Loss Reserve Discounting

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Loss Reserve Discounting International
Accounting Ralph Blanchard, FCASCAS
representative to the IAA Insurance Accounting
Committee
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OVERVIEW
Current intl standard Future proposed
standard Fair value mechanics Prognosis
U.S. Options
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CURRENT INTERNATIONAL STANDARD
There isnt any IFRS 4 (phase I of ins.
Project) Effective in 2005 Interim step Cant
go to undiscounted Can move to discounted using
current rates Cant move to discounted using
asset returns Company acquisition fair value
acquired reserves
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PROPOSED FUTURE STANDARD Phase II of
project Exposure Draft mid 2005? Implement 2007?
(2008?)
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PHASE II OUTLOOK In the Boards view,
discounting of insurance liabilities results in
financial statements that are more relevant and
reliable (IFRS 4, BC 126) Tentative phase II
conclusions (IFRS 4, BC 6) Assets and
liabilities arising from insurance contracts
should be measured at fair value Should gain
at inception be allowed under fair value?
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• PHASE II OUTLOOK (CONT.)
• As implied by the definition of fair value
• An undiscounted measure is inconsistent with
  fair value
• (ii) Discount rate should not reflect
  expected asset returns
• (iii) Adjust for risk
• (iv) Adjust for credit standing i.e,
  likelihood that insurer will pay its
  claims. Include effect of
  co-guarantors (e.g., guarantee funds)

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FAIR VALUE MECHANICS Time value of
money Payment pattern non-issue Discount
rate Risk free rate, not invested asset
return Risk-free assets are those assets with
readily observable market prices whose cash flows
are least variable for a given maturity and
currency. (Nov. 2001 DSOP, par. 6.2)
U.S. Treasury rates Alternative View
High-grade corporate, adj. (default,
volatility risk)
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FAIR VALUE MECHANICS Risk adjustment fair value
should include an adjustment for the premium that
marketplace participants would demand for risks
and mark-up in addition to the expected cash
flows (IFRS 4, BC 6c (i) ). IASB preference
calibrate to the market Many ways to estimate
the risk, BUT can it be reliably
calibrated? Is the theory workable in practice?
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FAIR VALUE MECHANICS Credit standing Fair value
should reflect the credit characteristics of
the insurer, including the effect of
co-guarantors, such as guarantee funds. (IFRS
4, BC 6c (iv) Theory, not practice Adjust for
co-guarantors (e.g., Guarantee fund, insured?),
Reflect bankruptcy priority Method?
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FAIR VALUE MECHANICS Credit standing
(cont.) May not be adopted by EU, FASB
Regulator influence Precedent for regulatory
influence No one doing currently BUT - Canadian
standard for pension lump sum commutations?
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FAIR VALUE MECHANICS Alternative approach No
profit at issue Entry price fair
value Initial loss reserve zero profit
reserve Exit vs. entry price (standard is exit
price)
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U.S. PROGNOSIS IASB-FASB Convergence
Agreement FASB probably will expose phase II
expos. draft in U.S. FASB has a fair value
project Discounting part of fair value SEC
has supported fair value for acquired
liabilities But what about normal insurance
liabilities? uncertain if practical problems
can be suitably met.
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• OPTIONS
• No discounting?
• Discounting with
• Market calibrated risk adjustment
• Rules of Thumb for risk adjustment
• No risk adjustment?
• Discounting sounds likely for IASB (2008?)
• U.S. GAAP??
• (unlikely for U.S. stat.)