Regulators warn on insurance accounting
Insurers’ accounting practices are so opaque there is a danger their financial disclosures are failing to show the damage done by persistently low interest rates, top European regulators have warned.
Supervisors have raised fresh concerns about insurers’ bookkeeping across much of the continent, as a 15-year effort to reform the sector’s accounting rules remains held back by disagreements between the industry and watchdogs.
“There is a real risk that firms could build up hidden problems,” said the European Insurance and Occupational Pensions Authority on Thursday in a report on financial stability.
The warning came as industry-wide figures stressed the difficulties low interest rates are causing insurance companies. The problems are especially acute for life assurers that need to generate investment returns to meet promises made to policyholders.
EIOPA disclosed that investment returns for typical European life assurers – whose portfolios are dominated by conservative fixed income assets – have dropped more than two-fifths over the past year, to 2.8 per cent.
This means some companies in the sector are earning less from their investment portfolios than the returns – of as much as 4 per cent a year – they have guaranteed policyholders.
The problems associated with low interest rates may be slow to emerge on insurers’ books, however, EIOPA said.
In most jurisdictions insurance liabilities are valued using discount rates calculated at the time policies were written, rather than reflecting prevailing market conditions.
“The fact that the effects of low interest rates are slow to emerge in balance sheet terms does not mean the problem is not there,” EIOPA said. “The low interest yield environment is still the most prominent risk” for the sector, it added.
Leading accountants have estimated the bookkeeping shortcomings could mean insurance companies’ disclosures may underestimate their liabilities by billions of euros, but that the effect is difficult – if not impossible – to quantify.
EIOPA added that the levels of capital held by insurers under the so-called Solvency I regulatory requirements, which are being phased out, were “dropping” but nevertheless remained “very healthy”.
Even so, the authority – which is planning to conduct stress tests of European insurers next year – indicated that if calculated using the forthcoming Solvency II regulations, the companies’ financial positions may not appear to be so strong.
The International Accounting Standards Board has been trying for years to make insurers’ accounts more comprehensible to investors and in June drew up a fresh set of proposals to satisfy the industry.
Since then insurers have told the regulators they are broadly supportive of the principle that their accounts should reflect market conditions. But they remain concerned about how the plans will work in practice and worry the proposals will make their profitability appear artificially volatile.
The IASB is considering their responses to a consultation it held in recent months.
The reforms are unlikely to be introduced before 2018.