Insurer Update: Annual report preparation – food for thought
There have been no major accounting standard changes or amendments for accounting periods beginning in 2022. But that doesn’t mean the 2022-year end will be without its challenges.
Significant changes in UKGAAP are not expected until the FRC completes its second periodic review of the standard, which is currently under way. An exposure draft of the proposed changes is expected before the end of 2022, with changes not effective until 1 January 2025 at the earliest.
We expect this periodic review to focus on the potential introduction of all or some of the requirements of IFRS 9 Financial instruments, IFRS 15 Revenue from contracts with customers and IFRS 16 Leases. Insurers should consider what impact these standards may have on their financial statements (and potentially their capital position), taking lessons from IFRS reporters.
Corporate reporting – FRC annual and thematic reviews
Annual review of corporate reporting 2020/21
Every year, the FRC releases a summary of the findings from its corporate monitoring work, undertaken by its Corporate Reporting Review (CRR) team. This aims to communicate the FRC’s view of what better quality reporting looks like, as well as areas where it sees a need for improvement. The top 10 areas for improvement in the most recently released report are:
- Judgements and estimates
- Statement of cash flows
- Impairment of assets
- Alternative performance measures (APMs)
- Financial instruments
- Strategic report and the Companies Act
- Provisions and contingencies
- Income taxes
We expect these 10 to be continued areas of focus when the CRR reports its most recent findings for 2021/22.
Given the continuing need for improvement in reporting relating to judgements and estimates, it’s not surprising to see the FRC undertake another thematic review on this subject. The following areas were identified as requiring improvement:
- Companies should explicitly state whether estimates have a significant risk of a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
- Sensitivity disclosures should be provided more often and in the way that’s most meaningful to readers.
- Sources of estimation uncertainty may vary from year to year. Companies should reassess whether disclosures made in a previous year need to be revised.
- Where additional estimate disclosures are provided, such as those carrying lower risk, having smaller impact or crystallising over a longer timeframe, they should be clearly distinguished from those with a significant short-term effect.
Another key thematic review focused on the FRC’s findings in relation to climate change disclosures under the TCFD framework. Whilst this framework is currently mandatory only for certain companies in the UK, insurers have been set certain expectations for their assessment and disclosure of climate risk.
The findings commented on areas such as the balance, granularity and specificity of the information disclosed, as well as the interlinkage with other parts of the annual report. It’s likely this feedback will also be relevant to PRA authorised insurers.
Global trend impacts upon insurer results for the 2022 year end
As at the end of August 2022 the US dollar is at 1.16 to the pound compared to 1.35 at 31-21-21 – a 14% decrease and the lowest rate since 1985. However, the euro at 1.16 is only 3% up on 1.19 at 31-12-21. The very high US dollar to the pound will make US dollar driven results expressed in pounds look more dramatic. This will increase income and profits for many, but potentially make losses look even worse for some. These effects will not only be felt in exchange profits and losses but could also feed through to asset values and claims costs.
UK insurers with large US business portfolios are likely to show some impressive results. The Lloyd’s half-year results, for example, show 17.4% growth in written premium with exchange accounting for 5.0%, price increase 7.7% and volume 4.7%.
Many insurers will need to think carefully about how they articulate their 2022 performance to users of their financial statements. We expect some entities will make use of alternative performance measures on a constant currency basis, which will need to be clearly explained.
Generally, the first half of 2022 led to very significant (mostly unrealised) investment losses for many insurers. This has two main elements.
- For those involved in equities there were falling stock markets as concerns about inflation, global politics and stalling economies increased. There has been some recent recovery after the large losses earlier in 2022 but the trends for the rest of the year remain uncertain.
- For most insurers their portfolios are heavy with bonds that have partly been affected by the ability of issuers to repay on time. But the greater effect is from increasing interest rate expectations. As interest rates increase, bond yields need to increase to remain competitive and this can only happen if bond prices fall. The currently high inflation levels have caused most major economies to increase government interest rates for the first time in several years. And, as inflation expectations grow, so the pace of recent increases picks up. For the rest of 2022 it will be interesting to see whether inflation expectations start to decrease and future interest rate rises slow.
The overall Lloyd’s market result before tax for the first half of 2022 is a £1.8bn loss compared to a £1.4m profit for the first half of 2021.
This adverse £3.2bn swing has been driven by a £3.7bn adverse swing in investment returns to a £3.1bn investment loss for the period. Most of this loss is unrealised. £1.5bn of the loss is changes in equity prices but £3.0bn of the loss is attributable to the repricing of yields on fixed interest bonds.
These bond losses are therefore likely to be recouped by higher yields on the bond portfolios over subsequent years, unless there are further major changes in future interest rates.
Global premium rates are still continuing upwards in 2022 to date, although at a slower pace now of around 9%, compared to a high at the end of 2020 of around 22%. The UK and US have seen the fastest decrease in rates.
Cyber continues to have high price increases, but this is aligned to high levels of claims. The sanctions arising from the Russian attack on Ukraine will have impacted certain lines of business. The changing sanctions picture means insurers need to be careful to control the business they accept.
The reported income at the top line will be influenced not only by pricing but also exchange rates, particularly for UK insurers with large US portfolios. At Q2 2022 the Lloyd’s market has reported 19 consecutive quarters of positive price movements. Casualty has the highest current improvement, and energy and motor the lowest.
As well as driving up all types of costs from fuel to salaries and, indirectly, interest rates and the impact of imports priced in US dollars, the effects of inflation are likely to be felt particularly by insurers in their claims costs.
This can manifest itself not only in increased costs of replacement parts, but supply chain problems that mean remedial action is delayed. This in turn can cause more damage to occur, increased periods of loss of income and require even more costly parts when they are finally received.
High demand for repair staff across most sectors also adds to inflation. What’s more, the disruption to economies caused by the pandemic has led to more indirect impacts upon claims costs. These include the shortage of new cars, which increases second hand car prices where a replacement is required.
We should also mention the effects of social inflation upon awards and the increase in claims as economic conditions for some individuals deteriorate.
It will be a major challenge for claims handlers and actuaries to identify the impact of these various factors. Not only have they clearly been in a state of flux in the last year or two, but how they will develop over the next couple of years is also uncertain.
In debate will be how much inflation has already been factored into case reserves, and how much above this should actuaries allow for. For Lloyd’s, administration expenses are only up by 0.1% of premiums in the first half of 2022 but there has been a saving of 0.4% in acquisition costs such as brokerage.
The regulators are keen for the impact of inflation on claims reserving and premium pricing to be well understood by insurers. That’s why they have issued guidance. Lloyd’s, in particular, expects a clear demonstration of this in capital modelling by the syndicates. A key element is to identify excess inflation that insurers may face if the business they’re involved in is above the pure inflation level shown by the Consumer Prices Index.
Accountants and actuaries should exercise significant judgement in their next year end reporting, where there is a need to take a medium or long term view of inflation. Where this is a key judgement or estimate, appropriate disclosure will be necessary.
Preparers of financial statements will also need to monitor inflation rates in overseas territories where they have business operations and consider whether hyper-inflationary accounting will be necessary. The International Practices Task Force (IPTF) of the Centre for Audit Quality (CAQ) monitors the status of ‘highly inflationary’ countries to aid in this assessment.
The hurricane season to the end of August has been very benign. But there are still a couple of usually very active months to go. Despite this, global insured losses are some 22% above their 10 year average. These are mostly severe weather and flooding events from around the world, rather than dominated by the US.
Most insurers have now emerged from the pandemic without major disruption to their business. But business lines such as travel insurance were severely impacted, and some insurers suffered significant business interruption claims. Many of these have now been resolved but for the unlucky there are still ongoing disputes regarding coverage.
For the first half of 2022 compared to the first half of 2021, Lloyd’s is showing major losses up from 6.8% of premiums to 9.9%. These are driven by £1.1bn of losses from the Ukraine conflict. This includes the Lloyd’s share of claims related to leased aircraft stranded in Russia, which are uncertain in outcome and which policy will respond to these losses, but some analysts believe could ultimately across the global insurance market be 7 times the scale of the World Trade Centre Loss in 2001. Attritional losses as a percentage of premium are down by 1.6% to 48.9% and prior year releases are up from 0.9% of premium to 2.8%.
If you would like to discuss any of the issues raised in this article, please contact Neil Coulson.