Deloitte on the publication of the IASB Exposure Draft of the new International Reporting Standard for Insurance Contracts

New York - The International Accounting Standards Board (IASB) today published the Exposure Draft (ED) of the new International Financial Reporting Standard (IFRS) for insurance contracts.

The publication proposes fundamental changes to the financial reporting of insurance companies applying IFRS, with a goal of making it more consistent and transparent than it has been so far.

“Given the increased adoption of IFRS worldwide, it is no exaggeration to suggest that this proposed accounting standard would have a global impact and could fundamentally change the way insurance companies measure, report, and evaluate performance of their insurance contracts,” said Joel Osnoss, Global IFRS Leader, Clients & Markets, Deloitte Touche Tohmatsu.

“Many insurance companies would experience a significant amount of change in their financial statements and would need to modify their information systems, risk management programs, and possibly even product design. There would also be a need for education of stakeholders, including shareholders, policyholders, analysts, and more. In the end, the hope is for consistency, comparability, and transparency across insurance companies operating in different jurisdictions around the globe.”

The IASB has stated that there will be a four-month comment period on the ED, with the final standard due for publication in 2011. The mandatory application will be decided after the comments have been received, and it will be at the earliest from 1 January 2013 when the other major change on investments accounting becomes effective. However, the IASB is prepared to delay the implementation date of the two projects in parallel if necessary.

Francesco Nagari, Global IFRS Insurance Leader at Deloitte United Kingdom, commented: “The publication of the Exposure Draft is a landmark stage in the IASB’s 13-year project to develop a consistent standard for insurance accounting and will have a significant impact on insurers across the world. Under the proposed IFRS, all insurance contracts, both life and non-life, will be measured using the same building blocks based on discounted probability-weighted best estimate cash flows.”

Insurers have been previously permitted to use very different methods to report insurance contracts, based on a variety of national practices developed under the previous IFRS. This has greatly reduced the comparability of insurers’ financial reports, penalizing them when they accessed capital markets with a higher cost of capital than most other industries.

The IASB has also been working closely with the U.S. Financial Accounting Standards Board (FASB) in developing the new IFRS. “We understand that the FASB may publish its new proposals for insurance accounting in late August, meaning there is a prospect of truly global convergence in accounting for insurance contracts,” continued Osnoss.

Nagari added, “We expect the FASB proposals also to be based on discounted probability-weighted cash flows, although in the discussions between the IASB and the FASB there has been a significant area of disagreement in accounting for the underlying cash flow uncertainty, the key driver on how insurance profits get reported.”

The IASB ED contains two alternative approaches to this issue. In the first, an explicit risk liability is added to the best-estimate calculation of the insurance cash flows. This approach requires the insurer to make a judgment on how much profit to account for based on the remaining uncertainty of the in-force contracts: the lower the uncertainty the higher the profit (with a resulting lower risk liability). In the second approach, the profit is initially deferred and then accounted for in a systematic basis every year. With this method profit recognition is independent of whether the future cash flows are more or less uncertain than last year.

The IASB has requested that respondents to the ED provide their views as to the two approaches, having expressed a preference for the first approach. The FASB instead does not support it because they believe that there are not yet generally accepted and reliable techniques to calculate this risk liability.

“I would encourage insurers to start planning for the introduction of the new IFRS,” said Nagari. “Developing the building blocks will require many insurers to reorganize their data in different ways or develop new valuation models. A successful operational implementation of the new standard will require consideration of the impact on projects in other developing areas. In particular, Solvency II within the European Union is based on a valuation model for insurance liabilities that is very similar to the one preferred by the IASB, and the Solvency II regulations require a reconciliation between the IFRS and the Solvency II valuations to be published every year.”
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