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Analysts Want Clearer Insurance Financial Reporting

Source: Pricewaterhouse Coopers

Posted on 12 Jan 2010

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Lack of quality, consistency and transparency in financial reporting has the potential to hurt many insurance companies by creating uncertainty about their financial condition and business drivers, according to the PricewaterhouseCoopers report Making Sense of the Numbers.

In-depth interviews with 43 financial analysts who cover the insurance sector, found widespread dissatisfaction with the current insurance financial reporting framework and what analysts say they believe is inadequate disclosure of relevant information on balance sheets, income and cash flow statements, as well as management’s discussion and analysis. The overwhelming consensus of the interviewed life analysts is for a new reporting structure that reflects the economic realities and unique underlying business model of insurance companies.

The International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) are reportedly working jointly to develop a single, new standard of reporting that will address recognition, measurement, presentation and disclosure requirements for insurance contracts, and provide investors with more useful information to make informed decisions. At their joint November 2009 meeting, the IASB and FASB presented a revised timetable for a new exposure draft from December 2009 to April 2010. As the Boards reach a decisive stage in their planned overhaul of insurance contract reporting, PricewaterhouseCoopers’ findings from the interviews conducted with financial analysts appear to offer standard-setters some clear messages:

Virtually all analysts interviewed from the United States and three-quarters of those in the rest of the world think that insurance is distinctive enough to deserve its own reporting model.

* Of all those supporting a distinct model, slightly more than half prefer a different approach for life and non-life business, and nearly three-quarters would like aspects of a particular contract that has different risk and earnings profiles, such as savings and investment management services, to be accounted for separately as opposed to being bundled and presented as a whole.

* IFRS users who analyze the life insurance sector expressed the greatest dissatisfaction with the current reporting framework.

* A vast majority of analysts interviewed in the United States agreed that, on day one of a contract, insurance companies should recognize neither a profit nor a loss, and about four-fifths do not think insurers should record acquisition costs as an expense at the inception of a contract. Most felt that acquisition costs should be deferred. This differs from initial IASB/FASB consensus that profit and loss should be accounted for from the inception of a contract.

* Nearly two-thirds of all analysts interviewed would prefer to simultaneously adopt new rules for classification and measurement of financial instruments with changes in contract reporting.

Those who would prefer adoption of the new financial instruments standard believe this would make it easier to compare the insurance industry to other industries.

“The true financial condition of insurance carriers seems to be uncertain to analysts, shareholders and the entire investment community,” said Donald Doran, partner, PricewaterhouseCoopers insurance practice. “We believe insurers need a new and improved approach to financial reporting applied consistently around the world that meets the challenges facing such a diverse and complex industry, as well as the needs of their stakeholders.”

Risk margins

In commenting on the joint FASB/IASB project, just more than half of US analysts interviewed and nearly three-quarters of non-US analysts reported that they would like insurers to report a risk margin component of their liabilities, with some arguing that it might provide greater insight into the information they believe some companies may use when pricing their products. However, insurers do not typically report risk margins, and few analysts said they know how such margins would work. Those who opposed reporting a risk margin said they felt that it would be too subjective a measure.

Most analysts said they would like to see profit recognition over the life of the contract in line with the unwinding of the associated risks. They said they believe this would give a better indication of how management judges the contract’s current profitability.

Measurement and classification of financial instruments The business model of many insurers includes the transfer of risk from individual clients to a risk pool, a practice that enables insurers to manage risk in a sound financial manner. As a result, insurers become long-term investors in a variety of assets backing their liabilities, and they seek a return that matches the guarantees or promised return of the policyholders.

When asked about the preferred basis of measurement of these financial instruments, most analysts interviewed said they support the continued use of amortized cost and fair value through profit and loss for debt instruments. There was less of a consensus on the continued use of the available-for-sale designation, with four-fifths of US analysts saying they were in favor of this classification versus only about two-fifths of non-US analysts.

According to PricewaterhouseCoopers, marking-to-market might increase earnings volatility, but many participants said they would like both the book value and the fair market value to be clearly disclosed in either the primary statements or notes. Amortized cost provides decision-useful information since, in the event that the entity holds an asset to maturity, amortized cost would be an appropriate reflection of value. In addition, amortized cost can provide useful information in the event that determining fair value is unusually challenging.

“There appears to be room for improvement in reporting in the insurance industry,” said Stephen O’Hearn, partner, PricewaterhouseCoopers insurance practice. “We believe stakeholders want a better understanding of the drivers of the insurance business and a much clearer view of where their profitability is coming from. To the extent that there is ongoing debate about the future direction of reporting standards, it is essential that industry and standard-setters work together to achieve a workable solution.”

A full copy of the report Making Sense of the Numbers is available at

About the Study

PricewaterhouseCoopers conducted in-depth interviews with 43 insurance analysts from Europe, the US, Asia and Australia during the fall of 2009 to gain their perspectives on the current state and future direction of insurance financial reporting. The study follows a similar PwC study published in 2007. Sixty-nine % of the participants cover life and non-life insurers, while 21 % cover life insurers and 10 % cover non-life insurers.