International Financial Reporting Standards and the Captive Insurance Industry

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International Financial Reporting Standards and
the Captive Insurance Industry
GSCCA
Presented by Evelyn Brady David Becker
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International Financial Reporting Standards and
the Captive Insurance Industry
GSCCA
Working party members
Aon Deloitte Ernst Young GFSC KPMG
Marsh Prism PwC Thomas Miller Willis
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Session 1 - Summary

• IFRS 4 includes definition of insurance contract
• Limited guidance on reserving aspects. Additional
  guidance expected in phase 2
• Extensive disclosure requirements which may
  require data collection and system changes
• Number of potential boundary issues

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Agenda

• Background
• Other International Financial Reporting Standards
• IAS 32 and IAS 39

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Background

• IFRS to apply to consolidated accounts of all
  listed EU companies for periods starting on or
  after 1 January 2005
• Compliance with IFRS
• Means all IAS and IFRS
• Not acceptable to state all standards except
  for

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IFRS 1 - First-time Adoption of International
Financial Reporting Standards

• Requires retrospective application with some
  exceptions.
• Many disclosure requirements under IFRS 4 do not
  apply to comparatives relating to periods before
  1 January 2005.
• The disclosure requirements that do apply to
  comparatives are
• Accounting policies for insurance contracts and
  related assets, liabilities, income and
  expenses.
• The recognised assets, liabilities, income,
  expenses and cash flows from insurance
  contracts.
• Any gains and losses recognised in profit or
  loss relating to the buying
  of reinsurance and any
  deferred gains and losses through the use of
  amortisation.

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Impact of other IFRSs on the financial statements
of captives

• IAS 1 Presentation of financial statements
• Four core statements including Income statement,
  Balance sheet, statement of changes in net equity
  and cash flow
• A single performance statement which combines
  underwriting results with non-technical results
• Two-sided balance sheet (i.e. Assets and Equity
  Liabilities) Dividends are deducted from equity
  (not income statement)
• Statement of changes in net equity

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Impact of other IFRSs on the financial statements
of captives

• IAS 7 - Cash flow statements
• IAS 7 requires all entities to prepare a cash
  flow statement
• Three main headings operating, investing and
  financing
• Cash and cash equivalents (similar to pre FRS 1
  revised)
• Indirect and direct method allowable

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Impact of other IFRSs on the financial statements
of captives

• IAS 8 Accounting policies, Changes in
  Accounting Estimates and Errors
• Disclose judgements, apart from estimates, in
  applying accounting policies
• Key assumptions about the future and key sources
  of estimation uncertainty
• Impending change in policy based on standard not
  yet in force
• Prior year adjustment for all material errors
• IAS 10 Events after the Balance Sheet Date
• Similar to UK GAAP, except proposed dividends
• If dividend proposed after the year end this
  cannot be included in accruals Narrative
  disclosure only

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Impact of other IFRSs on the financial statements
of captives

• IAS 14 Segmental reporting
• Applicable to entities with publicly traded
  securities, however adoption by all entities is
  encouraged
• Definitions define business and geographical
  segments
• For the purposes of segmental reporting under
  IFRS 4 insurers will be required to identify
  reportable segments reflecting differences in the
  risks and returns of the entitys products and
  services
• Possible to adopt the same segments for risk
  reporting as for segmental reporting

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Impact of other IFRSs on the financial statements
of captives

• IAS 21 The Effects of Changes in Foreign
  Exchange Rates
• Choice of reporting currency
• More detailed, drawn from US guidance
• Functional v Presentational currency
• IAS 24 Related Party Disclosures
• No intra-group exemptions
• Separate disclosure for each type of related
  party
• Amount of the transactions
• Amount of outstanding balances, including
  guarantees
• Provisions for doubtful debts on the outstanding
  balance and the expense recognised during the
  period
• Key management compensation

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IAS 32 / IAS 39

• IAS 32 Financial Instruments Disclosure and
  Presentation
• IAS 39 Financial Instruments Recognition and
  Measurement

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Financial instruments

• A financial instrument is any contract that
  gives rise to a financial asset of one entity
  and a financial liability/equity instrument of
  another entity.
• Financial assets and financial liabilities are
  generally recognised on the Balance Sheet only
  when the entity becomes a party to the
  contractual provisions of the instrument.

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Overview of IAS 32

• Standard outlines disclosure requirements
• Classification of financial instruments
• Nature/extent of an entitys use of financial
  instruments
• Business purpose/associated risks/managements
  policy in controlling those risks of the
  financial instrument

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Overview of IAS 32

• IAS 32 specifically requires disclosure on
• A. Market Risk currency risk, interest rate
  risk, price risk
• B. Credit Risk (loans to parent and associates)
• C. Liquidity Risk
• D. Cash flow interest rate risk

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Overview of IAS 39

• Initial Recognition
• Classification
• Measurement
• Fair Value
• Impairment

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Initial Recognition

• A financial instrument is any contract that
  gives rise to a financial asset of one entity
  and a financial liability/equity instrument of
  another entity.
• Financial assets and financial liabilities are
  generally recognised on the Balance Sheet only
  when the entity becomes a party to the
  contractual provisions of the instrument.
• Applicable to contracts not meeting IFRS 4
  definition on Insurance contracts

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IAS 39 - Classification Financial Assets (Four
categories)
 

• 1. Financial assets at fair value through profit
  or loss (FVTPL)
• 2. Loans and receivables
• 3. Held to maturity
• 4. Available for sale

 
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Classification Financial Assets (Four
categories)
1. At fair value through profit or loss
Held for trading
Designated at inception
Intention of short term profit All derivatives
except hedges.
No restrictions on designation Irrevocable
cannot be reclassified.
 
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Classification Financial Assets (Four
categories)
 
2. Loans and receivables
Non-derivative financial assets. Fixed or
determinable payments. Not quoted. No intention
of trading.
 
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Classification Financial Assets (Four
categories)
3. Held to maturity
Non-derivative financial assets. Fixed or
determinable payments. Fixed maturity. Entity has
the positive intention and ability to hold to
maturity.
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Classification Financial Assets (Four
categories)
4. Available for sale

• All equity securities not classified in FVTPL
  category.
• All financial assets not in another category.
• Any financial assets other than those held for
  trading
• may be designated to this category at
  inception.

 
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Classification Financial Liabilities(Two
categories)
 
1. At fair value through profit or loss
Held for trading
Designated at inception
Intention of short term profit All derivatives
except hedges.
No restrictions on designation Irrevocable
cannot be reclassified.
 
2. Other financial liabilities
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Why is classification important?

• Because it drives measurement

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Subsequent measurement
Assets/Liabilities at fair value through profit
or loss
At FV through profit or loss
Loans and receivables
At amortised cost
Held to maturity
Other liabilities
At FV through equity
Available for sale
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Amortised cost
Amortised cost
Cash paid
Principal repayments
Unamortised Prem/disct (inc interest)
Impairment
-
/-

-

• Requires use of effective interest rate method

No option to use straight line method
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Fair Value Hierarchy
Active market Published bid quotations
Best evidence
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Fair Value Hierarchy
Active market Published bid quotations
Best evidence
No active market Valuation Techniques
Alternative
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Fair Value Hierarchy
Active market Published bid quotations
Best evidence
No active market Valuation Techniques
Alternative
No active market - Equity investments only ? Cost
less impairment
Very rare
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Fair value

• Consider
• Star owns 15 of shares of Moon.
• Shares of Moon quoted on a local stock exchange,
  trading volume indicates sufficiently active
  market.
• The quoted bid price is 100 per share.
• If decided to sell entire block of shares, the
  price they believe they would be able to obtain
  would be 80 per share.
• Transaction costs brokerage commission and
  transaction costs need to be separately
  disclosed.

Answer 100
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Impairment

• Step 1 Objective evidence of impairment
• Step 2 Calculate recoverable amount/fair value
• Step 3 Record impairment in income statement

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Impairment - loansObjective evidence
Significant financial difficulty of the issuer
Granting of a concession to the borrower
High probability of bankruptcy
Breach of contract, such as default
or delinquency in interest or principal
Adverse change in payment status or factor (eg
unemployment)
Disappearance of an active market because of
financial difficulties
And what about equities?
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Impairment - equitiesObjective evidence
Adverse effect in the technological, market,
economic or legal environment
Significant or prolonged decline in the FV of an
investment below its cost
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Pros and cons of FVTPL

• PRO
• All gains/losses in one place
• No impairment testing
• No splitting of FX component on monetary
  instruments

• CON
• More natural to defer unrealised gains in
  equity to reduce volatility of earnings
• Potential tax consequences
• Inconsistency with investor tax reporting

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Summary

• Other than IFRS 4 a number of standards will
  affect captive insurance companies
• Contracts which do not qualify as insurance
  contracts will usually be accounted for under IAS
  32/39
• Expect more guidance with the introduction of
  phase II on reserving aspects
• All captives will now require a cash flow
  statement