Last week's top story for InsuranceERM was based on comments from (Baroness) Sharon Bowles that IFRS 17 cannot be proper accounting because insurers can take credit for anticipated future income. And she went further, saying anyone on the UK’s accounting standards board who endorses IFRS 17 must be in the pocket of the insurance industry.
To put this into context, we have to backtrack a bit and introduce some accounting and actuarial concepts.
Bear with me.
IFRS 17 is the accounting standard for insurance contracts that is due to come into effect in 2023. It was finalised in 2020 but now jurisdictions have to officially endorse it. In the UK, that task will be carried out by the newly formed Endorsement Board.
Traditional accounting theory says companies should discount their future liabilities by the risk-free rates observable in the market (i.e. government bond yields or interest rate swaps).
But IFRS 17 says insurers can discount their future liabilities by more than risk-free, if their liabilities – and the assets backing them – are held for the long term.
Why so? Well, the theory is life insurers buy and hold fixed-income assets (e.g. bonds) for the long term. Therefore they are not exposed to the same risks as other types of investors, who might be forced to sell in a downturn.
(In technical language, insurers are not exposed to the risk of changes to the bond’s value, only the risk of the bond being downgraded or the issuer defaulting.)
So while insurers will pay the same as other investors to acquire the assets, their risks are lower, so they shouldn’t actually be paying the same.
Hence, there exists an “illiquidity premium”, which auditors and regulators agree insurers can capture by adjusting the rate at which they discount their future liabilities, to an extent determined by the type of assets they’re investing in.
Of course, whether or not there is an illiquidity premium is only really discovered when the liabilities and assets run off, which is decades into the future. But the accounting standard allows insurers to recognise it today.
This is paramount when trying to establish whether an insurer is solvent, or not, as the illiquidity premium can contribute billions to a large life insurer’s balance sheet.
Bowles’s argument is there shouldn’t be any upfront credit for anticipated future income.
There are a few other voices who agree with her – notably Dean Buckner and Kevin Dowd.
But the concept is deeply rooted in the sector. The regulator, standard setter, most of the actuarial profession and insurers are not on her side.
Bowles has engaged in a David vs Goliath-esque battle, but this one will not be settled with a single stone.
To extend the metaphor, she will need a small army. Who is willing to join her?
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