Insurance accounting rules finally underway, prepare for a bumpy ride

In a new Sigma survey published by the reinsurance group, Swiss Re pointed out that the timetable for implementation is likely to be further delayed. The reinsurer believes that near-term prospects are 'not bright' for a converged global insurance accounting standard. The reinsurer said that the recent shift in accounting towards an economic view is a big improvement. But it added that more transparency is needed.hideThe publication Insurance accounting reform: a glass half empty or half full? concludes that the proposed accounting reforms can contribute to more meaningful financial reporting in insurance. But the reinsurer states that it probably needs to be complemented with additional metrics that 'clearly and concisely' communicates insurers' underlying economic value to their stakeholders. Most risk and insurance managers would welcome such clarity as they grapple to work out the finances of their core service providers. Swiss Re correctly points out that the insurance accounting reform project has progressed very slowly. "For over a decade, accounting standard-setters have been wrestling with how best to improve insurance accounting practices. In particular, the International Accounting Standards Board (IASB), in collaboration with the US-based Financial Accounting Standards Board (FASB), has been developing a new valuation framework for insurance contracts and has sought to upgrade existing accounting standards for other financial instruments," pointed out Swiss Re. At its September 2012 meeting, the IASB decided to seek further industry feedback on its proposals. "The IASB's decision to re-consult highlights the continued willingness to move these reforms forward, but realistically, it means that new international accounting standards for insurance are now unlikely before 2016," commented Kurt Karl, Chief Economist of Swiss Re. "Furthermore, the near-term prospect of a single global accounting standard for insurance has dimmed somewhat. While the FASB are due to expose their proposals for external review in the first half of next year, they announced in June 2012 that a converged international standard for insurance contracts is unlikely to emerge any time soon," he continued. Swiss Re pointed out that insurance presents 'significant challenges' for accounting professionals. "In order to prepare their financial statements, companies need methods to value their assets and liabilities and to recognise associated revenue and expenses. At face value, this would seem straightforward. But in fact it raises significant questions concerning valuation and measurement. Although these issues are not unique to insurance, they are arguably more acute than in many other industries," pointed out Swiss Re. According to the reinsurance group one of the key challenges is that future cash flows that stem from insurance contracts are difficult to estimate in advance and so it is hard to place on them a value. "Some insurance risks, such as motor cover, are reasonably easy to assess. But other insurance products are very complex and their associated liabilities can extend over very long time periods, making valuation - and thus accounting ? difficult. For example, to give long-term life insurance guarantees a value, an insurer must consider not only the timing and size of the possible benefits, but also the policyholder's continued willingness to pay premiums," explained the reinsurer. But change needs to happen because existing accounting systems can lead to measurement mismatches, said Swiss Re. The company explained that, because of such measurement challenges, a mixed attribute model of accounting has developed. Thus, insurers value their assets at historic costs or at current market values depending on their intended use and establish actuarial-based loss reserves to cover future insurance obligations, stated the reinsurer. "This not only creates the potential for various accounting mismatches but can also mask important economic mismatches if the intrinsic value of assets and liabilities respond differently to changes in economic conditions," explained Swiss Re. Long-tail liabilities on some insurance covers will, for example, be more sensitive to changes in interest rates than the supporting assets, which may not show up in insurers' accounts if the actuarial assumptions are locked-in at inception. Also, there are 'significant' differences in accounting practice across countries that make international comparisons of insurers' financial statements difficult, pointed out the reinsurer. Above all insurers need to anticipate the ramifications of the final accounting standards and customers should perhaps prepare for a potentially more volatile future. "Shifting towards a more economic valuation of asset and liabilities should, in principle, help to illuminate the full costs of producing insurance, including the cost of capital required to support the business," said Külli Tamm, co-author of the sigma study. "At the same time, it may make insurers' reported financial statements more volatile, which could unduly drive up insurers' cost of capital and put them at a disadvantage compared with other industries," stated the reinsurer. But Swiss Re said that such cost of capital fears may be exaggerated and its certainly not all doom and gloom as the changes in financial reporting could also bring potential benefits for insurers. Darren Pain, co-author of the sigma study said: "The new accounting standards should encourage insurers to be more open about the source of uncertainty surrounding their estimated assets and liabilities as well as the rewards for bearing risk, but to foster improved transparency, additional reporting metrics will probably be needed."

Insurance accounting rules finally underway, prepare for a bumpy ride

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