QFIP-150: IFRS 9 For Insurers

Question 1

IFRS 9 measurement bases for reporting gains/losses on financial assets

Answer 1

• Amortized cost: We completely disregard the change in market value of the instrument, and just amortize the premium/discount amount of the bond into P&L as the contract matures
• Fair Value Through Other Comprehensive Income (FVOCI): The change in the market value of the asset will flow through to a line item called other comprehensive income
  
  • The P&L will only get impacted once the asset is sold and the loss or gain on the asset is realized. When this occurs, the outstanding balance of the OCI for this asset will get recognized as P&L
  • Will result in a more stable P&L from changes in the asset values, since the day-to-day unrealized gains/losses from these assets would go into OCI instead of P&L
• Fair Value Through Profit and Loss (FVTPL): The change in the market value of the asset will immediately flow through into the income statement as profit and loss (P&L)
  
  • This results in more volatile P&L movements from the assets, as the mark-to-market value of these assets will impact the company’s net income each reporting period, even if these change in market values are unrealized

Question 2

IFRS 9 Asset Classification Examples

Answer 2

• Amortized cost
  
  • SPPI bonds that are expected to be held to maturity in order to collect contractual cash flows
  • A debt instrument is classified as Solely Payments of Principal and Interest (SPPL) if its cashflows just consist of principal and interest payments
  • This includes plain vanilla fixed rate bonds
• FVOCI
  
  • Equity instruments that have explicitly been designated by the company as being held at fair value for OCI
  • SPPI bonds that are held by the insurer with the objective of both collecting contractual cashflows and selling financial assets
• FVTPL
  
  • Most equity instruments
  • Derivatives
  • Bonds that are held for trading purposes
  • Bonds whose contractual cashflows are more complex than SPPI (i.e. convertible bonds)
  • Bonds where the company wants to apply FVTPL in order to eliminate accounting mismatch with the liabilities
    
    • This is an important consideration for financial assets that back insurance liabilities
    • For the most part, insurance liabilities are measured at fair value under IFRS 17 because they will be discounted using current market rates

Question 3

IFRS 9 Application to Insurer’s Financial Liabilities

Answer 3

• Applies to investments contracts without discretionary features and financial guarantee contracts
• Financial liabilities can be measured at amortized cost or FVTPL. FVOCI option is not available
• The impact on fair value of changes in the credit risk of financial liabilities measured at FVTPL is recognized in OCI (rather than P&L)
  
  • Insurers should consider the impact of recording changes in credit risk in OCI, and whether or not it creates an accounting mismatch
  • Insurers should consider the operation impact of the requirement to record changes in credit risk in OCI

Question 4

IFRS 9 Impairment Requirements

Answer 4

IFRS 9 requires that insurers calculate an expected credit loss (ECL) for all financial assets measured at amortized cost and debt investments measured at FVOCI

• This impairment calculation will be calculated on an expected, not incurred, basis
• The ECL calculation will be forward looking and influenced by a variety of factors, such as the credit rating of the bond issuer and current macroeconomic conditions

If there has been no significant increase in credit risk over the reporting period, companies can simplify the calculation by having the impairment provision equal the 12 month ECL (i.e. expected credit losses you’d incur over the next year)

• This makes the impairment calculation easier for most insurers, as insurers generally hold financial investments with high credit ratings and low probability of default

If there has been a significant increase in credit risk, though, the impairment provision must be the lifetime ECL

• This results in an impairment provision that will be higher than the 12 month ECL

Question 5

Hedge Accounting under IFRS 9

Answer 5

Hedge accounting refers to rules that allow an insurer to account for changes in the market value of derivative assets into Other Comprehensive Income (OCI) instead of directly into the income statement through P&L

• Insurers can apply hedge accounting to their derivatives only if those derivatives were used to hedge financial risk in the liabilities
• In the context of variable annuity guarantees, examples of hedging include:
  
  1. Using futures contracts to hedge equity and FX risk
  2. Using interest rate swaps to hedge interest rate risk
  3. Using call/put options and variance swaps to hedge equity volatility risk
• Hedge accounting can help smooth the P&L of the insurance company, since the change in market value of these hedge assets would flow into OCI instead of P&L

Question 6

Describe a few disclosures that insurers need to provide if they decide to defer implementation of IFRS

Answer 6

• How the company concluded it is eligible for a temporary exemption from applying IFRS 9
• The fair value and changes in fair value at the end of reporting for financial assets
• For financial assets with contractual cash flows that meet SPPI criteria, insurer must also provide:
  
  • The carrying amount of the assets by credit risk grade
  • The fair value and carrying value of assets that do not have low credit risk

Question 7

Describe a few disclosures that insurers need to provide if they decide to implement IFRS

Answer 7

• In the statement of comprehensive income, the following new line items are required:
  
  1. Credit impairment losses
  2. Change in fair value attributable to change in the credit risk of financial liabilities designated at FVTPL
• Disclosures in the following areas:
  
  • Investments in equity instruments designated as FVOCI
  • Impairment for items like credit risk
  • Hedge accounting decisions (IAS 39 vs. IFRS 9)