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Copyright Aditya Birla Nuvo Limited 2008
•Copyright Birla Sun Life Insurance Company Limited 2008
IFRS Seminar, The Institute of Actuaries of India - Mumbai, 17 October 2011
Concepts of IFRS 4 – Insurance Contracts
& Implementation Challenge
Presented by: Mr. Mayank Bathwal
CFO - Birla Sun Life Insurance Co Ltd.
Copyright Birla Sun Life Insurance Company Limited 2008
Outline for Discussion
IFRS 4 : Insurance contracts - Phase II
Measurement
Models
Accounting
and
Disclosure
Gaps
PresentationMajor
Implications
Overview & Project
timelines
IFRS 4 : Insurance contracts - Phase I
Product
Classification
Unbundling
/Embedded
Derivatives
Liability
adequacy test
Accounting
policies/
Disclosures
Definition
A
B
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IFRS 4 : Insurance contracts - Phase I
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Definition
A contract under which one party accepts significant insurance risk from another party
by agreeing to compensate the policyholder if a specified uncertain future event
adversely effects the policyholder.
Insurance Contract
Significant insurance risk
- Sufficient probability of occurrence &
- Sufficient magnitude of effect
Significant changes will be required in IT systems and actuarial models to bifurcate & measure the products as insurance and investment contracts
IFRS 4 Phase I
Key Impact
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Product Classification flowchart
Contract components
Significant insurance risk ?
Insurance contract
IFRS 4
Unbundling ?
Yes
No Yes
IFRS 4 Deposit element: IAS 39
Insurance – IFRS 4
Financial risk ?
YesNo
Investment contractService contract
No
Any
Discretionary
Participating
Features ?
Accounting:
IFRS 4
Yes
IFRS 9 Fair value or
Amortised cost
IAS 18
Recognise
Revenue as
earned
IFRS 4 Phase I
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Examples of Product Classification
Mortgage
Term
EndowmentPension
Term
Fund
Invidual Life- Insurance
Group - Insurance
Group - Invesmtnets
Invidual Life- Investment
IFRS 4 Phase I
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Unbundling & Embedded Derivatives
Embedded derivatives should be
separated from host contract,
measured at fair value and changes
in fair value to be taken in profit and
loss
– This requirement applies to an
insurance contract also, unless the
embedded derivative itself is an
insurance contract
– An exception allowed when there is a
policyholder option to surrender an
insurance contract for a fixed amount
• The life insurance products in India are
designed in such a way that embedded
derivative components cannot be
separated from host contract
• Unbundling of insurance contracts has
also been prohibited in IRDA Report for
IFRS
IFRS 4 Phase I
Derivatives & Embedded Derivatives DefinedUnbundling
Some insurance contracts contain both insurance and deposit components. Unbundling is required if both the following conditions are met:
i. Insurer can measure the deposit component separately
ii. Insurer‟s accounting policies do not otherwise require it to recognise all obligations and rights arising from the deposit component.
If unbundled, IAS 39 will apply to the deposit component and IFRS 4 to the Insurance Component
• This will impact the top line of the
company as deposit component will be
reduced from the total premium and
accounted under IAS 39 Financial
Instruments
• IT systems needs to be upgraded /
modified to separately capture the
deposit component and recognise front
end fees as revenue
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Liability Adequacy Test
An insurer shall assess at the end of each reporting period whether its recognised
insurance liabilities are adequate, using current estimates of future cash flows under its
insurance contracts.
IFRS 4 requires to perform liability adequacy test by the Actuary
The minimum requirements of test are the following:
- The test considers current estimates of all contractual cash flows, and of related cash
flows such as claims handling costs as well as cash flows resulting from embedded
options and guarantees.
- if the test shows that the liability is inadequate, the entire deficiency must be recognised
in profit or loss
The liability measurement principles are pretty stringent in India as negative reserves are
not considered in valuation of policy liabilities
IFRS 4 Phase I
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•
Accounting policy
IFRS 4 Phase I
IFRS 4 permits to continue with current accounting
policies except;
Measuring insurance liability on undiscounted basis
Measuring contractual rights to future investment management
fees at an amount that exceeds its fair value – using non uniform
accounting policies for the insurance liabilities of subsidiaries
Catastrophe and equalisation provisions
Deposit components to the extent invested in various fund/s are to be
accounted as liability directly into the Balance sheet.
Benefits and claims paid on investment contracts directly need to be adjusted
against the liability.
Deferred acquisition costs (DAC) needs to be deferred over contract period
Deferred income (DOF) needs to be deferred and recognised as revenue
over the contract period.
Investment Contract;• Deposit accounting will reduce the top line of company
• DAC and DOF accounting will reduce volatility in the bottom line by equalising the acquisition costs and Income over the contract period
• Actuarial models & IT systems need to be upgraded to capture and track deposit component, DAC & DOF separately
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Additional Disclosures
System changes for capturing disclosures such as sensitivity analysis, credit risk, interest rate and
maturity profile are required
IFRS 4 Phase I
Areas
Risk ManagementFramework
Details
Objectives & Policies
Risk identification and classification
Risk Mitigation Strategies & Review mechanism
Impact and Sensitivity of various risks
Insurance risk
Interest rate risk
Credit risk
ALM risk
Others
Basis used for classification of contracts into insurance contracts and investment contracts
Movement in Actuarial Liabilities
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Impact : Balance sheet of an Indian Insurer
IFRS 4 Phase I
Particulars Impact
ASSETS
Non Current assets
Financial Investments Negligible
Current Assets
Financial Investments Negligible
Other Financial Assets Below 15%
EQUITY AND LIABILITIES
Retained Earnings Negligible
Other comprehensive income New item
Non-Current Liabilities
Other Financial Liabilities New item
Current Liabilities
Other Financial Liabilities Below 10%
Transaction costs on FVTPL
investments charged off.
Investments Fair valued
Impact on recognition of DAC
and DOF on investment
contracts
Deferred lease expense
charged off
Notional interest income
recognised on deposits given.
Premium/(Discount) amortised
on investments reversed.
Gain/(loss) on AFS recognised
in OCI
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Financial Impact: Profit & Loss Account
IFRS 4 Phase I
Premium, Commission,
investment income and claims
on investment contracts are
removed from Profit & Loss
Account
DAC and DOF amortised
Notional interest income
recognised on deposits given
Premium and benefits and
claims on investment contract
impact adjusted in change in
investment liability
Particulars Impact
Income
Premium
Other income
Expenses
Commission Negligible
Operating Expenses related to Insurance
BusinessNegligible
Benefits paid (Net)
Change in investment liabilities
Profit/(loss) for the year Negligible
Depends on
product mix
Depends on
product mix
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IFRS 4 Insurance contracts -Phase II
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Overview
Current IFRS 4 definition of “Insurance” carried forward
Single model for all types of insurance contracts
– a „building block‟ approach to measure insurance liabilities
– a margin approach to report performance (income statement)
Measurement is current, i.e. no locking-in of assumptions (except for residual margin)
and based on a “fulfillment of obligations” notion.
Acquisition costs included in contractual cash flows, if incremental ; all other costs to
be expensed.
Implementation will be complex, but other projects can be leveraged
– Economic capital
Adoption of IFRS 9
– a „big bang‟ change for insurers
IFRS 4 Phase II
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Project timelines
IFRS 4
Insurance
contracts
IASB –
Discussion
Paper
issued
Jan
End of
Comment
Periods (IASB
And FASB)
IASB –
Exposure
Draft
IASB and FASB
Meetings to
Develop
Accounting
standards
FASB –
Joined the
project
Reissue of
IASB
Exposure draft
Final
Standard
Implementation
Date
2005
FASB –
Invitation
to comment
May Aug Nov
2006 2007
Oct Jan’09 to Jul’10 Jul Nov
2008 2009 2010
TBD TBD
201? 201?
IFRS 4 Phase II
Phase 1 Phase II Implementation
H2 2012
End of
comment
period
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Measurement Models - Building blocks
1 Expected future cash
flows
2 Discounting
3 Risk adjustment
Premium
4 Residual margin
IASB
5. Unallocated premium reserve for pre-claims liability short duration contracts
(FASB not decided yet)
Present value of fulfilment cash flows
FASB: Composite margin
Concept: what happens as the insurer fulfils contracts with policyholders over time
Consequence:
no gain at issue
IFRS 4 Phase II
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IFRS 4 Phase II model- How does it work?
Cash inflows
o Premiums, including initial
premiums and future premiums
within contract boundary
o Potential recoveries (e.g., salvage
and subrogation)
Cash outflows
o Payments to (or on behalf of)
policyholders, including payments
in kind and Incurred but not
reported (IBNR)
o Claim handling costs
o Cash flows that will result from
options and guarantees embedded
in the contract
o Payments to policyholders as a
result of a contractual participation
term
o Transaction-based taxes and
levies (VAT, premium tax)
o Incremental costs of selling,
underwriting, and initiating
successful insurance contracts
o Policy administration and
maintenance costs
PV of future cash
inflowsRisk
adjustment
Nil
Short-
duration
pre-claims
liability
(net of
incremental
acquisition
costs)
Residual margin
PV of fulfilment cash flows
Diagram 1: Profitable contract
PV of future cash
inflows
Risk adjustment
Nil
PV of future cash
outflow
PV of fulfilment cash flows
Loss on inception
Liability adequacy test
Diagram 2: Non profitable contract FASB:
Composite margin
PV of future cash
outflow
Short-
duration
pre-claims
liability
(net of
incremental
acquisition
costs)
IFRS 4 Phase II
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Phase II highlights- Key aspects of the ‘Building blocks’
1. Cash flows 2. Discounting 3. Risk margin 4. Residual margin 5. Unallocated
premium
Initial • Recognise
when being “on
risk”
• Unbiased
probability
weighted cash
flows
• At
contract/portfolio
level
• Reflect
characteristics of
contract
• Exclude “own risk”
• Risk free rate plus
allowance for
illiquidity
premiums
• Cost of capital,
conditional tail
expectation or
confidence level
methodologies
• Portfolio level
• No diversification
benefit between
portfolios
• Eliminate day 1
gain
• Interest accretion
• Portfolio level
(date of inception
and life of policy)
• Offset with
incremental
acquisition cash
flows
• Mandated contracts
less than 1 year
coverage
• Amortise
incremental
acquisition costs
• Onerous contract
test on fulfilment
cash flows
• Portfolio level
Subsequent • Re-measured • Re-measured • Re -measured • Not re-measured
• Release over
“coverage period”
• Release over
“coverage period”
• Onerous contract
test
Presentation
and
disclosure
s
• Reconcile
opening to
closing balance
• Present
separate
changes in
experience and
estimates
• Disclose
• Need to disclose
discount rate
applied
• Present changes
in discount rate
and interest
accretion
• Reconcile opening
to closing balance
• Present changes in
risk adjustments
• Disclose the
methodology basis,
inputs to calculate
risk margin and the
confidence level
achieved
• Reconcile opening
to closing balance
• Reconcile opening
to closing balance
including
premiums, claims,
expenses and
amortisation of
acquisition
expenses
• Disclosure of
additional liabilities
for onerous
contracts
IFRS 4 Phase II
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Accounting and Disclosure Gaps
Data warehouse Outsourcing
General ledger Source systemsFront-end applications
Identify the data requirement needs from outsourced providers
Identify the general ledger accounts to which gaps relate.
Trace the general ledger transactions back to their source:
- Directly to source systems
- through the data warehouse(s).
Trace the transactions back to the front-end application, when appropriate.
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Income Statement - Margin model
Summarized margin- Overview
(A 1) Risk adjustment
(A 2) Residual Margin
Underwriting Margin
(B) Losses on initial recognition
(C) Experience adjustment
(D) Changes in estimates
(E) Interest on insurance liability
(F) Investment income
Profit
Change in estimates flow through
income statement
Premium and claims are deposit
accounted
Investment income included in
income statement
Premiums, claims and expenses
can still be shown in the income
statement
IFRS 4 Phase II
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IFRS 4 Phase II:-More than accounting impact
Anticipation of changes to product features due
to changes in profit signatures, regulatory capital
Significant changes to financial statement
presentation and disclosures; new processes
and controls
Alignment of financial and management
reporting metrics and processes
Training and communication
Profound impact on processes, data and
systems. The impact on closing processes
and reporting
Restructuring of the technology landscape is
expected to be complex and costly.
Process and controls
PM, MI, KPIs
Systems and data
People
Governance and
organisation
Policies
A number of key areas need to be considered
IFRS 4 Phase II
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Insurance contracts Unearned Premium Reserve
(UPR)– at cost
Insurance contracts res./compos.
•margin deferred profit – at cost
Insurance contracts BE+risk margin
•at fair value (through P&L)
4. Hedge accounting (P&L or OCI) as variation to fair value option
3. Amortised cost (debt securities)
2. Fair value in OCI (equity securities)
1. Fair value through P&L
?
?
?
LiabilitiesAssets
How do you prevent the accounting mismatch?
IFRS 4 phase II versus IFRS 9
IFRS 4 Phase II
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Business Implications
Insurers may see greater discipline in their pricing processes as a result of the new
model.
To reduce volatility in reported results - Insurers may consider changes to their
current product offerings, moving out of longer term products with embedded
guarantee towards products in which more investment risk is borne by policyholders.
Insurers may enter into outsourcing arrangements, restructure sales compensation
arrangements with their employees and buy more reinsurance to mitigate the impact
of proposed changes to the recognition of acquisition costs.
Phase II will place significant demands on skilled actuarial and finance resources.
Gaps are likely to be addressed by hiring additional resources, outsourcing to third
parties, training and redeploying skilled resource to focus on Phase II.
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Challenges for insurers
Clarity and implementation guidance required from Institute of Actuaries, IRDA and
ICAI on the proposed changes
Resolution of the key issues and concerns raised
Significant systemic changes & dearth of trained resources
No field testing available to validate the practical results of implementation
Timing of the standard and effective dates not clear
Preparing two set of books for financial reporting & regulatory reporting
Divergence on certain issues between IASB and FASB to be addressed
Necessary changes in Tax laws, IRDA Act, SEBI Act, RBI Act and other regulations
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Questions or Comments
E mail id: [email protected]