required to report on whether the accounts give a ‘true and fair’ view11 there was much debate in the UK over what further changes, if any, might be needed to meet this requirement, which stimulated discussion of various forms of ‘realistic’ reporting (Horton & Macve, 1995; cf. Yardley, 1995).
There have also been significant pressures from the restructuring of the UK industry through take-overs and demutualisations. There have been take-overs not only by other insurers consolidating their position but also increasingly by banks as part of the wider restructuring of the financial services industry. Managers have wished to be able to report their performance more realistically so as both to demonstrate the return from the take-overs they have made and also to provide a defence against being taken-over or, if taken-over, against being marginalised in the new corporate structure.12 There was widespread concern that listed life companies were undervalued by the stock-market and in particular that the Pearl had been acquired cheaply by AMP in the hostile 1989 takeover. In response companies began more systematic disclosure of their ‘embedded values’ (incorporating the value for shareholders expected from the future releases of surplus from the life fund)13 and of results computed on the basis of the change in embedded value, of which a major proportion was the value added by writing new business. Meanwhile the ABI, beginning in 1990, proposed an alternative methodology of ‘realistic’ accounting— the ‘accruals method’—which sought to apply the principles of the ASB’s SSAP 9 (ASC, 1975) to the industry’s long-term contracts and which it was thought would prove more acceptable for accounting purposes than the more actuarially driven ‘embedded value’ approach.14 But embedded values remained popular (as they form the basis for valuations in take-over situations)15 and after some experiment the ABI produced guidance on ‘achieved profits’ reporting (which could utilise either the accruals or the embedded value methodology) and this was increasingly adopted as a form of supplementary reporting and incorporated by some companies, in particular the bancassurers, into their main consolidated accounts. However both the ASB and then the IASB had concerns about the compatibility of embedded value based accounting with their own conceptual frameworks (in particular because a profit is recognised on inception of a life policy contract) and the ASB has so far banned its use by stand-alone insurers16 while the IASB has generally discouraged its adoption.
11 12 This was already required in France and Germany. A related issue has been the changes in the ‘business model’ for life insurers: what was traditionally seen by actuaries as a ‘fund’ for policyholders has become seen by more generalist managers as an investment for shareholders. Managing the ‘business risks’ (e.g. the effect of changes in incidence of policy lapses) has become as, if not more, important and significant to overall results and financial strength as managing the more traditional insurance and investment risks.
13 ‘Embedded value’ only values the existing (‘in force’) book of policies—addition of the value of expected profits on future business gives ‘appraisal value’ (Horton & Macve, 1995).
14 15 For an attempt to measure the impact see Horton & Macve, 1998. The London Evening Standard on 12 December 2004 reported the sale of the closed life funds of HHG (including Pearl, London Life and NPI) for around 80% of embedded value: http://www.thisislondon.co.uk/news/business/articles/timid396263 (accessed 13/3/05). As the funds are closed to new business there can only be ‘embedded value’. More recently, Resolution has made a reverse take-over of Britannic and its closed life-fund : http://www.thisislondon.co.uk/news/business/articles/timid401197?source=This%20is%20Money (accessed 12.6.05)
16 The ban has not applied to the Republic of Ireland (ASB, 2004b, Appendix IV para. 7.6) and embedded value is still reported in its main financial statements by Irish Life & Permanent (http://www.irishlifepermanent.ie/ipm/ir/reportsandpresentations/annualandinterim/ accessed 13.3.05).