1. 1 Insurance accounting under IFRS and conversion issues A presentation to the African Insurance Organisation’s Finance and Risk Management Seminar 2010 Insurance accounting under IFRS and conversion issues A presentation to the African Insurance Organisation’s Finance and Risk Management Seminar 2010 Alfons van der Vyver

2. 2 Disclaimer This presentation and the accompanying slide pack are provided solely for the benefit of the parties hereby represented and are not to be copied, quoted, or referred to in whole or in part without our prior written consent. We accept no responsibility to anyone other than the parties hereby represented for the information contained in this presentation. Case studies, examples presented and opinions or explanations relating to hypothetical circumstances are general in nature and should not be relied upon as a formal accounting opinion. Written opinions relating to specific circumstances can be provided on request and subject to proper consultation and agreement of terms.

3. 3 Agenda Key features of IFRS 4 Insurance Contracts Overview of the IASB’s project on insurance contracts Conversion to IFRS Impact on entity Conversion challenges

4. 4 IFRS 4 Insurance Contracts Effective for annual periods beginning on or after 1 January 2005

5. 5 What is IFRS 4 all about? The highlights of IFRS 4 Definition of an insurance contract Guidance on non-insurance contracts falling into IAS 39 Financial Instruments: Recognition and Measurement Disclosures Does not provide guidance on recognition and measurement of insurance contracts (part of IASB’s project on insurance contracts) Only applies to the issuers of insurance contracts, not the policyholders, but does apply to reinsurance

6. 6 Definition of an insurance contract The definition is not legal in nature but rather substance based Definition is applied on a contract–by–contract basis A 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 affects the policyholder

7. 7 Insurance risk versus financial risk Insurance risk is risk, other than financial risk, transferred from the holder of a contract to the issuer Financial risk is risk of a potential future change in one or more of: Interest rate Security price Commodity price Foreign exchange rate Index of price or rates A credit rating A credit index or other variable In case of non-financial variable, variable is not specific to a party to the contract

8. 8 Significant insurance risk The standard describes insurance risk as significant only if: an insured event could cause an insurer to pay significant additional benefits in any scenario excluding scenarios lacking commercial substance (i.e. having no discernible effect on the economics of the transaction) The additional benefits refer to amounts that exceed those that would be payable if no insured event occurred (excluding scenarios that lack commercial substance)

9. 9 Uncertain future event Must exhibit uncertainty over one or more of the following: Whether future event will occur When the future event will occur How much the insurer will need to pay if the insured event occurs

10. 10 Liability adequacy test An assessment of whether the carrying amount of an insurance liability needs to be increased (or the carrying amounts of related deferred acquisition costs or related intangible assets need to be decreased), based on review of future cash flows Consider contractual and related cash flows as well as embedded options and guarantees If net liability needs to be increased, recognise the loss in profit or loss

11. 11 Liability adequacy test (continued) If an insurer does not have an accounting policy that deals with the above described liability adequacy test, then the insurer needs to ensure that the net liabilities are at least equal to what the similar liabilities would have been if calculated in terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets

12. 12 Reinsurance assets Reinsurance assets should be tested for impairment based on objective evidence of credit losses arising after initial recognition if the event has a reliably measurable impact

13. 13 Unbundle deposit component when? Unbundling of a deposit component is permitted if: The deposit component can be measured separately Unbundling of a deposit component is required if: the deposit component can be measured separately AND the resulting rights and obligations are not otherwise recognised under the insurer’s accounting policies Unbundling of a deposit component is prohibited if: an insurer cannot measure the deposit component separately

14. 14 Investment contracts Requires IAS 39 to be applied to pure investment contracts But not to insurance contracts with discretionary participation features, within scope of IFRS 4

15. 15 Disclosure requirements of IFRS 4 Explanation of recognised amounts arising from insurance contracts Two pillars Enable user to evaluate nature and extent of risks arising from insurance contracts

16. 16 Disclosure: Explanation of recognised amounts Accounting policies for insurance contracts The amounts of the recognised assets, liabilities, income and expense arising from insurance contracts Process used to determine the most significant assumptions that have greatest effect on recognised amounts (and if practicable, the assumptions themselves) Information about the effect of changes in assumptions Reconciliations of changes in insurance liabilities, reinsurance assets and if any, deferred acquisition costs

17. 17 Disclosure: Nature and extent of risks arising from insurance contracts Objectives, policies and processes for managing risks and methods used to manage risk Information about insurance risk Sensitivity to insurance risk (sensitivity analysis or qualitative information) Concentrations of insurance risk Claims development Information about credit risk, liquidity risk and market risk Information about exposures to market risk under embedded derivatives

18. 18 IASB’s project on insurance contracts

19. 19 Background Background IASB Discussion Paper – Preliminary Views on Insurance Contracts (May 2007) – Current Exit Value Approach FASB Invitation to Comment wrapping IASB paper (August 2007) FASB joins IASB project (October 2008) The deliberations to date have focused on the measurement model, acquisition costs, policyholder behaviour, unbundling, presentation and embedded derivatives Exposure draft expected in May/June 2010 Presumed first time application in 2013

20. 20 Insurance project scope Scope applies to insurance contracts not insurance enterprises Reinsurance accounting will be included IASB and the FASB both would include accounting by cedant and reinsurer Policyholder accounting (excluding reinsurance) Currently the IASB has tentatively decided to exclude policyholder accounting from the scope of the exposure draft FASB has not yet decided if policyholder accounting should be addressed

21. 21 Unbundling The boards (IASB and FASB) discussed whether to account for components of an insurance contract as if those components were separate contracts (i.e. unbundle those components) The IASB decided tentatively that, for recognition and measurement, an insurer should: unbundle a component of an insurance contract if it is not interdependent with other components of that contract not unbundle a component that is interdependent The FASB decided tentatively that if unbundling is not required for recognition and measurement, it should not be a permitted option

22. 22 Acquisition costs Both Boards have agreed that acquisition costs should be expensed when incurred IASB Board initially leaned toward recognizing revenue at inception equal to incremental acquisition costs incurred Part of premium received is compensation for acquisition costs Measurement at inception should not be different for otherwise identical contracts acquired through different distribution channels Measuring insurance contracts initially at the amount of total premium received (without deduction for acquisition costs incurred) would not represent faithfully the remaining obligation FASB Board would not recognise any revenue at inception Revenue should only be recognised when it satisfies performance obligations under the contract (consistent with Revenue Recognition project)

23. 23 Acquisition costs (continued) Acquisition Costs – In October 2009, the Boards held a discussion which focused on the consistency of IASB model (recognition at inception of the contract the premium equal to incremental acquisition costs) to the revenue recognition model The Boards held a tentative vote which indicated a preference for the FASB model (no recognition of revenue at inception)

24. 24 Measurement approach The boards have decided tentatively that the measurement approach should portray a current assessment of the contract, using the following building blocks: the unbiased, probability-weighted average of future cash flows expected to arise as the insurer fulfils the contract the effect of time value of money a risk adjustment for the effects of uncertainty about the amount and timing of future cash flows an amount that eliminates any gain at inception of the contract (a residual margin)

25. 25 Discount Rate What discount rate should be used to discount cash flows? The IASB tentatively decided that the discount rate should not represent the earnings rate on the assets supporting the obligation The IASB tentatively decided that the discount rate for insurance liabilities should conceptually adjust estimated cash flows for the time value of money in a way that captures the characteristics of that liability The FASB has not yet discussed what discount rate should be used in the model

26. 26 Risk adjustment The risk adjustment should be defined as the amount the insurer requires for bearing the uncertainty about the resources it will require to fulfil the net or remaining net obligation The risk adjustment should be re-measured every reporting period The measurement of an insurance liability should not be updated for changes in the risk of non-performance by the insurer

27. 27 Residual Margin The Boards considered when the initial measurement of an insurance contract results in day one negative difference (loss), if an entity should recognize the negative day one difference (loss) in the statement of comprehensive income Considerations: Unit of account for loss recognition - contract or portfolio basis The vast majority of IASB members and all FASB members agreed with the staff recommendation that when the initial measurement of an insurance contract results in a negative day one difference (i.e. a day one loss), then an entity should recognise the day one loss in profit or loss No decision was made regarding the unit of account for loss recognition

28. 28 Policyholder participation An insurance contract giving the policyholder both guaranteed benefits and a right to participate in favourable performance of the relevant class of contracts, related assets or both Insurer charges a larger premium – if actual outcomes are in line with the insurer’s expectations, the insurer refunds part or all of the excess premium to participating policyholders

29. 29 Policyholder participation (continued) The boards discussed participating features in insurance contracts. Two views presented: View 1: All cash flows that arise from a participating feature should be included in the measurement of the insurance liability on an expected present value basis View 2: The cash flows expected to arise from a participating feature are analysed to determine whether those flows are required (e.g. by the contract or by a statute) or are discretionary. Required cash flows (if there are any) will be included in the measurement of the insurance liability. Discretionary cash flows will be recognised when the entity has an obligation to make payments. The IASB tentatively decided on view 1 and the FASB tentatively decided on view 2

30. 30 Reinsurance assets A cedant should recognise and measure its reinsurance asset using the same recognition and measurement approach that it uses for the reinsured portion of the underlying insurance contracts that it has issued This measurement approach includes: the expected present value of the cash flows required to fulfil the reinsured portion of the insurer's obligations the addition of the risk margin (but not the residual margin) included in the measurement of the reinsured portion of the contract liability the addition of the residual margin implied by the pricing of the reinsurance contract the impact on the reinsurance asset of possible impairment and coverage disputes, measured using the building block approach, in other words an expected value basis, rather than an incurred loss basis

31. 31 IASB and FASB Project Timetable – can this be achieved? As part of the Memorandum of Understanding that was reaffirmed on November 5th, 2009 there was an indication that the IASB and FASB agreed to postpone the issuance of the exposure draft until Q2 2010 The updated timetable as presented to the Boards in February 2010 reflects an expected May 2010 date for issuance of the ED with comments due in September 2010 Expected issuance of the standard remains June 2011.

32. 32 Conversion to International Financial Reporting Standards (IFRS)

33. 33 Conversion to IFRS International Financial Reporting Standards (IFRS) consists of 38 Financial Reporting Standards 27 Interpretations Conversion is not necessarily a straight-forward exercise especially if the existing accounting framework is very different to IFRS Conversion has to be planned and managed Staff needs to be trained on IFRS IFRS will impact accounting and reporting, systems and processes, people and the business The challenges faced should not be underestimated

34. 34 Conversion challenges we have experienced…. There is a scarcity of resources with IFRS knowledge The scope of the conversion project is often underestimated The changes in systems required to cope with IFRS are underestimated – results in manual workarounds A lot of valuations and information are required on date of transition and for comparatives which are not always readily available Top management often does not see the conversion project as a priority

35. 35 Project management of IFRS conversion Necessary IFRS skills Impact analysis Training and communication needs Understand business and process impact

36. 36  Mobilise project team  IFRS awareness training  Perform gap analysis  Financial impact assessment  Set timelines  Mobilise business  Mobilise finance functions and IT  Customised IFRS training  Build tools (policies, financial statements, reporting packages)  Convert budget  Convert systems  Testing  Dry run  Opening statement of financial position  Prepare comparatives  Manage business on IFRS basis  Cut-over to IFRS …Challenge: remain in full control from start until finish & carry on busines as usual Phase 2Phase 3 Assess ImplementDesign Roll out and parallel run Phase 1 Learn and build the tools  Identify training needs  Identify system impact  Plan conversion path  Resource budget  Present results to management for decisions Assess impact and plan the conversion Methodology we have followed

37. 37 Insurance specific conversion – limited guidance in IFRS IFRS 4 states that an insurer: shall not recognise as a liability any provisions for possible future claims, if those claims arise under insurance contracts that are not in existence at the end of the reporting period such as catastrophe provisions and equalisation provisions shall carry out the liability adequacy test shall remove an insurance liability (or a part of an insurance liability) from its statement of financial position when, and only when, it is extinguished i.e. when the obligation specified in the contract is discharged or cancelled or expires shall not offset: reinsurance assets against the related insurance liabilities OR income or expense from reinsurance contracts against the expense or income from the related insurance contracts shall consider whether its reinsurance assets are impaired

38. 38 Insurance specific conversion challenges experienced…. Analysis of the product/contract wording of whole portfolio required Exercise necessary to classify contracts into insurance or investment contracts Consider whether the deposit element should be unbundled Changes to systems required to meet onerous disclosure requirements Sourcing of comparative information for disclosure purposes can be a difficult and timeous process Drafting of accounting policies based on limited guidance in IFRS 4 (unless more guidance provided from regulatory point of view) Drafting of risk management disclosures – significant input from business is required Dry-runs of asset & liability reconciliation exercises required

39. 39 What if financial statements for next financial year have to be in compliance with IFRS? Many companies across the world have converted to IFRS and have succeeded!! Most important PLAN conversion and then take conversion step by step

40. 40 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. © (2009) KPMG Services (Proprietary) Limited, the South African member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in South Africa. Alfons van der Vyver KPMG Services (Pty) Ltd +27 (0) 11 647 5655 www.kpmg.co.za