The newsletter discusses the recent IASB Discussion Paper (DP) on
Insurance Contracts. The newsletter expresses Deloitte's general support of the overall approach of valuing insurance liabilities on a market consistent basis. It notes, however, that the current exit value ('CEV') approach proposed in the DP raises many questions the industry will need to consider. It is important that market participants continue to provide input in the development of the principles into a standard across the life and non-life insurance industry. The newsletter identifies the key implications of the proposals in the DP. These are outlined below.
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Key Implications of the Insurance DP and Issues for Consideration:
- the application of discounting for insurance cash flows (including non-life liabilities) and the selection of the related discount rates;
- the requirement to consider all possible cash flows in deriving probability weighted expected mean average cash flows;
- development of industry market practice for the determination of market consistent risk margins and service margins;
- whether an overall insurer's risk margin should take into account portfolio diversification;
- the risk and service margins established at inception may, in certain circumstances, allow an insurer to report a profit or loss on inception of the insurance business;
- the volatility of insurer liabilities and the resultant profits and losses that will arise as market consistent discount rates and estimates of risk and service margin change after inception;
- the subjectivity of many of the estimates required and the likely range of acceptable estimates will present challenges for directors and auditors in determining the appropriateness of the overall estimates for insurance liabilities;
- detailed disclosure of the assumptions and methodologies used to calculate risk and service margins will be crucial to the effect of market disclosure in promoting the development of established industry practice for the consistent estimation of these margins;
- whether accounting differences between the CEV proposals and the IAS 18 requirements for investment contracts should be eliminated and if not, whether the increased cost and complexity of unbundling insurance and investment contracts would be justified;
- whether the CEV should reflect the credit characteristics of the insurer or be estimated on a consistent basis by all insurers;
- convergence of accounting, regulatory, pricing and risk management modelling of insurance liabilities so that the basic modelling techniques can be embedded within the business and deliver consistency of reporting and measurement;
- introducing new accounting systems to determine CEV will be costly but they will be likely to be more cost effective if they can be utilised throughout the business, not just for financial reporting; and
- the need for insurers to educate users of financial statements on the implications of applying this new reporting model to their particular business.
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