1. Click to edit Master title style !@# Casualty Loss Reserving Seminar – San Diego, CA September 10 – 11, 2007 www.ey.com/us/actuarial INSURANCE AND ACTUARIAL ADVISORY SERVICES International Accounting – Emerging Issues Fair Value Accounting Update Gareth Kennedy

2. 1 © 2007 Ernst & Young LLP Section I Agenda  Overview of the International Accounting Standards Board (IASB) Discussion Paper (DP) with tentative American Academy of Actuaries (AAA) Working Group (WG) feedback: –Measurement model –Estimate of future cash flows –The time value of money –Risk margins –Unit of account –Reinsurance

3. 2 © 2007 Ernst & Young LLP Overview of the IASB DP Measurement Model  Single measurement model to be used for future cash flows: –For P&C and Life insurance contracts –For insurance and reinsurance contracts –During claims period and pre-claims period  DP proposes that insurance liabilities be measured at Current Exit Value (CEV) Continued

4. 3 © 2007 Ernst & Young LLP Overview of the IASB DP Measurement Model  Definition of CEV: –“…the amount an insurer would expect to pay at the reporting date to transfer its remaining contractual rights and obligations immediately to a market participant.”  IASB has not yet identified any significant difference between the notion of CEV and fair value Continued

5. 4 © 2007 Ernst & Young LLP Overview of the IASB DP Measurement Model  To measure CEV the IASB proposes that three explicit building blocks are required for insurance contracts: Estimated future cash flows Effect of the time value of money Risk and service margin

6. 5 © 2007 Ernst & Young LLP Overview of the IASB DP Estimate of Future Cash Flows  IASB’s preliminary view is that cash flows should be: –Explicit –Consistent with observable market prices –Unbiased –Current –Exclude entity specific cash flows

7. 6 © 2007 Ernst & Young LLP Overview of the IASB DP The Time Value of Money  Requires that best estimates of future cash flows are explicitly reduced for the time value of money  Discount rate should be based on current market rates for cash flows with the same timing as the weighted average contract cash flows Continued

8. 7 © 2007 Ernst & Young LLP Overview of the IASB DP The Time Value of Money  DP does not specify a discount rate although it is presumed by many that a risk-free rate or close to one will be used  P&C members of the AAA WG believe discounting with the addition of a separate risk margin is compliant with Actuarial Standard of Practice 20 and is a good measure of economic value

9. 8 © 2007 Ernst & Young LLP Overview of the IASB DP Risk Margins  IASB’s preliminary view is: –“the risk margin should be an explicit and unbiased estimate of the margin that market participants require for bearing risk” –It is not intended as a shock absorber for unexpected losses nor to enhance the insurer’s solvency –“the observed price for a transaction with a policyholder …. should not override an unbiased estimate of the margin another party would require to take over the insurer’s contractual rights and obligations” Continued

10. 9 © 2007 Ernst & Young LLP Overview of the IASB DP Risk Margins  The last point may result in profits or losses at a policy’s inception  Some IASB members are in favor of an alternative definition that calibrates the risk margin to the premium at inception, combined with a liability adequacy test  Supporters of CEV believe this is an entry value approach Continued

11. 10 © 2007 Ernst & Young LLP Overview of the IASB DP Risk Margins  IASB does not plan to prescribe what methods are appropriate to develop a risk margin  Instead the IASB will publish attributes that the methods should have and leave industry practitioners to develop further guidance

12. 11 © 2007 Ernst & Young LLP Overview of the IASB DP Unit of Account  Definition: “portfolio of contracts that are subject to broadly similar risks and managed together as a single portfolio”  When developing risk margins, the DP proposes that it should be calculated at a unit of account level  No benefit of diversification beyond unit of account

13. 12 © 2007 Ernst & Young LLP Overview of the IASB DP Reinsurance  There is a lack of mirror accounting and recognition between a ceded reinsurance asset and an assumed liability in the DP for a reinsurance contract written on a policies attaching basis  DP argues remaining asset has little contractual value if underlying policies are issued at CEV  Reinsurance liability would be valued using all future cash flows

14. 13 © 2007 Ernst & Young LLP Section II Agenda  Comparison of DP to Financial Accounting Standards Board (FASB) Statements 157 and 159: –FASB Statement 159 –FASB Statement 157 –Comparison to IASB DP

15. 14 © 2007 Ernst & Young LLP FASB Statements 157 and 159 FAS 159 – Fair Value Option  Provides a voluntary election to account for certain assets and liabilities at their fair value – including P&C insurance liabilities  Provides a one-time chance to elect fair value option for any existing liabilities without affecting income  Option is irrevocable and all future changes in fair value must be recognized in income

16. 15 © 2007 Ernst & Young LLP FASB Statements 157 and 159 FAS 157 – Fair Value Measurement  Defines fair value for financial reporting purposes under U.S. GAAP as the “… price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”  Market based not entity specific entity specific measurement  Statement is not insurance specific

17. 16 © 2007 Ernst & Young LLP FASB Statements 157 and 159 Comparison of FAS 157 to IASB DP  FAS 157 more general than IASB DP  Principles from DP currently fit well into the more general FAS 157 principles  Impact of FAS 157 currently optional for P&C insurance liabilities – IASB standard that will arise from DP will be compulsory

18. 17 © 2007 Ernst & Young LLP International Accounting – Emerging Issues Fair Value Accounting Update Gareth Kennedy 312-879-4459 gareth.kennedy@ey.com