A global accounting standard setter proposed a new rule for insurers on Friday, aiming to shine a light on a sector criticized by investors for being a black box that keeps them in the dark.
The International Accounting Standards Board (IASB), whose rules are used in over 100 countries including in the EU which is home to insurers like Aviva , Axa , Generali and Allianz , published its draft rule on how to measure the value of insurance and reinsurance contracts.
It will replace a mishmash of national approaches which makes it hard for investors to compare the profitability of insurers and reinsurers from different countries.
The IASB introduced an interim standard in 2004 but it has no common measurement method.
A fundamental review of insurance accounting was long overdue, with current practice resulting in financial information that is impenetrable to all but the most expert of users, IASB Chairman David Tweedie said in a statement.
The insurance industry came up with its own method for measuring the value of insurance contracts, known as embedded value, to estimate future cash flow but it is not fully recognized by all investors and regulators globally.
The IASB standard, due to come into force probably in 2011, would value contracts using several aspects that look at the cash flow when the insurer fulfils the contract.
LACK OF CLARITY
A discussion paper had leaned more toward fair value or the going market rate but this raised opposition in the industry.
Investors have applied an accounting discount to the multi-trillion dollar sector because of the lack of clarity over how much cash the insurance contracts produce.
The new standard marks a second big challenge facing the European industry in particular, which is already having to overhaul its prudential rules under a new EU law known as Solvency II from January 2013.
Ernst & Young, one of the world's Big Four auditors, said the short-term pain from switching to the new accounting rule will be worth it for insurers across the world.
The benefits to the industry and the wider financial community cannot be underestimated, said James Dean, E&Y's global IFRS insurance leader said.
Insurers will have a greater certainty about how their organization is viewed and evaluated by investors, regulators and other key stakeholders, Dean said.
Insurance experts said it was difficult to know which companies will emerge as winners or losers.
Some have called the existing system a black box. There is a bit of a concern the new rule will increase earnings volatility, but you will get a better alignment of assets and liabilities which will hopefully reduce volatility rather than increase it, IASB board member Elke Koenig told Reuters.
The IASB aims to converge its accounting rules with U.S. practices by mid-2011 and is working closely with its U.S. counterpart on an insurance standard.
(Editing by David Holmes)