guarantees do not meet the definition of an insurance contract they are required to be measured separately at fair value (i.e. including both intrinsic and time value) unless they are ‘closely related’ to the insurance contract, i.e. they are so interdependent that an entity cannot measure the embedded derivative separately (i.e. without considering the host contract) (BC189-90; BC193).
With regard to the potential mismatch between the ways in which an insurer accounts for its financial instruments under IAS39—often at fair value—and the ways in which it accounts for its policy liabilities, the standard has addressed the problem, not by providing for special forms of financial asset accounting but by permitting the remeasurement of designated liabilities at current interest rates (and, if the insurer so elects, other current estimates and assumptions) and by clarifying the applicability of the practice known as ‘shadow accounting’. It has also allowed the choice of whether to use cost or fair value under IAS40 to be made separately for investment properties that back contracts that pay a return linked directly to the fair value of, or returns from, specified assets including that investment property and for all other investment property (BC178). Additional flexibility is provided by the provision that, where an insurer changes its accounting policies for insurance liabilities, it may reclassify some or all financial assets as ‘at fair value through profit and loss’ (BC145).
Of potentially greater significance are the provisions that circumscribe the use of ‘embedded values’ in the main financial statements. Currently UK insurers are forbidden to do so by the ABI SORP (at the behest of the ASB), while other entities such as banking groups (and Irish insurers) do have freedom to include their insurance activities on this basis. IFRS4 does not require an entity that is currently using embedded value to abandon it or to change the methodology used: but it limits the extent to which companies can change to using embedded values in two ways. It prohibits a change of accounting policy for insurance contracts that involves measuring contractual rights to future investment management fees at an amount that exceeds their fair value as implied by a comparison with current fees charged by other market participants for similar services. And it introduces a rebuttable presumption that an insurer’s financial statements will become less relevant and reliable (and therefore the change cannot be made) if it introduces an accounting policy that reflects future investment margins in the measurement of insurance contracts. Some present embedded value methodologies include these features and therefore companies using them would not generally be able to start introducing embedded values into their main accounts. However, the recent statement by the European CFO Forum (representing the chief financial officers of major European insurance companies (CFO, 2004)) addresses at least the second of these features in its revised European Embedded Value Principles, which member companies all propose to adopt from no later than 2005.32 Subject to clarification of the treatment of future investment management fees it will therefore be possible, at least during Phase I, for companies to incorporate embedded values on this basis into their main accounts (BC138-144). However the IASB has indicated that in Phase II it may not accept methods that give rise to a profit on the inception of a contract unless there is strong market-based evidence for this.
32 In the UK Aviva has already announced (on 6/1/2005) their adoption from 2004 for its supplementary reporting (http://www.aviva.com/?PageID=55&NewsID=1968 ), which apparently was associated with a favourable share price reaction for the sector on 7/1/2005 (Independent 7 Jan 2005: http://news.independent.co.uk/business/news/story.jsp?story=598474 ). On 9th March 2005 it released its preliminary results for 2004 incorporating the ‘EEV’ numbers: http://www.aviva.com/index.asp?PageID=55&year=&newsid=2029&filter=