“Moving Toward a Global Financial Reporting StandardFinancial Reporting Standard –

How will This Impact You?”

Canadian Reinsurance ConferenceCanadian Reinsurance ConferenceApril 29, 2010

Today’s Presenters

• Phil Arthur – Overview of IFRS 4• Nicholas Bauer – Actuarial perspectivep p• Tom MacKinnon – Analysts perspective• Dave Thomson Moderator• Dave Thomson - Moderator

Phil ArthurPhil Arthur“Moving Toward a Global Financial ReportingFinancial Reporting Standard – How will This Impact You?”

Outline• Background• Decisions Made to March• April and May Meetingsp y g• The Most Difficult Issues• Timeline to a Standard• Timeline to a Standard• What Will All This Look Like?• Whither the Americans?

Decisions Made to March - 1• Insurance Definition and Scope• Recognition and Derecognition• Measurement Approachpp

– Decomposition of Margins– Measurement at inceptionMeasurement at inception

• Acquisition CostsMargins Subsequent Treatment• Margins – Subsequent Treatment

Decisions Made to March - 2• Discount Rates• Participating Features• Use of Inputsp• Unearned premium• Policyholder Behaviour/Contract• Policyholder Behaviour/Contract

BoundariesTh P f St t t• The Performance Statement

April IASB/FASB Meeting• Application of Risk/Residual Margins• Application of Composite Margins• Level of Measurement• Discount Rate• Contract Boundaries• Contract Boundaries• Recognition

May IASB/FASB Meeting• Margins• Unbundling• Unearned Premium Approachpp• Scope• Receivables Related to Acquisition Costs• Receivables Related to Acquisition Costs• Reinsurance (Ceding Commission)• Disclosures

The Most Difficult Issues• Measurement Approach• Acquisition Costs• Marginsg• Discount Rate• Contract Boundaries• Contract Boundaries• The Performance Statement and

Di lDisclosures

Timeline To A Standard• May 2010 Pre Balloting• June 2010 Sweep Issues• June 2010 Exposure Draftp• October 2010 Comments Due• To March 2011 Comments Debated• To March 2011 Comments Debated• April to June 2011 Final Standard

“Moving Toward a Global gFinancial Reporting Standard How will This Impact You?”– How will This Impact You?”

Nicholas Bauer, Eckler Ltd.

Overview• Conversion to IFRS Jan.1 2011 – IFRS 4 (Phase 1)• Revision of IFRS 4 (“Phase 2)( )

– Overarching changes • A/L delinking• Building blocks

– Specific items• Discount rate• Margins

A i iti t• Acquisition costs• Other (FX and income taxes)

– DisclosureSome issues for Canadian stakeholders– Some issues for Canadian stakeholders

Conversion to IFRS – Jan 1, 2011• Classification

– Insurance contracts – IFRS 4Insurance contracts IFRS 4– Investment contracts – IAS 39– Service contracts – IAS 18

• Continuation of current accounting policy for insurance contracts (CALM)

• Reinsurance• Reinsurance– Is insurance– Presentation of reinsurance as asset (no netting)( g)

Revision of IFRS 4 (Phase 2)

• Overarching changes expected:– Value of L independent of value of A, unless

policy benefit dependent on AM bj i– Measurement objective:“An entity’s current estimate of the present

l f i d t f lfill th tvalue of resources required to fulfill the net obligation created by the insurance contract”

Revision of IFRS 4 (Phase 2)

• Measurement model: four building blocks– Unbiased probability-weighted average of futureUnbiased, probability-weighted average of future

cash flows, as insurer fulfills obligations– Time value of money– A risk adjustment for uncertainty of amount and– A risk adjustment for uncertainty of amount and

timing of cash flows– No gain at issue

N t i li t t h• Note: implies remeasurement at each valuation date, with update of assumptions and cash flows (i e current assumptions)and cash flows (i.e. current assumptions)

Time value of money (Discount rate)

• Not based on expected return on assets, unless policy benefits dependent on themunless policy benefits dependent on them– Participating

Unit linked (guarantees)– Unit-linked (guarantees)• “Captures the characteristics of the

liability”liability– Timing, liquidity, currency, non-performance

risk (“arguably”) but NOT own credit riskrisk ( arguably ) but NOT own credit risk

Time value of money (Discount rate)

• Two basic options consideredL t j d t f ( t )– Leave to judgment of preparer (actuary)

• “reflect characteristics of the liability”• “standard should not give detailed guidance”standard should not give detailed guidance

– Prescribe• High quality corporates (less a deduction?)

– Long-tail liabilities• Highly controversial – intense debateg y

Margins• Risk margin

– Charge of insurer for bearing uncertainty (risk)C a ge o su e o bea g u ce ta ty ( s )– How calibrate?

• Quantile methods• Cost of carry of capitalCost of carry of capital • Update at each valuation

• Residual marginTo eliminate day one gains (not losses!)– To eliminate day one gains (not losses!)

– Assumptions locked in, release over life of policy• Driver of release

C it i (FASB)• Composite margin (FASB)

Acquisition costs

• “Incremental” may be offset by premium– Material increases in liabilities possible

• Impacts long-term periodic premium contracts more

• FASB would not allow any acquisition costs to be offset– Huge increases in liabilities possible for long-

term contracts (some increase for all contracts)M t i ll i l di fi i l lt– Materially misleading financials may result

Other issues• FX –use balance sheet conversion rates

– Corollary – no provision for adverse deviationCorollary no provision for adverse deviation permitted

• Income taxes – IAS 12 – no discounting– Currently impact of discounting of future income

taxes related to liabilities included in policy liabilities; this will continue on conversion (b t f t ti li )(because part of current accounting policy)

– Will IFRS 4 (Phase 2) time value of money model override IAS 12? Likely not y

Disclosure

• Much more extensive than currently• Mandatory disclosure will likely include

– Best estimate liabilities– Risk margins (= PfADs)– Sensitivities

Some issues for Canadian stakeholders

• Who are they? Companies, regulators, employees, agents shareholders

• Increased volatility of results– Delinking– Long-tailg

• Wide range of practices possible– Non-level playing field?

• Increase in liabilities → decrease of capital• Increase in liabilities → decrease of capital• Long-term fixed products

– Increased costD d il bilit ?– Decreased availability?

T M KiTom MacKinnonBMO Capital Marketsp

Moving Toward a GlobalMoving Toward a Global Financial Reporting Standard – How will This Impact YouImpact You

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Overview of Presentation

• What do investors from financial reporting d h t th l ti t i ?and what are the valuation metrics?

• Review previous accounting regime changes and impact

• Key issues with IFRSy• How will investors deal with the inherent

volatility?volatility?

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What do Investors want from a Financial Reporting Standard?Financial Reporting Standard?

• Earnings, earnings growth and ROE are the key driver of valuations so a Financial reporting p gframework should be– Understandable– Interpretable– Interpretable– Consistent from reporting period to reporting period– Sufficiently detailed

A f k h i ll• A framework whose earnings are generally smooth and reflect change in revenue– Investors don’t like volatilityy

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Traditional Valuation Metrics for Life InsurersInsurers

• Forward P/E• P/BV vs forward ROE• Just P/BV only when earnings are y g

absolutely/totally unpredictable– but this metric ignores relative underlying g y g

profitability

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Accounting Standards were changed in 2007 – Little Impact2007 Little Impact

• For assets backing liabilities moved from amortized cost to marked-to-market, and no more amortization of ,realized/unrealized gains/losses on stocks– No impact since liabilities linked to statement values of assets

• For assets backing surplus realized gains/losses flow toFor assets backing surplus realized gains/losses flow to bottom line – Some impact but generally disclosed

Income not particularly different than the old smoothing method– Income not particularly different than the old smoothing method• Unrealized gains/Losses on surplus assets flows to OCI

– OCI generally not looked atAOCI i t b k d t f BV– AOCI in most cases backed out of BV

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Did the accounting cause volatile earnings in 2008/2009?g

• Seg fund reserving was the primary culpritBut if pension plans were accounted for on the same– But if pension plans were accounted for on the same basis most manufacturing companies would have significantly suffered as well

A ti d ith th h i• Assumptions moved with the changing environment

• Big swings in interest/credit spreads magnified• Big swings in interest/credit spreads magnified any potential ALM mismatch

• Volatility gave way to “other” valuation metricsy g y

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Key issues with IFRS Phase II

• Delinking assets from liabilities will lead to i ifi t l tilitsignificant volatility

• Consistency between accounting periods and companies of:– Discount rate– Handling of credit risk– Marginsg

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Is the U.S. moving to IFRS?

• To date IFRS has been adopted, or is due t b d t d i 100 t ito be adopted, in over 100 countries– BUT NOT THE U.S.

• If the U.S. isn’t on board this could hurt valuations Canadian lifecos– The volatility likely won’t attract the coveted

U.S. institutional investor

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Impact on Capital

• MCCSR standardized approach modifies current framework in anticipation of IFRScurrent framework in anticipation of IFRS Phase II– Recalibration of factors– Recalibration of factors– Expect to be ready before 2013 Phase II

• We won’t know the impact until we’re in• We won t know the impact until we re in Phase II – Likely be transitional issuesLikely be transitional issues

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On what metrics will management be compensated?p

• Traditionally its been the key drivers investors are looking for:investors are looking for:– ROE

Earnings growth– Earnings growth • In a volatile IFRS Phase II environment

what will the metrics be?what will the metrics be?– Will have a direct impact on stock valuation

and stock valuation metricsand stock valuation metrics

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How will investors deal with the inherent volatility?y

• Continue to look for guidance from i ?companies?

– Adjusted underlying earnings from operations• Increasing importance on source of

earnings analysis– Is good but perhaps too high level

• Maybe Embedded Values?Maybe Embedded Values?

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