© 2012 Deloitte MCS Limited. Private and confidential
IFRS 4 Phase II & Solvency IIMaximising the synergy benefits3 October 2012Marylène Lanari-Boisclair Rakesh B Patel
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Introduction
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Contents
3 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
The IFRS 4 Phase II landscape
IFRS 4 Phase II alignment with Solvency II
Wider impacts of IFRS 4 Phase II
Questions
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The IFRS 4 Phase II landscape
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The IFRS 4 Phase II landscape Timeline of wider IASB projects
Solvency IIEffective 1/1/15?
Q4 2012 2013 2014
Insurance contracts Effective date 1/1/17?
Insurance contractsIFRS 4 Phase II
Re-exposure and timing ?
IAS37 LiabilitiesAmended IFRS
IFRS 9 Financial InstrumentsReplacement of IAS 39
Effective 1/1/15
IFRS 13 Fair Value measurementEffective 1/1/13
2015+
5 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
Revenue Recognition(replacement of IAS 18)
New IFRS
IAS19 post employment benefits
Effective 1/1/13
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Re-exposure of the Insurance StandardA new exposure draft announced by the IASB
• The exposure draft will ask questions on a limited number of topics:
1. the decision that participating contracts will be measured on the same basis as the backing assets;
2. the requirement for premiums to be presented in the statement of comprehensive income;
3. the “unlocking” of the residual margin;
4. the use of the OCI solution for changes in the discount rate;
5. the proposed transition requirements.
• The exposure draft is expected in Q1 2013
• Comment period between 3 to 4 months
• The European Commission demanded a 3 years gap between publication of the Phase II final requirements and effective date
6 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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The IFRS 4 Phase II landscapeIFRS Phase II – insurance contracts liability
Block 1:
Present Value of Best Estimate Fulfilment CFs
Block 3:Residual Margin
Block 2:Risk Adjustment
Total IFRSInsurance Liability
Amounts the insurer expects to collect from premiums and pay out as
it acquires, services and settles the contract
Quantifies the amount between a certain and an uncertain liability (similar
concept to a Solvency II risk margin)
Quantifies the unearned profit the insurer expects to earn as it fulfils the contracts
(e.g. Premiums less BEL less Risk Adjustment)
Principles
• Measurement model uses a “building block” approach
• Measurement is current i.e. no locking-in of assumptions
• Measurement objective based on a “fulfillment of obligations” notion
• Discounting done using either a “top down” or “bottom up” approach
7 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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The IFRS 4 Phase II landscapeSummary of the current tentative decisions
• Current IFRS 4 definition of “insurance” carried forward, with some scope changes
• Single prospective measurement model for all insurance and reinsurance contracts, as well as financial instruments with Discretionary Participating Features issued by insurers (e.g. with-profits investment contracts)
• Premium allocation approach for short term contracts
• Prohibition of accounting profit on sale => residual margin defers expected profit
• Day-one losses recognised immediately through income
• Acquisition costs included in contractual cash flows if incremental and directly attributable
• Presentation and disclosures still being discussed
• Impact of assumption changes:
• arising from changes to discount rate => will go through Other Comprehensive Income
• arising from changes to non-economic assumptions => will be offset by a change to residual margin
8 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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IFRS 4 Phase II alignment with Solvency II
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IFRS Phase 4 alignment with Solvency IIBalance Sheet components
Typical Solvency IIBalance Sheet
Assets
Excess of assets over liabilities
Subordinatedliabilities
Best estimate liability
Other liabilities
Risk margin
Basic ownfunds
Tangible assets
Shareholder equity
Other liabilities
Best estimate liability
Goodwill / Intangibles
Residual margin
Risk adjustment
Proposed IFRSBalance Sheet
Ancillary ownfunds
Value of m
arket consistent liabilities
Callable capital instruments
Technical Provisions
Insurance contracts
Investment contracts (e.g.
unit-linked pure savings
contracts)
10 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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Component Challenge Key Areas of Impact
IFRS 4 Phase II alignment with Solvency II Key challenges
Residual Margin There is no concept of residual margin under Solvency IIData, systems /
Reporting
Risk Adjustment The measurement under IFRS4 is governed by principles rather than rules; additional disclosure of equivalent confidence interval requirement
Data and systems / Methodology / Assumptions
DiscountingUnlike Solvency II, the discounting under IFRS4 is governed by principles rather than rules
Assumptions / Systems
Best estimate cashflows Some cash flows may differ e.g. costs & contract boundaries
Assumptions / Methodology
ReportingP&L attribution process needs to be developedBalance sheet reconciliation between IFRS and SII
Data and systems / Methodology /
Reporting
Tax Tax implications need to be fully understoodAssumptions / Methodology
To establish a single common regulatory framework to maintain capital adequacy and risk management standards
To improve transparency and comparability of insurers’ financial statements, regardless of sector, geography or products.
IFRS4 “portfolio” level measurement for certain components may require different data segmentation, and investment contracts measurement is done under IFRS 9
Scope & unit of measurement
Data and systems / Assumptions / Inputs
to ICM / reporting
Tar
get O
pera
ting
Mod
el
Solvency II IFRS 4 Phase IIDiffering
Goals
11 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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IFRS 4 Phase II alignment with Solvency IIScope consequences
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Focuses on regulated entities and their regulated activities
Transactions that fall within the business follow the Solvency II valuation rules
Focuses on transactions – “insurance” contract irrespective of regulatory status of issuer
Absence of transfer of insurance risk does not scope liabilities out of Solvency II
IFRS 4 applies to “insurance” contracts as individual transactions
Deals with both sides of the balance sheetIFRS 4 only deals with the liability side of the balance sheet
Applies to the entire business of insurance undertakings
Insurers selling non “insurance” contracts use different IFRSs.
For example:Unit-linked pure savings contracts are accounted for as deposits (IAS 39 / IFRS 9); andAsset management services will be accounted for as service contracts (IAS 18).
Solvency II IFRS 4 Phase II
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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IFRS 4 Phase II alignment with Solvency IIRisk margin versus Risk adjustment
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Objective Technical provisions sufficient to meet the insurer’s obligations
A margin to reflect uncertainty in the estimate of fulfilment cash flows
Scope Assumes whole portfolio is transferred to another insurance company
Defined as “The compensation the insurer requires for bearing the uncertainty inherent in the cash flows that arise as the insurer fulfils the insurance contracts”.
Methods Cost of capital approach with the charge varying between Pillar 1 and Pillar 2
Following approaches can be used (but not limited to): confidence interval, conditional tail expectation and cost of capital.
Diversification Diversification across portfolio segments and legal entities
Unit of account not prescribed as long as objective met => potential for similar diversification benefits.
Risks coveredTypically, includes non-hedgeable risks such as underwriting, counterparty and operational risks. All market risks are typically assumed to be hedgeable.
Includes market risks (to the extent that they affect the payments to the policyholders only) and underwriting risks.
Reporting
Re-measured at each reporting period and explicitly reported at the same level of granularity as the best estimate liability.
Re-measured at each reporting period and explicitly reported in the financial statements as part of the insurance liability. Equivalent confidence disclosure requirements.
Solvency II IFRS 4 Phase II
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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IFRS 4 Phase II alignment with Solvency II Residual Margin
• Day 1 measurement:
• Eliminates gains at inception of a contract i.e. premiums less BEL less risk adjustment; and
• Measured at “portfolio” level, and within a portfolio, by similar date of inception / coverage period leading to additional data requirements.
• Subsequent measurement:
• Adjust for favourable and unfavourable changes in estimates (excluding economic);
• Residual margin can increase or decrease, but cannot become negative;
• Experience adjustments recognised in P&L account to the extent that there is no residual margin left;
• The release of the RM should be over the coverage period, on a systematic basis that is consistent with the pattern of transfer of services provided under the contracts (still under debate); and
• Accretes interest on carrying amount of residual margin using discount rate at inception.
14 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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IFRS 4 Phase II alignment with Solvency IIDiscounting
15
Principles
Consistent with current market prices.
Risk-free interest rate term structures will be the sum of:
a. basic risk-free interest rate term structure;
b. counter-cyclical premium (if applicable); and
c. Matching adjustment (if applicable).
This is still subject to debate between the industry and EIOPA.
Consistent with current market pricesExclude factors not relevant to the insurance contract.
Only reflect risks not included elsewhere in the measurement.
Yield curve may be determined using “top down” or “bottom up”.
Method
Highly prescriptive method published by EIOPA.
No prescribed method.
Guidance to be provided.
Non Participating
contracts
Reflect the characteristics of the insurance contract liability.
Participating contracts
The discount rate should also reflect the dependence between the assets and liabilities.
Solvency II IFRS 4 Phase II
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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Reconciling balance sheet components
Assets• Differences due to measurement
differences (FV versus MV)
• Assets category differences (e.g. goodwill, DAC and intangibles)
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IFRS Phase 4 alignment with Solvency II
Liabilities• Scope differences mean that UL liabilities are measured
differently (e.g. SV floor and DIR)
• Scope differences mean there is no risk adjustment for investment contracts, unlike SII
• Risk adjustment in IFRS is measured differently to risk margin under SII
• Differences caused by possible different discount rates
• Difference caused by the residual margin in IFRS which is not a component of the SII technical liability
Typical Solvency IIBalance Sheet
Assets
Excess of assets over liabilities
Subordinatedliabilities
Best estimate liability
Other liabilities
Risk margin
Basic ownfunds
Tangible assets
Shareholder equity
Other liabilities
Best estimate liability
Goodwill
Residual margin
Risk adjustment
Proposed IFRSBalance Sheet
Ancillary ownfunds
Value of m
arket consistent liabilities
Callable capital instruments
Technical Provisions
Insurance contracts
Investment contracts
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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Wider impacts of IFRS 4 Phase II
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Significant investment by companies in
embedding Solvency II
Many potential synergies between
Solvency II and IFRS Insurance, but also some differences
Alignment between Solvency II and IFRS
Insurance is critical to maximising the strategic
synergy benefits from your Solvency II
investmentCompanies are investing
in understanding all aspects of IFRS now
before Solvency II becomes too “locked
down”
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Maximising synergies with Solvency II
Wider impacts of IFRS 4 Phase II
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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An integrated or closely aligned approach to the implementation of the two projects is likely to minimise implementation costs and maximise benefits.
The key challenges that insurers will face Focus area
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Wider impacts of IFRS 4 Phase IIKey challenges
Business impacts analysisUnderstand the business impacts
Target Operating ModelIntegration with the existing TOM and WDT
Finance TransformationNeed for greater efficiency and cost savings
Programme management structure and designReadiness for IFRS implementation
Organisation structure review – tax efficiencyTax efficiency implications
Help the investment analysts understand business dynamicsManaging external
stakeholder relations
Management Information: Financial planning and
analysis
Providing accurate and fully explained reconciliations between IFRS and Solvency II
Benefits realisationDelivering the identified synergy benefits
Maximising the capability across Actuarial / Technol ogy / Accounting
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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Systems
Policy administration
systems, general ledger cost
hierarchies and cost allocation
systems will need to be updated.
Data
Data requirements for IFRS and SII are
similar.
Process
Mixed presentation model that requires multiple data feeds.
Performance management
The primary focus for SII is capital adequacy.
Approach will be familiar to insurers
already using embedded value.
People and culture
Incentivisation
Remuneration
Education
Strategy and governance
Market-consistent measurement basis
will lead to an increased focus on matching between
assets and liabilities.
Complianceactivities
Homogeneous valuations required
within the same group.
Increased documentation and
disclosure requirements.
External financial and regulatory
reporting
The proposed margin-based income statement is a
significant departure from traditional revenue account presentation.
Wider impacts of IFRS 4 Phase IIKey factors and issues to consider
External financial and
regulatory reporting
Compliance activities
Strategy and governance
People and culture
Performance management Process Data Systems
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Maximising the capability across Actuarial / Technol ogy / Accounting
IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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Questions
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Key Contacts
Marylène Lanari-Boisclair
Senior ManagerActuarial & Insurance Solutions
Tel: 020 7303 3227Email: [email protected]
David Hare
PartnerActuarial & Insurance Solutions
Tel: 0131 535 7068Email: [email protected]
Rakesh B Patel
DirectorActuarial & Insurance Solutions
Tel: 020 7303 3431Email: [email protected]
Tamsin Abbey
PartnerActuarial & Insurance Solutions
Tel: 020 7303 3154Email: [email protected]
22 IFRS 4 Phase II & Solvency II: Maximising the synergy benefits
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