‘Insurance Accounting Proposal Includes Liquidity Premium’

Apparently yielding to the global demand for a change in the basis for calculating Companies' Income Tax for insurance firms, the International Accounting Standards Board (IASB) has included liquidity premium in new proposals for insurance company accounting standards.

The proposal is expected to engender a shift from the more market consistent exit value-based approach whereby values of asset and liability reflect the cash required to liquidate them in line with the last draft in 2007.

The proposal was originally intended to be applied in Solvency II only to annuity contracts that cannot be lapsed or transferred and are therefore considered illiquid but it will now apply in different degrees to all insurance liabilities over one year in length.

The controversial premium would be added to the discount rate for liabilities, thereby decreasing their value notwithstanding the fact that its inclusion in the Solvency II directive caused uproar and accusations of protectionism because annuities providers in the United Kingdom will benefit most from it.

The draft proposals were welcomed by the umbrella body for insurance companies operating in the United Kingdom, Association of British Insurers (ABI) and operators in the global insurance market welcomed the inclusion of the premium in the proposals.

"The draft is definitely a step in the right direction as far as comparability is concerned, as current International Financial Reporting Standards (IFRS) accounts are not at all comparable, but some issues remain," said Duncan Russell, an insurance analyst at the London offices of US Bank JP Morgan.

"For example, the IASB hasn't given a prescription on how to calculate the liquidity premium, which means there will be some flexibility for different companies to use different numbers, leading to different valuations for the same liabilities. Given how investors reacted to MCEV assumptions, it's important that the industry provides full transparency on this," Russell said.

John Breckenridge, assistant director at the Association of British Insurers, said the extent to which this was replicated in accounting was dependent on the market's appetite for convergence with Solvency II.

"To the extent they want to keep accounting and solvency together it will drive the choice of which products it is applied. Solvency numbers have to be approved by the regulator, but with accounting you have to please your auditors, analysts and shareholders. Ultimately it will come down to what the market thinks is appropriate," Breckenridge said.

Breckenridge said it was largely reflective of what it and other industry groups had lobbied for saying "the industry weren't keen on the exit value-based approach, because there isn't a deep and liquid market for insurance liabilities."

He conceded that it was less market-consistent as a result of the switch towards a fulfilment value, in which profits and loss are accounted as they occur in cash revenue, although he said it was far more market-consistent than current insurance accounting principles, based around the International Financial Reporting Standard 4.

"They haven't used the phrase 'fulfilment value', but that's effectively what it is, and what we wanted," he said.

Meanwhile, opponents of the proposals argue tempered enthusiasm for a generally more comparable standard for insurers with healthy skepticism informed by the recent travails of market consistent embedded value (MCEV) whose credibility has been hit by wildly differing liquidity assumptions across the industry.