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New standards and their impact
- Accounting Standards Board introduced new standards to address when an entity would recognize a financial instrument on its balance sheet and how the financial instrument would be measured once recognized
- insurance contracts are excluded from scope of new standard, but use of a portfolio-based discount rate in determination of APV of policy liabilities results in an indirect impact of new standards
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Capital test would be affected by:
- adjustment for XS of market value over current book (used to recognize 50% of XS)
- capital required for assets (book value may change)
- capital required for UEP and unpaid claims (APV may change)
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Factors influencing expected investment return rate
- method of valuing assets and reporting investment income
- allocation of assets and income among LOBs
- return on assets at balance sheet date
- yield on assets acquired after the balance sheet date
- investment expense, and losses from default (C-1 risk)
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Held-to-maturity investments
- measurement is on an amortized basis
- net income is not affected by changes in fair value
- tainting: if sell more than an insignificant amount, all h-t-m assets must be reclassified as available-for-sale for at least 2 years
- this consequence is a major impediment to using this category
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Available-for-sale investments
- carried on the balance sheet at fair value
- investment income, changes in amortized cost, realized gains are booked to net income
- changes in the difference between fair value and amortized cost recorded as other comprehensive income (OCI) (segregate volatility of fair value outside of net income)
- following a market rate increase:
- assets: invested assets value decreases, no effect on net income, decrease in OCI
- liabilities: discount rate increases, decreasing liability value, so net income increases, with no effect on OCI
- equity: can go either way
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Held-for-trading including fair value option
- marked to fair value, with gains and losses recognized immediately in net income
- category can be used if can be proven that doing so eliminates or significantly reduces an accounting mismatch from measuring assets and liabilities on different bases
- following a market value increase:
- assets: invested assets value decreases, decreasing net income
- liabilities: discount rate increases, decreasing liability value, net income increases
- equity: can go either way
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DCAT impacts of new standards
- adverse scenarios relating to interest rates may have greater impact
- asset modelling requires more attention, particularly in regard to categorization
- models need to take into account new layout of financial statements
- may need to model tax timing differences
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4-level measurement hierarchy for fair value
- observable market prices, including market-based adjustments
- accepted valuation models or techniques
- (substitute) current cost, with possibility of substituting historical cost
- (substitute) models and techniques that use entity inputs
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