floris van diest tim schilders - zanders treasury and ... · ifrs 4 / 5 2. case study: lifeco -...
TRANSCRIPT
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IFRS 4 / 1
Knowledge sharing – IFRS 4Floris van Diest –Tim Schilders
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IFRS 4 / 2
Agenda
Opening
1 The road to a new balance sheet
2 Case study: LifeCo
3 Expected impact
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IFRS 4 / 3
1. The road to a new balance sheet
Where did this come from?
• 2001: IASB initiates IFRS 4 project
o No standard for insurance contracts in IAS
• 2005: IASB releases IFRS 4 Phase I:
o Interim standard: temporary exemption to IFRS principles
o Key definitions and enhanced disclosure requirements
o Still, IASB claims:”… current accounting practices are not true reflection of nature and extent
of the risks embedded in insurance contracts.”
o 2010, 2013: IASB releases first and second IFRS 4 Phase II Exposure Draft
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IFRS 4 / 4
1. The road to a new balance sheet
Where is it going?
• 2016: IASB will release final exposure draft
o Add transitional measures for application IFRS 9 Financial Instruments
‘Overlay approach’
‘Temporary exemption’
• 2018: Implementation IFRS 9
o Implementation transitional measures
• 2020: Implementation IFRS 4 Phase II (exp.)
LA
B/S
2013
Exposure draft:
IFRS 4
2014
Publication:
IFRS 9
2017 20192015
Draft amendments:IFRS 4 vs . IFRS 9
2016
Publ ication:
IFRS 4 (exp.)
2020
Implementation:
IFRS 4 (exp.)
2018
Implementation: IFRS 9
End of transitional measures
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IFRS 4 / 5IFRS 4 / 5
2. Case study: LifeCo - 2020
LifeCo introduction
• Owned by Tim Schilders and Floris van Diest
• (New) business strategy: issue life insurance contracts and invest in bonds
LifeCo issues 2 portfolios of life insurance contracts
• Tim and Floris issue one portfolio with 1,000 10-year contracts each on 31.12.2020
• Insurance contract:
o Provides death coverage (death capital = EUR 20,000)
o Requires one premium payment due on 01.01.2021
Tim’s contracts premium: EUR 10,000
Floris’ contracts premium: EUR 9,000
2020
Total 1,000Total 1,000
Cash 1,000 Equity 1,000
LifeCo B/S 30.12.2020 (in thousands)
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IFRS 4 / 6
Definition and scope
LifeCo has to apply IFRS 4 Phase II because…
• IFRS 4 applies to all instruments defined as insurance contract for any company issuing them
IFRS 4 definition
• ‘A contract under which one party (e.g. LifeCo) accepts significant insurance risk from another party (e.g. policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (e.g. death) adversely affects the policyholder’
In scope (upon significant risk) Not in scope
2020
2021
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IFRS 4 / 7
Accounting model steps
IFRS 4 Phase II accounting model
LifeCo reporting steps timeline
Step 5Provide
disclosures
Step 4Present in financial
statements
Step 3Remeasure in subsequent
periods
Step 2Measure at
initial recognition
Step 1Identify and
recognise the contract
Step 1 Step 2 Step 3 Step 4 Step 5
2020
2021
…
2020
2021
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IFRS 4 / 8
Accounting model steps
Step 1: Identify and recognise the contract
• An insurance contract is recognised at minimum of:
o Beginning of coverage period (for LifeCo portfolios: 31.12.2020)
o Date of first payment from policyholder (for LifeCo portfolios: 01.01.2021)
Unbundling
• Decompose (‘unbundle’) only if contract contains components that:
o would be within scope of other standard(s); and
o are not highly interrelated the host contract
• Example components:
o Insurance component
o Embedded derivatives
o Investment component
• N/A for LifeCo portfoliosUnbundling
Insurance component
Insurance contract
Investment component
Embedded derivative
2020
2021
54321
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IFRS 4 / 9
Accounting model steps
Step 2: Measure at initial recognition
• Standard model of IFRS 4: Building Blocks Approach (BBA)
o Applicable to LifeCo portfolios
• Alternative models:
o Variable fee approach: insurance contracts with participation features
o Premium allocation approach: short duration contracts or long duration contracts meeting certain criteria (for pre-claim periods)
Ass
etLi
abili
ty
Block 1Future cash
flows
Block 2Time value of money
Block 3Risk
adjustment
Block 4Contractual
service margin
Re
po
rtin
g a
mo
un
t0
2020
2021
54321
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IFRS 4 / 10
LifeCo portfolios
• Other than premiums, portfolios are identical
• B1 does not take into account the time value of money (B2). Hence, B1 typically results in a net liability.
Building Block Approach
FloTim
Acquisition costs
Costs
Lapses
Claims: Death
Maturities
2021 2022 ... 2030
Cas
h in
flo
ws
(-)
Cas
h o
utf
low
s (+
)
BBA Block 1: Future cash flows
• Sum of (undiscounted) probability weighted cash inflows and outflows estimated at moment of reporting
Totals Tim Floris
Cash outflow 11,000,000 11,000,000
Cash inflow -10,000,000 -9,000,000
Block 1 1,000,000 2,000,000 Costs
Lapses
Claims: Death
Costs
Lapses
Claims: Death
Premiums
Received on 01.01.2021
2020
2021
1
42
3
54321
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IFRS 4 / 11
Building Block Approach
Yield curve of actual or reference
asset portfolio
Credit risk premiums
Discount curve IFRS 4
Illiquidity premium
Top down approach
BBA Block 2: Time value of money (1/2)
• Discounting of future cash flows with market consistent discount curve
• Curve reflects currency and liquidity of contract and timing of cash flows
Two approaches:
• Top down approach: asset yield curve excluding factors irrelevant for insurance contract
• Bottom up approach: risk-free curve including factors relevant for insurance contract(No further guidance on how to determine adjustments)
Risk-free curve
Timing mismatch
Bottom up approach
2020
2021
1
42
3
54321
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IFRS 4 / 12
Block 1LifeCo portfolios
• Given portfolios are identical, portfolios have same discount curve
• Value block 2 equals difference between Block 1 and discounted value of Block 1
Building Block Approach
BBA Block 2: Time value of money (2/2)
Totals Tim Floris
Block 1 1,000,000 2,000,000
Block 2 -1,550,000 -1,550,000
Block 1 + 2 -550,000 450,000
Block 2
PV(Block 1)
Block 1
PV(Block 1)
Block 2
Ass
etLi
abili
tyA
sset
Liab
ility
Floris’ portfolio
Tim’s portfolio
2020
2021
1
42
3
54321
-550,000
450,000
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IFRS 4 / 13
Building Block Approach
BBA Block 3: Risk adjustment (1/3)
• “Compensation entity requires for risk of bearing uncertainty about amount and
timing of cash flows arising as entity fulfils the insurance contract.”
• Incorporating risk diversification and favourable vs. unfavourable outcomes of
uncertainty in line with entity’s risk aversion
Range of calculation techniques
• IFRS 4 doesn’t prescribe particular techniques
E(BE Liability) VaRα
RA
Pro
bability
Confidence level approach (VaR)
VaRα TVaRα
Pro
bability
Conditional Tail Expectation (CTE)
RA
T=0 T=1 T=2 T=n…
…
RA
= capital required
= capital charge ∙ capital required
Cost of capital approach
𝑃𝑉
2020
2021
1
42
3
54321
E(BE Liability)
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IFRS 4 / 14
Building Block Approach
BBA Block 3: Risk adjustment (2/3)
Costs
Lapses
Claims: Death
Claims: Death
Costs
Lapses
Claims: Death
Lapses
Costs
Lapses
Claims: Death
Costs
Mortality shock Lapses shock Expenses shock
2021 2022 ... 2030
CostsLapses
Claims: Death
Cost of capital approach:
• Mortality rates, lapses rates and expenses are shocked by predefined percentages
• For all future cash outflows
Cost of capital approach:
• Capital at Risk (CaR) = aggregated delta change in shock scenarios
• Discounted by a discount curve
Capital at risk Capital at risk Capital at risk
CostsLapses
Claims: Death
CostsLapses
Claims: Death
2020
2021
1
42
3
54321
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IFRS 4 / 15
LifeCo portfolios
• Given portfolios are identical, portfolios have same risk adjustment
• Cost of capital approach (6% charge) assuming mortality, lapse and expense shocks and diversification
• Block 1-3 defined as fulfilment cash flows
Building Block Approach
BBA Block 3: Risk adjustment (3/3)
Totals Tim Floris
Block 1 + 2 -550,000 450,000
Block 3 50,000 50,000
Block 1 - 3 -500,000 500,000
FloTim
Premiums
2020 2021 2022 ... 2030
Cas
h in
flo
ws
(-)
Cas
h o
utf
low
s (+
)
Costs
Lapses
Claims: Death
Maturities
Costs
Lapses
Claims: Death
Costs
Lapses
Claims: Death
Risk adjustment Risk adjustment
Risk adjustment
Acquisition costs
2020
2021
1
42
3
54321
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IFRS 4 / 16
Building Block Approach
BBA Block 4: Contractual Service Margin (CSM)
• “A component of measurement of the insurance contract representing the unearned
profit that the entity recognises as it provides services under the insurance contract.”
• Recognised on portfolio level for contracts with ‘similar’ date of inception
• Periodically ‘released’ (revenue in P/L) in accordance with insurance coverage provided
Recognition
• If [Block 1 + Block 2 + Block 3] < 0 then CSM = - [Block 1 + Block 2 + Block 3]
o CSM eliminates ‘Day One Gain’
• Else CSM = 0
o Portfolio is onerous – Report ‘Day One Loss’ in P/L equal to [Block 1 + Block 2 + Block 3]
LifeCoA
sset
Lia
bil
ity
Block 2
Block 3
Block 4
Block 1
Re
po
rtin
g a
mo
un
t
0
Ass
etLi
abil
ity
Block 2
Block 3
Block 1
Rep
ort
ing
amo
un
t
0
Totals Tim Floris
Block 1 - 3 -500,000 500,000
Block 4 500,000 0
Block 1 - 4 0 500,000Tim’s portfolio Floris’ portfolio
2020
2021
1
42
3
54321
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IFRS 4 / 17
Total 1,000Total 1,000
Accounting model steps
Step 4: Present results in financial statements
• Reporting (re)measured carrying amounts on B/S
• Reporting of P/L and OCI
LifeCo: 2020 Financial statements
• P/L & OCI: Recognition of onerous portfolio
o ‘Day One Loss’ reported as expense in underwriting result
• B/S: ‘Day One Loss’ eats capital via retained earnings
2020
Total comprehensive income -500
Change to OCI 0
Floris portfolio 500Cash 1,000
Equity 500
LifeCo B/S 31.12.2020 (in thousands)
LifeCo P/L and OCI For 12 Months Ended 31.12.2020 (in thousands)
Underwriting result -500Insurance contract revenue 0Insurance contract expense -500
Investment result 0
Profit or Loss -500
2020
2021
54321
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IFRS 4 / 18
Accounting model steps
Step 5: Provide disclosures
• “Disclose qualitative and quantitative information that should enable the users of the financial statements to interpret the nature, amount, timing and uncertainty of the future cash flows of the issued insurance contracts”
3 broad categories
• Explanation of recognised amounts
o To enable user to make reconciliations
• Significant judgements applied
o (Changes in) Judgements in measurements and estimations
• Nature and extent of risk arising from insurance contracts
o Exposures, how risks arise and how risks are managed
2020
2021
54321
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IFRS 4 / 19IFRS 4 / 19
2. Case study: LifeCo - 2021
Bond acquisition
• Part of premiums received (minus acquisition costs) invested in 2 bonds:
o Floris’ bond (10Y, 7 mln., 4.3%, p.a.) measured at amortised cost
o Tim’s bond (10Y, 8 mln., 3.8%, p.a.) measured at FVTOCI
2021
Claims underestimated
• Incurred claims higher than expected
o Change in estimates of future cash flows
o Change in risk adjustment
Lower interest rate environment
• Discount curves of assets and insurance liabilities lower
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IFRS 4 / 20
2.2 Accounting model steps
Step 3: Re-measure in subsequent periods
• Re-measurement of insurance contracts given all newly available information
• Changes in estimates respective blocks reported in P/L, OCI, or against CSM
BBA Block 1: Future cash flows
• Future cash flows increase:
o Premiums (-) have been received
o Expected future claims increased
FloTim
Premiums
Acquisition costs
2021 2022 ... 2030
Cas
h in
flo
ws
(-)
Cas
h o
utf
low
s (+
)
Costs
Lapses
Maturities
Costs
Lapses
Claims: Death
Costs
Lapses
Claims: Death
2020
2021
Claims: Death
Totals Tim Floris
Block 1 - 2020 1,000,000 2,000,000
Realised CFs +9,400,000 +8,400,000
Est. change +90,000 +90,000
Block 1 10,490,000 10,490,000
1
42
3
54321
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IFRS 4 / 21
2.2 Accounting model steps
BBA Block 2: Time value of money
• Time value of money decreases
o Unwind of time value based on 2020 discount curve
o Lower 2021 discount curve
BBA Block 3: Risk adjustment
• Risk adjustment is periodically released in accordance with services provided
• Due to inaccurate estimations, chosen to be more conservative by raising the shocks
2020
2021
Costs
Lapses
Claims: Death
Maturities
Costs
Lapses
Claims: Death
2021 2022 ... 2030
Totals Tim Floris
Block 2 – 2020 -1,550,000 -1,550,000
Unwind +250,000 +250,000
Lower curve +100,000 +100,000
Block 2 -1,200,000 -1,200,000
Totals Tim Floris
Block 3 – 2020 50,000 50,000
Release -5,000 -5,000
Change +10,000 +10,000
Block 3 55,000 55,000
1
42
3
54321
1
42
3
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IFRS 4 / 22
2.2 Accounting model steps
BBA Block 4: Contractual Service Margin
• CSM is periodically released in accordance with services provided
• CSM accretes interest to reflect time value against lock-in discount curve
‘Unlocking’ the CSM
• Changes in estimates of the B1 and B3 are recognised
against the CSM (if available):
o If changes are favourable then
CSMt+1 = CSMt + PV(Change B1 + B3)
o If changes are unfavourable then
CSMt+1 = max{CSMt - PV(Change B1 + B3), 0}
• Hence:
o If CSM is not exhausted, changes in future cash flows are not recognised in P/L
o If CSM is exhausted, PV(Change) – CSMt recognised as loss in P/L as insurance contract becomes onerous
2020
2021
CSM Tim Floris
Block 4 - 2020 500,000 0
Periodic release -50,000 0
Interest accretion +5,000 0
PV(Change B1+B3) -90,000 0
Block 4 - 2021 365,000 0
BBA Tim Floris
Block 1 10,490,000 10,490,000
Block 2 -1,200,000 -1,200,000
Block 3 55,000 55,000
Block 4 365,000 0
Total 9,710,000 9,345,000
Tim Floris
Block 1 1,000,000 2,000,000
Block 2 -1,550,000 -1,550,000
Block 3 50,000 50,000
Block 4 500,000 0
Total 0 500,000
2020
1
42
3
54321
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IFRS 4 / 23
2.2 Accounting model steps
Step 4: Present results in financial statements
LifeCo: 2021 P/L and OCI
• Underwriting result: Earned Premium Approach
FloTim
Premiums
Acquisition costs
2021 2022 ... 2030
Costs
Lapses
Claims: Death
Maturities
Costs
Lapses
Claims: Death
Costs
Lapses
Claims: Death
Risk adjustment Risk adjustmentLifeCo P/L and OCI For 12 Months Ended 31.12.2021 (in thousands)
Underwriting result -70
Insurance contract revenue 720Amortisation of acquisition costs 60Release in RA +10Release of CSM 50Expected claims and expenses 600
Insurance contract expense -790Incurred claims and expenses -620Incurred acquisition costs -60Losses onerous contracts -90Unexpected changes to IL -20
2020
2021
Risk adjustment
Experienceadjustment
54321
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IFRS 4 / 24
2.2 Accounting model steps
Step 4: Present results in financial statements
LifeCo: 2021 P/L and OCI
• Investment result
LifeCo P/L and OCI For 12 Months Ended 31.12.2021 (in thousands)
Investment result 95
Interest income 600On bonds 600
Interest expense -505On insurance liability -500On CSM -5
Underwriting result -70
Profit or Loss 25
FloTim
Premiums
Acquisition costs
Costs
Lapses
Claims: Death
Maturities
Costs
Lapses
Claims: Death
Costs
Lapses
Claims: Death
2021 2022 ... 2030
Unwind of timevalue based on 2020discount curve
2020
2021
54321
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IFRS 4 / 25
2.2 Accounting model steps
Step 4: Present results in financial statements
LifeCo: 2021 P/L and OCI
• Change to OCI
LifeCo P/L and OCI For 12 Months Ended 31.12.2021 (in thousands)
Investment result 95
Underwriting result -70
Total comprehensive income -5
Change to OCI -30
Profit or Loss 25
Discount curve changes on insurance liability -200
Fair value change of FVTOCI bond 170
Coupon
Notional
Coupon
2021 2022 ... 2030
Coupon
Premiums
Costs
Lapses
Claims: Death
Maturities
Costs
Lapses
Claims: Death
Risk adjustment
Risk adjustment
2021 2022 ... 2030
2020
2021
54321
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IFRS 4 / 26
Tim’s bond 8,170(FVTOCI)
Floris’ bond 7,000(AC)
Tim portfolio 9,720
2.2 Accounting model steps
Step 4: Present results in financial statements
LifeCo: Balance sheet
Floris’ portfolio 9,345
Cash 4,380Equity 495
LifeCo B/S 31.12.2021 (in thousands)
Total 19,550Total 19,550
2021
2020
2020
2021
54321
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IFRS 4 / 27IFRS 4 / 27
3. Expected impact
4.1 Solvency II vs. IFRS 4
4.2 IFRS 4 Phase I vs. IFRS 4 Phase II
4.3 Conclusion
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IFRS 4 / 28
4.1 Solvency II vs. IFRS 4
MV Assets
Best estimateliabilities
Risk Margin
MCR
SCR
Mark
et-c
onsis
tent v
alu
atio
nof
liabilitie
s
Excesscapital
Best estimateliabilities
Risk Adjustment
PV o
f best e
stim
ate
cash flo
ws
CSM
Equity
Solvency IIIFRS 4 –phase II
Premiums
Acquisition costs
Costs
Lapses
Claims: Death
Maturities
Costs
Lapses
Claims: Death
Costs
Lapses
Claims: Death
Risk adjustment Risk adjustment
Risk adjustment
2021 2022 ... 2030
VA
CSM
MA
B4
Comparison on balance sheet level Comparison on cashflow level
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IFRS 4 / 29
4.2 IFRS 4 Phase I vs. Phase II: Dutch insurer case
Dutch insurer case
• Comparison of IFRS 4 Phase I vs. Phase II based on Dutch insurer’s annual report (notes)
Step 5Provide
disclosures
Step 4Present in financial
statements
Step 3Remeasure in subsequent
periods
Step 2Measure at
initial recognition
Step 1Identify and
recognise the contract
B1
B2
B3
B4
B1
B2
B3
B4
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IFRS 4 / 30
4.3 Conclusion
An operational challenge
• Maintain a break-down of building blocks over lifetime
• Reporting of changes to blocks in P/L or OCI or via ‘unlocking’ of CSM
A conceptual relief
• Certain elements of IFRS 4 (e.g. risk adjustment, discount curves) are new from an accounting perspective…
• … but may be reused from Solvency II and the Liability Adequacy Test
A reassessment of the ALM strategy
• P/L and OCI reporting might be shaken by new elements (e.g. changes to blocks, EPA) and entries
• Additionally, reclassification of assets under IFRS 9 can strongly impact results
• An ex-ante reassessment of the ALM strategy might be required.