1. Adoption of IFRS 4 * PwC *connectedthinking Ioana Burada Audit Manager
23/10/2017
Adoption of IFRS 4 *
Ioana Burada
Audit Manager
PricewaterhouseCoopers
17 November 2004
PwC
*connectedthinking

2. Introduction to IFRS – What is IFRS?
23/10/2017
Introduction and overview of IFRS and IASB
Introduction to IFRS – What is IFRS?
International Accounting Standards are standards issued by the International Accounting Standards Board (IASB).
Recent standards issued by the IASB are called International Financial Reporting Standards (IFRS); all former standards continue to be referred to as International Accounting Standards (IAS).
All standards developed in accordance with the Framework which is fundamental to ensure development of consistent standards under asset and liability model
Due process for development of standards allows but does not require consultation with industry bodies and national standard setters including FASB.
Adoption of IFRS 4
17 November 2004

3. Introduction to IFRS – What is IFRS?
23/10/2017
Introduction and overview of IFRS and IASB
Introduction to IFRS – What is IFRS?
Consolidated financial statements published after 1 January 2005 by listed companies in the EU will have to be IFRS compliant (assuming full endorsement).
The European Commission (“EC”) reviews all standards to determine if they should be endorsed for application in Europe.
EC has endorsed all standards except IAS 32/39.
Partial endorsement currently being discussed with a decision expected in late 2004.
The IASB has a very demanding agenda for the next few years.
Adoption of IFRS 4
17 November 2004

4. Introduction to IFRS – What is IFRS?
23/10/2017
Introduction to IFRS – What is IFRS?
IFRS focuses on transparency through disclosures and through the increasing use of fair value measurement for assets and liabilities.
Requires the application of principles-based standards with limited flexibility.
Mixed measurement model: Cost and fair value.
Not designed to support national tax and other regulatory purposes.
Adoption of IFRS 4
17 November 2004

5. What will IFRS bring to Europe?
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What will IFRS bring to Europe?
“The International Accounting Standards Regulation will introduce a new era of transparency and put an end to the current Tower of Babel in financial reporting.
It will help European firms to compete on equal terms when raising capital on world markets and allow investors and other stakeholders to compare companies’ performance against a common standard.”
Frits Bolkestein, EC Internal Markets Commissioner
Adoption of IFRS 4
17 November 2004

6. To harmonise corporate reporting;
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Why do we need IFRS?
To harmonise corporate reporting;
To introduce comparability and consistency;
And transparency and reliability;
To widen access to capital markets;
To increase market efficiency…
…and hence reduce the cost of capital…
…and hence improve competitiveness…
…and hence boost growth
Adoption of IFRS 4
17 November 2004

7. Introduction to IFRS – What IFRS does not change…
23/10/2017
Introduction to IFRS – What IFRS does not change…
IFRS does not:
Change the future cash flows of a company (although the presentation may differ)
Change fair values of assets and liabilities
Change the company’s embedded value calculation methodology
Change the underlying economic reality
IFRS does change the timing of when profits are recognised.
Adoption of IFRS 4
17 November 2004

8. 23/10/2017
IFRS – So What?
The move to International Financial Reporting Standards (IFRS) is the most fundamental shift in accounting ever faced by most companies. It will transform:
The viability and design of products;
Data and information system requirements.
It could also change
How customers, shareholders, and analysts view the company;
The way the company is judged by investors and rating agencies;
The way the company manages its balance sheet and earnings;
The company’s regulatory and economic capital requirements.
Adoption of IFRS 4
17 November 2004

9. IFRS and Insurance Accounting
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IFRS and Insurance Accounting
For insurance assets, follow existing IFRS standards
For insurance liabilities, IASB acknowledge fair value implementation by 2005 impracticable
IASB have indicated two phased approach with Phase 1 - IFRS 4 issued in Spring 2004 – includes:
Requirements for certain quantitative and qualitative disclosures and minor modifications to current practices for insurance contracts (i.e. largely follow existing local GAAP except for those products treated as financial instruments).
Guidance on application of IAS 39
Full fair value standard implementation by disclosure was proposed for 2006
Adoption of IFRS 4
17 November 2004

10. provides a definition for insurance contracts;
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IFRS 4 overview
provides a definition for insurance contracts;
allows companies to apply current (local) accounting principles for insurance contracts;
non-insurance contracts will primarily be accounted for as investment contracts;
eliminates certain accounting practices that are deemed to be inappropriate;
requires loss recognition testing and the establishment of loss recognition reserves;
certain exemptions in respect of discretionary participation investment contracts;
requires extensive disclosure;
Adoption of IFRS 4
17 November 2004

11. Financials Statements (Phase 2)?
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IFRS 4 timetable
WE ARE
HERE!
1st IFRS 4
Annual Reports
Standard for phase II
ED for
Phase 1
IFRS 4
ED for
Phase 2
1st IFRS
Financials Statements (Phase 2)?
1st Half year
interim on IFRS
basis
Adoption of IFRS 4
17 November 2004

12. IFRS 4 - Definition of insurance contracts
23/10/2017
IFRS 4 - Definition of insurance contracts
IFRS 4 defines an insurance contract as ‘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.’
IFRS 4 is for insurance contracts not insurance companies
The term “investment contract” is used informally to refer to a financial instrument that does not meet the definition of an insurance contract
Adoption of IFRS 4
17 November 2004

13. IFRS 4 - Definition of insurance contracts (continued)
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IFRS 4 - Definition of insurance contracts (continued)
Insurer
Entity separate from policyholder
An insurer is one who issues insurance contracts
 Uncertain future event
Uncertainty (risk) present at inception of contract as to at least one of
Whether event occurs;
When it will occur or;
How much will it cost.
Adoption of IFRS 4
17 November 2004

14. An investment contract is one that is not an insurance contract
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Insurance contracts and Investment Contracts
An investment contract is one that is not an insurance contract
Investment / savings contracts are not directly defined in IFRS 4
Insurance contracts are defined
Therefore one cannot first describe a contract as a savings contract and then try and establish whether a feature may or may not classify it as insurance
It needs to follow a logical process using the definitions in IFRS 4
Only if it fails the insurance contract test, can one state that it is an investment contract.
Adoption of IFRS 4
17 November 2004

15. Product classification flowchart
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Insurance contracts and Investment Contracts
Product classification flowchart
Does the contract need to be unbundled?
Are any discretionary participation features present?
Insurance Component
Deposit Component
Yes No
Does contract contain significant insurance risk?
Investment Contract
Investment Contract with discretionary participation features
Insurance Contract
Adoption of IFRS 4
17 November 2004

16. Most contracts are easy, but the challenges are with the few
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Insurance contracts and Investment Contracts
Most contracts are easy, but the challenges are with the few
Most contracts are easy to classify, e.g. motor insurance, term insurance, disability insurance
Most of the difficulties lay with the type of contracts that contain both savings and insurance features, e.g. unit linked savings contracts, endowment bonds, whole life bonds, temporary annuities, financial reinsurance
Adoption of IFRS 4
17 November 2004

17. 23/10/2017
Insurance contracts and Investment Contracts
Definition of Insurance contracts -Distinction between insurance risk and other risks
Insurance risk is risk other than financial risk
Not changes in interest rates, security prices, commodity prices etc.
Changes in fair value of non-financial assets if linked to condition of asset held by insured is insurance
Must be pre-existing risk
Adverse effect on policyholder
Ex: Survival risk is an insurance risk
Adoption of IFRS 4
17 November 2004

18. What is significant insurance risk?
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Insurance contracts and Investment Contracts
What is significant insurance risk?
“Insurance risk is significant if, and only if, an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance (i.e. have no discernible effect on the economics of the transaction)…
If significant additional benefits would be payable in scenarios that have commercial substance, the condition in the previous sentence may be met even if the insured event is extremely unlikely or even if the expected (i.e. probability-weighted) present value of contingent cash flows is a small proportion of the expected present value of all the remaining contractual cash flows.”
Adoption of IFRS 4
17 November 2004

19. What is significant insurance risk? (continued)
23/10/2017
Insurance contracts and Investment Contracts
What is significant insurance risk? (continued)
Insurance risk evaluated at inception of contract.
A contract that initially does not meet the definition of insurance may subsequently do so
E.g. savings contracts with guaranteed annuity rate option at maturity:
not insurance contact at inception if insurer can price annuity at current rates when option is exercised
insurance if annuity rates guaranteed at inception if there is a reasonable expectation that the option will be exercised
Once insurance always insurance until all rights and obligations extinguished
Adoption of IFRS 4
17 November 2004

20. Significance test Test applies to those cash flows that will be paid:
23/10/2017
Insurance contracts and Investment Contracts
Significance test
Test applies to those cash flows that will be paid:
1. if the insured event occurs; and
2. in all other events (the probability of non-occurrence of the insured event)
Are cash flows under (1) > (2)?
Is it significant?
Does the scenario have commercial substance?
Adoption of IFRS 4
17 November 2004

21. Examples of insurance contracts
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Insurance contracts and Investment Contracts
Examples of insurance contracts
General insurance contracts such as insurance against theft, product liability
Life insurance and prepaid funeral plans
Life-contingent annuities and pensions
Disability and medical cover
Product warranties; travel assistance
Credit insurance that reimburses for losses from specified debtor default
Catastrophe bonds with reduced payments if a specified event adversely affects the issuer
Adoption of IFRS 4
17 November 2004

22. Examples of contracts that are not insurance
23/10/2017
Insurance contracts and Investment Contracts
Examples of contracts that are not insurance
Investment contracts that have the legal form of an insurance contract but do not expose the insurer to significant insurance risk.
Contracts that have the legal form of insurance, but pass all significant insurance risk back to the policyholder through mechanisms that adjust future payments by the policyholder as a direct result of insured losses.
Derivatives
Financial guarantee providing for payments in response to changes in specified interest rate, security price etc.
Catastrophe bonds with reduced payments based on a variable not specific to a party to the contract
Adoption of IFRS 4
17 November 2004

23. Insurance contracts out of scope
23/10/2017
Insurance contracts out of scope
Certain contracts are explicitly excluded from the scope of IFRS4, these include:
Product warranties issued directly by a manufacturer
Employers’ assets and liabilities under employee benefit plans
Contractual rights or obligations contingent on future use of a non-financial item (e.g. some license fees, royalties, contingent lease payments)
Financial guarantees that are within the scope of IAS 39
Contingent consideration in a business combination
Adoption of IFRS 4
17 November 2004

24. IFRS 4 - Unbundling of deposit components
23/10/2017
IFRS 4 - Unbundling of deposit components
Unbundling is required if both the following conditions are met
a) the insurer can measure the deposit component separately
b) the insurer’s accounting policies do not otherwise require it to recognize all obligations and rights arising from the deposit component.
Unbundling is permitted, but not required, if insurers can measure deposit component separately but accounting policy require recognition of an obligation and rights of deposit component.
Unbundling prohibited if cannot measure deposit component separately.
Deposit component is subject to IAS 39
Adoption of IFRS 4
17 November 2004

25. IFRS 4 - Discretionary Participation Features
23/10/2017
IFRS 4 - Discretionary Participation Features
Certain insurance and investment contracts contain discretionary participation features (DPF).
DPF are strictly defined.
Investment contracts with DPF are treated more or less as insurance contracts in IFRS 4
Adoption of IFRS 4
17 November 2004

26. IFRS 4 - Discretionary Participation Features (continued)
23/10/2017
IFRS 4 - Discretionary Participation Features (continued)
What is a participating feature?
- A contractual right held by an investor or policyholder to receive, as a supplement to guaranteed minimum payments, additional payments
- Additional payments, which are:
likely to be a significant proportion of the contractual payments
and that are contractually based on
the performance of a pool of contracts;
gains on pool of assets held by the issuer; or
the profit or loss of the company
What is a discretionary participating feature?
- A participating feature whose amount or timing is contractually at the discretion of the issuer
Adoption of IFRS 4
17 November 2004

27. Where do we stand? Where are we?
23/10/2017
Where do we stand?
Where are we?
An IFRS 4 Readiness assessment was recently prepared
Overall message, companies have a tremendous amount left to accomplish before 2005*/2006…
* - applicable in 2005 for listed companies only
Adoption of IFRS 4
17 November 2004

28. Where do we stand? (continued)
23/10/2017
Where do we stand? (continued)
Where are we going?
Phase I – a step forward?
Investment Contracts v. Insurance are here to stay
IAS 39 is here to stay
Embedded derivatives are here to stay
Phase II – to discuss but time scales are guess work
Get Phase I right as a firm foundation to Phase II.
Adoption of IFRS 4
17 November 2004

29. Results of survey of large insurance companies
23/10/2017
Results of survey of large insurance companies
Top TECHNICAL issues companies are currently facing:
Accounting for investment contracts (valuation)
Segment reporting
Risk disclosures
IAS 18 deferred revenue calculations
Taxes
Dealing with volatility of derivative portfolios
Use of FV option
Shadow accounting (i.e. recognition of certain elements directly in the equity)
Asset/liability management
Adoption of IFRS 4
17 November 2004

30. Results of survey of large insurance companies
23/10/2017
Results of survey of large insurance companies
Top PRACTICAL issues companies are currently facing:
Deposit accounting
Lack of resources/ training
Application of FV option
Uncertainty of statutory and tax basis (some countries may require two sets of financial statements; local GAAP and IFRS)
Obtaining high quality IFRS data from subsidiaries
Data gaps around disclosures
Collecting information for consolidations
Adoption of IFRS 4
17 November 2004

31. 23/10/2017
PwC
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