In the eye of the beholder– Jerry de St. Paer

This is a truly international effort as the London-based International Accounting Standards Board (IASB) works closely with the US Federal Accounting Standards Board (FASB) to try to ensure that the effort creates a level playing field across borders. As with the solvency standards, the US, Europe and the rest of the world do not exactly see eye to eye on these fundamental changes and convergence will take longer than the purists would like to see. But again as with Solvency II, the clock is ticking and the IASB wants to see a standard agreed by the summer, a deadline that many believe is too soon. Jerry de St. Paer, Executive Chairman of the Group of North American Insurance Enterprises (GNAIE), has been a leading figure involved with the lobbying effort in the US and internationally. In the first of a new series of interviews in which leading market figures are given the platform to state their views on a pressing issue, Commercial Risk Europe Editor Adrian Ladbury asked Mr de St. Paer some basic questions about the new rules and how it may affect policyholders and their carriers.hideAdrian Ladbury (AL): What in essence do the IASB and FASB propose to improve the way insurance accounting works for users of insurance company accounts such as policyholders? Jerry de St Paer: The IASB proposes and the FASB seeks comments on a comprehensive framework in which most insurance contracts would be measured by a current measurement model using these building blocks—the expected value of future cash flows, discounted to reflect the time value of money, and with margins. Cash flow estimates and discount rates would be updated at each reporting date. The FASB and IASB have different views on the nature and composition of the margins; but both would calibrate the margins in total so that no gain is recognised at the inception of insurance contracts. There is no generally accepted methodology for developing the discount rates or the risk margins. And the IASB would not intend to issue guidance on these issues. A simplified premium allocation measurement basis would be allowed for short duration insurance contracts without discounting, generally those contracts covering personal lines, property and casualty insurance risks. The boards believe that this accounting framework will provide information that will be relevant to users of financial statements and will provide comparability across entities, jurisdictions and capital markets. AL: How do the proposals contained within the IASB exposure draft published last summer and the FASB discussion paper published later in the year improve on the current system? How will they make insurance accounts easier to read and compare nationally and across borders? JdSP: The current IFRS (International Financial Reporting Standard) for insurance contracts (IFRS 4) is a temporary standard that allows continuation of most accounting practices that were in effect when IFRS 4 was issued in 2004. Thus, IFRS 4 allows continuation of accounting practices that can be very different in different countries. The FASB has a comprehensive framework to account for insurance contracts of insurance entities through different models depending on the nature of the insurance contracts. The FASB is deliberating with the IASB to determine whether the proposed changes will improve current US GAAP and will provide opportunities for a converged international standard. Some users of financial statements describe accounting today for long duration insurance contracts as a ‘black box’ that does not provide them with understandable relevant information. However, long duration insurance (typically life insurance and some annuity and health insurance) is a complex business, and it is not clear that accounts prepared according to the proposed model will be more understandable or reliably reflect the economics of the business. The IASB has coordinated limited field testing of the proposals, and the results are not conclusive. Additional field testing is needed to assess whether results of the proposals are relevant and a faithful representation, or will be more understandable and comparable among insurers. AL: What are the key differences in the suggestions of the FASB and IASB and why are there differences at all? Can these be reconciled and how? Is there a realistic chance of having a common international system any time soon? JdSP: The IASB has been deliberating a financial reporting standard for insurance contracts for over a decade. The FASB formally joined this project in 2008, but it was monitoring the IASB’s work on insurance contracts for several years before that. The two boards have been able to reach consistent positions on many of the key issues over their two years of joint deliberations, but a few differences remain. The FASB’s recent exposure document is a discussion paper, in which they seek input on their preliminary views and on issues on which they have not yet reached preliminary views. The IASB’s document is an exposure draft, which is closer to a final standard and in which they take positions on essentially all issues. The main issues on which the boards have different positions relate to the margins building block. While both boards would calibrate the initial margin to result in no gain at inception of an insurance contract, the FASB proposes a single composite margin which would be run off over the entire period until all of the insurer’s liabilities under the insurance contracts have been satisfied. The IASB proposes margins in two parts. First, a calculated risk adjustment, which conceptually is supposed to represent the maximum amount the insurer would rationally pay to be relieved of the risk that the ultimate cash flows to fulfil its obligations will exceed those expected. Second, a residual margin which would be calibrated to no gain at inception. The risk adjustment would run off as the insurer’s obligations are satisfied, while the residual margin would run off over the period of the insurance coverage. In most cases, the total margin at inception would be the same in the IASB and the FASB proposals, but the patterns of run-off would be very different. The margins in the FASB proposal are easier to calculate and understand, but the IASB believes that its margin proposals present better information on the uncertainty in timing and amount of insurance cash flows. However, many observers question whether risk adjustments calculated by different insurers would be comparable, or would reasonably describe the risks that insurers face. As mentioned above, there is no generally accepted methodology for calculating risk margins. The key issues on which the FASB has not yet reached preliminary conclusions include the simplified measurement approach for short duration (generally property and casualty) insurance contracts, and the model for presentation of financial results of insurance contracts. In its discussion paper, the FASB seeks comments on the positions taken by the IASB. AL: How are the FASB and IASB working together? JdSP: The boards began joint re-deliberations on insurance contracts in January, which included analysis of the comment letters the boards received on their exposure documents and the results of the limited field testing that has been done. The boards received over 320 comment letters from interested parties. The next step may not be a converged international standard, but it is likely that the differences in positions of the two boards will continue to narrow. AL: What is the current timetable for the introduction of a new accounting standard for insurance contracts and will this be achieved? Is there any chance of a delay and how would this be justified? JdSP: The board’s plan joint re-deliberations of insurance contracts over the first half of this year, and the IASB intends to finalise a standard (a new version of IFRS 4) by mid-year. At the end of these re-deliberations, the FASB will decide whether to issue an exposure draft for a new US GAAP standard for insurance. It is not clear when a new standard would be effective. Both boards are also seeking comments on a transition to several new standards that they are considering, and whether the effective dates of various new standards should be coordinated. They received a lot of feedback that the effective dates for new standards on insurance contracts and financial instruments should be consistent, because meaningful financial reporting for many insurance entities is heavily dependent on consistent accounting treatment of insurance liabilities and underlying financial assets. As I indicated above, the current IFRS for insurance contracts (IFRS 4) is a temporary standard that does not provide consistent treatment in different countries, while the FASB has a comprehensive financial reporting framework for insurance. Also, there is particular pressure on the IASB to have a new comprehensive accounting framework for insurance that aligns with requirements for the new Solvency II, although that pressure has lessened since the financial crisis demonstrated weaknesses in the Solvency II methodology. Therefore, there is more current pressure on the IASB to issue a new standard, although the FASB is very interested in improving the current framework and in convergence with IFRS. AL: What other interest groups has GNAIE worked with on this, notably in Europe, and do you present a common view? JdSP: GNAIE has been working with other interested parties for many years. In 2004, the IASB formed an Insurance Working Group, consisting of insurance financial reporting experts, to advise the board on this project. Several GNAIE members have been active in this group from the beginning, along with representatives of insurers from around the world, financial statement users, accounting and actuarial firms and professional organisations. We have worked with the CFO Forum and large Japanese life insurers in particular. We issued a joint comment letter with these organisations on the IASB’s 2007 discussion paper on insurance contracts, and have joined with them in other letters to the IASB over the years. We have many common views, although there are some points on which we differ. Over the years, the main differences between GNAIE and the CFO Forum (the group of CFOs of leading European insurers) positions have been in financial reporting for property and casualty contracts, the bases for determining the discount rates to be used in measuring the present value of expected cash flows, and the risk margins to be included in insurance liabilities. However, as the IASB and perhaps the FASB move closer to a new standard, and as the proposals and the problems with those proposals have become more clear, the global insurance industry has increased efforts to reach agreements that have eluded us until now. A particularly promising approach we’re now discussing is based on the approach the IASB took in IFRS 9, in which the classification and measurement of financial instruments is based in large part on the entity’s business model in managing those instruments. .............. The IASB singled out a number of key areas within the proposed accounting standards that need ‘re-deliberation’ in combination with the FASB over the coming months. These are the most important points of debate. CRE Editor Adrian Ladbury asked Jerry de St. Paer, Executive Chairman of the Group of North American Insurance Enterprises (GNAIE), to explain his perspective on each point. Click here for his explanations of the specifics.

In the eye of the beholder– Jerry de St. Paer

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