The Hindu Business Line : Gaping gap in insurance reporting

An effective financial report should be able to explain what the business is doing and the key business drivers. Non-financial information should be used to supplement a better understanding of the reported numbers.

Decoding the numbers.

Your insurance company might be eager to know a lot about you before offering you cover, which you may not want to share, much to the chagrin of the insurance companies. But a new survey has found that analysts tracking the insurance companies are in a much bigger dilemma, as they are unable to gather relevant data about how the companies go about their business.

This is partly to be blamed on a gaping information gap, said a report titled Insurance reporting at the crossroads: What do Analysts think prepared by one of the world’s largest professional services companies, PricewaterhouseCoopers (PwC).

It finds that there exists a significant gap between analysts’ rating of the potential ‘usefulness’ and current ‘adequacy’ of financial statements like balance-sheet, income statement and cash-flow statement, etc.

This indicates that the surveyed analysts are not able to drill down into where money is being made, or more specifically lost, by insurance companies with all that information that they collect from the ‘insured’. One of the major difficulties that analysts encountered is lack of consistency of disclosures. Comparability comes next.

“There are reams of literature written by accounting bodies and regulators on accounting for business transactions and disclosures. With businesses becoming complex, the accounting and reporting regimes have also gradually but surely become more complex. No amount of data provided would be effective in communicating a corporate’s performance unless it is in substance and manner that can be easily understood by the most important users — the investor community,” says Mr Thomas Mathew, partner, Price Waterhouse, in a recent interaction with Business Line. He is currently the firm’s ‘Territory Assurance Leader’.

“Investors moved from reviewing profit figures to EBITDA (earnings before interest, taxes, depreciation and amortisation) and now pushing towards understanding the fair values,” reckons Mr Mathew. “I believe that new generation tools like XBRL (Extensible Business Reporting Language) are important to help companies share more real time information and permit analysis by users. It is time that we look at financial reporting in a way to address ‘what may be useful’ rather than ‘what is required’.”

Reasons for disparity

The information gap is especially marked within countries that report under International Financial Reporting Standards (IFRS), to the extent that life analysts largely ignore the IFRS statements and generally use embedded value instead, says the 20-page report.

IFRS are standards and interpretations adopted by the International Accounting Standards Board (IASB). The significance of the standards is that they are used in many parts of the world, including the European Union, Hong Kong, Australia, Russia and Singapore amongst others. Indian standards generally toe the international line.

Analysts in the US, however, are more satisfied with the US GAAP (generally accepted accounting principles) information they receive, albeit with important reservations, the report notes.

Experts point out that the US GAAP provisions differ somewhat from IFRS, though efforts are under way to reconcile differences in principles so that financial statements produced under international standards will be considered acceptable within the US and, simultaneously, the US GAAP financial statements would be adequate internationally.

“US analysts are accustomed to the information provided under the US GAAP. Once adjustments have been made, they feel the data can provide a reasonably stable platform for rating an insurer and comparing performance with its peers and prior years,” the report says. In the absence of a clear benchmark, ‘adjustments’ might come handy for analysts worldwide.

But surveyed analysts outside of the US have not been so lucky as the report findings suggest that various different local accounting principles have been retained under the ‘temporary expedient’ of IFRS 4, making statements across the industry difficult to compare.

IFRS 4 is the first guidance from the IASB on accounting for insurance contracts. The Board issued IFRS 4 because it saw an urgent need for improved disclosures for insurance contracts, and modest improvements to recognition and measurement practices, in time for the adoption of IFRS by listed companies throughout Europe and elsewhere in 2005.

There are difficulties, though, in the comparison of IFRS statements with those of previous years. The introduction of IAS 39 for financial instruments is one such example.

Since IFRS is a primarily principles-based framework, it gives companies considerable discretion in how they convey information, PwC reminds. “As a result, a common and comparable cross-industry template for disclosure under IFRS has yet to emerge.” A case in point is the presentation of loss development tables; these are highly valued by analysts, but the presentation tends to vary markedly from one company to another, the report observes.

In short, current IFRS lacks the all-important consistency of its US GAAP counterpart, though the application of a common framework is one of the clear aims of the planned IFRS Phase II (which is currently under way), the authors add.

Digging up embedded value

Another thorny area, the survey found, was none of the current bases for insurance financial reporting, be it the US GAAP, IFRS or the alternative of embedded value, has the unequivocal support of analysts. “A key demand is greater transparency and explanation of managements’ assumptions and accounting judgments. This is especially critical as any scepticism or uncertainty will lead analysts to apply discount factors to reported values,” the report cautions.

The embedded value of a life insurer is the current value of all potential surpluses for that company, taking into account reserve releases. The company’s net asset value is added to this total. This is partly because life insurance policies are long-term contracts, where the policyholder pays a premium for many years. In return he is covered against an adverse event like death that may occur many years into the future.

While assets of an ordinary company include buildings, cash, and stock — for an insurer the assets could be measured to include the probable payment of upcoming premiums for policies that have been already sold. Likewise, an insurer’s liabilities are generally considered to include possible claims to be paid out in future, if and when the ‘insured’ dies. Hence, ‘embedded value’ allows these uncertain future cash flows to be valued. This allows them to have a more pragmatic picture of the company’s financial position.

“Perceptions of cloudiness could also put off investment in a particular company or the insurance sector as a whole and, eventually, result in a higher cost of capital for all insurers,” the report says. However, the report stresses that that many of the survey interviews were carried out at the peak of the credit market crisis and this would appear to have heightened concerns about the reliability of management judgment in the reported numbers, especially among respondents in the US.

Nonetheless, the scepticism about management input is at odds with analysts’ frequently stated desire for disclosure, which more fully reflects the views of management and the way the business is run, the report said.

For standard-setters, the survey findings highlight the challenge of being on the lookout for meeting the needs of users of accounts with very different perspectives and approaches to valuation, the report says.

“This includes considerable differences in the way the US and the rest of the world analysts operate now, along with strong US misgivings about any standard that would increase the need for subjective or mark-to-model valuation,” concedes PwC. “That being said, some analysts stressed that the place for the management’s eye view is within the supplementary disclosure, rather than the audited financial statements,” it adds.

“I am not surprised that there is increased hunger for qualitative disclosures like segmental information,” remarks Mr Mathew. “An effective financial report should be able to explain what the business is doing and the key business drivers. Non-financial information should be used to supplement a better understanding of the reported numbers.”

Mr Mathew believes that there is a definite need to make corporate reporting more cost effective and relevant to shareholders. “Investing community, including retail investors, are important users of the report and any framework that does not address their requirements would be inadequate.”

D. MURALI

INDRA NATH

http://AccountSpeak.blogspot.com

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