IFRS in Insurance Industry

ICAI routinely releases Exposure Drafts on the proposed Accounting standards and of late have begun to release IFRS compliant ASs. Recently, the Exp Draft of AS 39 was released for comments. I wrote the following letter to ASB, which I thought I should share with members at lage. Here it goes:

Dear Sirs,

I have glanced through the ED on AS 39 (Insurance Contracts) put on the ICAI's website.

Fundamentally, I have a few concerns and apprehensions:

This ED is taken verbatim from IFRS 4. I agree that we are in the convergence mode and hence commonality with international standard adopting regime is desired. However, in a specialised industry like insurance which is the second largest in the financial services sector, should we not take the uniqueness with which the Industry operates in our country due to the regulatory parameters and restrictions and then tweak the IFRS (even if we have to adopt it) to our needs?  There have been repeated assertions from ICAI that while accepting IFRSs, our country's concerns will be certainly addressed. May I ask, sirs, what happened to such assertions and assurances in the matter of IFRS-4?

There is a domain regulator for this industry from whom, there is a report on this issue (Dr Kannan committee report), a copy of it should be available with ICAI also. The said report has analysed the IFRS 4's adoption (or convergence, as ICAI may choose to call it) and has come out with certain suggestions (Page 86 of the Report).  At the beginning itself,   it has been mentioned that in view of the various constraints involved in the implementation programme, it is recommended that the desired roadmap should be drawn in a phased manner instead of a sudden transfer to the new accounting regime. I want to know whether ASB has deliberated this report before issuing the ED? If so, why there is no mention about the same anywhere?

The ED itself mentions certain conflicting issues (legal and regulatory) in Appendix 3. However, there is no methodology prescribed to address such of those issues. Are we going to let these conflicting issues unaddressed?

Sirs, I list below a few unique features of Indian Insurance Industry to drive home the points as to how differently the business is run in our country due to the socio-economic and regulatory perspectives:

a)     In India, Insurance business is done with a socio-economic tinge and the State has carefully crafted legislations accordingly. There are regulations that provide for the compulsory business mix with social and rural sector businesses.

b)     The investment norms have been designed by the Regulator with a definite agenda that the insurers cannot be allowed a free hand in the said activity as the Government feels that the safeguarding the policyholders' interests is paramount. The need to invest in Government securities, infrastructure projects, social sector etc. are mandated as a matter of Govt's policy of utilising the public funds usefully and safely. Such tight norms are to be found nowhere in the world.

c)     In India, limits on expenditure are mandated by law and stiff penalties prescribed for extravagent insurers. This has been done to ensure that insurers do not 'indulge' with the money of policyholders. Not many countries have such controls.

d)     Insurance is a product that is NOT available on credit in India. This again is a unique feature not to be found in many other nations.

e)     Reinsurance regulations are quite prudent in India and do not give free hand to the insurers to do what they want and how they want. Local market capacity exhaustion etc. are all basic requirements here.

f)       The impact of ULIP in India is almost incomparable with any other nation. The whole life business is heavily skewed towards this portfolio.

g)     In no other country in the world, we have a statute afforded unlimited liability in Motor Third Party and this is one singular factor that has been affecting the insurers heavily. To add to the miseries, no non life insurer can escape from his share from the TP pool also. To add further dose of misery, in the 'detariffed' world, the TP is still under Administered Price Regime.

h)     In India, drain on Forex reserves are carefully monitored by RBI as mandated by FEMA and Exchange control regulations. Insurance, being  an industry  with heavy forex outflows on RI activity, will have to tread on the beaten track only.

I want to know whether there was any attempt to factor these unique features (already factored in the Accounting, Investments, Reinsurance Regulations of IRDA) in to the proposed AS which is supposed to be for a long time to come? The IFRS-4 talks of concepts like embedded derivatives, unbundling of deposit components etc. which are life industry specific and in a way the whole IFRS is skewed towards life industry. For time immemorial, in India, we have separate accounting rules for Life and Non-Life. In AS-39 scenario, no such distinction is available even. The concept of Shadow Accounting is not even explained in IFRS-4 properly and the paragraph on it appears to have been inserted without any thought whatsoever in to the standard and AS-39 simply follows it.

To come to specifics, AS-39's ED says as follows:

14 (a) Specifically, an insurer; (a) shall not recognise as a liability any provisions for possible future claims, if those claims arise under insurance contracts that are not in existence at the end of the reporting period (such as catastrophe provisions and equalisation provisions).

      (b) shall carry out the liability adequacy test described in paragraphs 15–19.

In 14 (a) above, eventhough the catastrophe/ equalisation provisions have been cited as examples, the primary clause would mean that an insurer cannot have outstanding claim provision on policies that are not in force on the reporting date.

Also, he cannot keep any provision as IBNR. This is repugnant to the conservative method which insurers are, by design, accustomed to.

 The proposed liability adequacy test -14 (b)- will merge the URR/UPR provisions and the Outstanding Claims provisions  and will strip the balance sheets of the need to keep adequate reserves.

The fairvalue measurement concept can work in asset centric balance sheets but Insurabnce companies’ Balance sheets are liabilities-centric. How can fair values of liabilities be measured and if not possible or warranted, how will ALM be achived?

The issues are profound and deep. ASB may have experts in accounting but when this kind of a standard is pushed, it is important that views of domain experts, industry CFOs are also taken.

I urge ASB to consider the issues in a comprehensive and wholesome manner and not hurry the standard just because we have to somehow converge with IFRS.  National concerns are more important than convergence with a standard which is not suitable to us. Let not posterity blame us for our proclivity to yield to timelines by sacrificing quality.

Regards

PS Prabhakar