ifrs 4 phase ii updates - actuaries.org.hk 4 phase ii updates.pdf · page 3 overview ifrs 4...

Mike Wong, Ernest Yip, Steve Cheung 10 June 2015

IFRS 4 Phase II updates

Agenda

1 Overview

2 Insurance contracts standard: non-par contract

3 Current discussion: par contract

Section 1

Overview

Overview IFRS 4 Insurance contracts & IFRS 9 Financial instruments – timeline

Ongoing IASB deliberations Implementation period Reporting

IFRS 4 phase II final standard?

IFRS 4 phase II effective date ?

IFRS 4 phase II first financial statements?

IFRS 4 phase II re-exposure draft

IFRS 4 phase II start of comparative period ?

IFRS 9 first financial

statements

IFRS 9 start of comparative period

IFRS 9 final standard

IFRS 9 effective date 1 Jan 2018

IFR

S 4

IF

RS

9

IFRS 9 deferred effective date for

Insurers?

2013 2014 2015 2016 2017 2018 2019 2020

Overview A Standard that better meets the needs of users

Single accounting approach

Provides up-to-date market consistent information of

obligation including value of options & guarantees

Reflects time value of money

Treats services provided by underwriting activity as revenue and expenses in comparable way to other non-insurance business

Provides separate information about the investment and underwriting performance

Reflects the characteristics of the insurance contract rather than the risk related to asset/ investment

activity

The goal of new standard is to improve the quality of financial reporting by providing more transparent and comparable information.

Section 2

Insurance contracts standard: Non-par contract

Insurance contracts standard Building block approach – overview

Risk adjustment

Time value of money

Fulfilment cash flows

Contractual service margin

The unearned profit that the entity recognizes as it provides services

The compensation that an entity requires for bearing the uncertainties about the amount and timing of the cash flows

Discount rate that reflects the characteristics of the liabilities

An explicit, unbiased and probability-weighted estimate of future net cash flows that will arise as the entity fulfils the insurance obligations

Overview

Use of current market rate

Explicit estimate of the effect of

uncertainty about amount and timing of cash flows

Eliminate Day 1 gain

Profits earned over coverage period

Acquisition cost deferral

Reflect the impact of discount rate change through P/L or OCI

Spread the impact of changes in estimate of future cash flows over contract period

Insurance contracts standard Building block approach - contractual service margin

Risk adjustment

Time value of money

Future cash flows


Represent the unearned profit that the entity will systematically recognize as it provides services under the contract

At initial recognition:

CSM is recognized as an amount opposite to the sum of:

The amount of the fulfilment cash flows for the insurance contract at initial recognition and

Any pre-coverage cash flows

Eliminate any day 1 gains

CSM shall not be negative. If the contract is onerous, all loss should be recognized in profit or loss

Example:

At inception of the policy,

BEL(0) = - 100

RA(0) = 20

Hence,

CSM(0)

= - BEL(0) – RA(0) = 80


Risk adjustment

Time value of money

Future cash flows


Represent the unearned profit that the entity recognizes as it provides services under the contract

At subsequent measurement:

CSM at the end of the period equals to:

CSM at the start of the period

Plus accretion of interest using locked rate at the inception of the contracts

Minus the amount recognized for services that were provided in the period

Unlock for the difference between current and previous estimate of BEL and RA

Example:

CSM(0) = 80

Interest rate = 5%

Amortization = 20% per year

No change in future estimates of BEL and RA

CSM(1)

= CSM(0) x (1 + 5%) x 80%

= 80 x (1 + 5%) x 80%

= 67.2


Risk adjustment

Time value of money

Future cash flows


Discount rate:

Use locked-in rate at the inception of the contract for accreting interest on the CSM and for calculating the change in PV of future CFs that offset the margin

Significant impact to

system and data storage

2005 cohort

2006 cohort

2007 cohort

2008 cohort

2009 cohort

2010 cohort

BEL

= 80 BEL

= 50

RA

= 30 RA

= 20

• Locked-in rates

• Previous non-

economic

assumptions

• Locked-in rates

• Latest non-

economic

assumptions

Change in future

estimates

Unlocking of CSM:

Unlock CSM for changes in estimate of BEL and RA that relate to future services or coverages

Base Scenario 1 Scenario 2

Before Assumption Change

Favorable Assumption Change

Unfavorable Assumption Change


Risk adjustment

Time value of money

Future cash flows


• No change in the total liability

• No P/L impact

• CSM is exhausted

• P/L impact = - 20

BEL = 100

RA = 80

CSM = 20

BEL = 90

RA = 70

CSM = 40

BEL = 120

RA = 100


Risk adjustment

Time value of money

Future cash flows


Previously recognized losses:

Keep track of the previously recognized losses

Allow for accretion of interests and amortization of the balance going forward


Risk adjustment

Time value of money

Future cash flows



Recognize favorable changes in estimates in P/L to the extent that they reverse the previously recognized losses

Favorable change = 200

Favorable change in future estimates Reverse previously recognized losses Recognize profit in P/L


Risk adjustment

Time value of money

Future cash flows



Re-establish CSM when all previous losses are reversed

Favorable change = 400

Another favorable change in future estimates

Re-establish positive CSM of 150

Continue to reverse previously recogized losses and recogize profit of 250 in P/L


Risk adjustment

Time value of money

Future cash flows


Profit recognition:

Recognize the remaining CSM in P/L over the coverage period in a systematic way that best reflects the remaining transfer of the services

The service represented by the CSM is insurance coverage that is provided:

on the basis of passage of time and

reflects the expected number of contracts in force


Risk adjustment

Time value of money

Future cash flows


Level of aggregation:

Objective of the standard is to provide principles for the measurement of an individual insurance contract. In applying the standard, an entity could aggregate insurance contracts provided that it meets the objective; and

At initial recognition, onerous contracts should not be aggregated with profit-making contracts

Despite the clarity provided by the IASB, the industry is still concerned about the level of aggregation for determining CSM because it may not be in line with how they manage their business

Statement of comprehensive income

Insurance contract revenue X

Total revenue X

Claims & expenses incurred X

Non-attributable expenses X

Losses at initial recognition of contracts X

Minus: reverse of previously recognized losses X

Total expense X

Underwriting result X

Investment income on the underlying assets X

Interest expense X

Investment result X

Other profit and loss X

Profit or loss before tax X

Income tax expense X

Profit or loss net of tax X

Other comprehensive income X

Total comprehensive income net of tax X

Insurance contracts standard Interest expenses and accounting option for the effect of discount rate change

• Investment result = Investment income on the underlying assets – Interest expense on insurance liability

• An entity can choose to present the effect of discount rate change in either P/L or OCI as its accounting policy

Present the effect of discount rate change through

P/L OCI

Interest expense Current

rate Locked-in rate

Other comprehensive income

-

Difference in interest expense calculated using current rate and

locked-in rate

Insurance contracts standard Subsequent measurement – recap

Contractual service margin (Expected contract profit)

Future cash flows

Risk adjustment

Discounting

Fulfilment cash flows

Change in CFs related to past

and current services

Release of RA related to past

and current services

Effect of changes in

discount rates

Release of CSM

Interest expense at locked in

discount rate

Changes in the measurement of the insurance contracts would flow through different line items of the financial statements, depending on the sources of the changes.

Profit or loss: Underwriting result

Profit or loss: Investment result

Other comprehensive income

Change in estimates relating to

future services

Insurance contracts standard Simplified approach - premium allocation approach

Premiums received (plus any

additional onerous contract liability)

Acquisition costs

Liability for remaining coverage


► An entity may simplify the measurement using the PAA when: ► The coverage period at initial recognition is one year or less; or ► PAA produces a reasonable approximation of BBA

Start of coverage period Valuation date Insurance liability is extinguished




Acquisition costs





Insurance contract revenue

► Recognition of insurance contract revenue in profit or loss

► On the basis of passage of time; but

► If the expected pattern of release of risk differs significantly from the passage of time, then on the basis of expected timing of incurred claims and benefits





Present value of

expected cash flows

Risk adjustment


Liability for incurred claims

► Measured using BBA


Acquisition costs



Insurance contracts standard Reinsurance overview – cedent’s perspective

CSM

Expected future cash

flows

Risk adjustment

Time value of money

CSM

Reinsured part of cedent’s liability

Expected future cash

flows

Risk adjustment

Time value of money

Cedent’s reinsurance

asset

CSM

Consistent assumptions as the underlying direct contract

Reflect the non-performance

risk

Positive/ negative CSM

► Measurement for reinsurance held

► Any net cost or net gain -> recognise as a CSM except there is net cost on the coverage relates to event that occurred before the purchase of the reinsurance

► To avoid asymmetric treatment between reinsurance and direct contracts

► After inception, if there are changes in future estimate of direct contract that would impact P/L, entity should also recognise in P/L the corresponding impact from the reinsurance contract

Separated from the direct contracts

Bearing the risk

Provision of coverage and services

Non-distinct investment component


Risk adjustment

Expected claims and expense, and the part of the premium allocated to the

recovery of directly attributable acquisition cost

Present value of premium income at inception of the contract

Insurance contracts standard Presentation - insurance contract revenue

► An entity should:

► Present insurance contract revenue (ICR) and expenses in the statement of comprehensive income

► Be prohibited from presenting premium information

Performance obligations

Non-distinct investment components are excluded from the definition of ICR and claims

& expenses incurred

Interest Allocate total revenue over the coverage period of the contract

Insurance contracts standard Presentation - insurance contract revenue

Year 1 2 3 4 5 6 7 8 9 …

Non-distinct investment component


Risk adjustment

Expected claims and expense, and the part of the premium allocated to the

recovery of directly attributable acquisition cost

1. Release in CSM 2. Release of RA relating to past coverage 3. Expected claims and expenses and 4. The part of the premium allocated to the recovery of

directly attributable acquisition costs

Present value of premium income at inception of the contract


Statement of comprehensive income

Insurance contract revenue X

Total revenue X

Claims & expenses incurred X

Non-attributable expenses X

Losses at initial recognition of contracts X

Minus: reverse of previously recognized losses X

Total expense X

Underwriting result X

Investment income on the underlying assets X

Interest expense X

Investment result X

Other profit and loss X

Profit or loss before tax X

Income tax expense X

Profit or loss net of tax X

Other comprehensive income X

Total comprehensive income net of tax X

Insurance contracts standard Presentation – statement of comprehensive income

1

2

3

Insurance contracts standard Transition

► Three approaches for transition are proposed:

Approach Conditions

Full retrospective approach When historical data exists and hindsight is not required

Simplified retrospective approach

When not all historical information is available but information about historical cash flows is available or can be constructed

Fair value approach When no historical information about cash flows is available to determine the CSM

Insurance contracts standard Transition

► Re-designation of financial assets

► The IASB tentatively decided to consider providing further transition relief to permit or require an entity to reassess the business model for financial assets at the date of initial application of the new insurance contracts standard.

► The European Financial Reporting Advisory Group (EFRAG) had advised the European Commission to ask the IASB to defer the effective date of IFRS 9 for insurance businesses and to align it with the effective date of the new insurance contracts standard.

Numerical example: Non-par contract

A non-par product 10 year limited pay, whole life coverage

Issued in 1998

Sum assured upon death

Cash value upon surrender

IFRS 4 Phase I valuation: net-level premium approach

Locked-in valuation assumptions (discount rate = 7%)

IFRS 4 Phase II valuation: building block approach

Transition date: YE 2014

Numerical example Background

Valuation date 1998 2014 2014 2014 2014

Non-economic assumption

1998 1998 2014 2014 Prudent

Discount rate 1998 1998 1998 2014 7.0%

BEL = (11.0)

BEL = 51.5 BEL = 46.9 BEL = 95.6

CSM = 6.3

CSM = 3.8

RA = 2.5

RA = 2.5

Initial measurement

Subsequent measurement Phase I

result = 116.6

RA = 4.7

RA = 4.8 CSM = 10.7

CSM = 10.7 (Unit in mil)

Phase II result = 108.8

<

1 2 3 4 5

Numerical example Overview of results – step by step

Transition

0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2014 2024 2034 2044 2054

Calendar year

Profit & loss

IFRS 4 Phase II investment result

IFRS 4 Phase II underwriting result

IFRS 4 Phase II profit & loss

IFRS 4 Phase I profit & loss

(Unit in mil)

In this example, on P&L:

► Phase I P&L ( black line): more

profit is released at later period ► Phase II P&L ( red line): profit

is accelerated ► Mainly due to underwriting

result ( color)

► Investment result ( color), can become negative under low interest rate environment

Numerical example Profit & loss

Section 3

Current discussion: Par contracts

► Mirroring approach in 2013 Exposure Draft:

► Applies when (i) the contract requires holding underlying items, and (ii) specifies a link between the payments to the policyholder and the returns on those underlying items.

► When applicable, measure the fulfilment cash flows that are expected to vary directly with returns on underlying items by reference to the carrying amount of the underlying items.

Current discussion Participating contracts - 2013 Exposure Draft

Behaviour of cash flows

Vary directly Vary indirectly Do not vary

Measurement By reference

to underlying items Building block approach

Presentation of measurement changes

Consistent with underlying items

Profit or loss Profit or loss or OCI,

following general requirements

► The ‘mirroring approach’ proposed in the 2013 ED was considered by many respondents as being overly complex and not fit for purpose.

► In November 2014, the IASB held an education session in which representatives of the European CFO Forum presented their alternative proposal for the accounting for contracts with participation features.

Current discussion Participating contracts - industry concerns on 2013 Exposure Draft

Key principles of the alternative proposal:

1. Applicable to all types of participating contracts

2. One measurement basis for all insurance contracts

3. Fully unlocked CSM

4. CSM is released in P/L in a way that best reflects the transfer of services under the contract

5. Current portfolio book yield used to determine interest expense in P/L

6. The insurer elects to present the effect of changes in the discount rate in OCI or P/L as an accounting policy choice

► The IASB held two educational sessions in 2015 to discuss the possible adaptions to the general model for contracts with participation features. No tentative decisions have been made so far.

► The staff proposed two possible views on the entity’s interest in such underlying items:

Current discussion Participating contracts – educational sessions by the IASB

View of entity’s economic interest Measurement model

Indirect participation

contract

As a share of economic returns from the underlying items

General model approach

Direct participation

contract

Promise to pay an amount equal to the value of underlying items less a variable fee for services

Variable fee approach

► Three criteria for variable fee approach:


The contract specifies a participation in clearly identifiable underlying pools of assets (or other underlying items).

1

The entity expects that a substantial proportion of the cash flow from the contract will vary with underlying items.

2

The entity expects that the policyholder will receive a substantial share of the returns.

3


► Key differences between indirect and direct participation contract:

Indirect participation contracts [General model approach]

Direct participation contracts [Variable fee approach]

Unlocking of CSM due to change in underlying item

The CSM would not be unlocked:

• The changes in estimates that arise because of changes in financial assumptions (change in discount rate) would be recognized in P/L or OCI

The CSM would be unlocked for changes in:

• The expected present value of variable fee for service and

• The expected present value of the cost of guarantees

Discount rate for accretion of CSM and unlocking

View 1: Follow the general model approach

• Locked-in rate

View 2: Follow the variable fee approach

• Current rate

• No need to accrete interest on the CSM as the measurement of the value of the underlying items already reflects the time value of money in the obligation

• Unlock the CSM using the current liability rate at reporting date


► Key differences between indirect and direct participation contract

► Assuming that the OCI option is permitted:

Indirect participation contracts [General model approach]

Direct participation contracts [Variable fee approach]

Interest expenses

The entity may choose as its accounting policy to determine the interest expense in P/L using • the current discount rate or • an effective yield approach

When the entity has not held the assets in each reporting period: • the entity may choose as its accounting policy to determine interest

expense in P/L using

• the current discount rate or • an effective yield approach. When the entity expected at inception to hold the assets and has held the assets in each reporting period. • the entity may choose as its accounting policy to determine interest

expense in P/L using either

• the current discount rate, • an effective yield approach or • a current period book yield approach


• In scope of variable fee approach; and

• The underlying items are held by the entity to ensure an exact match between the items underlying the obligation and the obligation itself exists

Current period book yield approach

► The interest expense would be equal and opposite to investment income on the underlying items.

Year 1 Year 2 Year 3 Year 4 Year 5

Investment income

70.0

164.7

61.7

64.8

68.1

Interest expense

(70.0)

(164.7)

(61.7)

(64.8)

(68.1)

Investment results 0 0 0 0 0

Other comprehensive income 10 12 32 (9) (20)

► The difference between the interest expense in profit or loss and the interest expense determined based on current rates would be reported in OCI for both the underlying items and the insurance liability.

Insurance contracts standard Major open discussion points in IFRS 4

Participating contracts

► Variable fee approach ?

► Approach for universal life contracts ?

► Re-open debate on the general model ?

► Allocation of CSM over coverage period?

► Interest expense ?

► Presentation of changes in discount rates ?

► Transition

Level of aggregation

► Objective of IASB: measure CSM at individual contract level

► No compensation between onerous and profitable contracts

► “Mutualisation” in participating contracts

► Implications for non-participating contracts

Key items to be resolved ► Participating contracts ► Level of aggregation

No decisions taken

Significant impact

Thank you

EY

Assurance | Tax | Transactions | Advisory

About EY

Ernst & Young is a global leader in assurance, tax,

transaction and advisory services. Worldwide, our over

200,000 people are united by our shared values and an

unwavering commitment to quality. We make a difference by

helping our people, our clients and our wider communities

achieve potential.

For more information, please visit

www.ey.com.

EY refers to the global organization of member firms of Ernst

& Young Global Limited, each of which is a separate legal

entity. Ernst & Young Global Limited, a UK company limited

by guarantee, does not provide services to their clients.

© 2015 Ernst & Young

All Rights Reserved.

ifrs 4 phase ii updates - actuaries.org.hk 4 phase ii updates.pdf · page 3 overview ifrs 4...

Documents