January 27th, 2010

Financial Stability Considerations Drive Regulatory Response, Part I: Overview

Posted at 10:00 AM ET

Two main themes emerged in the response to the aftermath of the recent financial crisis. Efforts to improve the transparency of accounting and reporting regimes gained ground and debate focused on how best to structure and approach regulation in order to achieve tighter control and reduce market turmoil. Through working parties, the International Association of Insurance Supervisors is tackling these issues: revision of core principles, financial stability and group supervision.

Transparency

The existence of a wide range of different accounting regulatory and reporting regimes hinders accurate analysis and comparison of insurance company performance. PricewaterhouseCoopers’ recent global survey of insurance analysts indicates that a lack of quality and consistency in insurance reporting continues to cause undervaluation of some of the world’s leading insurance companies.

Because of financial and operational issues unique to the insurance industry, the development of an insurance-specific reporting model is a priority. The industry eagerly awaits the International Accounting Standards Board’s and the Financial Accounting Standards Board’s overhaul of insurance contract reporting along with revised standards for financial instruments. In the absence of a perfect accounting model that copes with the insurance cycle, analysts are looking for full disclosure of assumptions, market adjustments, volatility and sensitivities.

Asset volatility has caused both criticism and defense of the application of Fair Value accounting on both sides of the Atlantic.

fairvaluechartbig

Additionally, rating agencies are sensitive to any accounting disclosure changes that may impact credit markets. The agencies have specifically highlighted: fair values; off balance sheet activities; securitization activities; pension funding and reporting; financial statement presentation and International Financial Reporting Standards.

 
Structuring and Approach to Regulatory Model

Another issue concerns the best model for supervision of banks and insurers. Should there be one regulatory body to oversee both industries or separate bodies? The single regulatory body approach exists in the U.K.

In Germany, the proposal to regulate both banks and insurers under one agency has ignited considerable debate. A question remains as to whether the existing banking regulator should take over the role and functions of BaFin.

In addition to the structure of the regulatory system, another issue revolves around the regulatory approach: rules-based, principles- based or a mixture of both? According to an international survey in 2009 by CFO Research, the transition from a rules-based approach to a principles-based approach to accounting should be the top priority for the standard setters. A leading reinsurer questions whether the implementation of the latest risk-based regulations will reinforce the cyclical nature of the market to the detriment of sound capital management. Generally, it appears that “soft touch” policy is out of favor. The large volume of legislation in the pipeline in many jurisdictions will require further regulations in order to bring about implementation.
 

Statements concerning accounting, legal, regulatory or tax matters should be understood to be general observations based solely on the author’s experience in the reinsurance industry, and may not be relied upon as accounting, legal, regulatory or tax advice which he is not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.

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