Insurance Company’s Main Challenges of Adopting IFRS 9

Nan Shan Life 256.3

AFS to NAT Nan Shan Life 95.3

2012 HTM to AFS

Fubon Life 19.2

China Life 384.8

Mercuries Life 161.5

2013

AFS to HTM Nan Shan Life 42

AFS to NAT Nan Shan Life 292.6

Taiwan Life 37.2

3.3. Insurance Company’s Main Challenges of Adopting IFRS 9 3.3.1. Contractual Cash Flows Characteristics Assessment

Contractual cash flows characteristic should be assessed by instrument level, the process of assessing Vanilla Bond3 may be simple but structured instruments should go through complex process. Under IFRS 9, structured instruments that the payments are contractually linked to the payments received on a pool of other instruments, such as mortgage-backed securities, should be assessed by using a” look through” approach. The approach looks at not only the terms of the instruments itself but also through the pool of underlying instruments. Insurance company should assess the term based on the conditions at initially recognition date and only the instruments that pass the contractual cash flows characteristics test could be book at amortized cost.

If the insurance company has difficulty to conclude that the contractual cash flows of an financial instrument is solely the principal and interest, the interests are the time value of money and credit risk associated with the principal outstanding during a specific period for could ,the

3 A bond with no unusual features, paying a fixed rate of interest and redeemable in full on maturity

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financial asset must be measured at fair value through profit or loss.

3.3.2. Business Model Assessment

The business model assessment is based on how key management actually manages the business instead of their intention for specific financial assets, a company may has multiple business model, one portfolios for collect contractual cash flows and other one for trading to realize capital gains. However, the insurance company manages cash flows, insurance liabilities and assets together upon asset-liability management concept, to maximize its financial results and match cash outflows to policyholders with inflows from investment and from new policyholders. The business model assessment requirement under IFRS 9 did not reflect the linkage between assets and liabilities from an asset-liability management approach.

In addition, assets-liability matching is not always achievable; the financial assets of sufficient duration assets are not available, especially in Taiwan. The insurance company may have the difficulty to make their assets and liabilities economically matched, nevertheless, the accounting mismatch.

3.3.3. The Consequence Effect of Adopting IFRS 4 Phase II

IFRS4 phase II may drive the desired classification under IFRS9, in order to minimize accounting mismatches and profit validity. Insurance companies should consider the impact of adopting IFRS 4 phase II.

Based on the latest development of IFRS 4 phase II, insurance companies have the option to reflect the changes in discount rate in profit or loss or OCI at portfolio level, however, insurance

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companies do not use simple debt or equity instruments to match insurance liability, the asset portfolios may include two or more type of assets classifications, furthermore derivative instruments may be used to diversify the foreign exchange rate risk. Assets-liability management strategy should be evaluated and reestablished carefully.

3.3.4. The Development and Implementation of Solvency II

A risk-based capital regime came into force in Taiwan in 2003; Taiwan is expected to come up with a regulation that will require insurers to do an Own Risk and Solvency Assessment (ORSA). Likewise, there have been discussions on the possible development of an economic capital model for the insurance industry.

Solvency II started with the intention of building upon measurement rules of the future IFRS for insurance contracts. The different IFRS and Solvency II timelines place insurance companies in a conflicting position. There are some overlaps and differences between Solvency II and IFRS 4 phase II (see figure 7). Insurance company should consider the consequence effect of adopting IFRS 4 phase II and have to evaluate the dependencies with Solvency II.

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Data source: Ernst& Young 2 , January 2012

Figure 7: Overlaps and Differences between Solvency II and IFRS 4 phase II

3.3.5. The Impact on the Assets that Have Been Reclassified Before Adopting IFRS 9

Insurance companies have to access and design the classification of financial assets at the initial date of application. Some financial assets will be qualified to be recorded at amortized cost but some should be measured at fair value. IFRS 9 should be applied retrospectively at the first adoption date; assets reclassification may have impact on the company’s equity. For instance, AFS investment be reclassified to amortized cost, thus, unrealized capital gain recognized on OCI should be reversed, the company’s equity will reduce simultaneously.

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3.3.6. Reclassification Is Prohibited under IFRS 9

A company is required to reclassify all effected financial assets when its business model change and such changes should be infrequent. Before adopting IFRS9, Taiwanese insurance companies reclassified the financial assets to mitigate the volatility of shareholder’s equity;

however, it is questionable whether the reclassification is a way for window - dressing financial reports or not. This reclassification is prohibited under IFRS9; insurance companies should classify the financial assets at initial recognition, only in rare circumstance that an insurance company could meet the criteria of change the business model and reclassify its financial assets.

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