By: FARRUKH REHMAN Partner, A.F. Ferguson & Co. a member firm of the PwC network A PRESENTATION ON MODIFIED ACCOUNTING REGULATIONS FOR INSURANCE COMPANIES.

By: FARRUKH REHMAN

Partner, A.F. Ferguson & Co.a member firm of the PwC network

A PRESENTATION ON

MODIFIED ACCOUNTING REGULATIONS FOR INSURANCE COMPANIES

Date: 20 August 2013

Draft Insurance Accounting Regulations, 2012 were issued by SECP on 19 November 2012

Therefore, this presentation covers the applicability and changes applied through these regulations.

Scope

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Session to cover:

• Developments in respect of Accounting Regulations for

insurance companies in Pakistan

• Some concerns in existing Accounting Regulations

• Changes in presentation of Published Financial Statements

• Presentation of Insurance Liabilities for life insurers

• Applicability of IAS-27, IAS-39 & IAS-40

• Recognition of Cover Note in the books of accounts

• Explanation of management and other expenses – non-life

insurers

• Change in premium deficiency requirement

• Key issues identified in modified regulations

• Prior to the Insurance Ordinance, 2000 the concept of Accounting Regulations alongwith the prescribed format of financial statements was also given in Insurance Act, 1938. The Accounting Regulations were basic and the formats of financial statements were not keeping pace with the changes happening in the world with respect to the International Accounting standards.

• The Insurance Ordinance, 2000 brought about number of changes for the insurance industry and there under the new Accounting Regulations & formats of financial statements were introduced in 2002. The accounting regulations both for life and non life segments were detailed enough to address all aspects of the insurance transactions. The financial statements formats were also largely brought in line with International Accounting Standards.

• Some of the major changes included method of premium income, recognition of IBNR claims, creation of separate statutory funds for life business, introduction of premium deficiency etc. This was considered a major change at that time.

Developments in respect of Accounting regulation for Insurance companies

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• With the passage of almost 10 years now there have been further developments in the International Accounting Standards relating to insurance.

• In 2004, the first Insurance specific IFRS-4 was issued and SECP made this applicable for insurance companies from period commencing from 1 January 2009. IFRS -4 did not change the existing accounting practices in any substantive way. It catered more of disclosure requirements than recognition and measurement.

• Recently the IASB has issued exposure draft of IFRS-4 as part of its phase II for developing insurance specific standard. This is expected to change significantly the recognition and measurement requirements of insurance industry.

Developments in respect of Accounting regulation for Insurance companies – contd.

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Some concerns in existing regulations

• Difference in Financial Statements for Insurers and Other Sectors under the International Financial Reporting Standards (IFRS)

• Total earnings of the Life Insurer not reflected completely

• Consolidated financial statements are not required for investment by statutory funds

• Applicability of IAS 39 and IAS 40

• Issues relating to calculation and classification of incurred but not reported claims – IBNR

• Correct classification / allocation of Management Expenses

• Recognition of Cover Note in the books of accounts

• No basis of preparation for Statement of Exposures

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The modified accounting regulations now prescribes

format of Financial Statements in accordance with

International Accounting Standards.

A complete and detailed illustrative accounts have now

been provided in Published Financial Statements format

by SECP. This has been done to provide consistency

across the insurance sector as done in banking sector.

A comparison of existing and revised Statements

comprising Financial Statements is given in the

following slide.

Changes in presentation of Published Financial Statements

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• Balance sheet

• Profit and loss account

• Statement of cash flows

• Revenue account -

(for life insurers only)

• Statement of premiums

• Statement of claims

• Statement of expenses

• Statement of investment

income

• Notes to the accounts

• Statement of financial position

• Statement of comprehensive income

• Statement of cash flows

• Statement of changes in equity

• Notes to the accounts

Changes in presentation of Published Financial Statements - contd .

Comparison of balance sheet (Life insurers)Shareholders Aggregate Aggregate

Fund Ordinary life Conventional Accident & current prior(investment business health year year

Cash and Bank Deposits linked)Cash and others Current and other accounts Deposits maturing within 12 months Fixed Deposits maturing after 12 months

Loans Secured Against Life Insurance Policies

Loans Secured Against other assetsTo employees To agentsOthers

Unsecured Loans

To employees or agents Others

Investment Property

Investment in subsidiaries and associatesFixed Income Securities Listed Equities Unlisted Equities

Other InvestmentsGovernment SecuritiesOther Fixed Income SecuritiesListed EquitiesUnlisted EquitiesMutual FundsOthers (describe)

Deferred Taxation

Preliminary and Deferred Expenses

Current Assets - OthersPremiums due but unpaidAmounts due from other insurers/ reinsurersInvestment Income Due but OutstandingInvestment Income AccruedTaxation - payments less provisionPrepaymentsSundry receivablesOthers (please specify)

Fixed Assets

Tangible & IntangibleLand and BuilldingsFurniture, Fixtures and Office EquipmentMotor VehiclesCapital Work in ProgressIntangibles (Please specify)

TOTAL ASSETS

NoteCurrent

yearPrior year

Assets

Property and equipment 5Intangible assets 6 - - Investment property 7 - - Investments in subsidiaries and associates 8 - -

(applicable where equity accounting is followed)Investments - -

Equity securities 9Government securities 10Debt securities 11 - - Term deposits 12 - - Mutual funds 13 - - Others (please specifiy)

Loans secured against life insurance policiesInsurance / reinsurance receivables 14 - - Other loans and receivables 15Deferred tax asset 16 - - Taxation - payments less provision - - Prepayments 17Cash & Bank 18 - -

- - Total Assets - - Equity and Liabilities

Capital and reserves attributable to Company's equity holders

Ordinary share capitalShare premium - - Reserves 20 - - Unappropriated profit/(Accumulated loss) - -

- - Total Equity - -

Surplus on Revaluation of Fixed Assets 21 - - LiabilitiesInsurance Liabilities 22Liabilities under Investment ContractsRetirement benefit obligations 23 - - Deferred taxation 16 - - Borrowings 24 - - Premium received in advance - - Insurance / reinsurance payables 25 - - Other creditors and accruals 26 - - Taxation - provision less paymentsTotal Liabilities - -

Total Equity and Liabilities - - Contingency(ies) and commitment(s) 27

Rupees in thousand

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Comparison of balance sheet (Life insurers) – contd.

Shareholders Aggregate AggregateFund Ordinary life Conventional Accident & current prior

(investment business health year yearShare Capital and Reserves linked)

Authorised Share Capital Issued, subscribed and paid up Share CapitalAccumulated Surplus/(Deficit) Other Reserves (describe)

Less: Capital contributed by shareholders fundNet Shareholders' Equity

Balance of statutory fund (including policyholder liabilities Rs. Prior year: Rs. )

Deferred LiabilitiesDeferred TaxationStaff Retirement BenefitsOthers

Creditors and AccrualsOutstanding claims (including IBNR)Premiums Received in Advance Amounts due to other insurers/reinsurersAmounts due to AgentsAccrued Expenses Taxation - Provision less paymentsOther Creditors and Accruals (describe)

Borrowings

Short term running financeLoans received from banksOther loansOther debt security issued

Other liabilitiesOther liabilities (please specify)

TOTAL LIABILITIES

TOTAL EQUITY AND LIABILITIES

CONTINGENCIES AND COMMITMENTS (if applicable)

NoteCurrent

yearPrior year

Assets

Property and equipment 5Intangible assets 6 - - Investment property 7 - - Investments in subsidiaries and associates 8 - -

(applicable where equity accounting is followed)Investments - -

Equity securities 9Government securities 10Debt securities 11 - - Term deposits 12 - - Mutual funds 13 - - Others (please specifiy)

Loans secured against life insurance policiesInsurance / reinsurance receivables 14 - - Other loans and receivables 15Deferred tax asset 16 - - Taxation - payments less provision - - Prepayments 17Cash & Bank 18 - -

- - Total Assets - - Equity and Liabilities

Capital and reserves attributable to Company's equity holders

Ordinary share capitalShare premium - - Reserves 20 - - Unappropriated profit/(Accumulated loss) - -

- - Total Equity - -

Surplus on Revaluation of Fixed Assets 21 - - LiabilitiesInsurance Liabilities 22Liabilities under Investment ContractsRetirement benefit obligations 23 - - Deferred taxation 16 - - Borrowings 24 - - Premium received in advance - - Insurance / reinsurance payables 25 - - Other creditors and accruals 26 - - Taxation - provision less paymentsTotal Liabilities - -

Total Equity and Liabilities - - Contingency(ies) and commitment(s) 27

Rupees in thousand

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Comparison of profit and loss (Life insurers)Current Year Prior Year

Investment income not attributable to statutory funds

Income from trading investments

Gain/ loss on tradingDividend IncomeOthers if any (please specify)

Income from non-trading investments

Held to maturity or Available for sale (classify as appropriate)Return on government securitiesReturn on other fixed income securities and depositsDividend incomeOthers (please specify)

Gain/(Loss) on Sale of Investments Available for sale

Gain/(Loss) on revaluation of investmentsTrading investmentsAvailable for sale

Provision for Impairment in Value of investmentsProvision for portfolio held to maturityProvision for portfolio available for sale

Less: Investment Related Expenses

Net Investment Income

Rental income from investment propertyOther revenue (provide details)

Less: Expenses not attributable to statutory funds (provide details)

Add: Surplus transferred from statutory funds

Profit/(Loss) before tax (and extraordinary items, if any)

Extraordinary items (provide details)

Profit/(Loss) before Tax and after extraordinary items

Tax expense

Profit/(Loss) after tax

Profit and Loss appropriation account

Balance at commencement of the yearProfit for the yearPrior year adjustment (provide details)Dividends paidTransfers to / (from) reservesOther appropriations (provide details)Balance at end of year

NoteCurrent

YearPrior Year

Premium Revenue - - Premium ceded to reinsurers - - Net premium revenue 28 - -

Fee income 29 - - Net investment income 30 - - Net rental Income 31 - -

Net realised gains / losses on investment property

Net unrealised gains / losses on investment propertyOther income / loss 32 - -

Net income - -

Insurance benefits - - Recoveries from reinsurers - - Claims related expenses - - Net claims 33 - - Acquisition expenses 34 - - Marketing and administration expenses 35 - - Other expenses 36 - - Total Expenses - -

Finance costs 37 - -

Excess of Income over Claims and Expenditure - -

Add: Policyholder liabilities at beginning of year - - Less: Policyholder liabilities at end of year - - Results of operating activities - - Share of (loss)/profit of associates - - Profit before tax - - Income tax expense 38 - -

Profit for the year - - Other comprehensive income:

Change in unrealised gains/(losses) on - - available-for-sale financial assets

Currency translation differences - - (related to net investment in foreign currency)

Other comprehensive income for the year, net of tax - -

Total comprehensive income for the year - -

Earnings (after tax) per share - Rupees 39

Comparison of balance sheet (Non - life insurers)Current Prior Current Prior

Share Capital and Reserves year year Cash and Bank Deposits year year

Cash and other equivalent

Domestic companies Current and other accounts

Authorised Share Capital Deposits maturing within 12 months

Paid-up share capital Deposits maturing after 12 months

Retained earnings

Reserves Loans (Secured or un-secured - classify as appropriate)

Other equity (please specify) To employees

To agents

Foreign companies Others

Head office account

Other equity (please specify) Investments

Investment Property

Underwriting provisions

Provision for outstanding claims (including IBNR) Deferred Taxation

Provision for unearned premium

Commission income unearned Preliminary and Deferred Expenses

Current Assets - Others

Premiums due but unpaid

Total underwriting provisions Amounts due from other insurers/ reinsurers

Reinsurance recoveries due but unpaid

Deferred Liabilities Reinsurance recoveries against outstanding claims

Deferred Taxation Salvage recoveries accrued

Staff Retirement Benefits Premium and claim reserves retained by cedants

Others (please specify) Accrued investment income

Taxation - payments less provision

Deferred commission expense

Creditors and Accruals Other deferred acquisition costs

Premiums Received in Advance Prepayments

Amounts due to other insurers/reinsurers Sundry receivables(provide details)

Accrued Expenses

Taxation - Provision less payments Fixed Assets

Other Creditors and Accruals (describe) Tangible & Intangible

Land and Builldings

Borrowings Furniture, Fixtures and Office Equipment

Short term running finance Motor Vehicles

Loans received from banks Capital Work in Progress

Other loans Intangibles (Please specify)

Other debt security issued

Other liabilities

Other liabilities (please specify)

TOTAL LIABILITIES

TOTAL EQUITY AND LIABILITIES TOTAL ASSETS

CONTINGENCIES AND COMMITMENTS (if applicable)

NoteCurrent

year Prior year

Assets

Property and equipment 5 - - Intangible assets 6 - - Investment property 7 - - Investments in subsidiary and associate 8 - - Investments

Equity securities 9 - - Debt securities 10 - - Term deposits 11

Loans and other receivables 12 - - Insurance / Reinsurance receivables 13 - - Reinsurance recoveries against outstanding claimsSalvage recoveries accrued - - Deferred Commission Expense / Acquisition cost 29 - - Deferred taxation 15 - - Taxation - payment less provisionsPrepayments 16Cash & Bank 17 - - Total Assets - -

Equity and Liabilities

Capital and reserves attributable to Company's equity holders

Ordinary share capital 18 - - Share premium - - Reserves 19 - - Unappropriated profit/(Accumulated loss) - - - - Total Equity - -

Surplus on revaluation of fixed assets - -

LiabilitiesUnderwriting Provisions - -

Outstanding claims including IBNR 27 - - Unearned premium reserves 24 - - Premium deficiency reserves - - Unearned commission income 26 - -

Retirement benefit obligations 14 - - Deferred taxation 15 - - Borrowings 20 - - Premium received in advance - - Insurance / Reinsurance Payables 21 - - Other Creditors and Accruals 22Taxation - provision less paymentTotal Liabilities - -

Total Equity and Liabilities - -

Contingency(ies) and commitment(s) 23

Rupees in thousand

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Comparison of profit and loss (Non - life insurers)

Note Fire Marine, Motor Act Liability Others Treaty Current Prior& Aviation & Year Year

Property Transport AggregateAggregateRevenue AccountNet Premium Revenue

Net Claims

Premium Deficiency Expenses

Expenses

Net Commission

Underwriting result

Investment IncomeRental IncomeOther Income (provide details)General and administration expenses

Profit/(Loss) before tax

Provision for Taxation

Profit/(Loss) after tax

Profit and Loss Appropriation Account

Balance at commencement of year

Profit/Loss after tax for the yearPrior Year Adjustments (provide details)Proposed Dividend/Remittance to Head OfficeTransfers to/(from) reserves (provide details)Other appropriations (provide details)

Balance Unappropriated Profit/(Loss) at end of Year

NoteCurrent

year Prior year

Net insurance premium 24 - -

Net Insurance Claims 25 - - Premium Deficiency - - Net commission and other acquisition cost 26 - -

Insurance claims and acquisition expenses - -

Management Expenses 27 - - Underwriting results - -

Investment income 28 - - Rental income 29 - -

Other income 30 - - Other expenses 31 - - Results of operating activities - -

Finance costs 32 - - Share of (loss)/profit of associates - - Profit before tax - -

Income tax expense 33 - - Profit after tax - - Other comprehensive income:Unrealised gains / (losses) on - -

available-for-sale investmentsOthers (please specify) - - Other comprehensive income for the year - - Total comprehensive income for the year - -

Earnings (after tax) per share - Rupees 34 - -

Rupees in thousand

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Segmental information to be disclosed

The segment information which at present is given on the face of

the profit and loss account and the information in the statements

of premiums, claims, investment income and expenses have now

been presented in the note Segment Information.

Revenue Account in the life insurers financial statements now also

forms part of the Segment Information. Additionally Segmental

results by line of business are now to be disclosed:o an analysis between group life, group health, individual life

distributed through direct sales force, individual life distributed through banks;

o an analysis between business written in Pakistan and business written outside Pakistan.

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Change in presentation of Financial Statements - contd .

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Presentation of insurance liabilities

One of the major changes in the modified accounting

regulations for life insurers relates to the classification of

insurance liabilities:

1.Balance of statutory funds

Previously, retained earnings accounts A to D were part of

balance of statutory funds which was disclosed after the

Shareholders’ Equity.

In the modified accounting regulations retained earnings

accounts C and D, which are effectively arising out of

surplus of the statutory funds attributable to the

shareholders are therefore made part of shareholders’

equity.

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Presentation of insurance liabilities – contd.

2.Incurred But Not Reported Claims (IBNR)

IBNRs were previously made part of Policyholder

Liabilities on the basis that these are determined by

actuaries and payable to policyholders. However, the

nature of IBNR is different from policyholder liabilities in

that IBNR is something where the claim event has actually

happened but yet to be reported to the insurer. Whereas,

policyholder liability is in respect of future event. The

revised format of Financial Statements includes IBNR as

insurance liabilities after outstanding claims.

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EXISTING BALANCE SHEET

LINE ITEMS

• Outstanding Claims

• Balance of statutory fund

Balance of statutory fund

includes:

o Policyholder liabilities

(including IBNR)

o Balance in ledger

account A

o Balance in ledger

account B

o Balance in ledger

account C

o Balance in ledger

account D

Presentation of insurance liabilities – contd.

POST CHANGE BALANCE SHEET LINE ITEMS

• Insurance Liabilities

• Unappropriated Profit / (Loss)

Insurance Liabilities include:o Outstanding claimso IBNRo Policyholder liabilitieso Balance in ledger

account Ao Balance in ledger

account B

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Applicability of IAS 27, IAS 39 and IAS 40

• As per existing regulations, insurers are given certain

exemptions from IAS 27, IAS 39 and IAS 40.

• However, revised regulations have encouraged compliance

with IFRS, therefore these exemptions have been withdrawn.

• These are presented in next slides.

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Applicability of IAS 27, IAS 39 and IAS 40 – contd.

Applicability of IAS 27

As per existing regulations, consolidated published financial

statements in respect of investments made through statutory

funds is not required to be presented. However, this exemption

has been withdrawn in modified regulations.

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Applicability of IAS 27, IAS 39 and IAS 40 – contd.

Applicability of IAS 39

The existing regulations requires available for sale investments

to be valued at lower of cost or market value.

Now the accounting regulations adopts the requirements of IAS

39 completely and all investments requiring marked to market

will be valued accordingly.

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Applicability of IAS 27, IAS 39 and IAS 40 – contd.

Applicability of IAS 40

Under IAS 40 companies have the option to select accounting

policy of valuing investment property either on cost or fair value

basis. The existing regulations however provides restriction and

do not allow the use of fair value option. The revised accounting

regulation removes this restriction.

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In non-life insurance business, particularly in Marine Insurance

there is a practice of issuing cover notes for temporary period

which remain in force until the insurance policy is issued. It was

observed that the insurance companies start recognising the

accounting for such transactions only when the insurance policy

is issued. However, it was viewed that the company needs to

record the transaction since its inception.

The existing and revised requirements of the accounting

regulations are in the next slide:

Recognition of Cover Note in the books of accounts

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EXISTING

Premium receivable under a policy shall be recognised as written from the date of attachment of the policy to which it relates.

Recognition of Cover Note in the books of accounts- contd.

REVISED

Premium receivable under a policy / cover note shall be recognised as written from the date of attachment of risk of the policy / cover note.

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Explanation of management and other expenses – non-life insurers

Previously, there was no explanation of ‘expenses’ and ‘general and

administrative expenses’ for non-life insurers. However, in modified

accounting format ‘management expenses’ and ‘other expenses’

have been identified.

Following are included in other expenses in modified format:

o Legal and professional fee other than business related

o Auditors’ remuneration

o Subscription

o Registration fee

o Expenses of bonus issue

o Donations

o Workers Welfare Fund

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Change in premium deficiency requirement

Existing

Where the unearned premium

liability for any class of business is

not adequate to meet the expected

future liability, after reinsurance,

from claims and other expenses,

including reinsurance expense,

commissions and other

underwriting expenses, expected to

be incurred after balance date in

respect of policies in that class of

business in force at balance date, a

premium deficiency reserve shall

be recognised to meet the deficit.

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Revised

The provision for premium

deficiency (liability adequacy

test) shall be recognised in

accordance with the

requirements given in

International Financial

Reporting Standard 4 –

Insurance Contracts.

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Change in premium deficiency requirement– contd.

If an insurer's liability adequacy test meets the minimum

requirements as above, the test is applied at the level of

aggregation specified in that test.

Liability less related deferred acquisition cost

and intangible assets

then recognise deficiency in profit and loss

IF Current estimates of future contractual cash flows

Liability adequacy test

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Key issues highlighted in modified regulations – life insurance

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Possible adverse impact of taxation

• The taxability of life insurers is computed as per the

provisions of Fourth Schedule of Income Tax Ordinance,

2001. As per the Fourth Schedule only the amount of

surplus transferred from revenue account to profit and loss

account is subject to taxation.

• The existing regulations present separate revenue account

and profit and loss account in which the transfer of surplus

from revenue account to profit and loss account is separately

disclosed.

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Key issues highlighted in modified regulations – life insurance – contd.

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Possible adverse impact of taxation

• In the modified accounting regulations there will be no

revenue account and profit and loss account is prepared on a

combined basis for all statutory funds and shareholders fund

therefore, the transfer of surplus would not be separately

identifiable on the face of profit and loss account.

• The life insurance industry strongly feels that unless the

requirements of Income Tax Ordinance are changed to reflect

the new accounting regulations, taxation authorities may

create huge demands on the insurance companies.

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The amount representing solvency margin in account D

shall not be taken as equity.

The surplus of any statutory fund which is not yet transferred

to profit and loss account is disclosed as ledger account D

relating to non participating business. This amount may be

held in view of solvency margins. It is viewed that since there

is a restriction on transfer such amount should be treated as

liability.

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Key issues highlighted in modified regulations – life insurance – contd.

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Thank you

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