On 31 July the ASB is issuing as a Consultation Paper the IASB’s proposals on ‘Insurance Contracts’. The closing date for comment is 31 October 2003.
This Phase I exposure draft is an interim step towards a radical reshaping of accounting for insurance contracts which will be introduced in Phase II. The IASB has decided that Phase II should develop an accounting standard that will require recognition of the asset or liability directly created by insurance contracts measured at fair value, which will, in the absence of an active market for insurance contracts, usually be calculated using a discounted cash flow model.
Accounting by insurers worldwide is at present inconsistent and fails to conform with the IASB’s framework for accounting. The ASB therefore wholly supports the IASB’s plans for developing a principled approach to insurance accounting in Phase II and the tentative decisions taken to date.
However, many difficult issues need to be tackled in Phase II, including issues of reliability and the treatment of risk, renewal premiums and surrender values. There is also considerable international opposition among insurers, particularly in North America, to the tentative fair value proposals. Any new Phase II proposals will need field testing and time allocated to amend the systems and build up the databases. It is therefore important to assess the impact of the Phase I proposals properly.
The ASB has concerns about the lack of restrictions on the way that consistency with IFRS can be achieved under the Phase I proposals, which allow many existing accounting policies to be continued. In order to achieve a workable interim solution which avoids imposing major systems changes on entities at this stage, the IASB proposes to exempt insurance contract accounting from complying with the normal qualitative requirements of IFRS (including relevance and reliability) for accounting periods beginning before 1 January 2007. The result may be considerable flexibility in the timing of the recognition and measurement of profits on some insurance contracts. In contrast, changes to accounting policies after initial adoption are much more closely regulated.
In the United Kingdom, the regulation of financial reporting has resulted in some diversity of practice:
- in their statutory financial statements, insurance entities use a deferral and matching approach based on the release of cash flows after meeting regulatory requirements;
- in supplementary financial information, many insurance entities include information about their long-term (life) contracts on a discounted cash flow basis taking into account cash flows released from the regulatory system (embedded value); and
- in the consolidated statutory financial statements of non-insurance entities (such as banks), embedded value amounts are sometimes recognised for long term policies in both the balance sheet and profit and loss account.
The ASB is concerned that diversity of practice may even increase in the UK because of the flexibility permitted by the IASB for existing accounting policies. The ASB has consistently rejected requests to sanction embedded values for the statutory financial statements; such methods usually include future investment margins and management fees thus resulting in the recognition of a profit on the inception of an insurance contract, usually in advance of alternative methods, including those planned for Phase II. The ASB seeks a position for the UK where from 2005 insurance contracts should be accounted for on a comparable basis by all entities which choose to adopt an ‘assets and liabilities approach’. The ASB believes this would be achieved if Phase I has the same requirements for continuing with existing accounting policies for insurance contracts as it has for changes to accounting policies.
