session 64pd: ifrs 17 - understanding financial impacts · 2018. 9. 13. · pwc | ifrs 17 –...

Session 64PD: IFRS 17 - Understanding Financial Impacts

Moderator: Rodrigo Careaga, ASA, MAAA

Presenters: Rodrigo Carega

Stefan John Dunajewski Takeko Uemoto FSA,MAAA

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IFRS 17 – Illustrative product actuarial implications2018 Valuation actuary symposium

www.pwc.com

August 28, 2018

PwC | IFRS 17 – Illustrative product actuarial implications

Content

Background

IFRS 17 profit emergence illustration

Term life analysis

Deferred annuity analysis

Implications


Background

• IFRS 17 is the new Insurance Contracts accounting standard issued by the IASB to be adopted in January 2021

• Fundamentally changes the way that insurance contracts are measured and results are communicated to the market

• As firms continue to progress with their implementation of the new accounting standard, the full implications of the standard and its financial impacts will continue to emerge

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• Observations on the potential impacts of transitioning from US GAAP to the new IFRS 17 standard for sample life and annuity products

- Analysis was based on representative product designs and does not consider the full range of product types or options. Therefore, anticipated impacts for any individual company may differ from the conclusions of this analysis


IFRS 17 – Profit emergence illustration under General modelBasic concepts

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Cash FlowsDuration 1 2 3 4

Premium (BoP) 2,000 1,800 1,600 700

Benefits (EoP) 800 1,000 1,200 700

IFRS 17 LiabilityTime 0 1 2 3 4

PV of FCF (2,457) (1,271) (455) (20) -

RA 344 274 182 68 -

CSM 2,113 1,438 817 251 -

Total: - 442 545 298 -

Statement of Comprehensive Income1 2 3 4

Expected Benefits 800 1,000 1,200 700

RA Release 80 100 120 70

CSM Release 738 664 591 258

Insurance Revenue 1,618 1,764 1,911 1,028 Service Expense (800) (1,000) (1,200) (700)

Underwriting Result 818 764 711 328

Finance Income 120 135 129 60

Finance Expense (60) (67) (64) (30)

Finance Result 60 67 64 30

Pre-tax Net Income 878 832 775 358

No investment component

No expensesSimplified approach for RA

Asset yield of 6%

Single discount rate of 3%

Face amount as basis for coverage units

Non-variable CF

Experience emerges as expected

Simplified Assumptions

Observations:• New presentation splits underwriting from finance result

E.g., Year 1Pre-tax Net Income = Underwriting Result + Finance Result

= 810 + 60 = 878• Underwriting result driven by release of RA and CSM because

experience emerges as expectedE.g., Year 1Underwriting Result = Release of RA + Release of CSM

= 80 + 738 = 818• Finance result shows difference between investment income on

assets and interest accretion on the liabilityE.g., Year 1Finance Result = Investment Income (6%) – Interest Accretion (3%)

= 120 - 60 = 60


Level term life analysis

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ProductTerm Life

Opening equityDecrease

Profit emergenceDelayed

Earnings volatilityMore

Opening equity:Overall, anticipate an increase in liabilities, leading to a decrease in opening equity

1. Lower discount rates - US GAAP best estimate earned rates, which many insurers have locked-in over the last decade or more, may be much higher (as much as 300-400 bps) than IFRS 17 discount rates

2. Favorable assumption update - Requirement to update historical locked-in assumptions under IFRS 17, with an expected reduction in the liability levels based on assumed life expectancies improving faster than anticipated mortality rates*

3. Lower PAD - The Risk Adjustment (RA) is anticipated to be less than historical PADs of 5-10%.

* Analysis does not consider the impact of post-level term assumptions, for which the impact could be significant if such assumptions are either particularly conservative or optimistic


Level term life analysis (continued)

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ProductTerm Life




Profit emergence: Anticipate profit emergence will be delayed for newly issued term life policies.

1. Investment spread

• Investment spreads are earned as the difference between the investment return on underlying assets and the interest accretion on the liabilities

• For recurring premium contracts, investment margin recognition will build gradually as premiums are received and reserves grow and then decrease as lapses and death occur

• Discount rates under IFRS 17 will typically be lower than the US GAAP discount rates. Additional investment margin will be recognized under IFRS 17, but in a slower pattern than the offset to the profit loading described below



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ProductTerm Life




Profit emergence (continued): 2. PADs and RA

• For US GAAP, the mortality PAD is released in proportion to the expected death benefits. Since mortality increases with age, a practice of applying a level percentage PAD to the mortality rate delays profit recognition

• Under IFRS 17, the RA is expected to be relatively small for well diversified companies, resulting in a larger IFRS 17 profit loading amount (CSM), which is recognized in a more straight-line pattern as described below

3. Profit Loading

• The remaining underwriting margin for current US GAAP is released in proportion to gross premiums. Under IFRS 17, the residual margin is the contractual service margin (CSM), which is released in proportion to coverage units

• Expect this amortization to be generally consistent between US GAAP and IFRS 17 if projected in-force amounts are used as the basis to estimate coverage units

Overall, the differential between IFRS 17 and US GAAP discount rates and resultant impact on profit loading will dominate the difference in mortality PAD vs. RA, leading to a deferral of IFRS 17 income compared to US GAAP



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ProductTerm Life




Earnings volatility: Anticipate an increase in earnings volatility for term life business.

• The impact of assumption updates will be offset by adjustments to the CSM for non-onerous contracts, but this will be limited for contracts with low profit margins

• Losses could be recognized earlier than under US GAAP for unfavorable assumption updates because the level of aggregation (i.e., contract grouping) in IFRS 17 is expected to be at a more granular level than what is currently used for US GAAP loss recognition testing.


Fixed deferred annuity analysis

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ProductFixed Deferred Annuity



Earnings volatilityLess

Opening equity:Anticipate an increase in fixed deferred annuity liabilities, leading to a decrease in opening equity

1. Fixed deferred annuities are typically classified as investment contracts under US GAAP, but these contracts will typically be included within the scope of IFRS 17 due to their underlying annuitization guarantees.

2. Given IFRS 17’s more granular aggregation requirements and the market guarantees commonly contained in older blocks of business, along with the requirement to value all financial options and guarantees, we expect that implementation of the standard will result in higher reserves and a reduction in opening equity


Fixed deferred annuity analysis (continued)

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ProductFixed Deferred Annuity




Profit emergence: Overall, anticipate profit emergence may be delayed for newly issued fixed deferred annuity contracts

1. Investment spread

• Under current US GAAP, the investment margin is recognized as it is earned

• For IFRS 17, the analysis needs to consider a few moving pieces. Part of the investment margin will be recharacterized as CSM given that an asset-based discount rate may be used for discounting cash flows that vary with the performance of the underlyings (i.e., projecting cash flows at the credited rate and discounting at a higher asset based discount rate will produce a CSM)

• Assuming that the CSM is not recognized over the financial risk period (based on May TRG meeting), the recognition of the investment spread will be delayed compared to US GAAP

PwC | IFRS 17 – Illustrative product actuarial implications 11

Product




Profit emergence (continued): 2. PADs and RA

• There is no concept of PAD under current US GAAP for these products.

• We expect a relatively small RA under IFRS 17, principally relating to lapses, resulting in no significant impact to profit emergence compared to US GAAP.

3. Profit Loading

• Surrender charges are a key source of earnings in deferred annuity contracts.

• Under current US GAAP, surrender charges are recognized as they occur (generally in early years). Under IFRS 17, surrender charges will be embedded in the CSM and therefore, the recognition of the underwriting margin will likely be delayed compared to US GAAP


Fixed Deferred Annuity

PwC | IFRS 17 – Illustrative product actuarial implications 12

Product




Earnings volatility: On balance, a reduction in earnings volatility for fixed deferred annuity contracts.

• The profit recognition approach (i.e. revenue and benefits as they occur) along with the retrospective unlocking of DAC, can produce significant volatility in US GAAP financials

• IFRS 17 provides companies with a mechanism to reduce volatility through the effective yield approach or adjustments to the CSM or OCI, but the lower level of aggregation will likely result in faster recognition of losses, especially for spread products like fixed deferred annuities

• Whether or not the implementation of the new standard will result in higher earnings volatility compared to current US GAAP will depend of specific facts and circumstances of the product itself


Fixed Deferred Annuity


Fixed deferred annuity illustrationProfit emergence

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Duration 1 2 3 4 5 6 7 8 9 10Account Value C 100,000 101,148 102,287 103,414 104,523 105,607 106,661 107,676 108,642 109,550 Expected Benefits AV Released on Death H 312 337 367 402 443 490 546 610 683 765 Cash Surrender Benefit K 1,540 1,558 1,575 1,592 1,608 1,624 1,640 1,654 1,668 112,071 Total Benefits 1,852 1,895 1,942 1,994 2,051 2,114 2,185 2,264 2,351 112,836

IFRS 17 Liability 0 1 2 3 4 5 6 7 8 9 10PV of FCF (13,270) 88,781 90,881 93,028 95,221 97,455 99,726 102,029 104,356 106,700 -RA 859 801 738 670 596 516 428 333 230 118 -CSM 12,411 12,721 13,039 13,365 13,699 14,042 14,393 14,752 15,121 15,499 -Total - 102,303 104,658 107,063 109,516 112,012 114,547 117,114 119,707 122,317 -

Simplified assumptions:

• FCF projected under single deterministic scenario (credited rate of 3%)

• Portfolio earned rate as discount rate (4.5%)

• No expenses

• No surrender charges

• Assumes all contracts lapse at the end of year 10

• Simplified calculation of RA (based on PV of FCF)


IFRS P&L 1 2 3 4 5 6 7 8 9 10Expected Benefits - - - - - - - - - -RA Release 97 99 101 104 107 110 114 118 123 123 CSM Release - - - - - - - - - 15,887

Insurance Revenue 97 99 101 104 107 110 114 118 123 16,010 Actual Benefits - - - - - - - - - -

Service Expense - - - - - - - - - -Finance Income 4,500 4,604 4,710 4,818 4,928 5,041 5,155 5,270 5,387 5,504 Finance Expense (4,252) (4,349) (4,449) (4,551) (4,654) (4,760) (4,867) (4,975) (5,084) (5,194)

Finance Result 248 254 261 267 274 281 288 295 302 310 Pre-tax Net-income 345 353 362 371 381 391 402 413 425 16,320

Observations:

• FCF are projected at the credited rate and discounted back at the portfolio asset rate (due to the variability on FCF), which results in a transfer of the investment spread to the CSM at inception of the contract

• There are no benefit payments in excess of the account value. Therefore, excluded from revenue and service expense (investment component)

• Pre-tax net income driven by release of RA, release of CSM and investment spread

• Fixed Deferred Annuities measured under the General Model, which delays the recognition of the CSM. Based on the May TRG meeting, the determination of coverage units for contracts under the General Model should consider the patter of services for the insurance component only

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Fixed deferred annuity illustration (continued)Profit emergence

- 2,000 4,000 6,000 8,000

10,000 12,000 14,000 16,000 18,000

1 2 3 4 5 6 7 8 9 10

IFRS 17 Pre-tax Net Income

Pre-tax Net-income


Implications

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Implementers of IFRS 17 continue to evaluate their accounting policies in order to gauge the impact the new standard will have on their products

Opening equity at transition, volatility of future earnings and the timing of profit recognition will change. All of these indicators are extremely important and as such need to be closely monitored

Delving into the specific drivers of change will provide an increased understanding of the transition and on-going financial implications of accounting policy choices and how these may impact management decisions, product design and risk management strategies

© 2018 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

Thanks!

CONFIDENTIAL

IFRS 17 Session

Takeko Uemoto, FSAAugust 28, 2018

Content

I. How Prudential Approaches IFRS Implementation

II. Product Analysis

III.IFRS 17 IT

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Full adoption of IFRS IFRS is adopted; insurance companies subject to alternate accounting standards

IFRS not allowed for domestic issuers or for statutory reporting Reporting based on IAS standards

IFRS is voluntary (Local GAAP, if not used) National standards in line with IFRS, either no or a pending timetable for full adoption

Many countries adopted IFRS; Japan and the U.S. are not required• IFRS is optional for Japan• 8 local operations adopted IFRS• Some potential growth regions are likely IFRS filers

I. How Prudential Approaches IFRS Implementation - Countries

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I. How Prudential Approaches IFRS Implementation – Roadmap

Expected tasks will increase over time toward 2021

PII P

rogr

am S

uppo

rt

• Project team set-up• Basic Training – Prophet and/or

IFRS 17• Industry/Regulatory Update

• IFRS 9 Strategic Analysis• IFRS Methodology Paper • IFRS B/S Impact Study • IFRS 17 product analysis• IFRS 17 IT Design • IFRS 17 Liability CF Modeling• Project team set-up• Basic Training – Prophet and/or


• IFRS 17 Parallel Run and Go live Testing• Finance, Ledger and Internal Control • Audit preparation• Other analyses (investment, risk, capital,

projection, and etc.)• IFRS 9 Implementation• IFRS Methodology Paper • IFRS B/S Impact Study • IFRS product analysis• IFRS 17 IT Implementation• IFRS Liability CF Modeling• Project team set-up• Basic Training – Prophet and/or


Time

2017 2018 2019-2020

I. How Prudential Approaches IFRS Implementation – Current Structure

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Global program councils

Local operation project teams

Global program working groups• IFRS 17 Methodology Product study Opening balance sheet impact study

• IFRS 17 IT Liability cash flow model and ALM model IFRS 17 IT design Financial Statement and Ledger Setup

• IFRS 9 strategic analysis

• Operations Governance and operating model Planning and budget governance Training

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Types of analysis• Profit emergence and profitability measures with methodology options• High level time zero analysis• Stress tests• IFRS 17 new business grouping process• Qualitative assessment

Other framework to coordinate• Required capital (IAIS ICS like local regulatory capital, internal capital)• US GAAP targeted improvement

Challenges• Pricing metrics • Complex products and sophisticated analysis tools• Methodologies, approaches and simplifications• Ultimate tools• Timeline

II. Product Analysis : Approach

II. Product Analysis : IFRS 17 Methodology

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Have been writing methodology papers Established a review and oversight process Noted some topics to be coordinated with FASB Targeted Improvements

Categories No IFRS 17 Liability Sub-topics FASB Targeted Improvement

Contract Characteristics

1 Level of aggregation Cohort2 Unbundling 3 Contract Boundary (Short duration and long duration)

Measurement

4 Future Cash Flow / BEL 5 Discount rate Discount rate6 Risk adjustment 7 CSM and Coverage Unit Amortization 8 Measurement model Methodology changes9 General Model

10 Premium Allocation Approach 11 Variable Fee Approach 12 Onerous Contracts treatment

Considerations

13 Transition Data, Transition14 Reinsurance 15 Expense (Deferrable) 16 Presentation and Disclosure Disclosure17 Modification/De-recognition

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II. Product Analysis : Consideration for FASB Targeted Improvement

In general, Targeted Improvement reserve and DAC are closer to IFRS 17 than the current GAAP In methodology, financial impact analysis, infrastructure and implementation, IFRS 17 and

Targeted Improvement need to be coordinated

Category Products IFRS 17 FASB Targeted Improvement

Long-duration

TraditionalLife with non-par feature (like Term life, Endowment, whole life)

General Model

• FAS 60 LD & FAS 97 LP Reserve with no PAD and retrospective unlocking (inforce block will ‘pivot’ from existing reserve balance)

• Discount rate based on “upper-medium grade fixed income yield” (inforce block will use original locked-in GAAP discount rate)

• DAC/FEL with simple amortization• No loss recognition test

Participating General Model

Universal Life General Model • FAS 97 UL Reserve = AV• DAC with simple amortization• SOP 03-1 for ULSGInterest Sensitive General Model

Variable Life/Annuity VFA

• FAS 97 UL Reserve = AV• SOP 03-1(GMDB)=>Market Risk

Benefit (Fair Value) • FAS 133 + FAS 157 (GMAB/GMWB)

Short-duration Group Life, Term Life, YRT PAA FAS 60 SD

Key preliminary findings:• Profitability (IRR/VNB) may improve in general, mainly due to implicit expenses deferral, lower

total liability/reserve for certain products, and profit release/amortization pattern

• However, profitability is very sensitive to key assumption/methodology such as:

Discount rate

Directly attributable cost

Coverage unit

Key preliminary implications: • Profit measure for the future

• Significance of directly attributable expense: further research and expense study

• IFRS as potential management reporting tool

• Pricing process for cohort/portfolio creation

II. Product Analysis : Key Takeaways From Preliminary Study

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Have taken steps and used workshop to derive the optimal IT design Searching for a target operating model

III. IFRS 17 IT - Design Journey

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Workshop #1 Workshop #2 Workshop #3 Workshop #4

Proposed Feasible Solutions

IFRS17 requirements

Financial statement and disclosure training

Walk-through of in-house

tools

IT design objective

Vendor solutions

Experience ofOther insurers

S1

S2

S3

S4

S5

S6

Prudential to select options for POC and agree on test plan

S1c

Proof of Concept (POC) Testing

• Prudential to perform POC testing

• Summarize the test results

POC

workable

Agree on optimal solution

Final design and high level implementation plan

Test results

S1c

S3Final

S3

S1a

Local operation road show and discussion

III. IFRS 17 IT – Key Functionalities Reviewed

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Liability cash flow calculation Cloud CSM calculation Database Subledger, reporting and analytics Workflow management

Source: SAS

session 64pd: ifrs 17 - understanding financial impacts · 2018. 9. 13. · pwc | ifrs 17 –...

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