24th October 2013 IFRS Foundation Publications Department, 1 st Floor, 30 Cannon Street London EC4M 6XH United Kingdom

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1 24th October 2013 IFRS Foundation Publications Department, 1 st Floor, 30 Cannon Street London EC4M 6XH United Kingdom Comments on Insurance Contracts ED/2013/7 Dear Sir/Madam, It is a great honour for Ping An Insurance (Group) Company of China, Ltd. to have the opportunity to provide feedback on the Insurance Contracts exposure draft of the International Accounting Standards Board ( IASB ). Our comments on the proposed amendments described in the exposure draft are as follows: Question 1 Adjusting the contractual service margin Do you agree that financial statements would provide relevant information that faithfully represents the entity s financial position and performance if differences between the current and previous estimates of the present value of future cash flows if: (a) differences between the current and previous estimates of the present value of future cash flows related to future coverage and other future services are added to, or deducted from, the contractual service margin, subject to the condition that the contractual service margin should not be negative; and (b) differences between the current and previous estimates of the present value of future cash flows that do not relate to future coverage and other future services are recognised immediately in profit or loss? Why or why not? If not, what would you recommend and why? We agree to unlock the contractual service margin, which should not be negative, but we recommend maintaining the consistency between the risk adjustment and best-estimate cash flow, and allowing adjusting the contractual service margin for changes in estimates of cash flows related to coverage and other services (either the previous or future). Our reasons are as follows: According to the exposure draft, changes in the risk adjustment will not be absorbed by the contractual service margin, and all the changes in the risk adjustment, including changes caused by the discount rate, should always be presented in profit or loss. The suspicion of Double Standard arises because these 1

2 are not in accordance with the standard for other best-estimate cash flows. The risk adjustment which reflects the uncertainty of future cash flows and the best-estimate cash flows are components of total fulfillment cash flow, it s better to maintain the consistency between the relevant principles. Although the contractual service margin should be amortized gradually over the life of the contract in the systematic way that best reflects the remaining transfer of services that are provided under the contract, the insurance companies provide a variety of services, which can hardly be perfectly matched by the systematic amortizing ways in practice. There are always differences between the expected and actual amortization, i.e. the unamortized contractual service margin does not equal to the current estimates of the future profitability. Either the changes in the estimates of cash flows are related to the future or past coverage, they both cause the changes of the day-one profits of insurance contracts portfolio, and should be presented in profit or loss in a reasonable manner. If we just adjust the contractual service margin for the differences of the estimates of cash flows related to future coverage or services, and recognize in profit or loss gradually when the contractual service margin releases in the future, while the differences of cash flows related to current and previous coverage or services are recognized immediately in profit or loss, the entities are supposed to keep the records of all differences of the estimates of cash flows of each insurance contracts in every accounting period. In practice, it will add great complexity to the business and valuation system, significantly increase the operational costs, and is very hard to achieve. 2

3 Question 2 Contracts that require the entity to hold underlying items and specify a link to returns on those underlying items If a contract requires an entity to hold underlying items and specifies a link between the payments to the policyholder and the returns on those underlying items, do you agree that financial statements would provide relevant information that faithfully represents the entity s financial position and performance if the entity: (a) measures the fulfilment cash flows that are expected to vary directly with returns on underlying items by reference to the carrying amount of the underlying items? (b) measures the fulfilment cash flows that are not expected to vary directly with returns on underlying items, for example, fixed payments specified by the contract, options embedded in the insurance contract that are not separated and guarantees of minimum payments that are embedded in the contract and that are not separated, in accordance with the other requirements of the [draft] Standard (ie using the expected value of the full range of possible outcomes to measure insurance contracts and taking into account risk and the time value of money)? (c) recognises changes in the fulfilment cash flows as follows: (i) changes in the fulfilment cash flows that are expected to vary directly with returns on the underlying items would be recognised in profit or loss or other comprehensive income on the same basis as the recognition of changes in the value of those underlying items; (ii) changes in the fulfilment cash flows that are expected to vary indirectly with the returns on the underlying items would be recognised in profit or loss; and (iii) changes in the fulfilment cash flows that are not expected to vary with the returns on the underlying items, including those that are expected to vary with other factors (for example, with mortality rates) and those that are fixed (for example, fixed death benefits), would be recognised in profit or loss and in other comprehensive income in accordance with the general requirements of the [draft] Standard? Why or why not? If not, what would you recommend and why? It is not specific in the proposals of the exposure draft whether the participating insurance contract and universal insurance contract belong to the held and linked contract. We recommend to apply the proposals of if a contract requires an entity to hold underlying items and specifies a link between the payments to the policyholder and the returns on those underlying items only to the unit-linked insurance products. Furthermore, without specific criteria and involving many subjective judgments, the proposals of separating cash flows, measuring and applying the discount rate to different cash flows are too complicated to be practical and comparable. Meanwhile, too many detail data without practical significance will make it more difficult for the investors to understand the financial statement data, and reduce the attraction of the insurance industry to those investors. So we recommend simplifying the relevant 3

4 standards, just to differentiate the directly related cash flows on underlying items and others. The details of applying the standards may be as follows: To apply the Mirroring Approach to the directly related cash flows on underlying items. The interest expense based on the discount rate of initial measurement of cash flows, which are not directly related to investment, are recognized in profit or loss, and the effects of changes in the discount rate between the evaluation point and initial measurement are recognized in other comprehensive income. Question 3 Presentation of insurance contract revenue and expenses Do you agree that financial statements would provide relevant information that faithfully represents the entity s financial performance if, for all insurance contracts, an entity presents, in profit or loss, insurance contract revenue and expenses, rather than information about the changes in the components of the insurance contracts? Why or why not? If not, what would you recommend and why? We agree with the presentation proposals in this exposure draft, i.e. an entity presents revenue and expenses in profit of loss for all insurance contracts, rather than information about the changes in the components (i.e. the summarized-margin approach proposed in the 2010 Exposure Draft), which makes no differences with other industries about the presentation of comprehensive income, and is easy for the investors to understand. But we disagree with the measurement of the presentation items, e.g. insurance contract revenue and expenses, because it makes a great difference with the prevailing accounting practice, especially the insurance contract revenue. We recommend that any investment components in a separated insurance contract should not be excluded from the revenue. Our principal considerations are as follows: 1. To exclude investment components will greatly decline the revenue of a life insurance company, influence the global ranking of a listed insurance company (especially the life insurance company), and shrink the market size of insurance industry based on the statistics of premium income, hence, it is against the promotion of insurance industry in the whole financial system. The insurance contract revenue recognized after exclusion will not reflect the amount of the new businesses, and do not equal to the sum of premium received in the corresponding accounting period, so there will be permanent differences with the premium income recognized in prevailing accounting practice. The difficulties in financial budget, performance analysis and performance appraisal will increase accordingly, while it is against to comprehend the entity s financial performance by the investors, analysts and other users of the financial statements. 2. According to the proposal, the insurance contract revenue equals to the expected expenses and payment to the policyholder, plus the changes in the risk adjustment, plus the release of contractual service margin, plus the premium which covers the 4

5 amortization of acquisition cost of the relevant insurance contract, and should exclude any investment components (defined as amounts that an insurance contract requires the entity to repay to a policyholder even if an insured event occurs or not). A different entity choose a different carrier of risk adjustment and contractual service margin amortization, so there will be a great difference with the revenue even on the same business in the same accounting period. In addition, for it is not specific in the proposals about how to determine the investment components, there might be deviation in comprehension among the entities, therefore, the presented revenue in the financial statements and the comparability of the financial statements among the different entities will be influenced as well. According to our practices in China, the pricing of insurance products, the benefit payments, and the assets management and operation and otherwise, are overall considered as a whole. To present the investment components in premium income separately is not only against the original intention of the insurance products design and operation practices, but also lack of an objective, consistent standard therefore involved in many subjective judgments, it is not operable at all. 3. In China, the recognition of insurance contract revenue will lead to many tax issues as well, such as how to determine pre-tax deduction rules of commission expenses, the basis of tax exemption of qualified tax exemption insurance contracts after the exclusion, and otherwise. Question 4 Interest expense in profit or loss Do you agree that financial statements would provide relevant information that faithfully represents the entity s financial performance if an entity is required to segregate the effects of the underwriting performance from the effects of the changes in the discount rates by: (a) recognising, in profit or loss, the interest expense determined using the discount rates that applied at the date that the contract was initially recognised. For cash flows that are expected to vary directly with returns on underlying items, the entity shall update those discount rates when the entity expects any changes in those returns to affect the amount of those cash flows; and (b) recognising, in other comprehensive income, the difference between: (i) the carrying amount of the insurance contract measured using the discount rates that applied at the reporting date; and (ii) the carrying amount of the insurance contract measured using the discount rates that applied at the date that the contract was initially recognised. For cash flows that are expected to vary directly with returns on underlying items, the entity shall update those discount rates when the entity expects any changes in those returns to affect the amount of those cash flows? Why or why not? If not, what would you recommend and why? In principle, we agree with the proposal that part of the changes in the discount 5

6 rates is recognized in other comprehensive income to reduce the volatility of profits. Without specific criteria and involving many subjective judgments, the current standards of separating cash flows, measuring and applying the discount rate to different cash flows are too complicated to be practical and comparable. Meanwhile, too many detail data without practical significance will make it more difficult for the investors to understand the financial statement data, and reduce the attraction of the insurance industry to those investors. It will make asset and liability management far more difficult than before to segregate the effects of the underwriting performance from the effects of the changes in the discount rates. We need to achieve an economic and accounting match. We recommend simplifying the related proposals: just to differentiate investment directly related cash flows for insurance related portions and other cash flows after the desegregation of the not-closely-related embedded derivative and the distinct investment components. The discount rates of investment directly related cash flows should reflect the extent of dependence on the investment returns. The details are as follows: To apply the Mirroring Approach to the directly investment related cash flows for held and linked products. To recognize the changes in interest expense of the directly investment related cash flows in profit and loss for Non- held and linked products. The interest expense based on the discount rate of initial measurement of cash flows, which are not directly related to investment, are recognized in profit or loss, and the effects of changes in the discount rate between the evaluation point and initial measurement are recognized in other comprehensive income. Question 5 Effective date and transition Do you agree that the proposed approach to transition appropriately balances comparability with verifiability? Why or why not? If not, what do you suggest and why? As to the effective date, we recommend to take the synchronization of IFRS9 for the financial instruments and IFRS 4 into consideration. If there is the time difference between the forced effective date of the new standards of financial instruments and insurance contracts, the mismatching issues might arise in insurance companies and increase the entities implementation cost. If it is impossible to synchronize, we recommend that insurance companies can reassign the financial assets classified to FVTPL as well as reclassify other financial assets to avoid the mismatching issues in accounting, when the IFRS 4 become effective. As to the transition, we recommend to specify the transition period and method as soon as possible because there will be a great large amount of data and relevant works even in the simplified treatments, and the transformation of information 6

7 system and the retrospective application of historical data need some time as well. We also recommend to take the simplified treatments into consideration in the initial implementation, e.g. to keep the total liabilities unchanged and rewind the residual margin so as to avoid the re-estimate of historical data. Question 6 The likely effects of a Standard for insurance contracts Considering the proposed Standard as a whole, do you think that the costs of complying with the proposed requirements are justified by the benefits that the information will provide? How are those costs and benefits affected by the proposals in Questions 1 5? How do the costs and benefits compare with any alternative approach that you propose and with the proposals in the 2010 Exposure Draft? Please describe the likely effect of the proposed Standard as a whole on: (a) the transparency in the financial statements of the effects of insurance contracts and the comparability between financial statements of different entities that issue insurance contracts; and (b) the compliance costs for preparers and the costs for users of financial statements to understand the information produced, both on initial application and on an ongoing basis. It may save the entities implementation cost compared with 2010 Exposure Draft, but some of the proposals may cost more than the possible benefits, as mentioned above in Questions 1-5. Furthermore, the likely effects of the proposed standard are as follows: (1) Combination of insurance contracts: The proposals in the exposure draft required that an entity shall combine two or more insurance contracts that are entered into at or near the same time with the same policyholder and shall account for those contracts as a single insurance contract if certain criterion is met. In practice, there are different combinations for an insurance product, which can all satisfy the conditions stated in the proposals. But the current experience analysis and the valuation model of reserve are both based on the product types, while in case of combined measurement they should be based on the customer segments. A greater cost of implementation and management will arise. So we recommend eliminating the requirements of combination, and changing it to optional. (2) Risk adjustment: The proposal is principle based. That is why it does not specify the methods of risk adjustment. However, it still requires the disclosure of confidence level of the risk adjustment. Those entities that do not use the confidence level technique for determining the risk adjustment have to calculate once more in order to disclose the confidence level. Because of the differences of assumptions and subjective judgments, the disclosure will not always be comparable, and the benefits of these extra works 7

8 may not outweigh the corresponding costs. Nowadays there is a technique gap between the insurance industry in China and developed countries. The basic data are also more volatile. In addition, some of the Chinese insurance companies have limited company data to generate the risk distribution. Even using industry data, the disclosed confidence lever will not properly reflect the risk profile of the companies, no mention the limited industrial data in China. So we recommend eliminating the disclosure of confidence level of the risk adjustment. (3) The measurement of discount rate: Insurance companies in emerging market, like China, will encounter difficulties while using either the top-down or bottom-up approach. It is hard to reasonably evaluate the liquidity premium, tax premium and credit risk premium in the developing capital market without observable or referable data. So we recommend that in the emerging market, the local regulator determines the reference discount rate according to the economic development environment so as to reduce the unnecessary volatility and keep the stabilization of the insurance companies operation. (4) Acquisition cost: The different definitions of the acquisition cost will affect the profit emerging pattern. Considering the different cost structure in different market development stages (especially in the emerging market, more inputs are needed in the market cultivation), we recommend not to use the standard definition of acquisition cost. (5) As mentioned above, the complicated measurements and reporting standards proposed in the ED will cause inevitable difficulties in disclosure. Especially, it will increase the implementation cost significantly. So we recommend appropriately reducing the complexities, and simplifying the disclosure requirements. (6) It will challenge the internal controls, accounting and management of the insurance companies: (1) the deviation between the financial statements and actual business will bring difficulties in financial budget, performance analysis and performance appraisal; (2) the difficulties in explanation of financial performance to the users (such as the shareholders and otherwise) will increase accordingly; (3) It is a great challenge for financial and actuarial employees while the financial systems upgrade, the accounting rules switch and actuarial models reform; (4) While more subjective judgments are involved, financial results will depend more on the judgment of the actuaries; therefore high command on their professionalism; and (5) Because of the complexities, a listed insurance company will face the time pressure of disclosure. 8

9 Question 7 Clarity of drafting Do you agree that the proposals are drafted clearly and reflect the decisions made by the IASB? If not, please describe any proposal that is not clear. How would you clarify it? Most of the proposals are drafted clearly and reflect the decisions made by the IASB, but some of the proposals were not described in details and might lead to the deviation in comprehension, and too many subjective judgments involved in practice. Here are some examples: how to determine the investment components in the premium income as mentioned above; how to determine if a contract requires an entity to hold underlying items and specifies a link between the payments to the policyholder and the returns on those underlying items, whether the participating insurance contract and universal insurance contract belongs to this kind of contract; the scope of acquisition cost of insurance contract is not specific enough either. We recommend clearly defining the relevant contents. Meanwhile the examples in the exposure draft are detached from reality and too simplified to make the entities fully comprehend how to apply and coordinate the standards in practice (usually the given discount rate is zero, the risk margin is zero, an average amortization of contractual service margin, the same estimate and real cash flows, and otherwise). We recommend that the IASB could provide some practical examples to demonstrate how to separate the cash flows, the measurements and the reporting. The proposals which are mainly about the principles and lack of the guidance of specific operations lead to many subjective judgments in practice, so we recommend that a detailed guidance is needed to enhance the consistency in the implementation of all the entities. Best regards, 麦伟林 MAK, Wai Lam William Deputy Chief Financial Officer 9