S&P Comments on Standardizing Global Insurance Accounting Rules

October 16, 2007

In a new report Standard & Poor’s states that the “International Accounting Standard Board’s (IASB) discussion paper on insurance contracts may well set the tone for a new global frame work.”

The report – “Toward A Global Financial Reporting Standard For Insurance: Standard & Poor’s Comments On The IASB’s Preliminary Views On Insurance Contracts -“, indicates that formulating such global standards “are appropriate and long overdue.”

“The proposals are radical and would, if implemented, meaningfully change how financial statements of insurers are presented and liabilities and profits are calculated,” explained S&P credit analyst Rob Jones.

S&P called the discussion paper “a first step in a move towards a comprehensive phase II of the International Financial Reporting Standard (IFRS).” Within the European Union (EU) the changes are “consistent with the progress of Solvency II,” S&P notes, “but for other jurisdictions, particularly the US, this would be more burdensome.”

Although S&P’s bulletin didn’t spell it out, the framework for insurance industry regulation, contained in the EU’s Solvency II directive, could well change the entire nature of insurance regulation. Upon implementation the current “rules-based” system will be replaced by a “principles-based” format – the “Three Pillars” approach. The first pillar – “Solvency Capital Requirements” – will continue to assess capital adequacy, but measured by the level of risk as well as assets. The second requires greatly increased risk management, and the third requires transparency or full disclosure of the company’s risk-based financial position. At the International Insurance Society Conference in Berlin last July it more or less dominated discussions (See also IJ magazine Sept. 24 on the I.I.S. Conference).

Jochen Sanio, President of the German Federal Financial Supervisory Authority (FFSA) told conference delegates that if Solvency II works “it could become a blueprint for regulatory regimes around the globe.”

Jerry de St. Paer, Senior Vice President for Finance at AIG, openly addressed the potential conflict. He spoke on behalf of GNAIE – the Group of North American Insurance Enterprises – which represents a number of major U.S., Bermudan and Canadian companies in matters concerning standards and regulations. “We support level regulatory playing fields,” he said. But, he complained that Solvency II is designed to give EU insurers an advantage, particularly as it provides for “Group Supervision” – i.e. one regulatory team for an insurance group that covers all of its business activities, wherever located.

The U.S. rather obviously doesn’t have such supervision. De St. Paer noted that this provision of Solvency II could give EU players “a greater advantage in diversifying their activities in third countries.”

The underlying problem for the U.S. is deeper than that. If U.S. insurance regulators stick to the current system, they risk being bypassed by the Europeans, who may well impose restrictions on U.S. insurers who don’t meet EU regulatory requirements. If the U.S. changes the system, it will inevitably give up much of its independence as well as its leadership position.

S&P is concerned about the “the financial reporting of life insurers,” which it described as “in a poor state globally.” The rating agency did indicate that the “situation for pure non-life insurers is not such a concern,” but it added that it’s “not in a perfect condition either.”

In conclusion Jones stated: “Many users have still to be educated on the impact of the discussion paper and are not highly engaged in the debate. We believe that all prospective users need to be engaged to play their part in the end product. In the long run, external financial reporting could also be more transparent and better aligned with regulatory filings and requirements. Insurance would be a better managed and thriving industry, and better understood by a broader investor group.”

The report is available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor’s credit ratings, research, and risk analysis, at: www.ratingsdirect.com. If you are not a RatingsDirect subscriber, you may purchase a copy of the report by calling (1) 212-438-9823 or sending an e-mail to: research_request@standardandpoors.com. Ratings information can also be found on Standard & Poor’s public Web site at: www.standardandpoors.com; under Credit Ratings in the left navigation bar, select Find a Rating, then Credit Ratings Search.

Source: Standard & Poor’s

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