IFRS 17 : An Actuarial Challenge - Ordineattuari.it

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IFRS 17 : An actuarial challengeNew standard and new challengesThomas BéharActuarial Association of Europe

IFRS 17Il nuovo paradiso attuariale ?oIl peggior incubo dell’assicurazione ?

IFRS 17Uno standard contabile basato su modelli e logica molto attuarialieUno standard contabile più difficile da decifrare, spiegare e confrontare

IFRS 17 IFRS 17 basics The role of the actuary facing IFSR 17 IFRS 17 topics under review

IFRS 17 basicsIFRS 17 is the new accounting standard for Insurance Contracts published 18 May 2017 Replacethe interim standard IFRS 4 (not standardized across jurisdictions) EU endorsement still under process Go-live 1st January 2022IFRS 4 Phase IIExposureDraftIFRS 4 Phase IExposure DraftNewdeliberationsDeliberations2004June 2013IFRS 17PublicationIFRS 17Go-live !Transitoryperiod18 May 2017Effective applicationof IFRS 17 & IFRS 91st January 2022IFRS 17amendments ?EU endorsement ?

IFRS 17 basicsIFRS 17 align as much as possible insurance accounting with the general IFRS accounting of other industries Introduce three accounting models for all types of insurance contract Provide useful information about profitability of insurance contracts Reflect economics and risks in a timely manner Increase the comparability of financial statements of insurance undertakings Consistent withIFRS 9One of the most substantial change to insuranceaccounting requirements in over 20 years !Fundamentally change financial reportingfor insurers.

IFRS 17 basicsIFRS Balance sheetSHAREHOLDERS’ EQUITYFinancial capitalOther ComprehensiveIncomeCumulative ResultsASSETSclassified and valuatedin accordance with IFRS 9INSURANCE & INVESTMENTCONTRACTS LIABILITIESContractual Service MarginFulfillment Cash FlowsFuture Cash FlowsTime ValueRisk Adjustment

IFRS 17 basicsIFRS Profit or Loss

IFRS 17 basicsActuaries will be responsible for IFRS 17 Insurance Liabilities valuations : CSMContractual Service Margin : profit that the businessexpects to make after paying out all claims andexpenses and providing for the risk adjustment. RARisk Adjustment for Non-Financial Risks: reflects uncertain premiums & claims at best estimate is a buffer in case experience changes for the worst Release of the risk adjustment is a profit. BELPresent value of expected cash flows : all expected premiumsfrom the policy (in contract boundaries), claims & expenses tobe paid out, valued at today’s terms. Valuation similar to Solvency 2 Best Estimate Liabilities.

IFRS 17 basicsContracts eligible to IFRS17Contracts withdirect participation features substantially investment-relatedservice contractsunder which the entity promises aninvestment (substantial share)return based on a clearly identifiedpool of underlying items.VFA – Variable Fee ApproachCSM absorbs the effect of the change infinancial and technical assumptionsCurrent interest rate curve(Ex : Savings contracts)Non participating contractsIndirect participating contracts contracts whose cash-flows varywith the underlying items but noteligible for VFA reinsurance contracts whose cash-flows don’tvary with the underlying itemsBBA – Building Block ApprochPAA – Premium allocation ApproachGeneral ModelSimplified ApproachCSM absorbs the effect of the change intechnical assumptionsAt initial recongnition interest rate curve(Ex : Credit insurance contracts)Produce non-materially different resultsfrom the use of the general model andCoverage period of each contract is lessthan 1 year (Ex : P&C contracts)

IFRS 17 basicsDifferences between Solvency 2 and IFRS 17Solvency 2IFRS 17Solvency 2 Value of In-Force in own fundsCSMCSM absorbs shocksand decreases at each periodEntity x LoBGranularityCost of capitalRisk MarginSwaps yield curve Volatility adjustmentPortfolio x Group of contractsMethod to be definedby the entityDiscount ratesTop down or bottom up approachCash-flows consistent with Solvency 2Best EstimateCash-flows consistent with IFRS 17P&LP&L IFRS 17QRT, RSR & SFCRDisclosingFinancial statements(including annexes)QuarterlyReporting periodMonthly to Annually (regulation & entity)

The role of Actuary facing IFRS 17New actuarial solutionsNew accounting standards Calculation on a prospective basis New granularity in actuarial tools New metrics : CSM and RA Storage of results : yield curves, CSManalysis of variations etc. Complexity to estimate future profits Impacts on accounting and steering tools Transition New financial statements and newchart of account Coexistence of 3 accounting models Articulation IFRS17 / IFRS9 Analysis and justification ofdifferences between standards : localGAAP / IFRS17 / SII Reduction of time delaysNew financial communication & strategic impacts New reading of profits recognition and new indicators Potential impacts on production conception and on pricing activities Transformation of processes and internal organization Substantial changes on actuarial and accounting tools Revision of business management and anticipation of future financial communication12

The role of Actuary in Europe facing IFRS 17Moving the role of Actuary1st January2016The actuarybefore1st January2022The actuary withinSolvency 2 contextThe actuaryfrom 2021Actuaries domain of intervention will soon go upon the estimation of insurance liabilities cover the establishment of future group financial statementsActuaries constraints regarding communication and popularization of actuarial technics will be largely strengthened.

The role of Actuary in Europe facing IFRS 17The actuary before Limited contribution of actuarial models to Group financial statements Relative flexibility in actuarial methodologies for modelling purposes Justification of technical choicesgiven to internal management, MCEV reviewers and local supervision authorities

The role of Actuary in Europe facing IFRS 17The actuary within Solvency 2 context Creation of the Actuarial Function Control role at a second level Duty to report to AMSB Broader use of actuarial methologies in financial communication : necessity to Actuaries dealing withcommunicate and formalizetwo main environments : local/IFRS 4 GAAP and Solvency 2 / MCEV Business steered throughrisk management More significant contributionto IT projects (data quality, controls, complex actuarial tools etc.)

The role of Actuary in Europe facing IFRS 17The actuary from 2021 Strong contribution of actuarial models to Group financial statements Actuaries dealing withthree main environments : local GAAP, IFRS GAAP and Solvency 2 / MCEV Justification of technical choicesgiven to internal management, auditors and local supervision authorities New KPI to build and monitor Strong interdependency between actuarial, accounting and management control teams New role under legal audit ?

IFRS 17 subjects on the agenda Accordingto Paper of the IASB November 2018, effective date of IFRS 17 and temporary exemption to IFRS 9 inIFRS 4o will be deferred by one yearo entities will be required to apply IFRS 17 & IFRS 9 for annual periods beginning on or after 1st January 2022 Next Transition Resource Group for IFRS 17 Insurance Contracts meetingon 4 April 2019o instead of 4 December 2018 (because of limited number of submissions received since last TRG meeting)o Fine-tuning of IFRS 17 standard: accordingooooto IASB meeting, the Board:unanimously agreed criteria for evaluating any future potential amendments to IFRS 17 no deterioration of the information provided no additional cost of implementationno new arguments on the substance appear in CFO Forum communicationsimplementation costs have been clarified and the standard could be refined only for the purpose of reducingthemthese refinements will however be minor and will not bring substantial modifications to the standard

IFRS 17 subjects on the agendaIFRS 17 principles basedapproachleads many questions: Separating componentsIn order to determine to which standard the component is subject to,separation of the components of an insurance contract between: Insurance Investment Goods and non-insurance services A long and tedious mapping of the products Building groups of contractsContracts should be separated in groups of contracts following 3 criteria :Portfolio / Profitability / Cohort A lot of interpretations to do!And how to understand notion of “Sets of contracts” ?Contract boundariesHow and how long future premiums have to be projected for Savings andPension business?Accounting modelDifficulty to justify the use of alternative approach instead of general model: BBA – Building Block Approach “general model” VFA – Variable Fee Approach PAA – Premium Allocation ApproachDiscount ratesComplexity for building discount rate with top-down or bottom-up approach.Normativeinterpretationsand/or Marketdisagreements

IFRS 17 subjects on the agendaIFRS 17 principles basedapproachleads many questions: Attributable acquisition costsWhich costs are attributable ? Which are not ? Impact on the level of the CSMCSM amortizationCSM recognized in P&L in each period to reflect the services (coverage units).How to define “service” in insurance?Which driver for CSM amortization?ReinsuranceInconsistency between Assets and Liabilities for Savings and Pensions businessbecause reinsurance must be valuated with BBA.Transition3 possible approaches for calculating the CSM at transition : Full retrospective approach Modified retrospective approach Fair value approachThey each have their advantages and drawbacks and the entity could not beable to put into practice the most accurate (lack of data).Financial disclosureNew financial disclosure to implement: need to identify the bottom end of thebalance sheet to be integrated in BEL and define issues related to thepresentation of the groups of contracts in active or passive positionNormativeinterpretationsand/or Marketdisagreements

IFRS 17 subjects on the agendaThe Actuarial Association of Europe (AAE)welcomes many aspects of the new standards: market consistencygreater anticipated consistency and comparability acrossthe accounts of different insurers and reinsurers recognizes many complexities. Concerns relate to: inconsistent treatment of direct insurance and reinsurancein the accounts of reinsurers complexity of the regime level of interpretations required to be made across manydifferent elements of the standard which could put the aimsof consistency and comparability at risk allowance for risk release of profits in line with the underlying earnings profile calls for a prominent role for qualified actuaries in undertakings required to comply with IFRS 17 and underlines theimportance of actuarial involvement in implementation and ongoing preparation of IFRS17 accounts possibility of a regulatory requirement for actuarial involvement in closing the accounts ? considers that reconciliation between Solvency II and IFRS 17 balance sheets will be an important exercise for insurers and forregulators.

IFRS 17 subjects on the agendaThe International Actuarial Association (IAA) published ISAP 4(International Standardof Actuarial Practice 4) IAN 100 provides guidance to actuaries when performing actuarial services increase intended users’ confidence that:o actuarial services are carried out professionally and with due careo results are relevant to their needs, are presented clearly and understandably, and arecompleteo assumptions and methodology (including models and modelling techniques) used aredisclosed appropriately is an educational document on an actuarial subject to assist actuaries in producing actuarialwork-products by offering practical examples of ways in which actuaries might implement ISAP 4and IFRS17 deals with all the main topics describes previously : Classification of Contracts, ModelIntroduction, Estimates of Future Cash Flows, Discount Rates, Risk Adjustments for Non-FinancialRisks, CSM, Contracts with Participation Features and Other Variable Cash Flows, PAA,Reinsurance, Presentation, Contract Modifications and Derecognition, Business Combinations andPortfolio Transfers, Embedded Derivatives, Value, Transition

Annex - Separating components from an insurance contractIFRS 17 provides for the separation of the components of an insurance contract, such as derivatives, investment components or thesupply of goods or services1) Existence of an integratedderivative product to beseparated?YesOther contract componentsNo2) Existence of a separatedinvestment component?YesNo3) Separate commitment toprovide a good or service?NoApply IFRS 17Measured at fair value withchanges in fair value recognized inprofit and loss as they ariseApply IFRS 9Other contract componentsYesApply IFRS 15Other contract components

Annex - Granularity3 levels of aggregation of insurance contracts in order to define groups of contracts (level required for CSM calculation) :A portfolio is a group of insurancecontracts subject to similar risksand managed togetherA group of contracts shallnot include contracts issuedmore than one yearPortfolio of insurance contracts #1Cohort #1Profitability:OnerousCohort #NProfitability:No significantpossibility tability:Onerous Profitability:No significantpossibility ofbecomingonerousProfitability:OthercontractsAn entity shall divide a portfolio of insurance contracts issued into at least the 3 following groups : contracts onerous at initial recognition contracts have no significant possibility of becoming onerous subsequently remaining contracts in the portfolio

Annex - Contract boundariesFuture premiums are projected when they give rise to a significant obligation for the insured or the insurer (respectively for the paymentof premiums and for the supply of a service).Commitment deemed to be due when the insurer has the right to revise the price or collateral to reflect the risk at the policy or portfoliolevel.No future premium beyond this date.End ofprojectionBeginning ofprojectionProjection of future premiums!Contract boundaryentity has the right to revaluethe benefits or reassess theprice of the contractAs in Solvency 2, the question of the projection of future premiums arises for savings guarantees in General Fund.IFRS 17 and Solvency II contract boundaries are not necessarily the same one.

Annex - Discount rates3 possible approaches for building interest rate curve:Top-Down ApproachBottom-Up ApproachDurationadjustmentMismatchadjustmentYield curvebased on actualreference FRS 17Discount rates!No interest rate to the ultimate is imposed by the texts.The implementation of these principles is likely to differ widely from one actor to another.Risk Free Rates

Annex - Transition3 possible approaches for calculating the CSM at transition:Method deemed"unrealistic"Modified retrospectiveapproachFull retrospectiveapproachFair value approachApproachFull retrospectiveapproachPrincipeRevaluation of contracts according to the new standard as soon as they are subscribed, as if thestandard had always existedModified retrospective Simplification of the fullretrospective approachapproachFair value approach Valuation of a transfer value of the portfolio Default method required Most accurate assessment of balance sheet accounts at transitionOperationally very constrainingRequires to build complete historical data(cash-flows and discount rate)Application to sets of contractsBased on the value of the asset attransition Requires significant retrospective dataNeed less dataPotentially easier to implement Method unknown at this stageDon’t take into account entity’s specificities

IFRS 17 basics IFRS 17 is the new accounting standard for Insurance Contracts published 18 May 2017 Replace the interim standard IFRS 4 (not standardized across jurisdictions) EU endorsement still under process Go-live 1st January 2022 18 May 2017 IFRS 17 Publication Effective application of IFRS 17 & IFRS 9 1st January 2022 IFRS 17 Go-live ! Transitory

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