SAP 104-Valuation of Assets, Liabilities and Solvency Capital Requirements Flashcards
Outline the 5 accounting standards that need to be adhered to in published reporting? (5)
• IFRS 9 financial instruments: This standard relates to the recognition and measurement of IFRS defined investment contracts. (replacing IAS 39 in 2018)
• IFRS 13 Fair value measurement. This relates to defining fair value and setting out a single IFRS framework of the measurement of fair value
• IFRS 4 insurance contracts. This relates to the recognition, measurement and disclosure of insurance contracts.
• Financial instruments IFRS 7 disclosures. This relates to the disclosure of IFRS defined investment contracts.
• IFRS 15 revenue from contracts with customers. This relates to revenue recognition and is very relevant to investment management contracts
State why the financial soundness condition should be included in published reporting? (3)
The ability of an insurer to:
• Declare dividends
• Reduce shareholder equity
• Write new business
Is among other things depend on the insurer satisfying the financially sound condition. Insurers should therefore calculate and publish the financial sound condition.
Explain why it is importnat to distinguish between insurance business and investment business in the context of financial reporting? (3)
• One of the implications of IFRS is to distinguish investment business from insurance business. The accounting standard applied to each business is different.
• IFRS 9 is not applicable to contracts under which fall under IFRS 4 i.e. contracts which have discretionary benefits
• IFRS 9 requires assets and liabilities that fall under its scope to the valued as fair value i.e. the price received to sell an asset or price paid to transfer liabilities in an orderly transaction between market participants
Describe the definition of an insurance contract under IFRS 4? (5)
o The definition in IFRS 4 i.e. a contract where one party (insurer) accepts significant insurance risk from another party (policyholder) by agree to compensate the policyholder of a uncertain future event adversely affects the policyholder
o There needs to be a plausible probability of event occurring
o The consideration in the difference between death and surrender may be required
o Survival risk meets the definition of insurance risk
o Example of insurance contracts whole life, terms assurance, endowments, credit life, IP, group insurance, CI, universal life, funeral, life annuities
Describe the definition of an investment contract for the purpose of IFRS reporting? (3)
o Investment contracts are polices that don’t fall in definition of insurance contract
o Example non-profit single premium guaranteed contracts, annuity certain, market linked living annuity, market linked savings products, group smooth bonus contracts
o Switching from pure investment to discretionary participations needs to be monitored
Outline how to determine if a contract with discretionary participation is an insurance or investment contract? (4)
The classification between insurance and investment may require the consideration of Market value adjustors (MVA)
o If the MVA applies to a surrender or death benefit but not on maturity the contract has survival risk and is classified as insurance
o Similarly where the MVA applies to surrender and maturity but not death then the classification is insurance
o However if the MVA is only applied to surrenders and not death and maturity then the contract will be classified as an investment contract
Note that although all discretionary participation contracts are valued according to IFRS 4 disclosure requirements are different between insurance and investment contracts
Describe the valuation of investment contracts without discretionary participation features? (9)
o These contracts are valued in accordance with IFRS 9. To ensure consistency if the value of the assets are valued at fair value then the value of the liabilities should also be valued a fair value
o The market value should be used for quoted prices
o IFRS 13 describes three valuation methods for unquoted prices
o market approach (replication)
o Income approach (discounted cashflow)
o Adjusted net asset method
o No loss or gain will be recognised at inception for quoted prices. Gains or loss at inception needs to be recognised over the lifetime of the contract
o An account balance is an appropriate reserve for unit linked contract
o If actuarial funding is implemented then the value of the liability will be either the unfunded value (total liability) or the difference between unfunded and funded value should be treated as a deferred revenue liability
o A company issue an investment contract needs to recognise a minimum liability equal to the demand deposit (surrender value).
o Any DAC (deferred acquisition cost ) should not be netted off the demand deposit floor
o Embedded derivatives e.g. financial guarantees must be fair valued would need to be valued using a market consistent stochastic approach
Describe the valuation of investment contracts with discretionary participation features? (4)
o The financial soundness valuation method would be applicable
o The liability cannot be less than the guaranteed element of the contract
o The vested bonuses applicable to the policy is regarded as guaranteed element which needs to be calculated using prospective discounted cashflows rather than the face value (Not required in South Africa as the whole bonus stabilisation reserve is held)
o It should be noted that IFRS 4 permits premiums, claims and other cashflows to be recognised as revenue
Describe the valuation of investment management contracts? (6)
o The deposit component would be treated separately (in terms of IFRS 9) of to the investment management component (service fees) according to IFRS 15
o Excess initial fees (over recurring fees) are not to be recognised upfront but as revenue as the service are provided
o In the same way incremental costs are to be recognised and amortised when services are provided e.g. commission
o One can perform the calculations on a policy per policy basis or on a portfolio level
o This will influence how the DAC and DRL is spread over time i.e. actual policy duration or expected policy duration
o DAC should only be held to the extent that it is recoverable in the future
