Financial reports created using proposed international accounting standards may look strange at first, but they give clear information about how insurance contracts are really doing, Patrick Finnegan says.
Finnegan, a member of the International Accounting Standards Board (IASB), London, who once worked for Moody’s Investors Service, New York, has written about the proposed IASB insurance contract standards that were released in July in an IASB insurance standards proposal commentary posted on the site of IASB’s parent, the Internationl Financial Reporting Standards Foundation, London.
Today, a typical U.S. insurance company would report on its performance by showing a figure for premiums and deposits; figures for other types of revenue, such as investment revenue; a total revenue figure; and a net income figure.
IASB wants to replace the list of revenue figures with a list showing profit or loss margins on the major components of the company’s overall profit, or loss.
The company might report on underwriting results by showing the company’s risk adjustment margin; the “residual margin,” or the difference between the original expected contract values and the initial premiums collectedex; the underwriting margin; an experience adjustment; and a figure for “changes in estimates.”
The company then would give the net interest and investment result, which could be broken down into investment income and interest on insurance liability.
A company also would report changes in insurance liability by showing the
level of liability at the start of the year, the liability at the end of the year, and the marginal effects of the items that caused the liability change. The report would show how shifts in factors such as a change in risk adjustment and release of residual margin have affected liability.
The “building blocks” used to come up with the margin figures would be estimates of cash flows, current market discount rates, and a risk adjustment. The risk adjustment would represent “an explicit and unbiased estimate of the effects of uncertainty about the amount and timing of the cash flows arising from an insurance contract,” Finnegan says.
“The margin approach differs markedly from what investors are accustomed to seeing in the income statement of insurers,” Finnegan says. “However, today’s reporting fails to provide an investor with clear and direct signals about whether an insurer is underwriting profitably, managing expenses efficiently and realising returns on its investments.”
The margin-based approach would be helpful in accounting for life insurance contracts, because it would eliminate the need to make artifiicial distinctions between premiums and deposits, Finnegan says.
Report readers who are used to getting information about an insurer’s premiums, deposits and total revenue figures would miss seeing that information in a purely margin-based reporting system. IASB members have decided that getting information about premiums, claims and expenses is relevant to users of financial information, Finnegan says.
“The board proposes to require disclosure of such information in the notes,” Finnegan says. “As a result, the data to perform traditional loss and expense ratios, as well as combined ratios, would still be available.”