Insurance and Pension Services

1. Insurance and Pension Services Workshop on International Trade in Services Beirut April 18-20, 2011

2. Overview Include services for providing: • Nonlife insurance (incl. freight), life insurance and annuities, reinsurance, pensions, standardized guarantees, auxiliary services • (see SNA 2008 paras. 6.175-6.206) Insurance and Pension Services

3. Overview • Insurance • nonlife insurance • are designed primarily to spread risks across all policy-holders • typically, number of claimants much smaller than number of policyholders; no relationship for individual policy-holder between premiums paid (“price”) and claims received • but insurance companies establishes such relationship mostly on annual basis • pay claim only if an insured event occurs Insurance and Pension Services

4. Overview • Insurance • life insurance • policyholder makes regular payments in return for an agreed sum, or an annuity, at a given date • form of saving • relationship between premiums and claims over time; insurance company must combine saving aspect of a single policy with actuarial calculations on insured population when determining relationship between premium and benefit (e.g. analysis of mortality, production of life-tables, etc) • redistribute income for a single policyholder across time periods Insurance and Pension Services

5. Overview • Insurance • reinsurance • allows insurance risk to be transferred from one insurance provider to another • direct insurers become policy holders and may pass on • the entire risk / a proportion of risk / a risk above a given threshold (e.g. due to a catastrophic loss) • undertaken by few companies and usually cross-border in nature! • no consolidation between direct insurer as issuer of policies to its clients, and as a holder of a policy with the re-insurer • Two types of reinsurance: • Proportionate reinsurance: the insurer accepts an agreed proportion of the risks • Excess of loss reinsurance: the re-insurer pays all losses over a given threshold Insurance and Pension Services

6. Overview • Insurance • freight insurance • raises particular issues for the valuation of goods • provides coverage against theft, damage, and lost of freight • the FOB concept determines who pays the insurance, and whether it is included in the price of the good (included in FOB price up to the border of exporter; beyond exporters border, premiums are payable by importer) Insurance and Pension Services

7. Overview Pension services similar to insurance— providers act as intermediary for investing funds and redistribute some risks provide benefits for retirement or invalidity of specific groups of employees may be operated as a separately constituted fund as part of the employer, or unfunded Insurance and Pension Services

8. Overview Standardized loan guarantee schemes common for student loans and export guarantees distinguished from one-off guarantees or financial derivatives issued in large numbers (usually for fairly small amounts) may be issued by financial institutions or government Insurance and Pension Services

9. Overview Standardized loan guarantee schemes similar in nature to nonlife insurance not possible to establish likelihood of default on a specific loan but possible andstandard practice to estimate how many loans out of a given batch would default guarantor operating on commercial terms would be able to cover expected defaults based on fees, investment income, and reserves Insurance and Pension Services

10. Measurement of output /insurance servicesFor nonlife insurance: Transactions between insurer and policyholder include: insurance company accepts premium from a client holds it until a claim is made, or insurance period expires in the meantime, it invests the premium the investment income is an extra source of funds to meet claims due income is implicit supplement to actual premium, attributed to client Insurance and Pension Services

11. Measurement of output /insurance servicesFor nonlife insurance: Insurance company sets level of actual premiums, so that Premiums earned + investment income earned on them – expected claims = margin that insurance company can retain represents what is available to enterprise to cover costs and provide operating surplus Insurance and Pension Services

12. Measurement of output /insurance servicesFor nonlife insurance However, recording actual premiums received and claims paid would not reflect these links between premium and claims, therefore these processes have to be rearranged to partition actual transactions and impute others … in order to bring out the underlying economic nature of these operations Insurance and Pension Services

13. Measurement of output /insurance servicesFor nonlife insurance: In order to “mimic” the premium setting policy of insurance companies, and to avoid extremely volatile, or even negative output of the insurance activity,… …we have to identify five separate items: premiums earned premium supplements expected claims claims payable adjusted for claims volatility insurance technical reserves Insurance and Pension Services

14. Measurement of output /insurance servicesFor nonlife insurance: • Accrual principle. • gross premiums paid vs. premiums earned (receivable) • claims paid vs. claims incurred (payable) Insurance and Pension Services

15. Measurement of output /insurance servicesFor nonlife insurance: gross premiums earned: proportion of actual premiums, relating to the accounting period in question rather than to the period covered by the insurance policy refers to those premiums payable that cover the risks incurred during the accounting period differ from premiums received, as they are usually paid in advance Example: annual policy with a premium of 120 starts April 1, with the accounts being prepared for the calendar year premium earned is 90 unearned premium is 30, which is actual premium received for period past the accounting period, i.e. prepayment for first 3 months of next year = credit extended by the policyholder to insurance company, i.e. unearned premiums Insurance and Pension Services

16. Measurement of output /insurance servicesFor nonlife insurance: claims payable: claims for events that occurred during the accounting period, even if payment is made some time later Claims outstanding cover claims that have not been reported have been reported but not yet settled have been reported and settled but not yet paid … and are recognized as due on an accrual basis, whether or not paid, settled or reported. claims payable include claims paid plus “reserves against claims outstanding” Insurance and Pension Services

17. Measurement of output /insurance servicesFor nonlife insurance: adjustments for claims volatility: to reflect a longer term view of claims behavior level of claims varies from year to year, with exceptional events causing high level of claims However, the concept of insurance service is the service of providing cover against risk; production occurs continuously, and not just when risk occurs! volume / price of insurance services should not be affected by volatility of claims Insurance and Pension Services

18. Measurement of output /insurance servicesFor nonlife insurance: adjustments for claims volatility: = difference between actual claims and a normally expected level of claims adjusted claims may be calculated by modeling past claims (= expectations approach, ex-ante) , or from accounting information (ex post) without adjustment, output could turn negative for some types of nonlife insurance, limited volatility and no adjustments necessary Insurance and Pension Services

19. Measurement of output /insurance servicesFor nonlife insurances: • reserves in insurance: • in many cases, the insurance period for which a premium is paid in advance and during which the insurance company bears the risk does not correspond with the financial year • the part of the premium relating to the insurance period falling in the next financial year has not been earned by the end of the current year, and must be transferred to reserves at the end of the financial year Insurance and Pension Services

20. Measurement of output /insurance servicesFor nonlife insurance: reserves in insurance: since not all claims will be settled by the end of the financial year in which they arise, provisions must be made in the balance sheet for these outstanding claims or claims likely to be incurred but not yet notified. Such provisions are known as loss reserves or reserves for claims outstanding (= accrual accounting, estimates for claims not yet reported are correctly included) Insurance and Pension Services

21. Measurement of output /insurance servicesFor nonlife insurance: reserves in insurance: = amounts of the estimated obligations to beneficiaries and holders that were accrued during the period in the time between, the sum involved is at the disposal of the insurance company to invest and earn income from it the income earned from it allows to charge lower premiums Insurance and Pension Services

22. Measurement of output /insurance servicesFor nonlife insurance: premium supplements: as part of the business of insurance companies, these reserves are managed on the financial markets the income generated by these investments have a considerable influence on the level of premiums that these companies have to charge; they can give a “discount”, i.e. lower the premiums suppose an insurance company receives 100 as premiums and pays 102 as claims. Is it making a loss? not necessarily. If the 100 is paid at the start of the year , invested and earns 5, the insurance company is 3 better off at the end of the year Insurance and Pension Services

23. Measurement of output /insurance servicesFor nonlife insurance: premium supplements: consequently, the income earned is treated as being receivable by the policyholders who are then treated as paying it back to the insurance companies as premium supplements (=imputation) Insurance and Pension Services

24. SummaryFor nonlife insurance: Derived items for the BOP? (viewpoint: resident insurer) • Goods and services account: • insurance services= gross premiums receivable + premium supplements - expected claims (actual claims payable plus adjustment for claim volatility) • Primary income account: • investment income attributable to policyholder (premium supplements) • Secondary income account: • net premiums receivable= gross premiums receivable + premium supplements – insurance service • claims payable • Financial account: • insurance reserves, (increase in liability to insurances holder) • (currency and deposits, i.e. premiums received; claims paid) • IIP: • the stock of claims outstanding Insurance and Pension Services

25. ExampleFor nonlife insurance: Calculation of nonlife insurance services • Resident insurers with separate data on policyholders abroad: • Example: The insurance corporation determined the premium charged for home insurance in a year by relating them to the amount of claims it expects to pay in a certain geographical area this year (excluding certain types of disasters, such as flood and earthquakes, that require additional coverage) Insurance and Pension Services

26. ExampleFor nonlife insurance: Calculation of nonlife insurance services Resident insurers with separate data on policyholders abroad: Premiums earned from abroad_________100 (premiums received 105) Claims payable abroad________________140 (claims paid 130) Net increase in technical reserves relating to insurance with nonresidents due to prepayment_______5 Net increase in technical reserves relating to insurance with nonresidents due to claims incurred but not yet paid _______10 Income attributable to policyholders______5 (premium supplements) Adjustment for volatility in claims payable:______- 40 Insurance and Pension Services

27. ExampleFor nonlife insurance: Resident insurers with separate data on policyholders abroad: Derived items for the BOP? (viewpoint: resident insurer) • Goods and services account: • insurance services= gross premiums receivable + premium supplements - expected claims (actual claims payable plus adjustment for claim volatility) • expected long-term claims: claims payable – adjustment: 140 – 40 = 100 • 100 + 5 – 100 = 5 • Primary income account: • investment income attributable to policyholder (premium supplements) • = 5 Insurance and Pension Services

28. ExampleFor nonlife insurance: Resident insurers with separate data on policyholders abroad: Derived items for the BOP? (viewpoint: resident insurer) Secondary income account: net premiums receivable= gross premiums receivable + supplements – insurance service 100 + 5 – 5 = 100 claims payable = 140 Financial account: insurance reserves, increase in liability to insurances holder 5 + 10 = 15 currency and deposits, decrease assets 105 – 130 = - 25 Insurance and Pension Services

29. ExampleFor nonlife insurance: (ii) Resident insurers with separate data on policyholders abroad for premiums only: • Total insurance services (to residents and nonresidents combined)__50 • Total premiums_________________________________________200 Of which: Premiums from residents____________________120 • Premiums from nonresidents_______________________________80 • Estimated insurance services provided to nonresidents, using a ratio____20 = 80 / (200) * 50 • Exports of nonlife insurance services can be approximated by using ratios, according to the lines of business (reinsurance, term life, etc) • The same pro-rating technique can be used for life insurance, pension funds, and standardized guarantees • Premium supplements and claim volatility should be taken into account Insurance and Pension Services

30. ExampleFor nonlife insurance: (iii) Nonresident insurers with resident policyholders: • Premiums from residents_________________________________40 • Ratio of service charge to premiums (av. from data on insurers abroad)—25% • Estimated insurance services from nonresidents_______________10= 40 * 0.25 • For imports of services, information is less complete. • ratios from resident insurers of the same type may be approached • ratios could be taken from published accounts of large insurers, or other countries • To avoid understatement of services, premium supplements and claim volatility should be taken into account for estimates Insurance and Pension Services

31. ExampleFor nonlife insurances: Expectations approach (ex ante): actual premiums earned plus premium supplements minus adjusted claims incurred adjusted claims (and also to a lesser extent premium supplements) are estimated from a model based on past pattern of claims payable advisable to use information broken down by line of insurance Accounting approach (ex post): adjusted claims are determined by actual claims incurred plus the changes in equalization provisions* and, if necessary, contributions from own funds *equalization provision are funds the company sets aside to meet unexpectedly large claims output may be estimated based on sum of costs, plus an allowance for normal profit See paragraphs 17.26 – 17.29, SNA 2008 Insurance and Pension Services

32. Measurement of output /insurance services Calculating the output of reinsurance, and of standardized guarantee schemes is the same as for non-life insurances. Insurance and Pension Services

33. Measurement of output /insurance servicesFor life insurance: • Gross premiums earned + premium supplements – benefits due – increases (+decreases) in life insurance actuarial reserves Insurance and Pension Services

34. Measurement of output /insurance servicesFor life insurance: • Actuarial reserves: • underwriting reserves for life insurance which, together with future premiums, serve to ensure that sufficient funds are available to pay all benefits to which an insured person may be entitled • or: an actuarial reserve is a liability equal to the present value of the future expected cash flow of a contingent event; i.e. present value of the future cash flows of an insurance policy Insurance and Pension Services

35. Measurement of output /insurance servicesFor life insurance: the bonuses declared to holders of life policies should be recorded as investment income receivable by the policyholders and are treated as premium supplements paid by the policyholders to the insurance corporations these payments are the rewards for putting financial assets “at the disposal” of the insurance corporation two further distinguishing features: length of time between payment of premiums and receipt of claims certainty that a claim will occur for these reasons, part of the premiums paid may be regarded as saving and part of claims as withdrawals from savings Insurance and Pension Services

36. Measurement of output /insurance servicesFor life insurance: net premiums and payments of benefits are therefore recorded in the financial account, rather than the secondary income account Insurance and Pension Services

37. BPM5 – BPM6: Summary Changes from BPM5 entail that premium supplements are taken into account reinsurances and direct insurances are treated consistently the estimate of insurance claims used to derive the value of insurance services may be adjusted to take account of claim volatility more detailed elaboration of accrual principle and on pension schemes and standardized guarantee schemes Insurance and Pension Services

38. BPM5 – BPM6: Summary Changes from BPM5 entail that insuranceclaims may be treated as capital transfers in exceptional cases of catastrophic losses to be consistent with the SNA provisions for calls under standardized guarantees are identified and treated similarly to insurance technical reserves BPM5's definition of technical reserves is effectively the same as in BPM6 (see BPM5 257, footnote 6 ), with technical reserves recorded as separate additional detail in other investment / other assets/liabilities, where relevant Insurance and Pension Services