Implementation of IFRS 4

1
Implementation of IFRS 4

• Practical Issues Faced By Caribbean Insurers

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Classification Of Insurance Contracts

• IFRS 4 relates to insurance contracts.
• Contracts are either going to be Insurance
  Contracts or Investment Contracts
• IFRS 4 defines Insurance Contracts
• Not at your discretion for existing policies.
• Consider product design for future business.
• Different accounting treatments.
• Insurance Contracts - IFRS 4
• Investment Contracts - IAS 39
• Affects the timing of profit emergence.
• Affects disclosures
• IFRS 4 generally allows continuation of
  accounting policies.
• Less short-term work involved compared to IAS 39
• New systems may be needed to implement IAS 39

3
What is An Insurance Contract ?

• IFRS 4 defines Insurance Contract
• Contains significant insurance risk
• Pays significant additional benefit in any
  scenario with commercial substance
• Risk not created by the contract
• Pre- and Post-accumulation phases need to be
  considered together
• Lapse and expense risk alone do not constitute
  insurance risk
• Investment contracts with discretionary
  participation features governed by IFRS 4
• Significant insurance risk may be present even if
  probability is low across whole block of business
• Once classified as insurance always insurance
• relevant for face or fund death benefit

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Classification
5
Classification cont
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Gray Areas ?

• Only insurance risk is return of premium on
  death.
• Only insurance risk is waiver of surrender
  penalty on death.
• Experience rated group business with ability to
  recover premium deficit.

7
Accounting for Insurance Contracts Under IFRS 4

• Continue to use existing accounting policies
  subject to certain modifications
• No catastrophe reserves
• No claims equalization reserves
• Reinsurance reporting
• Unbundling
• Discretionary participation features
• Embedded derivatives
• Liability adequacy testing
• Prohibits commencement of certain accounting
  practices

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Reinsurance

• Cannot report net liabilities.
• Show gains and losses on buying insurance.
• Need to recognize reinsurance impairment.

9
Unbundling

• Some insurance contracts include both a deposit
  and an insurance component.
• Must unbundle if current accounting policies do
  not recognize deposit component and deposit
  component is separately measurable.
• For example, surplus relief reinsurance contracts.

10
Discretionary Participation Features

• Covers participating/profit-sharing contracts.
• Falls under IFRS 4 but subject to fair value
  disclosure requirement under IAS 32
• Must disclose if impractical to calculate.
• Caribbean practice of measuring guaranteed
  element as a liability and discretionary element
  as a component of equity allowed to continue.
• Must be disclosed separately as an element of
  equity.

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Embedded Derivatives

• A guarantee or option is an embedded derivative
  if
• Meets strict definition
• Not closely related to host contract
• Needs to be held at fair value.
• Many significant guarantees and options are not
  embedded derivatives.
• Examples of embedded derivatives ?
• Minimum interest guarantees on surrender or
  maturity
• Minimum equity linked returns on surrender or
  maturity

12
Liability Adequacy Testing

• Comparison of current estimates of future cash
  flows to the net carrying amount.
• Include claim handling costs and cashflows from
  options and guarantees
• Any deficiency recognized in PL immediately.
• Use accounting policy if meets the minimum
  requirements. If not refer to IAS 37.

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Liability Adequacy Testing cont

• Companies using Net Premium Valuation Methods
  need to set up new systems.
• Need current estimates
• Government bonds
• Pricing assumptions

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Implications of Practices That Cannot Be
Introduced

• Excessive prudence or deliberate overstatement of
  liabilities.
• Reflecting future investment margins
• Introduction of Embedded Value Reporting
• Recognizing Deferred Acquisition Costs
• Non-uniform accounting policies across subs.

15
Accounting for Investment Contracts Under IAS 39

• Payments received are not recognized as revenue
• Treated as deposit
• Payments made to policyholders are not treated as
  expense
• Treated as reduction in policyholder liability

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Accounting for Investment Contracts Under IAS 39

• 2 methods
• Amortised cost
• Fair value
• Use of fair value limited by recent amendments to
  IAS 39.
• Choice is irrevocable.
• Choice is on a contract by contract basis.

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Amortised Cost

• Determine effective interest rate as IRR
  equating initial value to PV of future payments.
• Initial value is fair value at inception less
  transaction costs.
• Subsequent values is revised estimate of future
  contractual cashflows discounted at effective
  interest rate.
• Must separate embedded derivatives not closely
  related to host contract.
• Value at fair value
• Fair value disclosures are still required.

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Fair Value

• asset exchanged or liability settled between
  knowledgeable parties in an arms length
  transaction.
• Based on presumption of going concern.
• Best evidence is quoted price on active market.
• If no active market then use valuation technique
• Recent arms length market transaction
• Fair value of similar instruments
• Discounted cash-flow analysis
• Option-pricing model
• CSV floor

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Disclosure - The Sting In The Tail ?

• Significant work to develop reporting systems.
• Extended details on accounting policies
• Gains or losses on buying reinsurance
• Significant assumptions, sources of measurement
  uncertainty and impact of changes in assumptions.
• Reconciliation of changes in reserves.
• Risk management objectives

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Disclosure

• Risk mitigation objectives
• Sensitivity analysis of cashflows
• Risk concentration
• Details of lapse and expense risk
• Details of interest rate and credit risk

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QUESTIONS