Canadian authorities resist international accounting standards

By Alain Thériault | January 23 2014 04:14PM

Once an advocate for the adoption of the International Financial Reporting Standards (IFRS), Julie Dickson who heads the Office of the Superintendent of Financial Institutions (OFSI), is now asking for the International Accounting Standards Board (IASB) to adjust the standards to Canadian insurers’ reality.Canada’s Accounting Standards Board (AcSB) also wants to see modifications made to IFRS in insurers’ favour.

IFRS have shaped the presentation of financial results for all entities in Canada, public and private, since 2011. From the get-go, AcSB pledged to follow the global standards.

Recently, some major stumbling blocks in the application of the standards have cropped up. For insurers, the most controversial is undoubtedly that of IFRS for insurance contracts. The IASB confirmed its approach at the international consultation on the standards, which ended on October 25. The standard to determine the discount rates of long-term insurance contract liabilities is a thorn in the side of Canadian insurers. For one, it would create unprecedented volatility in their financial results.

The IASB is preparing a definitive version of the IFRS standards for insurance contracts, which it plans to release in 2015. They will take effect in 2018. Meanwhile, a formidable Canadian lobby group is taking shape.

Stark turnaround

In a stark turnaround since last year, when she asked insurers to prepare for the arrival of IFRS, Julie Dickson of OSFI is now urging the IASB to temper its policies. She appears to be clearly convinced by the arguments of the life insurers she supervises.

In a letter sent to the international organization based in London, the superintendent expressed the hope that IFRS for insurance contracts will better reflect the long-term nature of life insurance products sold in Canada. She also asked the organization to keep these standards simple. Specifically, Dickson thinks that some standards should be optional instead of mandatory.

Canadian accounting of insurance products has proven itself, Dickson argues. “Canadian life insurers have experienced three years of very low interest rates. The Canadian accounting methodology (Canadian Asset Liability Method) has worked to incorporate market changes while taking account of the long-term nature of the Canadian life insurance business,” she wrote.

Without this method, Dickson fears that insurers will be forced to discount their long-term obligations at a rate that would make their financial results highly volatile.

The Superintendent thinks the proposed standards would force the OSFI in turn to modify insurers’ financial results related to regulatory capital. The new standards would make assumptions about capital requirements laxer rather than more rigorous, she contends.

For its part, the Accounting Standards Board shifted from a commitment to accept the IFRS in full to a more skeptical stance. Following the IASB consultation, the AcSB began its own consultation on the exposure draft among Canadian entities.

In its submission to the IASB, The AcSB also set out where it believes the international rules are off track. It says it agrees with the fundamental principles in the proposed standard, but sets out recommendations to amend some aspects of the proposed standard to result in financial reporting that would represent the economics of insurance contracts faithfully.”

Expressed reservations

The AcSB also expressed reservations about the liability discount rate in long-term insurance contracts. It would like to see the standard clarified, and even amended. “Slight changes in the rate on long-term contracts can result in dramatic changes in the reported amount of insurance liabilities,” the AcSB wrote.

The AcSB will consider the responses to its exposure draft and the further work that the IASB will carry out in addressing all of the comments it receives from Canada and elsewhere. Based on that information and other analysis, the AcSB will determine whether to adopt the IASB’s final standard as part of Canadian GAAP,” responded AcSB’s chair, Linda Mezon to questions from The Insurance and Investment Journal.

“While we anticipate that some fundamental aspects of the proposal won’t change, we expect that it might modify some aspects of the guidance for implementing those fundamental elements,” said Mezon.

She added that she believes the IASB is making the required effort to understand the Canadian situation. “Given the amount of outreach the IASB did within Canada – holding four formal roundtables and having several private meetings with Canadian insurance industry stakeholders – we are confident that they fully understand Canadian circumstances and the significance of our concerns, and that they will give our comments careful consideration,” she adds.

Insurers take up arms

At accounting firm Ernst & Young (EY), teams in charge of advising insurer clients say a Canadian lobby group has formed around this issue. “Many people are criticizing the IFRS method of determining the reserve discount rate. It is complex, difficult to apply and likely to distort insurers’ financial statements. It is sparking outrage,” Raymond Morissette, EY certification partner, told The Insurance and Investment Journal in an interview.

To model the discount rate, Canadian insurers must use refined data that cover long periods (more than 10 years), Morissette explains. “These data are not always available, leading to assessment problems,” he adds. European insurers do not have this problem because their insurance product liabilities are short term.

A lobby group emerged following the first IASB exposure draft in 2010. The June 2013 draft added fuel to the fire. The most prominent members include Manulife Financial, Sun Life Financial, Great-West Lifeco and Industrial Alliance. The group is supported by the Canadian Life and Health Insurance Association.

A panelist at an Autorité des marchés financiers gathering in November, SSQ Financial Group’s CEO, René Hamel, also took aim at the IFRS as he shared his worries about the potential impact of these standards on Canadian insurers’ financial results. Today the topic is on everyone’s lips, Mr. Morissette notes.

The discount rate assessment method and the volatility they foment are not the only problems spawned by IFRS for insurance contracts, Mr. Morissette continues. Insurers must now calculate the regulatory capital twice: for regulatory authorities and according to accounting standards. The new capital requirements are based on a total solvency approach that includes liabilities and capital, Mr. Morissette explains. Regardless of the level of liabilities obtained under the new standards, the total solvency requirement will remain the same.

Insurers must also review their asset and liability management strategies. They must foresee adding new items to their financial statements. Consequently, insurers will have to educate financial statement users and invest in systems that can process more refined data.

Impact on distribution

The effects will also be felt in distribution. Insurers will need to simplify and modify their products, particularly their features, pricing and advisor compensation, Raymond Morissette continues.

Under the IFRS, companies will now have to present premiums and insurance benefits paid in their overall results. “Accountants will lose power,” Morissette says. “Today, insurers’ accountants can link premiums and benefits paid in financial statements. It will now be largely up to teams of actuaries to determine the margin on contractual services for these elements.

Hélène Baril, senior manager, insurance and actuarial consulting services at EY, worked as an actuary at Desjardins Insurance for several years. She says that in field testing IFRS fell short. In addition, the IASB staff lack insurance experience, she says, which leads to illogical standards. “IFRS that look correct in theory pose problems when applied. We then see nonsensical, problematic elements that need clarification.”

Baril adds that very few insurers had tested the phase 2 IFRS before they were updated after the latest IASB exposure draft. “Insurers do not want to invest in analysis before they know where the IFRS are heading,” Baril explains.

She cites, however, an unprecedented study recently published by one Canadian and three American insurers: Manulife Financial, Metropolitan Life, New York Life and Prudential of America. This is the first survey that covers more than one insurer. It also presents the results of an analysis of the impact of IFRS over a long period. “The field testing, for the full years of 2007 to 2011, shows aberrations and much volatility,” she says.

In the foreword to the study, Steve Roder, Senior Executive Vice President and Chief Financial Officer at Manulife, notes that the group results “were either not in line with our expectations or not reflective of actual economics.” On behalf of the group, Mr. Roder asks the IASB outright to help find an alternative to the problematic IFRS (see Draft accounting standards are “inappropriate”).

The next step? “For now, the IFRS already in place have not had a major impact on insurers, other than for reporting and contract classification. In contrast, phase 2 raises problems,” Ms. Baril says. The IASB has received 160 responses to its consultation from Canada, including from insurers, the CLHIA, and accounting and actuary firms.

Politics weigh in

“Will the IASB ignore the comments from our industry or make adjustments? What’s left is the politics part. We don’t know exactly how much weight Canada will wield. The fact is, we have long-term contracts, unlike other countries, and this must be considered if we want our industry to remain competitive,” Baril explains.

For now, politicking is in full swing. Industrial Alliance CEO Yvon Charest was among those who attended a series of meetings in October marking the end of the consultation period. Within the same week, a meeting with the IASB and Canada’s Accounting Standards Board was followed by a gathering of the Accounting Standards Oversight Council and the AcSB. The Oversight Council supervises the work of the AcSB, Charest says.

“We want to make sure that the same message is conveyed everywhere and that all parties concerned understand it,” he told The Insurance and Investment Journal in an interview.

Emboldened by the study published by the four insurance titans, he chastised the IASB for lacking vision. “The IASB itself told us not to apply standards whose impact we had not previously field-tested. They didn’t do that or they did it and kept the results confidential. It doesn’t look like they were taking it seriously,” he says.

The IASB says it made changes in its 2013 exposure draft since the 2010 edition, but Charest is unimpressed. “No elements show how this new standard gives results that make sense. The industry is extremely concerned with the choice of discount rate to calculate reserves. In that respect, I would say that the 2010 exposure draft made financial statements 10 times more volatile, and the 2013 version makes them five times more volatile, which still isn’t very good.”

Another bone of contention: displacement. Charest notes that the IFRS transfer much of the pressure attributable to volatility in the income statement to other elements of the overall results. So volatility is not cancelled but rather transferred within the balance sheet and constantly rises or falls sharply, he says. (To learn more on Yvon Charest’s views on this subject, see article No need for Canada to always follow international trends)