IFRS 17 Forum 2018 Exploring Challenges with Reinsurance Sections - PowerPoint PPT Presentation

November 2018 IFRS 17 Forum 2018 Exploring Challenges with Reinsurance

Sections 1 Important Concepts for Reinsurance Contracts 2 Case Studies 2 2

IFRS 17 – Important Concepts for Reinsurance Contracts Insurance Reinsurance Contracts Contracts Issued Held Policyholders Cedent Reinsurer — Reinsurance contracts held must be accounted separately from the underlying insurance contracts issued by the cedent. — Unlike IFRS 4, the concept of “netting contractual obligations” is no longer applicable based on the principle that policyholders’ obligations are not extinguished simply because the underlying contracts are reinsured. — Reinsurance contracts are generally treated as an asset (rather than a liability) and represent a net cost (negative CSM). — Reinsurance costs can be deferred over the lifetime of the contract in cases claims relates to future events, otherwise a loss needs to be recognized at inception. — Initial recognition of insurance contracts and reinsurance contracts may differ depending on whether the risk transfer is proportional or non-proportional. — For proportional treaties, the initial recognition would be set a the later of (1) the beginning of the coverage period or (2) inception date of the underlying insurance contracts. For non-proportional treaties, as the losses refer to a group of aggregate contracts, the recognition would generally be set at the beginning of the coverage period. — The boundaries of a reinsurance contract can differ from the underlying insurance contract leading to potential use of different measurement approaches (Premium Allocation Approach vs Building Block Approach) or timing of profits recognition. 3

Building Blocks Approach – Insurance Best Estimate Liability Time value of money Risk adjustment Fulfilment cash flows Contractual service margin q Future cash flows within the q Future cash flows are q The risk adjustment or risk q The expected profit over the boundary of an insurance discounted at rates margin is to reflect the life of the transaction contract include: “consistent with observable uncertainty of future cash q This is deferred on day 1 and market prices” flows § Premiums spread over time, subject to § Claims q Choice of appropriate q There are different potential subsequent measurement on § Direct acquisition costs discount rates to use ways to calculate this, e.g. each reporting date using CoC approach. § Claims handling costs § Administration and maintenance costs 4

Building Blocks Approach - Reinsurance Best Estimate Ceded Liability Time value of money Risk adjustment Future Cash Flows Contractual service margin q Future cash flows within the q Use the same discount rates q Risk adjustment can be q Reinsurance contract boundary of a reinsurance contract as for the underlying allocated to risk being resulting in a net cost is not include: insurance contracts transferred by the cedent. necessarily recognized immediately in profit or loss § Ceded Premiums q e.g. Mortality reinsurance recognition but can be § Ceded Claims would cede mortality risk deferred over the lifetime of § Ceded Commissions (treated as capital but not the investment the contract reduction in premiums if risk capital. q Reinsurance can be payment is not contingent on recognized as a net loss claims, otherwise negative (debit CSM) or net gain expenses) (credit CSM) § Profit commissions (treated as a reduction to claims). *Credit risk of reinsurer to be adjusted in cash flows. *A mismatch in maturities between contracts is reflected in the boundary of the contract. 5

CSM for Insurance Contract Issued vs Reinsurance Contract Held — The CSM on a group of reinsurance contracts equals the inverse of the future cash flows on insurance contracts issued adjusted for their own respective contract boundaries and risk adjustments. − Reinsurance held is treated as an asset on the cedent’s balance sheet. − Net cost from reinsurance is treated as an asset (i.e. negative CSM). Insurance Contract Reinsurance Issued Contract Held (Liability) (Asset) - + Future Cash Flows Future Cash Flows Discounting + - Discounting - + Risk Adjustment Risk Adjustment CSM > 0 (liability) - CSM > 0 (reinsurance cost) CSM = CSM CSM < 0 (loss recognition at - CSM < 0 (reinsurance gain) = inception) Need to take the negative amount as this would be recognized as an asset. 6

Sections 1 Important Concepts for Reinsurance Contracts 2 Case Studies 7 7

IFRS 17 – Case Studies of Reinsurance — Case studies on accounting for reinsurance contracts under IFRS 17 — Case Study 1: Yearly Renewable Term Insurance (YRT) — Case Study 2: Excess of Loss (XOL) — Case Study 3: Traditional Coinsurance — Case Study 4: Reinsurance Commission Financing — Case Study 5: Loss Portfolio Transfer 8

Case Study 1 - Quota Share YRT — Under a Quota Share Yearly Renewable Term (QS YRT) treaty: − 50% Quota Share = Reinsurer pays 50% of any claims − Reinsurance premium on a specified schedule depending on the year − Reinsurance profit commission of 50% of profits after expense charge of 10% of insurance premium Insurance YRT reinsurance Premium 200.0 Technical Result = Premium - 70.0 110 – 2.5 = 107.5 Claims - 90.0 Profit commission 22.5 Net result 110.0 Net Premium - 47.5 50% claims 45.0 Net result - 2.5 Insurance premium Reinsurance premium Cedent Reinsurer Claims Claims Profit commission 9

Case Study 1 - Quota Share YRT — Under IFRS 17 the pool of insurance contracts and the reinsurance contract are valued as two items under the Building Blocks Approach – here assuming cash flows for 20 years. Insurance cash flows -388 -168 500.0 Insurance 300.0 3,820 100.0 3,264 -100.0 -300.0 2011 2014 2017 2020 2023 2026 2029 Premium Claims Fulfilment Time value Risk adjustment Contractual cash flows of money service margin 6 YRT Reinsurance cash flows 500.0 Reinsurance 300.0 84 -87 100.0 -100.0 -300.0 9 2011 2014 2017 2020 2023 2026 2029 As 50% of the risk is ceded, the risk Since reinsurance is Net Premium 50% claims adjustment is quite material relative to the viewed as an assets profitability to the reinsurer in part due to a positive amount the 50% profit commission. correspond to a profit. 10

Case Study 1 - Quota Share YRT Statement of profit or loss and — Under IFRS 17, the results are other comprehensive income presented in a different manner, but over a 1 year horizon with no changes in Reinsurance Total Insurance 0.1 74.7 interest rates or other assumptions, this Release of contractual service margin 74.6 - 1.9 1.9 should be in line with IFRS 4. Release of risk margin 3.8 - 45.0 45.0 Expected claims 90.0 — The major change is the split between - - Recoverable of acquisition costs - underwriting result and investment Insurance contracts revenue 168.4 - 46.8 121.6 income. 45.0 - 45.0 Claims and expenses current period - 90.0 — This level of detail would be presented - Acquisition costs in the notes to the accounts, with the - 45.0 Insurance service expenses - 90.0 45.0 totals presented in the overall statement 76.6 Insurance service result 78.4 - 1.8 of profit or loss. 30.9 Investment income 31.6 -0.7 - Insurance finance expenses 30.9 Net finance result 107.5 Profit or loss Corresponds to the unwind of the time value of money of the future cash flows. 11

Case Study 2 – Excess Of Loss Reinsurance — Under an Excess Of Loss (XOL) catastrophe cover treaty: − The treaty lasts for only 1 year − No ceding commission − Reinsurance pays for claims for a single event with a loss over 30 millions No claims A claim of 40 mio Premium 0.5 Premium 0.5 Claims 0 Claims -10.0 Net result 0.5 Net result -9.5 Probability 99% Probability 1% Insurance premium Reinsurance premium Cedent Reinsurer Claim if XOL threshold reached Claims 12

Case Study 2 – Excess Of Loss Reinsurance — Under an Excess Of Loss (XOL) treaty, we look at the probability weighted cash flows of the contract: Premium 0.5 Claims -0.1 Net cost 0.4 — As the treaty is only for 1 year, there is no issue of contract boundaries. — The result under the BBA will be very close to the Premium Allocation Approach (PAA). — The PAA is a simplified liability measurement approach based on earned premium and can be used as long as the eligibility criteria are met (1) . — As the premium is so low, any Risk Adjustment and CSM calculated will be very low. (1) Eligibility criteria for PAA includes: reinsurance contract must be less than 1 year and no variability in the fulfilment cash 13 flows.