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Title – Times New Roman 28pt, Line spacing 28pt Title 2 – Times ... Title – Times New Roman 28pt, Line spacing 28pt Title 2 – Times ... Presentation Transcript

  • Investment Accounting for Insurance Companies Staying Current in the Changing Economic Environment May 11, 2009
  • Topics
    • Introduction
    • Permitted Investments
    • CICA HB Section 3855 Refresher
    • Derivatives
    • Impairments
    • Considerations of Investments by Actuaries
    • Financial Statement Disclosures
    • Impact of IAS 39 on Investment Accounting
    Investment Accounting for Insurance Companies
  • Introduction Investment Accounting for Insurance Companies
  • Current Economic Environment
    • Manulife
    • It is an understatement to say that 2008 was difficult. Battered equity and credit
    • markets, high-profile corporate failures and government bailouts are just a few of the
    • events that marked - what many are calling - the most difficult economic conditions in
    • modern history.
    •   
    • Our disciplined investment approach ensured
    • that our portfolio performed comparatively well and helped us avoid many of the asset
    • classes that plagued our industry. Our conservative investment philosophy was designed
    • to help deliver superior returns over the long term and steer us safely through periods of
    • economic distress, and in 2008 I am pleased to report that this philosophy paid off.
    • Dominic D’Alessandro May 2009
    •  
    • But as we look forward, knowing that there is risk of further turmoil in capital markets,
    • our focus is going to be on balancing our business mix, reducing risk and
    • strengthening capital levels. Our first priority is to ensure our financial position continues to be strong.
    • Manulife new CEO says carnage over, but will boost capital ratio. Don Guloien May 2009
    Investment Accounting for Insurance Companies
  • Current Economic Environment
    • ING
    • Continuing equity market weakness led to $186 million in impairments on common shares
    •  
    • Unprecedented volatility and instability of the capital markets could result in additional investment losses for
    • the industry.
    •  
    • We also continued to reduce the impact of the volatility of the capital markets on our balance sheet.
    •  
    • With industry returns and capital levels under pressure, conditions are more conducive to
    • industry consolidation and point to higher premiums overall.
    •  
    • The Canadian economy is weakening under the pressures of the global financial crisis and reduced commodity prices. However, the property and casualty insurance industry has historically been less sensitive to economic slowdown than many other sectors.
    •  
    • Charles Brindamour, President and CEO
    Investment Accounting for Insurance Companies
  • Headlines
    • U.S. ‘crazy’ to water down fair value accounting rule: IASB chair
    • By Financial Post, April 20th, 2009
    • Fair-Value Accounting: A Better Reflection of Reality
    • U.S. moves to ease 'fair value' accounting rule
    • Fair-Value Accounting Rule Eased by EU
    • Canada contemplates US fair value rule change
    • Changes offer greater flexibility in accounting for bad assets
    U.S. bailout legislation thwarts market transparency allowing Wall Street accountants to cook the books, postpone recording losses, and suspend fair value accounting at SEC. Criticism of U.S. accounting changes mounts SEC Suspends Fair Value Accounting The Securities and Exchange Commission (SEC) suspends fair value accounting. Investment Accounting for Insurance Companies
  • ING Canada Reports 2008 Fourth Quarter and Year-End Results Strong financial position with $428 million in excess capital and no debt Continuing equity market weakness led to $186 million in impairments on common shares
    • ING Canada Inc. (TSX: IIC) reported a net loss of $64.1 million or $0.53 a share for the quarter ended December 31, 2008 compared to a gain of $95.8 million or $0.77 per share last year. The decline reflects the impairment of $185.8 million or $1.06 per share of common equities as a result of the deep and prolonged drop in value of Canadian common equities.
    • “ Given the deep and prolonged decline of the Canadian stock market and the level of uncertainty about its recovery, we took a significant impairment on our common equity portfolio. We also continued to reduce the impact of the volatility of the capital markets on our balance sheet. Our financial position is strong with significant excess capital and no debt, which allows us to pursue our growth strategy and to capitalize on the acquisition opportunities that may arise as a result of the current market conditions
    • Unprecedented volatility and instability of the capital markets could result in additional investment losses for the industry.
    • Impairments do not have an impact on either the regulatory minimum capital or the excess capital position of the company since these measures already take into consideration the market value of all assets
    Investment Accounting for Insurance Companies
  • ING Canada Reports 2008 Fourth Quarter and Year-End Results (continued)
    • The loss on invested assets in the fourth quarter was largely due to $185.8 million of common share impairments reflecting the deep and prolonged decline of the stock market, particularly in the fourth quarter of 2008. The impairment process for common equities includes a review of all common shares, particularly focusing on those trading below book value for six months or more and more than 25% below book value at year end.
    • Management applies judgment based upon a review of each issuer’s financial condition, considering various factors including latest financial results and cash flows, changes in credit ratings, capital structure or dividend payouts as well as security analysts’ recommendations. Management also takes into account the length of time the security has been below book and the significance of the unrealized loss. The stock market decline in late 2008, and the level of uncertainty around the timing of a market recovery, led management to give significant weight to the general market downturn in the judgment process. If such weighting had not been given to the capital market environment, it is estimated that common share impairments would have been approximately $60 million. Impairments do not impact excess capital or the MCT ratio.
    Investment Accounting for Insurance Companies
  • ING Canada Reports 2008 Fourth Quarter and Year-End Results (continued)
    • Preferred shares and debt securities were not impaired. Preferred shares are generally only impaired if the issuer is significantly downgraded, stops paying dividends, or declares bankruptcy. After careful review, management determined that there was no objective evidence at the time of assessment which suggested the company would not receive the contractual cash flows from these securities, which include either dividends or interest payments. Management uses third party credit ratings as well as other public information in its analysis of the quality of debt securities and preferred shares.
    • At the end of December 2008, the company had $632.8 million in unrealized losses on invested assets compared to $417.5 million at the end of the third quarter. The increase in the unrealized loss position reflects a sharp decline in common and preferred share market values. To illustrate the market decline the S&P/TSX Composite Index was down 24% in the quarter and the preferred share index was down 14%. On a year to date basis, the S&P/TSX Composite Index was down 35% and the preferred share index was down 22% compared to the same periods in 2007.
    Investment Accounting for Insurance Companies
  • ING Canada Reports 2008 Fourth Quarter and Year-End Results (continued)
    • The remaining unrealized losses on common shares amount to approximately $134 million and can be further analyzed as follows:
    • The above table provides information on the quality of the portfolio of AFS common shares. It is not intended to provide any indication of future impairments
    Investment Accounting for Insurance Companies Table 11 As at December 31, 2008 (in millions) >25% below book value for <3 consecutive months 77 >25% below book value for >=3 and <6 consecutive months 21 >25% below book value for >= 6 consecutive months 2 Other unrealized losses, net of unrealized gains 34 Unrealized losses as at December 31, 2008 134
  • Current Economic Environment
    • Allstate Report Highlights Q1 2009
    • Conservative Investment Management (extracts of)
    • While the investment markets remain difficult, Allstate’s proactive risk mitigation and return optimization programs continue to benefit shareholder value. The company remains focused on reducing its exposure to rising interest rates and real estate investments while maintaining a significant exposure to corporate credit to capture appreciation as spreads tighten.
    • Net realized capital losses for the quarter were $359 million pre-tax, due primarily to $620 million of impairment write-downs on investments where losses in value were determined to be other-than-temporary, $143 million of net losses on the valuation of limited partnerships, and $105 million of losses on securities where we could no longer assert our intent to hold them until their value recovers.
    • On April 9, 2009, the Financial Accounting Standards Board issued new staff positions covering fair value measurement / disclosure and other-than-temporary impairment. These rules will be adopted by Allstate effective April 1, 2009, and reflected in the company’s second quarter 2009 results. The impact of this guidance is currently being studied and assessed. The company expects that it will result in an increase to retained income offset by a decrease in accumulated other comprehensive income
    Investment Accounting for Insurance Companies
  • Current Economic Environment
    • Chairman of FASB on How Fair Value Accounting Will Affect Economic Recovery
    • There are two ends of the spectrum about the length of time it will take to recover from the credit crisis. Some, like Warren Buffet, recommend buying stocks now because in a few years it will be too late — that the economic recovery will be in full swing. Others predict a financial nuclear winter of 10 to 15 years.
    • Which prediction comes closest to reality depends in part on accounting standards, said Dennis Chookaszian, ’68, chairman of the Financial Accounting Standards Advisory Council and a keynote speaker at the eighth annual Chicago Asia Business Conference October 18 at Harper Center. The student-led Chicago Asia-Pacific Group sponsored the conference.
    • “ These are unprecedented times, but I’m reasonably confident you’re going to see recovery in a couple of years,” Chookaszian said. “I’m not one who believes in nuclear winter.”
    • A few Congressmen and the American Bankers Association have written to the Securities and Exchange Commission demanding that FAS 157, a fair value accounting standard, be suspended. That way, the “banks won’t look like they’ve got these big losses, and we won’t have this liquidity crisis,” Chookaszian said.
    Investment Accounting for Insurance Companies
  • Current Economic Environment
    • Chairman of FASB on How Fair Value Accounting Will Affect Economic Recovery (continued)
    • He criticized the proposal. “What they’re really saying is, let’s not look at anything; let’s just pretend that the values are what we paid for them. Who cares what the real values are?”
    • Chookaszian pointed to the a similar, earlier crisis in Japan where fair value accounting was not required. Japanese banks had “phony” balance sheets, he said. Consequently, it took Japan 12 to 13 years to emerge from its credit crisis.
    • “ Do you want to tear the band-aid off slowly as Japan did over 15 years or just rip it off, like what fair value causes you to do?” Chookaszian questioned. “I’d argue that you might as well get on with it.”
    Investment Accounting for Insurance Companies
  • Q: When do you perceive an economic recovery occurring? ? Second half of 2009 First half of 2010 Second half of 2010 2011 and beyond 1 2 3 4
  • Fair Value Accounting in Illiquid Markets
    • International consensus – fair value is superior
        • More “how to” guidance
        • Enhanced disclosure
      • A few quick fixes
      • Addressing the root problem- complexity
    Investment Accounting for Insurance Companies
  • Reducing Complexity
    • Some major issues
        • Multiple classifications
        • Multiple impairment models
          • When and how impairment is measured
    Investment Accounting for Insurance Companies
  • Q: What are your views on the increasing use of fair value accounting? ? Fair value is superior but requires professional judgement Fair value is superior but only if more detailed guidance is provided Fair value should only be used when active reliable markets exist Forget it and return to historical cost 1 2 3 4
  • Permitted Investments
    • Property & Casualty Insurers
    Investment Accounting for Insurance Companies
  • Q: What are the relevant sources and guiding principles for permitted investments by P&C companies? ?
  • General Constraints on Investments
    • Insurance Companies Act, Part IX: Investments
        • Investment Standards
          • 492. The directors of a company shall establish and the company shall adhere to investment and lending policies, standards and procedures that a reasonable and prudent person would apply in respect of a portfolio of investments and loans to avoid undue risk of loss and obtain a reasonable return.
        • Restrictions on control and substantial investments
          • For the purpose of this seminar we will explore the permitted investments in the context of an investment portfolio, as we have elected to exclude those considered to be substantial investments and or control related.
      • OSFI Guideline B-1 (January 1993): Prudent Person Approach
          • This guideline outlines factors that the Office of the Superintendent of Financial Institutions expects the management and the board of directors of a financial institution to consider in establishing investment and lending policies and in ensuring that they are effectively implemented.
          • It is meant to serve as a guide and the provisions of the guideline should be adapted by each institution to reflect the activities and risks of its business.
    Investment Accounting for Insurance Companies
  • OSFI Guideline B-1 (January 1993): Prudent Person Approach
    • Policy
        • Requirement to have written investment policies
        • Should describe the objectives for the investment programs and the overall risk philosophy of the institution
        • Should take into account the strength of the institution's capital and its ability to absorb potential losses
      • Procedures
        • Requirement to have written internal procedures outlining how the investment policies will be implemented and monitored
        • Procedures should:
          • Identify responsibilities and accountabilities;
          • Set out the process for recommending, approving, and implementing decisions; and
          • Prescribe the frequency and format of reporting.
    Investment Accounting for Insurance Companies
  • OSFI Guideline B-1 (January 1993): Prudent Person Approach
    • Limits
        • The investment policy should identify acceptable ranges for investments in different types of instruments, including cash, equities, bonds and debentures, and real property.
        • Financial institutions should set limits on investments and loans according to their quality.
        • Financial institutions should establish limits to contain the risks arising from potential changes in currency or interest rates.
        • They should have policies outlining the circumstances in which derivative instruments can be used.
        • In addition, they should establish limits on the use of derivative instruments by type of instrument (e.g., swaps, options, futures) and by counterparty.
      • Approval
        • At least annually, the board of directors of the financial institution or a subcommittee appointed by the board should review and approve the investment and lending policies and be advised in writing of adherence to these policies.
    Investment Accounting for Insurance Companies
  • Q: What is the maximum concentration limit in equities for federally regulated P&C insurers? ? 50% of total assets 35% of total assets 25% of total assets 10% of total assets 1 2 3 4
  • OSFI Guideline B-1 (January 1993): Statutory Investment Limits for Federally Regulated Financial Institutions Investment Accounting for Insurance Companies Restrictions on Investments in Real Estate
      • Property and Casualty Insurance (Domestic)
      • Paragraph 506(d) - 10% of total assets
      • Property and Casualty Insurance (Foreign)
      • Subsection 618(3) - 10% of assets in Canada
    Restrictions on Investments in Equities
      • Property and Casualty Insurance (Domestic)
      • Paragraph 508(f) - 25% of total assets plus more if excess assets maintained
      • Property and Casualty Insurance (Foreign)
      • Subsection 619(3) - 25% of assets in Canada
    Restrictions on Aggregate Investments in Real Estate and Equities
      • Property and Casualty Insurance (Domestic)
      • Paragraphs 509(f) & (g) - 30% of total assets, or up to 35% of total assets if assets that exceed the assets required under section 516 are maintained
      • Property and Casualty Insurance (Foreign)
      • Paragraph 620(c) - No regulations promulgated
  • OSFI Guideline B-2 (March 1994): Investment Concentration Limit for Property and Casualty Insurance Companies
    • Define “Investments”:
          • An investment within the normal meaning of the term as used by P&C insurance companies.
          • P&C companies should also take into consideration other forms of exposure to an entity or group of related entities even in cases where an investment or commitment is not shown on the balance sheet; for example, options, futures, forward contracts and unfunded portions of committed loans.
          • An investment excludes loans to, and loans guaranteed or securities issued or guaranteed by the Government of Canada, a Canadian province or an OECD central government.
    Investment Accounting for Insurance Companies
  • OSFI Guideline B-2 (March 1994): Investment Concentration Limit for Property and Casualty Insurance Companies
      • Investment Concentration Limits:
        • Canadian Company
          • The aggregate book value of investments by a Canadian P&C insurance company in any entity or group of related entities shall not exceed 5 per cent of the company's assets.
          • Investments include investments made by all subsidiary companies
        • Canadian Branch of a Foreign Company
          • The aggregate book value of investments of a foreign company in any entity or group of related entities vested in trust shall not exceed 5 per cent of the company's assets in Canada.
        • Excess Investments
          • A company with excess investments in an entity or in a group of related entities must reduce its exposure below the 5 per cent limit. Meanwhile, the amount of investments in excess of the 5 per cent limit will be deducted from the total assets in calculating the company's Assets Adequacy Test.
    Investment Accounting for Insurance Companies
  • OSFI Annual Return Detailed Instructions: Grading of Investments Investment Accounting for Insurance Companies Government Grade
    • Includes securities issued by, loans made to, or securities or loans guaranteed by, and accounts receivable from:
      • • the federal government or an agent of the Crown;
      • • a provincial or territorial government of Canada or their agent;
      • • a municipality or school corporation in Canada; and,
      • • the central government of a foreign country where:
        • - the security is rated AAA or, if not rated,
        • the long-term sovereign credit rating of that country is AAA.
    Investment Grade
      • Asset/Guarantor Ratings
    Not-Investment Grade
      • Includes any item not included in the Government Grade or Investment Grade categories or where a credit rating is not available. I.e. BBB graded investments.
    Rating Agency Commercial Paper Bonds & Debentures Preferred Shares Moody’s Investor Service P-1 A Aa Dominion Bond Rating Service R-1 (low) A Pfd-2 Standard and Poor’s Corporation A- A AA
  • Q: What is the capital margin required on investments in publicly traded common shares? ? 15% 4% 8% 0.5% 1 2 3 4
  • Q: What is the capital margin required on a not-investment grade derivative financial instrument? ? 15% 4% 8% 0.5% 1 2 3 4
  • Minimum Capital Test Extract of OSFI Annual Return Form P&C-1 (pg 30.71) Investment Accounting for Insurance Companies
  • Minimum Capital Test Extract of OSFI Annual Return Form P&C-1 (pg 30.70) Investment Accounting for Insurance Companies
  • Investment Composition Before the Storm Top 25 P&C Insurance Groups in Canada (Q2, 2008) Investment Accounting for Insurance Companies Source: MSA Database
  • Investment Composition After the Storm Top 25 P&C Insurance Groups in Canada (Q4, 2008) Investment Accounting for Insurance Companies Source: MSA Database
  • CICA HB Section 3855 Refresher Investment Accounting for Insurance Companies
  • Q: What are the classifications available under CICA HB S. 3855 – Financial Instruments, for financial assets? ?
  • CICA HB Section 3855 Refresher Classification Categories
    • Classification Categories
        • All financial assets are classified in one of four categories
        • Non-derivative financial liabilities are presumed to be classified as Other liabilities but an entity may elect to classify them as Held for trading
        • Classifications of financial instruments are important to determine accounting but these categories do not need to be used on the face of the balance sheet
        • An entity must classify and document the classifications of its financial assets when they are initially acquired
        • Use of HFT classification is restricted and subject to OSFI Guideline D-10 – Accounting for Financial Instruments Designated as Fair Value Option.
          • Should eliminate or significantly reduce a measurement or recognition inconsistency ; or
          • Should be managed and its performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy
    Investment Accounting for Insurance Companies
  • CICA HB Section 3855 Refresher Classification Categories
    • Appropriate classification of financial instruments is determined by consideration of the:
        • Financial instrument type (for example, investment in debt securities versus a loan or receivable)
        • Entity's intentions with respect to the financial instrument (for example, held to maturity versus held for trading)
        • Occasionally, an entity's desired choice of category
    • All derivatives are classified as held for trading unless in a designated hedging relationship
    Investment Accounting for Insurance Companies
  • CICA HB Section 3855 Refresher Available Classifications Investment Accounting for Insurance Companies Category Definition Held for trading (HFT) (FVO) Includes: • Financial instruments acquired for purpose of trading or as part of a trading portfolio • All derivatives that are not designated in hedging relationships • Any financial instrument designated as trading Held to maturity (HTM) A financial asset with fixed payments and maturity that the entity has the intent and ability to hold to maturity Available for sale (AFS) Includes: • Non-derivative financial assets designated as available for sale • Financial assets not classified in another category Loans and receivables A financial asset, that is not a debt security, resulting from a delivery of assets in exchange for a promise to pay Other liabilities A financial liability not classified as held for trading
  • Investment Composition by Designation Top 25 P&C Insurance Groups in Canada (Q4, 2008) Investment Accounting for Insurance Companies Source: MSA Database
  • CICA HB Section 3855 Refresher Measurement
    • The measurement of a financial instrument and the recognition of associated gains and losses is determined by the financial instrument classification category)
    Investment Accounting for Insurance Companies Category Classification Measurement Gains and Losses Financial Assets Held for trading Fair value Recognized in net income in the current period Held to maturity Loans and Receivables Amortized cost Recognized in net income in the period that the asset is derecognized or impaired Available for sale Fair value Recognized in other comprehensive income until realized through disposal or impaired Financial Liabilities Held for trading Fair value Recognized in net income in the current period Other liabilities Amortized cost Recognized in net income in the period that the liability is derecognized
  • CICA HB Section 3855 Refresher Measurement
    • Measurement Issues
        • CICA 3855 establishes a fair value hierarchy under which:
          • Quoted market prices in an active market are to be used if available
          • Valuation techniques should only be used when quoted market prices are not available. Alternative valuation techniques, in order of preference, include:
            • Recent arm's length market transactions between third parties
            • Fair value of instrument that is substantially the same
            • Discounted cash flow analysis and option pricing models
          • Quoted market prices must be bid prices for assets held and ask prices for liabilities. Practice of using closing prices is no longer appropriate.
    • EIC-173, Credit Risk and the Fair Value of Financial Assets and Financial Liabilities
        • The Committee discussed the fair value measurement of financial assets and financial liabilities. It noted that, in particular, there has been diversity in practice as to whether an entity’s own credit risk and the credit risk of the counterparty should be taken into account in determining the fair value of derivative instruments. The Committee reached a consensus that these risks should be taken into account and agreed to issue this consensus as a final Abstract.
    Investment Accounting for Insurance Companies
  • Q: Can you change the classification of a financial instrument if it has been previously designated under CICA HB S. 3855? ? Yes, always No, never It depends 1 2 3 For your response above, provide a reason to support your answer.
  • CICA HB Section 3855 Refresher Classifications
    • CICA HB Section 3855.80:
        • ¨ An entity:
          • should not reclassify a derivative out of the held-for-trading category while it is held or issued;
          • should not reclassify any financial instrument out of the held-for-trading category if upon initial recognition it was designated by the entity as held for trading; and
          • may, if a financial asset is no longer held for the purpose of selling it in the near term (notwithstanding that the financial asset may have been acquired principally for the purpose of selling it in the near term), reclassify that financial asset out of the held-for-trading category if the requirements in paragraph 3855.80A are met.
        • An entity should not reclassify any financial instrument into the held-for-trading category after initial recognition.”
      • CICA HB Section 3855.82:
        • “ When, as a result of a change in intention or ability, it is no longer appropriate to classify an investment as held to maturity, it should be reclassified as available for sale…”
        • Generally results in tainting of classification for two years (3855.26/83)
    Investment Accounting for Insurance Companies
  • Derivatives Investment Accounting for Insurance Companies
  • Q: Which of the following is not a characteristic used in the definition of a derivative? ? Value changes with underlying variable Traded on an active exchange Requires little or no initial net investment 1 2 3 Settled at future date 4
  • Derivatives Definition of a Derivative
    • A derivative is a financial instrument or other contract with all 3 characteristics
        • Value changes with underlying variable – Contract contains a price or rate
        • Requires little or no initial net investment – No upfront payment is made or payment is small relative to the notional amount at the trade/signing date of the contract
        • Settled at future date – Any financial instrument that can be settled at a future date.
          • There are 3 ways to meet this last criterion for any other contract (e.g., contracts to buy or sell a non-financial item). If any one of the following is met, then this criterion is met:
            • 1. Explicit – contract permits either counterparty to settle the contract net in cash without transfer of the product
            • 2. Implicit – although not stated in the contract, company has a practice of settling similar contracts net in cash (e.g., by entering into offsetting contracts or by selling the contract before its exercise or end date), or
            • 3. Market mechanism – product can easily be traded on the market or company has practice of taking delivery of product and selling it immediately for purpose of generating immediate profits due to market fluctuations in price
    Investment Accounting for Insurance Companies
  • Derivatives Accounting for Derivatives
    • Fair value derivatives at each reporting date on the balance sheet
    • Record changes in fair value through net income
    • Eligible for hedge accounting designation
    • Examples of derivatives include:
        • Currency forwards
        • Currency swaps
        • Interest rate swaps
        • Credit derivatives
    Investment Accounting for Insurance Companies
  • Derivatives Definition of an Embedded Derivative
    • An embedded derivative is a component within a financial instrument or other contract that has features similar to a derivative. As a whole, the financial instrument or other contract is considered to be a hybrid (combined) instrument consisting of both a host contract and an embedded derivative.
    • Requirement to account separately for the embedded derivative if, and only if, all of the following three conditions are met:
        • the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract
        • if the embedded derivative were a separate instrument with the same terms that meets the definition of a derivative
        • the hybrid (combined) instrument is not re-measured at fair value (i.e., it is not a held for trading financial instrument)
    Investment Accounting for Insurance Companies
  • Impairments Investment Accounting for Insurance Companies
  • Q: On May 4, 2009, 1500 units of M. Pear Mint Trust were purchased for $63.25 per unit. At December 31, 2009, the fair value of the Trust units are $41.75 each. The investment is designated as AFS. The fair value of the M. Pear Mint Trust units has been consistently below 70% of cost since June 2, 2009. Is the investment considered to be impaired? ? Yes No It Depends 1 2 3
  • Q: What if this was a fixed income debt instrument designated as AFS? Is the investment considered to be impaired? ? Yes No It Depends 1 2 3
  • Impairments Impairment Considerations Under Canadian GAAP
    • Basic principles
        • Different rules for Debt Securities, Equity Securities and Equity Method Investees
        • An entity must assess whether a financial asset within the scope of CICA 3855 is impaired at each balance sheet date (including interim periods), unless the financial asset is classified as held for trading.
        • A financial asset is impaired when objective evidence exists that indicates that events have adversely affected the asset’s estimated future cash flows.
        • An impairment loss is required to be recognized in net income when the fair value of the asset has declined below its cost basis and the decline is considered to be “other than temporary”. The Section does not provide explicit guidance regarding what constitutes “other than temporary”.
        • Before Section 3855, Canadian GAAP presumed an impairment to be other than temporary if the condition giving rise to the impairment had lasted three or four years. Section 3855 did not carry forward this presumption. The intention is that that a decline in fair value for much shorter periods can be identified as other than temporary.
    Investment Accounting for Insurance Companies
  • Q: When an investment is considered to be impaired, how do you quantify the amount of the impairment charge to be recorded? ? Equal to permanent portion of decline Fair value less estimated amount that can be recovered in near term Fair value on impairment date less cost/ amortized cost None of the above 1 2 3 4
  • Impairments Impairment Considerations Under Canadian GAAP
    • Basic principles
        • The significance of the decline or the length of time (duration) of the decline should be considered when determining whether the impairment is “other than temporary”. It is possible that a significant decline in fair value below cost for a relatively short period of time could indicate that the financial asset is impaired even after the short period of time if the decline in value is “significant”.
        • The amount of impairment loss to recognize in net income is the difference between the fair value of the asset at the balance sheet date and its cost or amortized cost basis.
        • Section 3855 does not permit an entity to record a “partial impairment”, being an amount which is less than the full difference between the cost of the financial asset and the fair value at the balance sheet date.
        • Appropriate disclosure of impairment losses and related fair values of impaired financial assets is required.
    Investment Accounting for Insurance Companies
  • Impairments Impairment Considerations Under Canadian GAAP
    • Debt Security Considerations
        • Section 3855 also affirms that a decline in the fair value of a financial asset below its carrying amount does not necessarily mean that the asset is impaired. Section 3855 clarifies that a decline in fair value resulting from an increase in the basic, risk free interest rate is not objective evidence of impairment.
          • example, assume an entity holds an investment in a fixed rate, five year bond issued by the Government of Canada. In this situation, it is reasonable to assume that an increase in interest rates would not adversely affect estimates of the probability that the government will make payments in accordance with the bond terms, even though the increase in interest rates would result in the fair value declining below cost.
        • If a decline in the fair value of a financial asset cannot be attributed to changes in the basic, risk free interest rate, understanding the reasons for the decline might uncover objective evidence of impairment. In some cases it may be appropriate to presume that the decline constitutes objective evidence of impairment. This might be the case, perhaps, when the decline in fair value is acute and there are no factors that can explain the decline other than the deterioration in the ability of the issuer to make payments in accordance with the debt terms.
    Investment Accounting for Insurance Companies
  • Impairments Impairment Considerations Under Canadian GAAP
    • Equity Security Considerations
        • Section 3855 provides specific guidance for assessing investments in equity instruments for impairment. It states the objective evidence of impairment exists if:
          • There has been a significant or prolonged decline in the fair value of the investment below its cost; or
          • There is information about significant changes with adverse effects that have taken place in the technological, market, economic or legal environment in which the issuer operates and indicate that the carrying amount of the investment in the equity instrument may not be recovered.
      • In addition to the general considerations listed above, there are other considerations which may indicate there is objective evidence of impairment in an equity security such as:
        • Structural changes in the industry or industries in which the issuer operates, such as changes in production technology or the number of competitors.
        • Changes in the level of demand for the goods or services sold by the issuer resulting from factors such as changing consumer tastes or product obsolescence.
        • Changes in the political or legal environment affecting the issuer’s business, such as enactment of new environment protection, tax or trade laws.
        • Changes in the issuer’s financial condition evidenced by changes in factors such as its liquidity, credit rating, profitability, cash flows, debt/equity ratio and level of dividend payments.
    Investment Accounting for Insurance Companies
  • Impairments Impairment Considerations Under Canadian GAAP
    • Equity Security Considerations
        • Section 3855 presumes that any time a significant or prolonged decline in the fair value of an investment occurs it has been triggered by events that can be expected to adversely affect the issuer’s future cash flows. While this is not necessarily the case, this presumption generally is difficult to rebut.
        • It is not possible to overcome the presumption that a significant or prolonged decline in fair value below cost is indicative of impairment by asserting that the holder has the intent and ability to hold the equity security until recovery as there is no certainty that an equity security value will ever recover to the original cost value. Note that mutual fund units and or pooled fund units are considered equity securities even if the underlying assets within the mutual fund are debt instruments.
        • There is no bright line test in Canadian GAAP for determining whether a decline in fair value is significant or prolonged. This is a matter of judgment.
    6 Investment Accounting for Insurance Companies
  • Impairments Impairment Considerations Under Canadian GAAP
    • Equity Method Investments
        • Although not explicitly addressed by Section 3855, the criteria for determining whether a long term investment such as an equity method investment is impaired were amended with the adoption of Section 3855.
        • Section 3051 requires that when there has been a loss in value of an investment that is other than a temporary decline, the investment should be written down to recognize the loss. In addition, the Section specifies that a significant or prolonged decline in the fair value of an investment below its carrying value is evidence of an other-than-temporary loss in value of an investment.
        • The fair value for equity method investees which are not quoted in an active market should be determined using valuation techniques consistent with the guidance in CICA 3855.
        • As mentioned above, with the adoption of Section 3855, the criteria in Section 3051 relating to whether an impairment of a long term investment was other than temporary were amended to remove the presumption the impairment was other than temporary if it had lasted for three or four years. This means that the timeline could now be much shorter to the recognition of an impairment loss on an equity method investment.
    Investment Accounting for Insurance Companies
  • Impairments AcSB deliberations regarding fair value and impairment of debt investments
    • Summary of deliberations
    • No changes are proposed to the Canadian GAAP fair value guidance.
    • Changes to impairment guidance intended to “close the gap” between CGAAP and IFRS on the impairment of certain debt investments.
    • Measurement of Impairment for HTM investments will change such that the amount of the impairment loss be equal to the incurred credit losses calculated under CICA 3025, rather than the full decline in fair value below amortized cost.
    • Impairment losses previously recorded through earnings on AFS debt investments will be required to be reversed in a manner consistent with the requirements of IAS 39 when the loss decreases in subsequent periods.
    • Transition guidance:
        • Debt investments which an entity reclassifies from AFS to either Loans and Receivables or HTM upon adoption of these proposals, once finalized, will be transferred at amortized cost less any impairment losses recorded in accordance with CICA 3025.
        • Guidance will be provided in the exposure draft to assist entities in determining what transitional entries will be required in the first interim or annual reporting period in which the proposals are applied.
    Investment Accounting for Insurance Companies
  • Impairments AcSB deliberations regarding fair value and impairment of debt investments
    • Summary of deliberations (continued)
    • Disclosures will be required to explain the effect of any changes in accounting policies and or reclassifications on adoption of the proposals.
    • AcSB is planning to issue an exposure draft containing these proposed amendments by May 30, 2009.
    • The comment period will be 30 days and the expected effective date will be for interim or annual periods ending on or after October 31, 2009, with early adoption permitted.
    • Note that these proposed amendments do not apply to equity investments or to debt investments that have been classified as HFT under CICA 3855.
    Investment Accounting for Insurance Companies
  • Considerations of Investments by Actuaries
    • Property & Casualty Insurers
    70 Investment Accounting for Insurance Companies
  • Q: Name the three margins most commonly used by actuaries in arriving at the present value unpaid claims adjustment expenses. ?
  • Considerations of Investments by Actuaries Margins for Adverse Deviation
    • The Appointed Actuary discounts the unpaid claims and adjustment expenses, and adds three provisions for adverse deviation (PfADs) as required by the CIA standards of practice to reflect the degree of uncertainty in the selected interest rate, the estimated claim development and collectibility of reinsurance recoverables:
    72 Investment Accounting for Insurance Companies Present Value Unpaid Claims Adjustment Expenses + Interest Rate Margin [CIA: 0.5% - 2.0%] + Claims Development Margin [CIA: 2.5% - 15.0%] + Reinsurance Margin [CIA: 0.0% - 15.0%] = Accepted Actuarial Practice Unpaid Claims Adjustment Expense
  • Considerations of Investments by Actuaries Margins for Adverse Deviation
    • For short this provision is often referred to as “PfAD”
    • It is defined as “ The additional reserves required by adding margins to the valuation variables ”.
    73 Investment Accounting for Insurance Companies Interest rate margin - An additive factor which decreases the interest rate Claims development margin - A multiplicative factor which increases gross and net outstanding claims Reinsurance recovery margin - A multiplicative factor which decreases ceded outstanding claims recoverable
  • Considerations of Investments by Actuaries Impact on discounting
    • Discount rate based on book yield of investments
        • Careful to note that book yield can be either market yield or a yield based on amortized cost, depending on the mix of the investment portfolio and designations under 3855
    • Potential mismatch in the income statement resulting from the fluctuation of fair values of investments
        • Depends on the designations elected under CICA HB Section 3855
          • HFT – Changes offset in P&L, as fair value increases, liabilities also increase
          • HTM – Fluctuations or changes in FV does not impact the P&L as the investments are recorded at amortized cost, and the discount rate is based on book yield
          • AFS – Mismatch given changes in unrecognized gains and losses are reflected through OCI, while they have a direct impact incurred losses via the effect of discounting
    74 Investment Accounting for Insurance Companies
  • Considerations of Investments by Actuaries Illustrative example: Impact of change to discount rate (AFS) 75 Investment Accounting for Insurance Companies
  • Q: What impact does an impairment have on the valuation of unpaid claims and adjustment expenses? ? Increases the reserves Decreased the reserves None 1 2 3
  • Considerations of Investments by Actuaries Impairments
    • Generally have no impact on discounting of actuarial liabilities
        • AA would typically exclude the impaired investment from the book yeild calculation (provided that the Company has sufficient investments to cover their liabilities)
    • Conversely, if there is a significant change in the portfolio mix of investments, this could potentially have a significant effect on the discounting of actuarial liabilties
    • Impact would vary due to impact on book yield of conservative vs. risky investments and the corresponding interest margin PfAD
    77 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures 78 Investment Accounting for Insurance Companies
  • Q: Under which circumstances are disclosures of fair value not required under CICA HB S. 3862? ?
  • Financial Statement Disclosures Extracts of qualitative disclosure requirements
    • Items of income, expense, gains or losses
    • An entity shall disclose the following… either on the face of the financial statements or in the notes (3862.20):
        • (d) interest income on impaired financial assets; and
        • (e) the amount of any impairment loss for each class of financial asset.
      • Fair value
      • Disclose FV for each class of financial assets and financial liabilities in a way that permits it to be compared with its carrying amount.
      • An entity shall also disclose the methods and, when a valuation technique is used, the assumptions applied in determining fair values of each class of financial assets or financial liabilities (3862.27 (a))
      • Disclosures of fair value are not required (3862.29):
        • when the carrying amount is a reasonable approximation of fair value
        • for financial assets or financial liabilities transferred or originated in a related party transaction that are classified as held-to-maturity investments, loans or receivables, or financial liabilities other than ones held for trading.
      • There are additional requirements when FV have not been disclosed (3862.30)
    80 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures Extracts of quantitative disclosure requirements
    • Credit risk
      • An entity shall disclose by class of financial instrument:
    • (a) the amount that best represents its maximum exposure to credit risk at the balance sheet date without taking account of any collateral held or other credit enhancements;
    • (b) in respect of the amount disclosed in (a), a description of collateral held as security and other credit enhancements;
    • (c) information about the credit quality of financial assets that are neither past due nor impaired; and
    • (d) the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been renegotiated.
    81 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures Extracts of quantitative disclosure requirements
    • Financial assets that are either past due or impaired
      • Section 3862.37(b1) requires explicit disclosures when objective evidence of impairment exists for certain financial assets but an impairment loss has not been recognized in net income because the decline in recoverable amount (in the case of financial assets measured at cost) or fair value (in the case of all other financial assets) is not other than temporary. Disclosures should include the information (both positive and negative) the entity considered in reaching the conclusion that the decline is not other than temporary.
      • The impairment principles in Section 3855 differ from IFRS and US GAAP in some notable respects. In addition, moving to IFRS conceivably could affect the timing of recognition of impairment losses in net income in some situations.
    82 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures Examples from Canadian Public Companies
      • Reviewed five Canadian public companies ranked by direct premiums written:
        • ING / Intact
        • TD MelocheMonnex
        • Dominion of Canada
        • Kingsway
        • RBC
      • Trend was that the specific criterion used to establish whether or not a decline in the fair value of an investment below its cost / amortized cost was “other than temporary” was not disclosed in the Annual Reports.
      • Rather, Companies elected to go with broader disclosures that discuss some of the considerations given to determining whether a financial instrument is impaired.
      • However, in the case of ING and Kingway, some of the specific criterion were disclosed.
    83 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures Examples from Canadian Public Companies
      • Impairment considerations disclosed:
      • Source: Dominion of Canada 2008 Annual Report
    • “ All investments with other than temporary impairments in value are written down to their fair value with the impairment loss recorded in Net realized gains on sale of investments in the Consolidated statement of income (loss). Various factors are considered when determining if there is an impairment loss including the length of time and extent to which the fair value has been below cost, the financial conditions and near term prospects of the issuer and the ability and intent to hold the investment for a period of time sufficient to allow for recovery.”
    84 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures Examples from Canadian Public Companies
      • Impairment criterion disclosed:
      • Source: ING Canada 2008 Management Discussion & Analysis:
        • “… The impairment process for common equities includes a review of all common shares, particularly focusing on those trading below book value for six months or more and more than 25% below book value at year end. Management applies judgment based upon a review of each issuer's financial condition, considering various factors including latest financial results and cash flows, changes in credit ratings, capital structure or dividend payouts as well as security analyst's recommendations.
        • Preferred shares are generally only impaired if the issuer is significantly downgraded, stops paying dividend, or declares bankruptcy... Management uses third party credit ratings as well as other public information in its analysis of the quality of debt securities and preferred shares.”
    85 Investment Accounting for Insurance Companies
  • Financial Statement Disclosures Annual Disclosure Requirements – OSFI Guideline D1B (February 2009)
    • Amended February 2009
    • Two parts – Disclosure and Risk Management and Control Practices
    • Our focus is on disclosure
    • Disclosure split into investments and policy liabilities
    • Largely consistent with 3862 and 3863 disclosure requirements:
        • Disclose types of investments separately, e.g. Term deposits, bonds and debentures, common shares, etc.
        • Should be segregated by category of classification under 3855
        • Disclose maturity profile of fixed income securities and pref shares w/ fixed redemption dates
        • Separate disclosure is expected for each sub-category of investments that constitutes 10% or more of total investments
        • Expected to disclose separately, where applicable, the income, expense and gains and losses resulting from each investment category
    86 Investment Accounting for Insurance Companies
  • Impact of IAS 39 on Investment accounting 87 Investment Accounting for Insurance Companies
  • Q: Which area of IAS 39 do you think will have the biggest impact on your investment management systems? ? Don’t know Treatment of transaction costs Foreign currency Accounting for impairments 1 2 3 4
  • Financial Instruments – Overview IAS 39 CICA 3855 – FI CICA 3865 – Hedges CICA 3862 – FI: Disclosures CICA 3863 – FI: Presentation and related EICs CICA 3861 – FI: Discl & Pres IAS 32 IFRS 7 89 Investment Accounting for Insurance Companies
    • Differences between Canadian GAAP and IFRS
    • Impairments
    Financial Instruments: IAS 39 Recognition and Measurement - Overview 90 Investment Accounting for Insurance Companies
  • Financial Instruments - Conversion Consideration: Scope 91 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Volume Rebates
    • 3855.7m scopes out contracts that require a payment based on specified volume of service revenues; that are not traded on an exchange
    • Commitments to provide a loan at a below-market interest rate are within the scope of the standard (IAS39.4c)
  • Financial Instruments - Conversion Consideration: Classification 92 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Classification of investments
    • Fair value through P&L; AFS; HTM; and loans and receivables
    • Aligned
  • Financial Instruments - Conversion Consideration: Fair Value Measurement (cont’d) 93 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Transaction costs for items other than HFT/FVTPL
    • Policy choice to add to carrying value of financial instrument or expense immediately
    • No policy choice – must be added to carrying value of financial instrument
  • Financial Instruments - Conversion Consideration: Interest bearing instruments 94 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Interest Income (IAS 18 & 39)
    • 3400.09 Revenue requires recognize interest on a time apportioned basis
    • Effective rate in 3855.19 is aligned with IAS 39.9
    • Interest income should be recognized using the effective interest rate (IAS 18.30)
    • The effective rate is the rate of interest that discounts the future cash flows of the instrument to its current FV (IAS 39.9)
  • Financial Instruments - Conversion Consideration: Foreign exchange 95 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS FX translation gains/losses
    • Does not require FX gains and losses on monetary financial instruments be separately recognized in P&L
    • IAS 21.28 requires FX on monetary items is taken to P&L
    • Foreign exchange gains/losses on AFS Debt securities recognized in P&L
    Impairments of AFS Equity shares
    • Canadian GAAP considers loss events & “other than temporary” e.g. intent and ability to hold, severity and duration of impairment.
    • IFRS considers loss events and uses the term “significant or prolonged decline in FV”
    • In practice theses criteria lead to only minor differences
  • Financial Instruments - Conversion Consideration: HTM Impairment 96 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Financial instrument impairment
    • Cannot be reversed until sale or disposal (3855)
    • AcSB is currently proposing new rules about impairments including:
    • 1. reversals of impairments on AFS debt securities when the impairment no longer exists.
    • 2. HTM impairment loss is the incurred credit loss not the full fall in FV below Amortized Cost
    • Must be reversed for instruments carried at Amortized Cost (IAS39.65) e.g. loans and HTM
    • Reversed by either writing back the cost or by adjusting an impairment “allowance account” (IAS 39.65)
    • Not reversed for instruments held at cost (IAS39.66)
    • AFS bond impairments must be reversed (IAS39.70)
    • AFS equity impairments are not reversed (IAS 39.69)
  • Financial Instruments - Conversion Consideration: Fair Value Measurement (cont’d) 97 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Impairment methodology (continued)
    • The objective evidence model in 3855 is similar to IAS 39
    • Impairments arise from “other than temporary” declines in FV below Amortized Cost
    • The model in IAS 39 uses objective evidence of impairment as a result of one or more loss events occurring after initial recognition of assets; and loss event(s) has impact on cash flows and can be reliably measured (IAS 39.59)
    • “ Other than temporary” terminology does not exist
    Measurement of interest income on an impaired HTM
    • Continue to recognize interest income at original effective rate
    • Same (IAS 39.63)
  • Impairment of Financial Assets
    • Requires all financial assets, with the exception of those measured at fair value through profit and loss, to be assessed for impairment at each b/s date on an incurred loss basis
    • Accounting literature on the review for impairment largely harmonized, although may have difference in practice
    • IFRS Methodology:
    98 Investment Accounting for Insurance Companies 1. All financial assets reviewed for impairment at each balance sheet date a) Standalone Assessment
      • Asset “individually significant”?
        • assessed on a standalone basis
      • Asset not “individually significant”?
        • assessed on a standalone basis or as a group
    b) Group Assessment
      • Includes all assets for which impairment has not been taken
      • Items in group should contain “similar credit risk characteristics”
        • Indicative of debtors’ ability to pay all amounts due according to the contractual terms (i.e. asset type, industry, geographical location)
      • Groups sharing similar risk characteristics cannot be identified?
        • Group assessment cannot be performed
    2. Impairment loss recognized when there is objective evidence from a loss event that impacts estimated future cash flows of the asset
  • ? Don’t know Depends Yes No 1 2 3 4 Q: An insurance company issues a loan. Based on historic experience a 5% future loss is expected. Should an impairment be recognized?
  • Recognizing an Impairment
    • What is a loss event?
    • A loss event is one or more event that occurred after the initial recognition of the asset.
      • It may not be possible to identify a single, discrete event that caused impairment – consider combined effects of several events.
    • Losses expected as a result of future events, no matter how likely, are not recognized.
    100 Investment Accounting for Insurance Companies
  • Examples of Loss Events
    • Observable data that comes to the attention of the holder, including:
      • Significant financial difficulty of the issuer or obligor;
      • A breach of contract (e.g. default of payment of interest or principal);
      • A concession granted by lender to borrower as a result of financial difficulty of borrower;
      • Probability of bankruptcy or other financial reorganization of the borrower;
      • Disappearance of an active market due to financial difficulties;
      • Observable data indicating a measurable decrease in future cash flows from a group of assets that cannot yet be identified with individual assets, including:
          • Adverse changes in payment status of borrowers in a group (e.g. increase in credit card borrowers at credit limit)
          • National or local economic conditions correlating to defaults (e.g. unemployment in a geographical area)
    101 Investment Accounting for Insurance Companies
  • Examples of Events That are NOT Loss Events
    • Examples of events that are not loss events:
    • Disappearance of an active market because an entity’s financial instruments are not publicly traded;
    • Downgrading of an entity’s credit rating, in the absence of other information indicating a loss event;
    • Changes in fair value of a fixed rate debt investment due to movements in the risk-free interest rate;
    • Empirical evidence of a rate of default for a particular class of borrower.
    102 Investment Accounting for Insurance Companies
  • Measuring an Impairment
    • For AFS bonds the impairment loss is measured as the difference between the assets amortized cost and it’s current fair value
    • For AFS equities the impairment loss is the difference between cost and current fair value
    • If there is a range of possible amounts, use best estimate, or mid-point in the case of range of equally possible outcomes.
    103 Investment Accounting for Insurance Companies
  • ? Don’t know No Depends Yes 1 2 3 4 Q: An AFS equity share becomes impaired. Should the cumulative loss recognized in equity, including FX, be transferred to the P&L?
  • Fixed interest rate impairment example
    • There are two elements to consider when an AFS bond becomes impaired:
    • Impact of the impairment on the carrying amount of the instrument and the transfer of unrealized losses out of AFS reserves
    • The calculation of interest income
    105 Investment Accounting for Insurance Companies
  • Fixed interest rate example Accounting for amortized cost & Fair Values – no impairment Year (a) (b = a × 10%) (c) (d = a + b – c) FV Accumulated Amortised Interest Cash flows Amortised FV Adj cost income cost at in equity the beginning the end of of the year the year 20X0 1,000 100 59 1,041 1040 -1 20X1 1,041 104 59 1,086 1087 +1 20X2 1,086 109 59 1,136 1138 +2 20X3 1,136 113 59 1,190 1191 +1 20X4 1,190 119 1,250 + 59 – 0 106 Investment Accounting for Insurance Companies
  • Fixed interest rate impairment example Accounting for amortized cost & Fair Values – impairment in final year Year (a) (b = a × 10%) (c) (d = a + b – c) FV Accumulated Amortised Interest Cash flows Amortised FV Adj cost income cost at in equity the beginning the end of of the year the year 20X0 1,000 100 59 1,041 1040 -1 20X1 1,041 104 59 1,086 1087 +1 20X2 1,086 109 59 1,136 1138 +2 20X3 1,136 113 59 1,190 1191 +1 20X4 1,190 119 1,250 + 59 – 0 20X4 (R) 454.55 45 500 – 0 Discount the future CF at 10% to PV at start of 20X4 Impairment charge is the difference between the old amortized cost and the present value of estimated value of future cash flows (FV) = 1191 – 454.55 = 736.45 107 Investment Accounting for Insurance Companies
  • Impairment of fixed income securities – the future: separation of credit losses from interest rate losses (FASB discussion) 108 Investment Accounting for Insurance Companies Before loss event Amortized cost before loss (approximates to FV) after loss event FV movement due to interest rates FV movement due to loss event New fair value Impairment loss
  • ? Don’t know Yes No Depends 1 2 3 4 Q: If the aggregate fair value of a portfolio of AFS bonds is less than their amortized cost, should the aggregate net loss in equity be transferred to the P&L?
  • Fixed income securities – with a variable interest rate IAS 39 AG6 states that premiums or discounts paid to buy a variable rate bond should be amortized over the period to the next re-pricing date; not over the life of the instrument. a)   Set out the cash flows of the variable rate instrument at acquisition; use current interest rate (future rates are unknown) b) Discount the cash flows at the rate that derives the acquisition cost excluding the premium or discount on acquisition to derive the effective rate c) The premium or discount on acquisition is added back to the carrying amount of the instrument to get fair value but is written off over the first interest period d) At the beginning of the second interest rate period there is no premium or discount left on the books; and it has been excluded from the calculation of the effective rate going forward; ie we have achieved the aim of writing off the premium or discount over the first interest period 110 Investment Accounting for Insurance Companies
  • IFRS 1 – Matching Financial Assets with Insurance liabilities
    • IFRS 1.25A allows an entity on transition to IFRS to:
    • Designate any financial asset or financial liability as held at fair value through the P&L provided certain criteria are met
    • Make an AFS designation
    • The IASB has indicated that IFRS 4 Phase II will require claims discounting. The rate may not continue to be the yield on a portfolio of FVTPL financial assets, rather it may be a composite rate of:
        • Currency;
        • Duration;
        • Liquidity; and
        • Credit characteristics of the underlying cash flows
    • Question is how this will affect your classification of financial assets.
    111 Investment Accounting for Insurance Companies
  • ? Don’t know No Yes Depends 1 2 3 4 Q: Final thought: Do we need to think about Held for Trading assets when we consider impairments?
  • Financial Instruments - Conversion Consideration: Other financial liabilities 113 Investment Accounting for Insurance Companies Consideration Canadian GAAP IFRS Financial Guarantees (incl. structured settlements)
    • Financial guarantee contracts are currently accounted for as contingent liabilities
    • Related party guarantees are excluded from 3855
    • Financial guarantees are within the scope of IAS 39 (IAS 39.2e)
    • Continue with your current accounting treatment (IAS 39.47c)
    • Additional disclosure requirements (IAS 32; IFRS7)
    • No such exemption for related party guarantees
  • Regulatory Update 114 Investment Accounting for Insurance Companies
  • IFRS Regulatory Update
    • All Publically Accountable Entities and expected to adopt IFRS for fiscal years beginning on or after January 1, 2011
    • Canadian Securities Administrators (CSA) guidance Staff notice 52-320 for public companies (May 9 th 2008):
    • 2009
    • Interim “An issuer should provide an update of progress on its IFRS changeover plan and any changes in its plan, in the issuer’s MD&A
    • Annual “the issuer should discuss the status of the key elements and timing of its changeover plan”.
    • And: describe the major identified differences between the issuer’s current accounting policies and those the issuer is required or expects to apply in preparing IFRS financial statements.
    • Such differences include any difference due to an expected change in accounting policy even though the issuer’s existing policy under Canadian GAAP is permissible under IFRS
    115 Investment Accounting for Insurance Companies
  • IFRS Regulatory Update
    • Canadian Securities Administrators (CSA) guidance Staff notice 52-320 for public companies:
    • 2010
    • Annual and Interim “The issuer’s discussion of changes relating to accounting policies should include decisions about accounting policy choices available under IFRS 1 First-time Adoption of International Financial Reporting Standards and other individual IFRS standards that are relevant to the issuer.
    • If an issuer has quantified information about the impact of IFRS on the key line items in the issuer’s financial statements available when it prepares its interim and annual MD&A for the financial year beginning one year before an issuer’s changeover date, an issuer should include this information in its MD&A
    116 Investment Accounting for Insurance Companies
  • OSFI IFRS reporting requirements: Oct 7 th 2008 letter
    • IFRS project structure
      • Timelines, governance, and accountabilities
    • IFRS project status
      • Status against project plan
    • Significant accounting impacts
      • Differences between IFRS and existing accounting policies, processes, and reporting
    • Significant accounting changes
      • Detailed evaluation of accounting impacts, including
        • Qualitative assessment
        • Issues identified
        • Choices, elections, or policies, and decisions made
        • Quantitative impact
    117 Investment Accounting for Insurance Companies
  • Contacts Doug Gray Tel: (416) 601-6399 Email: [email_address] Ricardo Cardoso Tel: (416) 867-8105 Email: [email_address] Liam Neilson Tel: (416) 601-6215 Email: [email_address]
  •