IFRS 4 presents major opportunities for global insurance industry

Ernst & Young welcomes the long-awaited exposure draft (ED) on phase II of International Financial Reporting Standard (IFRS) 4 Insurance Contracts, adding that there is now real potential for insurance companies to include IFRS into their wider implementation programs for capital management.

The IFRS 4 exposure draft, which has been a decade in development, was published by the International Accounting Standards Board (IASB) and, once transitioned into a standard in 12 months time, will replace a confusion of grandfathered generally agreed accounting principles (GAAPs) with a single IFRS for all insurance contracts. To date, insurers have been relying upon the GAAP of their individual countries or elements of US GAAP.

James Dean, Ernst & Young’s Global IFRS Insurance Leader, comments: “Without doubt, IFRS 4 will create a level playing field for the insurance industry, providing all financial statement users and preparers – from policyholders to investors to analysts, competitors and regulators – with greater comparability and transparency about performance as a direct result of consistent measurement and presentation models brought by the standard. There will be a consistent financial reporting structure for the industry – and this has to be welcomed. The standard has been long-awaited and it is essential that the industry takes part in the critical four-month consultation period ahead.”

Short term pain for long term gain
Dean adds: “Implementing the new IFRS standard is likely to be a complex process for insurers but there will be important milestones to meet in the next few years. However, with everyone playing by the same rules in future, implementing IFRS 4 is likely to be a short term pain for a much longer term gain. The benefits to the industry and the wider financial community cannot be underestimated. Insurers will have greater certainty about how their organization is viewed and evaluated by investors, regulators and other key stakeholders, reducing the cost of capital.”

Business challenges ahead

Insurers across the board will have to ensure their IT systems are able to provide the required information to comply with the proposals. At the same time, insurers will face an increased challenge in communicating their results due to investors focus on cash generation, variations in profit drivers and, for some life companies, diversity in embedded value accounting.

Garth Coppin, the national director for accounting for Ernst & Young in South Africa, comments: “The proposals apply the same principles to both short-term and long-term insurers. At present the income statements for these insurers are quite different and thus in the future the income statements of insurers will not be easily comparable to those presently produced. This means that analysts will have to understand the impact of the changes on their models. As many users find insurance accounting, particularly that of long-term insurers, difficult to understand, the proposals are aimed at making it easier to understand what drive the profits of such companies. The other benefit is that financial statements will be more comparable, not only between companies operating in South Africa, but also between insurers in different countries.

“Key performance indicators will change, supporting improved decision making. For many insurers, meeting these challenges head on could act as a catalyst to sort out the current burden of supporting multiple measurement systems and transform their business for the better,” concludes Coppin.

Comments Tim Rutherford, Ernst and Young’s Life Insurance sector spokesperson, while the current version of IFRS 4 is being complied with by most insurers in South Africa, the updated version, is intended to allow users other than experts, to better understand the economics of the insurer, and therefore local insurers will need to review the revised standard carefully for their ability to comply.