INSURANCE AND ACTUARIAL
ADVISORY SERVICES
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International Accounting – Emerging Issues
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Fair Value Accounting Update
Gareth Kennedy
Casualty Loss Reserving Seminar – San Diego, CA
September 10 – 11, 2007
www.ey.com/us/actuarial
Section I Agenda
 Overview of the International Accounting
Standards Board (IASB) Discussion Paper
(DP) with tentative American Academy of
Actuaries (AAA) Working Group (WG)
feedback:
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Measurement model
Estimate of future cash flows
The time value of money
Risk margins
Unit of account
Reinsurance
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Measurement Model
 Single measurement model to be used for
future cash flows:
– For P&C and Life insurance contracts
– For insurance and reinsurance contracts
– During claims period and pre-claims period
 DP proposes that insurance liabilities be
measured at Current Exit Value (CEV)
Continued
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Measurement Model
 Definition of CEV:
– “…the amount an insurer would expect to pay at
the reporting date to transfer its remaining
contractual rights and obligations immediately to
a market participant.”
 IASB has not yet identified any significant
difference between the notion of CEV and fair
value
Continued
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Measurement Model
 To measure CEV
the IASB proposes
that three explicit
building blocks are
required for
insurance contracts:
Risk and service margin
Effect of the time value
of money
Estimated future cash flows
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Estimate of Future Cash Flows
 IASB’s preliminary view is that cash flows
should be:
–
–
–
–
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Explicit
Consistent with observable market prices
Unbiased
Current
Exclude entity specific cash flows
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© 2007 Ernst & Young LLP
Overview of the IASB DP
The Time Value of Money
 Requires that best estimates of future cash
flows are explicitly reduced for the time value
of money
 Discount rate should be based on current
market rates for cash flows with the same
timing as the weighted average contract cash
flows
Continued
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© 2007 Ernst & Young LLP
Overview of the IASB DP
The Time Value of Money
 DP does not specify a discount rate although
it is presumed by many that a risk-free rate or
close to one will be used
 P&C members of the AAA WG believe
discounting with the addition of a separate
risk margin is compliant with Actuarial
Standard of Practice 20 and is a good
measure of economic value
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Risk Margins
 IASB’s preliminary view is:
– “the risk margin should be an explicit and unbiased
estimate of the margin that market participants
require for bearing risk”
– It is not intended as a shock absorber for unexpected
losses nor to enhance the insurer’s solvency
– “the observed price for a transaction with a
policyholder …. should not override an unbiased
estimate of the margin another party would require to
take over the insurer’s contractual rights and
Continued
obligations”
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Risk Margins
 The last point may result in profits or losses
at a policy’s inception
 Some IASB members are in favor of an
alternative definition that calibrates the risk
margin to the premium at inception,
combined with a liability adequacy test
 Supporters of CEV believe this is an entry
value approach
Continued
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Risk Margins
 IASB does not plan to prescribe what
methods are appropriate to develop a risk
margin
 Instead the IASB will publish attributes that
the methods should have and leave industry
practitioners to develop further guidance
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Unit of Account
 Definition: “portfolio of contracts that are
subject to broadly similar risks and managed
together as a single portfolio”
 When developing risk margins, the DP
proposes that it should be calculated at a unit
of account level
 No benefit of diversification beyond unit of
account
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© 2007 Ernst & Young LLP
Overview of the IASB DP
Reinsurance
 There is a lack of mirror accounting and
recognition between a ceded reinsurance asset
and an assumed liability in the DP for a
reinsurance contract written on a policies
attaching basis
 DP argues remaining asset has little contractual
value if underlying policies are issued at CEV
 Reinsurance liability would be valued using all
future cash flows
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© 2007 Ernst & Young LLP
Section II Agenda
 Comparison of DP to Financial Accounting
Standards Board (FASB) Statements 157 and
159:
– FASB Statement 159
– FASB Statement 157
– Comparison to IASB DP
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© 2007 Ernst & Young LLP
FASB Statements 157 and 159
FAS 159 – Fair Value Option
 Provides a voluntary election to account for
certain assets and liabilities at their fair value
– including P&C insurance liabilities
 Provides a one-time chance to elect fair
value option for any existing liabilities without
affecting income
 Option is irrevocable and all future changes
in fair value must be recognized in income
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© 2007 Ernst & Young LLP
FASB Statements 157 and 159
FAS 157 – Fair Value Measurement
 Defines fair value for financial reporting
purposes under U.S. GAAP as the “… price
that would be received to sell an asset or
paid to transfer a liability in an orderly
transaction between market participants at
the measurement date”
 Market based not entity specific entity
specific measurement
 Statement is not insurance specific
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© 2007 Ernst & Young LLP
FASB Statements 157 and 159
Comparison of FAS 157 to IASB DP
 FAS 157 more general than IASB DP
 Principles from DP currently fit well into the
more general FAS 157 principles
 Impact of FAS 157 currently optional for P&C
insurance liabilities – IASB standard that will
arise from DP will be compulsory
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© 2007 Ernst & Young LLP
International Accounting – Emerging Issues
Fair Value Accounting Update
Gareth Kennedy
312-879-4459
gareth.kennedy@ey.com
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© 2007 Ernst & Young LLP