IFRS could impact insurance business

New global accounting standards could spell the end of the insurance business in Canada as we know it. That was the warning from Paul Brown, president and CEO of Worldsource Insurance Network, at Advisor Group’s annual Distributors’ Summit, held May 31 to June 2 at the Fallsview Casino and Resort in Niagara Falls, Ontario.

Since the late 1990s, there’s been a push for global accounting standards. Investors spread across multiple jurisdictions want uniform financial statements, regardless of where a company is based. International Financial Reporting Standards (IFRS) are designed to meet this objective.

In January of this year, the first phase of the shift to IFRS was implemented in Canada. Brown said making the change at his own firm felt more like a tweak than an overhaul. “It was cumbersome and a bit of a pain, but it didn’t change our business to a large extent.”

The real issue, Brown said, is with IFRS Phase II. In July 2010 the International Accounting Standards Board (IASB) released a discussion paper that lays out the second phase of IFRS. The original plan was to finalize and implement the proposals outlined in the draft in June of this year.

But the backlash against the paper’s proposals has been so vehement as to cause major delays. The paper elicited about 250 responses from insurance companies around the world, with Canadian companies right at the tip of the spear, Brown noted.

“Once they read it they knew it was going to have a huge impact. The proposals are drastic and completely out of whack with what we’re doing in Canada.”

IFRS Phase II ignores asset-liability matching, the basic principle for pricing long-term guarantees; implements a short-term “mark to market” for liabilities, without regard for when the liability will emerge; and uses a risk-free rate for determining reserves. The result would be unwarranted volatility in reserves, income levels and capital position; incomprehensible financial reporting from insurance companies; and, most ominously for Canadian insurers and MGAs, drastic price increases or withdrawal of guaranteed products.

“Every insurance executive I’ve talked to has said this is unworkable,” said Brown. “Guaranteed products might have to be withdrawn because they would have to be priced high to meet the requirements of IFRS. That would cut us off at the knees.”

The Canadian Life and Health Insurance Association didn’t mince words responding to IFRS Phase II: “The proposed approach is in such radical disharmony with the underlying business model and with economic reality as to result in financial reports that will be neither relevant nor reliable, extremely difficult to explain and likely lack comparability.” The IASB has recognized the potential pitfalls of IFRS for the Canadian insurance industry. The original June 2011 implementation deadline for IFRS Phase II has been extended until year’s end, but Brown says the revised date won’t stick. He sees the implementation date coming in 3-to-5 years. “So it’s not something we have to deal with directly today.”

The bad news? “If it’s implemented the way it has been proposed, it will be difficult for insurance companies to market long-tail guaranteed products, which are the foundation of our business. MGA distribution would be hit hard, and advisors would probably be forced to shift their focus away from risk-based protection, long-term guaranteed products to financial planning and investments,” Brown said, accompanying his slide with an image of a nuclear detonation.

The most important thing to do at this point is to keep the pressure on. MGAs, advisors and SROs “all have to send a message to our government and the IASB that Phase II cannot happen as proposed.”

Most of the major players in the industry are confident major substantive changes will be made. Brown warned, however, not to assume that because IFRS Phase II is so unacceptable, it couldn’t possibly come into effect. “If we don’t take action, it just might.”