Casualty Actuaries of New England (CANE) September 26, 2008
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Casualty Actuaries of New England (CANE) September 26, 2008. Dispelling the Fog: ERM, Solvency II & IFRS. PwC. FOG. A state of mental dimness and confusion. PricewaterhouseCoopers.

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Casualty Actuaries of New England (CANE) September 26, 2008

Dispelling the Fog:

ERM, Solvency II & IFRS

PwC


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FOG

  • A state of mental dimness and confusion.

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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  • ERM can provide a solid foundation for many key aspects of IFRS implementation, as well as synergies to help ease the cost of compliance with other forthcoming risk/capital management directives, including Solvency II.

  • Regulatory challenges include overcoming the continuing uncertainty with respect to insurance reporting under IFRSand gearing up for the forthcoming Solvency II. Increased pressure from regulators and rating agencies alike sees more focus on ERM.

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Agenda

  • Introductions

  • Overview of ERM

  • Solvency II Update

  • Overview of IFRS

  • Linkages between ERM, Solvency II, and IFRS

  • Company perspective

  • Q&A

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Navigating Through Fog

  • Stay Calm

  • Slow Down

  • Avoid Braking Often

  • Avoid Distractions

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Section One

ERM Overview


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Does ERM matter?

  • “Risk management adds value not only to individual companies, but also supports overall economic growth by lowering the cost of capital and reducing the uncertainty of commercial activities.”

  • James Lam

  • “Enterprise Risk Management – From Incentives to Controls”

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

ERM Overview

  • The benefits of ERM are derived from integration:

  • an integrated organization, which often includes a centralized risk management unit reporting to the board, CEO or CFO with responsibility for broad risk policy setting across risk taking activities;

  • an integration of risk transfer strategies (considering all risks, and any diversification benefits between them); and

  • the integration of risk management into business processes, optimizing performance through risk adjusted pricing, resource allocation, and enhanced business decision making.

Source: James Lam – Enterprise Risk Management – From Incentives to Controls

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

ERM Overview

  • An ERM infrastructure must be developed…

  • risk management governance;

  • risk management policies and procedures;

  • risk assessments and audits;

  • systems and financial models;

  • measures and reports; and

  • risk limits and exception processing.

  • Develop from the top down!

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

ERM Overview

  • …however, ERM benefits will only be realized when companies:

  • build risk awareness through senior management commitment;

  • create a culture for risk management;

  • facilitate open communication;

  • identify and/or develop talent; and

  • reinforce behavior.

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

ERM Overview – An Illustrative Framework

Environment

Infrastructure

Process

Strategy

Validation/re-assessment

Business mission and strategy

Risk strategy

Value proposition

Risk appetite

Risk awareness/

Identification

Risk assessment/

Response

Operations

Measurement

and Control

Reporting

Organisation and people

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Culture

Training

Communication

Performance

measures

Reward

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

Integration of Enterprise Risk Management

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Organisation and people

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Enterprise Risk Management

ERM Infrastructure – Organization and people

  • Centralized independent risk management function

  • CRO or senior executive with risk role

  • Oversight committees at the Board / senior management levels

  • Risk awareness, culture and values

  • Risk training

  • Talent management

  • Linkages between risk and compensation

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Organisation and people

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Enterprise Risk Management

ERM Infrastructure – Limits and Controls

  • Define corporate-wide and product-specific risk appetites

  • Risk assessments

  • Risk inventories

  • Exposure limits and triggers

  • Risk controls

  • Risk escalation

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Risk Appetite

A measure of the potential financial impact that the company is willing to take in exchange for a targeted return

ERM programs may have multiple definitions for risk appetites

Capital (Ruin focus)

Earnings (Volatility focus)

Rating (May be driver of probability choice)

Alignment with product pricing

Enterprise Risk Management

ERM Terminology

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Risk Tolerance

Relates to management strategies

Risk Limits

Defining risk limits - connection with the company-wide risk appetite, approval processes

Risk escalation processes

Procedures used for monitoring and responding to limit breaches

Automatic triggers, risk dashboards

Enterprise Risk Management

ERM Terminology

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

Process in Place to Define Risk Appetite

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

Process in Place to Deal with Breaches of Limits

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Organisation and people

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Enterprise Risk Management

ERM Infrastructure – Methodologies & Models

  • Insurance, market, credit and operational risk management

  • Economic capital models & capital allocation

  • Risk analytics, including scenario analysis, risk indicators, risk-adjusted returns

  • Risk transfer strategies

  • Linkage of planning and risk strategy

  • Linkages to product pricing

  • Performance management

  • Capital management

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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“Excess” Capital

Assets available

for required capital

Economic Capital

Assets covering liabilities

Liabilities

Enterprise Risk Management

Economic capital models

Key areas where survey respondents identified benefits of implementing an economic capital model:

  • Better allocation of capital than under a regulatory capital model

  • Definition of risk appetite

  • Freeing up of capital for use in the business

  • Changes in the pricing of products to better reflect risk

  • Changes in strategic direction after assessing risk-adjusted performance

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Aggregate Economic Capital Model

Inter-risk Diversification

Market Risk

Insurance Risk

Credit Risk

Operational Risk

BU 1

BU 2

Inter-segment Diversification

BU 3

Corporate & Other

Enterprise Risk Management

Economic capital models (cont’d)

  • Types of models

    • Factor based

    • Stress tests

    • Combination models (usually a combination of factor based models with either stress testing or stochastic modeling)

    • Fully stochastic models

  • Range of risks

    • Insurance risks — typically modeled using stress tests for life business and stochastically for non-life business

    • Market risk and credit risk — often modeled stochastically

    • Operational risk — factor based or “scenario driven models” are common

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

Economic capital models (cont’d)

Source: 2008 PwC survey covering ERM in the global insurance industry

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management

Model Development Timeline

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Traditional Operational Risk Management - Separate Silo Risk Management for:

IT Risks

HR Risks

Regulatory & Compliance Risks

Fraud Risk

Internal Controls

Reputation Risk

Business Continuity

Distribution Risks

Outsourcing/Vendor Risk

Enterprise Risk Management

Operational Risk

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise ORM – leading to Management for:Strong ORM assessment by S&P usually associated with:

Comprehensive assessment of risks & control capabilities

Identification of risks not adequately controlled by existing programs

Prioritization

Development of key risk indicators, tracking process & problem resolution system

Excellent ORM assessment usually associated with:

Repeated application

Refinements of controls & KRIs

Response programs

Enterprise Risk Management

Operational Risk Management

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Organisation and people Management for:

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Enterprise Risk Management

ERM Infrastructure - Systems

  • ERM supporting technology

  • System interface, mapping tools, middleware

  • Risk registers

  • Exposure analytics, drill-down capabilities

  • Risk reporting tools

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Organisation and people Management for:

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Enterprise Risk Management

ERM Infrastructure – Data

  • Risk and portfolio data requirements:

    • Access

    • Common definitions

    • Quality assessments

    • Cleansing

  • Data warehouses

  • Industry data

  • Benchmarking data

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Enterprise Risk Management Management for:

Rating Data Management Expenditures

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

PricewaterhouseCoopers


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Organisation and people Management for:

Limits and controls

Methodologies & Models

Systems

Data

Policies

Reporting

Enterprise Risk Management

ERM Infrastructure – Policies

  • Market, credit, insurance, operational risk policies and procedures, including:

    • Risk rating policies;

    • Exposure management policies;

    • Risk limit policies;

    • Monitoring and review policies;

    • Risk transfer policies;

    • Management and board reporting policies.

  • Overall risk policies

  • Emerging risk policies

  • CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Organisation and people Management for:

    Limits and controls

    Methodologies & Models

    Systems

    Data

    Policies

    Reporting

    Enterprise Risk Management

    ERM Infrastructure – Reporting

    • Board reporting, including enterprise view on aggregate losses, risk incidents, policy exceptions, key exposures, KRIs

    • Key risk indicators that quantify major trends and risk exposures

    • Limit exception reporting

    • Risk dashboards

    • ERM disclosures

    • Finance effectiveness – exploiting synergies between requirements for financial reporting, ERM, Solvency II, and IFRS

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Enterprise Risk Management Management for:

    Does ERM matter?

    • Through improved…

      • Coordination

      • Communication

      • Financial discipline

      • Transparency

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Section Two Management for:

    Solvency II Update


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    Solvency II Management for:

    Solvency II – EU taking a global lead in insurance regulation

    • “This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers. We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently.”

    • Charlie McCreevy

    • Internal Market and Services Commissioner

    • Speaking at the launch of the Solvency II draft Framework Directive

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Is Solvency II likely to have Global impact?

    • Principles-based risk sensitive regulation is becoming the norm

      • US led the way (RBC models) initially, then Canada (DCAT)

      • More recently: Australia, UK (ICAS) and Switzerland (SST)

      • Many other jurisdictions are looking at implementing Solvency II or seeking “equivalent regime” status

        • NAIC publicly-stated intention to consider options

        • However, State-based US system adds significant complexity to regulatory innovation/connectivity with other global regulators; e.g.

          • Principles-based reserving discussions likely to take years to finalise

          • Policy forms and premium rates still needing regulatory approval

        • The Optional Federal Charter solution?

    • IAIS has now got real traction

    • Global footprint of CFO and CRO Forum members

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Economic capital – lies at the heart of Solvency II and at the core of managing your business

    Solvency &Financial

    Reporting

    Economic

    Capital

    Rating

    Agencies

    Delivering Shareholder Value

    EnterpriseRisk Management

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Solvency II – Timescales

    Solvency II system in operation

    (31 October 2012)

    High Level Principles (Level I Directive) adopted

    Draft Framework Directive published

    EU member states to transpose into law

    2007 2008 2009 2010 2011 2012

    Model pre-approval process

    Quantitative

    Impact Study v.3

    Quantitative

    Impact Study v.4

    Detailed rules (Level II implementing measures)

    The above timeline corresponds closely to the current IFRS timescale – but the two projects are not formally linked

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Solvency II – Draft Framework Directive - overview

    GROUP SUPERVISION – all pillars applicable to solo entities and groups

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Solvency II – Quantitative requirements

    Proposed framework for Pillar I

    Assets available

    for SCR/ MCR

    Solvency Capital Requirement (SCR)

    MCR

    Risk margin

    for non-hedgeable risks

    Best estimate

    Assets at Market Value

    Assets covering technical provisions

    Technical Provisions

    Market consistent valuation for hedgeable risks

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Current areas of contention within Solvency II/ outstanding issues

    • Group supervision and group support

      • role of lead versus country supervisor

      • group support mechanism

      • Treatment of 3rd countries (e.g. USA, Bermuda, Far East)

    • Design and calibration of MCR

    • Treatment of surplus funds (Germany), equities re: market risk (France)

    • Proportionality (e.g. should there be a de minimis threshold?)

    • Public disclosures – extent, timing

    • Captives and mutuals

    • Use of internal models

    • Role of audit (overlap with financial reporting)

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Solvency II – Progression from Solvency I

    Solvency I

    Solvency II

    Pillar 1

    • Local GAAP/IFRS

    • No internal model

    • RMM

    • Market consistent valuations

    • MCR, SCR

    • Internal model optional (use

    • subject to supervisory approval)

    Pillar 2

    • Supervisory review

    • No EU harmony

    • Group capital assessment

    • (post IGD) – no

    • diversification benefit

    • Supervisory review process

    • Emphasis on governance

    • and risk management

    • Capital add on: exceptional

    • Group capital assessment with

    • diversification benefit

    • ORSA

    Pillar 3

    • Public Disclosure

    • FSA Return, IGD data

    • Public Disclosure

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Small Management for:

    Large

    Solvency II

    Summary of possible implications of Solvency II

    Multinational

    • Reconsideration of HO location

    • Diversification benefits / reduced capital req.

    • Reconsideration of operating structure

    • Acquisition opportunities (e.g. amongst

    • small players)

    • Strategic re-evaluation of business lines

    • Disposals or run-off of underperforming /

    • capital intensive books

    • Capitalfungibility challenges

    • Inability to meet SII requirements?

    • Disproportionate compliance

    • costs

    • Reconsideration of operating structure

    • Seeking merger partners

    • Industry roll up possibilities

    • Discontinuation of business

    • Insolvency

    • Seek merger partners to obtain

    • diversification benefits

    • Reconsideration of operating structure

    • Acquisition opportunities (e.g. amongst

    • small players)

    • Strategic re-evaluation of business lines

    • Disposals of run-off/underperforming books

    • Capital fungibility challenges

    Domestic

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    What are we seeing European firms doing at present?

    • Broad EU industry support for the proposals

    • SII approach and level of engagement differs by country and segment

      In Europe generally, what are companies typically doing:

    • General education and awareness raising

    • Companies taking a more proactive stance:

      • Impact assessments/gap analyses (see below for typical themes)

      • Setting up Solvency II project teams

      • Examining specific aspects e.g. risk appetite/ERM framework

      • Restructuring ahead of the final Directive wording

      • Data warehouse set-up, model specification and build

      • Projects covering economic capital, IFRS, MCEV

      • Addressing broader finance transformation and actuarial integration

        Outside EU, already some regulators and companies looking at same concepts

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Market implications - Rating agency interaction with Solvency II

    • Capital is just one element of ratings

    • Rating agencies not all using DFA models – but moving in that direction

    • Agencies stated intention to converge

      • Consider companies’ internal model (S&P launched limited EC model review)

      • Still the option of qualitative add-on for other agency factors

      • Some major differences in approach (diversification benefits less generous, no explicit discount for lack of fungibility of capital)

  • Calibration differences (SCR is approximate to BBB)

  • Agencies and indeed markets will react to any Pillar II add on

  • Regulators may expect an integrated approach to calculating capital held

  • Increased focus on ERM concepts

  • CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Key Challenges Management for:

    Integration of ORSA into the business’ strategic management

    ORSA expected to serve multiple purposes including regulatory compliance

    Ability to have risk management systems that monitor, manage and report risk on a continuous basis (at individual and aggregate level)

    Use for allocation of capital, consistency between pricing and capital decisions

    Solvency II

    Link to ERM - Impact on organisations from the Solvency II risk and governance requirements – Pillar II - ORSA

    Management

    Strategy

    ORSA

    Operations

    Internal

    Models

    EMBEDDING RISK MANAGEMENT

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Draft Solvency II Directive:

    Regulatory approval of an internal model will require an entity to satisfy three broad tests:

    • Test 1: Statistical Quality Test (Article 119) – Actuarial model

    • Test 2: Use Test (Article 118) – Internal risk management

    • Test 3: Calibration Test (Article 120) – Regulatory capital

  • In addition, entities must satisfy:

    • Validation Standards (Article 122)

    • Documentation Standards (Article 123)

  • CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Solvency II Management for:

    Internal Models – External Review

    Draft regulatory requirements for approval of internal models:

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Public disclosure Management for:

    Annual disclosure of solvency and financial condition report

    Subject to approval groups may disclose only one report

    Systems/ structures required to ensure ongoing appropriateness of information disclosed

    Link to IFRS

    Conceptually in line with IFRS approach and timeline

    Solvency and financial condition

    report to contain information on

    The nature and performance of the business

    Governance systems

    Risk management approach and risk profile

    Valuation basis for assets and liabilities

    Capital management including structure and quality of own funds, MCR and SCR

    Non-compliance with MCR and SCR during reporting period

    Solvency II

    Pillar III - Public disclosure and link to IFRS

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Section Three Management for:

    IFRS Update


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    International Financial Reporting Standards (IFRS) Management for:

    What is IFRS?

    SEC Roadmap

    Insurance Contracts Today

    Insurance Contracts Phase 2


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    What is IFRS? Management for:

    Background

    • IFRS—International Financial Reporting Standards

    • Standard setter—International Accounting Standards Board (IASB) founded in 2001 and based in London

    • International Accounting Standards Committee (IASC) Foundation

      • Appoint IASB members

      • Exercise oversight

      • Raise funds

      • Similar to Financial Accounting Foundation (FAF)

    • Predecessor organisation was International Accounting Standards Committee (IASC) founded in 1973

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    IASC Management for:

    Foundation

    22 trustees

    Appoint

    Appoint

    Appoint

    Govern

    Fund

    SAC

    50 members

    IFRIC

    12 members

    IASB

    Chairman plus

    12 members

    Advise

    Interpret

    Create

    IFRS

    High quality, enforceable and global

    What is IFRS?

    Standard setting structure

    Trustees

    Board

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    A simpler set of accounting guidance Management for:

    25,000 pages

    • 2,500 pages

    What is IFRS?

    • IFRS

    • Standards

      • IFRS: 8

      • IAS: 29

    • Interpretations

      • IFRIC: 8

      • SIC: 11

    • Framework

    • US GAAP

    • Standards:

      • SFAS: 106

      • APB: 16

      • ARB: 4

    • Interpretations

      • FSP: 49

      • EITF: 108

      • FIN: 27

    • Concepts Statements: 6

    • Other

      • FTB: 32

      • AICPA Interpretations: 6

      • SOP: 51

      • AICPA Industry Audit and Accounting Guides, SABs, DIGs…

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    What is IFRS? Management for:

    IFRS Framework

    Responsive to users’

    needs for clarity

    and transparency

    Consistency with a

    clear conceptual

    framework

    Faithful presentation

    of economic reality

    Criteria for

    principles-based

    standards

    Based on an

    appropriately

    defined scope

    Written in clear,

    concise and plain

    language

    Allows for use of

    reasonable judgment

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    International Financial Reporting Standards (IFRS) Management for:

    What is IFRS?

    SEC Roadmap

    Insurance Contracts Today

    Insurance Contracts Phase 2


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    SEC Roadmap Management for:

    When might the transition to IFRS occur in the US?

    Reasonable timeline for the US transition to IFRS

    January 2009-2014

    Voluntary application of IFRS permitted for certain US registrants

    March 2007

    SEC roundtable on US GAAP reconciliation for IFRS filers

    August 2007

    SEC concept release on use of IFRS for US registrants

    August 27, 2008Roadmap was issued

    2009

    2007

    2011

    2013

    2015

    2008

    2010

    2012

    2014

    January 2014Proposed roadmap targets potential mandatory adoption in 2014-2016?

    July 2007

    SEC proposal eliminating US GAAP reconciliation for IFRS filers

    December 2007

    SEC roundtable on IFRS in the US

    November 15, 2007

    Reconciliation eliminated for IFRS filers

    During 2011SEC will reconvene to decide whether a mandatory conversion date should be set

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    SEC Roadmap Management for:

    Proposed Roadmap

    • Targets potential mandatory adoption of IFRS in the U.S. beginning in 2014 (or 2014-2016)

    • Lays out several milestones that would need to be achieved prior to the SEC mandating use of IFRS for all U.S. issuers

    • Proposed rule for certain qualifying domestic issuers to use IFRS as early as 2009

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    SEC Roadmap Management for:

    Requires Future SEC Action

    • SEC would reconvene in 2011 to decide whether:

      • Milestones have been achieved

      • Mandatory IFRS conversion date should be set for all issuers

      • Option to early adopt IFRS should be expanded to a larger population of issuers

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    SEC Roadmap Management for:

    Milestones

    • Continued improvements to IFRS accounting standards

    • Independent funding of the IASC Foundation

    • Enhanced ability for interactive data (XBRL) to accept IFRS data

    • Sufficient progress in IFRS education and training in the U.S.

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    SEC Roadmap Management for:

    Optional Early Adoption of IFRS in the U.S.

    • The SEC proposal would permit early adoption of IFRS by a limited number of eligible U.S. issuers. The issuer would need to meet the following two criteria in order to qualify for early adoption of IFRS:

      • The issuer would need to be among the 20 largest companies, measured by market capitalization, in their industry group and

      • IFRS must be used by the majority of the 20 largest companies, measured by market capitalization, in that industry group

    • Early adoption requires approval of the SEC Division of Corporation Finance

    • SEC estimates that at least 110 U.S. multinational companies in 34 different industries would be eligible for early adoption

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    International Financial Reporting Standards (IFRS) Management for:

    What is IFRS?

    SEC Roadmap

    Insurance Contracts Today

    Insurance Contracts Phase 2


    Slide61 l.jpg

    Yes

    No

    Does the contract need to be unbundled?

    Are any discretionary participation features present?

    No

    Yes

    No

    Yes

    Deposit Component

    Insurance Component

    Investment Contract with discretionary participation features

    Insurance Contract

    Investment Contract

    (IAS 39)

    Amortized Cost or FV

    Use existing valuation

    Liability or equity

    Insurance Contracts Today

    IFRS 4 Measurement

    Insurance risk = Risk other than financial risk transferred from the holder of the

    contract to the issuer.

    = No requirement for underwriting and timing risk.

    Significant = Where an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance, irrespective of the likelihood of such event.

    The “additional benefit” is measured in comparison to that which would be paid if the insured event did not occur.

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Insurance Contracts Today Management for:

    IFRS 4 Disclosures

    • General disclosure principles

      • Principle 1: Identify and explain significant amounts in financial statements

        - Accounting policies and significant assumptions

        - Changes in amounts and assumptions

      • Principle 2: Help users understand future cash flows

        - Objectives managing risks & policies for mitigating risks

        - Terms and conditions and affect on cash flows

        - Insurance risks - sensitivity analysis, concentrations, loss development

        - Interest rate and credit risks

    • Sensitivity analysis

      • Actual changes in financial results for changes in key assumptions

      • Sensitivity of financial results for changes in all variables that have a material impact on assets, liabilities, income and expenses (e.g. interest rates, inflation rates, equity markets, mortality, persistency, frequency and severity )

      • Companies have not historically not provided sensitivity analysis in audited financial statements

        < - Will need to determine data requirements

        < - Will need to benchmark / emerging practice

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    International Financial Reporting Standards (IFRS) Management for:

    What is IFRS?

    SEC Roadmap

    Insurance Contracts Today

    Insurance Contracts Phase 2


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    FASB ITC Management for:

    Aug 07

    Insurance Contracts Phase 2

    Status Update

    • Current IFRS situation for accounting for insurance contracts is inconsistent across jurisdictions

    • Results in too much diversity, less relevance and reliability

    • The IASB started with a clean slate to develop Phase 2

    • FASB may pursue joint project with IASB (IFRS/US GAAP convergence)

    Phase II IFRS effective 2013?

    Discussion Paper published

    May 07

    Phase II IFRS published 2011?

    Phase II work begun

    Jul 04

    Comment period ends

    Nov 07

    Phase II Exposure Draft published Late 09?

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    We are here

    PricewaterhouseCoopers


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    Insurance Contracts Phase 2 Management for:

    Technical Overview – key features

    • Discounting for non-life business

    • Strong opposition from US non-life industry

    • Prospective cash flow model

    Single accounting model

    • Controversial (inside and outside IASB)

    • Possible day one gains

    • Obligation may arise on contract signing

    Exit Model

    • Exit vs. Entry value – illustration:

    • 10 year single premium policy sold by insurer X for $1,000

    • Insurer X expects to realize a profit of $250

    • Insurer Y prepared to purchase policy from X for $900 (after allowing for risk)

    • Entry value liability = $1,000 Initial profit is $nil (before or after acq. costs?)

    • Exit value liability = $900 Initial profit is $100

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value

    • IASB rationale for current exit value:

      • More faithful representation of insurer obligations and rights

      • Conveys more useful information about amounts, timing, uncertainty of cash flows

      • Current estimates and use of explicit rather than implicit assumptions require insurer to actively consider whether circumstances have changed

      • Explicit rather than implicit risk margin

      • Avoids need for separate liability adequacy test

      • More coherent framework for complex contracts such as multi-year, multi-line, or stop loss contracts, avoiding need for arbitrary rules

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value

    • IASB rationale for current exit value (cont):

      • Eliminates need to separate embeddeds

      • Consistent with IAS 37 and IAS 39 which require current estimates of future cash flows

      • Reduces motivation to use reinsurance to recognize previously unrecognized gains

      • No need for arbitrary criteria to distinguish amendments to existing contracts from new contracts

      • Reduces possible accounting mismatches between assets and liabilities

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value

    • Opponents of exit value approach:

      • Exit value places too much reliance on hypothetical transactions that rarely occur (i.e. transfers)

      • Entry value reflects real transaction – price charged to PH

      • No conceptual basis for Day 1 gains

      • Market-consistent cash flow assumptions and market-consistent risk margins are not observable or attainable – introduces more subjectivity and non-comparability into the estimates

      • Some believe discounting of non-life liabilities is not appropriate due to unpredictable nature of cash flows

      • Current exit value inappropriately implies a greater measure of precision in the estimate that just isn’t there

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Insurance Contracts Phase 2 Management for:

    Technical Overview – key features cont’d

    Core liability measurement

    • Current, not past conditions

    • Market participant vs entity specific

    • Modelling demands

    • Expected mean value, not deterministic most likely

      • More complex (stochastic?) models

    • What cash flows to include? Contractual?

    Current, unbiased, market consistent, probability weighted estimates of contractual cash flows

    • Liability moves with market rate changes

    • Insurer’s investment strategy not relevant, except for par business

    Current marketdiscount rates

    • Estimate of market risk margin

    • Limited guidance on calculation

    • Controversial feature, due to lack of market

    • Key driver of day one profit

    Risk margin

    Service margin

    • Amount of expected future market-based service profits

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Section Four Management for:

    Linkages Between ERM, Solvency II, IFRS


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    Linkages Between ERM, Solvency II, and IFRS Management for:

    Review of the Common Features

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


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    Section Five Management for:

    Company Perspective


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    Company Perspective – ERM, Solvency II, IFRS Management for:

    ERM & Capital Modeling

    • ERM Stochastic Modeling

      • GAAP equity

      • Statutory surplus

      • Economic capital

      • Other measures


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    Company Perspective – ERM, Solvency II, IFRS Management for:

    IFRS and GAAP Balance Sheet Accounting

    • Key Difference

      • GAAP  Full value loss reserves

      • GAAP  Full value loss reservesIFRS Fair


    Ifrs solvency ii two sides of one coin l.jpg

    Company Perspective – ERM, Solvency II, IFRS Management for:

    IFRS & Solvency II – Two Sides of One Coin

    • IFRS = Fair value = (Economic value) concept

      • Convergence of economic and accounting values

      • Aim: IFRS net assets = Available economic capital

    • Solvency II = (Fair) value-at-risk concept

      • One-year time horizon

      • 99.5% confidence level

      • Aim: (IFRS) Net Assets VaR99.5%  Required economic capital


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    Questions Management for:

    • Do you have any questions regarding what you have learned in this session?

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS

    PricewaterhouseCoopers


    Slide77 l.jpg

    www.pwc.com Management for:

    © 2008 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. The information contained in this document is provided 'as is', for general guidance on matters of interest only. PricewaterhouseCoopers is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional adviser. Although we believe that the information contained in this document has been obtained from reliable sources, PricewaterhouseCoopers is not responsible for any errors or omissions contained herein or for the results obtained from the use of this information.

    PwC


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    ADDENDUM - IFRS Management for:

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Premium Cash Flows – Conceptual Framework

    • Definition of an asset per the Framework

      • “…a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”

    • Definition of a liability per the Framework

      • “…a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.”

    • Internally developed intangible assets are generally not recognized except in business combinations

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Premium Cash Flows

    • Premiums relate to an intangible asset: portion of customer relationship with the policyholder

    • IASB decided to present it together with insurance liability

    • Re-pricing the policy makes it a new contract from accounting perspective and therefore not eligible for asset recognition

      • e.g., short duration property/casualty contract

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Premium Cash Flows

    • Future premiums on existing contracts recorded as part of customer relationship if any of the following 3 criteria met:

      • Policyholder must pay premium to retain guaranteed insurability

        • Guaranteed insurability = right that permits continued coverage without reconfirmation of PH risk profile and at price that is contractually constrained

      • Insurer can compel policyholder to pay premium (rare)

      • Including the premiums and resulting policyholder benefit will increase the measurement of liability

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 1st

    • Determining expected present value:

      • Identify each possible scenario

      • PV cash flows in that scenario

      • Make unbiased estimate of probability of that scenario

      • Insurer might develop estimates of each scenario by:

        • identifying individual scenarios

        • developing a formula that reflects insurer estimate of shape and width of probability distribution, or

        • by random simulation

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


    Building blocks of the iasb current exit value 1st83 l.jpg

    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 1st

    • Market-consistent vs. entity specific cash flows:

      • Should not capture cash flows due to synergies between insurance liability and other assets or liabilities

      • But should capture specifics of portfolio being measured

      • For unobserved variables (e.g., frequency/severity of claims, mortality), rarely persuasive evidence that insurer’s own estimates differ from estimates other market participants would make

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


    Building blocks of the iasb current exit value 1st84 l.jpg

    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 1st

    • Reflect market participant (not entity specific) efficiency

      • Use servicing costs that market participants would incur

      • Don’t use entity specific servicing costs that reflect synergies others don’t have

      • Don’t use costs reflecting inefficient servicing system (e.g., antiquated claims administration system)

    • But reflect characteristics of contract; strategy for handling

      • Level and type of service provided

      • Approach to claims management

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 2nd

    • Discount rates

      • Consistent with observable current market prices

      • For cash flows whose cash flows match those of insurance liability in terms of:

        • Duration

        • Liquidity

        • Currency

      • Discount all liabilities (long and short duration)

      • Not insurer’s investment yield rate

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 3rd

    • Risk Margin

      • Explicit and unbiased estimate of margin that market participants require as compensation for bearing risk

      • Reflects uncertainty in timing and amount of estimated future cash flows

        • Not a “cushion”

      • What a third party would require to assume risk

        • Not calibrated to premium

        • But premiums provide reasonableness check

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


    Building blocks of the iasb current exit value 3rd87 l.jpg

    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 3rd

    • Risk margin is portfolio rather than entity specific, reflecting pooling of liabilities

      • Unclear about market participant diversification across portfolios or negative correlation that different portfolios could provide

    • No specific method prescribed; example approaches provided

      • Confidence level, CTE, TVaR, cost of capital

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


    Building blocks of the iasb current exit value 3rd88 l.jpg

    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 3rd

    • Characteristics of the risk margin will likely include the following:

      • The less that is known about the current estimate and its trend, the higher the risk margin

      • Risks with low frequency and high severity will have higher risk margins than risks with high frequency and low severity

      • For similar risks, long duration contracts will have higher risk margins than those of shorter duration

      • Risks with a wide probability of distribution will have higher risk margins than those risks with a narrower distribution

      • To the extent that emerging experience reduces uncertainty, risk margins will decrease, and vice versa

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Building blocks of the IASB current exit value – 3rd

    • Service Margin

      • Market consistent margins for rendering services

        • e.g., investment management services

        • Unit-linked and variable contracts, universal life

      • Income (loss) recognition on Day 1 if insurer receives fee higher (lower) than market participants would demand

      • Differs from current revenue recognition under IAS 18 based on stage of completion

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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    Insurance Contracts Phase 2 Management for:

    Reinsurance – Cedent Perspective

    • Reinsurance asset follows same model as direct reinsured liability (exit value approach)

    • Risk margin for reinsurance assets equals risk margins for corresponding part of direct reinsured liability

      • Because one can’t transfer rights of indemnification of reinsurance contract without underlying liabilities’ rights and obligations

    • Reinsurance asset is adjusted for expected default and disputes

    • Recognize contractual right, if any, to obtain potentially favorable reinsurance rates

      • e.g., existing non-cancellable prospective reinsurance contract on future negotiated direct contracts

    CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS


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