Insurance IFRS Seminar December 1, 2016 Francesco Nagari Session 2 Financial Reporting for Insurance Companies (including management reporting) Insurance IFRS Seminar December 1, 2016 Francesco Nagari Session 2 Session 2

An example 20 year Term insurance policy Policyholder pays $100 at the beginning of the contract. The insurance company gives that $100 to the agent who sold the contract If the policyholder is still alive, he pays the insurer another $100 on every anniversary (which is not given to the same agent). If he doesn’t pay, then the contract ends. As long as he pays, this goes on until he dies or 20 years pass If he dies at anytime while the contract is in-force, the insurer will pay his beneficiaries $100,000

An example What can happen Policyholder pays all premiums and doesn’t die: Insurer collects $2,000 less the $100 to the sales agent: $1,900 Policyholder stops paying premium at some point and lapses the policy: insurer collects something less than the $1,900 Policyholder dies at some point and his beneficiary receives the death benefit: Insurer pays between $100,000 and $98,100 At the beginning of the contract, right after the company received the first $100 and give it to the agent, what should they report? Nothing? A liability sufficient to cover the death benefit? An assets equal to the expected cash inflows and associated investment income? A liability sufficient to cover mildly adverse experience with mortality? It depends on the framework / purpose of the reporting.

Financial reporting frameworks Insider reporting Have all the information available Can be customized to fit your needs Outsider Limited information Uniformity and comparability are key Solvency Does the company have enough capital to cover the risks it is taking? Value Is the company creating value for shareholders and other stakeholders?

Financial reporting frameworks Outsider Insider Value Should I invest in or make a deal with this company? E.g. buy shares, business deal Compare to other insurers Compare to other industries Solvency Is this company stable or safe? E.g. buy a policy, loan money Assess credit worthiness Assess security, ability to keep promises

Financial reporting frameworks Outsider Insider Value Should I invest in or make a deal with this company? E.g. buy shares, business deal Compare to other insurers Compare to other industries Solvency Is this company stable or safe? E.g. buy a policy, loan money Assess credit worthiness Assess security, ability to keep promises

Financial reporting frameworks Outsider Insider Value Should I invest in or make a deal with this company? E.g. buy shares, business deal Compare to other insurers Compare to other industries Are we effectively running our company and satisfying our stakeholders Functional KPIs Value based decision making e.g. product pricing Capital based decision making e.g. product pricing Anticipate outsider concerns Solvency Is this company stable or safe? E.g. buy a policy, loan money Assess credit worthiness Assess security, ability to keep promises

Outsider value reporting Balance sheet or income statement focus? Estimate the expected value created over the life of the relationship or product? Estimate the value as of the reporting date regardless of the past? Very different answers Example: Samsung microprocessors Maybe the right answer is a combination of both?

Things to keep in mind Cash flows are both uncertain and far into the future so can vary drastically from expectations Insurance contracts often have several options and guarantees These are not often the reason the contract was purchased so may not be efficiently exercised. Unlike other financial transactions, insurance is not an efficient market with information parity. We are measuring the liability independently but ultimate cash flows may depend partly or wholly on asset performance

Things to keep in mind (cont’d) Financial reporting changes only affect timing. They do not affect the overall profitability of a company Given the very long duration and cash flow uncertainty of many insurance contract relationships, that timing can make a drastic difference Compounding these issues, the insurance industry has developed differently in most jurisdictions and as a result it is hard to find a solution that works in all cases Designing simple and comparable measures across all these complex insurance products has been something that experts have been chasing for years…

Thank you!