Standard & Poor's research suggests fears are overblown over the cost of implementing new International Financial Reporting Standard 4 on insurers.
The ratings agency says since IFRS 4 is the result of compromises, the standard has been watered down “substantially” and leaves insurers with “room for manoeuvre”.
As a result, it is unlikely there will be any significant credit rating changes, S&P adds.
A major change is expected in published financial statements from UK insurers, however.
”Of greater concern to most companies has not been the restated primary financial statements, that is, profit and loss account and balance sheet, but rather the increased level of footnote disclosure,” S&P says.
”It remains to be seen whether the spirit of IFRS 4 will be interpreted similarly in different countries. However, in the UK, where the term ‘true and fair view’ has historically been interpreted more onerously than elsewhere in Europe, the level of disclosure is expected to result in financial statements that are up to double the size!”
Life insurers will be affected by the redefinition of certain contracts as financial instruments, while non-life companies will have to deal with adjustments linked to the elimination of equialisation/catastrophe reserves and revaluations of investments, S&P says.
Even groups reporting substantial changes to their figures are, however being left unmolested by ratings agencies.
S&P says Skandia Insurance Co. Ltd. reported a 20% reduction in year-end 2004 equity as a result of the standard, but its rating was still left unchanged by the ratings agency.
In the case of Skandia, S&P says around 50% of its business fails to qualify as insurance under IFRS 4 because of a lack of significant insurance risk in its unit-linked business.
Skandia has also decided to “unbundle” its unit-linked business into investment and insurance components so around 95% of its liabilities will be reported as deposits in 2005 rather than insurance liabilities, significantly changing the makeup of its balance sheet and income statement, S&P says.
This situation means even as Skandia grows its revenue, IFRS 4 will depress its earnings because it will have to defer income previously recognised in full under Swedish generally-agreed accounting principles, S&P says.
Most European insurers, including those in the UK, have reported a rested equity impact of less than 5%, S&P says.
Groups such as Aviva, with more diversity in life products, will be far less impacted than Skandia as S&P estimates the UK insurer has just 14% of its business classified as deposits under IFRS 4.
Similar to Skandia, however, Aviva will also see earnings depressed as revenues grow because it will not be able to defer acquisition costs to the same extent as possible under UK GAAP.
Royal & Sun Alliance has seen a 13% reduction in equity as a net result of implementing IFRS 4, although a bigger issue for that company is its pension scheme deficit, which under International Accounting Standard 19 represents 22% of the reported equity, S&P says.
”The impact of IFRS 4 is likely to be greatest in countries such as France, Spain and Italy, where the bancassurance model prevails and many life insurance savings products provide little insurance protection,” S&P says in its research.
It continues: "However, this will only apply to insurers that previously deferred acquisition costs. Many banks and their life insurance subsidiaries in this region chose not to defer. UK banks that previously recognised the embedded value of this life insurance business in their equity will cease to do so following this redefinition as financial instruments. Standard & Poor’s already deducts embedded value when calculating core capital for these groups.”
The one area the new standard may have significant impact is in re-insurance. This is because of enhanced disclosure requirements on contracts resulting in recognition of gains at inception.
”IFRS 4, followed by the Phase II standard, Solvency II and Basel II, not to mention investigations of financial reinsurance transactions, will progressively narrow the opportunities for so-called ‘finite reinsurers’ over time,” S&P states.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Jonathan Boyd on 020 7484 9769 or email [email protected].IFAonline
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