By Michael P. Voelker
Although the details still are being worked on and the time line is open for debate, the way Jerry M. de St. Paer sees it, the question for U.S. insurers is not whether there will be convergence between U.S. GAAP and IFRS standards—but when.
“The international movement behind IFRS is tremendously strong,” says de St. Paer, executive chairman at the Group of North American Insurance Enterprises. “I believe the U.S. insurance industry is going to sign on to IFRS because to do otherwise would isolate ourselves at a time when competitive advantage is particularly important.”
His assessment is shared by Francesco Nagari, who as a partner at Deloitte & Touche in London, has been monitoring the progress of convergence for several years. “I’ve never seen in my professional life the degree of commitment from all parties involved in this project as high as it is now,” he says. “We are in the best condition ever to finish this job.”
Insurers therefore are asking what this likely convergence will mean for both U.S. GAAP and statutory accounting. Nagari and de St. Paer are two members of a panel that will explore this issue in today’s Accounting Super Session, titled “Will the Rise of IFRS Be the Fall of U.S. GAAP and Statutory Accounting?” at 3:30 p.m.
Creating Convergence
The session will include a brief overview of IFRS. “The idea of the panel is to help participants understand where we are and how we have gotten here,” Nagari says. “That includes what the major elements of the new accounting standard will be based on the decisions that have been reached by the IASB and FASB as well as the major issues yet to be discussed.”
As accounting professionals are aware, IFRS 4 was the first guidance from the IASB on accounting for insurance contracts, applying to companies listed in Europe and effective in 2005. However, IFRS 4 was intended to be a stopgap measure to improve disclosures for insurance contracts, rather than the final standard.
“IFRS 4 for insurance contracts was just a compromise—an interim solution,” Nagari says. “There still is too much difference in reporting among different companies.” Therefore, work over the past four years has centered on the second phase of the IASB’s insurance project.
“Under the new standard, there will be one type of measure for all insurance contracts, rather than different measures for different types as currently exist. There will be a model for accounting based on the ‘three building blocks’ approach,” Nagari says. Those blocks include an unbiased value of all future cash flows arising from the contract, a market-consistent discount rate, and a margin for uncertainty.
Preparing to Comply
A time frame for convergence has been set in memorandums of understanding between the IASB and FASB, including a March 2009 memorandum where the two boards agreed to issue proposals to replace their respective financial instruments standards with a common standard in a matter of “months, not years.” However, at an April meeting of the Financial Crisis Advisory Group (FCAG) in London, FASB chairman Robert Herz predicted, in a perfect world, convergence could take “10 to 15 years.” Despite this level of uncertainty regarding the ultimate time line, de St. Paer asserts what’s important for insurers to understand is, in whatever form convergence materializes, GAAP and stat reporting will never be the same for carriers.
“We either will convert to IFRS or be heavily influenced by it. Whether the U.S. insurance industry formally adopts IFRS or not, the fact is GAAP will look a lot like IFRS in the end,” he contends.
Therefore, de St. Paer stresses carriers need to be actively engaged in the process at an industry level. “Whether you agree or not with everything the IASB and FASB have done, if you want to have a say in where the bus is going, you need to get on it. If they don’t get involved now, they’ll simply have to take what we get at the end.”
Internally, carriers need to begin assessing their readiness, from both a business process and technology standpoint, to comply with IFRS-based standards.
“This process is going to require a wholesale change of systems for many carriers,” de St. Paer predicts. “This will have a bigger systems impact than the Y2k issue, and people need to start thinking about it now because we already can see the direction of it. Software vendors already are gearing up on it, and large carriers already are preparing for it, as well.”
“By understanding the decisions already made to this point, insurers can prepare themselves,” Nagari says. “One of the key questions they need to ask is how prepared they are to create the new value calculations.”
That includes assessing whether current systems can create the “three building blocks” approach. “The logic of the building blocks is very similar to the logic insurers follow in their pricing, but that logic often is not carried through the reserving process. If you have a system that can do that, you are one step ahead of the competitors. If not, you’ll have to think about how you will do that—not necessarily by spending millions of dollars now but at least by looking at providers of systems that can offer that capability,” says Nagari.
“Liabilities are treated very differently under IFRS,” de St. Paer adds. “Simply estimating cash flows is something that is not done the same way among different life companies and often not at all by non-life companies, but it will be a key IFRS requirement. Systems need to include a very heavy modeling-type orientation.”
The possibility of changes and questions regarding the time line of convergence does create some risk for early adopters. “There is a risk from an operational perspective consensus will not be achieved. It’s one of the most complex projects ever, and it does carry a risk of failure,” Nagari says. “But on the optimistic side, there never has been a degree of commitment as high as now. There is not only a joint effort by the IASB and FASB but great intervention from the insurance industry to assist in the discussion of the new proposed model.”
Additionally, de St. Paer believes the bigger risk for insurers is not being prepared. “We can’t sit and think this is going to go away,” he says. “This process is moving forward one way or another.”