TASK 1- FRS 4 : Insurance Contracts

Description
FRS 4 covers insurance contract issued by insurer and reinsurance contracts that it holds,
except for the contracts covered by other FRSs. Last but not least, FRS 4 - Insurance Contracts
does not address accounting by policy holders.

Issue/Advantage/Debate of the FRS
Many of financial report users considers insurance accounting in current FRS as a black
box that does not supply relevant information about an entitys financial status and execution.
Needs of FRS development are to:
1. Requires insurer to provide relevant information for economic decision making
2. Eliminate contradiction and deficiencies in current practices
3. Provide pliability across entities, jurisdictions, and capital market

Out of numerous issues in the current practice of FRS 4 Insurance Contracts, there are
several main issues that will be discussed further below.






Discount Rate
International Accounting Standard Board (hereafter will be referred to as IASB) proposed
that usage of discount rate by entities for non-participating contracts is suggested to reflect the
attributes of the insurance contract liability. This is because creation of bundle of rights and
obligation to produce a cash inflows (premium) and outflow (benefit and claims) in insurance
contract principle (IFRS, 2010).
Professional opinion (PriceWaterhouse Coopers)
While PriceWaterhouse Coopers (hereafter will be referred to as PwC) supports
reflection of insurance contract liability attributes through discount rate and not the entitys own
credit risk, it also supports the exception of liability measurement alteration. However, PwC
noted that some situations where personal account risk is exempted from discount rate may cause
in the loss recognition in day one. It could happen, for example, when insurance contract priced
by entity carry an expected return which is higher than the risk free rate. Its recommended that
IASB examine such uneconomic result in combination with field testing to see how exemption to
the model generally is acceptable and if there is a need to add extra disclosure
PwC also recommended a choice to use locked-in discount rate if it extinguish or
decrease an accounting mismatch and create consistency with the insurers business model of
fulfilling the contracts. This is due to IFRS 9 Financial Instruments supporting assets for
insurance contracts are allowed to be measured at amortized cost. This will lead to accounting
mismatch if insurer applies stated discount rate approach while applying amortized cost based on
IFRS 9 as well (PwC, 2010).






Risk Adjustment
IASB proposed the need of explicit risk adjustment with a purpose of reflecting the effect
of diversification emerged from within an insurance contracts portfolio and not the effects of
diversification between that portfolio and other portfolio. The insurer should use only confidence
level, conditional tail expectation, and cost of capital technique (IFRS, 2010).
Professional opinion (PriceWaterhouse Coopers)
PwC shows concern that the inclusion of explicit risk adjustment will question the
comparability among insurers. It is recommended that IASB works closely with the insurance
industry and financial statement users to understand the impact and operational feasibility of
explicit risk adjustment. If explicit risk adjustment is permitted in the measurement model, PwC
isnt convinced in the limitation of risk adjustment calculation to only 3 prescribed method.
Although PwC supports consistency in usage of methodology, this limitation will prevent insurer
from using unprecedented and better risk adjustment technique that may be discovered along the
way (PwC, 2010).
Residual Margin
IASB proposed the calibration of residual margin at an amount where insurer recognizes
no gain on entering into insurance contract. Over the coverage period, this amount will be
relinquished in a systematic manner based on passage of time except there is a more suitable
pattern of claims and benefits. IASB faces an issue whether to use residual margin and risk
adjustment separately or to use composite margin which combine both residual margin and risk
adjustment (IFRS, 2010).
Professional opinion (PriceWaterhouse Coopers)
Its a concern of PwC where residual margin isnt re-measured while all alteration in
approximates in comprehensive income statement is making use of immediate recognition.
Residual margin could have been recalibrated by using cash flow estimates with all current
information discounted at original discount rate. This would allow updated expected profit to be
reflected by the remaining residual margin and its relinquishment due to coverage period that use
latest information and prediction of future cash flows.
Recognition of a loss in the year period performance statement ensued by amortization of
profits from the relinquishment of locked in residual margin in the next periods will not produce
utilizable information when insurance contract becomes onerous after the issuance. In finalizing
composite margin model, its important that IASB work together with related industry to grasp
the implications and feasibility understanding of the approach (PwC, 2010).
Short Duration Contracts
IASB proposed the usage of allocation of premium received during the coverage period
of 1 year or less and estimation of claim liabilities for insured events that have already happened
through usage of building block approach (IFRS, 2010).
Professional opinion (Price Waterhouse Coopers)
Modification of measurement approach should be allowed and not obligatory since some
might discover that 2 different accounting methods are more difficult than using a full model to
all their contracts. Coverage period should be allowed if measurement under the full building
block model is predicted to be a sufficient estimation (PwC, 2010).








TASK 2 - J.P. Morgan & Co. Agency problem

Background
The company was started by a business man named J.P. Morgan in 1871 which known as
J.P. Morgan & Co in the future. The company works primarily as Financier. In 1895, the
company was powerful enough to be sought by America government to for help with depression
in that time. Furthermore, the company also helped in thwarting financial crisis in 1907. During
late 1800s, J.P Morgan & Co. was criticized for creating monopolies and dominated two
industries especially railroad industry in East and United States Steel Corporation in 1901
which became the Worlds largest steel manufacturer around 1911. Currently, J.P. Morgan &Co.
covers asset management, investment banking, private banking, treasury & security services, and
commercial banking (Morgan, 2013).
Issue
As one of the largest public traded business firm in the world, J.P. Morgan & Co.
(hereafter will be referred to as J.P. Morgan) was not seen to be unfamiliar with lawsuit, critics,
federal investigation, and issue with its investors and clients. The followings are few examples of
cases against J.P. Morgan:
In April 2011, New York Times investigated at a Lawsuit and observed how the bank
concealed its own end made a few billion dollars- while its clients lost hundreds of millions of
dollars (Chittum, 2011).
In the field of mortgages, J.P. Morgan & Bear Stearns were sued for misleading investors
in regards of mortgages-backed securities in the period of 2006-2007. The lawsuit also included
misinterpretations about the sale to four credit unions with the first lawsuit filed by Credit Union
Administration in 2011.
J.P. Morgan bought Bear Stearns in 2008. According to latest lawsuit in 2012, Bear
Stearns was seen to know that around 74% of subprime mortgage that it sold would fail within a
year. Despite this, it continued to sell the securities (Turner, 2012). In November 2012, J.P.
Morgan concurred to settle claims by Securities and Exchange Commission for $ 296.9 Million
in regards of Bear Stearns failure in providing problematic loans information in the portfolio
(Silver-Greenberg, 2013).
Out of these few cases, perhaps, the biggest and most influential issue that J. P. Morgan
has ever faced was known as London Whale that has caused losses around $6.2 billion which
is far from $ 2 billion estimation made by Jamie Dimon (CEO of J.P. Morgan) in May 2012.
Before, this big issued is discussed; maybe the first question that should be asked is how
investors and clients could involve with these problematic investments despite their background
profile and experiences in investment field.
A Man of Trust
Dont judge the book from its cover perhaps describe how Dexia, a Belgian-French
bank, and other clients and investors involved in J.P. Morgan issue feel in regards of investments
that they bought. J. P. Morgan management was led by its CEO, Jamie Dimon, who has a
brilliant profile. Jamie Dimon was a class A director (representative of member banks in the
district) during his serving time in Federal Reserve of New York (Johnson, 2012) and regarded
as the golden boy of the Wall Street (Business, 2012).
Beginning of an end
Jamie Dimon Joined J.P. Morgan in 2004 and was changing the company from a
conservative unit that manage risk to a profit center 2006. As Jamie Dimon became CEO, Ina R.
Drew (hereafter will be referred to as Drew) was appointed as Chief Investment Officer (CIO)
and directly reporting to the CEO. Jamie gave not only support to invest in riskier asset, but also
allow investment in credit derivatives such as Credit Default Swap (hereafter will be referred to
as CDS) and other risky instrument as a hedge during financial crisis in 2008 where the profit
surged as assets quadrupled to $356 billion (Kopecki & Abelson, 2012).



Weapon of Massive Destruction
CDS was a type of credit derivatives in which its principles were developed by Blythe
Masters and a team that worked at J.P. Morgan at that time. The principle idea in credit
derivatives was to remove default risk on loans from the loans itself, in which derivatives were
seen as financial weapons of mass destruction by Warren Buffet. In CDS case, the credit
derivative was an insurance against possibility of companys failure in paying its debt (such as
bonds) (Teather, 2008). Now, the second question is how can J.P. Morgan involved with CDS
despite of high default possibility in 2008? Isnt it like giving a house that has high chance to
collapse insurance?
London Whale
Due to CDS nature that acts as an insurance, instability of the market in 2008 drove the
demand of CDS as the market is afraid in the collapse of security price. J. P. Morgan identified
the opportunity and this might be the reasons of supports from the CEO to enter derivative
market. At the beginning credit derivatives trades were controlled tightly until Achilles Macriss
mandate, a team member of the CIOs, directed the bank into riskier products and less
disciplined approach in investing.
The team which was located in London accumulated a portfolio as big as $ 200 billion
with $5 billion profit in 2010 alone. One of the team members, Bruno Michel Iksil had collected
positions in securities big enough to drive prices in $10 trillion market in 5 April 2012. This
incident caused some participants to call him the London Whale (Kopecki & Abelson, 2012).
The Lemon failed to be Lemonade
Despite the profits that J.P. Morgan had accumulated during the transaction of credit
derivatives, a loss which was stated in May 2012 by Jamie Dimon grew into $ 6.2 billion dollars
lemon. Now, isnt there such thing called Volcker rule that ban this type of trading? The Volcker
rule ban commercial banks from speculative trading and allow hedging. Apparently, J.P. Morgan
received the funds from Federal Reserve and lied to banking regulator by claiming that the funds
will be used to hedge risk when the bank actually used the money to invest in credit derivatives
(Wagstaff, 2013).
There are several points that proved J.P. Morgan activity as proprietary trading and not
hedging (Phillips, 2013):
1. Traders were unpaid to hedge
When the point of an investment is to offset risk, there should be a reward for
traders for being a good risk off setter. However, reward was designed to pay
trader when profits are made when the real objective is to make financially
profitable bets

2. Hedging objective
When an investment is used to hedge, there must be something that it hedge
against. However, the London whale trades didnt specifically highlight what
they were offsetting against.

Outcome
The ambition of J.P. Morgan, which was led by the CEO Jamie Dimon, has shown how
distortion in rewards doesnt give shareholders better control over the company activities. From
year of 2000 until 2012, stock price has gone down 15% which affects shareholders and taxpayer
(bailout come from government which means usage of tax payers money) (Johnson, The
Problem with Corporate Governance at J.P. Morgan Chase, 2013).
Glass, Lewis & Co. and Institutional Shareholder Services Inc. have asked for
shareholders to vote against Jami Dimon who currently act as CEO and Chairman of J.P. Morgan
and split the role of Chairman and CEO. Theoretically, the role of the boards chairman was to
represent shareholders and keep the manager of the company to be honest. However, a study in
2011 by Conference Board discovered that the board capability is determined by his/her
knowledge, leadership skills, and influence instead of specific leadership structure. In nutshell, a
good Chairman is a good Chairman, regardless of the occupation as both Chairman and CEO or
not. Regardless of the debate, the outcome of the votes is predicted to be announced this Tuesday,
21 May 2013 (Matthews, 2013).

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