28 th India Fellowship Seminar Topic IFRS 17

28 th India Fellowship Seminar Topic: IFRS 17 - Introduction, History, Features and Implications on Insurers Guide Name: Kamlesh Gupta Presenters Name: 1. Jimmy Jacob 2. Rohit Mall 3. Subhasree Nigamma 4. Nandan Nadkarni Date: November 10, 2017 Venue: Mumbai Indian Actuarial Profession Serving the Cause of Public Interest

Coverage Aspects Paras Content Level of Aggregation 14 -24 Minimum criteria for grouping Recognition 25 -28 The contract recognition date ---Initial Measurement 32 -38 Estimation of fulfilment cash flows and contractual service margin ---Subsequent Measurement 40 -43 The measurement of subsequent carrying amount and the impact on P&L ---Onerous Contracts 47 -52 Treatment of onerous contracts Measurement www. actuariesindia. org Source: IFRS 17 2

Coverage (Contd…) Aspects Paras Content ---PAA approach 53 -59 An alternate measurement approach ---Reinsurance Contracts held 60 -69 Recognition and Measurement of Reinsurance contracts ---Investment Contracts with DPF 71 Modified requirements for these contracts Modification and Derecognition 72 -74 The conditions for modification and derecognition Presentation 78 -87 Presentation Requirements Disclosure 97 -114 Disclosure requirements www. actuariesindia. org Source: IFRS 17 3

Areas to be addressed Introduction and History Features Implications Three valuation methods Life Insurance Timelines and Scope Aggregation Level General Insurance History General Measurement Model Common Onerous Contracts www. actuariesindia. org 4

Time Lines and Scope Disclosure of expected impacts of the issued but not yet effective standard 2017 2018 IFRS 17 issued Revised IFRS 9 classification from IFRS 17 implementation 2019 2020 IFRS 17 start of comparative period 2021 First IFRS 17 compliant financial statements 2022 IFRS 17 effective 1 January 2021 • IFRS 17 applies to: o Insurance and reinsurance contracts that an entity issues o Reinsurance contracts that it holds o Investment contracts with DPF (provided entity issues Insurance contracts) • Applicable for annual periods starting on or after 1 st Jan, 2021, comparative reporting through 2020 • Early application permitted for entities that apply IFRS 9 and IFRS 15 www. actuariesindia. org Source: EY IFRS 17 report 5

History IFRS 4 permitted wide latitude in a/c practice Need for a common global insurance standard Non-marketability of an insurance contract posed measurement issues Hampered comparability of financial statements Some a/c practices under IFRS 4 did not reflect true financial position IFRS 17 focuses on transparency and consistency of accounting practice! www. actuariesindia. org Source: IFRS 17 6

Areas to be addressed Introduction and History Features Three valuation methods Timelines and Scope Aggregation Level Implications Life Insurance General Insurance History General Measurement Model Common Onerous Contracts www. actuariesindia. org 7

Three valuation methods General Measurement (GM) Model (Building block Approach-BBA) • Insurance Contracts (without Direct Participating feature) • Unearned profit over the coverage period • Estimates of Future cash flows PAA Approach • Short term contracts (< than 1 year) Variable Fee Approach (VFA) • Stable cash flows • Direct Participating Contracts and Investment Contracts with DPF • Simplified GM model • Variant of GM model • Similar to ‘Unearned premium approach’ • Long term Contract with Investment Component • Long term contracts www. actuariesindia. org 8

Level of Aggregation Onerous contracts are loss making contracts! Profitable and unlikely to be onerous Contracts with similar risks to be grouped together Minimum Grouping at inception Nature Duration Onerous Issue dates. Maximum one year apart Remaining “Profitable and unlikely to be onerous”? ? . . Judgment? ? www. actuariesindia. org 9

IFRS 17 and the valuation methods • IFRS 17 Aim/Intention • Focus on Profit drivers • Three valuation methods • General Measurement Model- Deviation from current practice? ? www. actuariesindia. org 10

General Measurement (GM) Model -Building Block approach (BBA) Unearned profit amortized over coverage period Eliminates gain at contract inception For non-financial risks Best Estimate Liability at a liability discount rate Liability for future coverage Contractual Service Margin(CSM) Risk Adjustment Probability weighted discounted EPV Liability for Incurred claims + Risk Adjustment Probability weighted discounted EPV Risk Adjustment + Probability weighted discounted EPV=Fulfilment Cash flows www. actuariesindia. org 11

Subsequent Measurement. BBA CSM P&L Risk Adjustment Estimated cash flow changes OCI Probability weighted discounted EPV P&L Release post this reassessment 1. Reassessment of fulfilment cash flows 2. Release through P&L/OCI www. actuariesindia. org + Risk Adjustment Probability weighted discounted EPV 12

BBA- CSM Impact of changes for future coverage CSM P&L (CSM Release) Risk Adjustment Estimated changes related to future service Probability weighted cash flows Discount rate changes Why through CSM? ? www. actuariesindia. org P&L Other Comprehensive Income 13

GM Model- New components Unearned profit amortized over coverage period Eliminates gain at contract inception For non-financial risks Liability for future coverage Contractual Service Margin(CSM) Risk Adjustment Liability for Incurred claims + Risk Adjustment Risk adjustment /CSM at the portfolio level? ? Judgment in allocation IFRS guidance for Risk Adjustment estimation Cash flow characteristics; Probability distribution of cash flows Confidence Interval Components to be tracked www. actuariesindia. org 14

Initial Recognition Pricing equation… CT 5! Quantifying the CSM Liability at inception is NIL. CSM ensures that the Income/Expense in NIL Subsequent Measurement Key Aspects of GM Model ---Reevaluate the fulfilment cash flows ---P&L/OCI impact The change in cash flows impact either the CSM or the P&L/OCI Cash Flow Changes Flow through P&L Absorbed in Balance sheet(CSM) Flow to OCI www. actuariesindia. org 15

General Measurement Model (BBA) -Illustration Insurance Contract (without Direct Participating Features) Coverage period (years) Values Comments 4 Total premium at inception(in Rs. ) 1500 Initial acquisition cost (in Rs. ) 100 Expected claims and expenses (in Rs. ) 800 Incurred evenly over 4 years No lapse assumed Risk adjustment for nonfinancial risk (in Rs. ) 80 Assumed even release Discount rate Actual Experience www. actuariesindia. org Negligible Same as expected & no assumption changes Source: KPMG, July 2017 16

GM Model (BBA) -Illustration (Contd. . ) Years Cash flow description EPV of cash inflows EPV of cash outflows Risk adjustment Fulfilment cashflows Contractual service margin Insurance contract liability www. actuariesindia. org Initial recognition 1 2 3 4 Premium Expected claims and expenses (incl. acquisition cost) 1500 -900 -600 -400 -200 0 Non-fin risk adj -80 -60 -40 -20 0 520 -660 -440 -220 0 -520 -390 -260 -130 0 0 -1050 -700 -350 0 Source: KPMG, July 2017 17

GM Model (BBA)-P&L Impact Change in liability for remaining coverage Years Opening balance Premiums received Acquisition cash flow Expected claims Risk adjustment recognised CSM allocation Closing balance P &L impact Expected claims Risk adjustment recognised CSM allocation Revenue for services provided Revenue to cover acquisition cash flows Insurance revenue Service expenses Revenue to cover acquisition cash flows Insurance service expenses Insurance service result www. actuariesindia. org 1 0 -1500 100 20 130 -1050 2 -1050 0 0 20 130 -700 1 200 20 130 350 25 375 -200 -25 -225 150 3 -700 0 0 20 130 -350 4 -350 0 0 20 130 0 2 3 4 200 200 20 20 20 130 130 350 350 25 25 25 375 375 -200 -25 -25 -225 150 150 Source: KPMG, July 2017 18

GM Model (BBA)-Balance Sheet Impact Balance Sheet Years 1 2 3 4 Asset Cash Liability and Equity Insurance contract Liability Equity Total Liability and Equity www. actuariesindia. org 1500 -100 - 1200 -200 = 1000 -200 = 800 -200 = 200= 1200 1000 800 600 1050 700 350 0 150 300 450 600 1200 1000 800 600

General Measurement Model. Macro Perspective (Contd. . ) CSM Risk Adjustme nt Estimate d changes related to future service Probability discounted cash flows Balance sheet measurement www. actuariesindia. org Flow to Income/OCI Source: PWC, March 2, 2017 20

General Measurement Model. Macro Perspective (Contd. . ) CSM Release Risk Adjustme nt Release of Risk Adjustment Estimate d changes related to future service Interest on Insurance liability at inception rate (unwind of discount rate) Probability discounted cash flows Discount Rate changes (update current market rates) Changes in cash flows related to past and current service period Balance sheet measurement www. actuariesindia. org Flow to Income/OCI Source: PWC, March 2, 2017 21

General Measurement Model. Macro Perspective (Contd. . ) CSM Release Risk Adjustme nt Release of Risk Adjustment Estimate d changes related to future service P&L (Underwriting Result) P&L (Investment Result) Interest on Insurance liability at inception rate (unwind of discount rate) Probability discounted cash flows Discount Rate changes (update current market rates) Changes in cash flows related to past and current service period Balance sheet measurement www. actuariesindia. org Other Comprehensive Income (Equity) Flow to Income/OCI Source: PWC, March 2, 2017 22

Onerous Contracts Definition When? CSM Impact Treatment • Total fulfilment cash flows are a net outflow • Loss making contracts • Initial Recognition; or • Subsequent Measurement • Wipes out the CSM • Immediate recognition of the liability • P&L Management judgment to identify profitable contracts that could turn onerous! www. actuariesindia. org 23

Areas to be addressed Introduction and History Features Three valuation methods Timelines and Scope Aggregation Level Implications Life Insurance General Insurance History General Measurement Model Common Onerous Contracts www. actuariesindia. org 24

Life Insurers: Likely Impact on Segment Mix Business Mix for life Insurance Industry [for 6 months ended 30 th Sep 2017 (FYP)] Category Individual Single Premium Individual Non-Single Premium Group Yearly Renewable Premium Business Mix 14% 26% 57% 2% 2% Key Aspects IFRS 17 amends the way revenue is measured and disclosed. Likely to Impact Single premium mix; since it will not contribute to immediate top line growth Aggressive sale of ULIP/Group fund based products may not translate in to top line growth www. actuariesindia. org 25

Life Insurers: Likely Impact on Segment Mix Key results disclosed in Income statement Underwriting result Net Interest and Investment income Profit/ Loss Total comprehensive income • Key Performance indicators likely to change. • Likely that Insurers will focus on more Profitable segments like Protection Products. www. actuariesindia. org 26

Life Insurers: Measurement Approach for different Segments Measurement Approach General Measurement Approach (Building Block Approach) Need for the Approach Default model for all Insurance contracts. Applicable for contracts without direct participating features. Types of contract (Illustrative list) • • • Term / Whole life / Endowment Long term health Other protection business Certain annuities Immediate annuities Premium Allocation Approach (PAA) Simplified approach for Short term contracts Short term life contracts Variable fee approach (VFA) To deal with Participating business, where payments to policy holders are linked to underlying items like assets. • • Variable Insurance contracts Unit linked contracts Applicable for contracts with direct participating feature. www. actuariesindia. org 27

Variable fee Approach : Illustration Facts for ULIP contract Values Coverage period (years) 3 Single premium (payable at inception) (in Rs. ) 150 Number of Policies issued 100 Benefit payable -Account balance, if the policy holder survives -In case of death, higher of guaranteed death benefit of 170 or Account balance. Expected claims One Policy holder will die at the end of each year. Return on underlying assets (p. a. ) 10% Service charge levied by Insurer(p. a. ) 2% Risk free interest rate (p. a. ) 6% Risk adjustment for non-financial 25 (12 to be recognized in profit statement in risk year 1) www. actuariesindia. org Source: KPMG, July 2017 28

Variable fee Approach : Illustration Estimate of CSM Estimate of Present value of cash inflows (100 Policies*150) 15, 000 Estimate of Present value of cash outflows (14, 180)* *Factors in the current discount rate as well the time value of guarantee in providing a minimum death benefit Risk adjustment (25) Fulfillment cash flows 795 CSM to be recognized www. actuariesindia. org (795) Source: KPMG, July 2017 29

Variable Fee Approach : Illustration Fair value of Underlying assets at end of year 1 Premium received on inception 15, 000 Investment return at 10% 1, 500 Annual charge [16, 500 * 0. 02] (330) Payment for death [(16, 500 -330)*1/100] (162) Fair value at end of year 1 16, 008 CSM at end of year 1 Opening balance (795) Company’s share of change in fair value of underlying items (increase of 1500*. 02) (30) Effect of time value of money and other financial risk (67) CSM before Allocation (892) CSM to be allocated for year 1(892*percentage of service provided in year 1) Percentage of service provided in Year 1: (100/(100+99+98)) =34%. CSM at end of year 1 www. actuariesindia. org 300 (592) Source: KPMG, July 2017 30

Variable fee Approach : Illustration Results for Year 1 Expected claims and other expenses (Guaranteed amount of 170 minus account balance of 162) 8 Changes to risk adjustment for the non-financial risk 12 CSM allocation during the period 300 Insurance Revenue 320 Insurance service expenses 8 Insurance service result Investment income Insurance finance expenses 312 1500 (1500) Finance result 0 Profit www. actuariesindia. org 312 Source: KPMG, July 2017 31

Life Insurers: Acquisition cash flows • IFRS 17 : Insurance Acquisition cash flows to be included in determining CSM on initial recognition. : Insurance Acquisition cash flows eventually affect profit or loss through the CSM release process (So in effect we defer acquisition cost). • Current Practice : Expense all Acquisition cash flows at inception. • Implication of implementing IFRS 17 : Smaller losses at inception (less year one strain) : Lower profit in Year 2 & later. www. actuariesindia. org 32

Implications – General Insurance Aspect Implication Method • Expectation – PAA • Long tailed Lo. B – application of PAA – doubtful Judgments – Regarding Onerous • • Acquisition cost • Realised year after year • Long term contracts may be affected www. actuariesindia. org Cash flow Determination, risk adjustment Non availability – Year wise High volatility – more judgment Same implications as BBA approach

Implications-General Insurance Aspect Implication Recognition of • Different from current practice incurred claims • Not - (Paid + Changes in O/S & IBNR Claims) Key metrics • Review of Combined ratio, Incurred claims ratio required Actuaries will have a greater role! www. actuariesindia. org

Common Implications – Cost/Data Aspect Implication Aggregation (Grouping) By inception dates and nature (Onerous, profitable, etc) implies large storage requirements CSM/Risk Adjustment release Allocation methodology to be devised e. g could depend upon the number of contracts, coverage offered, etc. Risk Adjustment An explicit adjustment; No specific IFRS guidance; Impact on comparability Confidence Interval www. actuariesindia. org

Common Implications – Cost/Data Aspect Implication Reconciliation E. g. CSM and Risk Adjustment Cash flows Information on cash flows (Historical and Future), discount rates and risk adjustments for each contract group to be stored Adverse circumstances Methodology to monitor circumstances indicating onerous contracts ‘Facts and Circumstances’ for onerous under PAA e. g CSM margin at inception, sensitivity of cash flows to assumption changes etc. www. actuariesindia. org

Common Implications – Cost/Data Aspect Implication Discount rates Two set of discount rates to be stored Performance Appraisal New benchmarks to be developed; incentives around new KPIs Data, Systems Human Talent Upgradation of legacy systems New controls and increased interaction of actuaries and accountants Indeterminate Impacts www. actuariesindia. org Tax authorities and Regulators

Common Implications – Disclosures Disclosure Requirement Insurance risk Sensitivity to changes in risk exposure, claim development Credit risk, Liquidity risk, Market risk Exposure to risk, Policies and process to manage the risk More time and effort Working group by IRDA for reviewing and early adoption of IFRS 17 www. actuariesindia. org

Thank you www. actuariesindia. org 39