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The Actuary The magazine of the Institute & Faculty of Actuaries
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Life insurance accounting worries

Actuaries make a wide-ranging contribution to the production of financial information in life insurance, as preparers of accounts, advisers, and auditors. The Accounting Issues Committee of the Life Board has recently sought comments from actuaries about possible problems arising from current accounting practices in UK life insurance. The findings from this work will influence the future direction of the Committee.

Accounting standards
Why is the current situation so relevant if we expect an international accounting standard (IAS) for life insurance to apply in 2005? Developments from the International Accounting Standards Board (IASB) have been monitored closely by the committee and the new IAS is expected to have a significant influence on reporting. For example, the Financial Services Authority’s realistic balance-sheet requirement is one consequence we are already experiencing. In 2005, an interim standard is expected to apply to insurance contracts, but some of the IASB’s usual rules won’t apply, allowing UK insurers to continue some of their current accounting practices. This would continue pending completion of a final standard in maybe 2007. Therefore current UK accounting has an important role to play for UK insurers for the next four or five years. This is illustrated by ongoing activity from the UK Accounting Standards Board, the Association of British Insurers, and the British Bankers’ Association to resolve their outstanding differences on matters of mutual concern.

Professional concerns
The Life Accounting Issues Committee has concerns about a number of current life accounting practices. We asked 24 senior actuaries working in life offices (including reinsurers) and consultancies (including auditors) for their views. We are very grateful to all who participated. The comments, collected using telephone interviews, were given in a professional capacity rather than as company views, and addressed those areas of practice that may produce potentially misleading results, or are poorly regarded by other stakeholders.
Many of the respondents were concerned about the multitude of different financial statements life insurers issue, with some of the output considered to be of limited value. Some of the major issues were:
– ‘Modified statutory is not relevant and not reliable.’
– ‘Nobody cares and consequently limited effort is put into it; management are not remunerated by UK GAAP and do not manage by it.’
– ‘Treatment of optionality and risk in general.’
– ‘We have to prepare accounts on different bases; ideally have one basis (realistic) that is used for everything.’
All respondents saw scope for significant differences in how expenses (acquisition, development, ongoing) were categorised, and most were concerned about inconsistencies from year to year. Only a minority of the insurance company actuaries thought it should be permissible to assume improvements in efficiency ‘in practice, planned improvements do not always materialise’. However, most consultants thought this should be possible, subject to conditions such as the corresponding investment having taken place, and strong evidence that savings would be realised.
On mortality improvements, a minority of respondents felt annuity portfolios were sufficiently homogeneous across the market for companies to have similar views on best estimates of future improvements. However, most respondents thought this was an area where guidance would be useful.

Guaranteed annuity options
Accounting for guaranteed annuity options (GAOs) is an issue the profession has grappled with in recent years. Many life insurers with GAOs have now bought hedges to match the investment risk in the options. Most respondents thought the market value of such hedges was sufficiently relevant and reliable for the profession to expect this value to be used in GAO provisions. Several actuaries raised the problem of making judgements about take-up rates of the option. In addition, there are substantial doubts about the adequacy of disclosure of key assumptions, exposure and risks, though some noted the difficulty in expressing all the information conveniently for companies’ accounts.
The focus of life company management on embedded values gave rise to concerns. In particular, such values are inadequate in recognising the value of guarantees. Most actuaries also believed there should be further consideration given to using differential risk factors to reflect differential risks. And many respondents were unhappy about inconsistencies across the market, for example in calculating the new business value of with-profits policies.

Relative priorities
Lastly, we asked respondents to comment on five specific concerns, rating these from 1 (current practice acceptable) to 9 (very serious concerns). The results are shown in figure 1.
These findings reinforce the comments on options and guarantees, and the adequacy of disclosure. They also provide a guide to the relative priorities, as seen by respondents.
Over the coming months the Life Accounting Issues Committee will seek to develop practical and effective responses and to engage in discussions with the relevant industry and accounting professions.

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