Bottom Line: Accruals may be better for age of full disclosure
Friday 21 May 1993
Accruals accounting is a way of taking a substantial early profit on the long-term savings contracts life insurers sell. For the Pru, accruals convert the pounds 444m made on life business last year into a profit of pounds 807m, and the group pre- tax profit is pounds 769m instead of pounds 406m. Its shareholders also find themselves with an accrued interest of pounds 2.8bn in the life fund, which boosts their funds to pounds 3.3bn. This has the happy corollary of giving the Pru a debt-equity ratio of 21 per cent instead of nearly 140 per cent.
Despite appearances, accruals accounting is not just an easy way to flatter profits and financial strength. Even conservative offices such as Britannic Assurance accept that the system of statutory profits gives a poor idea of the value of company and its business. The costs of selling new business and establishing reserves can depress the profits of a company that increases sales of (eventually profitable) contracts.
Prudential's second set of accruals numbers offered some insights into what the approach may offer. The 1992 life profit of pounds 807m was 9 per cent higher than the pounds 738m reported for 1991, but much of the interest was not in the totals but in their constituent parts.
For example, although the contribution of Prudential Assurance, the main life business, rose from pounds 431m to pounds 487m, this was largely driven by new business sales, from which profits increased by 30 per cent to pounds 226m. But profits from the business already on the books fell by 31 per cent because of poor investment returns in Australia and losses on property investments in Canada. Such features will not always show up in the statutory numbers.
While analysts seem to be warming to the prospect of additional information, many life offices remain unenthusiastic. Calculation of accruals figures is costly and takes a great amount of additional work. So far, only BAT Industries, the owner of Allied Dunbar and Eagle Star, has followed the Pru's lead.
Legal & General doggedly favours an embedded value approach, which involves discounting the future profits from business already written. TSB, which like other banks also uses this approach, is also reluctant to change, arguing that accruals accounting is even more dependent upon management assumptions about key variables.
The outlook for insurance accounting is further confused by the EC's forthcoming accounts directive, which some believe may outlaw embedded value. Accruals accounting seems to offer more and better information than embedded value, which is to its advantage in this age of full disclosure. But this argument will probably not be enough to win the day.
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