Insurance principles: Hurdles towards insurer harmony

Changes to accounting standards are on their way for medium-sized companies across the UK, but the challenge for those in the insurance sector is particularly acute.

The UK’s Generally Accepted Accounting Principles (GAAP), which are used by private companies, are being phased out in favour of a version of the globally recognised International Financial Reporting Standards (IFRS). Listed UK companies have already switched to IFRS.

The shift may be especially troublesome for mutual and privately owned insurers because it coincides with several other distinct, but often related, regulatory and accounting changes. Notably, IFRS for insurers is itself set to change.

“We have changes coming in over the next four years that will affect the UK insurance industry in a manner that is unprecedented,” says Francesco Nagari, partner and global IFRS insurance leader at Deloitte, the accountancy firm.

Martin Shaw, chief executive of the Association of Financial Mutuals, says many of its members are concerned about the implications of the changes.

Smaller private and mutual insurers are a less powerful force than they were but remain significant. Mutual insurers retain a market share of about 7 per cent, according to the association, whose 50-plus members cater for 20m people.

The UK Financial Reporting Council’s (FRC) Accounting Council has proposed that the country’s GAAP is replaced by a simplified version of IFRS from the start of 2015.

Separately, however, the International Accounting Standards Board has been trying to agree on a new standard for insurance accounting with the US Financial Accounting Standards Board.

“They are essentially rewriting IFRS,” says Mr Nagari. “You have a completely different way of measuring insurance liabilities from what you do today, both in the life and the general insurance sectors.”

Changing capital requirements and other regulations add another layer of complexity for smaller insurers. UK GAAP is aligned with existing solvency standards, but these are being replaced by new EU-wide Solvency II capital requirements.

Insurers have until January 1 2014 to adopt Solvency II, which is designed to better match the capital they hold with the risks they take.

“Of itself, the change in UK GAAP isn’t necessarily too big,” says Charles Garnsworthy, partner and leader of the Solvency II multi-disciplinary team at PwC, the accountancy firm.

“But when you couple it with the change in IFRS and the fact that the regulatory environment is changing, that is where the complexity comes in.”

The timing and content of the three sets of changes are, to varying degrees, uncertain. The introduction of each has already been beset by delays.

In particular, with EU member states still negotiating over important details of how Solvency II will work in practice, many analysts believe the implementation of that regulatory system will be delayed further.

For its part, the IFRS insurance convergence project has been in the works for more than a decade. It remains subject to significant political wrangling, with the standard-setting bodies involved yet to reach agreement.

Few consultants expect it to be introduced before 2016. “There are lots of people out there who think it will never happen. They’ve been talking about it for the best part of 20 years,” says Mary Trussell, insurance partner at KPMG, the accountancy firm.

The new standards present practical challenges and strategic questions for mutual and privately owned insurers. The former set of problems range from the need to upgrade computer systems to training employees.

Ms Trussell likens the introduction of the accounting reforms after Solvency II to completing a marathon, “only to have to do another lap”.

“The big global insurers have people who spend all their time monitoring the developments in insurance accounting,” she adds. “If you are a bit smaller or are a mutual, you don’t have huge resources.”

Mr Shaw adds: “Small organisations in particular seem to be increasing the amount of money they are spending on professional service fees. The figures just keep going up.

“Organisations are getting questions from their policyholders as to whether that money is being well spent – organisations that are so small that any shift in the cost base runs the risk that the costs are greater than their income.”

The staggered nature of the changes might also pose significant problems. The Solvency II regulations look likely to be implemented before the accounting switch from GAAP to IFRS.

This means smaller insurers could be required to collate Solvency I data for the purposes of meeting the accounting standards, while at the same time having to comply with Solvency II for their regulatory filings.

“It does seem likely there will be a gap,” says Mr Garnsworthy. “It is a difficult situation.”

The UK FRC’s Accounting Council is currently consulting on how to address the problem.

Aside from the challenges in compliance, the accounting reforms also raise potentially more profound questions about whether a change to the basis of financial statements changes the business insurers do.

“Which products are written, investment strategy – all of those things could look different,” says Mr Garnsworthy.

While the details of the new IFRS remain uncertain, analysts believe they are likely to result in greater transparency – for investors and policyholders.

“You can dive in and see [what] management believes is the best estimate for the business written – how much is the margin for risk, the margin for profit – which today you really cannot see,” says Mr Nagari.

Smaller insurers have yet to be persuaded of the merits of IFRS, however. “The real problem is whether it is practical to use as the member of a mutual organisation,” says Mr Shaw.

“In particular, if you are a mutual you have customers as owners, rather than shareholders.

“They all have very tiny holdings in the organisation and they are not for the most part confident in dealing with even a basic summary of a financial statement let alone the complicated format of the accounts under IFRS.

“The layers of detail become so dense that it becomes difficult for them to get any value from that.”

Ms Trussell adds: “The broad idea is to make the measurements of insurers’ liabilities more market-consistent.

“That is really tough because insurance liabilities aren’t traded in the open market. So that requires a lot of modelling – models have to be recalibrated each time insurers draw up their balance sheet using current assumptions.”

Smaller insurers are also unhappy about this. “If part of your investment portfolio is two shops, for example, you don’t want to have to send a valuer around every few months to recalculate their underlying value,” says Mr Shaw.

“If you are a small organisation you don’t want to have to bear the cost of regular reassessment.”

One the main goals of the new IFRS is to harmonise the inconsistent approaches across jurisdictions to measuring the value of insurance contracts.

Investors have long complained that insurers’ financial statements are opaque and that their diversity makes it difficult for them to compare companies operating in different markets. This ultimately can make it harder for the sector to raise capital.

However, the advantages of adopting the new IFRS are less obvious for mutual and smaller private insurers.

“Do we believe mutual insurers should be producing information that listed companies are producing and is designed for capital markets?” asks Kevin Griffith, a partner and leader of the UK insurance team at Ernst & Young, the accountancy firm.

As Mr Shaw puts it: “The value of IFRS accounting is if you are a large insurance company with global aspirations and [investors] can see the value in being able to see accounts that are comparable across different countries.

“If all of your customers live within 15 miles of the river Tyne, for example, you are very unlikely to have any demand from them to be able to compare your accounts with those of a big, complicated insurer.”

Still, Mr Nagari says of the accounting changes: “In general, many people are welcoming it. They are just frustrated by the continuous delay, which is driven by politics and not knowing when this is going to be done and what exactly they will have to do.”

Roger Marshall, chair of the UK FRC’s Accounting Council, says: “We are consulting on how to make life easy for small insurers in the interim period when Solvency I gets switched off.

“There is an interim problem that we are consulting on. Our main concern is to make sure we don’t put a disproportionate burden on small insurers.”

He adds that the introduction of a simplified version of the new IFRS is only one option under consideration.

In spite of all the changes, insurers may find public sympathy can be limited. “If you want to play in the game called insurance and you want to make your money that way, that means you’re a big grown-up organisation,” says Ms Trussell.

“There is a huge degree of complexity to which, if you are in business doing insurance, you basically get signed up, whether you like it or not.”

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