1. IFRS 4 PHASE II Global overview
Baltic actuarial days Latvian Actuarial Association – ACTUAM S.à.r.l Date: 23/09/2016 – Time: 02:30 pm – Location : RIGA
IFRS 4 PHASE II
Global overview
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2. Table of contents 1. Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS under IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
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IFRS 4 PHASE II - ACTUAM
23/09/2016
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3. Table of contents 1. Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS under IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
1. Why IFRS 4 PHASE II?
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4. Expected Effective Date 3 years from the publication
1. Why IFRS4 PHASE II?
Regarding the IASB* IFRS 4 PHASE II is expected to transform the insurance industry as it is set to create a new financial language to help insurers and inform investors on the performance of the insurance industry.
* IASB: International Accounting Standards Board
Timetable:
2016
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Issuing IFRS 4 PHASE II
(2nd half of the year)
Expected Effective Date
3 years from the publication
Implementation
Phase
2018
IFRS 9
2021
IFRS 4/2
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5. Table of contents Why IFRS 4 PHASE II?
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS under IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
2. Global Impacts with IFRS 4 PHASE II
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6. 2. Global impacts with IFRS 4 PHASE II
Capability of analysts about comparing insurance companies
What constitues revenue and profit in an insurance company
Introduces unprecedented levels of transparency on profit and risk levels embedded in insurance liabilities
Operating model is bound to change including new processes and systems for the insurers
Transforms how insurers account for income and liabilities from insurance contracts they sell
It creates a higher transparency (new standard) with which to inform investors about the performance of the insurance industry
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7. Table of contents 1. Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS under IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
3. Technical Impacts with IFRS 4 PHASE II
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8. 3. Technical impacts with IFRS 4 PHASE II (1/6)
Best Estimate(BE) 1 2
Expected future cash flows:estimate of the current value of expected future cash flows (premiums, claims and benefits…)
Discounted at risk free rate:Future cash flows adjusted to take into account the time value of money
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9. 3. Technical impacts with IFRS 4 PHASE II (2/6)
Margins 1 2
Risk Adjustment Margin:adjustment to reflect uncertainty in the amount and timing of the future cash flows
Contractual Service Margin: expected contract profit which eliminates any gain at inception of the contract
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10. 3. Technical impacts with IFRS 4 PHASE II (3/6)
Best Estimate (BE): Cash flow projections (Discounted at Risk Free Rate)
Risk Margin(RM): Will be adjusted to reflect the uncertainty in the projected cash flows e.g. Expected profit at the t0 of the contract (t0=creation date)
Consistency with the other reports (ex: IFRS 15): Impacts (ex: on P&L)
Taking into consideration the performance obligations
For the UPR (unearned premium reserve) compatibility as investment components related to the premiums and claims no longer flow through P&L
Changes in estimates of future cash flows that don’t adjust the CSM** (claim reserves, onerous contracts) will be included in P&L
Actual claims and service expenses (ex investment components) included in P&L
All changes of insurance contract liability flow through P&L
Interest expense (locked-in yield curve w/non-par business, unless FVPL*) will be included in P&L
* fair value though profit or loss and as in IFRS9 the underlying items are measured at FVPL
** Contractual Service Margin (to defer profits under IFRS4/P2)
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11. 3. Technical impacts with IFRS 4 PHASE II (4/6)
Insurers cannot use “premium differentiation” to reflect differences in expected claims costs due to the :
Regulatory constraints on pricing ( new MT*: unisex tariffs)
Reputational: not taking into consideration few ethical considerations in pricing (fear of reputation e.g.: level of education etc.)
Cost of price differentiation (e.g.: health checks)
CSM will vary depending on unit of account as the cash flows capture the differences in expected claims costs.
IASB allows the aggregation of contracts for the measurement of CSM only if a group of contracts is accounted for as “VFA(**)” and the “mutualisation (***)” effect exists among the contracts
cash flows from contracts(****) are deemed to be closely interrelated in the following situations:
For Par contracts: where the dividends to policyholders are calculated based on an entity’s net earnings, losses from A group of par contracts have an impact on B group’s dividend cash flows.
For Renewal premium contracts: where the renewal premium is calculated based on costs of claims made by whole policyholders at the expiration, losses from A group of policyholders have impact on B group’s renewal rates.
For ISP(*****) where the accretion rate is based on an entity’s portfolio earning rates, investment losses from A group have an impact on B group’s accretion rate.
Insurance liabilities are measured on a cost basis, which means they will significantly increase at transition due to the future profits (CSM) from in-force contracts, which results in a decrease in net assets.
(*) Mortality Tables
(**) Variable Fee Approach
(***) Mutualisation of the risks in the same pool for instance
(****)all the contracts are managed in a single pool (e.g.: general fund)
(*****) Insurance proposal
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12. 3. Technical impacts with IFRS 4 PHASE II (5/6)
Illustrative example:
This example will illustrate the changes in the measurement basis of insurance liabilities from cost to fair value (under IFRS 4 PHASE II)
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13. 3. Technical impacts with IFRS 4 PHASE II (6/6)
Illustrative example:
What can we see in the illustrative example of the previous slide?
We can see clearly, an insurer A, which measures its liabilities on a cost basis, will be double penalized due to the adoption of IFRS4 Phase II.
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14. Table of contents 1. Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS under IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
4. Solvency II with IFRS 4 PHASE II
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15. 4. Solvency II with IFRS 4 PHASE II (1/4)
SII
01/01/2016
2018?
2021?
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(*) Classification and valuation of the financial instruments which will replace the actual IAS 39
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16. 4. Solvency II with IFRS 4 PHASE II (2/4)
RAM (*)
Discounted Reserves
CSM
Calculation/
delivery: especially on a quarterly basis
Increase due to new contracts being written during quarter vs decrease due to amortization of in-force business
Will increase the P&L due to its nature of embedded profits
Calculation/
delivery: especially on a quarterly basis
Timing constraints for SCR calculation
Reporting deadline for IFRS: Y/E for March / April (N+1)
IFRS disclosure requirements and consistency with SCR
Quarterly calculation needed
Calculation/
delivery: especially on a quarterly basis
Explanation of the impacts on the discounting regarding the non discounting BE reserves
Consideration of the yield curve per currency
Historical data (rates) needed as the basis for P&L and current rates for the B&S
Impact of any change in discount rates represented in Other(**) Comprehensive Income (OCI)
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(*) Risk Adjusted Margin
(** )Change in Equity (Net Assets) during a period resulting from transaction and other events mainly driven by the valuation method ( revaluation rather than cost model) especially for the long live assets
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17. 4. Solvency II with IFRS 4 PHASE II (3/4)
RAM
Discounted Reserves
CSM
The RM is basically based on the CoC (Cost of Capital)
MVM* =CoC ∑i=1m E(SCR(i)]/[1+r0(i+1)]i+1
Assumptions should be taken into consideration such as:
Use modified duration of the Liabilities (RDR)
Amortization assumptions (simple way) (CSM)
Use a benchmark for quarterly calculation
In Solvency II and Embedded Value calculation, CSM is regarded as a component of net assets in order to reflect the nature of insurance business.
Therefore, in order to provide the economic substance of insurers to stakeholders, insurers should rely on Solvency II and EV reporting.
* Market Value Margin
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18. 4. Solvency II with IFRS 4 PHASE II (4/4)
B&S SII
B&S IFRS4/P2
Own Funds
Free Assets
Goodwill
(GW)
Equities
SCR
MCR
TAX
Assets
Tangible Assets & others (IFRS9)
TAX (IAS12)
BE(L)+ RM
=TP
Residual Margin +
RM+
BE(L)
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19. Table of contents 1. Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS with IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
5. Illustrative BS with IFRS 4 PHASE II
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20. 5. Illustrative BS under IFRS 4 PHASE II (1/3)
Discounted impact
MVM
CSM
IFRS 4 Phase II
UPR
12.093,75
,75
461,25
1.100,00
Claims Res
10.317,50
,50
Total
22.411,25
NPV (Prem Res)
11.250,00
NPV (Claims Res)
9.600,00
TOTAL
This example is just for illustration purpose therefore the calculation are simplified :
MVM (Market Value Margin) calculated using CoC method
Only reserve risk considered
Reserve risk follows a lognormal distribution taking into consideration as parameter the coefficient of variation of the reserves of each individual contract
Risk measure is the VaR at 99.5 %
Yield curve for each ccy
Premium reserves = 100% ULR * unearned premium
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21. 5. Illustrative BS under IFRS 4 PHASE II (1/3)
If for instance we modify the yield curve and the ULR on the QE* we will have impacts on:
A mechanical decrease of the claims reserves
A decrease of the MVM
A mechanical increase of the CSM due to the way in which we estimate it
impact of the yield curve change over the ULR movements
Consequences
a positive P&L impact when ULRs are reduced (actual situation/ IFRS4 Phase I)
IFRS 4 Phase II
reserve release will increase the CSM, which can be understood as deferred profits
transfer of the surplus reserves to the CSM
IFRS 4 Phase II accounting standard is closer to an Embedded Value standard
CSM will be a key in the B&S in a way how to manage the impact of the P&L resulting from reserves releases
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(*) Assumptions should be taken into consideration such as:
Use modified duration of the Liab (RDR)
Amortization assumptions (simple way) (CSM)
Use a benchmark for quarterly calculation
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22. 5. Illustrative BS under IFRS 4 PHASE II (3/3)
Few points to have in mind
Complexity of explaining quarterly variations
Keep attention on the P&L movements
A deep knowledge of each portfolio
Data quality
Actuaries will be more and more involved
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23. Table of contents Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS with IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
7. Implementation issues (grey areas to discuss)
6. Practical example (illustration) on impacts for life and non-life insurers
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24. What are the main steps to follow under IFRS 4 PHASE II?
6. Practical example (illustration) on impacts for life and non-life insurers (1/8)
LIFE INSURERS
NON-LIFE INSURERS
What are the main steps to follow under IFRS 4 PHASE II?
STEP 1: To determine if their contracts are compliant with the IFRS 4 insurance contract definition
Definition: « A contract that transfers a significant risk to the issuying company, by agreeing to compensate the policyholder for adverse effects of a specified uncertain future event »
STEP 2: To determine which model to use to mesure their contracts
STEP 3: To perform re-measurement of their contracts on subsequent periods
STEP 4: To present the results in the financial statements
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Building Blocks Approach (BBA) (Standard Model of IFRS 4)
Variable fee approach (VFA)
(For insurance contracts that incorporate participation features)
Premium Allocation Approach (PAA)
(For shorter duration contracts or longer-term contracts that meet certain criteria*)
- the coverage period of the contract at initial recognition is one year or less;
OR use of the PAA produces measurements that are a reasonable approximation to those of the BBA
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25. ENTITY A main features: IFRS 4 PHASE II Expected Effective Date
6. Practical example (illustration) on impacts for life and non-life insurers (2/8)
LIFE INSURERS
EXAMPLE 1:
ENTITY A main features:
provides life insurance coverage (15-years contracts)
Start date of coverage period: 01/01/2020 (which is in the « Expected» implementation period of IFRS 4 PHASE II)
ILLUSTRATION OF THE STEPS TO FOLLOW UNDER IFRS 4 PHASE 2
STEP 1: Are the contracts of ENTITY A compliant with the IFRS 4 insurance contract definition?
Definition: « A contract that transfers a significant risk to the issuying company, (ENTITY A) by agreeing to compensate the policyholder for adverse effects of a specified uncertain future event (life insurance coverage) »
IFRS 4 PHASE II Expected Effective Date
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ENTITY A has to apply IFRS 4 PHASE II
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26. 6. Practical example (illustration) on impacts for life and non-life insurers (3/8)
EXAMPLE 1 (Continued):
2. STEP 2: Which model is appropriate to be used by ENTITY A to measure its contracts?
Building Blocks Approach (BBA) (Standard Model of IFRS 4)
Variable fee approach (VFA)
(For insurance contracts that incorporate participation features)
Premium Allocation Approach (PAA)
(For shorter duration contracts or longer-term contracts that meet certain criteria*)
Block 1
Future cash flows
Block 2
Time value of money
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Block 4
Contractual service margin
Block 3
Risk adjustment
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27. Contractual service margin
6. Practical example (illustration) on impacts for life and non-life insurers (4/8)
LIFE INSURERS
EXAMPLE 1 (Continued):
2. STEP 2: Which model is appropriate to be used by ENTITY A to measure its contracts?
Block 1
Future cash flows
Block 2
Time value of money
Block 4
Contractual service margin
BLOCK 1
CASHFLOWS OUT
CASHFLOWS IN (premiums)
Net Liability
Block 3
Risk adjustment
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Discouting of future cashflows with discount curve
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28. Value-at-Risk approach
6. Practical example (illustration) on impacts for life and non-life insurers (5/8)
LIFE INSURERS
EXAMPLE 1 (Continued):
2. STEP 2: Which model is appropriate to be used by ENTITY A to measure its contracts?
Block 1
Future cash flows
Block 2
Time value of money
Block 4
Contractual service margin
Value-at-Risk approach
Risk adjustment
Block 3
Risk adjustment
Probability
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Other approaches:
- TVaR
- Cost of Capital
E(BE liability)
VaR (α)
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29. IMPACTS of IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers (6/8)
LIFE INSURERS
EXAMPLE 1 (Continued):
EXAMPLE 1 (Continued):
3. STEP 3: ENTITY A will re-measure its contracts in subsequent periods (e.g: changing underlying assumptions for 2021 given new information)
4. STEP 4: ENTITY A will present the results in the financial statements (reporting of « Profit and Loss » and « Other Comprehensive Income » which reports the PERFORMANCE of the ENTITY A
IMPACTS of IFRS 4 PHASE II S
Important on DATA and OPERATIONAL
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Quality data and breakdown of the contracts over the Building Blocks for the contract’s lifetime are needed
Operational implification for the CSM which is a new element (not in Solvency II)
New aspects from an accouting basis for which the Entity will have to be familiar with
(certains aspects of Solvency II can be used but there are some differences of interpretation between Solvency II and IFRS)
- Implementation costs
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30. ENTITY B main features: IFRS 4 PHASE II Expected Effective Date
6. Practical example (illustration) on impacts for life and non-life insurers (7/8)
NON-LIFE INSURERS
EXAMPLE 2:
ENTITY B main features:
provides property coverage (12-months contracts)
Start date of coverage period: 01/01/2020 (which is in the « Expected» implementation period of IFRS 4 PHASE II)
ILLUSTRATION OF THE STEPS TO FOLLOW UNDER IFRS 4 PHASE 2
STEP 1: Are the contracts of ENTITY B compliant with the IFRS 4 insurance contract definition?
Definition: « A contract that transfers a significant risk to the issuying company, (ENTITY B) by agreeing to compensate the policyholder for adverse effects of a specified uncertain future event (property coverage) »
IFRS 4 PHASE II Expected Effective Date
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ENTITY B has to apply IFRS 4 PHASE II
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31. 6. Practical example (illustration) on impacts for life and non-life insurers (7/8)
EXAMPLE 2 (Continued):
2. STEP 2: Which model is appropriate to be used by ENTITY B to measure its contracts?
Building Blocks Approach (BBA) (Standard Model of IFRS 4)
Variable fee approach (VFA)
(For insurance contracts that incorporate participation features)
Premium Allocation Approach (PAA)
(For shorter duration contracts or longer-term contracts that meet certain criteria*)
Simplier to apply than the Building Blocks Approach as it requires insurers to forecast or risk-adjust the excepted future claims only if they identify contracts as being potentially onerous
It is similar to the « Unearned Premium Reserve » Approach which is applied in current accounting for non-life contracts
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32. IMPACTS of IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers (8/8)
NON-LIFE INSURERS
EXAMPLE 1 (Continued):
EXAMPLE 2 (Continued):
3. STEP 3: ENTITY B will re-measure its contracts in subsequent periods (e.g: changing underlying assumptions for 2021 given new information)
4. STEP 4: ENTITY B will present the results in the financial statements (reporting of « Profit and Loss » and « Other Comprehensive Income » which reports the PERFORMANCE of the ENTITY B
IMPACTS of IFRS 4 PHASE II S
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Data quality and processes
Could reduce the implementation costs compared to the use of the Buildings Block Approach
Maintain consistency with the Buildings Block Approach
The inclusion of Risk Margin generally leads to deferment of profits
Premium Allocation Approach is a simplification but further analysis needs to be carried (actuarial analysis may be required)
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33. Table of contents Why IFRS 4 PHASE II?
2. Global Impacts with IFRS 4 PHASE II
3. Technical Impacts with IFRS 4 PHASE II
4. Solvency II with IFRS 4 PHASE II
5. Illustrative BS with IFRS 4 PHASE II
6. Practical example (illustration) on impacts for life and non-life insurers
6. Implementation issues (grey areas to discuss)
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7. Implementation issues (grey areas to discuss)
IFRS 4 PHASE II - ACTUAM
23/09/2016
© Copyright ACTUAM 2016

34. 7. Implementation issues (grey areas to discuss)
The adoption of IFRS 4 Phase II will take place in parallel with several European reforms of insurance risk-based capital regulations that are anticipated to be based on broadly the same principles offering strategic synergy benefits in terms of financial and solvency reporting
Implementation time frame is extensive, the implementation costs material and the activities will impact several dimensions of insurers’ operating models.
Unit of Account –i.e. Level of Aggregation into Portfolios?
What are directly attributable expenses?
How will discount curves be determined?
How frequently are discount curves updated?
Which simplifications will be made in cash flow projections?
Which products will be considered in scope of the Variable Fee approach (VFA)?
CSM measured based on Lower unit of account Vs. Higher unit of account which one does properly represent the contracts’ profitability?)
Does the definition of “mutualisation” proposed by IASB properly capture the nature of insurance business?
How to reflect the economic substance of insurers on the financial statements?
ACTUAM S.à.r.l - Actuarial and Risk Services
66, rue du X Octobre ∙ L-7243 Luxembourg
Tel : +352   :
Site:
©Copyright ACTUAM 2015
IFRS 4 PHASE II - ACTUAM
23/09/2016
© Copyright ACTUAM 2016

35. We are happy to answer any question:
8. Questions & Answers
We are happy to answer any question:
address:
Tel: (+352)
Website:
ACTUAM S.à.r.l - Actuarial and Risk Services
66, rue du X Octobre ∙ L-7243 Luxembourg
Tel : +352   :
Site:
©Copyright ACTUAM 2015
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IFRS 4 PHASE II - ACTUAM
23/09/2016
© Copyright ACTUAM 2016