Major changes ahead for insurance accounting, says KPMG

KPMG welcomes today’s release of proposals by the International Accounting Standards Board (IASB) for a new accounting model for insurance contracts. The proposals are the result of a project that has been active for more than thirteen years. Arriving at common requirements is likely to have a significant impact on the insurance industry, considering the current diversity in accounting practices in different geographies and amongst insurers.

Insurers will need to get to grips with these proposals as they represent some far-reaching changes, according to KPMG. They come at a time when there are already significant proposed changes on how financial organisations of all kinds measure their financial instruments.

The proposals apply to life and short-term insurers as well as reinsurers. Aspects of the proposals which are likely to attract debate amongst life insurers include determining a discount rate for obligations based on the characteristics of the liability as opposed to the return expected from the assets that back the liability, as is the case currently in South Africa. It is also expected that the requirement for changes in assumptions, whether financial such as interest rates or non-financial such as mortality and morbidity rates, be recognised in income each reporting period may bring about more volatility in insurers’ results.

Another area that may impact significantly the way life insurers view the proposals relates to the requirement that no profits may be recognised at the inception of a contract. In South Africa some insurers currently reduce their net policyholder liabilities by recognising negative margins i.e. future expected profits from policies underwritten. The proposals may limit some insurers’ ability to continue with this practice.

Short-term insurers will also be affected. The proposals require an insurer to make a current assessment of the amount, timing and uncertainty of the future cash flows that the insurer expects its existing insurance contracts to generate as it fulfils them. The proposed measurement model uses ‘building blocks’ to measure an insurance liability. Short-term insurers have historically used a deferral and matching approach to revenue recognition whilst the proposals are prospective in nature.

Another area which is likely to draw significant comment is the presentation of the statement of comprehensive income. Although the IASB has proposed a presentation for the statement of comprehensive income which follows the new measurement model, this presentation focuses on net margins rather than reporting revenues and expenses of an insurance contract. As a result, there may be a loss of information needed for financial statement users to analyse an insurer’s business.

Commenting on the proposals, Gerdus Dixon, KPMG’s insurance industry leader in South Africa, said: “The development of a comprehensive IFRS for insurance contracts should be viewed by insurers in conjunction with the Solvency Assessment and Management (SAM) regime. SAM is the South African version of Solvency II addressing the regulatory capital adequacy requirements for insurers. The recognition and measurement of assets and liabilities under SAM follow, to a large extent, similar techniques to the insurance proposals, which may allow companies to combine financial and regulatory reporting processes. However, there are differences in the detail. It is preferable that reconciliation exists between the financial and regulatory reporting frameworks to avoid confusion on what is the financial position of an insurer.”

Mr Dixon continued “There is undoubtedly a significant amount of technical information to digest, but as insurers work through the detail they should begin to identify the systems, data and process areas impacted by this proposed accounting change together with the likely broader business and people impacts to derive a plan to address these matters in a way that meets likely adoption timelines.”