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Draft for discussion at ICAEW IISC meeting, 20th June 2005 - page 10 / 51





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Other countries have also been experimenting with new methods of reporting for both financial reporting and regulatory purposes (e.g. Australia, New Zealand, Canada, South Africa) while in the USA, where US GAAP accounts were already distinct from the statutory bases used for state regulatory purposes, there were also calls from the industry for a new approach to be developed. The various solutions developed (see e.g. Horton & Macve, 1995, Appendices V-VII; Forfar & Masters, 1999, Appendices B & C; Klumpes, 1999) adopt varying approaches to whether or not a profit is recognised on inception of a life policy, how ‘deferred acquisition costs’ are treated, and what is the complementary method for reporting investment gains and losses. These international developments were given additional momentum when, as noted above, the IASC in 1997 added the development of an international standard for insurance companies to its agenda, albeit not to its ‘core standards’ project. Subsequently this insurance project has been taken over by the IASB.

A major reason for the international interest in new accounting methods (apart from the global pressures for the restructuring of the financial services industry) has been the worldwide developments in accounting for financial instruments. Insurers are, of course, major financial institutions and hold large positions in financial instruments, in particular their investment portfolios and associated derivatives, and many of the problems with the current state of life insurance accounting arise from the mismatch between the ‘fair value’ basis on which many of these financial instruments are now being measured (e.g. under SFAS133 (FASB, 1998) and IAS39 (IASB, 2004b)) and the various bases on which the related insurance contracts are measured, and from the resulting volatility in reported earnings and net assets. Although valuation of investments at market value has long been the practice of insurers in the UK, the treatment of realised and unrealised gains and losses has been subsumed into the actuarial valuation of the fund: but a new approach to policy liability valuation will require explicit consideration of how such gains and losses are to be reported. The developments in ‘fair value’ reporting of financial instruments (which will also affect the rest of Europe when IASB standards come into force for listed companies throughout the EU from 1.1.2005) are therefore also driving the concerns to resolve the issues about ‘realistic’ reporting of life business profits. Correspondingly, the conceptual difficulties highlighted by the difficulties in getting agreement (including full EU acceptance) on the implementation of IASB’s financial instruments standards—and in particular IAS39—spill across into difficulties about insurance accounting (e.g. Horton & Macve, 2000; Macve, 2004a).

More generally the need for the IASB to have a comprehensive set of accounting standards in place in time for 2005 has been seen as crucial in establishing the credibility of international standards vis-à-vis US GAAP: and a standard on insurance that is applicable worldwide was needed to complete the set.

There have been other recent developments in the regulatory regime in the UK which have reinforced the urgency here of finding a more satisfactory basis for life insurance accounting and reporting. While the concept of the ‘reasonable expectations of policyholders’ has been in the legislation for a long time the understanding of its practical import has been evolving only gradually. One aspect of this has been the development by insurance companies of a measure of with-profits policyholders’ ‘asset shares’. This approach looks at the with-profit policyholders in a manner similar to ‘unit-linked’ policyholders, and ascribes to them their share of investment returns and gains and losses achieved to date, less policy costs and other necessary


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