Workshop on international accounting

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Workshop on international accounting

• IV Conference on Insurance Regulation and
• Supervision in Latin America
• Punta Cana, May 6-9 2003
• Makoto Okubo, Advisor
• International Association of Insurance
  Supervisors (IAIS)

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Main items

1. IASB Activities
2. IASB projects for insurance contracts
3. IASB projects for financial instruments
   (including contracts that do not qualify as
   insurance contracts)
4. Existing accounting practices for insurers
5. Questions

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I. IASB Activities

• Why are international accounting standards in the
  limelight?
• Globalisation
• Other standards setting activities, including
  other financial sectors
• Convergence of accounting standards
• Seven liaison members (Australia New Zealand,
  Canada, France, Germany, Japan, US, UK)
• The EU will require the use of IAS and IFRS for
  publicly traded companies by 2005 with some
  exemptions, after the EU assesses standards
  whether to endorse for use.
• FASB and IASB have issued a memorandum of
  understanding on October 2002 towards the
  harmonisation of US and international accounting
  standards.
• Many jurisdictions (including those in Latin
  America) approved IAS for use.

• Why is the role of the IAIS important in
  international accounting setting?
• Insurance regulators are key stakeholders in
  accounting setting.
• Insurance regulators need to decide the extent to
  which regulatory reporting may be based upon
  general-purpose financial statements.
• Importance of the advice of the national
  insurance regulators in the implementation of
  international accounting standards.

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I. IASB Activities

• IASB Active Projects (examples)
• Improvements to existing International Financial
  Reporting Standards
• Amendments to IAS 32, Financial Instruments
  Disclosure and Presentation, and IAS 39,
  Financial Instruments Recognition and
  Measurement
• Activities of financial institutions disclosures
  and presentation
• Reporting performance
• Insurance contracts, Phase I Phase II
• Concepts - revenue, liabilities and equity

• IASB Active Research Topics (examples)
• Aspects of accounting for financial instruments
• The application of international accounting
  standards to small and medium-sized entities and
  in emerging economies

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I. IASB activities
Planned schedule of IASB projects on insurance
Financial Assets And Liabilities (other than
insurance contracts)
Amendments to IAS39 Exposure Draft 2002 June
IFRS?
JWG Launched 1997 October
JWG Exposure Draft 2000 December
(Note) JWG was disbanded. Discussion on the full
fair value approach for financial instruments was
slowed down to an active research topic, while
insurance project remains taking the approach.
Insurance contracts
Field Visit
Insurance Steering Committee Launched 1997 Apri
l
Insurance Issues Paper 1999 December
The Board starts discussion on insurance
contracts 2001 November
(Note) On May 2002, the Board split its project
on insurance contracts into two phases.
Phase I
Exposure Draft (2Q)
IFRS?
Phase II
Field Test?
Exposure Draft?
IFRS?
(Note) The international Joint Working Group of
Standard Setters (JWG) was established by the
IASC Board and other national accounting
standard-setters to develop an integrated and
harmonised standard on financial instruments,
which proposed the full fair value model for
financial assets and liabilities.
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II. IASB proposals for insurance contracts
Phase I Phase II
Scope - Accounting for insurance contracts - Accounting by policyholders is not addressed in Phase I It would not create a new category of financial assets (financial assets held to back insurance liabilities) that could be held at amortised cost. - Accounting for insurance contracts by both parties to those contracts (insurer and policyholder) and not other aspects of accounting by insurers or policyholder, such as investments held by insurers
Definition of insurance contract An insurance contract is defined as a contract under which one party (the insurer) accepts significant insurance risk by agreeing with another party (the policyholder) to compensate the policyholder or other beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder or other beneficiary Some contracts that have the legal form of insurance are excluded from the definition of insurance contracts for accounting purposes (notably investment contracts under IAS39). This definition is used throughout IFRS and to change all scope exclusions in IFRS that refer to insurance entities to insurance contracts (for example, IAS18, IAS32, IAS37, IAS38 and IAS39) An insurance contract is defined as a contract under which one party (the insurer) accepts significant insurance risk by agreeing with another party (the policyholder) to compensate the policyholder or other beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder or other beneficiary Some contracts that have the legal form of insurance are excluded from the definition of insurance contracts for accounting purposes (notably investment contracts under IAS39). This definition is used throughout IFRS and to change all scope exclusions in IFRS that refer to insurance entities to insurance contracts (for example, IAS18, IAS32, IAS37, IAS38 and IAS39)
Other issues Scope exclusions Embedded derivatives Unbundling of some deposit-like components Discretionary participating feature of an investment contract - Unbundling of individual elements of an insurance contract (to be discussed at a future meeting) - Discretionary participation feature of an insurance contacts (to be discussed at a future meeting)
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Note 1 Example of insurance contracts
Examples of items that are not insurance
contracts under the proposed definition
Examples of insurance contracts under the
proposed definition
Insurance against theft or damage to
property Insurance against product liability,
professional liability, civil liability or legal
expenses Life insurance and prepaid funeral
plans Life-contingent annuities and
pensions Disability and medical cover Surety
bonds, fidelity bonds, performance bonds, bid
bonds Product warranties (Note product
warranties directly issued by manufactures and
dealers are tentatively excluded) Title
insurance Travel assistance Some catastrophe
bonds Insurance swaps and other contracts that
require a payment based on climatic, geological
or other physical variables that cause an adverse
effect on the holder of the contract Reinsurance
Investment products that have the legal form of
an insurance contract but do not expose the
insurer to insurance risk Contracts that have the
legal form of insurance, but that pass all
significant insurance risk back to the
policyholders through mechanisms such as
performance-linking Self-insurance, in other
words an entitys decision to retain a risk that
could have been covered by insurance A contract
(such as a gambling contracts) that requires a
payment if a specified uncertain future event
occurs, but does not require that the event
adversely affects the policyholder or other
beneficiary specified in the contract Derivatives,
in other words contracts that require one party
to make payment based solely on financial risk,
i.e. changes in one or more of a specified
interest rate, security price, commodity price,
foreign exchange rate, index of prices or rates,
a credit rating or credit index or similar
variable. Contracts that require a payment based
on climatic geological or other physical
variables regardless of any adverse effect on the
holder of the contract (commonly described as
weather derivatives)
(Source International Accounting Standards
Committee Foundation)
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II. IASB proposals for insurance contracts
(cont.)
Phase I Phase II
Recognition and measurement - The continuation of existing practices (national GAAP) with some exceptions A loss recognistion test should be included. An insurer is prohibited from changing its accounting policies that involve Measuring insurance liabilities on an undiscounted basis Creating or increasing a deliberate overstatement of insurance liabilities Reflecting future investment margins in the measurement of insurance liabilities, for example, by using an asset-based discount rate Permitting subsidiaries to use non-uniform accounting policies for their insurance liabilities The asset-and-liability measurement model is used rather than a deferral and matching model. Full fair value approach assets and liabilities arising from insurance contracts are measured at their fair value with two caveats (entity-specific assumptions / no recognition of net gain at inception for new contacts) Undiscounted measure is inconsistent with fair value. Expectation about the performance of assets should not be incorporated into the measurement of an insurance contract (unless the amounts payable depend on the performance of specific assets) Fair value measurement of an insurance contract reflects the credit characteristics of that contract, including the effect of policyholder protection schemes Policyholder behavior should be taken into account. Acquisition cost recognised as expense when incurred
Recognition and measurement - An insurer should not recognise catastrophe or equalisation provisions Offsetting reinsurance assets against the related direct insurance liabilities should be prohibited. The same derecognition requirements for an insurers insurance liabilities as those for financial liabilities - An insurer should not recognise catastrophe or equalisation provisions Offsetting reinsurance assets against the related direct insurance liabilities should be prohibited. The same derecognition requirements for an insurers insurance liabilities as those for financial liabilities
Presentation and disclosure - Fair value of insurance assets and insurance liabilities should be disclosed by 31 December 2006. All fair value changes in insurance assets and liabilities should be recognised in the income statement of the reporting year.
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Note 2 Accounting models

• The model is an asset-and-liability model in
  Phase II, rather than a deferral and
  matching model.

• An asset-liability-model would
• Measure the assets and liabilities that arise
  from insurance contract.
• Define income or expense as an increase or
  decrease in economic benefits during the
  accounting period, respectively.
• Prohibit the recognition of assets or liabilities
  that do not meet the Frameworks definition or
  recognition criteria, including deferred
  acquisition costs.

• A deferral and matching model would
• Recognise revenues and expenses from insurance
  contracts over time as services are provided.
• Premiums are deferred and recognised as revenues
  over the term of the contract for short-term
  contracts and when received for longer-term
  contracts.
• Acquisition costs are often deferred and
  amortised in order to match those costs with
  related premium revenue over the term of the
  contract.

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Note 3 Accounting models (cont.)
A Simplified Example (Proposed Model)
Asset-and-liability Measurement Approach
A Simplified Example (Traditional) Deferral and
Matching Approach
Balance Sheet FV of assets
XXX FV of liabilities
XXX
Equity XXX
Balance Sheet Cash Investments
XXX Deferred acquisition cost
XXX Unearned premiums XXX Claims
payable XXX Claims incurred but not
reported XXX Equity
XXX
Income Statement FV of current future premiums
XXX FV of current
future claims
(XXX) Provision for risk and uncertainty XXX FV
of current future maintenance costs
(XXX) Acquisition costs XXX
Profit or loss from new business XXX Changes
to estimates for previous years
business XXX Profit or loss from insurance
business XXX Changes by passage of time
XXX Changes to discount rate XXX Return
on investments XXX Profit or loss from
investing and XXX Financing activities Net
profit or loss XXX
Income Statement Premium earned
XXX Claims incurred (XXX)
Amortisation of acquisition cost
(XXX) Maintenance costs (XXX) Profit or
loss from insurance business XXX Investment
income XXX ( Profit or loss from
investing and Financing activities) Net profit
or loss XXX
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III. IASB proposals for financial instruments
(including contracts that do not qualify as
insurance contracts)
IAS39 IAS39 Proposal JWG Proposal
Financial assets Securities held for trading - Fair value (P L) Securities available for sale - Fair value (equity or PL) Securities held to maturity - Amortised cost Cash deposit - Amortised cost Loans - Amortised cost Securities held for trading - Fair value (P L) Securities available for sale - Fair value (equity only) Securities held to maturity - Amortised cost or fair value (PL) Cash deposit - Amortised cost or fair value (PL) Loans - Amortised cost or fair value (PL) All financial assets - Fair value (P L)
Financial liabilities -Amortised cost (except for liabilities arising from trading activities) -Amortised cost or fair value (PL) All financial liabilities - Fair value (P L)
Own debt (and insurance liabilities for contracts outside the scope) -Amortised cost -Amortised cost or fair value (PL, taking own credit risk into consideration) - Fair value (P L, taking own credit risk into consideration)
Hedge accounting Permitted under some conditions Permitted under some conditions Not permitted
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IV. Existing accounting practice for insurers
Country Australia U.K. Canada U.S. France Germany Japan
Securities held by insurers Stocks - Fair value Bonds - Fair value GAAP Stocks Fair value Bonds -Fair value or Amortised cost SAP Transferable within 97.5 of the market value - Fair value Other transferable - Reasonably estimated value not exceeding the market value Non-transferable - Reasonably estimated surrender or redemption value Stocks - Acquisition cost adjustment (1) Bonds - Amortised cost Assets held to cover specific policies ( i.e. universal life) - Market value (1) Adjustment reflects fair value change by 15 moving average method. Recognition in PL by 15 of unrealized and capital gains each year. GAAP Held for trading - Fair value (PL) Available for sale - Fair value (equity) Held to maturity - Amortised cost (Note)Shadow DAC adjustment SAP Stocks - Fair value Bonds - Amortised cost (Note) For life, Asset Valuation Reserve (AVR) Stocks - Acquisition cost (2) Bonds - Amortised cost or acquisition cost (2)Provision would be set up when overall realized value at current value falls below book value (for stocks and real estates) (Note) Current value must be disclosed. Stocks held for long-term (fixed assets) - Acquisition cost (3) Stocks held for short-term (current assets) Lower of acquisition cost and current value Bonds - Amortised cost, notional amount, or lower of acquisition cost and current value (3) Introduced by the legislation in 2002. Allowed only when fluctuation is deemed temporary. (Note) Current value must be disclosed. Held for trading Fair value (PL) Available for sale Fair value (equity) Held to maturity - Amotised cost Bonds that correspond to policy reserves - Amortised cost
Technical provisions Fresh start For life, MOS (Margin on Service) Prospective (prudent assumptions) Actuary has some discretion over the discount rate. FFA (Fund for future appropriations) Fresh start PAD (Provision for adverse deviation) Actuarial report required For non-life, a premium deficiency reserve needs to be booked if premiums do not cover future costs Lock in Non-discounted Actuarial report required Premium deficiency reserve needs to be booked if premiums do not cover future costs Prospective (prudent assumptions) Technical provisions cannot be below the surrender value - Prospective (prudent assumptions) The maximum discount rate is fixed Technical provisions cannot be below the surrender value Lock in Additional reserves must be added, if deemed insufficient after the future cash flow analysis
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V. Questions

• Please discuss the following questions in your
  group and make a brief presentation. (5 minutes
  for each group)
• Which of your jurisdictions have already used or
  plan to use international accounting standards?
  
• (Note The proposals may have an
  immediate impact in such jurisdictions. )
• What are existing accounting practices for
  insurers in your jurisdictions?
• What would be your implications if the proposed
  accounting changes should be adopted?
• IAS39 and JWG
• Phase I and Phase II

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References

• IASB Project summaries
• IASB Project summary Insurance Contracts (phase
  1) (Latest revision 2003/04/07)
• IASB Project summary Insurance Contracts (phase
  2) (Latest revision 2003/02/03)
• Use of IAS Around the World
• http//www.iasb.org.uk
  (Latest
  version 2002/07/11)
• IAIS comment letters to the IASB
• http//www.iaisweb.org

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Annex Existing accounting practice for insurers
Country
Securities held by insurers Stocks Bonds Stocks Bonds Stocks Bonds Stocks Bonds Stocks Bonds Stocks Bonds Stocks Bonds
Technical provisions