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Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame

Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame. PwC. *connectedthinking. Agenda. History of the IASB Insurance Project Summary of the Discussion Paper. History of the IASB Insurance Project. History of the IASB Insurance Project. 1998. 1999. 2000. 2001. 2002.

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Discussion Paper Preliminary Views on Insurance Contracts Sabine Wuiame

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  1. Discussion Paper Preliminary Views on Insurance ContractsSabine Wuiame PwC *connectedthinking

  2. Agenda • History of the IASB Insurance Project • Summary of the Discussion Paper

  3. History of the IASB Insurance Project

  4. History of the IASB Insurance Project 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1997 • IASC starts insurance project in 1997 • “Issue Paper” published in 1999 – followed by issuance of a “Draft Statement Of Principles” • Not feasible to complete a project on insurance contracts before 2005. • Phase I = IFRS4 = Wide variety of accounting practices • DP issued on 3rd May 2007 • Comment period : 16 November • Will be used to develop Exposure Draft (? End 2008/2009) • Final Standard should be published in +/- End 2009/2010? • Effective transition date more than one year later (Jan. 2011?) Start of insurance project December: Issue Paper /DSOP Project split in two phases March: IFRS4 May: D.P. ED? IFRS?

  5. Principles of Phase I – IFRS4 • Contract classification and measurement: • Insurance contracts and investment contracts with dpf : IFRS4 • Investment contracts with no dpf: IAS39 • Phase I of the insurance project (IFRS4) is an interim phase • Continuation of local accounting policies with amendments: • Elimination of equalisation reserves • Liability adequacy test • Reinsurance impairment test • Change in accounting policies permitted: • Aimed at eliminating accounting mismatch • Shadow accounting • Use of current interest rates • Extensive disclosure requirements

  6. Convergence with other projects • Convergence project with US GAAP • Convergence with other IASB projects • Revenue recognition • Fair value measurement • Financial instruments • IAS37 • Framework • Definitions of liability and equity • Financial statements presentation • Convergence with Solvency II

  7. Summary of the Discussion Paper

  8. Summary of the Discussion Paper • Published in May 2007 • 7 Chapters: • 1-Scope • 2-Recognition and Derecognition • 3-Measurement - core issues • 4-Policyholder behaviour, customer relationship and acquisition costs • 5-Measurement- other issues • 6-Policyholder participation • 7-Changes in insurance liabilities

  9. Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities

  10. Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities

  11. Scope

  12. Scope • Definition of an insurance contract in IFRS4: • “contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder” • Insurance liability = insurer’s obligations under an insurance contract • Insurance asset = insurer’s rights under an insurance contract • Applies to all types of contracts (life, non life, accepted reinsurance)

  13. Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities

  14. Measurement

  15. Measurement • Concept of “current exit value” • Based on building blocks Service Margin Risk Margin Current exit value Best estimate of future cash-flows Discount Rate

  16. Measurement • Best estimate of future cash-flows (1) • No detailed guidance • Explicit • Consistent with observable market prices • If observable: direct inputs without adjustments • Not observable : • All available data, external and internal • Should not contradict market data • Include – in an unbiased way- information about amount, timing and uncertainty of all cash flows • Full range of possible outcomes and their probabilities

  17. Measurement • Best estimate of future cash-flows (2) • Current • >< “locked-in” assumptions • Exclude entity-specific cash-flows • Economic characteristics of the liability • Do not capture CF arising from synergy with other assets and liabilities • Do not capture CF that are specific to the insurer and would not arise for other market participants with the same obligations • Portfolio specific vs entity specific

  18. Measurement • Discount rate • Applies to all types of contracts • Including non life • Should not reflect the characteristics of the assets • Consistent with observable current market prices for cash flows whose characteristics match those of the insurance liability • No detailed guidance

  19. Measurement • Risk margin (1) • Effects of uncertainty • Liability with fixed cash flows vs liability with uncertain cash flows • “Explicit and unbiased measurement of the compensation that entities demand for bearing risk” • NOT a shock absorber • Captures all risks associated with liability • List of compliant actuarial methods • Should not reflect the benefits of diversification between portfolios and negative correlation between portfolios

  20. Measurement • Risk margin (2) • Calibrating the risk margin per unit of risk • Two approaches: • Implementation A : calibrates at inception directly to actual premium charged (less relevant acquisition costs) • Need to define acquisition cost, liability adequacy test • Implementation B: use actual premium only as reasonableness check • Profit at inception • Majority of Board Members in favor of implementation B

  21. Measurement • Service margin • Insurer might provide other services as well • Should be included if market participants require such a margin

  22. Measurement • Future premiums • Future premiums (+ related benefits) included if any of the following criteria is met: • Policyholder must pay premium to retain guaranteed insurability • The insurer can compel the policyholder to pay the premium • Including the premiums and the resulting policyholder benefits will increase the measurement of the liability

  23. Measurement • Acquisition costs • Should be recognized as an expense • Not as the cost of an asset

  24. Measurement • Assets backing insurance contracts • Phase I: accounting mismatches • Existing options to avoid accounting mismatches • Assets at fair value through P&L • Fair value model for investment property • These are not required • Shadow accounting • Shadow accounting no longer relevant for non-participating insurance liabilities • For participating business • Could be considered if assets classified as “available for sale”

  25. Measurement • Reinsurance assets • No offset • Current exit value • Risk of default (or disputes) of the reinsurer should be considered based on the expected loss model

  26. Measurement • Unbundling • Preliminary view based on interdependence : • If components so interdependent that can be measured only on an arbitrary basis, Phase II should apply to the whole contract • If components not interdependent, Phase II applies to insurance component and IAS39 applies to the deposit component • If components interdependent but can be measured on basis that is not arbitrary, then insurance component = measurement of whole contract under Phase II less IAS39 measurement of deposit component

  27. Measurement • Other • Current exit value should reflect liability’s credit characteristics • Unit of account does not affect the expected PV of future cash flows • No specific proposals for investment contracts

  28. Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities

  29. Policyholder Participation

  30. Participating contracts • Discretion (with constraints) over amount or timing of distribution to policyholders • Definition of DPF is not discussed • Is such right creating a liability? • Include in each scenario policyholder dividends that satisfy a legal or constructive obligation at the reporting date • Applies to participating insurance and investment contracts

  31. Summary of the Discussion Paper • Scope • Measurement • Policyholder Participation • Changes in insurance liabilities

  32. Changes in insurance liabilities

  33. Changes in Insurance Liabilities • Are insurance premiums revenue or deposits? • No preliminary view yet • No preliminary view yet on separate presentation of specified components of the changes in insurance liabilities: • Income or expense at inception of new contracts • Cash flows • Expected changes • Changes in circumstances • Policyholder participation • Income or expense from reinsurance held • Effects of business combinations and changes in foreign exchange rates

  34. Changes in Insurance Liabilities • Profit or loss should include all changes in the carrying amount of insurance liabilities

  35. Questions?

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