Last chance for industry to limit accounting standards' impact

By Alain Thériault | September 25 2010 08:34PM

The deadline is fast approaching for the new accounting standards that govern insurance contracts. The industry has until Nov. 30 to make its complaints known. After that, there will be no opportunity to influence the development of accounting standards which could transform life insurance products in Canada.

The new International Financial Reporting Standards (IFRS) is a matter of particular interest to insurers, especially when it comes to the famous Phase II, which applies to insurance contracts.

In July, the International Accounting Standards Board (IASB) published its exposure draft of rules for insurance contracts and opened the comment period on the future standards that will dictate how insurance contracts are dealt with in financial statements.

After Nov. 30, the IASB will use the comments received during the consultation period to shape a final and binding version of IFRS Phase II. The final version is expected to be published sometime in the second quarter of 2011, and will come into effect in 2013.

After generating an eventful preliminary discussion in 2007, today's document continues to stir up controversy in the industry, particularly when it comes to life insurance in Canada.

The Canadian industry fears that these new standards for the classification and valuation of in force contracts will put an end to existing methods that are tried and true. Insurers suggest that the new standards could create artificial volatility in their financial statements, and also lead to both higher pricing in certain products and to the abandonment of certain guarantees.

The IASB argues that the goal is transparency, and suggests that financial results related to insurance contracts have become so complex that ordinary mortals are no longer able to decipher them.

However, the international accounting watchdog is still prepared to take other points of view into consideration, and will survey the industry before finalizing the new accounting standards.

The Canadian Life and Health Insurance Association (CLHIA) is preparing its response, but is not prepared to comment at the moment. When contacted by The Insurance and Investment Journal, the association's spokesperson, Wendy Hope, said that they were preparing a memo for the IASB, but were not able to discuss its contents because they were currently collecting feedback from member insurers.

Yvon Charest, the CEO of Industrial Alliance, is involved with the CLHIA committee that is dealing with the matter. He dismisses out of hand the IASB's suggestion that insurers' financial statements have become too opaque. "In Canada, we have a very good tool called sources of earnings," he says.

Developed during the time when many insurers were demutualizing, this method allows an insurer to describe and quantify different sources of profit. "Half of the questions that analysts ask us after financial results have been released deal with this aspect, and the method allows us to clearly explain our results in different sectors," says Mr. Charest.

He also provides an overview of the principles that CLHIA intends to defend in its memo. "This Phase II that will come into force in 2013 is very negative for the industry, particularly for companies that sell a lot of long-term contracts, such as whole life insurance products and annuities," says Mr. Charest.

He says insurers are not pleased to see the IASB ignoring the strength of the Canadian accounting system, which he says was well tested during the crisis of 2008-2009. "We also do not like the fact that the IASB has not changed its position since the earlier discussion on insurance contracts," he says.

The insurers' grievances have not changed either. The CEO of Industrial Alliance dislikes the idea of a discount rate, which is a "conservative" rate of return that insurers must use to calculate their obligations, and which will be the same for everyone, regardless of the individual company's investment performance. He also dislikes the idea of de-linking the assets from liabilities in the calculation of actuarial reserves.

"This standard creates too much volatility," says Mr. Charest. "Canada is unique in the world in that it sells more long term insurance policies, more than in Europe, for example. Canadian insurers invest in 20 to 30 year bonds, in infrastructure, real estate, mortgages, and it will now have to evaluate these long-term investments based on the current fair market value. This calls the most important accounting principle in our financial statements into question," he says.

Insurers are not giving up the fight. Mr. Charest will be one of those who meets with top IASB executives during a special visit to Toronto on Nov. 23 and 24. By then, the CLHIA will have probably submitted its memo, which will likely be one of many.

Philippe Thieren is a partner at PricewaterhouseCoopers (PwC). He specializes in training Canadian insurers about IFRS. He understands the insurers' complaints. While the Phase II standards will be generally implemented in all business sectors, he says they will affect the Canadian life insurance industry most of all.

Mr. Thieren understands that the IASB's positions concerning the discount rate and the separation of assets and liabilities are creating a stir. Until now, the close ties that exist in Canada between regulation, accounting and actuarial science have allowed the Canadian model to perform well. However, he says that IFRS's Phase II is undermining one of these three pillars.

"We are departing from a Canadian approach that works very well. It isn't easy. This separation of the investment component and the insurance component of a product like universal life will require insurers to separate the two premiums in their financial statements. This will create volatility in their results and it is natural that the insurance industry is trying to find a way to limit the impact," comments Mr. Thieren.

Change possible

Mr. Thieren is encouraging all insurance companies to respond to the IASB's survey. "This organization listens and it would not be its first reversal," he says. Phase II is in fact the result of pressures that have existed since 2000, when the standards for the insurance contracts first appeared in Phase I. "Canada's influence is not ignored, and its accounting expertise is recognized worldwide. The IASB is listening to every market, but with an international perspective - Canada not more or less than Japan or China," he says.

Despite some reservations, Mr. Thieren believes that the current document represents significant progress from the first document that was issued some years earlier. "It is not perfect and could pose problems for Canada, but are we obliged to reject it outright? I don't think so," he says. He adds that most of the anticipated difficulties lie mainly in how to interpret financial results.