Canada’s life insurance industry is pushing back against proposed changes to insurance accounting standards, arguing that the changes will lead to massive volatility in quarterly financial statements and could hamper the ability of insurers to continue to offer products with long-term guarantees.
In June, the International Accounting Standards Board (IASB) published for comment its proposals for a set of global accounting standards dealing specifically with insurance contracts. The comment period ended in late October, and the high volume of critical feedback from stakeholders around the world – including regulatory and accounting bodies, along with insurers – suggests the proposals have missed the mark.
“We do support the initiative to have a high-quality global standard,” says Steven Easson, vice president and chief actuary with the Canadian Life and Health Industry Association Inc. “But it must be truly global, it must be robust and it must result in useful information to users. More work is needed.”
The IASB’s proposals are the latest step in a lengthy and complex project that has been underway for more than a decade. The goal is to improve consistency and transparency, given that there are big differences in the accounting policies used by various insurers to account for insurance contracts. Consistency is important for consumers and regulators to be able to compare the riskiness of institutions.
Although the insurance industry supports the effort to establish a single global accounting standard in general, there are a variety of concerns with the specific accounting practices being proposed and the unintended consequences they may have.
“The rules, as they’re laid out, are pretty onerous,” says Peter Wouters, director of tax and estate planning with Kingston, Ont.-based Empire Life Insurance Co., “and could, in some respects, destroy certain types of business that we’re able to offer in Canada.”
The industry’s concerns are related largely to the proposal for insurers to report their liabilities on an entirely market-consistent basis. Under the existing Canadian standards, liabilities are calculated using prudent assumptions for longer-term rates, reflective of historical averages – an approach that the industry supports, as it smooths out the value of liabilities over time.
In contrast, the proposed changes could cause the value of an insurer’s liabilities to fluctuate significantly from quarter to quarter as a result of short-term swings in interest rates. Given the long-term nature of life insurance contacts, insurers argue, short-term market noise should not be reflected on their balance sheets. Says Wouters: “It’s focusing on the short term for a business that’s actually focused on the long term.”
Short-term rates can be appropriate for calculating the valuation of shorter-term liabilities, the industry argues, but a long-term average rate should be used for longer-term liabilities. Otherwise, says Steve Roder, senior executive vice president and chief financial officer with Toronto-based Manulife Financial Corp., it could result in enormous volatility in insurers’ quarterly financial statements.
“A small change in the discount rate could produce billions of dollars of change in the valuation of liabilities,” Roder said in a recent speech at the Citi Global Financial Conference in Hong Kong. “We could have massive impacts on the balance sheets of life assurers.”
Such extreme volatility would probably make it harder for insurers to raise capital, which would hurt insurers’ ability to offer products with long-term guarantees, such as term-100 life insurance policies. Higher capital requirements already have driven down the profitability of those products. And, assuming that international financial reporting standards (IFRS) continue to be the basis for the capital requirements that insurers face, the added volatility would make it more challenging for insurers to manage the capital required to offer those products.
“That hits those products particularly hard,” says Wouters. “It affects the profitability of those products and even the viability to keep offering those products.”
Another concern with the proposed standard is complexity. This would make the process of compiling financial statements more costly and time-consuming for insurers and could create confusion for those who read the statements.
There’s also concern that not all jurisdictions will end up adopting the proposed standards, thus defeating the original purpose of the exercise. Says Easson: “We’re not convinced that all the major territories – notably, the U.S. – are going to adopt it.”
In Canada, the default is for the insurance industry to adopt any standards imposed by the IASB. But that’s not the case with all other jurisdictions that use IFRS. The U.S., which does not adhere to IFRS, has been working with the IASB toward a convergence of accounting standards. But the proposed standards for insurance contracts from the U.S. Financial Accounting Standards Board diverge from the IASB’s proposals in some respects.
This presents challenges for insurers with operations in both Canada and the U.S. Such insurers are required to file a different set of financial statements, with potentially significant differences in results, in each country.
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