CLAIM DISCOUNTING REGULATIONS LOOM

The Insurance Bureau of Canada’s (IBC) annual “Financial Affairs Symposium” held in Toronto served the stage for a new industry regulatory battle with the Office of the Superintendent of Financial Services (OSFI) over what many insurers regard as a “surprising turn” by the federal regulator toward reporting of discounted unpaid claims. In addition to increased costs resulting from the new reporting requirement, the proposed discounting requirements would make Canada an anomaly relative to international accounting practices currently applied to the property and casualty insurance sector, the IBC charges.

Toward the beginning of this year the Insurance Bureau of Canada (IBC) was informed by the Office of the Superintendent of Financial Services (OSFI) that the federal regulator will be looking to implement new company reporting requirements reflecting discounting of unpaid claims as from the first quarter of 2002. This will require insurers to effectively begin keeping discounting records this year, thereby making the change over retroactive to January of this year, the IBC says.

In its “Financial Affairs” quarterly newsletter, the IBC expresses its surprise at OSFI’s supposedly sudden turn in the direction of discounting reporting. Not only is the IBC opposed to the proposed reporting requirements on the table (see below for details), but believes that inadequate consultation had been made with the p&c insurance industry in advance to the announcement. The IBC’s CEO George Anderson has since met with OSFI superintendent John Palmer who has requested insurers on an individual basis to consult the regulator on their views toward discounting.

Argument against discounting

In essence, discounting of unpaid claims is an accounting attempt to match future values to liabilities and assets/reserves. So far, only Australia currently requires discounting reporting, although the International Accounting Standards Committee (IASC) is said to be moving in this direction as part of finalizing a long-term policy of harmonized international accounting practices. The IBC’s vice president and chief economist Paul Kovacs notes that a switch to discounting reporting will reduce the Canadian p&c industry’s reserves by about $400 million, although the impact on individual companies will vary greatly with some showing higher reserve levels. It is this “huge variance” resulting from discounting of liabilities to reserves that concerns the IBC, he adds.

The IBC’s “Financial Affairs Symposium” therefore ignited a few sparks, with the bureau’s accounting advisor Nunzio Tedesco of KPMG pointing out, “accountants will now have to become actuaries, this is going to cause headaches for all”. The IBC set out the following concerns over the proposed discounting requirement:

Any decision should be part of a comprehensive review of the overall [accounting] framework;

[Discounting] should be harmonized with international developments (not just Australia);

The compliance costs [of discounting] brings no benefits;

That to introduce full discounting now would be a “piece-meal” approach to the regulatory review process.

Furthermore, in its “Financial Affairs” newsletter, the IBC points out that there is no actual relationship between the values of the liabilities and investments of p&c companies. Nor is there any significant effort by p&c companies to match investments to liabilities as is done by life insurers.

Argument for discounting

While the IBC and industry accountants are against full discounting reporting, the Canadian Institute of Actuaries (CIA) appears to be standing by OSFI. CIA representative Brian Pelly says that discounting, if carried out properly, is in accordance with actuarial practices. “In principle, the CIA supports discounting. We believe it is a more accurate reflection [on reserves]. But, we feel that we should get all of our ‘ducks in a row’ before making this kind of change. OSFI has an aggressive agenda, although it is do-able.”

OSFI assistant superintendent Michael Hafeman disagrees that there has not been “open discussion” with the industry on discounting. The first discussions between the regulator and the industry date back to the early 1990s, he notes, which resulted in a review document being issued by OSFI in 1997. “Last year we did a follow-up on the 1997 review, and we thought agreement had been achieved on some issues [relating to discounting].”

Hafeman says OSFI will be responding to insurer comments on discounting reporting in coming weeks. However, he notes, the industry’s current accounting approach is a combination of both discounting and non-discounting methodology. As such, he claims, the industry already prepares much of the reporting material required for discounting purposes, and the additional reporting requirements are minimal. “We’re not looking for financial figures per contract, but on an aggregate basis, which is already being produced by the industry.” In this respect, he believes that a move toward discounting would be a better practice than the current “mixed practice” of accounting. “Comment from the industry suggests that the financial statements [of companies] would be distorted by discounting. Our view is that policy liabilities are always just estimates. Financial statements should be based on more explicit requirements [than current reporting].”

Furthermore, Hafeman points out that international accounting standards are moving toward a practice of discounting of future liabilities, and, while a “fair value assessment of assets and liabilities [as a common applied practice] is not here yet (which is the direction the IBC is pursuing), the best direction in the immediate future lies in discounting reporting. “International standards are moving toward discounting, and we’re not prepared to wait another five years [before approval by the IASC].”