pd-25: ifrs updatemeetings.actuaries.ca/annual/2009/pd-25 parkinson.pdfget ready parallel ifrs...

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PD-25: IFRS UpdatePD-25: IFRS Update

CIA Annual Meeting

Halifax, June 25, 2009

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AgendaAgenda

Review of timelines for implementationReview of timelines for implementation

IFRS Phase I implementation in 2011IFRS Phase I implementation in 2011

�� IFRS 4 overviewIFRS 4 overview

�� Other IFRS standards of interestOther IFRS standards of interest

�� Issues and impacts identified so farIssues and impacts identified so far

�� What choices do you have?What choices do you have?

IFRS Phase II for insurersIFRS Phase II for insurers

�� Status and timingStatus and timing

�� What will the new insurance standard look like?What will the new insurance standard look like?

�� Issues and impactsIssues and impacts

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International convergence – direction of Canadian and US GAAP

International convergence – direction of Canadian and US GAAP

IFRS

Cdn. GAAP

U.S. GAAP

2008 2011

Direction of US? • FASB intention is to converge

US GAAP with IFRS – by 2014?

2005

How big a “bang” at the end?

• SEC proposed to drop US GAAP reconciliation for

foreign IFRS filers, and proposes to for U.S.

companies too

decideddecideddecideddecided

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Implementation timetableImplementation timetable

Dec 2009

Dec 2010

Dec 2011

Dec 2008

Disclosure that IFRS is coming

(‘08 annual report)

Qualitative disclosures of

differences (‘09 annual report)

Quantified IFRS disclosures? (2010 annual

report)

IFRS go-live

Prepare

opening IFRSbalance sheet

Parallel IFRSGet ready

Quarterly reports

on IFRS basis

First IFRS annual report

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IFRS Phase I implementation in 2011

IFRS Phase I implementation in 2011

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IFRS - accounting for insurance contractsIFRS 4

IFRS - accounting for insurance contractsIFRS 4

In 2011, Canadian insurers will adopt IFRS with whatever insuranIn 2011, Canadian insurers will adopt IFRS with whatever insurance ce standards are in force at that timestandards are in force at that time

Existing IFRS 4 provides for only limited minimum standards for Existing IFRS 4 provides for only limited minimum standards for insurance contract accounting, and allows IFRS adopters to largeinsurance contract accounting, and allows IFRS adopters to largely ly continue existing precontinue existing pre--IFRS practicesIFRS practices

May 2007 Discussion Paper released (May 2007 Discussion Paper released (““IFRS Phase IIIFRS Phase II””), proposed a ), proposed a new global model as discussed laternew global model as discussed later

�� Exposure draft of a new standard scheduled by end of 2009, mightExposure draft of a new standard scheduled by end of 2009, mightbe delayed until March 2010be delayed until March 2010

�� New standard will likely not be mandatorily adoptable until 2013New standard will likely not be mandatorily adoptable until 2013 or or laterlater

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Insurance accounting under current IFRS

Insurance accounting under current IFRS

Agreement on how to measure insurance Agreement on how to measure insurance

contracts was not reached in time for the contracts was not reached in time for the

comprehensive introduction of IFRS in 2005. comprehensive introduction of IFRS in 2005.

Existing Existing ““national GAAPnational GAAP”” approaches continue approaches continue

until Phase II standards on measurement are until Phase II standards on measurement are

agreed (Discussion Paper issued May 3, 2007)agreed (Discussion Paper issued May 3, 2007)

Insurance project Insurance project

Phase II (future)Phase II (future)

Disclosures required for financial instruments Disclosures required for financial instruments

and related risks, additions to IFRS 4and related risks, additions to IFRS 4IFRS 7 IFRS 7

(in force 2007)(in force 2007)

Defines insurance contractsDefines insurance contractsIFRS 4 IFRS 4

(in force 2005)(in force 2005)

• IFRS – account for insurance contracts, whatever the type of enterprise that issues them

(Current Canadian GAAP – defines accounting frameworks for insurance enterprises, separately for life and P&C)

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IFRS - accounting for insurance contractsIFRS 4 – some specific requirements


Exceptions to separation:

the derivative is itself an insurance contract

policyholder surrender options for fixed amounts

Under certain conditions, separate embedded derivatives from host insurance contracts and account for them under IAS 39 (IFRS 4 7-9)

Permitted but not required where all aspects of the contract are measured (as would be expected under CIA standards) – limited appetite for unbundling

Unbundle deposit elements included in insurance contracts in certain circumstances (IFRS 4 10-12)

Classification of life insurance contracts is a significant issue involving judgment – expect some savings and service products to be reclassified

Account for contracts not meeting the definition of insurance contracts as a financial instrument under IAS 39 or as a service contract under IAS 18 (IFRS 4 B19-B21)

Likely impactLikely impactRequirement

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General view is that valuations that comply with CIA standards of practice should meet this requirement

Consider if current policies meet the minimum specified requirements for the liability adequacy test (IFRS 4 14(b)

Change in practice for life insurers from existing net treatment

Present reinsurance assets, liabilities, revenues and expenses on a gross (rather than net) basis (IFRS 4 par. 14(d))

Mostly a “geography” issue? Provisions in reinsurance asset rather than in actuarial PfADs

Consider if reinsurance assets are impaired. (IFRS 4 par. 14 (e))

Possible issue for P&C insurance structured settlements

Only derecognize an insurance liability (or part thereof) when and only when it is extinguished (IFRS 4, 14 (c))

Likely no impact for Canadian insurers Not recognize catastrophe or equalization provisions (IFRS 4 14 (a))

Likely impactLikely impactRequirement

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Contract classification under IFRS 4Contract classification under IFRS 4

IFRS 4 defines insurance contracts as: IFRS 4 defines insurance contracts as:

““contract under which one party (the insurer) accepts significantcontract under which one party (the insurer) accepts significant insurance insurance

risk from another party (the policyholder) by agreeing to compenrisk from another party (the policyholder) by agreeing to compensate the sate the

policyholder if a specified uncertain future event (the insured policyholder if a specified uncertain future event (the insured event) event)

adversely affect the policyholderadversely affect the policyholder””

Differences from current Canadian GAAP mostly apply to Differences from current Canadian GAAP mostly apply to lifecoslifecos

Life insurer savings products (e.g. deferred annuities, term cerLife insurer savings products (e.g. deferred annuities, term certain tain

annuities) could be considered deposit contracts rather than annuities) could be considered deposit contracts rather than

insurance, and deposit elements of insurance contracts could reqinsurance, and deposit elements of insurance contracts could require uire

““unbundlingunbundling”” (bifurcation)(bifurcation)

Similarly some contracts could be considered service contracts (Similarly some contracts could be considered service contracts (egeg. .

ASO)ASO)

Implementation in Europe Implementation in Europe –– lots of effort in distinguishing between lots of effort in distinguishing between

insurance contracts and deposit contractsinsurance contracts and deposit contracts

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Contract classification under IFRS 4, cont’d

Contract classification under IFRS 4, cont’d

Examples of contracts identified to date as nonExamples of contracts identified to date as non--

insurance insurance

Term certain annuities, Term certain annuities, RRIFsRRIFs

Deferred annuities without meaningful conversion optionsDeferred annuities without meaningful conversion options

Funds products without meaningful death or maturity guaranteesFunds products without meaningful death or maturity guarantees

Group contracts with strong riskGroup contracts with strong risk--limiting features limiting features

How much insurance risk is enough?How much insurance risk is enough?

No quantitative guidance, judgment requiredNo quantitative guidance, judgment required

Seems to be wide range of practice in EuropeSeems to be wide range of practice in Europe

Expect diversity of practice here too!Expect diversity of practice here too!

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Current insurance IFRS – IFRS 4, cont’d

Current insurance IFRS – IFRS 4, cont’d

Measurement:Measurement: Does not address measurement of insurance contract Does not address measurement of insurance contract

liabilities, but requires a liabilities, but requires a ““liability adequacy testliability adequacy test””; valuations in ; valuations in

compliance with CIA standards should pass such a testcompliance with CIA standards should pass such a test

Reinsurance risk transfer:Reinsurance risk transfer: Defines reinsurance contracts too, but does Defines reinsurance contracts too, but does

notnot require quantitative testing of risk transfer as in US FAS 113 require quantitative testing of risk transfer as in US FAS 113 (as a (as a

result, IFRS currently allows a wider range of reinsurance contrresult, IFRS currently allows a wider range of reinsurance contracts to acts to

be given reinsurance accounting than is the case under US GAAP, be given reinsurance accounting than is the case under US GAAP, or or

OSFI Guideline DOSFI Guideline D--9 for P&C)9 for P&C)

IFRS 4 provides for options that may or may not exist in Stage IIFRS 4 provides for options that may or may not exist in Stage II:I:

ReRe--designation of assetsdesignation of assets to heldto held--forfor--tradingtrading

Use of Use of ““shadow accountingshadow accounting”” –– putting liability movements caused putting liability movements caused by AFS asset changes through AOCby AFS asset changes through AOC

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Current insurance IFRS – IFRS 4Current insurance IFRS – IFRS 4

IFRS 4 (and 7) disclosures:IFRS 4 (and 7) disclosures:

Requires a wide range of disclosures on insurance Requires a wide range of disclosures on insurance

contracts:contracts:

Risk selection and risk concentrationsRisk selection and risk concentrations

Sensitivity analysis Sensitivity analysis

Requirements similar in principle to Canadian GAAP, Requirements similar in principle to Canadian GAAP,

but require more detailed disclosuresbut require more detailed disclosures

Some of these disclosures arrived in Canada Some of these disclosures arrived in Canada in 2008in 2008

with the introduction of CICA 1535 and CICA 3862/3 with the introduction of CICA 1535 and CICA 3862/3

(which extensively cross(which extensively cross--reference IFRS 7) reference IFRS 7)

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IFRS - accounting for insurance contractsIFRS 4 and OSFI


OSFI October 31, 2008 letter OSFI October 31, 2008 letter ““Optional Accounting Changes Arising Optional Accounting Changes Arising from the Adoption of IFRS 4from the Adoption of IFRS 4”” expresses OSFIexpresses OSFI’’s view that insurers s view that insurers should should ““maintain their existing accounting policies for insurance maintain their existing accounting policies for insurance contractscontracts””, except for:, except for:

�� Any change required to comply with IFRS (few expected)Any change required to comply with IFRS (few expected)

�� Certain specified Certain specified ““permitted accounting optionspermitted accounting options”” ::

Unbundling of insurance and deposit components (IFRS 4 par. 10 (b))

Application of “shadow accounting” (IFRS 4 par. 30)

Use of the expanded presentation for insurance contracts acquired in a business combination or portfolio transfer (IFRS 4 par. 31-33)

Separate recognition of the guaranteed element and discretionaryelement of a participation feature (IFRS 4 par 34 (a))

�� Other optional changes Other optional changes -- if preif pre--approved by OSFI approved by OSFI

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OSFI October 31, 2008 letter OSFI October 31, 2008 letter ““Optional Accounting Changes Arising Optional Accounting Changes Arising from the Adoption of IFRS 4from the Adoption of IFRS 4””, cont, cont’’dd

Requests for preRequests for pre--approval of optional changes to be made at the first approval of optional changes to be made at the first IFRS progress review (Feb 2009) or if later, 24 months before stIFRS progress review (Feb 2009) or if later, 24 months before start of art of first fiscal year the change would be applied first fiscal year the change would be applied

effect is any optional change for 2011 should have been stated ieffect is any optional change for 2011 should have been stated in n the Feb 2009 progress review!the Feb 2009 progress review!

OSFI May 28, 2009 letter OSFI May 28, 2009 letter ““Progress Reports Feedback on initial reports Progress Reports Feedback on initial reports and expectations going forwardand expectations going forward””

Expressed a desire for quantification of IFRS impacts (from all Expressed a desire for quantification of IFRS impacts (from all current IFRS standards) in future reportscurrent IFRS standards) in future reports

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Other IFRS standardsIFRS versus Canadian GAAP – Similarities

Other IFRS standardsIFRS versus Canadian GAAP – Similarities

Comprehensive set of principlesComprehensive set of principles--based standardsbased standards

Similar to Canadian GAAP in structure and formSimilar to Canadian GAAP in structure and form

Similar basic concepts and recognition / measurement principlesSimilar basic concepts and recognition / measurement principles

Similar structure and content of financial statementsSimilar structure and content of financial statements

Many standards in IFRS provide approach similar to Canadian Many standards in IFRS provide approach similar to Canadian

GAAPGAAP

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Other IFRS standards IFRS versus Canadian GAAP – Differences

Other IFRS standards IFRS versus Canadian GAAP – Differences

Fewer bright lines and rulesFewer bright lines and rules

Some standards in IFRS differ Some standards in IFRS differ considerablyconsiderably from Canadian GAAP from Canadian GAAP

e.g. impairment and provisions e.g. impairment and provisions –– expect to recognize value expect to recognize value

impairments more often and earlier, but also to reverse them if impairments more often and earlier, but also to reverse them if

values recovervalues recover

More accounting policy choices, and More accounting policy choices, and differences in differences in

application/interpretationapplication/interpretation

��Applying IFRS requires more professional judgement Applying IFRS requires more professional judgement

and results in greater volume of disclosuresand results in greater volume of disclosures

�� IFRS is not standing still IFRS is not standing still -- significant changes are in significant changes are in

process process

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Other IFRS standardsClassification of investments

Other IFRS standardsClassification of investments

Changes in contract classification under IFRS 4 could affect howChanges in contract classification under IFRS 4 could affect how

an insurer prefers to classify investmentsan insurer prefers to classify investments

HeldHeld--forfor--trading (HFT) likely still preferred for assets backing trading (HFT) likely still preferred for assets backing

insurance contracts valued under CALMinsurance contracts valued under CALM

However, availableHowever, available--forfor--sale (AFS) and heldsale (AFS) and held--toto--maturity (HTM) may maturity (HTM) may

be preferable for assets related to investment and service contrbe preferable for assets related to investment and service contractsacts

Also will need to consider possible changes to IFRS accounting Also will need to consider possible changes to IFRS accounting

rules for financial instruments (IAS 39)!rules for financial instruments (IAS 39)!

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Other IFRS standardsCurrent proposals to modify IAS 39

Other IFRS standardsCurrent proposals to modify IAS 39

IAS 39 is very similar to CICA 3855 IAS 39 is very similar to CICA 3855 Financial Instruments Financial Instruments ––

Recognition and MeasurementRecognition and Measurement -- the IASB has been under strong the IASB has been under strong

pressure from European regulators to bring forward and fastpressure from European regulators to bring forward and fast--track track

significant changes to IAS 39significant changes to IAS 39

Current proposals under considerationCurrent proposals under consideration

Financial instruments would be measured at either fair value or Financial instruments would be measured at either fair value or

amortized costamortized cost

Amortized cost could be used for investments with Amortized cost could be used for investments with ““loanloan”” features, features,

that are managed on a contractual yield basis that are managed on a contractual yield basis -- the the ““tainting tainting

provisionsprovisions”” that currently make heldthat currently make held--toto--maturity (HTM) hard to use maturity (HTM) hard to use

would be droppedwould be dropped

The availableThe available--forfor--sale (AFS) category would disappearsale (AFS) category would disappear

(cont(cont’’d)d)

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Other IFRS standardsCurrent proposals to modify IAS 39, cont’d

Other IFRS standardsCurrent proposals to modify IAS 39, cont’d

Current proposals under consideration, contCurrent proposals under consideration, cont’’dd

Equities Equities couldcould be designated as fair value through OCI, similar to be designated as fair value through OCI, similar to

the current availablethe current available--forfor--sale (AFS) designation, sale (AFS) designation, exceptexcept that that

realized gains/losses go straight to retained earnings (realized gains/losses go straight to retained earnings (nevernever

through income), and impairment decisions would not be required through income), and impairment decisions would not be required

A fair value option (fair value through income, same as heldA fair value option (fair value through income, same as held--forfor--

trading (HFT)) would continue to be available on the condition ttrading (HFT)) would continue to be available on the condition that hat

accounting accounting mismis--matches are reduced matches are reduced –– a good fit with current a good fit with current

practice under CALMpractice under CALM

If adopted, the changes would be available for IFRS reporting If adopted, the changes would be available for IFRS reporting

entities for December 2009 year ends (mandatory adoption not entities for December 2009 year ends (mandatory adoption not

before January 2012)before January 2012)

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Other IFRS standards Capital assets (includes own-use real estate)

Other IFRS standards Capital assets (includes own-use real estate)

Components approach Components approach –– more rigorously applied and broader more rigorously applied and broader

than under Canadian GAAPthan under Canadian GAAP

Borrowing costs directly attributable to construction or Borrowing costs directly attributable to construction or

production of production of ““qualifyingqualifying”” assets assets –– must be capitalized /must be capitalized /

extensive guidance providedextensive guidance provided

Option under IFRS 1Option under IFRS 1 allows cost basis to be set at fair value upon allows cost basis to be set at fair value upon

initial adoption of IFRS (with corresponding adjustment to equitinitial adoption of IFRS (with corresponding adjustment to equity) y)

–– ““deemed costdeemed cost”” exemptionexemption

Subsequent measurement options Subsequent measurement options

Cost model, or revaluation model (record at fair value through Cost model, or revaluation model (record at fair value through

equity)equity)

Apply to all items in a category of property and equipmentApply to all items in a category of property and equipment

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Other IFRS standardsReal estate investments

Other IFRS standardsReal estate investments

Fair value modelFair value model

Initially measure at cost*Initially measure at cost*

Adjust carrying value to fair Adjust carrying value to fair valuevalue

Do not deduct disposal Do not deduct disposal costs in arriving at FVcosts in arriving at FV

Recognize changes in FV Recognize changes in FV in P&L, not equityin P&L, not equity

No depreciation or No depreciation or impairment lossesimpairment losses

Cost modelCost model

Initially measure at cost*Initially measure at cost*

DepreciateDepreciate

Impairment lossesImpairment losses

Determine and disclose Determine and disclose fair valuefair value

* * Option under IFRS 1Option under IFRS 1 allows cost basis to be set at fair value upon initial adoptionallows cost basis to be set at fair value upon initial adoption

of IFRS (with corresponding adjustment to equity) of IFRS (with corresponding adjustment to equity) –– ““deemed costdeemed cost”” exemptionexemption

Property held for rental or capital appreciation Property held for rental or capital appreciation –– 2 options2 options

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Other IFRS standardsPension and other employee benefits

Other IFRS standardsPension and other employee benefits

IFRS and Canadian GAAP are broadly similar but there are IFRS and Canadian GAAP are broadly similar but there are

several important differences in detailseveral important differences in detail

IFRS 1 (firstIFRS 1 (first--time adoption) allows for unamortized actuarial gains time adoption) allows for unamortized actuarial gains

/ losses to be reset to zero (with corresponding adjustment to / losses to be reset to zero (with corresponding adjustment to

equity)equity)

Why would you decide to use the election?Why would you decide to use the election?

Avoid the reconstruction of unamortized pools of Avoid the reconstruction of unamortized pools of

actuarial gains and losses from inception of planactuarial gains and losses from inception of plan

If in a position of cumulative unamortized losses, If in a position of cumulative unamortized losses,

can avoid their subsequent recognition through the P&Lcan avoid their subsequent recognition through the P&L

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Impact of IFRS on capital Impact of IFRS on capital

Several IFRS changes would affect capital requirements, and any Several IFRS changes would affect capital requirements, and any

related change to the capital rules is not determinedrelated change to the capital rules is not determined

Reclassifications from insurance contracts to deposit and servicReclassifications from insurance contracts to deposit and service e

contracts contracts

GrossGross--up of reinsurance in the balance sheetup of reinsurance in the balance sheet

Revaluations of investment property to full market valueRevaluations of investment property to full market value

(Optional) revaluations of capital assets to fair value as initi(Optional) revaluations of capital assets to fair value as initial al

““deemed costdeemed cost””

(Optional) opening retained earnings adjustment for pension (Optional) opening retained earnings adjustment for pension

deficitsdeficits

Other possible additional Other possible additional ““on balance sheeton balance sheet”” items include lease items include lease

accounting and consolidated variable interest entitiesaccounting and consolidated variable interest entities

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The IFRS Insurance Phase 2 project

The IFRS Insurance Phase 2 project

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Status of the Stage II insurance projectStatus of the Stage II insurance project

May 2007 Discussion Paper released (May 2007 Discussion Paper released (““IFRS Phase IIIFRS Phase II””), proposed a ), proposed a new global model based on new global model based on ““current exit valuecurrent exit value””

�� Over 160 written responses, and consultations an debates continuOver 160 written responses, and consultations an debates continuee

�� Exposure draft of a new standard scheduled by end of 2009, but Exposure draft of a new standard scheduled by end of 2009, but may be delayed into early 2010may be delayed into early 2010

�� New standard will likely not be mandatorily adoptable until 2013New standard will likely not be mandatorily adoptable until 2013 or or laterlater

•• International Actuarial Association has initiated a project to dInternational Actuarial Association has initiated a project to draft IFRSraft IFRS--compliant actuarial standardscompliant actuarial standards

•• In November 2008, the U.S. FASB announced a decision to join witIn November 2008, the U.S. FASB announced a decision to join with h the IASB in the Stage II insurance projectthe IASB in the Stage II insurance project

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Status of the Stage II insurance projectStatus of the Stage II insurance project

Based on the comments on the Discussion Paper, the Based on the comments on the Discussion Paper, the IASB is attempting to finalize the conceptual framework, IASB is attempting to finalize the conceptual framework, with the following candidates:with the following candidates:

�� Current Exit Value (CEV), as proposed in the Discussion Paper, Current Exit Value (CEV), as proposed in the Discussion Paper, appears to be dead *appears to be dead *

�� ““Fulfilment ValueFulfilment Value”” –– similar to CEV, but using the enterprisesimilar to CEV, but using the enterprise’’s own s own experience instead of experience instead of ““marketmarket”” assumptions for cash flowsassumptions for cash flows

•• Fulfilment value being considered in three forms, including two Fulfilment value being considered in three forms, including two variations with variations with ““calibrationcalibration”” to the initial premium; IASB appears to the initial premium; IASB appears to have decided in favour of some form of calibrationto have decided in favour of some form of calibration

�� An unearned premium approach for shortAn unearned premium approach for short--term businessterm business

* June 18 * June 18 –– IASB voted 11IASB voted 11--2 to drop CEV as a candidate2 to drop CEV as a candidate

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Features of the IASB’s proposed measurement model

Features of the IASB’s proposed measurement model

Single measurement modelSingle measurement model::

Life insurance and nonLife insurance and non--life insurancelife insurance

Prospective valuation:Prospective valuation:

Value of insurance contract = PV (all future cash flows)Value of insurance contract = PV (all future cash flows)

Current exit valueCurrent exit value::

The amount the insurer would The amount the insurer would expect to pay to another entity expect to pay to another entity if it transferred all its remaining if it transferred all its remaining

contractual rights and contractual rights and obligations immediatelyobligations immediately

Fulfilment valueFulfilment value::

The amount the insurer would The amount the insurer would expect to pay to fulfil its expect to pay to fulfil its

remaining contractual rights and remaining contractual rights and obligations in the ordinary course obligations in the ordinary course

(reflects own assumptions)(reflects own assumptions)

VS.

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Features of IASB discussion paper’s proposed measurement model

An insurer should use the following inputs to measure An insurer should use the following inputs to measure its insurance liabilities (the its insurance liabilities (the ““3 building blocks3 building blocks””))

1.1. Current Current unbiasedunbiased probabilityprobability--weighted estimates of weighted estimates of future cash flows (ie an expected value approach)future cash flows (ie an expected value approach)

2.2. Current market Current market discountdiscount rates that adjust the estimated rates that adjust the estimated future cash flows for the time value of money future cash flows for the time value of money

3.3. An An explicitexplicit unbiased estimate of the margin that market unbiased estimate of the margin that market participants require forparticipants require for

Bearing risk (a risk margin); andBearing risk (a risk margin); and

Providing other services (a service margin)Providing other services (a service margin)

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The proposed measurement modelThe proposed measurement model

The The ““3 building blocks3 building blocks”” making up making up Current Exit ValueCurrent Exit Value

Expected cash flows

DiscountingRisk

margin

Current exit value

Premium

Service margin

Can/should

there be a differenceat inception?

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The proposed measurement modelThe proposed measurement model

The The ““3 building blocks3 building blocks”” under under Fulfilment ValueFulfilment Value

Expected cash flows

Discounting

Risk and service margin

Current exit value

Premium

No differenceat inception, except for

“onerous contracts”

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Liabilities and Margins under Current Fulfilment Value

Liabilities and Margins under Current Fulfilment Value

This model is This model is ““calibratedcalibrated”” to to the premium, to avoid day one the premium, to avoid day one profitsprofits

Unlike Unlike PfADsPfADs, the margin is a , the margin is a residual rather than being residual rather than being directly directly calculated (Q calculated (Q -- underunderwhat circumstances would you what circumstances would you get new business get new business strain?)strain?)

Composite margin is not reComposite margin is not re--measured, and is released to measured, and is released to income over the life of the income over the life of the policy on some policy on some basis, egbasis, eg. . release from release from risk (Q risk (Q –– would would we need to track and compute we need to track and compute for separate cohorts or for separate cohorts or generations of policies?)generations of policies?)

Composite margin

Expected present value of

future cash flows,

excluding cost of

bearing risk

• Initial margin set

to eliminate any day one profit

• No explicit, distinct margins for risk or service

• Not re-measured

• Current estimate of the expected

(ie, probability-weighted) present value of future

cash flows to fulfill the liability

• Re-measured based on current information

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Liabilities and Margins under IAS 37 Alternative to Current Fulfilment Value

Liabilities and Margins under IAS 37 Alternative to Current Fulfilment Value

““TheThe amount the entity would amount the entity would rationally rationally pay ...pay ... to be relieved to be relieved of the of the presentpresent obligation, plus obligation, plus a residual a residual marginmargin”” (to(to avoid avoid day one day one profits)profits)

UnlikeUnlike PfADsPfADs, the , the ““residual residual marginmargin”” is a residual rather is a residual rather than being directly than being directly calculated; calculated; similar to the similar to the ““composite composite marginmargin”” under CFV, it is not under CFV, it is not rere--measured, and is released measured, and is released to income over the life of the to income over the life of the policy on some basis (eg. policy on some basis (eg. release from risk)release from risk)

Explicit margins for risk and Explicit margins for risk and service make it more likely service make it more likely that newthat new business business strain strain could resultcould result

Residual margin

Expected present value of

future cash flows

• Initial residual margin set to

eliminate day one profit, not re-measured

• Explicit marginsfor risk & service,

re-measured

• Current estimate of the expected

(ie, probability-weighted) present value of future

cash flows to fulfill the liability

• Re-measured based on current information

Service margin

Risk margin

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Features of the proposed measurement model, cont’d

Discounting to use market rates, so valuation will not Discounting to use market rates, so valuation will not match with own asset portfoliomatch with own asset portfolio

Risk margins Risk margins -- IASB has not defined IASB has not defined howhow margins margins should be determined but will suggest criteria, and should be determined but will suggest criteria, and actuaries are starting to work on approachesactuaries are starting to work on approaches

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Implications of the IFRS model: Future cash flows

Implications of the IFRS model: Future cash flows

IFRS standards emphasize consistency across industries, so the IFRS standards emphasize consistency across industries, so the treatment of insurance premium revenue may not be insurancetreatment of insurance premium revenue may not be insurance--specific:specific:

�� The The IASBIASB’’ss current Revenue Recognition project emphasizes a current Revenue Recognition project emphasizes a contractual approach to revenuecontractual approach to revenue

�� The Discussion Paper attempted to provide guidance on what The Discussion Paper attempted to provide guidance on what future revenue should be reflected in accounting for insurance future revenue should be reflected in accounting for insurance contracts, and proposed contracts, and proposed ““guaranteed guaranteed insurabiltyinsurabilty”” –– feedback feedback on the concept was largely negativeon the concept was largely negative

�� Future premium revenue under IFRS stage II may not reflect all Future premium revenue under IFRS stage II may not reflect all premium cash flows currently used in CALMpremium cash flows currently used in CALM

�� Future cash flows would not include income taxes, or adjustmentsFuture cash flows would not include income taxes, or adjustmentsfor discounted future tax liabilities for discounted future tax liabilities

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Implications of the IFRS model: Other issues

Implications of the IFRS model: Other issues

What is an appropriate basis for selecting a market What is an appropriate basis for selecting a market interest rate? Riskinterest rate? Risk--free or highfree or high--quality corporate?quality corporate?

Determination of margins, and how should they be Determination of margins, and how should they be released?released?

Reinsurance risk transfer Reinsurance risk transfer –– no quantitative risk transfer no quantitative risk transfer test required under IFRS 4, and not discussed in the test required under IFRS 4, and not discussed in the discussion paper; will FASB push for one?discussion paper; will FASB push for one?

Own credit risk Own credit risk –– IASB position has been that the IASB position has been that the entityentity’’s own credit risk should affect the valuation of s own credit risk should affect the valuation of its liabilities; controversial and counterits liabilities; controversial and counter--intuitive intuitive ––currently being recurrently being re--deliberated by IASB deliberated by IASB

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Balance sheet impact – life insurersBalance sheet impact – life insurers

currentcurrent proposedproposed

AssetsAssets

-- InvestmentsInvestments $ xxx$ xxx $ xxx$ xxx 1,31,3

-- Reinsurance assetsReinsurance assets xxxxxx xxxxxx 22

-- OtherOther xxxxxx xxxxxx

Total assetsTotal assets $ $ xxxxxx $ $ xxxxxx

LiabilitiesLiabilities

-- Insurance liabilities Insurance liabilities $ xxx$ xxx $ xxx$ xxx 2,42,4

-- Other liabilitiesOther liabilities xxxxxx xxxxxx

-- Deferred realized investment gains Deferred realized investment gains xxxxxx -- 33xxxxxx xxxxxx

EquityEquity

-- Capital stockCapital stock xxxxxx xxxxxx

-- Retained earningsRetained earnings xxxxxx xxxxxx

-- Other comprehensive income (OCI)Other comprehensive income (OCI) xxxxxx xxxxxx 11

xxxxxx xxxxxx

Total liabilities and equityTotal liabilities and equity $ $ xxxxxx $ $ xxxxxx

Notes

1. Insurers may wish to make different choices in designating investments between available for sale and held for trading

2. Reinsurance assets will be shown gross rather than netted in policy liabilities

3. Deferred realized gains on real estate will disappear, and real estate investments will no longer be carried on a move-to-market basis (choice of cost or market basis)

4. Policy liabilities will no longer be closely connected with asset valuation, and would be affected by change in discount rate, cash flow definition, risk and service margins. Market based discount rate would tend to be lower than own portfolio rates currently used.

38

Comparison of IFRS Stage II insurance proposals to current Canadian GAAP

Comparison of IFRS Stage II insurance proposals to current Canadian GAAP

Consistent with current Canadian GAAPConsistent with current Canadian GAAPChanges in estimates Changes in estimates

reflected in liability reflected in liability

valuation immediatelyvaluation immediately

Not done now, at least not directly; not Not done now, at least not directly; not

necessarily the same as actuarial necessarily the same as actuarial PfADsPfADs

Possible some may resort to Possible some may resort to ““calibrationcalibration””, ,

to avoid day one profitsto avoid day one profits

Liability valuation to Liability valuation to

include explicit risk include explicit risk

and service marginsand service margins

Most Canadian insurers apply time value of Most Canadian insurers apply time value of

money, but using their own expected money, but using their own expected

portfolio returnsportfolio returns

Use of market discount rates could lead to Use of market discount rates could lead to

greater accounting greater accounting mismis--matches in reported matches in reported

incomeincome

Liabilities discounted Liabilities discounted

using market ratesusing market rates

Change from Canadian GAAP ?Change from Canadian GAAP ?IFRS Phase IIIFRS Phase II

39

Comparison of IFRS Stage II insurance proposals to current Canadian GAAP, cont’d


Not for life insurers Not for life insurers -- Canadian P&C Canadian P&C

insurers currently defer and amortize DAC insurers currently defer and amortize DAC

over the policy termover the policy term

Under IFRS, the Under IFRS, the ““current exit valuecurrent exit value”” liability liability

would resemble (but not necessarily equal) would resemble (but not necessarily equal)

the net amount of UPR less DAC for P&C the net amount of UPR less DAC for P&C

Acquisition costs Acquisition costs

expensed as incurred expensed as incurred

(no deferral, or (no deferral, or

““DACDAC””))

Not for life insurers Not for life insurers -- Canadian P&C Canadian P&C

insurers currently recognize premiums over insurers currently recognize premiums over

the policy term, and show an unearned the policy term, and show an unearned

premium liability (UPR)premium liability (UPR)

IFRS Phase II would align the P&C model IFRS Phase II would align the P&C model

more with Canadian life insurance GAAP; more with Canadian life insurance GAAP;

UPR would be replaced with a liability for all UPR would be replaced with a liability for all

future cash flows over the policy termfuture cash flows over the policy term

Unearned premiums Unearned premiums

(UPR) to be replaced (UPR) to be replaced

with the with the ““current exit current exit

valuevalue”” measuremeasure


40



Life insurer revenues will exclude some Life insurer revenues will exclude some

annuity deposits now shown as premiumsannuity deposits now shown as premiums

CALM does not CALM does not ““unbundleunbundle”” deposit deposit

elements of life insurance contractselements of life insurance contracts

Insurance vs. deposit Insurance vs. deposit

contractscontracts

classificationclassification

unbundlingunbundling

Stochastic methods not required currentlyStochastic methods not required currently

For life insurers:For life insurers:

CALM includes (and discounts) taxesCALM includes (and discounts) taxes

Probabilistic approach to future premiums Probabilistic approach to future premiums vs. tests such as guaranteed insurabilityvs. tests such as guaranteed insurability

Estimated cash flows Estimated cash flows

stochastic methodsstochastic methods

excludes taxesexcludes taxes

future premiumsfuture premiums

Canadian life insurers currently disclose Canadian life insurers currently disclose

““netnet”” -- no change for P&C insurersno change for P&C insurers

IFRS does not have a quantitative risk IFRS does not have a quantitative risk

transfer testtransfer test

Reinsurance to be Reinsurance to be

portrayed on a gross portrayed on a gross

basisbasis


41

Implementation issues for insurers

Implementation issues for insurers

42

Key questions for insurers:Two step conversion - IFRS 4, followed by Stage II in 2013 or later

Key questions for insurers:Two step conversion - IFRS 4, followed by Stage II in 2013 or later

Under IFRS 4, can continue existing accounting policies Under IFRS 4, can continue existing accounting policies

on contract measurementon contract measurement

IFRS 4 provides for options that may or may not exist in IFRS 4 provides for options that may or may not exist in

Stage II:Stage II:

ReRe--designation of assets to helddesignation of assets to held--forfor--tradingtrading

Use of Use of ““shadow accountingshadow accounting”” –– putting liability movements putting liability movements

caused by AFS asset changes through AOCIcaused by AFS asset changes through AOCI

Need to consider nonNeed to consider non--Stage II IFRS differencesStage II IFRS differences

Want to change existing policies?Want to change existing policies?

Need to meet relevance & reliability testsNeed to meet relevance & reliability tests

Stage II standard will likely be known or close to itStage II standard will likely be known or close to it

OSFI has imposed constraints on changesOSFI has imposed constraints on changes

43

Key questions for insurers:How will liabilities and surplus be affected?

Key questions for insurers:How will liabilities and surplus be affected?

Market discount rate likely lower, particularly for Market discount rate likely lower, particularly for lifecoslifecos(increasing liabilities)(increasing liabilities)

Computation of margins Computation of margins –– unsettled question; will not unsettled question; will not necessarily increasenecessarily increase

How will actuarial standards evolve? Will liabilities How will actuarial standards evolve? Will liabilities change much in aggregate?change much in aggregate?

Some aspects of current actuarial Some aspects of current actuarial PADsPADs may not meet may not meet the definition of a liability, and may migrate to capital the definition of a liability, and may migrate to capital (and be considered as part of capital requirements)(and be considered as part of capital requirements)

Global comparisons are likely to become more relevant, Global comparisons are likely to become more relevant, and influence reserving practices and influence reserving practices

Regulatory capital requirements likely to move towards Regulatory capital requirements likely to move towards a Solvency II (European) modela Solvency II (European) model

44

Key questions for insurers:How will income emergence be affected?

Key questions for insurers:How will income emergence be affected?

Use of current estimates will continue, but how will Use of current estimates will continue, but how will

releases of margins change?releases of margins change?

Potential for volatility is likely to increase because of Potential for volatility is likely to increase because of

““breaking the linkbreaking the link”” between assets and liabilitiesbetween assets and liabilities

Related questions Related questions –– Will ALM practices change? Will Will ALM practices change? Will

investment choices be affected by accounting? Will investment choices be affected by accounting? Will

product design be affected?product design be affected?

45

Key questions for insurers:What could I be missing?

Key questions for insurers:What could I be missing?

IT issuesIT issues

Product designProduct design

Legal issues (metrics and definitions in existing Legal issues (metrics and definitions in existing

contracts)contracts)

Compensation practicesCompensation practices

Integration into business planning, strategic Integration into business planning, strategic

planning, budgetingplanning, budgeting

46

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Neil ParkinsonNational Director, Insurance Industry PracticeKPMG LLP(416) [email protected]

© 2008 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. All rights reserved. Printed in Canada on recycled paper.

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