Professional Documents
Culture Documents
Analysts Summary
Andrew Murray ACA The introduction of International Financial Reporting Standards
+44 20 7417 4303 (IFRS) in 2005 will have a significant impact on the way that
andrew.murray@fitchratings.com many insurance companies report their financial statements. On
introduction, the consolidated accounts of almost all listed
Harish Gohil FIA insurance (and non-insurance) groups will have to be prepared in
+44 20 7417 4367 compliance with IFRS, including the recently published IFRS 4
harish.gohil@fitchratings.com Insurance Contracts. The IASB intends to progress as quickly as
practicable towards phase 2 although this is not expected to be
Keith Buckley CFA before 2007 at the earliest. The IASB has indicated a conceptual
+1 312 368 3211 preference for fair value accounting at phase 2 although the target
keith.buckley@fitchratings.com accounting model has yet to be finalised.
Julie Burke CPA, CFA Fitch welcomes the progress made by the IASB towards standards
+1 312 368 3158 that will be more transparent and comparable across regions. The
julie.burke@fitchratings.com agency recognises the significant limitations of phase 1 but
believes that the enhanced disclosure and greater consistency at
phase 1 of the insurance accounting project (set out in IFRS 4) will
aid in the analysis of insurers and is a useful stepping stone to the
more valuable phase 2.
Although concern has been raised by some about the effect of the
expected additional volatility stemming from IFRS, Fitch is only
critical of reported volatility that does not reflect the underlying
economic reality and therefore lacks informational content (i.e.
accounting volatility). Some accounting volatility may be
induced at phase 1 (e.g. due to bond price movements stemming
from changing interest rates where assets and liabilities are
matched), but the agency regards this volatility as being a small
price to pay for showing an up to date picture of the balance sheet
position. At phase 2, Fitch expects reported volatility to be more
closely related to the underlying economic reality. The agency
welcomes the transparency provided by this reported economic
volatility and in particular, the information provided on the
mismatch between assets and liabilities and therefore, overall risk.
The agency notes that it does not expect any rating actions as a
direct result of the move to IFRS. However, Fitch cannot rule out
the possibility that the additional disclosure and information
contained in the accounts could lead to rating changes due to an
improved perception of risk based on the enhanced information
available. In addition, the new accounting regime could have a
medium term rating impact for some companies depending on the
response of management and investment markets to the new
standards or if the basis of taxation were to be affected.
5 May 2004
www.fitchratings.com
Insurance
Introduction However, many of the points made for general
International Accounting Standards began to be insurance are also applicable to life insurance.
developed in 1973 when the professional Although many uncertainties surround phase 2, Fitch
accountancy bodies of Australia, Canada, France, believes that phase 1 2 can only be understood and
Germany, Japan, Mexico, the Netherlands, the UK, assessed in the context of the fair value accounting
Ireland and the USA founded the International that the IASB aims to achieve.
Accounting Standards Committee (IASC). In 2000,
This paper does include some comments in respect
the committee underwent a major restructuring
of IAS 39 (Financial Instruments) which will have
process and in 2001, the newly restructured and
an important impact on insurers but it should be
renamed International Accounting Standards Board
noted that the paper is deliberately limited in scope.
(IASB) held its first meeting.
The paper does not set out to outline all of the
The newly formed IASB adopted all of the standards consequences of IAS 39 3 implementation or the
that had been prepared by the IASC and new likely impact from the implementation of other
accounting standards produced by the board will be IFRSs (e.g. Employee benefit costs (IAS 19) or
known as International Financial Reporting Related party disclosures (IAS 24)). Where
Standards (IFRS). The term IFRS is understood in material, such issues are likely to be addressed by
this report to refer to both these new standards that subsequent Fitch reports.
will emerge over time and those set by the IASBs
This paper is divided into the following sections:
predecessor organization.
Overview of Insurance IFRS.
IFRS will become particularly important as from Main features of Insurance IFRS phases 1 and
2005, essentially all EU companies that are listed on 2.
European exchanges will be required to produce Key issues arising from the planned Insurance
their consolidated accounts in accordance with IFRS.
IFRS 1 . This is expected to affect around 7,000 Business implications of fair value reporting.
entities, including many of the largest insurance Impact of Insurance IFRS on analysis
companies in Europe. In addition, IFRS is likely to methodology.
also be adopted by companies in many other Impact of Insurance IFRS on ratings.
jurisdictions, including Hong Kong and Australia, Conclusion.
and many EU countries will permit non-listed
companies to file accounts under IFRS. Over time, The report also includes a number of appendices:
the use of these standards is expected to become Appendix A Principal benefits and costs of
increasingly prevalent, particularly for those the new Insurance IFRS reporting.
companies wishing to access the capital markets. Appendix B Additional Insurance IFRS issues
Currently, there is no IFRS that deals with the Appendix C Example of possible insurance
accounting treatment of insurance contracts. accounting treatment.
Companies that already use IFRS to prepare their
accounts typically use US GAAP to fill in the gaps Overview of Insurance IFRS
in the published guidance. The current project to The IASB has tentatively concluded that the overall
develop standards for insurance contracts aims to goal of new insurance standards should be to move
remedy this situation and improve the transparency towards fair value accounting (i.e. recording both
of reporting. assets and liabilities at the amount for which an
asset could be exchanged, or a liability settled,
This paper sets out the key issues surrounding IFRS between knowledgeable, willing parties in an arms
for insurance contracts (both phases 1 and 2) and the length transaction.4) More specifically, this can be
likely impact of these issues on insurance companies.
2
The paper focuses on general insurance issues and Phase 1 and IFRS 4 are considered to be equivalent and so
does not deal with issues specific to life insurers. these terms are largely used interchangeably in this report.
Phases 1 and 2 are considered to be two stages in the same
process and so are collectively referred to as Insurance IFRS.
3
1
Individual member states have the option of requiring all IAS 39 and IAS 32, which relate to accounting for, and
companies to comply with IFRS from 2005 onwards. It should disclosures of, financial instruments are yet to be endorsed by the
also be noted that some kinds of listed company, at the option of European Union in order to require their use from 2005. A
individual member states, may not have to comply with IFRS failure to endorse these standards would leave EU companies as
until 2007. This delayed implementation may affect companies being non-IFRS compliant and could negate many of the
with debt securities only (not shares) listed on a regulated market proposed benefits for a common reported standard (including
of a member state. In addition, companies with a listing outside acceptance by the SEC). Fitch expects resolution of this situation
the EU and already using internationally accepted standards (e.g. in the near term.
US GAAP) may also avoid IFRS implementation until 2007. 4
Appendix A of IFRS 4 Insurance Contracts
20
comparability over time and between companies.
15
In practice, Fitch believes that the chances of a Fitch welcomes the additional disclosure required at
significant impact on credit quality from changes to phase 1 and notes that disclosure at phase 2 will be
the cost of capital are low. This is a result of a low extremely important in interpreting financial
expected change in cost of capital, the ability of the statements. Experience with US accounting
insurance industry to pass on a higher cost of capital standards (e.g. FAS 133) has shown that fair value
to policyholders in the form of pricing, and a disclosure by itself is not sufficient. It is also
possible offsetting effect if market participants essential that disclosures allow users to assess the
perceive the new accounting information as being of level of risk associated with the fair values shown,
a higher quality. e.g. through disclosure of significant assumptions
and areas of judgment, as well as through sensitivity
Conclusion analysis. The agency would prefer to see a greater
Fitch is very supportive of the efforts being made by degree of prescribed disclosure at phase 2 to ensure
the IASB to bring greater comparability and that certain important disclosures are presented in a
consistent and comparable form.
18
Source: Tillinghast-Towers-Perrin 4/2003.
19
In response to concern from regulators that this proposal could
be open to abuse (e.g. by recognising profitability on financial
instruments whose valuation is subject to subjectivity), the IASB
has recently released an exposure draft that would somewhat
limit this option although still aims to meet the original objective.
Underwriting Profit 10 10 - - 20
BALANCE SHEET
Cash and Investments 81.6 84.9 88.3 31.8
Deferred Acquisition Costs 10 - - -
ASSETS 91.6 84.9 88.3 31.8
Unearned Premiums 50 - - -
Claims Reserves 30 60 60 -
Retained Earnings 11.6 24.9 28.3 31.8
LIABILITIES 91.6 84.9 88.3 31.8
CASHFLOW
Premiums 100 - - - 100
Expenses (20) - - - (20)
Claims - - - (60) (60)
Investment Income 1.6 3.3 3.4 3.5 11.8
Total 81.6 3.3 3.4 (56.5) 31.8
Source: Fitch estimates
BALANCE SHEET
Cash and Investments 81.6 84.9 88.3 31.8
ASSETS 81.6 84.9 88.3 31.8
CASHFLOW
Premiums 100 - - - 100
Expenses (20) - - - (20)
Claims - - - (60) (60)
Investment Income 1.6 3.3 3.4 3.5 11.8
Total 81.6 3.3 3.4 (56.5) 31.8
* Also known as the Market Value Margin or MVM.
Source: Fitch estimates
BALANCE SHEET
Cash and Investments 81.6 84.9 88.3 31.8
ASSETS 81.6 84.9 88.3 31.8
CASHFLOW
Premiums 100 - - - 100
Expenses (20) - - - (20)
Claims - - - (60) (60)
Investment Income 1.6 3.3 3.4 3.5 11.8
Total 81.6 3.3 3.4 (56.5) 31.8
Source: Fitch estimates
BALANCE SHEET
Cash and Investments 81.6 84.9 88.3 31.8
ASSETS 81.6 84.9 88.3 31.8
CASHFLOW
Premiums 100 - - - 100
Expenses (20) - - - (20)
Claims - - - (60) (60)
Investment Income 1.6 3.3 3.4 3.5 11.8
Total 81.6 3.3 3.4 (56.5) 31.8
* It has been assumed that as risk expires, the entry value method converges to an exit value method. Under this formulation, the 50% of risk that
is expired at the end of year 1 is accounted for on an exit value basis (i.e. profit is taken on this business in a similar way to the exit value with
MVM scenario) whilst no profit is taken on the 50% of risk that is unexpired. This is one of a number of possible formulations for entry value
accounting although details of the proposed required accounting treatment will become clearer as the phase 2 project progresses.
Source: Fitch estimates
Bibliography
The Implication of Fair Value Accounting for General Insurance Companies P. K. Clark, P. H.
Hinton, E. J. Nicholson, L. Storey, G. G. Wells, M. G. White.
Fair Value Accounting Julian Leigh. Development of principles set out in paper to 2003 GIRO
convention.
Draft Statement of Principles (DSOP) 2001 Chapters 1-6, 8-12. Published by IASB.*
ED 5 Insurance Contracts IASB
IFRS 4 Insurance Contracts - IASB
Financial Services and General Insurance Update Tillinghast Towers Perrin September 2003. (IASB
publishes ED5 insurance contracts)
Setting the Standard III Peter Wright and Douglas C. Doll In Emphasis Tillinghast-Towers-Perrin
2003/4.
IAS and their Tax Implications PriceWaterhouseCoopers
Insurance Contracts Phase 1 A Bridge to an uncertain future PriceWaterhouseCoopers
ED 5, Insurance Contracts: Detailed Summary Deloitte Touche Tohmatsu
* Neither the IASB nor the Insurance Steering Committee is responsible for this publication. This publication has not been reviewed or
approved by the IASB or the Insurance Steering Committee.
Copyright 2004 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.
Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. All of the
information contained herein is based on information obtained from issuers, other obligors, underwriters, and other sources which Fitch believes to be reliable. Fitch does not audit or
verify the truth or accuracy of any such information. As a result, the information in this report is provided as is without any representation or warranty of any kind. A Fitch rating is an
opinion as to the creditworthiness of a security. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not
engaged in the offer or sale of any security. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by
the issuer and its agents in connection with the sale of the securities. Ratings may be changed, suspended, or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch does
not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of
any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other
obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate
all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000
to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an
expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of Great Britain, or the securities laws of
any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to
print subscribers.