Insurers get an accounting reprieve

Jim Milholland, speaking at an Ernst & Young presentation on the implementation of accounting principles for insurers, said that the insurance industry has been waiting for some time for an accounting standard for insurance contracts, investment contracts

Following some fierce opposition to its first attempt at a fair value standard and disclosures and a lack of time, the staff at the International Accounting Standards Board (IASB) conceded that the insurance standard would not be ready for 2005 implementation.

Phase one implementation dates are probably going to be 2008, while realistically phase two implementation will move out to 2009 or even 2010.

Now there will be a two-phased approach. Insurance contract standards will be developed first - exposure draft (ED) 5 - while the other aspect - relating to financial assets, derivatives and investment contract liabilities and fair value, will be developed separately - International Accounting Standard (IAS) 39.

The IASB is meeting this week to resolve some of the outstanding insurance accounting issues.

Milholland says that insurers and their financial reporting structures shouldn't expect reams of regulations and information around disclosure, from the IASB.

Local implementation of international accounting standard AC133, ahead of some other countries, has meant that South African approaches have led to some interesting implementation issues.

The problem is that although implemented, ED5 may mean that there may be some more local changes, in the future.

In terms of the fair value discussion, Milholland says that there will be an asset-liability approach, with a single fair-value type valuation required.

The valuation will be independent of assets and no investment spreads will be allowed, unless the policyholder guarantees are based on assets.

Major issues facing the insurers on a technical and business level will be:

Technical product classification, the asset liability matching exercise, product design and reinsurance, disclosures, training, transaction cost definition, loss recognition, and fair value methods.

"Here the options are renewal premiums, demand deposit floors, discount rates, and calibration," Milholland explains.

In terms of calibration this seems to be one of the main stumbling points that all the players are looking at.

"The business implications include reinsurance and renegotiation of contracts, where there may be no difference between reinsurance and insurance, if it is a financial arrangement with no significant insurance risk."

Cash flows will be different, tax planning, remuneration policies. Tax planning will become a longer-term issue.

While remuneration for senior executives will become an issue as the way a company reports financially. On this score company executives get paid on earnings per share, increases thereof or options.

"The regulators are following the process carefully and there is great appeal for one single report, specifically in the USA, although there is no direct regulatory involvement," says Milholland.

In the US, US GAAP is looking for a single report and the doing away of insurance company reporting, but not on the same timetable, probably watching the teething process as it becomes apparent in the EU.

Milholland says that insurance companies need to start now. He suggests that they should be looking at some of the following issues.

Internationally there will have to a significant training initiative.

There has to be a product classification process, and inventory of guarantees and options, a methodology rule set for insurance related requirements, pilot studies, and profit analysis, business impact analysis for investment strategies and product design and issues surrounding the design and planning of the implementation process.

"Embedded value reporting will change, but may not go away. Disclosure will become more standard and we may even see enhanced embedded value disclosures, in the future."