Evolution of financial reporting of life insurers. The predominance of unregulated embedded value disclosure

Author:Rudolph A. Jacob, Samir El-Gazzar, Scott McGregor
Position:Pace University, New York, New York, USA

Purpose This paper aims to examine the capital market effects and predominance of unregulated embedded value (EV) financial reporting in the life insurance industry in foreign domestic markets, and US markets for foreign firms that cross-list in the USA. Design/methodology/approach Recent empirical archival data are analyzed and evaluated to determine the incremental and relative ... (see full summary)

Evolution of nancial reporting
of life insurers
The predominance of unregulated embedded
value disclosure
Rudolph A. Jacob and Samir El-Gazzar
Pace University, New York, New York, USA, and
Scott McGregor
Fairleigh Dickinson University, Madison, New Jersey, USA
Purpose This paper aims to examine the capital market effects and predominance of unregulated
embedded value (EV) nancial reporting in the life insurance industry in foreign domestic markets, and US
markets for foreign rms that cross-list in the USA.
Design/methodology/approach Recent empirical archival data are analyzed and evaluated to
determine the incremental and relative value relevance of an unregulated valuation metric that is disclosed by
life insurers.
Findings The ndings support the proposition that EV is valuable supplemental information in foreign
domestic markets, and in US markets for foreign life insurers that cross-list in the USA. Given that
International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) are
engaged in projects to improve accounting standard for insurance companies, and have faced criticism with
the existing drafts on this issue, the two institutions ought to consider the valuation relevance of EV
disclosures. Moreover, this analysis strongly suggests that nancial analysts in the USA should consider EV
in valuing life insurers’ stocks.
Practical implications The ndings discussed in this paper are of special interest to nancial reporting
policy makers, nancial analysts, rm compensation committees and managers, and academics.
Originality/value This paper contributes to the extant literature by providing recent evidence that
suggests that EV, an unregulated fair value market-driven metric, is more value-relevant than traditional
earnings metrics such as earnings and book value. It is the only study that we are cognizant of that critically
examines the recent empirical literature on this evolving issue.
Keywords Value relevance, Embedded value, Insurance accounting, Unregulated disclosure
Paper type Research paper
Over the years, nancial reporting in the international insurance industry has varied
widely across jurisdictions and has moved slowly toward standardization. The
International Accounting Standards Board (IASB) issued IFRS 4, Insurance Contracts,
in 2004 as an interim step while undertaking a project to develop a comprehensive
standard. IFRS 4 allowed insurers to continue existing accounting practices in most
instances and did little to alleviate the concerns for nancial reporting for life insurance.
The Financial Accounting Standards Board (FASB) and the IASB worked jointly on
guidance for insurance contracts from 2008 through FASB’s decision to take a different
approach in 2013. Additionally, insurance accounting in many jurisdictions was
constrained by a country’s statutory accounting regulations. Investors and nancial
analysts have expressed concerns that this reporting framework is not producing the
The current issue and full text archive of this journal is available on Emerald Insight at:
Journalof Financial Regulation
Vol.25 No. 1, 2017
©Emerald Publishing Limited
DOI 10.1108/JFRC-02-2016-0012
type of performance measures that reect the economics of this industry (CFO Forum,
2004;2005;IASB, 2014). Specically, they stated that traditional enerally accepted
accounting principles (GAAP) mismatches accounting results with economic
performance due to delayed recognition of revenues and expenses and the misalignment
of the valuation bases for assets (fair values) and liabilities (estimated exit value).
Moreover, insurance statutory accounting emphasizes solvency and conservatism over
relevance in recognizing periodic revenues and expenses, thus resulting in the
undervaluation of a life insurer’s equity (Horton, 2007).
In response to analysts’ concerns, approximately 100 life insurance companies
supplement their nancial statements with unregulated metrics known as embedded
value (EV) to better capture a rm’s performance. EV is an estimate of the present value
of future net cash ows from in-force life insurance business. The disclosure of EV
began with rms in the United Kingdom (UK) disclosing “achieved earnings” results in
the 1980s and spread to large European life insurers. Today, the disclosure practice
includes insurers in Canada, Japan, China, Australia and South Africa. Currently, no
United States (USA) domestic insurer discloses EV, although the US operations of
international insurers calculate the measure, and some life insurers’ managers have
used EV internally for performance evaluation and as a basis to value acquisitions.
While EV disclosure has grown signicantly, it has been criticized for the lack of
standardization. The CFO Forum, comprising nance ofcers from 20 large European
insurers, was formed in 2002 with an objective of standardizing EV disclosure. Over the
past decade, the CFO Forum has issued guidelines that have greatly improved the
comparability of the disclosure. The 20 CFO Forum member rms represent
approximately 95 per cent of the life insurance premium in Europe and are required to
follow the guidelines. However, the CFO Forum member rms still represent only
approximately 20 per cent of the rms issuing the disclosure worldwide, and although
many non-member rms choose to follow the CFO Forum’s guidelines, compliance is
There has been limited, but growing, study of EV. In spite of the lack of uniformity
and regulation, the empirical studies have documented a strong positive association
between changes in life insurers’ security prices and changes in EV.
The insurance industry, particularly the life insurance sector, faces evolving
reporting and disclosures. In addition to the adoption of EV disclosure practice globally
and the forthcoming IFRS guidance for insurance contracts, the European life insurance
industry is subject to new capital requirements under Solvency II, which is effective in
2016. Discussed in this paper is the evolution of nancial reporting in the life insurance
industry, internationally and within the USA with discussion on the capital market
effects of EV as a supplemental disclosure.
Evolution of insurance accounting
As mentioned, the IASB initially addressed insurance contracts in a two-phase approach.
The rst phase, IFRS 4, was adopted in May 2004 as a temporary measure for insurers
adopting IFRS in 2005. IFRS 4 allowed many of the existing recognition and reporting
practices to continue without major alterations. Therefore, there are multiple approaches and
a lack of uniformity among life insurers.
In 2006, the CFO Forum, which represents a signicant voice in the international
industry, published “Elaborated Principles for an IFRS Phase II Insurance Accounting
Model” (CFO Forum, 2006). In this model, the CFO Forum called for prots to be recognized
reporting of
life insurers

To continue reading