Insurance accounting standard proposals will usher in ‘fundamental’ change –Deloitte

Insurance accounting standard proposals would have a global impact and could fundamentally change the way insurance companies measure, report, and evaluate performance of their insurance contracts, Deloitte has said.

The professional services leader was reacting to the exposure draft (ED) of the new International Financial Reporting Standard (IFRS) for insurance contracts published by the International Accounting Standards Board on July 30.

The publication proposes fundamental changes to the financial reporting of insurance companies applying IFRS, with a goal of making it more consistent and transparent than it has been so far.

“Many insurance companies would experience a significant amount of change in their financial statements and would need to modify their information systems, risk management programmes, and possibly even product design,” Joel Osnoss, global IFRS leader, clients and markets, Deloitte Touche Tohmatsu, said.

“There would also be a need for education of stakeholders, including shareholders, policyholders, analysts, and more. In the end, the hope is for consistency, comparability, and transparency across insurance companies operating in different jurisdictions around the globe”.

The IASB has said there will be a four-month comment period on the ED, with the final standard due for publication next year. The mandatory application will be decided after comments have been received, and it will be at the earliest from ­January 1, 2013, when the other major change on investments accounting becomes effective. However, the IASB is prepared to delay the implementation date of the two projects in parallel if ­necessary.

Francesco Nagari, global IFRS insurance leader at Deloitte UK said the publication of the ED is a landmark stage in the IASB’s 13-year project to develop a consistent standard for insurance accounting and will have a significant impact on insurers across the world.

Under the proposed IFRS, all insurance contracts, both life and non-life, will be measured using the same building blocks based on discounted probability-weighted best estimate cash flows.

Insurers have been previously permitted to use very different methods to report insurance contracts, based on a variety of national practices developed under the previous IFRS. This has greatly reduced the comparability of insurers’ financial reports, penalising them when they accessed capital markets with a higher cost of capital than most other industries.

The IASB has also been working closely with the US Financial Accounting Standards Board (FASB) in developing the new IFRS.

“We understand that the FASB may publish its new proposals for insurance accounting in late August, meaning there is a prospect of truly global convergence in accounting for insurance contracts,” Mr Osnoss added.

The IASB ED contains two alternative approaches to this issue. In the first, an explicit risk liability is added to the best-estimate calculation of the insurance cashflows. This approach requires the insurer to make a judgment on how much profit to account for, based on the remaining uncertainty of the in-force contracts: the lower the uncertainty the higher the profit (with a resulting lower risk liability).

In the second approach, the profit is initially deferred and then accounted for in a systematic basis every year. With this method, profit recognition is independent of whether the future cash flows are more or less uncertain than last year.

The IASB has requested respondents to the ED to provide their views on the two approaches, having expressed a preference for the first approach. The FASB instead does not support it because they believe there are not yet generally accepted and reliable techniques to calculate this risk liability. Mr Nagari encouraged insurers to start planning for the introduction of the new IFRS. He said developing the building blocks will require many insurers to reorganise their data in different ways or develop new valuation models.

“A successful operational implementation of the new standard will require consideration of the impact on projects in other developing areas. In particular, Solvency II within the EU is based on a valuation model for insurance liabilities that is very similar to the one preferred by the IASB, and the Solvency II regulations require a reconciliation between the IFRS and the Solvency II valuations to be published every year,” he said.