The International Accounting Standards Board released proposals on Friday for a new accounting model for insurance contracts, which could impact the way Canadian insurers measure their profitability.

The proposed changes are intended to improve insurers’ financial reporting by making statements more understandable and relevant for users, eliminating inconsistencies and weaknesses in existing insurance accounting practices, and providing comparability across entities, jurisdictions and capital markets.

“Many users of financial statements describe insurance accounting today as a ‘black box’ that does not provide them with relevant information about an insurer’s financial position and financial performance,” the IASB says.

The board proposes a single International Financial Reporting Standard that all insurers, in all jurisdictions, could apply to all contract types on a consistent basis. The single measurement model would focus on a current assessment of the amount, timing and uncertainty of the future cash flows that the insurer expects its existing insurance contracts to generate as it fulfils them.

Specific changes to insurers’ accounting practices proposed by the IASB include:

• Enhancing cash flow transparency by reflecting changes in cash flow in profit or loss in the period in which they arise;
• Measuring insurance liabilities in a way that reflects all changes in economic circumstances;
• Discounting life insurance liabilities and non-life (property and casualty) claims liabilities using a current, risk-free discount rate, adjusted for liquidity;
• And, requiring insurers to include a risk adjustment in the measurement of the liability and disclose information about that adjustment; among other changes.

These changes addresses some of the IASB’s concerns with existing industry practices, including cash flow estimates that fail to provide current information about liabilities, accounting mismatches that result from liabilities failing to reflect changes in economic circumstances, and discount rates that reflect the characteristics of the assets backing the insurance liabilities, rather than the characteristics of the liabilities.

The proposals present far-reaching changes for insurers, according to audit, tax and advisory services firm KPMG.

“The IASB’s proposals would affect how all insurers measure their profitability and their financial position, and would likely result in greater volatility in many of the key measures they report,” said Neil Parkinson, KPMG’s insurance sector leader for Canada. “This volatility would be magnified for longer term insurance products, and is of particular concern for Canadian life insurers.”

Gary Reader, KPMG’s U.S.-based global insurance advisory leader, said firms should carefully consider the ways they could be impacted by the proposals.

“There is undoubtedly a significant amount of technical information to digest, but as insurers work through the detail they should begin to identify the systems, data and process areas impacted by this proposed accounting change together with the likely broader business and people impacts to derive a plan to address these matters in a way that meets likely adoption timelines,” said Reader.

The proposals are open for comment until Nov. 30, 2010.

IE