“Insurance companies are complex creatures – we want more simplicity” say SA insurance sector analysts

“South African insurance analysts consider complexity and inconsistency as significant challenges for insurers in order to improve the quality of financial reporting in the industry” says Victor Muguto, PricewaterhouseCoopers Southern Africa Insurance Leader. “There is a need to address the concerns of the various users of insurance company financial information – and the impending overhaul of the international insurance accounting standard should hopefully achieve this.”

From 2005, insurers have been following International Financial Reporting Standard (IFRS) 4: Insurance Contracts, which deals with the disclosure of insurance contracts. The measurement of such contracts is being addressed in a soon-to-be released international exposure draft.

Muguto says that the gap between financial statement users’ expectations and current insurance reporting practice is considerable. “South African insurance analysts generally feel this is negatively affecting market values and the level of investment in the sector. The shares of most listed life insurers in South Africa trade at considerable discounts to their EVs compared to their European counterparts, which trade closer to the EV. This would suggest that there is not enough information for investors to fully understand the results and the true value of insurance companies in South Africa. Insurers therefore need to disclose their results in a way investors can understand it, if they want to unlock value.”

These are some of the findings of a recent PwC survey in which seven South African insurance analysts were interviewed in early 2010 in order to gain their perspectives on the current state and future direction of financial reporting in the South African insurance sector. The survey follows a similar study carried out by the PwC global firm during the fourth quarter of 2009 in which more than 40 insurance analysts similarly revealed widespread dissatisfaction with the current state of insurance reporting.

Other findings in the local survey include:

• Supplementary Embedded Value (EV) reporting is deemed highly useful and provides the most important information for analysing life insurance company results. However, while there have been improvements in disclosure over the last few years, there are still concerns over the lack of consistency and the low level of disclosure of assumptions and methodologies used in the EV reports.

• Restatements are a concern, especially where these occur on a frequent basis and are not fully explained. In some cases there are significant assumption changes from year-to-year and it is not always clear where these come from.
• Lack of consistency among insurers is a concern, especially regarding the treatment of negative reserves and deferred policy acquisition costs. More detailed disclosure is required in these areas.

· Cash flow information is perceived as potentially useful; however, respondents would like to see more information about where the cash flows come from. Shareholder cash flows should be disaggregated and separated from policyholder cash flows.

• Analysts would like to see the distinction between policyholder and shareholder assets more clearly.
• The segment report was noted as being extremely helpful in analysing the results of the different types of business. However, it is not always aligned to the risk features of the various business units and their cash flows to enable sufficient detailed analysis.
• There have been improvements in insurance risk disclosures, but participants had mixed views on the usefulness thereof, questioning quantity versus quality and relevance. Analysts suggest that insurers should make risk disclosures simpler, direct and to the point, and describe how risks arise and how they are mitigated.
• Where companies have hedging strategies in place, disclosures are weak and the economic impact thereof not explicitly disclosed.
• Most respondents would like to see the introduction of explicit risk margins in reserving for insurance policyholder liabilities.
• The differences between EV and IFRS earnings are generally not very well explained. Analysts want reconciliations of these numbers (only one SA insurer presently does this) and explanations for the differences, which would help to make reporting more comparable amongst insurers.
• The analyst packs provided at results presentations are considered vital, because of the extent (and timeliness) of the information provided, although analysts felt more could be done.

“Overall, most participants felt that insurance is distinctive enough to deserve its own reporting standard. But the reporting framework should better reflect the fundamental economic realities of the business, with greater consistency, and improved disclosure of reserving assumptions. Analysts also want more simplicity and pragmatism rather than theoretical precision” concludes Muguto.