Current IASB Position Contracts with Participating FeaturesContracts: Measurement of the Insurance Contract Liability

Definition participating features A participation feature is a mechanism by which the entity shares the rewards and risk with the policyholder through payments that are additional to payments that are commensurate with the loss suffered on the occurrence of the insured event. Those additional payments to the policyholders may be affected by changes in market variables.

Measurement of the Insurance Contract Liability (Ignoring Presentation) All contracts (Life, non-life, par, non-par) at fulfilment value applying the three building blocks, except Separated components (distinct components, investment, service or derivative) Replicating portfolio applies (Cash /Flow exactly equal to instruments traded in market, e.g. in case of unit-linked contracts [I DO NOT THINK THIS STATEMENT IS CORRECT FOR UNIT LINKED CONTRACTS]) Unearned premium approach (as a simplification of the building block approach for short duration policies) Direct participating contracts (whether we call this a separate measurement model, difference in the Contractual Service Margin)

First Building Block: (Risk-neutral) Expected Value of Future Cash Flows Estimate of the current expected value of future cash flows, as expected to incur at the reporting entity in fulfilling the obligation as expected/estimated by the preparer reflecting all possible future scenarios risk-neutral (stochastic mean value of cash flows) WE COULD TALK ABOUT WHAT INTEREST RATE ASSUMPTIONS SHALL BE USED IN CASE FUTURE CASH FLOWS DEPEND ON INVESTMENT RETURNS; not necessarily risk-neutral, as long as entire calculation is market-consistent In practice, usually a set of market-consistent risk-neutral scenarios, where volatility of market parameters reflects market views not in contradiction to views of market participants about expected values as derived directly from observed market prices (objectivity precedence) Includes c/f cash flows under the contract from any minimum guarantee assymmetries (cash flows that depend asymmetrically / non-linearly on future asset development) non-separated embedded derivative p/hs‘ policyholder behavior obligation under the contract to refund its surplus of the contract to the collective portfolio of policies today or in future (as well any effect of allocation to individual policyholders if within the current contract boundary, i.e. insurer currently obliged to provide coverage from allocation etc.) future benefit at the future discretion of the insurer to the contract if within contract boundary

Second Building Block: Time Value of Money Discounting of c/f cash flows in determining the expected value, applying the time value of money as required by market participants (not entity-specific) market consistent (rates shall be consistent with observable current market prices for instruments with cash flows whose characteristics are consistent with those of the insurance contract, in terms of, for example, timing, currency and liquidity) in practice, usually a market rate risk free curve no double counting of c/f cash flows characteristics, i.e. ignoring any deviation risk of amount or timing (as considered in expected value and risk adjustment), typically the time value of money as charged for a deterministic c/f (risk-free illiquid) In practice, in case a risk free curve is applied, the discount rate curve applies equally to all cash flows in all scenariosc/f, including any minimum guarantee asymmetry non-separated embedded derivative p/hs‘ policyholders behavior obligation under the contract to refund surplus of the contract to the collective today or in future (as well any effect of allocation to individual p/hs‘ policyholders if within the current contract boundary, i.e. insurer currently obliged to provide coverage from allocation etc.) future benefit at the future discretion of the insurer to the contract if within contract boundary

Third Building Block: Risk Adjustment Value of the deviation risk of amount or timing of c/f cash flows as associated subjectively by the reporting entity (except in case of replicating portfolio, there the market participants view as directly observed in market) as affecting ultimately the (owner of the) reporting entity excluding any deviation risk re-transferred to p/hs‘ policyholders via par feature including any deviation risk retained by par feature (deviations of insurer’s share due to changes in u/i) WHAT DO YOU MEAN BY u/i? created by par feature (deviations due to changes in the percentage of insurer’s share) due to management’s future discretion (e.g. in response to competitive pressure) ????????? (the risks which can be hedged or avoided are not included) resulting from any c/f cash flows including: any minimum guarantee asymmetry non-separated embedded derivative p/hs‘ policyholders behavior

Contractual Service Margin CSM Liability for the remaining coverage of profitable contract includes a Contractual Services Margin Determined at outset absorbing any initial profit Released evenly over the coverage period with accretion of interest Adjusted for (as long as remaining positive) changes in the (estimated) expected value of future c/f cash flows as far as reflecting future services changes in the (estimated) risk adjustment that relate to future coverage and other services for deviation risks to be born in future (not all changes + overstroked the over stroked text which is not needed even though it is a fact) and, as sole measurement peculiarity of direct participating contracts, changes of insurer’s share in the u/i, except those hedged excluding effects of changes in discount rate and changes of c/f cash flows due to changes in market variables (i.e. variables with a directly observable market price) since that is not assumed to reflect future services (except if part of u/i for direct par contracts)

Open Measurement Issues for Direct Participating Contracts Sharing p/hs‘ policyholders in the Surplus of the Insurer How to measure the obligation to refund p/h policyholders a share of the surplus? At the expected share applied to the IFRS carrying amount of the surplus? At the expected share applied to the fair value of the surplus? At the expected share applied to the expected value of the surplus? At the amount of expected bonuses as expected to be paid to current and future p/hs‘ policyholders from the surplus of the contract? How to measure insurer’s share in the surplus to adjust the Contractual Services Margin? At the expected share applied to the IFRS carrying amount of the surplus? At the expected share applied to the fair value of the surplus? At the expected share applied to the expected value of the surplus? The Contractual Services Margin at initial recognition of contract A includes insurer’s share in the surplus from contract A. p/hs‘ Policyholders share is allocated later to current or future contracts, often by means of provision of additional services, generating again surplus. Is insurer’s share in that latter surplus (arising often under other contracts) as well as anticipated at initial recognition of contract A or is it beyond the contract boundary of contract A?

Direct Participating Contract the contractual terms specify that the policyholder participates in a defined share of a clearly identified pool of underlying items; the entity expects to pay to the policyholder an amount equal to a substantial share of the returns from the underlying items; and a substantial proportion of the cash flows that the entity expects to pay to the policyholder should be expected to vary with the cash flows from the underlying items