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News analysis: Insurance contract accounting revisited

The international accounting standard-setter has issued the long-awaited insurance contract revised exposure draft. Sophie Exton investigates what this means for the profession and the insurance industry.

The International Accounting Standards Board (IASB) published for public comment its long-awaited revised Insurance Contracts Exposure Draft (ED) in June. The revised accounting standard would replace IFRS 4 and apply to all insurance contracts including life, non-life, annuity, and reinsurance contracts. The proposals aim to make it significantly easier for investors to understand and compare insurers and assess their suitability.

"It's frankly impossible for an investor to compare one insurer to another under IFRS at the moment," KPMG UK partner Danny Clark says. According to Clark investors don't have time to analyse the policies and accounts of each individual insurer when they could be looking at 20 or 30 different stocks.

The IASB began working on the insurance contracts project in 2001. In 2005 it introduced an interim standard, IFRS 4, until a more comprehensive one for insurance accounting could be established. This has permitted insurance accounting practices to differ, resulting in inconsistency in the way insurers report their financial statements.

The IASB originally issued its first ED in 2010. During the extensive public comment period it received 251 comments letters, many expressing concerns over perceived artificial volatility. The re-exposed ED only seeks feedback on areas that have changed since the 2010 ED. The IASB acknowledges the revised proposals are more complex than the 2010 ED.

In a recent statement it encouraged input from insurers on "whether the costs of providing the revised information are justified by the benefits of the information provided".
Several accounting firms, including KPMG and PwC say the insurance industry should welcome the changes which would finally create a single accounting model for insurers. However, firms also reiterate that the new proposals will add a great deal of complexity to insurance contracts.

KPMG global insurance advisory leader Gary Reader says the new accounting model would introduce more volatility to the profit and loss account "but more accurately reflect the risks and liabilities undertaken by insurers, bringing insurance accounting into the 21st century - but not without a cost".

PwC global accounting services financial instruments leader Gail Tucker agrees the revised proposals will change accounting for insurance contracts for the better, but that it will take time.

Experts speaking to The Accountant say the introduction of a contractual service margin is the biggest change from the 2010 ED. What was previously referred to as a residual margin is now a contractual service margin which is effectively the future unearned profit.

Adjusting the contractual margin for changes in estimates of future cash flows essentially allows the impact of
updating assumptions to be spread over the remaining life of the contracts. Clark points out that because the contractual service margin needs to be unlocked at each reporting date, the challenge will be having data at a low level of granularity in order to track the value of that contractual surface margin at a sufficiently low level.

"You will need to unlock that at each reporting date, and one year the value could go down and the next year the value could rise again, and it has to be tracked at a sufficiently low level in order to be able to perform that calculation," Clark says.

Hitesh Patel, chairman of the insurance committee at the Institute of Chartered Accountants in England and Wales and chief executive of insurance company Lucida, agrees that the contractual service margin will be the most difficult change to implement.

He says it will be particularly hard for life insurance businesses to analyse and track going forward. He also expects a lot more feedback from life insurers compared to nonlife in the ED process.

Stakeholders are unanimous that in the quest for transparency the IASB's proposals have become a lot more complex. However, firms are aware that the IASB has noted this, and also that it's very difficult to make accounting for insurance straightforward for all to understand. Tucker says the reason this project has taken so long is because the products, especially on the life insurance side, are extremely complex and therefore the accounting is equally complex.

Nevertheless, she believes the IASB's revised proposals will be successful in bringing clarity to insurance contracts in the long term. Patel says clarity will depend on the quality of the disclosures, adding: "The main challenge is deciding how the income statement will be organised and particularly how investment gains are recognised. There is a raging debate still ongoing regarding that."

Clark and Tucker agree that the revised ED should benefit insurers and stakeholders in the long term. Most audit firms will be familiar with some of the changes which also came into effect under Solvency II. However, it's assumed that new actuarial and accounting systems will be needed to manage the additional data.

The Financial Accounting Standards Board (FASB) issued its own ED a week after the IASB. The two had been working together to come up with a similar standard, however its EDs are not the same. Tucker says she doubts they will come up with a converged solution that can be adopted globally. "I suspect we may have a different answer for the US under US GAAP," she adds.

"In the US market you are in a completely different place. They have a consistent set of accounting rules for insurance; it has drawbacks but everybody is doing the same. So I expect the US stakeholders will probably write to the FASB and not support their ED because they already have a consistent methodology and so they don't need this radical change."

In spite of concerns about complexity, experts from firms and professional bodies support the efforts of the IASB. The success of the new proposals will lie in how efficiently they are implemented. The proposals will require a lot of additional data and calculations and the IASB has advised insurers to adopt the new policies as quickly as possible for a smoother transition. The public comment period closes on 25 October for both IASB and FASB revised proposals.

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