International Financial Reporting for Insurance Contracts 2003 Bowles’ Symposium Sam Gutterman

Agenda Background Status Outstanding issues Future

Background International Accounting Standards Board –Newly formed in 2001 –Objectives include a global set of quality financial reporting standards –Initial impetus – 1997s Asian financial crisis –Renewed impetus for international convergence – recent US accounting scandals

Background - Insurance Insurance contract project began in 1996 –Originated due to lack of international standards and wide divergence of national standards, especially for life insurance 2005 pressure –European adoption of International Financial Reporting Standards(IFRS) and International Standards of Auditing(ISA)

Status In 2002 Insurance project split into two phases –Realization that insurance accounting issues were too complicated to solve in time to meet the 2005 deadline –Phase 1 – primarily investment products, embedded options, and disclosure –Phase 2 – insurance contracts

Phase 1 Most insurance contracts exempted –Only pure non-par investment contracts included Preliminary indications –Investment contracts – choice of amortized cost and fair value –Most insurance products – local GAAP –Fair value Possibly with no profit at issue Covers derivatives and possibly ceded reinsurance as an asset –“easy changes” – equalization, catastrophe reserves –Disclosure – fair value footnotes in 2006

Phase 2 Formal Board discussions still underway Asset and liability model –EFRAG may lobby for folding into IAS 39, with choice of method available –Possibly with no profit but possible loss at issue –Discount at risk-free rates Life / annuity products may have loss at issue –Own credit standing risk reflected

Phase 2 No DAC, although IAS 39 currently has external DAC Renewals reflected to the extent that the policyholder has valuable insurance benefits For non-life –Discounted loss reserves –Risk adjustment –Possibly unexpired risk reserves rather than unearned premium reserves

Outstanding issues Relatively few totally resolved Life industry dislikes fair value method –Earnings volatility –Subjective assumptions, particularly in the long-term –In some countries, prefers deferral & matching methods P & C industry, to the extent it has paid attention –Parts of it thinks it is hard enough to derive long-term liability estimates

Outstanding issues Level of accounting and actuarial guidance to be provided Many tough issues remain –Market value margins / risk adjustments Little guidance so far, but effect might be mitigated by no profit at issue –Participating contracts –Impairment testing Extent of ultimate international convergence

Future IASB pushing for 2007 Phase 2 –Likely winner – fair value approach Politicking might have some effect Move to converge –Across industries –Across nations Possible FASB convergence to IASB Phase 2?