New Zealand Society of Actuaries Financial Services Forum 27 November 2009

IFRS: Insurance Accounting. Charles Hett November 2009 Audit. Tax. Consulting. Actuarial. Financial Advisory IFRS Insurance Accounting - November 2009

Agenda Recap the Insurance Project to date Key Features of the Phase II Framework Issues and recent developments What this means for NZ reporting Implications and other IFRS/Reporting factors IFRS Insurance Accounting - November 2009

Recap the Insurance Project. IFRS Insurance Accounting - November 2009

Insurance Accounting timeline Thinking/Concern IFRS IFRS Phase II Development ?? Issues Paper 1999 IFRS 4 Phase 1 Discussion Paper May’07 Back to the Drawing Board IASB IFRS NZ 1 Jan 07 Extended Consultation DSOP Issued 1990s July 2001 January 2005 2007 2008+ IFRS Insurance Accounting - November 2009

Life insurance companies Insurance Disclosures Contract classification IFRS 4 Phase I Temporary measure to continue until Phase II standard emerges Intangible assets Insurance & Participating Contracts – Local GAAP Investment Contracts – IAS 39 Life insurance companies Non-life companies Insurance Disclosures NZ FRS 35 NZ FRS 34 Contract classification Assumptions and risk objectives Risk concentration Central Estimate OCR / IBNR UPR, DAC Risk Margin Best Estimate Planned Margins (recover AC) Analyses & Reconciliations Sensitivities Claims development Liability Adequacy NZ ~ Little methodology change, mostly level of disclosure IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Development of Phase II. IFRS Insurance Accounting - November 2009

The Proposed Model 3 building blocks to measure insurance liabilities : Explicit, unbiased, probability weighted and current estimates of the contractual cash flows; Current market discount rates that adjust the estimated cash flows for the time value of money; Margin: Explicit - Bearing risk (a risk margin) and providing other services (a service margin) Composite - Single margin (calibrate to premium) IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Phase II – Measurement: Three Building Blocks Estimates of future cash flows Explicit and Current view (Balance Sheet date) Unbiased and Probability weighted Considerations Not necessarily most recent information Availability of “market” data for insurance liabilities As consistent as possible with observed market prices “Market consistent” vs. “Entity specific” Complexity of possible stochastic scenarios – Looks unlikely IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Phase II – Measurement: Three Building Blocks (cont’d) Discounting Observable market rates: Timing Currency Liquidity Considerations Consistency with observable market rates Availability of market rates for long term insurance liabilities Does not reflect risk inherent in cash flows Own insurer’s credit position in measuring liabilities – unlikely Use of asset-based rates – only if directly linked to liabilities Liquidity Premium (avoid annuity mismatching) Further guidance – unlikely (Fair Value measurement: IAS39) IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Phase II – Measurement: Three Building Blocks (cont’d) Margins – Composite or Explicit Composite: single margin calibrated to premium (essentially current MoS) Risk Margin: Allow for variance and skew in underlying distribution(s) (Uncertainty in projected cash flows) Service Margin: The amount for servicing the contract Considerations: Risk Margin methods can have very different outcomes Percentile Basis (~ NZ non-life margin: 75% confidence level) Cost of Capital (~ Solvency II) Economic Capital (~ Adverse Scenarios/MCEVs) Not a shock absorber Availability of “market participant” data on servicing “Sub-contractor” profit margin or use “entity-specific” basis Residual Margin: To ensure no Day 1 profits IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Phase II Key Issues. IFRS Insurance Accounting - November 2009

Other Key Issues ½ DAC and Revenue Recognition Exit Price or Fulfilment Value : IAS 37 Margins Future Premiums: Contract Boundary ½ Profit/Loss at Inception Other Issues IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Position at Mid-October 2009 IASB Initial Measurement Selling should not affect measurement Day 1 revenue to cover acquisition costs AcqCosts – direct and incremental IAS 37 approach (draft) IAS 37 influenced by Insurance Project Consistency with other liabilities No market info. => Entity based estimates Explicit Margins (Risk, Service, Residual) Risk/Service Margin remeasured Expense Initial Costs as incurred No Profit/Loss at Inception FASB Initial Measurement Contract liability based on consideration Prohibit DAC (No Service at PoS) Current Fulfilment (CFV) Not inconsistent with IAS 37 (draft) Composite Margin Consistency with approach to Revenue Expense Initial Costs as incurred No Profit/Loss at Inception IFRS Insurance Accounting - November 2009

Proposed Models – Mid October 2009 IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Proposed Models – Mid October 2009 IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Proposed Models – Mid October 2009 IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Recent Developments. IFRS Insurance Accounting - November 2009

Late October 2009 Unwelcome Convergence! Revenue recognition is paramount Acquisition Costs expensed as incurred IASB agreed margins calibrate to full contract premium (after PoS) FASB agreed explicit margin for Risk (Uncertainty) Revisiting Policyholder Accounting Insurance Policies held by Customers (as assets) – reconsider, no decision IFRS Insurance Accounting - November 2009

Proposed Models – Before 28 October 2009 IFRS Insurance Accounting - November 2009

Proposed Models – After 28 October 2009 IFRS Insurance Accounting - November 2009

Other Issues Yet to be Discussed/Resolved Policyholder Accounting Policyholder Participation Rights Credit Characteristics of insurance liabilities Unbundling UPR, Recognition, IAS 39 Disclosure IFRS Insurance Accounting - November 2009

What This Means. IFRS Insurance Accounting - November 2009

Timetable (Updated 18 Nov) Next two years Exposure Draft to be issued January April 2010 A joint IASB/FASB Exposure Draft Comment period to May August 2010 Standard to be in place by June 2011 Substantial IASB membership changes July 2011 IASB/FASB appear to be allocating resource to ensure this timetable can be met IFRS Insurance Accounting - November 2009

Implications for New Zealand Many similarities to NZ MoS (composite margin) Some differences: Explicit assessment of Risk & Service margins Residual Margin may not be remeasured No income to cover acquisition costs (No DAC, -’ve PL) No mention of Tax (anywhere) => Gross of Tax liabilities and margins Reinsurance treated explicitly (as current) Financial Advice at Point of Sale a service? IFRS Insurance Accounting - November 2009

Business Implications for the Insurance Industry Need to review impacts on: IFRS Phase II Systems, data, models & processes External reporting, disclosures and financial communication Experience Monitoring Assumption setting Management reporting and budgetting Product pricing and design Regulatory Reporting Asset and Liability matching Capital Management Tax and Tax Planning Value Creation IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

Three key areas to consider Valuation Increased reliance on actuarial models Analysis to derive explicit margins ~ risk margin Assumption changes => not Re-spread ~ volatility Yet more disclosure? Product Development Reporting incentives to structure products (contract boundaries) Higher profit volatility Use of Reinsurance Impact of acquisition cost reporting loss on distribution costs Risk Management Risks and Controls for valuation models Managing market risk to mitigate profit volatility (closer link between risk management and reporting) Risk Margins  Risk Management IFRS 4 Phase II will likely be the chance to move more fully to a gross of tax profit reporting requirement (separate IAS 12 tax treatment) Overall a more explicit risk based reporting requirement should lead to stronger links between reported profits, risk management, reinsurance and investment strategy and capital requirements IFRS Insurance Accounting - November 2009

Contacts Charles Hett Head of Actuarial Services +64 4 470 3866 +64 21 616 040 charleshett@deloitte.co.nz Margaret Cantwell Manager - Actuarial Services +64 4 470 3537 +64 21 267 0975 mcantwell@deloitte.co.nz Klaas Stijnen Manager - Actuarial Services +64 4 470 3660 +64 (0)21 273 0303 kstijnen@deloitte.co.nz IFRS Insurance Accounting - November 2009

This presentation and the accompanying handouts cover topics only in general terms and are intended to give a wide audience an outline understanding of certain issues relating to Phase II of the IASB insurance project, and therefore cannot be relied on to cover specific situations; applications of the principles set out will depend on the particular circumstances involved. Furthermore, responses given in the presentation to questions are based on only an outline understanding of the facts and circumstances of the cases and therefore do not form an appropriate substitute for considered specific advice tailored to your circumstances. We recommend that you obtain professional advice before acting or refraining from acting on any of its contents. We would be pleased to advise you on the application of the principles demonstrated at the seminar and other matters to your specific circumstances but in the absence of such specific advice cannot be responsible or liable. Deloitte & Touche LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at Stonecutter Court, 1 Stonecutter Street, London EC4A 4TR, United Kingdom. Deloitte & Touche LLP is the United Kingdom member firm of Deloitte Touche Tohmatsu ('DTT'), a Swiss Verein whose member firms are separate and independent legal entities. Neither DTT nor any of its member firms has any liability for each other's acts or omissions. Services are provided by member firms or their subsidiaries and not by DTT. IFRS Insurance Accounting - November 2009 IFRS Insurance Accounting - November 2009

New Zealand Society of Actuaries Financial Services Forum 27 November 2009