Derivation of the IFRS 4 Statement of Comprehensive Income for Insurance Contracts

Transcription

1 Derivation of the IFRS 4 Statement of Comprehensive Income for Insurance Contracts The purpose of this document is to specify the creation of the proposed IFRS 4 Statement of Comprehensive Income for Insurance Contracts. If we ignore shareholder dividend payments, capital injections, expense not related to the insurance contract and income tax the traditional earnings by source can be derived in the following manner. Comprehensive Income = Change in equity [i.e. Equity E Equity S] = (Assets at end of period Insurance Contract Liabilities at end of period) (Assets at start of period Insurance Contract Liabilities at start of period) [i.e. (A E ICL E) (A S ICL S)] (1) Assets at the end of the period (A E) = Asset at the start of the period (A S) + Investment Income ( A II) + Premium Receipts ( A GP) Actual Expenses ( A E) Actual Death Benefits ( A DB) Actual Surrender Benefits ( A SB) Actual Other Benefits, including Policyholder Dividends ( A OB) A E = A S + A II + A GP A E M A DB W A SB A OB (2) Where sigma is defined assuming the only decrements are mortality and lapse. S M W E = sum over coverage in force at start of period = sum over deaths = sum over withdrawals = sum over coverage in force at end of period = S - M - W The recursive formula for the best estimate liability for insurance contracts using expected assumptions is; V S S + VP + VIE E (q*db) (w*sb) OB = V S [S]+1* (1 q w) (3) Where V S [S]+1 is the reserve factor per 1 life at the end of the period based on the period start expected assumptions. VP is valuation premium (expected gross premium), VIE is the expected interest expense based on the discount rate, E is expected expense, DB is the expected death benefit, SB is the expected surrender benefit and OB is expected other benefits including policyholder dividends. The insurance contract liability at period start is comprised of three elements: the best estimate liability ( BEL ), the risk adjustment ( RA ) and the contractual service margin ( CSM ). BEL and RA are based on fulfilment cashflows and discount rates assumed at period start. ICL S = BEL S + RA S + CSM S where BEL S = S V S S (4) Similarly, the insurance contract liability at period end is; ICL E = BEL E + RA E + CSM E where BEL E = E V E E (5) Note that S V S [S]+1 = E V S [S]+1 + M V S [S]+1 + W V S [S]+1 (6)

2 By substituting (2), (3), (4), (5) and (6) into equation (1) and adding interest expense on the risk adjustment at the discount rates ( si ) in effect at period start ( si RAIE ) and interest accredited on the contractual service margin at the discount rates ( oi ) at initial recognition ( oi CSMIE ), comprehensive income can be expressed as follows; Comprehensive Income = A II ( S VIE) si RAIE oi CSMIE gain from investment income + A GP S VP gain from cash flow experience differences + S E A E expense gain + S q*(db V S [S]+1) M ( A DB V S [S]+1) gain from decrement q + S w*(sb V S [S]+1) W ( A SB V S [S]+1) gain from decrement w + S OB A OB gain from other benefits and dividends + E (V S [S]+1 V E E) change in valuation expected basis impact on BEL + RA S + si RAIE RA E change in risk adjustment + CSM S + oi CSMIE CSM E change in contractual service margin To be consistent with the presentation requirements of IFRS 4, the previously derived Comprehensive Income requires modification for the following items: Exclusion of Investment Components An investment component is the amount that an insurance contract requires the entity to repay to a policyholder even if an insured event does not occur. Section 58 of the draft proposal requires that revenue and claims and other expense exclude any investment components. This requires that the revenue and expense from decrement q and decrement w be modified to exclude the investment component SB / A SB. This results in the following modification + S q*(db SB) + S q*(sb V S [S]+1) + S w*(sb SB) + S w*(sb V S [S]+1) M ( A DB A SB) M ( A SB V S [S]+1) W ( A SB A SB) W ( A SB V S [S]+1) Revenue for death benefit risk is S q*(db SB) and there is no revenue for surrender risk. Claim expense for death benefit claims is M ( A DB A SB) and there is no claim expense for surrender claims. The components [+ S q*(sb V S [S]+1), M ( A SB V S [S]+1), + S w*(sb V S [S]+1), W ( A SB V S [S]+1)] are displayed as gains or losses other than those recognized in other comprehensive income (Sec 60(i) of the draft standard). Revenue from Risk Adjustment The Risk Adjustment recognized in profit or loss excludes any future impact from any change in estimate of BEL future fulfillment cashflows. Letting RA S E represent the risk adjustment at the end of the period based on assumptions at the start of the period, the revenue from the Risk Adjustment ( RAR ) is RAR = RA S + si RAIE RA S E and the future impact of change in estimate is RA S E - RA E Revenue from Contractual Service Margin The Contractual Service Margin is recognized in profit or loss over the coverage period in proportion to the transfer of services, thus the amount recognized in the current period is in proportion to the service driver ( SD ) recognized in the current period. The service is insurance coverage that is provided on the basis of the passage of time and reflects the expected number of contracts in force. CSMR = SD * CSM S / PV S SD, PV S SD is discounted with rates in effect at initial recognition

3 Unlocking of the Contractual Service Margin At the end of the period the Contractual Service Margin is unlocked to absorb any change in estimate of BEL future fulfillment cashflows and related change in RA arising from changes in assumption, other than discount rates, subject to a floor of zero. Defining E oi V S E to be the BEL and oi RA S E to be the RA at the end of the period based on future fulfilment cashflows assumed at the start of the period and discount rates at initial recognition, E oi V E E to be the BEL and oi RA E E to be the RA at the end of the period based on future fulfilment cashflows assumed at the end of the period and discount rates at initial recognition the ending Contractual Service Margin is derived as CSM E = Max [0, CSM S + oi CSMIE CSMR + E ( oi V S E oi V E E) + oi RA S E - oi RA E E] Case 1) The zero floor is not encountered CSMR is the in period revenue from the contractual service margin, and CSM E = CSM S + oi CSMIE CSMR + E ( oi V S E oi V E E) + oi RA S E - oi RA E E Case 2) The zero floor is encountered CSMR is the in period revenue from the contractual service margin, and CSM E = 0 and a loss is generated = (CSM S + oi CSMIE CSMR + E ( oi V S E oi V E E) + oi RA S E - oi RA E E) However, in subsequent periods any favourable changes in estimates that arise after this loss is recognised in profit or loss should be recognised in profit or loss to the extent that such change in estimates reverse losses that relate to coverage and other services in the future. Thus if we define E ( oi V LT E) and oi RA LT E to be based on a set of assumptions such that CSM S + oi CSMIE CSMR = - E ( oi V S E oi V LT E) ( oi RA S E oira LT E), then = E ( oi V LT E oi V E E) ( oi RA LT E - oi RA E E) In the subsequent period the amounts E ( oi V S E ) + oi RA S E, E ( oi V LT E ) + oi RA LT E and E ( oi V E E ) + oi RA E E are calculated, where E ( oi V S E) + oi RA S E E ( oi V LT E) + oi RA LT E E ( oi V E E )+ oi RA E E is based on the assumptions at the start of period (note that these are the prior loss making assumptions in the period following the loss), is based on the assumptions that wiped out the prior CSM and is based on the new assumptions at the end of the period. Once these amounts are calculated there are 6 cases to be considered. Case 1: ( E ( oi V S E ) + oi RA S E ) > ( E ( oi V E E ) + oi RA E E) > ( E ( oi V LT E ) + oi RA LT E) = ( E ( oi V S E ) + oi RA S E ) - ( E ( oi V E E ) + oi RA E E), and

4 CSM E = 0 Case 2: ( E ( oi V S E ) + oi RA S E ) > ( E ( oi V LT E ) + oi RA LT E) > ( E ( oi V E E ) + oi RA E E) = ( E ( oi V S E ) + oi RA S E ) - ( E ( oi V LT E ) + oi RA LT E), and CSM E = ( E ( oi V LT E ) + oi RA LT E) - ( E ( oi V E E ) + oi RA E E) Case 3: ( E ( oi V E E ) + oi RA E E) > ( E ( oi V S E ) + oi RA S E ) > ( E ( oi V LT E ) + oi RA LT E) = ( E ( oi V E E ) + oi RA E E) - ( E ( oi V S E ) + oi RA S E ) and CSM E = 0 Case 4: ( E ( oi V E E ) + oi RA E E) > ( E ( oi V LT E ) + oi RA LT E) > ( E ( oi V S E ) + oi RA S E ) = ( E ( oi V E E ) + oi RA E E) - ( E ( oi V S E ) + oi RA S E ) and CSM E = 0 Case 5: ( E ( oi V LT E ) + oi RA LT E) > ( E ( oi V E E ) + oi RA E E) > ( E ( oi V S E ) + oi RA S E ) = ( E ( oi V E E ) + oi RA E E) - ( E ( oi V S E ) + oi RA S E ) and CSM E = 0 Case 6: ( E ( oi V LT E ) + oi RA LT E) > ( E ( oi V S E ) + oi RA S E ) > ( E ( oi V E E ) + oi RA E E) = 0, and CSM E = ( E ( oi V S E ) + oi RA S E) - ( E ( oi V E E ) + oi RA E E) Note that for cases 4, 5 and 6, where ( E ( oi V LT E ) + oi RA LT E) > ( E ( oi V S E ) + oi RA S E ), the previously recognized loss was entirely related to the coverage provided between the prior loss trigger point and the current favourable change in assumption point. The loss has entirely reversed into revenue and there is no future loss to be offset by the gain. In these cases the ( E ( oi V LT E ) + oi RA LT E) terms are ignored. This results in the following definitions when ( E ( oi V S E ) + oi RA S E ) > ( E ( oi V LT E ) + oi RA LT E): CSM E = Max[0, (( E oi V S E) + oi RA S E) Max[(( E oi V LT E) + oi RA LT E), (( E oi V E E) + oi RA E E)]] = Max[0, CSM S + oi CSMIE CSMR + (( E oi V LT E) + oi RA LT E) (( E oi V E E) + oi RA E E)] = Max[0, (( E oi V S E) + oi RA S E) ( E oi V E E) + oi RA E E))] Profit or and Other Comprehensive Income Under the proposed presentation the investment income is split between Profit or and Other Comprehensive Income ( OCI ). Other Comprehensive Income includes certain forms of investment income ( AOCI II ). In addition there is an option to present the effect of changes in discount rates in Profit or or in Other Comprehensive Income. If presented in Profit or, the interest expense is also presented in Profit or. If presented in Other Comprehensive Income, the

5 difference between the interest expense based on period start discount rates and the interest expense based on discount rates at initial inception must be presented in Other Comprehensive Income. Effect of changes in discount rates presented in Profit or OCI = + AOCI II investment income through OCI and going through Profit or = + A II AOCI II investment income through Profit or ( S VIE) si RAIE oi CSMIE interest expense through Profit or + E (V S E oi V S E V E E + oi V E E) effect of change in future discount rates on BEL + (RA S E oi RA S E oi RA E E + RA E E) effect of change in future discount rates on RA Applying these impacts and resorting terms into the required Statement of Comprehensive Income format; Statement of Comprehensive Income (with the effect of changes in discount rate presented in Profit or ) Insurance Contract Revenue + S E expected expense + S q*(db SB) expected death benefit less investment component + S OB expected other benefit and dividend + RAR revenue from RA + CSMR revenue from contractual service margin + A GP S VP cash flow experience differences + S q*(sb V S [S]+1) M ( A SB V S [S]+1) other gains or losses on death + S w*(sb V S [S]+1) W ( A SB V S [S]+1) other gains or losses on withdrawal + E (V S [S]+1 V S E) other gains or losses + Max[0, (( oi E V S E) + oi RA S E) Max[(( oi E V LT E) + oi RA LT E), (( oi E V E E) + oi RA E E)]] gains after losses previously recognized Insurance Contract Expense A E actual expense M ( A DB A SB) actual death benefit cost A OB actual other benefit and dividend Max[0, (( oi E V S E) + oi RA S E) (( oi E V E E) + oi RA E E)] loss not absorbed by CSM = Underwriting Result = Profit or = Comprehensive Income + A II AOCI II actual investment income through profit or loss ( S VIE) si RAIE oi CSMIE interest expense through Profit or + E (V S E oi V S E V E E + oi V E E) effect of change in future discount rates on BEL + (RA S E oi RA S E RA E E + oi RA E E) effect of change in future discount rates on RA + AOCI II actual investment income through OCI

6 Effect of changes in discount rates presented in Other Comprehensive Income If the effect of changes in discount rates is presented in Other Comprehensive Income, the difference between the interest expense based on period start discount rates and the interest expense based on discount rates at initial inception must be presented in Other Comprehensive Income. Defining E oi VIE to be the unwind of the discount at the end of the period based on future fulfilment cashflows assumed at the start of the period and discount rates at initial recognition and oi RAIE to be the unwind of the discount of the Risk Adjustment at the end of the period discounted projected on assumptions at the start of the period and discount rates at initial recognition, then Other Comprehensive Income would be; OCI = + AOCI II investment income through OCI ( S VIE) + ( oi E VIE) si RAIE + oi RAIE interest expense through OCI + E (V S E oi V S E V E E + oi V E E) effect of change in future discount rates on BEL + (RA S E oi RA S E oi RA E E + RA E E) effect of change in future discount rates on RA and going through Profit or ; = + A II AOCI II investment income through Profit or ( oi S VIE) oi RAIE oi CSMIE interest expense through Profit or Statement of Comprehensive Income (with the effect of changes in discount rate presented in OCI) Insurance Contract Revenue + S E expected expense + S q*(db SB) expected death benefit less investment component + S OB expected other benefit and dividend + RAR revenue from RA + CSMR revenue from contractual service margin + A GP S VP cash flow experience differences + S q*(sb V S [S]+1) M ( A SB V S [S]+1) other gains or losses on death + S w*(sb V S [S]+1) W ( A SB V S [S]+1) other gains or losses on withdrawal + E (V S [S]+1 V S E) other gains or losses + Max[0, (( oi E V S E) + oi RA S E) Max[(( oi E V LT E) + oi RA LT E), (( oi E V E E) + oi RA E E)]] gains after losses previously recognized Insurance Contract Expense A E actual expense M ( A DB A SB) actual death benefit cost A OB actual other benefit and dividend Max[0, ( (( oi E V S E) + oi RA S E) (( oi E V E E) + oi RA E E))] loss not absorbed by CSM = Underwriting Result = Profit or = Comprehensive Income + A II AOCI II actual investment income through profit or loss ( oi S VIE) oi RAIE oi CSMIE interest expense through Profit or + AOCI II actual investment income through OCI ( S VIE) + ( oi E VIE) si RAIE + oi RAIE interest expense through OCI + E (V S E oi V S E V E E + oi V E E) effect of change in future discount rates on BEL + (RA S E oi RA S E oi RA E E + RA E E) effect of change in future discount rates on RA

7 To complete the Statement of Comprehensive Income other items that need to be considered are; Reinsurance All the gain items are shown with a sign reversal for reinsurance revenue and expense. As there is no limitation on reinsurance contractual service margin ( R CSM ) there is no loss upon recognition of the reinsurance and no loss on change of future assumptions. R CSM fully absorbs the impact on the reinsurance best estimate liability R BEL due to change in assumptions. In addition, commission allowances are treated as an offset to premium and thus there are no reinsurance expense components. R CSM E = R CSM S + oir CSMIE R CSMR + E ( oir V S E oir V E E) + oir RA S E - oir RA E E After inception, the entity should recognize in profit or loss any changes in estimates of fulfillment cashflows and any associated risk adjustment on the reinsurance contract when those changes arise as a result of changes in estimate of fulfilment cashflows for an underlying direct contract that are recognized immediately in profit or loss. = Max[0, ((( E oir V S E) + oir RA S E) (( E oir V E E) + oir RA E E))] = Max[0, - (( E oir V S E) + oir RA S E) Max[(( E oir V LT E) + oir RA LT E), (( E oir V E E) + oir RA E E)]] 5) New Business CSM N at initial recognition ( N ) is equal to ( BEL N RA N) if (BEL N + RA N) is less than zero, otherwise a loss equal to (BEL N + RA N) is immediately recognized and CSM N = 0. at initial recognition = Max[0, (BEL N + RA N)] Once new business impacts at initial recognition are recognized, the new business will generate its own contribution to the elements of revenue and expense in the first reporting period. This is achieved by replacing S (sum over coverage in force at start of period) terms by N (sum over new business issued in period) terms. 6) Expense Not Related to the Insurance Contract This item is not included in the calculations shown. Treatment of this item is not covered in the IFRS 4 proposal but presumably such amounts would be shown in Other Comprehensive Income. 7) Corporate Tax This is not included in the calculations shown. Treatment of this item is not covered in the IFRS 4 proposal. IAS 12 Income Tax requires that cash income tax and deferred tax (non-discounted) effect are separated between Profit or and Other Comprehensive Income. Presumably this would be achieved by first calculating income tax effects for items in Profit or and then in total with the balance being allocated to Other Comprehensive Income.

8 This leads to a Comprehensive Statement Report for a cohort of the form: Statement of Comprehensive Income (with the effect of changes in discount rate presented in Profit or ) Insurance Contract Revenue + S E + N E expected expense + S q*(db SB) + N q*(db SB) expected death benefits less investment component + S OB + N OB expected dividends and other benefits + RAR S + RAR N revenue from Risk Adjustment + CSMR S + CSMR N revenue from Contractual Service Margin + A GP S VP N VP experience adjustments + S q*(sb V S [S]+1) + N q*(sb V S [S]+1) M ( A SB V S [S]+1) other gains or losses on death + S w*(sb V S [S]+1) + N w*(sb V S [S]+1) W ( A SB V S [S]+1) other gains or losses on withdrawal + E (V S [S]+1 V S E) other gains or losses + Max[0, (( oi E V S E) + oi RA S E) Max[(( oi E V LT E) + oi RA LT E), (( oi E V E E) + oi RA E E)]] gains after losses previously recognized Insurance Contract Expense A E actual expense M ( A DB A SB) actual death benefit less investment component A OB actual dividends and other benefits Max[0, (BEL N + RA N)] loss at initial recognition Max[0, ((( oi E V S E) + oi RA S E) (( oi E V E E) + oi RA E E)] loss not absorbed by CSM Reinsurance Consideration S q*( R DB R SB) N q*( R DB R SB) expected DB recovery less investment component R S OB R N OB expected dividends and other benefits recovery R RAR S R RAR N expense from reinsurance Risk Adjustment R CSMR S R CSMR N expense from reinsurance Contractual Service Margin R GP R S VP - R N VP experience adjustments S q*( R SB R V S [S]+1) N q*( R SB R V S [S]+1) M ( AR SB R V S [S]+1) other gains or losses on death S w*( R SB R V S [S]+1) N w*( R SB R V S [S]+1) W ( AR SB R V S [S]+1) other gains or losses on withdrawal E ( R V S [S]+1 R V S E) other gains or losses Max[0, ((( oir E V S E) + oir RA S E) (( oir E V E E) + oir RA E E))] gain offsetting direct losses not absorbed by CSM Reinsurance Recovery + M ( AR DB AR SB) actual DB recovery less investment component + AR OB actual dividends and other benefits recovery + Max[0, - (( oir E V S E) + oir RA S E) Max[(( oir E V LT E) + oir RA LT E), (( oir E V E E) + oir RA E E)]] losses offsetting gains not absorbed by CSM = Underwriting Result + A II - AOCI II actual investment income through Profit or ( S VIE) ( N VIE) si RAIE + oi CSM interest expense based on discount rate at initial recognition +( R S VIE) + ( R N VIE) + sir RAIE + oir CSM interest expense offset on reinsurance + E (V S E oi V S E V E E + oi V E E) E ( R V S E oir V S E R V E E + oir V E E) change in future discount rates impact on BEL + (RA S E oi RA S E -RA E E + oi RA E E) ( R RA S E oir RA S E - R RA E E + oir RA E E) change in future discount rates impact on RA = Profit or + AOCI II actual investment income through OCI = Total Comprehensive Income

9 Alternatively if the effect of changes in discount rate is presented in OCI, this leads to: Statement of Comprehensive Income (with the effect of changes in discount rate presented in OCI) Insurance Contract Revenue + S E + N E expected expense + S q*(db SB) + N q*(db SB) expected death benefits less investment component + S OB + N OB expected dividends and other benefits + RAR S + RAR N revenue from Risk Adjustment + CSMR S + CSMR N revenue from Contractual Service Margin + A GP S VP N VP experience adjustments + S q*(sb V S [S]+1) + N q*(sb V S [S]+1) M ( A SB V S [S]+1) other gains or losses on death + S w*(sb V S [S]+1) + N w*(sb V S [S]+1) W ( A SB V S [S]+1) other gains or losses on withdrawal + E (V S [S]+1 V S E) other gains or losses + Max[0, (( oi E V S E) + oi RA S E) Max[(( oi E V LT E) + oi RA LT E), (( oi E VE E) + oi RAE E)]] gains after losses previously recognized Insurance Contract Expense A E actual expense M ( A DB A SB) actual death benefit less investment component A OB actual dividends and other benefits Max[0, (BEL N + RA N)] loss at initial recognition Max[0, ((( oi E V S E) + oi RA S E) (( oi E V E E) + oi RA E E)] loss not absorbed by CSM Reinsurance Consideration S q*( R DB R SB) N q*( R DB R SB) expected DB recovery less investment component R S OB R N OB expected dividends and other benefits recovery R RAR S R RAR N expense from reinsurance Risk Adjustment OR CSMR S OR CSMR N expense from reinsurance Contractual Service Margin R GP R S VP - R N VP experience adjustments S q*( R SB R V S [S]+1) N q*( R SB R V S [S]+1) M ( AR SB R V S [S]+1) other gains or losses on death S w*( R SB R V S [S]+1) N w*( R SB R V S [S]+1) W ( AR SB R V S [S]+1) other gains or losses on withdrawal E ( R V S [S]+1 R V S E) other gains or losses Max[0, ((( oir E V S E) + oir RA S E) (( oir E V E E) + oir RA E E)] gain offsetting direct losses not absorbed by CSM Reinsurance Recovery + M ( AR DB AR SB) actual DB recovery less investment component + AR OB actual dividends and other benefits recovery + Max[0, - (( oir E V S E) + oir RA S E) Max[(( oir E V LT E) + oir RA LT E), (( oir E V E E) + oir RA E E)]] losses offsetting gains not absorbed by CSM = Underwriting Result + A II - AOCI II actual investment income through Profit or ( oi S VIE) ( oi N VIE) oi RAIE + oi CSM interest expense based on discount rate at initial recognition oir oir +( S VIE) + ( N VIE) + oir RAIE + oir CSM interest expense offset on reinsurance = Profit or + AOCI II actual investment income through OCI oi ( S VIE S VIE R oir S VIE + S VIE oi RAIE oir RAIE) interest expense through OCI + E (V S E oi V S E V E E + oi V E E) E ( R V S E oir V S E R V E E + oir V E E) change in future discount rates impact on BEL + (RA S E oi RA S E - RA E E + oi RA E E) ( R RA S E oir RA E - R RA E E + oir RA E E) change in future discount rates impact on RA = Total Comprehensive Income