CIA PD 30: 3855 Implementation:SLF View

Chris Christaki

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Introduction• 3855 = FIAC = Financial Instruments Accounting Changes• Sun Life world wide project• Main areas of Canadian impact:

– Investment Accounting– Tax– Actuarial Reserving– Impact to quarterly close period

• Lesson Learned:– knew International GAAP was on the horizon– Took simplest approach possible that was acceptable

under CSOP– Could have made this more complicated – but shelf life

is short (4-5years)

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Accounting Mismatch, Term of Liability>0• Under CALM, Actuarial Liabilities are equal to the Statement Value of the assets that back them.• Both AFS and HFT assets use market value on balance sheet.• Impact of Unrealized Gains and Losses on Actuarial

Liabilities always flows through Income via change in Actuarial Liabilities. (i.e., don’t get USGAAP shadow treatment)

HFT: Unrealized Gains and Losses in Income

Stable Income

AFS: Unrealized Gains and Losses in OCI

Unstable Income

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Accounting Mismatch, Term of Liability>0

Conclusion

– Choose HFT whenever possible

– Opposite of USGAAP• Lesson Learned: it is troublesome to have the

same asset designated 2 ways for 2 different bases. Lack of shadow accounting on the liabilities has created this.

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Accounting Mismatch, Term of Liability=0• Under CSOP, Actuarial Liability is equal to the Account Value or undiscounted value (e.g., IBNR)• Unrealized Gains and Losses do not impact Actuarial Liabilities and never

flow through Income via change in Actuarial Liabilities

HFT: Unrealized Gains and Losses in Income

Unstable Income

AFS: Unrealized Gains and Losses in OCI

Stable Income

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Accounting Mismatch, Term of Liability=0

Conclusion:• Choose AFS whenever possible• Same as USGAAP

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Valuation

Goals• Maintain existing control processes• Minimize inappropriate volatility of income

Issues• Deferred Tax Accounting

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Four Valuation Methods• CFVM (Cash Flow Valuation Method)• PPM + Fair Value Adjustment• Modified Account Value (some participating

products)• Account Value for term 0 liabilities

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PPM + Fair Value Adjustment

AssetsofValueStatement3855Pre

AssetsofValueStatement3855Post

Reserve3855PreReserve3855Post

•Use for portfolio segments

•Maintain Pre-3855 accounting and reserving

•Keep existing controls

•Stable base for SOE and MCCSR (e.g. Negative Reserves)

•Maintain Policyholder Reasonable Expectations (PRE) in Group and Individual Life

•Lessons Learned:

•double work for Investment accounting,

•Investment Accounting was not preserved perfectly,

•must carefully consider what is included in ratio (surplus, goodwill, short term liabilities).

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CFVM (Cash Flow Valuation Method)

FlowsCashAssetProjectedofValueDiscounted-

FlowsCashLiabilityProjectedofValueDiscounted

AssetsofValueStatement3855-Post Reserve3855-Post

•Use for CFVM segments (Individual Wealth and GRS)

•Manage under Discounted Values

•Keep existing controls

•Keep existing SOE

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Modified Account Value

AssetsofValueStatement3855Pre

AssetsofValueStatement3855Post1,Max

ValueAccountReserve3855Post

• Applies to Dividends on Deposit (DOD)• Demand liability, but credited rates are tied to portfolio rates on Pre-3855 basis• Because of PRE cannot change credited rate strategy quickly• If Post-3855 Asset Value> Pre-3855 Asset Value, need reserve larger than account value to support future credited rates

Term of Liability>0

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Modified Account Value cont’d

• If Post-3855 Asset Value < Pre-3855 Asset Value, Term of Liability=0, since extending the term of the liability lowers the reserve below the account value

Account Value Floor

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Account Value• Use for liabilities with Term of Liability=0• In theory should be backed with AFS assets to get

stable Net Income• Use HFT as liabilities are small and income

volatility from accounting mismatch is small

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Deferred Tax Accounting• Do CALM on a no-tax basis• Remove best estimate timing differences and

calculate Discounted Deferred Tax Liability (DDTL)

• Some 3855 adjustments are not taxed because they are permanent differences:Changes flow directly to after tax income

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December 28 2006 Proposals• Mark-to-Market Properties

• Gains/losses realized before 2007 continue to be spread over the remaining term to maturity• All debt obligations carried at fair market value for accounting purposes will be mark-to-market for

tax (Under current rules only new debt obligations were mark-to-market for tax)• Unrealized gains/losses of these investments as at January 1, 2007 will be spread evenly over a 5-

year period

• Changes in Policy Reserves

• Post-1995 Tax Reserves• Increase or decrease in reserves as of January 1, 2007 spread over 5 years starting with 2007

• Pre-1996 Tax Reserves• Beginning January 1, 2007 tax reserves for pre-96 policies (but not health) will be based upon

statement reserves (i.e. the rules that currently apply to post-1995 tax reserves will apply to ALL reserves). The one time change in pre-1996 tax reserves will be spread over 5 years starting with 2007

• Capital Tax

• Excess of statement policy reserves over tax policy reserves no longer in base

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December 28 2006 Proposals• GOOD NEWS – simpler!• BAD NEWS

• so late, no time to react• No real law, no guidance – essentially no one knew

what to do• CLIFR letter was distributed in April 13 (after quarter

end!)• Lesson Learned: If possible, try to start lobbying the

Department of Finance earlier to ensure there is enough time to implement appropriately.

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Accounting Issues• Should the Tax proposals be considered in the restatement under 3855 of

the opening balance sheet for 2007?• Tax proposals are not substantively enacted and may not be for some

time: • Debt Obligation and Capital tax proposals require changes to

Income Tax Act. Requires passing 3rd reading to be substantively enacted under minority government

• Reserve proposals require changes to regulations. To be substantively enacted, the Privy Council must pass an order (called an "Order in Council"). This process takes considerable time ..sometimes years

• Result – tax had to use current rules for all their calculations• Are the changes to the pre-’96 reserves separate from the 3855

changes and does the change flow through income? • agreement that it is not part of 3855 and that it will flow through

income

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Actuarial Concerns and Issues• CLIFR letter:

• No adjustment to 2006 year-end liabilities• Adjustments to opening balance sheet:

• Caution should be used in projecting any favourable tax timing changes as a result of the accounting changes

• If liabilities reduce, ignore impact until proposal is substantively enacted

• If liabilities increase, assume that proposed rules are a reasonable best estimate of future tax regulations

• Evaluation is in aggregate, but done separately for shareholders and policyholders

• Result: • For Actuarial Liabilities we used Proposed Rules (Dec 28th)• Set up additional tax PfAD in case of changes to proposed

rules• Similar approach in par blocks

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Implementation Challenges and Issues

• CRA (Canada Revenue Agency) likely will administrate as if rules were in place for 2007

• Implication:

• After-tax actuarial liabilities are done on proposed rules.

• Tax accounting done on current rules

• Use carve-out to preserve impact of proposed rules by looking at what Tax department has actually booked

• Lesson Learned: Work needs to be done twice• Accounting rules do not permit you to do anything else (Current rules)• Actuarial Rules allow you to do what is reasonable (Proposed rules)

(CSOP 1130.10)• Some asset segments did not line up with liability segments – this created a host

of issues

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Other 3855 related Impacts• SOE – preserved pre-3855 SOE and created new source

called 3855 (plan to drill down into more detail if needed).

– Lesson Learned: optimal solution is to apply 3855 appropriately to each source.

• EV – Changes were minimal– Only real impact is cost of capital due to increase in

MCCSR• CALM – CALM is essentially 3855 blind

• Essentially a cashflow is a cashflow• Need alternative base for any assumption that is based

on statement value of reserves e.g. defaults, investment expenses, etc…

• Lesson Learned: less 3855 impact in segments that are better matched