What considerations arise for (re)insurers for their year-end financial and solvency reporting arising from COVID-19?
Insurers will need to think about their reporting of this Post Balance Sheet Event in both their financial statements and in their regulatory reporting.
The Financial Reporting Council (FRC) has set out guidance for financial reporting by companies noting that the general consensus is that the outbreak of COVID-19 in 2020 was a non-adjusting event for the vast majority of UK companies preparing financial statements for periods ended 31 December 2019. However, companies will need to judge how much of the impact of COVID-19 should be considered to arise from non-adjusting events for subsequent reporting dates and that this judgement will be highly dependent on the reporting date, the specific circumstances of the company’s operations and any particular events under consideration. If the judgement has a significant effect on the amounts in the financial statements, then this judgement should be disclosed and explained.
The company’s Strategic Report needs to be forward looking and entity specific. It should be addressing the principal risks and uncertainties to the company’s resources (including the workforce), assets and customer and supplier relationships. Stakeholders will be concerned about the liquidity, viability and solvency of companies. No one can currently predict the extent and duration of the COVID-19 crisis nor its consequences for the global economy. However, stakeholders’ are reasonably entitled to expect that companies can articulate the possible impacts on their specific business in different scenarios. Directors therefore might need to think about disclosing summaries of their judgements of the impact on revenue, claims, assets, operations, and capital adequacy,
The key issues for financial reporting are likely to be:
Boards will currently be less confident about going concern judgements and statements and will need to set the judgement against the company’s specific circumstances and the degree of uncertainty and any assumptions made.The FRC thinks it is likely that more companies will disclose “material uncertainties” to going concern in current circumstances. “Material uncertainties” are uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern. In other words, if boards identify possible events or scenarios (other than those with a remote probability of occurring) that could lead to corporate failure, then these should be disclosed.
Significant judgements and estimation uncertainty
Given the lack of consensus on the future path of the COVID-19 crisis and its impact on the economy, companies will use differing assumptions to estimate the financial effects of the uncertainty. This lack of consistency makes the need for full disclosure of judgements, assumptions and sensitive estimates in the financial statements significantly more important than usual.
(Re) insurers will need to consider:
- The specific implications for the company based on the accounting policies applied, including assessing the potential impact on the assumptions for measuring liabilities for reported claims, incurred but not reported claims, future claims and reinsurance recoveries.
- The liability adequacy test (including recoverability of deferred acquisition costs) is based on current estimates of future cash flows and evaluate whether any deficit should be recognised in profit or loss.
- Whether a significant or prolonged decline in fair value has arisen for any available-for-sale equity investments.
- Whether there is a loss event that has affected the estimated future cash flows of any debt investments and whether to recognise an impairment loss.
- Considering whether there are material credit risk matters and premium adjustments that may be coming through after the year end.
- Expanding disclosures about operational risk management, any key demographic and market assumptions, sensitivities in those assumptions, major sources of estimation uncertainty, and liquidity, market and credit risks.
- Its capital disclosures, especially where there are concerns about the capital position relative to regulatory requirements or implications for debt covenants.
On 20 March, EIOPA stated: “Insurance and reinsurance undertakings should consider the current situation as a “major development” as referred to in Article 54(1) in the Solvency II Directive”. Article 54 states that in the event of any major development affecting significantly the relevance of the information disclosed in the Solvency Financial Condition Report (SFCR), insurance and reinsurance undertakings shall disclose appropriate information on the nature and effects of that major development. Thus, for 31 December 2019 and later year ends (re)insurers will need to consider the impact of COVID-19 on their businesses.
The PRA has followed EIOPA’s recommended flexibility on the timing for the publication of the SFCR in the light of the current crisis. SFCRs can be published up to 8 weeks later than the normal deadline and there is no need to produce a Regular Supervisory Report. The SFCR is all about the strength of the (re)insurers balance sheet and there maybe multiple impacts on the balance sheet post a year end of 31 December or later. The extra time provided by the regulator is to allow firms to enhance their thinking and therefore the disclosures they make.
EIOPA and the UK regulators have all stressed the importance of operational resilience (both of the firma and of its outsourcing partners) in the current crisis for the financial services sector. However, being able to operate will not mean that the business has not changed in terms of its ability to sell products, to pay claims and to predict the nature and extent of future claims.
Over and above the considerations for financial reporting firms and operational resilience firms will need to consider disclosing in their SFCRs:
- The impact of COVID-19 on your particular type of insurance business – differing classes or lines of business may be affected differently - and how the experience to date from the COVID-19 outbreak varies from any existing assumptions about pandemic risk and related mitigation or management.
- The impact on assumptions for, and sensitivities to, the measurement of insurance liabilities. These disclosures should also include consideration of risk concentration, claims development tables and related credit, liquidity and market risk. COVID-19 may increase the level of estimation uncertainty when measuring insurance liabilities. This may require enhanced disclosures and may also affect any disclosures on sensitivity analyses.
- For investment portfolios, insurers should disclose the nature and extent of risks arising from financial instruments and how they manage those risks. This means that insurers will need to explain the significant impacts of COVID-19 on those risks and how they are managing them. Insurers will need to exercise judgement to determine the specific disclosures that are relevant to their business.
- Decreases in asset valuations arising from the COVID-19 outbreak may impact the regulatory capital and solvency calculations and the related disclosures about how the entity manages capital. Disclosures will probably also be required for the non-adjusting COVID-19 events occurring after the reporting date that impact subsequent financial asset or insurance liability measurements.
Carrying out an ORSA re-run including all the relevant stress scenarios but possibly with new COVID-19 driven assumptions as part of the sensitivities and / or scenarios used should also be at the top of any firm’s COVID-19 response as they might (and definitely will at some point) need to satisfy regulators on their future projected capital adequacy margins under very different circumstances to the 2019 ORSA runs.
If you’d like more information about how to respond to COVID-19, please contact Alex Barnes or Charles Portsmouth.