b) ED34 and FRS27 Life Assurance (ASB, 2004a; 2004b) ED34 was issued July 2004 in response to the Treasury’s request (following publication of the Penrose report in March 2004) and proposed that the standard would require the liabilities of UK with-profits life funds falling within the scope of the FSA’s ‘realistic’ capital regime to measure liabilities in accordance with the FSA’s definition of ‘realistic’ value of liabilities, which includes provision for the constructive liability for terminal bonuses which arises from how an insurer’s past pattern of bonus distribution and the statements in its policy marketing illustrations create policyholders’ ‘reasonable expectations’. However, for practical reasons, this requirement is not extended to smaller funds, UK non-participating businesses and overseas businesses. A consequence of adopting this approach to valuing liabilities (argued to be closer to the requirements of FRS12 for provision for constructive liabilities—from which insurers are currently exempt) is that there should be no matching asset for ‘deferred acquisition costs’. The assumptions used in determining this measurement of the liabilities are to be disclosed together with the effect of changes in these assumptions.
The standard would take account of certain differences between the valuation of assets for ‘realistic’ balance sheet purposes and accounting bases, and permit the recognition of an additional asset where the realistic value of liabilities has taken an additional asset value into account.
It would require the adjustments to restate liabilities from MSSB to a ‘realistic’ basis, together with the consequential adjustments to assets, to be made to the profit and loss account but offset by an equal and opposite transfer to the FFA. For mutuals, this offsetting transfer is to be made to the FFA or retained surplus as a reserves movement. 33
It would require disclosures relating to the assumptions used for the determination of the realistic value of liabilities and the effect of changes in assumptions; and would require separate presentation of the FFA on the balance sheet.
The standard would permit entities that currently adopt ‘embedded value’ methods for including their interests in life assurance businesses in their financial statements to continue this practice subject to restrictions (i.e. to exclude future investment risk margins and in respect of the value of future management fees), similar to those imposed on changes in accounting policies for insurance contracts by the IASB in IFRS 4.34 However, entities that do not currently adopt embedded value methods would not be permitted to do so under UK standards.
The standard would require detailed disclosures relating to options and guarantees only if these are not measured on either a fair value basis or at a value estimated using a stochastic modelling technique. Although the standard would require such valuation methods only in relation to with-profits funds falling within the scope of the FSA’s realistic capital regime, it encourages their use for options and guarantees of smaller funds, non-participating businesses and overseas businesses.
The standard would require entities to include a capital position statement, analysing the capital position of each main section of the life assurance business, and
33 Although FRS27 para 4 appears to refer only to a mutual’s retained surplus it is clear from para 18 that where a mutual has an FFA (as e.g. does Standard Life) the offsetting transfer should be made to the FFA.
34 FRS27 para.26 now only imposes the first of these restrictions—see Appendix IV para 7.19—which is itself stronger than IFRS4’s ‘rebuttable presumption’.