 The Younger Members Convention 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire

 Fair values – FRS 17 for insurance companies? Michael White, PricewaterhouseCoopers 3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire

Agenda n Background n What are fair values? n What will be the impact? n Unresolved issues n Timetable

The story so far n All listed EU companies report under IAS by end 2005 n....but no IAS standard for insurance contracts n DSOP being prepared but standards not ready till after 2005 n Principles are based around a “fair value” type approach n UK regulation likely to follow similar principles to IAS

What has the reaction been? n Letter from American, German and Japanese industry bodies n CFO Forum n FSA supportive – favours fair value approach for regulatory solvency n US - harmonisation

So what is a fair value? n “...the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction.” n “Entity specific value”

Why is this different to what we do now? n Options and guarantees n Independence of assets and liabilities n Reserve for (some) discretionary benefits n Use of the yield curve n Unified approach for life\general business

Unit linked contract with maturity guarantee n Text alignment and case as Title page

Conventional with profit contract Statutory Profit Fair Value Profit Achieved Profit

Format of the P&L Possible IAS format Value of new business Release of risk Change in estimates and assumptions Change in policyholder interest in surplus Existing Premiums Investment income Claims Change in reserves Expenses

Valuation methodologies ProductMethodology Term assuranceDeterministic projection Unit linkedDeterministic (on suitable assumptions) for products without guarantees Conventional with profits \ Unitised with profits Stochastic modelling

Is it going to be easy? n Complexity – jargon, fundamental change n Modelling run-times n Performance reporting n Auditing n Dynamic decision rules n Choice \ calibration of model

What will be the impact? n Investment strategy n Securitisation n Investor community n Tax n Third Party Administrators n Product design

Product design - example n Unit linked product n 0.75% annual management charge n £40 per year renewal expenses n Guaranteed return of premiums at maturity

Product design With guarantee Impact of product design Fair value

Product design With guaranteeNo guarantee Impact of product design Fair value

Product design With guaranteeNo guaranteeMatched charges Impact of product design Fair value

Timetable IAS reporting required for listed EU companies (Phase I) PSB live for insurers Full IAS accounting for insurance? Exposure draft expected for Phase I

The interim solution n Continue to use existing GAAP n Assets and investment contracts under IAS 39 n Elimination of catastrophe and equalisation provisions n Embedded derivatives

The unresolved issues n Performance linked contracts n Income statement n Balance sheet presentation and disclosures n Market Value Margins n Renewal premiums n Policyholder behaviour n Profit on day one

Summary – FRS 17 for the insurance industry? n “Market value” n Independence of assets and liabilities n Analysis of movement n Radical n Transparency n Impact on the industry