The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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The insurance industry is suffering from International Financial Reporting Standards (IFRS) complacency. For years, insurers have been waiting for the standard that will allow them to report consistently across the globe in one clear and understandable format. For years, the standard setting boards have failed to deliver and for years, CEOs have felt that their businesses are under-valued. Is that about to change?

The industry's recent focus has rightly been on Solvency II to the almost complete exclusion of IFRS. The reporting objectives of Solvency II and IFRS are different but inter-related - the objective of the former is policyholder protection, the latter to communicate on business and financial performance.

With the forthcoming accounting standard for insurance contracts, insurers will need to consider this dual reporting revolution as a single comprehensive response to their public reporting requirements. Executives will need to pay greater attention to how they use these measures to communicate the value proposition, i.e. the story of the business, to investors.

"The key question to ask yourself is will the new standard help you communicate the value of your business to your stakeholders?"

The International Accounting Standards Board (IASB) has recently made considerable progress with the development of the Phase II Insurance Contracts Standard. For the first time, I feel confident in saying that an exposure draft can be expected towards the end of the second quarter of this year. The future development of the standard through the comment letter phase and on to the final version will most likely be in use for year-end 2014, if not before.

Will all this effort be good for insurers? Is this a giant leap forward in insurance reporting? The simple, although qualified, answer is yes, but the key question to ask yourself is will the new standard help you communicate the value of your business to stakeholders?

Widespread under-valuation of insurers
PricewaterhouseCoopers (PwC) recently sought the views of analysts focused on insurance companies around the globe. There was a widespread view that the current reporting model causes a lack of transparency and under-valuation of insurance firms on the world stock markets.

The obvious conclusion is that there is a need for the standard setters to come up with an improved reporting framework as quickly as possible, which means putting pragmatism before theoretical perfection. The survey concluded that there is a significant gap between analyst expectations and current practice, although reporting has improved marginally over the past couple of years. The table shows the adequacy gap, focusing on the usefulness of information as perceived by the analyst community and the adequacy of that information.

The table suggests that marginal improvement is not what is needed. Here are a few observations on those categories where I believe there are real lessons for the insurance industry, where the adequacy gap is greatest and where the value of the information is of most use to the analysts.

The income statement: One respondent to our survey referred to the "complete disaster" that is the income statement. To judge by the number of non-life firms using non-Generally Accepted Accounting Principles (GAAP) measures to tell the story of their businesses, CEOs and CFOs would agree.

Balance sheet: Given the number of companies currently trading at below book value, the balance sheet is clearly an important item for the standard setters to consider.

Segmental analysis: Studies on corporate reporting indicate that "telling the story of a business" through the strategies companies are following across individual segments is one of the ways that investors use to really try to understand the value drivers of a business. Getting the segmental information communicated in the right way seems to be far more important than presenting results on an adjusted basis into the market place.

Risk-based capital: In an era when Solvency II is at the forefront of executives' thinking, and capital allocation is being driven further down into the detail of a business, risk disclosures, even at the most simplistic level, should enable analysts to make assessments about future returns on capital employed and build these into their valuation models. Analysts want to understand more about risk in the context of value or capital at risk measures. Together with IFRS disclosures, the public reporting required under Solvency II should help in this regard, provided that it gives the same picture of the business!

A way forward for reporting?
The insurance industry still has a lot of work to do, as it is handcuffed by current accounting standards. Our survey concludes that analysts prefer appropriate accounting measures rather than selective highlights in order to assess performance and insurance firms still have some way to go in presenting the most useful information to analysts. The industry has tried through the use of non-GAAP measures to demonstrate value, but the investor community does not seem to be buying this. Will the new standard help you as managers of your business to address this issue?

So where should executives focus their energies? One message is clear - reporting should reflect the fundamental economic realities and underlying business model. It should put the figures making up key performance indicators in "bold lights".

Our survey suggests the answer to the following question should be a key consideration when doing your field testing of the standard prior to comment: Will the standard allow you to report your business in a way that is easy and clear to communicate, particularly in those areas where you believe you are not currently being given credit by the investor community?

Financial reporting issues cannot be considered in isolation from Solvency II and vice versa. There is significant overlap between Solvency II projects and the future outlook for International Financial Reporting Standards (IFRS). Solvency II is on the agenda of every CEO. IFRS needs to be there too, if not today, then definitely in about six months time.

A key focus of the IFRS/Solvency II debate is how closely the measurement bases can be aligned. Close alignment opens up opportunities for valuable synergies across the conversion projects, and beyond - in areas such as data management, modelling and investor relations. The mantra here is clear - avoid the disruption of "digging up the road twice".

So is this the time for you to start paying attention to the IFRS debate. In my view - absolutely yes. The dual reporting revolution should provide you with the opportunity to explain your business in a new way. Embrace the opportunity!

Andrew Hill is a partner with PricewaterhouseCoopers specialising in IFRS conversions.