In 2008, efforts to participate in the creation of new international accounting and solvency standards will be the focus of U.S. regulators as well as insurance trade groups.
International accounting changes could be in place by 2012, and U.S. insurers need to begin thinking about these changes now, says Mark Freedman, a principal of Ernst & Young’s insurance and actuarial advisory services practice, in the Philadelphia office.
Freedman points to several signs that U.S. GAAP will eventually be replaced by new international standards: a recent vote by the Securities and Exchange Commission to amend rules to allow foreign private issuers to submit financial statements without U.S. GAAP reconciliation; efforts by the International Accounting Standards Board to develop a new framework; and interest by the Financial Accounting Standards Board to participate in that effort.
With regard to the SEC comment, Freedman says that in the short term, U.S. companies have the option to convert to International Financial Reporting Standards or to continue to use GAAP accounting.
But in the long-term, “a fair value type of standard is a gigantic change.” As a result of such a change, earnings could be a lot more volatile, he says. And, according to Freedman, under the current exit value concept, a way to estimate current value, it would not be clear whether an insurer would make money, lose or break even on a contract at issue. However, under GAAP, a company would break even at issue, he continued.
One piece of the current exit value projection is risk margin, Freedman says.
Margin is one area of discussion raised during last month’s winter meeting of the National Association of Insurance Commissioners in Houston. The Group of North American Insurance Enterprises, New York, delivered a report to regulators regarding the role of risk margin in the calculation of technical provisions. GNAIE commissioned E&Y to compile the report.
Determination of the fair valuation of liabilities is a central component of solvency standards proposed by the European Commission (Solvency II) and the IAIS, according to GNAIE.
The report focuses on the practical implementation of the cost of capital method for estimating market value margins applicable to non-hedgeable insurance risks.
Among the implementation challenges cited in the report are:
–Setting the parameters of a market value margin calculation including the capital base and the cost of capital rate, in a manner consistent with the market
–Demonstrating that the simplified measures of mortality and lapse risk are consistent with the desired confidence level and confirming that projections of capital required in each future period of the MVM calculation are consistent with future risk levels.
–”Calibrating parameters to reflect market conditions at the end of the solvency time horizon after occurrence of the hypothetical ‘distress’ event, which reflect a reliable estimate of the change in the market’s assessment of the price of risk upon such an event.”
And, in response to an IASB call for comment, GNAIE said that it believes that the most appropriate measure for insurance contracts is a “no gain at issue” approach that recognizes profit over a period of time as risk protection services are provided and the insurer is released from risk.
GNAIE goes on to say in its letter that cash flows used in measuring life insurance contracts should be a best estimate of all expected future cash flows. And, it added, it believes that a single model for life and non-life insurance contracts is flawed because of their “fundamentally different” characteristics.