Louie Palu/The Globe and Mail
As Canada's major life insurers prepare to report earnings this week, they are gearing up for what promises to be a high-stakes battle in the coming months, one that could jack up their liabilities and eat away at their value.
At issue is a long-awaited set of rules that the London-based International Accounting Standards Board (IASB) proposed last week. The IASB says the rules are "urgently" needed because investors see insurance accounting as a "black box" that does not give them information that's necessary to understand an insurer's financial position and performance. Current rules also don't make it easy to compare one insurer with another.
This country's accounting watchdog, the Canadian Accounting Standards Board, has already pledged to adopt whatever rules the IASB decides on, in a bid to usher in one common set of rules across national boundaries. At the moment, there's a hodge-podge of rules in different countries.
But Canadian life insurers, including Manulife and Sun Life , argue that the proposed rules don't take into account the differences between themselves and European insurers.
The main problem is that North American insurers offer more long-term products than their competitors elsewhere, and the rules could have a dramatic impact on the value of those products. That could require Canadian insurers to bolster their capital levels.
The issue arises at a time when the insurance sector is struggling. Analysts expect Manulife to post a second-quarter loss on Thursday, and have been reducing earnings estimates for the industry as soft stock markets and interest rates continue to take a toll.
In the months ahead, the industry will make its campaign against the proposed accounting rules a priority as it seeks to reverse its fortunes.
Canadian insurers say that the rules would not only make financial statements more volatile and difficult to understand, they could also force insurers here to stop offering some popular products, such as life annuities.
Accounting rule makers, on the other hand, suggest that the changes will make insurers better reflect the risks they're taking. If those risks become too expensive on the books, perhaps they shouldn't be taking them.
A key sticking point is the "discount rate," or interest rate, that insurers use to calculate the current value of payments that they will have to make to customers in the future.
The rate that Canadian insurers are using basically allows them to take credit now for investment performance that they hope to achieve in the future, the IASB argues. Instead, it says, they should be using a current risk-free rate (essentially measured by the return on government bonds). Since that rate is lower, the Canadian insurers' liabilities will rise when the change kicks in, and it will be especially painful in areas such as life annuities or whole life non-participating insurance, when the insurers value payments that they owe customers decades from now.
That hasn't been lost on the IASB. Both Julie Dickson, the head of Canada's banking and insurance regulator, and Jim Flaherty, the Finance Minister, wrote to the international accounting body earlier this year asking it to consider the impact on the Canadian sector.
And although the rules are being created to help analysts and investors understand insurers, some say they won't work. "The problem is that when you delink the assets and the liabilities, it creates major volatility, and I don't think it really captures the economics behind this," said Mario Mendonca, an analyst with Canaccord Genuity Corp. If the rules pass as they're currently worded, they will substantially reduce the book value of companies such as Manulife, he added.
Despite the Canadian uproar, the IASB put the changes in its draft proposal released Friday. But the IASB also made it clear that it's open to listening.
The period for public comment on the rules stretches until the end of November, which is unusually long. In its draft, the accounting body asked the public to comment on the proposals the Canadian insurers are objecting to. It will ask insurers to do field testing to see how the changes would affect them. And the IASB's chairman, David Tweedie, will visit Canada before the period is over and will listen directly to the insurers' concerns, sources say.
"We have to organize ourselves to make as clear a case as possible about the impact that this would have, both on the volatility of reporting and also the unintended consequences related to products that we sell," said Frank Swedlove, president of the Canadian Life and Health Insurance Association.
A spokesman for Canada's banking and insurance regulator, the Office of the Superintendent of Financial Institutions, said it is happy that the IASB has agreed to further consider concerns, given the long-term guaranteed products that Canadian firms have.
If the rules pass, OSFI could conceivably change its capital rules to give insurers more breathing room, but the spokesman declined to speculate about that.
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