Supplementary memorandum by the Financial
RISK MANAGEMENT IN INSURANCE COMPANIES
1. When the FSA gave evidence to the Committee
on 15 February we undertook to provide a further note on two issues.
2. The Committee asked (Q 197) whether there
should be a change to the legislation so that financial provisions
reported by life insurers in their annual returns to the FSA would
have also to be included in the insurers' Companies Act (CA) accounts.
This note explains how financial accounts are drawn up by life
insurance companies and describes some of the important differences
between CA accounts for insurance and non-insurance firms. It
then contrasts CA accounts for insurance companies with the financial
returns submitted to the FSA under the Insurance Companies Act
("regulatory returns") and then deposited with the Registrar
3. The purpose of CA accounts is to give
a true and fair view of a company's financial position at the
end of the financial year and profit or loss for the financial
Accounting standards issued by the Accounting Standards Board
set generally accepted accounting practice for accounts for these
purposes. These include Financial Reporting Standard (FRS) 12
on provisions and contingencies. This standard requires companies
to set a provision (ie for a liability whose amount or timing
is uncertain) at the best estimate of the expenditure required
to settle the liability to which it relates. FRS 12 also requires
a narrative description of the uncertainties of the amount or
timing of the liability. For these purposes liabilities are defined
as including both legal and constructive liabilities. The latter
arise where a company's past practice creates valid expectations
on the part of others (eg customers). This combination of "best
estimate" measurement of both legal and constructive liabilities,
together with a narrative description of uncertainities, is widely
accepted as providing the most relevant information to users of
CA accounts. This combination is also the basis of the relevant
international accounting statement on provisions.
4. However, at present, FRS 12 does not
apply to liabilities arising from insurance contracts. The Accounting
Standards Board states in FRS 12 that this is because of "the
special regulatory position of insurance companies (for which
provisions are particularly important) and the [ongoing] review
of the accounting framework for insurance companies." At
present life insurance companies therefore typically only set
provisions in their CA accounts for legal liabilities.
In this respect CA reporting for life insurance companies is closer
to life insurance regulatory reporting than it is to CA reporting
outside the insurance sector.
5. Regulatory reporting, by contrast, takes
a more cautious view than CA reporting when measuring legal liabilities
whose amount or timing is uncertain. Provisions in regulatory
returns are intended to be sufficient not just in the expected
(ie "best estimate") situation but also in a wide range
of realistic alternative scenarios. This relects the different
purpose of regulatory reporting which is to give reasonable assurance
that financial resources are adequatenot (as with CA reporting)
to ensure that performance (ie profit or loss) is fairly reported.
Certain provisions in regulatory returns are required under current
accepted accounting practice to be reassessed for the purpose
of drawing up the CA accounts. However, the difference (if any)
must be included in reserves (ie money set aside) even where it
is not included as a provision.
6. The FSA recognises that the present reporting
requirements may not provide readily accessible information to
policyholders and other users. We believe that in the longer term
the appropriate way forward for life insurance CA reporting is
not for it to move even closer to regulatory reporting, but for
it to move closer to non-insurance CA reporting. This change would
result in a fuller narrative description of uncertainties
and provision being made for both legal and constructive liabilities.
The FSA is actively participating in international work to draw
up a new accounting standard for insurance based on this approach.
7. As we have already announced, we are
undertaking a review of the operation of with profits life insurance
business with a view to (amongst other things) bringing greater
transparency to this. We propose to include financial reporting
arrangements in this work and will liaise with DTI and the accounting
profession on this point.
8. The second issue on which the Committee
requested more detailed information (Q 210/11) concerned the number
of complaints by Equitable policyholders before 1998 about the
company's bonus policy on GAR contracts.
9. Prior to 1999, when the FSA took over
prudential regulation of insurance companies, the Department of
Trade and Industry and the Treasury (during 1998) were the prudential
regulators. A review of the relevant files indicates that there
is no record of a complaint about Equitable's bonus practice before
10. The Personal Investment Authority (PIA)
regulates conduct of business activities of insurance companies
(for example, ensuring information disclosed to consumers is clear,
fair and not misleading). There is no record of the PIA receiving
a complaint about Equitable's GAR practice before 1998.
11. As for complaints to the Ombudsman,
we understand that the data are not collected in a way which allows
the questions to be answered on the timescale required by the
12 March 2001
6 See Section 226 of the Companies Act 1985. Back
No provision is set for constructive liabilities, eg terminal
At present the Companies Act exempts insurance companies from
the requirement to include this narrative description for insurance