Could International Regulation Kill Long-Term Products?

A view from the top branch (Jose Luis Magana AP Images)) A view from the top branch (Jose Luis Magana AP Images))

I have been traveling around the world for more than ten years. I have visited over 50 countries and met supervisors and industry professionals from 150 jurisdictions. When talking about a wide range of issues, including financial stability, accounting, solvency, governance, and market conduct, I found common issues as well as differences. 

Most recently, one of the hottest topics is the volatility issue concerning long-term products. On this subject, I have been actively participating and presenting my views, which I would like to share in this editorial. While I officially represent the Japanese life insurance industry, my last name “OKUBO” consists of three Chinese characters 大久保 , meaning “big, long-term, insurance,” I often feel like I am, in fact, representing the global long-term insurance business.

The proposed International Financial Reporting Standards 4 (IFRS 4) and the inappropriately designed economic solvency regime would bring tremendous volatility to companies with long-term insurance business models.

The scope of  IFRS 4 Phase 2, as Deloitte states, is the treatment of liabilities insurance contracts. The aim is to achieve consistency in accounting and valuation of insurance & reinsurance contracts across companies, as well as to improve investors’ understanding of insurance companies' profitability and financial position. These new rules are supposed to have synergize with Solvency II pertaining to the organization processes, systems and data of a company.

However, a possible outcome might be an unwanted shift toward short-term and investment-type products which transfer most risks to customers. Also, insurers may be driven to refrain from investing in assets other than fixed income assets, which may have a negative impact on the economy.  

People may ask, “why do you continue to underwrite long-term protection products, facing so many challenges?” My answer is, “it’s not our choice, but our customers.”

We have earthquakes in Japan. We have typhoons. We don’t take vacations. But still our life expectancy in Japan is the longest in the world. Customers want long-term and stable insurance protection. As you know, Japan experienced a huge disaster last year. We are proud of supporting our people during this difficult time.

There are a number of children who lost their parents as a result of the tsunami. We offer hope for them. In our country, supporting policyholders for a lifetime tends to be considered exactly what a life insurance business should be. Should we tell them that we can’t do this anymore because if the current interest rate remains the same for the next 40 years, we might not be able to pay the claims in 40 years with certain probability?

We are not talking about numbers. No, we are not talking about formula.  No, we are talking about people.

Life insurance is not death insurance. We have to take care of people’s lives. Supporting society with long-term coverage as well as investment vehicles is our core activity. Accounting and solvency should not prevent that.    

Unlike banking, insurance business models vary by country. I have carried out comprehensive research on seven countried: the UK, France, Germany, the US, Canada, Australia and Japan. I found a clear linkage between their business models and solvency and accounting regimes, including the scope of their use of IFRS. In some jurisdictions, short-term investment-type products dominate the market. The UK and Australia are examples. They are living in a fair value world and it’s their natural choice. On the other hand, in continental Europe, North America, Japan and many emerging market jurisdictions, long-term protection products cover a significant portion of the market. Life insurers tend to play a role as long-term investors. For those jurisdictions, the impact is magnificent. We should focus on how to deal with those which would be affected most, instead of seeking a conceptual consensus among those who don’t share the same business models. International competition is like the Olympics, there are different players. Japan’s got gold medals in marathons, but it has never had the same success in the finals of the 100 meter dash. Don’t force everybody to run a 100 meter dash in order to judge the quality of an athlete. We are all excellent in many different ways. We should be assessed based on how we meet the different expectations of our customers. 

Let’s talk about solutions. The use of Other Comprehensive Income, (OCI) would be an effective way to avoid the volatility in accounting. Roughly speaking, massive claims payments due to the recent earthquake in Japan might correspond to about one basis point change of interest rates, given the long duration of the contracts. The volatility we are talking about is of such a magnitude the without OCI, other factors might become a margin of error on income statements.

Makoto “Mack” Okubo  is currently assigned as General Manager for International Affairs, Nippon Life Insurance Co., where he is responsible for international regulatory matters. Formerly, he served as a member of the IAIS Secretariat in Basel, Switzerland, sponsored by FSA Japan. Within the Secretariat, he was responsible for standards implementation, including technical assistance and training of insurance supervisors over 150 jurisdictions. He also spent fiveyears in New York as a lead researcher at NLI Research Institute on banking, securities and insurance sectors in the United States and Canada, and launched his personal site, Insurance-Finance.Com, a research portal for industry professionals, regulators and researchers used in over 90 countries.

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