Accounting For Insurance Contracts - Ifrs 4: International Financial Reporting Standards

International Financial Reporting Standards
Accounting for insurance contractsIFRS 4

Joint World Bank and IFRS Foundation train the trainers workshop hosted by the ECCB 30 April to 4 May 2012
The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation.
IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org
Introduction
IFRS 4 applies to insurance contracts issued by any entity, including entities that are not regulated as insurers Includes both insurance and reinsurance contracts issued Also includes reinsurance contracts held
It does not address other aspects of accounting by insurers, such as accounting for financial assets
Definition
Insurance contract
3
Under an insurance contract, 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 Some contracts having the legal form of insurance may not meet that definition Insurance contracts transfer insurance risks (rather than only financial risks)
Definition
Insurance contract continued
Significant insurance risk
significant additional benefits in any scenario (that has commercial substance) not a percentage test contract by contract
4
Unbundling a deposit component Embedded derivatives
Continuing previous accounting
IFRS 4 permits insurers to retain most aspects of their previous accounting for insurance contracts This avoids disruption while the IASB works on a comprehensive review of accounting for insurance contracts The nature and extent of judgements and estimates will, therefore, depend largely on that previous accounting Typically this will involve estimates of uncertain cash flows
Unbundling deposit component

NO Can measure deposit component separately? YES YES All rights and obligations recognised? NO MAY unbundle MUST NOT unbundle
MUST unbundle
Embedded derivatives
IFRS 9 requires fair value measurement for many embedded derivatives
IFRS 4 exempts embedded derivatives that:

are themselves an insurance contract (specific disclosure required); or
are an option to surrender insurance contract for fixed amount
Recognition and measurement

IAS 8 Hierarchy
Criteria to use in developing accounting policy in absence of specific IFRS guidance Exempt under IFRS 4 for insurance contracts issued, and reinsurance contracts held But
may not change policy unless result is more relevant and reliable may continue existing practice, but not introduce them

Liability adequacy test
Use existing test if minimum requirements met:
consider current estimates of all contractual cash flows, including embedded options and guarantees
recognise any loss immediately in profit or loss
Otherwise test using provisions standard (IAS 37)

Continue, but may not introduce
Non-discounting of insurance liabilities
10
Off-market measurement of contractual rights to investment management fees

Non-uniform accounting policies for insurance liabilities of subsidiaries Excessive prudence Future investment spreads (rebuttable presumption)
DPFs
DPF = Discretionary Participation Features Contractual right to additional benefits: likely to be significant portion of total benefits
11
amount or timing contractually at the discretion of the issuer, and contractually based on: performance of specified contracts returns on specified assets, or profit or loss
Insurance contracts with DPF

Guaranteed element policyholder has unconditional right
12
must classify as liability

Discretionary participation feature may classify as liability, equity or split
do not show as mezzanine
Investment contracts with DPF

May classify whole contract as liability if so, apply liability adequacy test
13
May classify part or all of DPF in equity

reported liability not less than IAS 39 measurement of guaranteed element
Judgements and estimates
14
Determining whether contracts with the legal form of an insurance contract are insurance contracts as defined in IFRS 4
Insurance models
Current current Current current with discretionary reserving
15
Cost cost with OCI

Cost cost
International Financial Reporting Standards
Accounting for insurance contracts IFRS 4 Phase II

Joint World Bank and IFRS Foundation train the trainers workshop hosted by the ECCB, 30 April to 4 May 2012
The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation.
Project objective
17
Improve comparability in the accounting for insurance contracts through:
coherent, principles-based framework for all types of insurance contracts (no need for add-on rules)
transparent reporting of changes in insurance contract liability transparent reporting of economic value of embedded options and guarantees
Urgent need for change

IFRS 4
exempts insurers from developing relevant and reliable accounting policies
18
wide range of accounting for different types of contracts

inconsistent application across jurisdictions exempts requirement for uniform accounting policies across a group
What are we trying to do?

Updated measurement of insurance contract liabilities that captures all features of the contract
19
Disclosures about inherent risk and uncertainty
Presentation that gives information about drivers of performance
Building block approach

Residual margin
20
Contract profit (reported over the life of the contract) An assessment of the difference between an uncertain liability and a liability whose amount is certain An adjustment that reflects the time value of money
Risk adjustment
Time value of money
Total insurance liability
Cash flows
The amounts the insurer expects to collect from premiums and pay out for claims, benefits and expenses, estimated using up-to-date information
The model: Key features

New updated information is more relevant than old information
Updated estimates and assumptions Current measurement of risk
21
Reflects the difference between an uncertain liability and a liability whose amount is certain
Market consistent estimates
Reflect time value of money
Reflects best available information
Investors are not indifferent to time value of money
Which cash flows?

Residual margin
22
Risk adjustment
Time value of money
An explicit, unbiased and probabilityweighted estimate of the future cash outflows less the future cash inflows that will arise as the insurer fulfils the insurance contract Confirmed use of expected value of cash flows incurred, considering all relevant information
Cash flows
+ Add guidance that not all possible scenarios need to be identified and quantified
Which cash flows? continued

Premium received Premium received
23
Recognition point: Contract starts when coverage period begins

Acquisition costs
Expenses
Claim payment
Contract boundary: Contract ends when: Not required to provide coverage Can reprice to reflect risks of policyholder When insurer can reprice to reflect risk of portfolio
Included in cash flows: All direct costs of originating and all directly attributable costs incurred in fulfilling a portfolio of insurance contracts
Time value of money

Residual margin
24
A discount rate that adjusts cash flows for the time value of money
Risk adjustment
Time value of money
Confirm discount rate: reflect only characteristics of the insurance contract liability current and updated each reporting period
+ Guidance on determining the discount rate top-down and bottom-up remove any factors not relevant to the liability
Cash flows
Residual margin
Residual margin
25
Risk adjustment
A residual margin that eliminates any gain at inception of the contract Confirm no gain at inception Adjust for changes in estimates of cash flows Adjustments made prospectively
Time value of money
Cash flows
Reinsurance assets
Residual margin
26
Time value of money
Same inputs and assumptions
Calibrated to direct contract premium
Risk adjustment
= =
=
Residual margin
Risk adjustment
Calibrated to reinsurance contract premium
Time value of money
Cash flows
Cash flows
Reinsured part of cedants liability

Cedants reinsurance asset
Reinsurance assets
Residual margin
27
Risk adjustment
Time value of money
ED: symmetry with underlying liability losses at inception recognised over contract term gains at inception recognised immediately Tentative decisions: use same estimates for reinsurance asset and underlying direct insurance liability gains recognised over contract term losses recognised immediately if for past events, otherwise deferred
Cash flows
Short duration contracts

Residual margin
28
Liability for remaining coverage reduced over coverage period

Onerous contract test when facts and circumstances indicate Claims liability discounted if material Eligible for this approach if outcome reasonably approximates BBA 12 month practical expedient approach is permitted, not required
Risk adjustment
Time value of money
Cash flows
Presentation: remaining questions

Provide information about premiums, claims and expenses
29
Still to conclude:
level of disaggregation on the income statement separately disclose short and long term contracts treatment of deposits in premium income presentation in other comprehensive income
Next steps
Complete remaining topics
30
Assess whether any differences between IASB and FASB can be reconciled Review draft or re-expose (early 2012)
Questions or comments?
Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter.
Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation.
32
The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January 2012 but not the IFRSs they will replace. The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.

Accounting For Insurance Contracts - Ifrs 4: International Financial Reporting Standards

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International Financial Reporting Standards

Accounting for insurance contractsIFRS 4

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Unbundling a deposit component Embedded derivatives

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Continuing previous accounting

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Unbundling deposit component

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IFRS 4 exempts embedded derivatives that:

are an option to surrender insurance contract for fixed amount

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Recognition and measurement

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Recognition and measurement

Otherwise test using provisions standard (IAS 37)

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Recognition and measurement

Off-market measurement of contractual rights to investment management fees

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Insurance contracts with DPF

must classify as liability

do not show as mezzanine

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Investment contracts with DPF

May classify part or all of DPF in equity

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Cost cost with OCI

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

International Financial Reporting Standards

Accounting for insurance contracts IFRS 4 Phase II

Improve comparability in the accounting for insurance contracts through:

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Urgent need for change

wide range of accounting for different types of contracts

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

What are we trying to do?

Disclosures about inherent risk and uncertainty

Presentation that gives information about drivers of performance

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Building block approach

Time value of money

Total insurance liability

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

The model: Key features

Market consistent estimates

Reflect time value of money

Reflects best available information

Investors are not indifferent to time value of money

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Which cash flows?

Time value of money

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Which cash flows? continued

Recognition point: Contract starts when coverage period begins

Time value of money

Time value of money

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Time value of money

IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org