Deloitte Finance Club The community for Financial ...€¦ · ©2014 Deloitte LLP. All rights reserved. Deloitte Finance Club The community for Financial Controllers and senior financial

©2014 Deloitte LLP. All rights reserved.

Deloitte Finance ClubThe community for FinancialControllers and senior financialexecutives

Wednesday, 19th November 2014


Deloitte Finance ClubA few facts

• Established in May 1997 as the Financial Controllers’ Club, and renamedDeloitte Finance Club in 2013

• Provides an annual programme of technical updates and hot topic briefings

• Connects our members to relevant experts as well as over 2,200 membersacross the country

Deloitte Finance Club – Key trends and developments in the UK insurance market (19 Nov 2014)2


Deloitte Finance ClubUpcoming programme

• Holiday finance checklist 2014Wednesday, 10 December 2014 – 8:30am-10:30am (arrivals from 8am)

2015 programme to be released soon


https://www.deloitte.co.uk/financeclub/register1210.cfm


Key trends and developments in UK insuranceAgenda

• Alex Arterton – opening remarks

• Peter Evans – Insurance disrupted

• Kush Patel – IFRS 9

• Derek Haynes – IFRS for Insurance Contracts



How technology is changingthe traditional UK generalinsurance model

Insurance disrupted

Peter Evans


Insurance disruptedKey messages

• The internet causes major disruption to business models

• Price comparison websites have eroded profit margins…

… creating big issues for the CFO

• Customers continue to rely on the phone to communicate with their insurers, theywill move to the internet

• Is telematics the future?


©2014 Deloitte LLP. All rights reserved.7

The use of price comparison websites (PCWs)has grown rapidly

Yes58%

No38%

Don’tknow

4%

% customers who use pricecomparison websites

Moneysupermarket

Confused.comGocompare

Comparethemarket

1999 2000 2001 2005 2006 2007

Source: Deloitte Insight/YouGov, 10-16 April 2014. Sample: 2,849

Deloitte Finance Club – Key trends and developments in the UK insurance market (19 Nov 2014)

©2014 Deloitte LLP. All rights reserved.Deloitte Finance Club – Key trends and developments in the UK insurance market (19 Nov 2014)8

Customers switch general insurer frequently% motor, buildings or contents customers who switched froma different insurer at last renewal


41%

51%

5%2%

Yes – I switched from adifferent insurer

No – I renewed with thesame insurer

Can’t remember Not applicable – it was myfirst policy


Price is the overriding reason customers switch% motor, buildings or contents customers who switched froma different insurer at last renewal – by reason (respondentschose multiple reasons)


7%

1%

0%

1%

1%

1%

2%

2%

2%

3%

3%

4%

4%

4%

4%

4%

28%

80%

Other

Don’t know

I was refused cover by my insurer

My insurer was slow (e.g. issuing documents)

My insurer’s website was hard to use

I wanted an insurer that was better known

I wanted a type of policy my insurer didn’t offer

My broker or financial adviser suggested I should switch to a different…

My insurer made mistakes (e.g. inaccurate policy documents)

My insurer’s staff were rude and unhelpful

I didn’t trust my insurer (e.g. to pay claims)

I wanted an insurer that was less hassle

I wanted more generous cover (e.g. protected no claims discount)

My insurer tried to sell me things I didn’t want

My policy no longer met my needs

I had a poor experience when I claimed

My insurer tried to put my premium up even though I hadn’t claimed

I found a cheaper premium with a different insurer


PCWs make customers more likely to switch onprice% motor, buildings or contents customers who switched froma different insurer at last renewal because they found acheaper premium – by PCW users

69%

84%

Non PCW users PCW users

Source: Deloitte Insight/YouGov, 10 – 16 April 2014. Sample: 1,160


Source: ABI Statistics


Price comparison websites have put already-lowmotor insurance margins under pressureUK domestic motor insurance underwriting results 1993-2013(£m)

Financial Year

-2000

-1500

-1000

-500

0

500

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013


PCWs are most widely used for motor insurance,use for other products is likely to increase% motor, buildings or contents customers who used a pricecomparison website before buying current policy – by type ofpolicy

Source: Deloitte Insight/YouGov, 10-16 April 2014. Sample: 1,435 (Motor); 717 (Buildings); 697 (Contents)

63%

53% 51%

33%

43% 44%

3% 5% 5%

Motor Building Contents

Yes, I did No, I didn't Can't remember


Customers will interact with their insurers more indigital channels% motor, buildings or contents customers who communicatewith their insurer – by channel

Source: YouGov survey for Deloitte – Sample: 238

79%24%

25%

telephone

website

email


Insurers have not yet created good enough webexperiences for wider digital channel adoptionLikelihood of customers communicating via digital channelswith insurer to recommend it vs. average across all customersat insurer

Digital channels: website, e-mail, online chat facility, smartphone app (all samples above 30)

-12%

-8%

-8%

-8%

10%

11%

18%

-15% -10% -5% 0% 5% 10% 15% 20%

Building or contents insurers

-24%

-6%

-2%

-2%

-1%

8%

15%

-30% -20% -10% 0% 10% 20%

Motor insurers

less likely than average to recommend more likely than averageto recommend

less likely than average torecommend

more likely than average to recommend


Insurance disruptedWhere next?• Telematics is the name for technology that captures and analyses data on driving,

replacing demographic and postcode-based risk assessment

Two types:

‒ Pay-As-You-Drive: GPS device monitors distances driven; insurer charges based ondistance driven

‒ Pay-How-You-Drive/Usage Based Insurance: monitors driving behaviour. GPS devicewith integrated accelerometer that monitors:

• Location – motorways vs. neighbourhood, city vs. suburbs, distance from home

• Frequency – daily vs. occasional, mileage, rush-hour vs. off-peak

• Behaviour – acceleration, speed vs. limit, braking, cornering, crash data, lanechanging


Device collects data onlocation, time and driving

behaviours

Data is transmitted overnetworks

Data is collected and storedin databases

Data is processed usingalgorithms and insights aregenerated for insurer as well

as customer

How it works


All change! Major accountingchanges for InsurersIFRS 9

Kush Patel


OverviewThe IASB has issued the final version of IFRS 9Financial Instruments on 24 July 2014

Classification and measurement

Impairment

General hedge accounting

Macro hedge accounting Separate project


No need to restate priorperiods

Application of allrequirements ofIFRS 9 (2014)

Exemption: Financialliabilities designated atfair value through profitor loss


Transition and effective date

01.01.2018retrospective

IFRS 9 shall be applied forannual periods beginning on orafter

Early applicationpermitted


Classification of financial assets

Contractual cash flow characteristics

PrincipalInterest on the principal

amount outstanding

Business Model

Held to collect contractual cash flows

Held to collect contractual cash flowsand for sale

Timevalue ofmoney

Creditrisk

Other basiclending risks or

costs

Fair Value(∆ OCI)

AmortisedCost

Fair Value(∆ P&L)

Fair Value Optionin case of an accounting

mismatch

FVTOCI-Optionfor investments in equityinstruments that are not

held for trading

Measurement basis


Measurement of financial assets

Statement offinancialposition

P&L

OCI

Recycling

Amortised costFair value through

OCIFair value through

P&LFair value through

OCI

Effective interestmethod, impairment& foreign exchange

differences

(all)Fair value changes

Dividends

---(other)

Fair value changes---

(all)Fair value changes

--- Yes --- No

Effective interestmethod, impairment& foreign exchange

differences

Initialrecognition

Fair Value measurement

Certain equityinvestment

Certain debtinstruments, equity

investments &derivatives

Certain debtinstrument

Certain debtinstrument


AC FVTOCIFVTPL/

FVTOCI Option forcertain equity instruments

Within the scope of the impairment model

Outside the scope ofthe impairment model

Financial assets in the scope of IFRS 9

Loancommit-ments

(unless @FVTPL)

Financialguarantees

(unless @FVTPL)

Leasereceivables

Contractassets

(IFRS 15)


Impairment – scope

Subsequent measurement …


Expected loss modelGeneral impairment model

Lossallowance

Apply effectiveinterest rate to…

Initialrecognition Stage 2

Lifetime expectedcredit losses

Gross carryingamount

Stage 3

Lifetime expectedcredit losses

Net carryingamount

Stage 1

12-month expectedcredit loss

Gross carryingamount

Objectiveevidence ofimpairment?

Significantincrease incredit risk?

Change in credit risk since initial recognition


Policy choice


Transfer out of Stage 1Assumptions and approximations

Stage 2Stage 1

Significant increase in credit risk?

Approximation

Low credit riskMore than 30days past due

12-month-PD

Rebuttableassumption

Assessment on borrowerlevel

Consistent thresholds onportfolio level Latest point of

transfer to stage 2e.g. investment grade


Exemptions from the general model

Special provisions

•No loss allowance on initial recognition

•Apply a credit-adjusted effectiveinterest rate (based on theexpected cash flows at inceptionincluding expected credit losses)

Stage 3Purchased or originated credit-impaired financial assets

General model

Stage 2 Stage 3Stage 1

• Trade receivables with asignificant financingcomponent

• Contract assets withsignificant financingcomponent

• Lease receivablesPolicychoice

• Trade receivables without asignificant financingcomponent

• Contract assets withoutsignificant financingcomponent

Simplified model

Stage 2 Stage 3


All change! Major accountingchanges for InsurersIFRS for Insurance Contracts

Derek Haynes


Background to the newIFRS for insurancecontracts


New IFRS for Insurance Contracts – backgroundConsistent, transparent method of accounting

Consistent measuresof cash flows

Existing issues

Reflects currentmarket conditions

Use of market-consistent measures

Greater comparabilitywith other insurers

Discounting reflectstime value of money

Inconsistent measuresof adverse deviation

Reflect uncertainty incash flows

Reflects all risks

Reflect full range ofpossible outcomes

Reflect discountingwhere significant

Discount rate reflectscontract characteristics

Reflect current market-based information

Consistent accountingfor all contracts

Little information aboutoptions guarantees

Lack of discounting forsome contracts

IASB’s objectives Impact on insurers

Discount rate does notreflect economic risks

Variety of accountingtreatments

Long duration contractsestimates not updated


New IFRS for Insurance Contracts – backgroundLatest estimate of timeline

20 June 2013

RevisedExposure Draft

25 Oct 2013

Commentletter deadline

2014 andH1 2015

Board re-deliberates issues

H2 2015?

Publishesnew IFRS

Effective date2019?

~3 years afterfinal Standard


New IFRS for Insurance Contracts – backgroundA tough few years, but you should see benefits• A sequence of demanding changes to reporting requirements

• Early planning will:

‒ minimise the impacts on your business; and

‒ enable you to maximise the benefits


2014 2015 2016 2017 2018

Current IFRS

IFRS 9

IFRS 4 Phase 2

Solvency I

Solvency II

• Accounting policychoices

• Avoid accountingmismatches withPhase II

• Solvency I reporting ceasesBUT

• May need to use these systemsfor financial reporting

• Solvency II reporting increases,timescales reduce.

• Proliferation of reporting will putstrain on working day timetable

• Implementationdate unknown

• Likely to be laterthan IFRS 9


IFRS 4 Phase II –progress to date


IFRS 4 Phase IIProgress to date – major topicsDescription of the topic ( ** re-exposed) Redeliberation complete?

Definition and Scope Yes

Unbundling Yes

Which Cash-Flows? Yes

Contractual Service Margin ** Yes, subject to participating contracts

Level of aggregation Yes

Discount rate and OCI solution ** Yes

Risk Adjustment Yes

Participating Contracts ** To be completed early 2015?

Reinsurance assets Yes

Premium Allocation Approach Yes

Presentation ** Yes

Disclosure Yes

Transition ** Yes, subject to participating contracts



IFRS 4 Phase IIProgress on re-deliberating 2013 Exposure Draft

Exposed topics

• Unlocking the CSM – DONE

• Insurance revenue – DONE

• OCI solution – DONE

• Transition - DONE

Non-targeted issues (all DONE)

• CSM earning pattern

• Gains on reinsurance contracts

• Level of aggregation and portfoliodefinition

• Non-observable discount rates

• Significant insurance risk

• Fixed fee service contracts

• Portfolio transfers and businesscombinations

• PAA – revenue and interest expense

All decisions reached for contractswith NO participating features onlyat this stage


IFRS 4 Phase IIoverview


• The value of the insurance contractsconsists of the present value of thefulfilment cash-flows and acontractual service margin

• The present value of the fulfilmentcash-flows includes a riskadjustment, which reflects theuncertainty in the cash-flows


Building Block ApproachOverview of measurement

Contractual Service Margin(CSM)

(Expected profit of the contract)

Fulfillment cash-flows

Expected cash-flows(Premiums, claims and

expenses)

Risk adjustment(Assessment of the

uncertainty of the amountof future cash-flows)

Discounting(Adjustment that converts

cash-flows into currentamounts)


Building Block Approach – fulfilment cash-flowsCash flows

Current estimate of all cash-flows that will arise, being:

• Premiums;

• Claims and benefits paid to policyholders, plus associated costs;

• Cash-flows resulting from options and guarantees;

• Costs (successful and unsuccessful) of selling, underwriting and initiatingcontracts; and

• Fixed and variable overheads directly attributable to fulfilling the portfolio.



Building Block Approach – fulfilment cash-flowsRisk adjustment

• An adjustment to reflect uncertainty in the estimate of fulfilment cash-flows

• Measures compensation required to make the entity indifferent between:

‒ fulfilling an insurance liability with a range of possible outcomes; and

‒ fulfilling a liability that will generate fixed cash-flows with the same expected presentvalue as the insurance contract

• Re-measured at each reporting period

• Effects of diversification between portfolios is allowed

• No technique specified



Building Block Approach – fulfilment cash-flowsDiscounting

• Adjusts cash-flows for time value ofmoney

• Discount rate based on characteristics ofthe insurance liability:

‒ Currency, duration, and liquidity

‒ Consistent with observable current market inputs for instruments with similar cash flowcharacteristics

‒ Rates should exclude factors not relevant to the insurance liability

• Updated each reporting period

• If amount, timing or uncertainty of cash-flows depend on return from underlyingitems the discount rate should reflect thatdependency


Tentative decisions

June 2014 – Developunobservable inputs using bestinformation available, reflectinghow market participants wouldassess such inputs

July 2014 – Contracts withoutparticipating features – use ratelocked-in at inception to accreteinterest and calculate presentvalue of cash flows that unlockthe CSM

September 2014 – Contractswith participating features – userate locked-in at date claimincurred to determine interestexpense


Building Block ApproachContractual Service Margin (CSM)

• Risk-adjusted expected profit from a contract

• Eliminates any gain at inception of the contract

• Unlocked for changes to actuarial assumptions

• Interest calculated using locked-in discount rate

• CSM cannot be negative, i.e. the present valueof losses must be charged immediately to profitor loss

• Amortised over remaining coverage period in asystematic way that best reflects the transfer ofservices


Tentative decisions

May 2014

• CSM unlocks forchanges to actuarialassumptions

• CSM unlocks forchanges to the riskadjustment due tochanges in actuarialestimates

• Past losses should berecovered from arestored CSM


Premium Allocation ApproachEligibility

• Measurement of the liability for the remaining coverage may be simplified if:

‒ doing so is a reasonable approximation to the BBA, or

‒ the coverage period at initial recognition is less than one year

• An approximation is reasonable if the components of the BBA would not havesignificant variability during the period before a claim is incurred

• Variability increases with

‒ the existence of options and guarantees in the insurance contract, and

‒ the length of the coverage period

• Liability for claims incurred should be calculated using the BBA. Discounting notrequired if cash-flows are expected to be paid in less than one year



PresentationPresentation of insurance revenue and expenses

Contractual ServiceMargin

Expected future cashflows

Risk adjustment forfuture cash flows

Discounting Effect ofchange indiscount rate

Unwind of thediscount rate

All otherchanges

Changedue toactuarialestimates

Changedue toactuarialestimates

All otherchanges


PresentationEffect of changes in discount rates

Non participating contracts (tentative decision)

Accounting policy choice

• The effect of changes in discount rate can either be presented in:

‒ Profit or loss; or

‒ OCI

• This is an accounting policy choice for each portfolio

• Where there is a change in accounting policy, the requirements of IAS 8 have tobe complied with (but see transition requirements)



PresentationDisclosure requirements

Tentative decision (May 2014)Confirmed all disclosure requirementswill be as per the 2013 ED


Participating contracts –current status


Contracts with participating featuresCurrent status of IASB debate

• 2013 ED proposed a “mirroring approach” which has been widely rejected

• Using the BBA with the following adaptations is being considered:

‒ “Unlocking” the CSM to take into account the changes in the insurer’s future share of returns generated by the underlying items

‒ An accounting policy option to present the discounting separately between OCI and profit or loss, using an asset dependent yield curve based on projected crediting rates



Contracts with participating featuresEuropean CFO Forum alternative proposal

• Would apply to all contracts that offer a variable return linked to a specified poolof assets irrespective of whether such assets are held by the insurer

• Broad scope which would capture investment contracts which includes adiscretionary return derived from underlying items

• The key features are:

‒ No bifurcation of cash flows

‒ Single discount rate curve for all cash flows for balance sheet measurement

‒ Book yield rate for the presentation of the time value of money in profit or loss, with the difference presented in OCI

‒ CSM represents the insurer’s share of future profits from the underlying items, with full unlocking of all variables

‒ Profit recognition based on delivery of the service to the policyholder



The impacts andchallenges of Phase II


The impacts and challenges of Phase IITransition – contracts with no participatingfeatures

• Full retrospective application of the new requirements is required, unless thisis impracticable

• Where impracticable, the simplified approach in the 2013 ED must be applied

• Where impracticable to apply the simplified approach, a fair value approach isapplied from the date of transition

• The above will require analysis and judgment

• Differing methods of transition are likely to be applied to different portfolios ofinsurance contracts within the same company



The impacts and challenges of Phase IIPractical, commercial and strategic implications

• Many years of changes – Solvency II, IFRS 9 and IFRS 4 Phase II

• Consequential impacts on e.g. working day timetable, management information,budgets and forecasts, dividends and executive remuneration

• Process, technology and information

‒ Technology and data

‒ Finance and actuarial systems

‒ Solvency II systems need the functionality to produce Phase II measures

• Consider impact on the Target Operating Model

• Communication with stakeholders



The impacts and challenges of Phase IIBasis of financial reporting for Life Insurers afterSolvency I

• Life insurers currently use the modified statutory solvency basis

• Most likely option is to maintain existing Solvency I systems to enable financialstatements to be prepared using consistent measurement bases

• A change in accounting policies is permitted if the financial statements morerelevant and no less reliable, or more reliable and no less relevant

• Could base insurance liabilities on Solvency II values, but changes in accountingpolicies in 2016 and again when Phase II is implemented

• Would require assessment of:

‒ the adjustments required to the Solvency II values

‒ cost and effort; and

‒ loss of comparability over a relatively short timescale



IFRS 9 FinancialInstruments interactionwith Phase II


IFRS 9 – interaction with Phase IIWhat are the implications for insurers?

• FVTOCI is notable because an insurer often undertakes regular buying andselling activity to rebalance its portfolio of assets to meet cash flow needs

• FVTPL is an option available on initial recognition if this would eliminate orreduce an accounting mismatch

• An assessment of the measurement impacts of the combination of IFRS 9 andPhase II will be needed to minimise volatility in profit or loss

• Investments of sufficient duration to match insurance liabilities may not beavailable, therefore insurers may hedge this mismatch by entering intoderivatives (which must be accounted for at FVTPL)

• An accounting mismatch will result if the accounting policy is to present in OCIthe effect of a change in discount rate on the insurance contract liability



Assets

Liabilities

Financial assetat FVOCI

Interest rateswap

Financial derivativeat FVTPL

20 years 30 years

Changes in current interestrates presented in OCI


IFRS 9 – interaction with Phase IIMismatches of duration between assets andliabilities


Insurance liabilities Financial assets

Present Valueof expected

fulfilment cashflows

ContractualService Margin

Risk adjustment

P&L

OCIEffect of change in

discount rate toOCI

P&L

OCI

Amortised cost- business

model- contractualcash flows

characteristics

Fair Value –not at

amortised cost

Change in CSM

Investment Income,realised gains and

losses andimpairments


IFRS 9 – interaction with Phase IIPotential accounting mismatches

Unrealised gainsand losses

Pro

spective

change

inC

SM


Next steps for Insurers


Next steps for InsurersOpportunity for more cost effective delivery

Maximise the synergybenefits with Phase II

Optimise the use of existingresources / knowledge

Optimise IFRS investment ina cost effective way

Learn lessons fromSolvency II journey

Earlier and smootheradoption into BAU

Establish a moresustainable delivery model

Costs

Effectivenessand efficiency

High level understanding ofbusiness impact

IFRSimplementation


Questions?


Deloitte Finance ClubUpcoming programme

• Holiday finance checklist 2014Wednesday, 10 December 2014 – 8:30am-10:30am (arrivals from 8am)

2015 programme to be released soon


https://www.deloitte.co.uk/financeclub/register1210.cfm


Deloitte Finance ClubContacts and resources• Alex Arterton – 020 7303 5996 [email protected]

• Derek Haynes – 020 7007 5740 [email protected]

• Kush Patel – 020 7303 7155 [email protected]

• Peter Evans – 020 7303 0010 [email protected]

• James Bates – 020 7303 0094 [email protected]

Resources:

• Deloitte Finance Club home page: www.deloitte.co.uk/financeclub

• UK Accounting Plus (formerly IAS Plus): www.ukaccountingplus.co.uk

• Future of UK GAAP: www.deloitte.co.uk/futureofukgaap


mailto:[email protected]





http://www.deloitte.co.uk/financeclub

http://www.ukaccountingplus.co.uk/

http://www.deloitte.co.uk/futureofukgaap


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Deloitte LLP is the United Kingdom member firm of DTTL.

This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend uponthe particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of thispublication. Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLPaccepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.


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Deloitte Finance Club The community for Financial ...€¦ · ©2014 Deloitte LLP. All rights reserved. Deloitte Finance Club The community for Financial Controllers and senior financial