New reporting standards will reveal to investors exactly how insurers’ reserves are calculated
A proposed overhaul of international insurance accounting standards could make insurers a more attractive investment, say accountants.
On Friday, the International Accounting Standards Board (IASB) published an exposure draft for accounting rules that would replace
the existing international financial reporting standards (IFRS) rules for insurance contracts worldwide. The industry has until 30 November to comment on the draft. In making the changes, the board aims to improve transparency and comparability of insurers’ financial reports globally.
Instead of detailing premiums minus claims at the top of their income statement, as happens now, insurance companies will be required to report four ‘building blocks’. These comprise a current estimate of future cashflows, the rate at which these future cashflows are discounted to represent their present value, an explicit risk adjustment, and a residual margin – in other words, the profitability of the contract over its life.
By separating the risk margin from the cashflows, investors should have a clearer view of the assumptions a company is making about the risk it takes on when it writes a contract and the reserves it is setting aside to cover it. Under current accounting, this is effectively hidden, making it difficult for investors to tell whether any profit from a contract was down to luck or good judgment.
“In the non-life sector, some would say it is a bit of a black box as to where the reserving number comes from,” PricewaterhouseCoopers partner Gail Tucker said.
Despite the work involved in adapting to the changes, accountants believe there are large benefits for insurers. The additional transparency and consistency, for example, could attract investors that have shunned the industry because of the difficulty in understanding and comparing insurance results.
“At the moment, there is an additional cost of capital for insurance companies when they want to raise money, simply because people don’t understand their financials,” Deloitte global IFRS insurance leader Francesco Nagari said.
In addition, the new regime would remove some of the distorting foreign exchange effects suffered by those companies that do a significant amount of US dollar business. Under the existing regime, unearned premium is classified as a non-monetary item and accounted for at a fixed exchange rate from the date the contract was entered.
But any associated dollar investments are accounted for at a current rate, creating a mismatch. “You get some quite big distortions, given the size of premiums relative to profits.
It has a very big effect on the income,” Ernst & Young’s global leader for IFRS insurance, James Dean, said.
Under the new regime, unearned premiums will be classified as a monetary amount and be accounted for at current interest rates.