1. International Accounting Standards Board ® May 2006 The IASB’s project on Insurance Contracts Peter Clark Senior Project Manager International Accounting Standards Board www.iasb.org.uk

2. ® May 2006 Overview Insurance contracts phase I Insurance contracts phase I  IFRS 4 Insurance contracts IAS 39 IAS 39 Insurance contracts phase II Insurance contracts phase II Convergence Convergence

3. ® International Accounting Standards Board May 2006 IFRS 4 Insurance Contracts Objectives Objectives Scope Scope Definition of insurance contract Definition of insurance contract Recognition and measurement Recognition and measurement Disclosure Disclosure

4. ® International Accounting Standards Board May 2006 IFRS 4 objectives Limited improvements for 2005 Limited improvements for 2005 Avoid Avoid  delay to phase II  changes that phase II might reverse

5. ® International Accounting Standards Board May 2006 Scope Insurance and reinsurance contracts issued Insurance and reinsurance contracts issued Reinsurance contracts held Reinsurance contracts held No exemption from other IFRSs No exemption from other IFRSs  IAS 39 covers financial assets, financial liabilities (‘investment contracts’) and derivatives

6. ® International Accounting Standards Board May 2006 Definition of insurance contract (1) 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 adversely affects the policyholder 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 adversely affects the policyholder

7. ® International Accounting Standards Board May 2006 Definition of insurance contract (2) Significant insurance risk Significant insurance risk  Significant additional benefits in any scenario (that has commercial substance)  Not a percentage test  Contract by contract Unbundling a deposit component Unbundling a deposit component

8. ® International Accounting Standards Board May 2006 Recognition and measurement Exemption from hierarchy in IAS 8 Exemption from hierarchy in IAS 8 Reinsurance Reinsurance Discretionary participation features Discretionary participation features

9. ® International Accounting Standards Board May 2006 IAS 8 hierarchy (1) Criteria to use in developing an accounting policy if no IFRS or Interpretation applies specifically Criteria to use in developing an accounting policy if no IFRS or Interpretation applies specifically  Relevance  Reliability  Other IFRSs  Framework

10. ® International Accounting Standards Board May 2006 IAS 8 hierarchy (2) Temporary exemption in phase I for: Temporary exemption in phase I for:  insurance (or reinsurance) contracts issued  reinsurance contracts held BUT BUT  Do not change accounting policy unless result is more relevant and reliable  Limited changes required (due to hierarchy)  May continue some existing practices, but not introduce them

11. ® International Accounting Standards Board May 2006 Limited changes No catastrophe or equalisation provisions No catastrophe or equalisation provisions Liability adequacy test Liability adequacy test Reinsurance Reinsurance Derecognition of insurance liabilities Derecognition of insurance liabilities  Only when the obligation is discharged or cancelled or expires

12. ® International Accounting Standards Board May 2006 Limited changes: Reinsurance Reinsurance contract Reinsurance contract  No special definition (insurance between two insurers) No offsetting No offsetting Impairment test Impairment test  Incurred loss model (as in IAS 39) Disclose gains at inception Disclose gains at inception

13. ® International Accounting Standards Board May 2006 Some existing practices may continue May continue, but not introduce: non-discounting of insurance liabilities non-discounting of insurance liabilities off-market measurement of contractual rights to investment management fees off-market measurement of contractual rights to investment management fees non-uniform accounting policies for insurance liabilities of subsidiaries non-uniform accounting policies for insurance liabilities of subsidiaries excessive prudence excessive prudence future investment spreads (rebuttable presumption) future investment spreads (rebuttable presumption)

14. ® International Accounting Standards Board May 2006 Discretionary participation features (1) What are discretionary participation features (DPF)? What are discretionary participation features (DPF)? Insurance contracts with DPF Insurance contracts with DPF Investment contracts with DPF Investment contracts with DPF Premiums Premiums Profit or loss attributable to DPF Profit or loss attributable to DPF

15. ® International Accounting Standards Board May 2006 Discretionary participation features (2) Contractual right to additional benefits: likely to be significant portion of total benefits likely to be significant portion of total benefits amount or timing contractually at the discretion of the issuer, and amount or timing contractually at the discretion of the issuer, and contractually based on: contractually based on:  performance of specified contracts  returns on specified assets, or  profit or loss

16. ® International Accounting Standards Board May 2006 Insurance contracts with DPF Guaranteed element Guaranteed element  Policyholder has unconditional right  Must classify as liability Discretionary participation feature Discretionary participation feature  May classify as liability, equity or split  Do not show as mezzanine

17. ® International Accounting Standards Board May 2006 Investment contracts with DPF May classify whole contract as liability May classify whole contract as liability  If so, apply liability adequacy test May classify part or all of DPF in equity May classify part or all of DPF in equity  Reported liability not less than IAS 39 measurement of guaranteed element

18. ® International Accounting Standards Board May 2006 Contracts with DPF: Premiums May report the whole premium as revenue May report the whole premium as revenue  Even for investment contracts  Even if part or all DPF is classified in equity Portion of profit or loss attributable to equity portion (if any) of DPF Portion of profit or loss attributable to equity portion (if any) of DPF  not expense, but allocation of profit

19. ® International Accounting Standards Board May 2006 Profit or loss attributable to DPF Profit for the period XXX Attributable to: Equity holders of the parent XXX Equity component of DPF XXX Minority interest XXX XXX

20. ® International Accounting Standards Board May 2006 Disclosure Reported amounts Reported amounts Amount, timing and uncertainty of cash flows, eg Amount, timing and uncertainty of cash flows, eg  Sensitivity analysis  Claims development

21. ® International Accounting Standards Board May 2006 Financial Instruments: IAS 39 Financial assets Financial assets Financial liabilities Financial liabilities  ‘investment contracts’

22. ® International Accounting Standards Board May 2006 Financial assets Economic mismatch or accounting mismatch? Economic mismatch or accounting mismatch?  NB disclosure implications May reclassify some or all financial assets as ‘at fair value through P&L’ May reclassify some or all financial assets as ‘at fair value through P&L’ May switch to current discount rates for some or all insurance liabilities May switch to current discount rates for some or all insurance liabilities ‘Shadow accounting’ ‘Shadow accounting’

23. ® International Accounting Standards Board May 2006 ‘Investment’ contracts IAS 39 applies Premiums = deposit receipt, not revenue Premiums = deposit receipt, not revenue Asset cash flows do not affect liability measurement Asset cash flows do not affect liability measurement Service fee revenue (see IAS 18 Revenue) Service fee revenue (see IAS 18 Revenue) Measure at: Fair value, or Fair value, or Amortised cost Amortised cost

24. ® International Accounting Standards Board May 2006 Phase II Key objectives up to date estimates of: up to date estimates of:  cash flows  an appropriate price for those cash flows use observable market inputs, where they exist use observable market inputs, where they exist a measurement attribute that users can understand, as a basis for economic decisions a measurement attribute that users can understand, as a basis for economic decisions  not just a computation

25. ® International Accounting Standards Board May 2006 Ingredients to meet those objectives estimates of future cash flows estimates of future cash flows time value of money time value of money a margin a margin

26. ® International Accounting Standards Board May 2006 Future cash flows Current estimates Current estimates Unbiased Unbiased Probability-weighted (expected value) Probability-weighted (expected value) Principles, not detailed guidance Principles, not detailed guidance

27. ® International Accounting Standards Board May 2006 Time value of money Even for non-life Even for non-life Current market discount rates Current market discount rates Expected returns on actual assets are not relevant (unless they affect the liability cash flows) Expected returns on actual assets are not relevant (unless they affect the liability cash flows)

28. ® International Accounting Standards Board May 2006 Margin As required by market participants, for As required by market participants, for  bearing risk (risk margin)  other services (profit margin) Not intended as a shock absorber Not intended as a shock absorber How calibrated? How calibrated?  Gain or loss at inception?

29. ® International Accounting Standards Board May 2006 A measurement attribute users can understand? Current exit value: amount the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity amount the insurer would expect to have to pay today to another entity if it transferred all its remaining contractual rights and obligations immediately to that entity … excluding any payment for other rights and obligations … excluding any payment for other rights and obligations

30. ® International Accounting Standards Board May 2006 Current exit value Best meets the objectives discussed earlier Best meets the objectives discussed earlier Relevant and reliable information to help users with economic decisions Relevant and reliable information to help users with economic decisions Does not imply that an insurer can, will or should actually transfer the liability to a third party Does not imply that an insurer can, will or should actually transfer the liability to a third party In most cases, insurers cannot transfer the liabilities and do not want to do so In most cases, insurers cannot transfer the liabilities and do not want to do so

31. ® International Accounting Standards Board May 2006 Advantages of the approach information on amount, timing and uncertainty of contractual cash flows information on amount, timing and uncertainty of contractual cash flows consistent approach to changing estimates of cash flows consistent approach to changing estimates of cash flows coherent way to resolve new issues coherent way to resolve new issues consistency with IFRSs on other liabilities (especially IAS 37) consistency with IFRSs on other liabilities (especially IAS 37) margins are explicit and reflect release from risk margins are explicit and reflect release from risk clear reporting of economic mismatches clear reporting of economic mismatches

32. ® International Accounting Standards Board May 2006 Other points (1) Unearned premium: Unearned premium:  sometimes a reasonable proxy Acquisition costs Acquisition costs  Expense (deferral would be double counting) Unit of account? Unit of account?

33. ® International Accounting Standards Board May 2006 Other points (2) Focus on contractual rights and obligations Focus on contractual rights and obligations Embedded options and guarantees Embedded options and guarantees Policyholder cancellation options Policyholder cancellation options Participating contracts Participating contracts Investment contracts Investment contracts

34. ® International Accounting Standards Board May 2006 Embedded Value? Increasingly common (life) Increasingly common (life)  Largely unregulated Some similarity with current exit value Some similarity with current exit valueBUT  includes future investment returns  capital lock-in  off-market measurement of contractual rights to investment management fees

35. ® International Accounting Standards Board May 2006 Other relevant projects Conceptual Framework Conceptual Framework Revenue Revenue Liabilities / equity Liabilities / equity Performance reporting Performance reporting Financial instruments Financial instruments

36. ® International Accounting Standards Board May 2006 Phase II timetable Discussion paper Q4 2006 Exposure Draft 2008 Standard2009 Implementation?

37. ® International Accounting Standards Board May 2006 Convergence – general A high priority A high priority SEC ‘roadmap’ SEC ‘roadmap’  eliminate reconciliation to US GAAP? Memorandum of Understanding between the IASB and FASB Memorandum of Understanding between the IASB and FASB A two-way process A two-way process

38. ® International Accounting Standards Board May 2006 Convergence – insurance contracts A ‘modified joint’ project. FASB expects : A ‘modified joint’ project. FASB expects :  to issue Discussion Paper (not deliberated)  to review the responses in assessing whether to join in a joint project US mini projects on insurance: US mini projects on insurance:  Risk transfer  Financial guarantees  Life settlements

39. ® International Accounting Standards Board May 2006 Convergence – insurance contracts A ‘modified joint’ project. FASB expects: A ‘modified joint’ project. FASB expects:  to issue Discussion Paper (not deliberated)  to review the responses in assessing whether to join in a joint project US mini projects on insurance: US mini projects on insurance:  Risk transfer  Financial guarantees  Life settlements

40. ® International Accounting Standards Board May 2006 Know More about IASB Our website www.iasb.org Our website www.iasb.org  includes news and project summaries  and much more… Newsletters: Newsletters:  IASB Insight (quarterly)  IASB Update (after each Board meeting)  IFRIC Update (after each IFRIC meeting)