European Insurance CFO Forum 17-Jul-07 Page 1 The IASB’s Discussion Paper on Accounting for Insurance Contracts IAIS Meeting – 2 August 2007 Denis Duverne

European Insurance CFO Forum Page 2 1. The CFO Forum 2. Our approach to the discussion paper 3. The three building blocks 4. Initial profit margin 5. Guaranteed insurability 6. Policyholder participation 7. Expenses 8. Unbundling 9. Credit characteristics 10. Linkages with other standards/projects 11. Conclusion Topics to Cover

European Insurance CFO Forum Page 3 The European Insurance CFO Forum AEGON Allianz Generali Aviva AXA BNP Paribas CNP Fortis Hannover Re If Formed in 2002 to influence the thinking on financial reporting Issued EEV principles in now widely adopted in Europe (and elsewhere) Elaborated Principles issued in 2006 to influence the development of the IASB’s Phase 2 standard ING Legal & General Mapfre Munich Re Old Mutual Prudential Scottish Widows Swiss Re Standard Life Zurich Financial Services

European Insurance CFO Forum Page 4 Our Approach to the Discussion Paper Response A fresh look at the Discussion Paper proposals – not simply a reiteration of our ‘Elaborated Principles’ No firm conclusions at this stage There are, however, a number of key points emerging in our discussions Will be finalising our positions in October Where possible we will be discussing our thinking and co-ordinating our response with other key industry groups  CEA  GNAIE  Japanese Life Insurers

European Insurance CFO Forum Page 5 The three building blocks Unbiased best estimate of cash flows (undiscounted) Agree with the basic idea of an unbiased probability weighted best estimate of cash flows as the basis Agree with the single model for life and general insurance We think that the basis of calculation should reflect economic reality as for Solvency 2 There are important determinants within the best estimate of cash flows, with which we disagree or are particularly concerned. These are discussed later:  Unbundling  Participating contracts  Guaranteed insurability (treatment of non-contractual premiums)  Treatment of expenses

European Insurance CFO Forum Page 6 Best estimate of liability Time value of money (using market consistent rates) Unbiased best estimate of cash flows (undiscounted) The three building blocks (continued….) We agree with the concept of market consistent discount rates,  Liabilities should when possible be valued independently from the assets  This is as used in market transactions

European Insurance CFO Forum Page 7 + Risk and service margins Best estimate of liability The three building blocks (continued….) Risk margins should be determined on a similar basis to MVM’s under Solvency 2 – i.e. using the cost of capital as a proxy  MVM: Market Value Margin corresponds to the amount to be paid by an insurer if it transferred its contractual rights and obligations immediately to another insurer.  Cost of Capital method takes into account both volatility and riskiness of the business and duration of reserves; it yields more information than an undiscounted – implicit risk margin approach Service margin concept is confusing and not very clearly explained – different interpretations yield markedly different results

European Insurance CFO Forum Page 8 Initial profit margin Best estimate of liability Risk and service margins Initial profit margin + + We disagree that there is not a significant difference between entry and exit value. There is a significant initial profit margin:  Embedded values in balance sheets (see below)  Values given to portfolios in market transactions, which clearly show that there is such an up front margin 11 CFO Forum members published market consistent EV numbers calculated in a broadly consistent manner to the IASB proposals (BEL and risk allowance)  The total initial profit they recognised (New Business Margin) amounted to 5.2 billion Euros. This is significant. Exit value

European Insurance CFO Forum Page 9 Risk and service margins What to do with the initial profit margin? Q1: Should the initial profit margin be regarded as liability or equity? Q2: Should the initial profit go straight to P&L? Option 1: Include the initial profit margin as part of the liability Option 2: Recognise the initial profit margin in the P&L at inception of contract Option 3: Recognise the initial profit margin in equity and release through P&L in line with release from risk Liability Equity No Yes There are 3 options being considered by us. No final decisions have yet been made.

European Insurance CFO Forum Page 10 Guaranteed Insurability This is an area that the IASB has been struggling with due to i) the constraints imposed by their framework and ii) the impact that their conclusions could have on other industries. Unfortunately we believe that this proposal has ended up in the wrong place The expected cash-flows will be artificially restricted by the ‘guaranteed insurability’ criteria Actual market portfolio transfers show that the market values include such future cash flows expected from a portfolio of contracts, not just those that meet the guaranteed insurability criteria. The restrictive ‘guaranteed insurability’ proposal is thus inconsistent with ‘current exit value’ and the general trend of IASB decisions to move towards market fair values.

European Insurance CFO Forum Page 11 Policyholder Participation The treatment of policyholder participation may be effected by how IAS 37 evolves, which creates additional uncertainty From the CFO Forum perspective, the accounting liability should include expected future discretionary benefits At the signing of a contract insurance companies have a ‘constructive obligation’ to pay out an amount (this amount could be zero) to policyholders – thus recognition is met. Thus an estimate should be made of all amounts that will be paid out – the measurement of the liability. Excluding expected future payments is inconsistent with the IASB’s ‘current exit value’ since transfer values should consider the full economic liability. Including future payments is more consistent with the general direction towards market fair values. These principles should cover investment contracts with DPF (i.e. they should be included in the Phase 2 standard and not be included in IAS 39).

European Insurance CFO Forum Page 12 Under current approaches, the liability valuation is based on the actual entity expenses. A less efficient insurer books a higher amount of liability than an average market efficient insurer. Market efficiency liability liabilities DP Proposals impact on profit recognition Y3 Y2 Y1 Y4 Under the DP: the less efficient insurer would book a lower amount of liability;…. that would trigger artificial profits recognised at inception.. ….while recognizing that inefficiency as losses over the lifetime of the contract Expenses The DP requires expense cash flows in BEL to be based on the market level of expenses not the entity’s – how is this hypothetical market level determined when there is no available market? Should one assume that an entity’s expenses are representative of the market? If so, what does this really all mean? Theoretical example:

European Insurance CFO Forum Page 13 So interdependent that split would be arbitrary Not Interdependent Interdependent, but split not arbitrary Unbundling The IASB has hardened its position over Phase 1. These requirements seem to be driven by the desire for compatibility between insurers and other industries. We do not support this since :  The “arbitrary” criteria is very vague  This does not provide meaningful information – analyst initial views are also not positive  The systems cost of capturing the data necessary to comply with this is potentially significant Three buckets of cash flows

European Insurance CFO Forum Page 14 Own Credit Characteristics We do not consider that the credit standing of an insurance contract should be considered in the valuation of the insurance liability :  The impact is counter intuitive - as companies are downgraded they could start recognising profits. This is potentially significantly misleading to users.  In a highly regulated industry is this really appropriate?  It is too theoretical and impractical to apply

European Insurance CFO Forum Page 15 Linkages with other standards/projects There are important interactions with a number of other standards that will need further consideration – IAS 39, IAS 37 and IAS 18 in particular. At present there is a lack of clarity about how investment contracts with DPF will be accounted for. Conceptually we believe that all par contracts should be treated the same.  the solution would be to include investment contracts with DPF in the Phase 2 standard in line with IFRS 4 as it stands today Investment contracts without DPF would stay under IAS 39. (It may be that some adjustment to IAS 39 is required to ensure consistency of treatment )

European Insurance CFO Forum Page 16 Conclusion We have not finally concluded on our response to the IASB’s Discussion Paper. However, our initial view is that some of the core elements of the proposals are sound, but there are important areas where there are misconceptions and flaws. There are significant similarities with Solvency 2 proposals – we think that this is a good thing in general terms because it both reduces cost for companies and is a closer reflection of the economic realities. Some of the specific components of the proposals need amendment – in particular the treatment of future premiums (guaranteed insurability), participating contracts, unbundling, use of market expense levels and own credit characteristics. We disagree with the IASB’s view that there is not a significant difference between implementation A and B. There is a significant initial profit margin - we are currently discussing three options for how this initial profit margin should be treated. We are concerned with the industry being used as a ‘guinea pig’ by the IASB. This is reflected in the complexity and highly theoretical nature of some of the proposals. We question whether user needs will be met by the proposals.