Transcript Slide 1

The IASB’s Discussion Paper on Accounting for
Insurance Contracts
IAIS Meeting – 2 August 2007
Denis Duverne
European Insurance CFO Forum
Page 1
17-Jul-07
Topics to Cover
1. The CFO Forum
2. Our approach to the discussion paper
3. The three building blocks
4. Initial profit margin
5. Guaranteed insurability
6. Policyholder participation
7. Expenses
8. Unbundling
9. Credit characteristics
10. Linkages with other standards/projects
11. Conclusion
European Insurance CFO Forum
Page 2
2 08 07
The European Insurance CFO Forum
AEGON
ING
Allianz
Legal & General
• Formed in 2002 to
Generali
Mapfre
Aviva
Munich Re
influence the thinking on
financial reporting
AXA
Old Mutual
BNP Paribas
Prudential
2004 - now widely adopted
in Europe (and elsewhere)
CNP
Scottish Widows
• Elaborated Principles
Fortis
Swiss Re
Hannover Re
Standard Life
issued in 2006 to influence
the development of the
IASB’s Phase 2 standard
If
Zurich Financial Services
European Insurance CFO Forum
• Issued EEV principles in
Page 3
2 08 07
Our Approach to the Discussion Paper Response
• A fresh look at the Discussion Paper proposals – not simply a reiteration of our
‘Elaborated Principles’
• No firm conclusions at this stage
• There are, however, a number of key points emerging in our discussions
• Will be finalising our positions in October
• Where possible we will be discussing our thinking and co-ordinating our
response with other key industry groups
CEA
GNAIE
Japanese Life Insurers
European Insurance CFO Forum
Page 4
2 08 07
The three building blocks
• Agree with the basic idea of an unbiased probability
weighted best estimate of cash flows as the basis
• Agree with the single model for life and general
insurance
Unbiased best
estimate of
cash flows
(undiscounted)
• We think that the basis of calculation should reflect
economic reality as for Solvency 2
• There are important determinants within the best
estimate of cash flows, with which we disagree or are
particularly concerned. These are discussed later:
 Unbundling
 Participating contracts
 Guaranteed insurability (treatment of non-contractual
premiums)
 Treatment of expenses
European Insurance CFO Forum
Page 5
2 08 07
Time value of
money (using
market
consistent rates)
Best
estimate of
liability
European Insurance CFO Forum
Unbiased best estimate of cash flows (undiscounted)
The three building blocks (continued….)
• We agree with the concept of market
consistent discount rates,
 Liabilities should when possible be valued
independently from the assets
 This is as used in market transactions
Page 6
2 08 07
The three building blocks (continued….)
• Risk margins should be determined on a similar
basis to MVM’s under Solvency 2 – i.e. using the
cost of capital as a proxy
 MVM: Market Value Margin corresponds to the amount to
Risk and
service margins
+
be paid by an insurer if it transferred its contractual rights
and obligations immediately to another insurer.
 Cost of Capital method takes into account both volatility
and riskiness of the business and duration of reserves; it
yields more information than an undiscounted – implicit risk
margin approach
Best
estimate of
liability
European Insurance CFO Forum
• Service margin concept is confusing and not very
clearly explained – different interpretations yield
markedly different results
Page 7
2 08 07
Initial profit margin
• We disagree that there is not a significant
+
Initial profit
margin
Risk and
service margins
+
difference between entry and exit value.
There is a significant initial profit margin:
Exit
value
 Embedded values in balance sheets
(see below)
 Values given to portfolios in market
transactions, which clearly show that
there is such an up front margin
Best
estimate of
liability
• 11 CFO Forum members published
market consistent EV numbers calculated
in a broadly consistent manner to the IASB
proposals (BEL and risk allowance)
 The total initial profit they recognised
(New Business Margin) amounted to
5.2 billion Euros. This is significant.
European Insurance CFO Forum
Page 8
2 08 07
What to do with the initial profit margin?
Q1: Should the initial
profit margin be
regarded as liability or
equity?
Liability
There are 3 options being
considered by us. No final
decisions have yet been
made.
Equity
Risk and
service margins
Option 1:
Q2: Should the initial
profit go straight to
P&L?
Include the initial
profit margin as part
of the liability
Yes
European Insurance CFO Forum
No
Option 2:
Option 3:
Recognise the initial
profit margin in the P&L
at inception of contract
Recognise the initial profit
margin in equity and
release through P&L in line
with release from risk
Page 9
2 08 07
Guaranteed Insurability
• This is an area that the IASB has been struggling with due to i) the
constraints imposed by their framework and ii) the impact that their
conclusions could have on other industries. Unfortunately we believe that this
proposal has ended up in the wrong place
•The expected cash-flows will be artificially restricted by the ‘guaranteed
insurability’ criteria
• Actual market portfolio transfers show that the market values include such
future cash flows expected from a portfolio of contracts, not just those that
meet the guaranteed insurability criteria.
• The restrictive ‘guaranteed insurability’ proposal is thus inconsistent with
‘current exit value’ and the general trend of IASB decisions to move towards
market fair values.
European Insurance CFO Forum
Page 10
2 08 07
Policyholder Participation
• The treatment of policyholder participation may be effected by how IAS 37
evolves, which creates additional uncertainty
• From the CFO Forum perspective, the accounting liability should include
expected future discretionary benefits
• At the signing of a contract insurance companies have a ‘constructive
obligation’ to pay out an amount (this amount could be zero) to policyholders –
thus recognition is met. Thus an estimate should be made of all amounts that
will be paid out – the measurement of the liability.
• Excluding expected future payments is inconsistent with the IASB’s ‘current
exit value’ since transfer values should consider the full economic liability.
Including future payments is more consistent with the general direction towards
market fair values.
• These principles should cover investment contracts with DPF (i.e. they should
be included in the Phase 2 standard and not be included in IAS 39).
European Insurance CFO Forum
Page 11
2 08 07
• The DP requires expense cash flows in BEL to be based on the market
level of expenses not the entity’s – how is this hypothetical market level
determined when there is no available market?
• Should one assume that an entity’s expenses are representative of the
Expenses
market? If so, what does this really all mean?
Theoretical example:
Under the DP:
• Under current
• the less efficient insurer would
approaches, the liability
valuation is based on the
actual entity expenses.
book a lower amount of liability;….
• that would trigger artificial
profits recognised at inception..
• A less efficient insurer
• ….while recognizing that
books a higher amount of
liability than an average
market efficient insurer.
inefficiency as losses over the
lifetime of the contract
Market efficiency
liability
Y1
liabilities
European Insurance CFO Forum
Y2
Y3
DP Proposals impact
on profit recognition
Y4
Page 12
2 08 07
Unbundling
Three buckets of cash flows
• The IASB has hardened its position
over Phase 1.
• These requirements seem to be
So interdependent that split
would be arbitrary
driven by the desire for compatibility
between insurers and other industries.
• We do not support this since :
 The “arbitrary” criteria is very
Not Interdependent
vague
 This does not provide
meaningful information – analyst
initial views are also not positive
Interdependent, but split not
arbitrary
European Insurance CFO Forum
The systems cost of capturing
the data necessary to comply with
this is potentially significant
Page 13
2 08 07
Own Credit Characteristics
• We do not consider that the credit standing of an insurance contract should be
considered in the valuation of the insurance liability :
 The impact is counter intuitive - as companies are downgraded they
could start recognising profits. This is potentially significantly misleading to
users.
 In a highly regulated industry is this really appropriate?
 It is too theoretical and impractical to apply
European Insurance CFO Forum
Page 14
2 08 07
Linkages with other standards/projects
• There are important interactions with a number of other standards that will
need further consideration – IAS 39, IAS 37 and IAS 18 in particular.
• At present there is a lack of clarity about how investment contracts with DPF
will be accounted for. Conceptually we believe that all par contracts should be
treated the same.
 the solution would be to include investment contracts with DPF in the
Phase 2 standard in line with IFRS 4 as it stands today
• Investment contracts without DPF would stay under IAS 39. (It may be that
some adjustment to IAS 39 is required to ensure consistency of treatment )
European Insurance CFO Forum
Page 15
2 08 07
Conclusion
We have not finally concluded on our response to the IASB’s Discussion
Paper. However, our initial view is that some of the core elements of the
proposals are sound, but there are important areas where there are
misconceptions and flaws.
•
• There are significant similarities with Solvency 2 proposals – we think that this
is a good thing in general terms because it both reduces cost for companies and
is a closer reflection of the economic realities.
• Some of the specific components of the proposals need amendment – in
particular the treatment of future premiums (guaranteed insurability),
participating contracts, unbundling, use of market expense levels and own credit
characteristics.
• We disagree with the IASB’s view that there is not a significant difference
between implementation A and B. There is a significant initial profit margin - we
are currently discussing three options for how this initial profit margin should be
treated.
• We are concerned with the industry being used as a ‘guinea pig’ by the IASB.
This is reflected in the complexity and highly theoretical nature of some of the
proposals. We question whether user needs will be met by the proposals.
European Insurance CFO Forum
Page 16
2 08 07