PD-16 Developments on International Accounting Standards from a P&C and Life Perspective Canadian Institute of Actuaries Annual Meeting June 28, 2007 Neil Parkinson National Director, Insurance Industry Practice Neil Parkinson National Director, Insurance Industry Practice

2 1.What is IFRS? How and when do we get there? 2.Current Insurance IFRS Standards 3.IFRS for Insurance Contracts (May 2007 Discussion Paper) 4.Getting Ready for Adoption Agenda

3 What is IFRS? Single set of globally accepted high-quality accounting standards Currently in use by over 90 countries around the world Issued by the International Accounting Standards Board Based in London, UK 14 members – one Canadian representative – Patricia O’Malley IFRS are principles-based standards

4 IFRS – Moving Towards a Global Standard Fixed deadlines for IFRS implementation Convergence plans US-GAAP - Convergence intended No intent to converge with IFRS

5 Why International Financial Reporting Standards? IFRS is becoming the basis of GAAP in most major jurisdictions outside Canada and the U.S. IFRS are principles-based standards, as opposed to rules-based standards (eg. US GAAP) In 2005, the Canadian Accounting Standards Board announced a directional change, from converging with US GAAP, to converging with IFRS IFRS concepts are beginning to permeate Canadian GAAP as new standards are issued Many Canadian companies, including insurers, already report upstream on this basis

6 International convergence – direction of Canadian GAAP IFRS Cdn. GAAP U.S. GAAP Direction – US GAAP to converge with IFRS – but how and how fast? 2005 How big a “bang”?

7 International convergence – US FASB Memorandum of Understanding FASB and IASB pledged to use their best efforts to: make existing financial reporting standards fully compatible as soon as is practicable; and coordinate future work programs to ensure that compatibility is maintained.

8 International Convergence Project – US SEC Statement by SEC Staff: A Securities Regulator Looks at Convergence Single set of globally accepted accounting standards Propose to eliminate the requirement to reconcile to US GAAP May accelerate adoption of IFRS for US domestic SEC registrants if SEC eliminates the IFRS-US reconciliation requirement

9 The Canadian AcSB’s Implementation Plan THE UNKNOWNS…. Confirmed transition date Outcome of the SEC’s review of the application of IFRS IFRS go-live Spring Calendar year periods AcSB’s progress review Qualitative disclosures of differences (‘08 annual report) Quantify effects of changeover to IFRS (‘09 annual report) Prepare comparative figures under IFRS

10 The New Financial Reporting Landscape in Canada The shift to IFRS will affect all publicly accountable enterprises in Canada (This means you!)

11 Current Insurance IFRS Standards

12 Insurance accounting under current IFRS IFRS 4 (in force) Defines insurance contracts IFRS 7 (in force) Disclosures required for insurance contracts and related risks Insurance project Phase II (future) Agreement on how to measure insurance contracts was not reached in time for the comprehensive introduction of IFRS in Existing “national GAAP” approaches continue until Phase II standards on measurement are agreed (Discussion Paper issued May 4, 2007) IFRS – account for insurance contracts, whatever the type of enterprise that issues them (Current Canadian GAAP – defines accounting frameworks for insurance enterprises, separately for life and P&C)

13 Current insurance IFRS – IFRS 4 IFRS 4 defines insurance contracts: “contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affect the policyholder” Difference from current Canadian GAAP Life insurer savings products (e.g. deferred annuities, term certain annuities) would normally be considered deposit contracts rather than insurance Implementation in Europe – lots of effort in distinguishing between insurance contracts and deposit contracts

14 Current insurance IFRS – IFRS 4, cont’d IFRS 4: Defines reinsurance contracts too, but does not require quantitative testing of risk transfer as in US FAS 113 (as a result, IFRS allows a wider range of reinsurance contracts to be given reinsurance accounting than is the case under US GAAP, or OSFI Guideline D-9) Deposit components may need to be unbundled from an insurance contract Did not address how to measure insurance contract liabilities, but requires a “liability adequacy test”

15 Current insurance IFRS – IFRS 4 and 7 Requires a wide range of disclosures on insurance contracts: Risk selection and risk concentrations Sensitivity analysis Requirements similar in principle to Canadian GAAP, but appear to require more detailed disclosures

16 IFRS for Insurance Contracts (May 2007 Discussion Paper)

17 Insurance Contracts Project Phase II Timetable Phase II restartedMid 2004 First meeting of IWGSep 2004 IASB Board meetings –Feb Discussion PaperMay 2007 Exposure Draft+ 18 months Final Standard+ 12 months

18 Features of IASB’s proposed measurement model Single measurement model: Life insurance and non-life insurance Prospective valuation: Value of insurance contract = PV (all future cash flows) Current exit value: The amount the insurer would expect to pay to another entity if it transferred all its remaining contractual rights and obligations immediately

19 Preliminary views of the IASB discussion paper Issue IASB preliminary view Measurement attribute Current exit value - single approach for all insurance types Discount rate Observable market rates for similar cash flows Unit of account Risk margins determined on portfolio basis Initial measurement Day one profits may be recognised Subsequent measurement All changes in estimates recognised immediately Policyholder behaviour Recognise future premiums only if certain tests are met Acquisition costs Acquisition costs are expensed as incurred Unbundling Unbundle deposit and service components unless interdependent Participating contracts Par component is a liability if a legal or constructive obligation exists Own credit risk Included in the liability measurement

20 Features of IASB’s proposed measurement model An insurer should use the following inputs to measure its insurance liabilities Current unbiased probability-weighted estimates of future cash flows (ie an expected value approach) Current market discount rates that adjust the estimated future cash flows for the time value of money An explicit unbiased estimate of the margin that market participants require for Bearing risk (a risk margin); and Providing other services (a service margin)

21 Calibration of risk margins – IASB model A small majority of IASB members believe that a net gain may be recognised on inception if there is a difference between the price charged to policyholders and the price that would be paid to another insurer to accept the risk A small minority of IASB members believe that the margin should be “calibrated” to the observed price for the transaction with a policyholder, with no net gain on inception. The IASB do not intend to attempt to define how margins should be determined but will suggest criteria an insurer should consider in selecting an approach to risk margins

22 Future premiums and policyholder behaviour Cash flows used in measuring insurance liabilities should include future premiums (and the additional benefits that result from those premiums) only if one of the following conditions are satisfied: The present value of future premiums is less than the present value of the resulting additional benefit payments The insurer has an unconditional contractual right to enforce payment of premiums The policyholder must pay the premiums to retain a right to guaranteed insurability (a right that permits continued coverage without reconfirmation of the policyholders’ risk profile at a price that is contractually constrained)

23 Acquisition costs Acquisition costs should be expensed when incurred To the extent that the premium paid includes an amount for the reimbursement of acquisition costs incurred, that amount should be recognised as premium on the inception of a contract

24 Discretionary policyholder participation rights Liability or equity? Policyholder participation rights create a liability only when the insurer has a legal or constructive obligation to pay dividends to policyholders In assessing whether an insurer has a constructive obligation the Board will rely on definitions in its current literature

25 Comparison of IFRS proposals to Canadian GAAP IFRS Phase II Canadian GAAP Liabilities discounted using market rates Most Canadian insurers apply time value of money, but using their own expected portfolio returns Use of market discount rates could lead to greater accounting mis-matches in reported income, particularly for lifecos Liability valuation to include explicit risk and service margins Not done now, at least not directly Possible some may default to “calibration”, to avoid day one profits Changes in estimates reflected in liability valuation immediately Consistent with Cdn GAAP (a possible change for lifecos reporting upstream in US GAAP, with its “locked in” assumptions)

26 Comparison of IFRS proposals to Canadian GAAP, cont’d IFRS Phase II Canadian GAAP Unearned premiums (UPR) to be replaced with the “current exit value” measure Not a conceptual change for lifecos Implementing this aligns the P&C model more with the life approach; UPR replaced with a liability for estimated cash future flows Acquisition costs expensed as incurred (no deferral, or “DAC”) Not a conceptual change for lifecos Canadian P&C insurers defer and amortize over policy term; the “current exit value” liability should resemble (but not necessarily equal) the net amount of UPR less DAC

27 Comparison of IFRS proposals to Canadian GAAP, cont’d IFRS Phase II Canadian GAAP Reinsurance to be portrayed on a gross basis Not a change for P&C insurers A change for life insurers however Classification of insurance vs. deposit contracts Not a P&C issue, but life insurer revenues would exclude a lot of annuity deposits currently shown as premiums

28 IFRS Phase II – many questions remain… The Phase II Discussion Paper expresses the preliminary conclusions of the IASB, but poses numerous detailed questions, on both a conceptual level and “how to” Other open questions on scope, eg.: Will credit insurance be treated as insurance, or as a financial guarantee? Workers compensation schemes covered?

29 Getting ready for adoption

30 Lessons Learned in Europe European companies found that transition meant: Training finance and accounting staff worldwide Upgrading their IT systems and adjustments to management reporting systems Development of policy and procedures manuals Renegotiating contracts (bank and compensation agreements) Managing market expectations Overall, European companies generally: Waited too long to get started Suffered from poor project management The result → Relied heavily on external expertise to get the job done

31 How will it be different in Canada? A Phased Transition to IFRS Earlier Communications to the Marketplace Certifications of Internal Controls PRIOR to Adoption of IFRS

32 THE TIME TO GET STARTED IS NOW! IFRS go-live Fall Anticipating change and Assess phase Design phase Implementation phase Pilot phase (comparatives under IFRS) Calendar year periods AcSB’s progress review SEC registrants may choose to adopt IFRS in advance of 2011

33 Anticipate the Change Fall Anticipating change and assess phase GAP analysis Systems and training needs assessments Assess other impacts of transition Impact of transition to internal control certifications Plan conversion path

34 Design the Plan Fall Mobilize project team and the business Develop training plan Develop communications plan Identify, quantify and secure required resources Design phase

35 Implement the Plan Fall Execute training plans and system changes Convert budgeted results Renegotiate agreements and modify internal structure Quantify reporting differences Build or update tools (manuals, policies, reporting packages, F/S) Implementation phase

36 Test the Conversion Fall Test the conversion and dry run Generate required comparative figures Prioritize issues from conversion and rectify Manage business on an IFRS basis Draft required reconciliations to Canadian GAAP financial statements Pilot phase (comparatives under IFRS)

37 Wrap Up Single biggest change ever to financial reporting Don’t underestimate the scale of the undertaking Affects educators, preparers, auditors and investment community Represents another huge and positive step forward in global financial reporting Possibility of more consistent regulatory approaches across jurisdictions Greater transparency, more comparability and potential for better investment decisions

38 “While it is now well known that the AcSB has opted to adopt IFRS, the AcSB is recommending that, in the short-term, boards of directors of public companies ensure that a member of management, or advisor, is responsible for reporting on a regular basis on the implications of IFRS conversion for their particular enterprise.” (Julie Dickson, Deputy Superintendent, OSFI, CIAA Conference, September 25, 2006)

39 The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. Neil Parkinson KPMG LLP (416) © 2007 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. All rights reserved. Printed in Canada on recycled paper.