Impact of IFRS on US P&C

Question 1

Definition of an “insurance contract” under IFRS

Answer 1

A contract under which one party accepts a significant insurance risk from another party by agreeing to compensate the policyholder if a specified uncertain future event adversely effects the policyholder

Question 2

List 4 requirements of Phase 1 of IFRS

Answer 2

1. Elimination of catastrophe & equalization provisions
2. Adequacy test of insurance liabilities & impairment test of reinsurance assets
3. Prohibition of offsetting insurance liabilities with reinsurance recoverables
4. Certain disclosures

Question 3

3 steps to determine liabilities according to IFRS

Answer 3

1. Calculation of unbiased probability weighted expected cash flows : inputs to the calculation are “market consistent”, difficult to obtain as liabilities are not traded in a deep and liquid market)
2. Application of discounting : use a risk free rate with adjustments to reflect currency, liquidity and cash flow timing
3. Application of margins

Question 4

4 recommendations regarding risk margins

Answer 4

• margins should be calculated using a consistent methodology over the life of the contract
• margins should be calculated using consistent assumptions to those made in the calculation of the liability
• margins should be consistent with sound insurance pricing
• margins should vary by product to reflect the difference in risk of the different products

Question 5

5 factors that would require higher risk margins

Answer 5

• less is known about the estimate
• low frequency / high severity
• longer duration
• wide probability distribution
• emerging experience increases uncertainty

Question 6

Outline 3 approaches to determine risk margins

Answer 6

1. Confidence level (VaR) technique: the needed load to the expected value to result in a specific probability that the insurer has sufficient funds to pay for the liabilities
2. Conditional Tail Expectation (CTE)/ Tail Value at Risk (TVaR): probability weighted average of all scenarios in the tail mean estimate. This has advantage over VaR that it reflects the skewed distributions
3. Cost of capital method: the amount necessary to produce an adequate return, after factoring in the investment return. This is the most risk sensitive method, and most closely related to pricing in other industries.