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Life assurance reporting – the more the merrier? Back  
The collapse of the Equitable Life in the UK, and the resulting Penrose Report, have resulted in the introduction of a new accounting stardard for life assurers – FRS 27. The overall impact of FRS 27 for Irish companies at first appears benign, writes Glenn Gillard, with little impact on reported profit. However, the disclosure detail required presents a far more significant challenge, he adds, which requires significant work by preparers of life assurance company financial statements to obtain and analyse information.
The Equitable Life failure in the United Kingdom and the subsequent report of Lord Penrose into the reasons for its collapse have significantly impacted life assurance industry and put greater focus on regulatory oversight and financial reporting.

As a direct reaction to the Penrose report, the Financial Services Authority (FSA) in the UK introduced the realistic balance sheet regime and enhanced reporting requirements especially for with-profit funds. As a reaction to the FSA changes and responding to requests from the UK Treasury, the Accounting Standards Board (ASB) needed to review its own standards for life assurance accounting and disclosures. The end result was Financial Reporting Standard 27, ‘Life Assurance’ (FRS 27

Implementation process
FRS 27 was published in December 2004 with an implementation date for all financial periods ending on or after 23 December 2005. The ASB had intended to implement the standard in time for December 2004 financial year ends. The impending implementation of International Financial Reporting Standards (‘IFRS’) for all listed companies in 2005, a process under which UK and Irish life assurers would continue to report on their insurance activities in line with the ASB standards in place at the date of transition to IFRS, imposed a requirement on the ASB to make the changes to its UK standards before 2005 to enable them to have effect for all life assurance companies, including those moving to IFRS.

However, the timeframe for implementation was considered too short for the industry as a whole and a compromise was reached. Eight of the largest UK listed insurance/bancassurance groups who would be adopting IFRS in 2005 signed a memorandum of understanding whereby they would disclose some of the information required by FRS 27 in their 2004 financial statements (in most cases within the Operating and Financial Review) and would undertake to comply with the requirements of FRS 27 in 2005 as part of the transition to IFRS. For all other companies 2005 represented the first year for implementing the standard. No Irish company disclosed information in relation to FRS 27 in 2004.

Key measurement requirements
There are two key measurement requirements relating to the measurement of insurance liabilities on a realistic balance sheet basis (RBS) and the use of embedded value.
Under an RBS regime, and therefore under FRS 27, the result must include:
• The cost of future bonuses
• The fair value of guarantees and options on a market consistent basis
• The cost of shareholders transfers
• Tax associated with future bonuses

The movement between liabilities under an RBS calculation and that under the existing modified statutory solvency basis (‘MSSB’) calculation is taken directly to the profit and loss account. Based on the figures produced by life assurance companies in their annual report last year the potential effect on reported profit can be substantial. As Irish insurance companies are not subject to the RBS regime of the FSA, the key measurement provisions of the standard are optional for Irish companies.

For bancassurers, the use of embedded value to calculate the profits of their life assurance business is still permitted. However, in calculating embedded value, FRS 27 does not allow future investment margins to be included and therefore requires the discount rate used to be a risk free discount rate.

Key disclosures requirements
While the measurement requirements may affect only Irish bancassurers and do not appear onerous for Irish life companies the additional disclosure requirements of FRS 27 present more of a challenge. The standard requires disclosure of a capital position statement and an analysis of movements in available capital.

A capital position statement, which is presented in tabular format, seeks to set out clearly the available capital of the company after taking into account any regulatory capital requirements or other restrictions on the use of capital which are not reflected in the financial statements. The table is accompanied by narrative disclosure requirements including information on the company’s target capital level and capital management policies, the assumptions made in determining available capital and the sensitivity of the available capital to changes in market conditions and other variables.

In disclosing the movement in available capital, companies are required to reconcile the change in available capital during the reporting period under four key headings, namely:
• Changes in assumptions used to determine the liabilities
• Changes in management policy
• Changes in regulatory requirements
• New business and other factors

Narrative disclosure is required to support the material movements under each of the categories. The disclosures, which include a table with accompanying narrative, require a much more detailed analysis of the emergence of profit in the company and bring into focus the effect of changing key assumptions from year to year in the overall profit and capital position. In the first year of adoption of the standard, an exemption from showing the movements table is available but the narrative information must be disclosed.

In addition to the two tables required above, further disclosures are required relating to the insurance liabilities and specifically in relation to options and guarantees that have not been valued on a market consistent basis. The equity market crash at the start of the decade has meant that in many cases the options and guarantees within policies are ‘in the money’ from a policyholder perspectibe and the Equitable Life failure highlighted that existing reporting frameworks may have understated the extent of obligations under these types of products.
FRS 27 has therefore tried to address the information deficit where market consistent valuation techniques are not used. The detailed disclosures required include information on the terms and conditions of the options and guarantees, the basis of valuation, the extent to which an amount is included for guarantees and options which is in excess of the amount required under the policy if there were no guarantees and the potential effects of adverse market conditions.

More the merrier
The overall impact of FRS 27 for Irish companies at first appears benign with little impact on reported profit. However, the disclosure detail required, particularly the information required on guarantees and options and the movements in capital, present a far more significant challenge which requires significant work by preparers of life assurance company financial statements to obtain and analyse information.

For the reader of financial statements, the new requirements of FRS 27 and the enhanced level of disclosure provide a much improved analysis of the financial strength of the company and will assist in providing greater transparency on the use of assumptions by life assurers in maintaining their capital and profit positions.

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