Analyst Reporting Perspectives

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Insurance

Making sense o the numbersAnalysts perspectives on current and uturereporting in the insurance industry

November 2009


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ContentsContents

01Foreword

02Executive summary

03About this survey

04Adequacy o current insurance reporting

06Future direction o nancial reporting or insurance contracts

10Future direction o the measurement and classication onancial instruments

12

Contacts


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A nancial reporting ramework that enables the

investment community to make inormed judgements is

critical to insurers ability to attract capital and ensure their

share prices refect the true level o value being created

within their businesses. However, our 2007 survey o

insurance analysts revealed strong dissatisaction with the

adequacy (level o quality, clarity and granularity) o

nancial reporting within the insurance industry.1 In turn,

some o the proposals or change being discussed at the

time were seen by many analysts as creating what one

described as a bigger, blacker box.

With the nancial crisis having intensied the competition

or capital and heightened the critical glare o market

scrutiny, we elt that it would be useul to nd out whether

investment proessionals believe that the adequacy gap

between their expectations and current practice has

widened or narrowed since 2007. As the International

Accounting Standards Board (IASB) and Financial

Accounting Standards Board (FASB) reach a decisive

stage in their planned overhaul o insurance contract

reporting, we also elt that this would be an opportune

moment to ask analysts how the eventual ramework could

best meet their needs.

Several important messages came through loud and clear

rom the more than 40 interviews we carried out as part othis survey. Many o the participants believe that a lack o

transparency is increasingly leading to the under-valuation

o a number o the worlds leading insurance companies.

To overcome these deciencies, they would like the IASB

and FASB to come up with a new and improved reporting

ramework as quickly as possible, encouraging the

standard setters to put pragmatism beore theoretical

precision. The desire or a swit solution was especially

strong among lie insurance analysts using IFRS.

Perhaps more o a surprise to us was the degree to which

a consensus is emerging among the analysts interviewed

on the undamentals that they believe should orm the

bedrock o the new reporting ramework. This consensus

is rooted in a desire or reporting to refect the economic

reality o an insurers business model. Moreover, it has

been interesting to note the areas where the analysts

view o reporting coincides with and diers rom

that o the IASB and FASB.

We recognise the scale o the challenge acing the

standard setters as they try to nd a single solution

that meets the needs o disparate stakeholder groups in

dierent territories. The eedback rom analysts is, however,

clear. The current situation is harming the industry and so

the Boards eorts must come to a conclusion, and quickly.

It is inevitable that some analysts and, indeed, insurers

will be disappointed by the Boards proposals. It is

thereore essential that all sides engage in the debate and

play an active part in achieving a workable compromise.

We would like to thank all the investment proessionals

who kindly gave their valuable time and insights to thissurvey. We hope that the ndings will provide a useul

contribution to the continuing debate over the uture

o reporting in the insurance industry.

Ian Dilks

PricewaterhouseCoopers (UK)

Global Insurance Leader

Foreword

The quality o reporting in the insurance industry certainly has an

impact on valuations and also aects the amount o money going

into the industry.

Analyst survey participant

1 Insurance reporting at the crossroads: What do analysts think?, published by PricewaterhouseCoopers in November 2007.

Making sense of the numbers PricewaterhouseCoopers 01


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Key fndings on the current state o insurance reporting

IFRS and US GAAP nancial statements (GAAP reporting):

Overall, the gap between participants expectations and

current practice was still considerable in our current survey.

Cash fow data was perceived as potentially more useul than

in 2007 a refection o the current market environment.

Supplementary non-GAAP reporting:

Potentially highly useul, but currently largely inadequate.

While many held Market Consistent Embedded Value (MCEV)

to be theoretically more appealing than its predecessors,there was rustration with its implementation.

Key fndings on the uture direction o the accounting

or insurance contracts

As the IASB and FASB reach a decisive stage in their plannedoverhaul o insurance contract reporting, the survey ndings

oer the standard setters some clear messages:

Reporting should refect the undamental economic realities

and underlying business model o insurance companies.

Underpinning these responses was strong support or the

concept o matching (e.g. matching the recognition o

acquisition costs and prot).

Most participants elt that insurance is distinctive enough

to deserve its own reporting model.

Very ew respondents would wish to see prot rom an

insurance contract recognised at its inception.

Most participants would like to see an explicit risk margin,

primarily because more inormation is better than less.However, very ew have experience o how the concept might

work in practice.

Key fndings on the uture direction o the measurement

and classifcation o fnancial instruments

Most participants would support the continued use o multiple

valuation bases.

The quality o the associated disclosures o both cost and airvalues was critical to many participants, as this would enable

them to make their own adjustments.

Timing o implementation

Most participants avoured adopting the undamental changesbeing proposed on nancial instruments and insurance liabilities

at the same time to avoid accounting mismatches.

Theres huge room or

improvement in reporting

in the industry.


Executive summary

Interviews with more than 40 investment proessionals revealed widespread dissatisaction with the current

state o nancial reporting. Many participants, especially lie insurance analysts using IFRS, would like the

IASB to move to a revised reporting ramework as quickly as possible. While recognising the diculties o

developing solutions or such a diverse and complex industry, many would encourage standard setters to put

pragmatism beore theoretical precision.

Its very dicult to gain a clear economic

view o where protability comes rom.


02 Making sense of the numbers PricewaterhouseCoopers


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2 PricewaterhouseCoopers reers to the network o member rms o PricewaterhouseCoopers International Ltd, each o which is a separate and independent legal entity.

3 Insurance reporting at the crossroads: What do analysts think?, published by PricewaterhouseCoopers in November 2007.

About this survey

In the autumn o 2009, PricewaterhouseCoopers2 conducted

in-depth interviews with more than 40 insurance analysts rom

the US, Europe, Asia and Australia to gain their perspectives on

the current state and uture direction o nancial reporting. The

survey ollows on rom a similar study carried out in 2007.3

The survey respondents were chosen to provide coverageacross all the major nancial centres and include a broad mix o

lie/non-lie, buy-side/sell-side and equity/xed income analysts.

The interviews were conducted ace-to-ace, allowing

interviewers to explore the rationale or any given reply.

In this report, we have noted areas where there was signicant

variance between the ndings or particular types o analysts

generally lie or non-lie. We have also noted distinctions

between the perceptions o US analysts and those in the rest

o the world.

What we want is an IFRS

presentation that explains the

proper drivers o the business.


Figure 1: Breakdown o survey participants

Buy-side

Sell-side

Ratings agencies

Life

Non-life

Life and non-life

Equity

Fixed income

79

21

44

41

15

21

10

69

% of participants

Source: PricewaterhouseCoopers

Figure 2: Geographical split o survey participants

12%

48%

40% Europe

US

Asia-Pacific

% of participants




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Dissatisaction with reported inormation remains

Our 2007 survey identied a substantial gap between analysts

perceptions o the useulness and adequacy o insurers

primary nancial disclosure (balance sheet, income statement,

cash fow and segmental inormation). While most participants

cited examples o a ew companies that had gone the extra

mile with their corporate reporting, overall the gap betweenpractice and expectations was as wide in our latest study. One

participant described the income statement as a complete

disaster, while segmental reporting was regarded by many

respondents as insuciently detailed or their analysis.

The only area where the perceived potential useulness

had signicantly increased since 2007 is the cash fow

statement, refecting the importance o cash in the current

economic environment. However, dissatisaction with

this statement was high one participant describing it as

pretty much gobbledegook. As the ocus shited towards

cash, interest in non-nancial inormation such as strategy

and market position had marginally declined.

The proo o the pudding is inthe eating we disregard the

cash fow statement.


Adequacy o current insurance reporting

The income statement does not

refect the reality o the business.


Figure 3: How potentially useul are the ollowing elements o nancial and non-nancial inormation? Are they adequate or your needs?

Usefulness 2009

Adequacy 2009

Usefulness 2007

Adequacy 2007

100

%

90

80

7060

50

40

30

20

10

0

Incomestatement

Balancesheet

Cashflow

Segmental

Insu

ranceriskexposures

Risk-basedcapital

Manage

mentcommunication

onstrategy

Resultspresentedon

non-GAAPbasis

Marketposition

Valuecreatinginformation

(e.g.

distributionchannels)

Go

vernanceinformation

Co

rporateresponsibility

reporting

Regulatoryforms

Usefulness 2009

Adequacy 2009

Usefulness 2007

Adequacy 2007




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I nd that non-GAAP inormation

provides the only reasonable

basis to judge management.


Non-GAAP inormation alls short o expectations

Overall, participants in the survey rated non-GAAP

disclosures as extremely useul. Many commented that

management had improved their asset disclosures over

the past year. However, despite the insurance industrys

increased ocus on non-GAAP reporting since our last

survey in 2007, disclosure in many areas still ell some way

short o expectations. For example, many participants

elt that sensitivity analyses should be based on morerealistic assumptions, recognising the interdependence

o certain scenarios. They also elt that operating prot is

inconsistently dened and would like more inormation on

the inputs supporting the calculation o combined ratios.

Embedded value (EV) and Market Consistent Embedded

Value (MCEV) generated an interesting debate among the

European lie analysts we interviewed. While many held

MCEV to be theoretically more appealing than its

predecessors, certain concerns were raised about its

implementation. A number o participants complained that

current practice lacks sucient transparency and ails to

refect the economic reality o some products. MCEV is airly

useless as it is inconsistently applied, said a participant.

Non-GAAP numbers always

seem to get better over time.

Its a little suspicious.


Figure 4: How potentially useul are the ollowing elements o nancial and non-nancial inormation? Are they adequate or your needs?

100

%

90

80

7060

50

40

30

20

10

0

Em

be

dde

dva

lue

Ma

ke

tcons

isten

t

em

be

dde

dva

lue

Asse

tdisc

losures

Sens

itivityana

lys

is

Regu

latorycap

ita

l

Opera

ting

income

Freecas

hflow

Marg

inana

lys

is

Com

bine

dra

tios

Usefulness

Adequacy




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Future direction o fnancial reporting or insurance contracts

Insurance has its own characteristics.

Thats why we have specialists to analyse it.


Distinct accounting model

Nearly 90% o participants elt that insurance should have

its own accounting model (this view was unanimous in the

US). O those supporting a distinct model, 56% would

avour a separate approach or lie and non-lie business.

Nearly 70% would like aspects o a particular contract that

have dierent risk and earnings proles, such as savings

and investment management services, to be accounted or

separately (unbundled). It would be useul to distinguish

between risk and investment businessIts currently

dicult to see exactly where the prots come rom, said

a participant.

Day one proft

More than three-quarters o participants were opposed to

recording a prot at the inception o the contract. Support

or the concept o a day one gain was marginally stronger

in parts o the world that are more amiliar with embeddedvalue. To the extent that theyre writing protable contracts,

Id like to see it, said a participant.

I dont think that there should be

a day one prot. Management

expectations do not add up

to value.


I come rom the old school. You

earn it beore you recognise it.


Figure 5: Does insurance require its own accounting model?

%

Total

US

87

13

100

19

Rest of the world 77

23

0

Yes

No


Figure 6: Should an insurance company recognise a prot on day one?

Yes

No

US 12

88


78

%




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I think there should be some deerral o acquisition

costs because youre buying a stream o premiums

rather than tossing money out o the door.


Acquisition costs

Most participants elt that acquisition costs should be

deerred. Your day one acquisition costs do not represent

the economics on day one, said a participant. However,

many would like more control and consistency in how costsare deerred. Deerred acquisition costs are too variable

and too open to manipulation at present, said a participant.

No day one loss on proftable contracts

Participants who avoured recording acquisition costs

as an expense at the inception o the contract were then

asked i revenue should be recognised to oset the

resulting loss. When the results o these questions arecombined, it is clear that, as long as the contract is

expected to be protable, ew would avour the recognition

o a day one loss.

While I dont care i you

expense up ront or not, I dont

think there should be a day

one loss unless there is someindication that you are using

the product as a loss leader.


Figure 7: Should acquisition costs be expensed on day one?

Deferred on day one

Expensed on day one

US 82

18


39

%


Figure 8: Should insurance companies recognise a day one loss?

No day one loss

Day one loss

US 88

12


14

%




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While there should be a risk margin,

what really matters is the disclosure

around that risk margin.


Risk margin

A majority o participants would like insurers to report a

risk margin, with some arguing that it might provide greater

insight into the inormation that they believe some companies

use when pricing their products. However, as insurers do

not typically report risk margins at present, ew participants

had rst-hand knowledge o how such margins would work.

This doesnt mean anything to me, said a participant.

Those against the inclusion o a risk margin elt thatit would be too subjective. Youll get a snowball o

assumptions, said a participant. Another participant

said that this was a urther sign that insurance contract

accounting is becoming too complicated.

Proft recognition over the lie o the contract

Most participants would like to see prots realised overthe lietime o the contract in line with the unwinding

o the associated risks. Recognising prot in line with

the unwinding o risk gives me a better indication o how

management judges the contracts current protability,

said a participant.

More inormation is better

than less, I guess.


Figure 9: Should an insurance contract liability include an explicit

risk margin?

0

0

Rest of the world

US

Only to assess ifloss making

5

Not yet considered

4

Always 72

58

Never 23

38

%


Figure 10: How should prot be recognised over the lie o the contract?

In line with claimspayments

In line with premiums less claims(reflecting net cash flows)

Other

Straight line over theperiod of coverage

In line with unwind ofrisk (reflecting risk profile)

%

11

72

12

2

3




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I nd it dicult to put economic assumptions through

the P&L on a reporting period basis. Youre just going

to end up with wacky P&L numbers.


Changes in assumptions

There was a clear geographical split to this question.

Around 60% o US participants wanted changes inassumptions to be immediately recognised in the income

statement, typically arguing that they would like the impact

o management adjustments to be as visible as possible.

I management has got it wrong, you want to know

theyve got it wrong, said a US participant. In contrast,

there was no strong consensus in the responses rom their

counterparts in other parts o the world.

Only around 15% o total survey participants elt that

companies should treat changes in economic

assumptions (e.g. interest rates) and non-economic

assumptions (e.g. mortality) in dierent ways.

Figure 11: How should changes in economic and non-economic

assumptions be accounted or?

As if identified at inception

Over the remaining contractual life

In the income statement when identified

US 28

59

13

27

33

40

Rest of the world

%




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Future direction o the measurement and classifcation

o fnancial instruments

You need the book value and the market value o

all the instruments they have. As long as I have all

o this, I can judge whether the unrealised gain or

loss is real or not.


Financial instrument classifcation

Most respondents support the continued use o amortised

cost and air value through prot and loss (FVTPL) or debt

instruments. However, there was less o a consensus

on the continued use o the available or sale (AFS)

designation, with US participants more likely to be in

avour than their counterparts in the rest o the world.

While marking-to-market might increase earnings

volatility, some elt this was preerable to a potentially

less transparent approach. Volatility is OK because we

can analyse it. To articially suppress it is something

we are less comortable with, said a participant. Many

participants would like both a cost and a air value basis

o measurement to be clearly disclosed in either the

primary statements or the notes.

Driver or classifcation

There were mixed views on what should drive the

classication o nancial instruments. Nearly hal o US

participants avoured an approach based on the nature

o the nancial instrument. In contrast, their counterparts

in other parts o the world were more likely to express

indierence, provided that assets and liabilities are treated

consistently.

I believe in classication by

the nature o the instrument

because a company can hide

behind a business model.


Figure 12: Which o the ollowing classications should be permitted

under the IASBs and FASBs reorms or nancial instruments?

n/a

n/a

Amortised cost

Available for sale

Fair value through profit and loss

Debt instruments Rest of the world

70

75

45

76

88

65

Debt instruments US

Equity securities Rest of the world

75

43

76

80

Equity securities US

%


Figure 13: What should be the primary driver or the classication o

nancial instruments?

0

Driven by business model

By nature of financial instrument

I am indifferent provided consistenttreatment for assets and liabilities

Not yet considered

US

19

6

3144

48

29

23

Rest of the world

%




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Contacts

I you would like to discuss any o the issues raised in this paper, please speak to your usual contact at

PricewaterhouseCoopers or one o the ollowing:

Ian DilksGlobal Insurance Leader


44 20 7212 4658

[email protected]

Caroline Foulger

PricewaterhouseCoopers (Bermuda)

1 441 299 [email protected]

Werner Hlzl

PricewaterhouseCoopers (Germany)

49 89 5790 5248

[email protected]

Paul Horgan

PricewaterhouseCoopers (US)

1 646 471 8880

[email protected]

Bryan Joseph

PricewaterhouseCoopers (UK)44 20 7213 2008

[email protected]

Andrew Kail


44 20 7212 5193

[email protected]

Ray Kunz

PricewaterhouseCoopers (Switzerland)

41 58 792 2380

[email protected]

David Newton


44 20 7804 2039

[email protected]

Dominic Nixon

PricewaterhouseCoopers (Singapore)

65 6236 3188

[email protected]

James Scanlan


1 267 330 2110

[email protected]

John Scheid


1 646 471 5350

[email protected]

Jonathan Simmons

PricewaterhouseCoopers (Canada)

1 416 869 2460

[email protected]

Kim Smith

PricewaterhouseCoopers (Australia)

61 2 8266 1100

[email protected]

Global Insurance Leadership Team

Donald Doran

Partner



Stephen OHearn

Partner



Alison Thomas

Director



Gail Tucker

Partner





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PricewaterhouseCoopers provides industry-ocused assurance, tax, and advisory services to build public trust and enhance value or its clients and

their stakeholders. More than 163,000 people in 151 countries across our network share their thinking, experience and solutions to develop reshperspectives and practical advice.

For more inormation about developments in IFRS, please visit www.pwc.com/insurance

This publication has been prepared or general guidance on matters o interest only, and does not constitute proessional advice. You should not act

upon the inormation contained in this publication without obtaining specic proessional advice. No representation or warranty (express or implied) isgiven as to the accuracy or completeness o the inormation contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers

does not accept or assume any liability, responsibility or duty o care or any consequences o you or anyone else acting, or reraining to act, in relianceon the inormation contained in this publication or or any decision based on it.

For more inormation about Making sense o the numbers: Analysts perspectives on nancial reporting in the insurance industry, please contact

Rebecca Pratley, Marketing Leader, Global Insurance, PricewaterhouseCoopers (UK) on 44 20 7804 3749 or at [email protected].

For copies, please contact Alpa Patel, PricewaterhouseCoopers (UK) at [email protected].


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pwc.com/insurance 2009 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers reers to the network o member rms o PricewaterhouseCoopers

International Limited, each o which is a separate and independent legal entity.

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Analyst Reporting Perspectives