European Life Insurers Hope Accounting Change Will Woo Investors

By | August 4, 2010

British life insurers reporting half-year results this month plan to simplify their notoriously complex financial statements in a move that could lift their flagging shares.

Standard Life, Britain’s fourth-biggest life insurer, two weeks ago became the latest to say it would prioritise International Financial Reporting Standards (IFRS) in its earnings statements, relegating the more complex Embedded Value (EV) approach to the margins.

Standard Life’s embrace of IFRS follows similar moves by rivals Aviva and Legal & General, and comes in response to growing investor distaste for EV, once touted by the industry as its preferred performance measure, but now seen as opaque, inconsistent, and downright confusing.

“People are explicitly saying we like your story, we like your strategy, but until we understand some of the numbers more clearly, it’s very difficult for us to invest,” Standard Life finance director Jackie Hunt told Reuters.

The shift away from EV is likely to be accelerated by a proposed new IFRS insurance accounting standard, published last week, which aims to harmonise inconsistent practices currently tolerated under both IFRS and EV.

This would make it easier for shareholders to compare insurers’ financial performance, and to assess the sector’s prospects relative to other industries, greatly increasing its appeal to investors, according to Francesco Nagari, a partner at audit firm Deloitte.

“Insurance will no longer be the ugly duckling of the capital markets because you can’t understand how they make money unless you have a degree in actuarial science,” Nagari said.

Life insurers’ shares could certainly do with a lift. The British life insurance index is down 40 percent since the onset of the credit crunch in the autumn of 2007, against a fall of just 20 percent for the wider FTSE 100.

DIVIDENDS ARE KEY

EV profits include the present value of future earnings from existing policies, a calculation that critics say relies on variable and sometimes questionable assumptions about future customer behaviour and interest rates.

IFRS, in contrast, takes only current year income into account, avoiding the inherent uncertainty of present value calculations.

Analysts say IFRS also better illustrates the company’s cash postition and therefore its ability to pay dividends — a consideration that has become especially important to investors since Aviva and L&G cut their payouts last year.

“Life insurance has always fundamentally been a yield-driven sector, so you want to know what the level of the dividend will be, how much it’s going to grow, and what the risk there is of it being cut,” said analyst Tim Young at Euler Securities.

“EV doesn’t really give you that.”

The International Accouting Standards Board, which oversees IFRS accounting rules, plans to publish a final draft of the proposed new insurance standard by the middle of next year.

If the new standard is adopted, IFRS will have suceeded where EV failed. In 2005, insurers enthusiastically adopted a revised version of EV, known as European Embedded Value, which also aimed to iron out inconsistent accounting practices.

But five years on, analysts and industry executives acknowledge that EV reporting remains as variable as ever.

However, EV — developed in the mid-1990s amid concerns that without some recognition of future earnings, high sales costs such as broker commissions were distorting profits when sales were strong — will continue to feature in insurers’ financial statements.

As the best measure of the value built up by an insurance company over time, EV will continue to be useful for long-term investors, and will also remain the touchstone for M&A bankers as they scour the sector for takeover targets.

“It’s what people look at when they think about buying businesses. I don’t think it’s going to go away,” said Bill Cooper, a managing director at Lloyds TSB Corporate Markets’ financial institutions group.

(Editing by Sitaraman Shankar)

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