On 21 July, the ASB issued proposals intended to result in substantial improvements in the clarity and transparency of the financial statements of entities with life assurance business, for the benefit of both policyholders and shareholders. The ASB's proposed accounting standard (issued as FRED 34) will apply to all such entities but will be particularly significant for the larger life assurance groups as well as banks and other non-insurance groups that have material life assurance subsidiaries. Comments on FRED 34 are requested by 8 October.

FRED 34 depends substantially on the new prudential regime announced by the Financial Services Authority (FSA) on 2 July. This requires large UK firms writing with profits business to make a new realistic calculation of their expected policyholder liabilities and to include this in their publicly available regulatory returns for years ending 31 December 2004. The realistic calculation recognises constructive obligations to pay future bonuses and uses stochastic modelling techniques to value options and guarantees written in life assurance contracts.

The ASB is proposing that:

• the realistic calculation of liabilities should be incorporated in the financial statements for December 2004 year ends onwards. This will bring the accounting basis for policyholder liabilities in major UK with-profits funds closer to that used by other businesses to account for long-term liabilities. It will also improve the consistency of financial and regulatory reporting.Consequential amendments to other balance sheet items will be required but this change will not affect reported net profits;
• funds not subject to the FSA's new regulatory regime (and which do not otherwise account for the full value of options and guarantees) should disclose information on the nature and extent of obligations under guarantees and options in life assurance contracts; and
• the financial statements should include a new disclosure, the capital position statement, which will provide significantly improved information about restrictions on the use of capital of a life assurer. This seeks to respond to criticisms that shareholders and policyholders have, to date, been given insufficient information about the financial strength of major life funds and of the entity as a whole.

The ASB is also, in FRED 34, responding to longstanding criticisms that life assurance business is reported in financial statements in fundamentally different ways by insurance groups and by others (for example banks with insurance subsidiaries). This affects the reporting of profit and, whilst the differences are a matter of timing, the impact can be significant and the periods involved can be very long. FRED 34 therefore includes proposals to constrain the recognition of future investment margins and of rights to future fee income in the 'embedded value' methodologies applied by some entities in their financial statements. The proposed constraints are in line with the position taken by the International Accounting Standards Board (IASB) in its standard, IFRS 4 'Insurance Contracts'.

An appendix in FRED 34 sets out in some detail the considerations and arguments that were thought significant by Board members in the development of the proposals. The ASB is grateful to all those who have participated in the discussions to date. It hopes to continue an active dialogue with constituents during the formal consultation period, in order to reach final conclusions on the standard as soon as possible.

The Board fully appreciates the practical issues that implementation of these proposals in 2004 may present. In particular it has carefully considered representations from the Association of British Insurers that implementation of the standard should be deferred until 2005. The Board believes strongly, however, that it is not credible for  entities to publish financial statements for 2004 incorporating liabilities on the old basis whilst measuring liabilities in publicly available regulatory returns on a new basis that is generally agreed to be more meaningful. Moreover, the impact of European law means that the proposed standard cannot be enforced unless it is applied from this year.

FRED 34 is in part a response to the concerns raised by the Penrose Report. It is not, however, the totality of the ASB's response. The Board intends to continue to develop its views on insurance accounting and to discuss with Government, the FSA and the IASB what measures might be needed to effect medium and long-term improvements in financial reporting.