U.S. Life Insurance Industry Expected to Adopt International Accounting Standard, According to Tillinghast CFO Survey

Opinion Split Whether Fair Value Will Be Chosen Standard;
U.S. GAAP, Statutory Reporting Expected to Prevail in Short Term

New York, NY, August 10, 2004 � A significant majority (81%) of North American life insurance company CFOs believe that the U.S. and Canada will eventually join with Europe in adopting a global accounting standard for insurance within the next 10 years, according to the Tillinghast business of Towers Perrin in its latest CFO survey. However, only about one-quarter (28%) of respondents believe it will happen within the next five years. Opinion is split on whether fair value will be the chosen standard. Nearly two-thirds (66%) of respondents believe fair value is highly or somewhat likely to become the accepted insurance industry standard in their country regardless of whether a global standard is adopted. All other respondents expect the accepted standard to include some aspects of fair value but not necessarily include it in full.

The survey — the eighth in a Tillinghast series — found that the trend has companies keenly interested in developments surrounding the adoption of a Phase 1 International Accounting Standard by the European Union, effective for 2005 statements. Nearly half (47%) of all respondents plan to increase their monitoring activity with respect to future IAS proposals.

“The IAS has set a precedent that we expect other countries to adopt, but the specific methodology and time frame for that activity is uncertain,� says Jack Gibson, Managing Principal for the North American Life Insurance and Financial Services Practice. �Fair value will likely prevail as the accepted standard to some degree for the insurance industry going forward, but no one expects it anytime soon. With an accepted industry standard in North America not expected within the next five years, U.S. GAAP and statutory reporting methods will continue to fill the void in the short term � but companies will have start addressing differences between GAAP, statutory and fair value accounting much sooner.”

U.S. GAAP and Statutory Reporting Shortfalls

While traditional U.S. GAAP and statutory financial reporting remain dominant for both internal performance measurement and senior management compensation, neither focuses on long-term value creation, a significant limitation for insurers. In turn, more companies have begun using value-based measures, but they are doing so with different priorities. Key survey findings include:

Internal Performance Measurement

  • Nearly three-quarters of respondents use more than one financial reporting measure for internal performance measurement, with 41% using three or more measures.
  • The majority of U.S. respondents (84%) still rely on U.S. GAAP reporting as their primary measure for internal performance measurement.

Compensating Senior Management

  • In contrast, most companies (63%) use only one financial reporting measure as the basis for compensating senior management.
  • Nearly three-quarters (72%) of U.S. companies say U.S. GAAP is their primary measure for this purpose.

Value-Based Measures

  • Only 28% of respondents also consider at least one value-based measure — such as embedded value, value of new business or economic/fair value — in determining senior management compensation, while 53% use at least one of these for internal performance measurement purposes.

“Value-based measures are gaining popularity as secondary reporting methodologies,” notes Mr. Gibson. “By providing better insight into value creation and enhancing strategic decision making, they are able to overcome the traditional shortcomings of U.S. GAAP and statutory financial reporting methods.”

Concerns About Sarbanes-Oxley

Sarbanes-Oxley was enacted in 2002 to deter and punish corporate and accounting fraud while improving the quality of financial reporting, independent audits and accounting services for public companies. Significant concerns exist in a variety of areas regarding its implementation.

Cost of compliance is the biggest concern, cited by 93% of respondents, and half worry that their key managers will be distracted from other high-priority duties.

Respondents also cited positive aspects of Sarbanes-Oxley implementation, most notably providing a more comprehensive consideration of risk management issues (57%) and improved internal transparency (43%). Yet it�s still unclear whether they believe these benefits outweigh the costs.

Companies Hedge to Mitigate Risks

Over 60% of respondents have hedging programs in place to help manage risks associated with product guarantees. It is somewhat surprising that recent U.S. GAAP accounting changes by themselves are not impacting the way most companies hedge their risks: Nearly two-thirds say these changes are not a factor in their hedging decisions. However, nearly 30% say that FAS 133 was an incentive to obtain hedges for certain product guarantees.

For over 85% of respondents, the primary objective of implementing a hedging program is to mitigate tail risk and/or manage earnings volatility. These findings echo similar findings from an earlier CFO survey in which Tillinghast reported that variable annuity writers are turning to hedging of guarantees as a way to manage downside risk. In that survey, 25% of respondents said they hedged tail exposure for equity product guarantees while an additional 34% said they planned to do so within the next 12 months to help minimize the impact of regulatory changes.

“Sarbanes-Oxley, coupled with a general lack of reinsurance, has forced senior management to deal with the risk management of guarantees. Best practice companies have enacted hedging programs that are intended to mitigate tail risk and limit revenue volatility,” says Hubert Mueller, Principal and Survey Leader. “Going forward, having these programs in place will enable these companies to better manage future capital market volatility. This will also lead to accelerated market consolidation.”

Positive Outlook for Second Quarter

Nearly 60% of respondents predict growth of at least 4% in new life and annuity premiums in the second quarter compared with the same period last year, while 22% believe the increase will be more than 10%. Over 70% expect revenues to increase by at least 4% versus the same quarter last year. Over 60% also predict net income to increase at least 4% quarter over quarter.

“The outlook for second quarter results is generally positive,” added Mueller. “These results offer a glimpse of how insurance industry results are expected to evolve going forward. While all signs point toward continued growth and prosperity, we are starting to see a bit of a slowdown in year-over-year earnings growth, given the recovery during the second half of 2003.”

These results reflect the CFOs’ broad industry outlook at the time they completed the survey and may or may not reflect company performance that actually emerges. CFOs’ views on future financial results for the industry will be a regular feature of the Tillinghast Life Insurance CFO Survey to track the direction of the industry over time.

About Tillinghast�s Life Insurance CFO Survey

The Web-based survey was conducted in June 2004 and is the eighth in a series of Tillinghast pulse surveys, which explore issues important to the North American life insurance industry and its CFOs. This three-part survey, which examined issues relating to financial reporting methodologies, had a respondent base of 32. Respondents primarily included CFOs from large and midsize North American life insurance companies; 64% had assets of $5 billion or more, and 16% were multinationals. For more information on this survey program, please contact Sarah Prevett, program leader, at 212-309-3979.

About Towers Perrin and Tillinghast

Towers Perrin is a global professional services firm that helps organizations around the world improve their performance through effective people, risk and financial management. Through its Tillinghast business, Towers Perrin provides global actuarial and management consulting to insurance and financial services companies and advises other organizations on risk financing and self-insurance. Areas of focus include mergers, acquisitions and restructuring, financial and regulatory reporting, risk, capital and value management, and products, markets and distribution. The firm�s other businesses are HR Services, which provides human resource consulting and administration services, and Reinsurance, which provides reinsurance intermediary services. Together, these businesses have over 8,000 employees and 78 offices in 76 cities in 24 countries. More information about Tillinghast is available at http://www.towersperrin.com/tillinghast