Timing gap between Solvency II and IFRS 4 phase II could be costly 07 September 2012 Solvency II and new IASB accounting rules for insurers have similarities, but an awkward gap between their implementation dates looks likely to give rise to operational difficulties and additional costs, says Kevin Griffith.
Kevin Griffith
Solvency II and new international accounting rules for insurance contracts (IFRS 4 phase II) have a number of similarities, including their timetables. They seek, respectively, to establish comprehensive frameworks for managing solvency capital and for accounting and reporting. While there are differences between the accounting model under IFRS 4 phase II and the principles for measuring available capital under Solvency II (see table 1), both projects have significant impacts on areas such as governance processes, operating models, reporting policies and processes, data and system requirements. But, as the two sets of rules are being developed by independent bodies which are juggling a host of global political interests, timetables have been difficult to set and stick to. Solvency II's harmonised prudential regime for EU insurance and reinsurance undertakings has already been delayed more than once and the current expectation is that it will have to be fully implemented by insurers in 2014. However, recent developments at the political level mean that this could now be at risk. The original dates in the Solvency II framework directive indicated an effective date of 1 November 2012. The draft Omnibus II directive, which seeks to amend the framework directive, now indicates an application date of 1 January 2014. But some believe that even this deadline is unlikely to be met or, at least, that a transitional phase will be in place for the first few years.
Uncertainty over IASB timing On a parallel track, the International Accounting Standards Board (IASB) is undertaking a project on insurance contracts - IFRS 4 phase II - which aims to provide a single source of principlesbased guidance to account for all types of insurance contracts. The purpose of IFRS 4 phase II is to eliminate inconsistencies in current practices, and provide comparability across entities, jurisdictions and capital markets. The IASB issued an exposure draft (ED) on insurance contracts in July 2010. Its proposals are intended to replace the current standard, IFRS 4, which is an interim standard that allows insurers to continue using various accounting practices that have developed in a piecemeal fashion over many years. Since December 2010, the IASB has been deliberating on the comments and feedback received in response to the ED. It expects to publish a review draft of the final standard or a revised ED during this quarter. The date for publishing the new standard and the effective date are yet to be determined but we do not expect the proposals to be effective before 2015.
Table 1 - Comparison of Solvency II and IFRS 4 phase II
Figure 1 - Expected implementation timelines - key dates
Figure 1 - Expected implementation timelines - key dates
Impact of delays Delays to the implementation dates for Solvency II and IFRS 4 phase II not only cause uncertainty, but also impact implementation activities, which can be costly. For insurers who have hired additional resources that are committed full-time to the Solvency II project, a delay may mean keeping these in place in addition to business-as-usual resources. Most organisations have said they will continue with implementation at the current pace even if there is a delay. But different insurers are at different stages in their preparations for implementing Solvency II and, while most have robust implementation plans in place, a delay of the effective date could cause a loss of momentum. For example, some firms have scheduled dry runs for own risk and solvency assessment (ORSA) reports and policies and the related risk management procedures in the second half of this year and early 2013. Others have planned dry runs and mock-ups for pillar 3 reporting or are already in the process of completing these activities. Any delays and issues that are yet to be resolved may mean that these exercises cannot be efficiently or fully completed.
Dilemma for internal model users For firms intending to use internal models to quantify their risk, a delay in the implementation date could mean that they have to decide whether to maintain the existing models for Solvency I reporting and keep the new Solvency II models running in parallel, or to switch off the new models until implementation of Solvency II. Most companies gearing up for Solvency II reporting are already considering their capabilities and the system changes necessary for them to meet the Solvency II requirements. A delay in the implementation date could slow down their planned system and data changes. Delays to either Solvency II or IFRS 4 phase II could also slow down activity on transactions and new product development. Insurers may have to wait for both projects to be finalised before they can assess the impact of any new products on their capital requirements, earnings and balance sheets. IFRS 4, in its current form, allows insurers to apply existing accounting practices that derive from their local regulatory frameworks and the Solvency I regime. If the 1 January 2014 date is maintained for Solvency II, the Solvency 1 regime will no longer be applicable from that date. But it is unlikely that a new insurance standard under IFRS 4 phase II will be in place by then.
Mind the gap So there is a potential gap between when Solvency I is no longer applicable and the time when an insurance contracts standard is issued and becomes effective. It is uncertain how insurers will account for insurance contracts in their IFRS or local GAAP financial statements in this period. Will financial reporting continue to be based on a superseded regulatory framework (Solvency I), or will companies apply a Solvency II basis for insurance liabilities? While firms need to keep an eye on the critical milestones and regularly monitor any changes in timetables, most will be looking to press on with their preparations for both Solvency II and IFRS
4 phase II. To do this, they will need to have plans in place to transition Solvency II project work into business-as-usual. Changes to requirements cannot be ruled out, so building flexibility into system, data, policy and process changes will be key to success in the long-term. In particular, firms planning to use internal models will need to prepare standard formula contingencies in case their model is not approved in time. The most dynamic firms are already planning for IFRS 4 phase II and thinking about how this project can build on the current Solvency II work. Finally, with the current scepticism about timetables and political pressures on both these initiatives, firms need to consider carefully how to respond to the investor community and rating agencies. It will be important for them to be able to tell the market a coherent story about how they create value, manage risk and safeguard investments across both financial and regulatory reporting. Kevin Griffith is partner, UK Insurance accounting advisory lead, at Ernst & Young
