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Session 6: External Forces & Industry Knowledge “Insurance Industry Market Update” 2 April 2012

Content

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The relevance of External Forces on the Actuarial Profession

Global trends in the insurance industry

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Trends in Asia

Name

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Thailand

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Š 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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1 The relevance of External Forces on the Actuarial Profession

• The Control Cycle and External Forces • Categorising External Forces • Why is it important to understand External Forces?

The Control Cycle and External Forces External forces are outside the actuary’s control, however, they affect the actuary’s work and should be recognized and considered when defining problems, designing solutions and monitoring results.

1Development

of the Control Cycle in an actuarial context is attributed to Jeremy Goford (1985), The Control Cycle: Financial Control of a Life Assurance Company. Paper presented to the Institute of Actuaries Students’ Society, February. © 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Categorising External Forces Demographics ■

Cultural/Social Values Knowledge, beliefs and customs of a society ■ Impacts the need for an external financial support system: • caring for the elderly • financing of education • healthcare • financial savings/security ■ Customer behaviour ■

Statistical data relating to the population and particular groups within it • death rate/birthrate • sex/age • income distribution/marital status • smoking/drinking

Law and regulations Contract and trust law ■ Taxation ■ Social insurance ■ Accounting regulations ■ ■

EXTERNAL FORCES

Economic and business environments Political stability Globilization ■ Competition ■ Inflation/interest rates ■ Investments options

Government influences

Physical environment Hazards • Natural • Man-made ■ Technology ■ Social media ■ Customer analytics ■ Data quality ■

Other

■ ■

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Unforeseen events: • Pandemics • Widespread medical illness trends ie

asbestosis, cancer ■ Medical developments

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Why is it important to understand External Forces Critical to the successful implementation of the actuarial control cycle • Integral to problem definition, designing solution and monitoring results • Greater understanding of client issues You are an expert • It is expected....

• Provides credibility • Raising the bar

Shaping the future • Constructive input into industry developments

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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2 Global trends in the insurance industry

• Global trends • Risks impacting future developments • Accounting and regulatory change • Risk and capital reform • Regulatory developments

Global trends • Total global premium grew by 2.4% in 2010 to US 4,324 bn in 2010, which was above the pre-crisis level • This was consistent with the recovery of the global economies with GDP increasing by 4% • Capital was restored in non-life, however, life still below pre-crisis • Profitability impacted by the continuing low interest rate environment

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Risks impacting future development • The global economic and political environment will create challenges for the growth of the insurance industry • Reduction of economic growth, particularly in the UK and US will results in continuing fiscal measures which will reduce inflation and dampen overall growth. This will have some impact on the growth rates in Asia • Continuing low interest rate environment • The euro debt crisis will have a direct impact to those with investment holdings in those countries impacted ie Greece, Portugal, Ireland, Spain and Italy • Increased political instability will likely arise

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

Real GDP growth, inflation and interest rates in selected regions from 2010 to 2013, %

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Accounting and regulatory changes for insurers and the implications 2012

2013

2014

2015

2016

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Insurance Phase II Accounting Change

Financial Instruments - Disclosures IFRS 10, 11, and 12 (consolidated financial statements, joint arrangements, and disclosure of interest in other entities)

Revised financial instruments standards Other expected standards: Lease Accounting? Revenue Recognition?

U.S. Solvency Modernization Regulatory Change

IAIS: revised insurance core principles effective EU: Solvency II preparation

EU: Solvency II effective?

Global changes.....

• Insurance contract accounting is changing • There are other significant changes in financial reporting • There are also significant changes coming to solvency and capital management • Taken together these changes are transformational – and impact for the business is significant • It is a case of when, rather than if, these changes will come © 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Risk and capital reform: IAIS reforms are expected to be a key regulatory driver in Asia ■ The new suite of IAIS Insurance Core Principals (ICPs) were adopted on 1 October 2011 (ICPs on ERM and Capital Adequacy are receiving much attention) ■ Many regulators in the region, and elsewhere in the world, are now citing the ICPs publicly as a driver of their regulatory reform packages ■ That said, regulators are often keen to emphasise they will implement change that will work in their local markets – as a result, uniform change across the region is perhaps not to be expected IAIS members: Africa - CIMA / Albania /Anguilla / Argentina / Armenia / Aruba / Asian Development Bank / Australia - APRA / Australia (NSW) / Australia - PHIAC / Austria /Republic of Azerbaijan / Bahamas / Bahrain / Barbados / Belarus (Republic of) / Belgium / Belize / Bermuda / Bhutan / Botswana / Brazil - ANS / Brazil - SUSEP / British Virgin Islands / Brunei Darussalam / Bulgaria / Cambodia / Canada - OSFI / Canada, Quebec / Cape Verde/ Cayman Islands BWI / Chile / China / China Hong Kong / Chinese Taipei / Colombia / Costa Rica / Croatia / Curacao and St Martin / Cyprus / Czech Republic / Denmark / Ecuador / Egypt / EIOPA / El Salvador / Estonia / European Commission / Finland (Authority) / Finland (Ministry) / France (ACP) / Georgia / Germany, BAFIN / Germany (Ministry) / Ghana / Gibraltar / Guatemala / Guernsey / Guinea / Hungary / Iceland / IMF / India / Iraq / Ireland / Isle of Man / Israel / Italy / Jamaica / Japan / Jersey / Jordan / Kazakhstan / Kenya / Republic of Korea / Kosovo / Labuan, Malaysia / Latvia / Lebanon / Lesotho / Liechtenstein / Lithuania / Luxembourg / Macau / Macedonia / Malawi / Malaysia / Malta / Mauritius / Mexico / Moldova / Mongolia / Montenegro / Morocco / Namibia / Nepal / Netherlands DNB / New Zealand / Nigeria/ Norway / OECD / Sultanate of Oman / Pakistan / Palestine / Panama / Papua New Guinea (Department of Finance & Treasury / Papua New Guinea (Bank of Papua New Guinea) / Paraguay / Peru / Philippines / Poland / Portugal / Qatar / Republic of Maldives / Romania / Russia / Rwanda / Samoa /Saudi Arabia / Serbia / Singapore / Slovakia / Slovenia / South Africa / Spain / Sri Lanka / Sudan / Suriname / Sweden / Switzerland / Swaziland / Syria / Tanzania / Thailand / Trinidad & Tobago / Tunisia / Turkey / Turks & Caicos BWI / Uganda / Ukraine / United Kingdom / United Arab Emirates / Uruguay / USA FIO / NAIC & 56 jurisdictions in USA / Uzbekistan / Vanuatu / Vietnam / World Bank / Zambia © 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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What regulatory developments are happening in key overseas markets?

United States

The European Union

• Currently undergoing the ‘Solvency Modernization Initiative’ (SMI) • The SMI is focused on a number of areas, including a review of the Risk Based Capital requirement, governance for insurers, and group supervision • The SMI includes development of the ORSA

• Solvency II has been in development since the turn of the century • Despite various announcements and delays, 2012 is expected to see the finalisation of most of the outstanding Solvency II framework rules and guidance • There are still a number of important technical components of Solvency II that remain to be finalised

Bermuda • Bermuda is a first-wave country in the EU equivalence process • In broad terms, EIOPA concluded that the commercial non-life sector was largely or partially equivalent

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

Australia • New Life and General Insurance Capital (LAGIC) standards are poised for release • These proposals are widely expected to increase capital requirements • The proposals will introduce a Three-Pillar approach to solvency regulation 12

Insurance Contracts Measurement – the ‘building blocks’ approach •

Acquisition costs to be included in the initial measurement of a portfolio of insurance contracts should be all the direct costs that the insurer will incur in acquiring that portfolio of contracts, successful or unsuccessful.

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Discount rate should reflect the characteristics of the insurance contract liability. No prescribed method for determining the discount rate - a “top-down” or “bottom-up” approach can be used.

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Measurement unit is at a portfolio level of contracts, except for residual margin which is currently being debated (ED prescribed cohort level). The risk adjustment has no prescribed unit of account.

Expected Future Cash Flows – explicit, unbiased and probabilityweighted estimates of future cash outflows less future cash inflows

Re-measured subsequent to inception through profit or loss.

Time Value of Money – discounted using current rates to reflect the time value of money

Risk Adjustment – to adjust for the effects of uncertainty about the amount and timing of future cash flows Adjusted prospectively for changes in estimates of future cash flows.

Experience adjustments recognised in profit or loss. Day one loss is recognised in profit or loss.

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Residual Margin – to remove any profit at inception and released over coverage period based on the pattern of transfer of services provided

Premium allocation approach (also known as the “modified measurement approach”) is required for pre-claims liabilities of short duration contracts. The eligibility criteria and mechanics for this approach is currently being assessed.

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Recap: insurer’s main concerns from the Exposure Draft (ED)

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Increased volatility of results

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Changes to performance reporting

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Revisions to the definition of acquisition costs

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Impact on relations with stakeholders and capital management

Š 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Financial Instruments Accounting Considerations for Insurers (IFRS 9) •

Classification

• Financial assets classified at initial recognition as either amortised cost or fair value, with reclassification permitted but expected to be ‘very infrequent’.

• Financial assets classified as amortised cost only if assets held in business model with objective to hold assets to collect contractual cash flows, and contractual terms of financial asset give rise to specified cash flows. The proposals do not contain tainting rules.

• Separation of embedded derivatives not required when host contract is a financial asset within the scope of IFRS 9, otherwise separation may be required.

• Final standard on hedge accounting yet to be issued by IASB, however proposals intended to simplify hedge accounting.

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Measurement

• Like IAS 39, financial instruments are recognised at fair value on inception. Subsequent measurement is based on the classification and is at either amortised cost or fair value.

• Equity investments measured at fair value with gain/loss recognised in profit or loss (except where fair value through OCI option exercised).

• Fair value option retained for financial instruments that qualify for amortised cost, but only to eliminate or significantly reduce accounting mismatches.

• New impairment standard is forward looking, based on expected credit losses rather than the current loss model.

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Presentation and disclosure

• Additional disclosure requirements under IFRS 9 compared to existing requirements under IFRS 7.

• Extensive disclosures for equity investments where fair value through OCI option is exercised.

• Reclassifications will trigger extensive disclosures that require an insurer to explain the change in business model and its effect on the entity’s financials.

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Transition

• As part of the process to finalise this and other proposals, the IASB will be considering how much time will be needed to implement the financial instrument proposals and how the standards should be implemented (retrospectively, prospectively, or with cumulativeeffect adjustments).

• The effective date is being considered and whether early implementation should be allowed.

The IASB is currently consulting on whether the mandatory effective date for IFRS 9 should be delayed by two years to 1 January 2015.

■ The IASB is currently contemplating making targeted improvements to IFRS 9 based on some of the ongoing deliberations relating to insurance contracts. Considerations include: – Whether there should be scope for more invested assets to be revalued through other comprehensive income – Whether the the IASB should reflect some of the proposals for financial instruments issued by the U.S. FASB in their final standards for financial instrument accounting (although convergence with the FASB is not an explicit objective of this exercise ■ The IASB is aware that some companies have begun work on IFRS 9 and is keen to neither disrupt these efforts nor jeopardise the 1 January 2015 effective date.

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3 Trends in Asia

• Southeast Asia: Favourable outlook • Extent of regulatory change • Risk based capital frameworks

Southeast Asia: Favorable outlook Growth in 2010 • Life 18% (2009: 12%) • Non-life 22% (2009:14%) Drivers of growth • Economic growth and development • Aging populations • Low penetration rate Risks • Impact of further recession in developed countries • Continued low interest rates • Regulatory developments • Tariffs • Selling practices • Capital requirements

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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Asia Pacific: Profiling the extent of regulatory change in the region Investments Regulators generally keep a tight grip on insurer investment rules.

■ Some Asian markets have been stung by overseas investments in the recent past.

■ Regulators are aware of the asset-liability mis-match due to the lack of availability of long dated assets.

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Customer treatment Customer treatment regulation in the region tends to revolve around product design and pricing.

■ Policyholder protection funds are becoming more commonplace.

■ We can expect further regulatory reform in this area in the future.

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Risk & Capital No uniform insurance capital requirements.

■ Risk-based capital is now common in the region, although large variants exist.

■ Risk management requirements are a hot topic, driven partly through IAIS reform.

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Governance and remuneration ■

Liquidity

Financial Sector Regulation

There are some examples that regulators are keen to reference and embed emerging international standards (e.g.

Hong Kong and the FSB’s 2010 compensation principles).

Systemic risk Compared to other regions, little is said about systemic risk.

■ That said, the region is producing some of the largest insurance groups and so the potential issue is a valid one.

■

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

Asset-Liability Matching is a key area of regulatory focus in the region.

■ Enhanced risk management standards, including stress and reverse stress testing has been introduced in the IAIS ICPs. ■

Supervision The region has an excellent recent case study of a regulatory college in action.

■ Regulators in the region are very aware of international, and (in our experience) local peer, developments.

■ Group supervision in some markets (e.g.

Singapore) is a hot topic.

■

Accounting and disclosure Adoption of IFRS 4 Phase I is now common across the region, though some major markets have yet to fully adopt.

■ There is concern in some markets of the impact of Phase II. ■ Disclosure and reporting will be significant issues for insurers in the region.

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Solvency II and IAIS standards

An Asia Pacific comparison of risk-based capital frameworks Solvency capital approaches: • Fixed ratio approach: fixed percentage applied to reserves and sum at risk, premium and historical claims • Risk-based capital approach ('RBC'): the assessment of the capital requirement by considering the risk profile of the insurance business written and of any other operations Insurance Market

Solvency capital calculation approach

Notes

China

Fixed-ratio approach

Soft tests of solvency, such as the 'dynamic solvency test', are also required to be performed

Hong Kong

Fixed-ratio approach

Soft tests of solvency, such as the 'dynamic solvency test', are also required to be performed

India

Fixed-ratio approach

Considering implementation of a more risk based approach

Philippines

Fixed-ratio approach

Based on insurance in-force and written premium

Vietnam

Fixed-ratio approach

The Vietnamese calculation is based on gross and retained premium

Taiwan

RBC

Taiwan’s RBC regime is similar to the US RBC regime in principle

Malaysia

RBC

RBC was implemented on 1 January 2009

Thailand

RBC

RBC implemented in September 2011

Japan

RBC

Japan has plans to impose stricter standards for insurer solvency assessments

Singapore

RBC

RBC introduced in 2005; categories include insurance, investment/market risk, concentration risks

Indonesia

RBC

RBC was introduced in 1999, one of the first countries in the region to adopt RBC

South Korea

RBC

Categories include insurance, interest rate, credit, market and operational risks

Australia

RBC

RBC was introduced in 2002; a new capital standard is currently under review

© 2012 KPMG Phoomchai Audit Ltd., a Thai limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Thailand.

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