid
 Impact on US P/C actuarial practice will depend on
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FASB view of timing to converge with IASB
FASB plans relative to IASB exposure drafts and standards
Views of Insurance Regulators on avoiding 2+ sets of books
US based insurers with European parents
US based insurers with significant European operations
US listed insurers who are also listed on EU exchanges
 Principles and standards have to be developed now
• Fair Value Issues papers by CAS, AAA and GIRO (2002)
• CAS proposes research on fair value measurement (Sept. 2003)
Highlights of Fair Value (Phase II)
 Discounting of P/C Liabilities
• Reserves for unpaid loss and loss adjustment expenses
• Reserves for unexpired risks (UPR)
 Market Value Margins – added to discounted liabilities
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Reflects risk and uncertainty in reserves
Reflects “market” price (margin) for reserve risk
Reflects “mark-up” for transaction cost of selling reserves
Own credit risk adjustment (controversial)
 Own Credit Risk
• Reduction in liabilities based on credit standing
• Offset by any government guarantees or legal preferences
More information is available on
www.IASplus.com
www.IASB.org.uk