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Insurancedigest

AMERICAS EDITION • DECEMBER 2003

The Americas Insurance Digest is published three times a year, to address the key issues driving the insurance industry.

If you would like to discuss any of the issues raised in more detail,please contact the individual authors or the Editor-in-chief, whose

details are listed at the beginning of each article.

We would also welcome your feedback and comments onInsurance Digest, and as such, we enclose a Feedback Fax Reply

form. Your feedback will help us to ensure that our publications areaddressing the issues that you feel most strongly about.

AMERICAS EDITION • DECEMBER 2003

Contents

EDITOR’S COMMENT • JOHN S. SCHEID 2

LOSS CONTROL TODAY: IT’S NOT JUST ABOUT INSPECTIONS AND RECOMMENDATIONS ANYMORE • LESLIE J. HAWKES

Loss control is taking a more important role in many insurers’ decisions to accept, price, and provide coverage for a widervariety of risks than ever before. Today’s loss control professionals have deeper and broader training and bring specializedskills to the insured-insurer-loss control partnership.

DEVELOPING EFFECTIVE ENTERPRISE-WIDE RISK MANAGEMENT • PAUL L. HORGAN, SHYAM VENKAT AND ERIC GRONNINGSATER

Most insurers now recognize the value of enterprise-wide risk management (ERM) in safeguarding their businesses. The real question going forward is how to customize an ERM program to foster growth and optimize return on capital.Paul L. Horgan, Shyam Venkat and Eric Gronningsater examine how companies are facing up to the challenge.

26

TRANSFER PRICING AT THE FOREFRONT OF TAX COMPLIANCE AND PLANNING FOR THE INSURANCE INDUSTRY

• BARRY L. DENNIS AND HSIN HUNG

Recent major developments, by both the OECD and the US IRS, have increased the importance and visibility of transferpricing for multinational companies, including insurance companies. The expected major changes that are likely tofollow emphasizes the importance for insurance tax practitioners to have an understanding of how transfer pricing rulesapply to insurance companies.

16

MORE EFFECTIVE REPORTING FOR INSURANCE COMPANIES AND THEIR STAKEHOLDERS

• PAUL L. HORGAN, ROBERT LEMBACH AND MIKE WILLIS

To achieve the critical goal of satisfying growing demands for more data in less time, the insurance industry is takingdefinitive steps to enable deployment of Extensible Markup Language (XML) and eXtensible Business Reporting Language(XBRL) standards across the insurance value chain.

20

ED5 – WHAT DOES THE INTERNATIONAL ACCOUNTING STANDARDS BOARD’S PHASE I EXPOSURE DRAFT MEAN TO US INSURERS? • MARIE BRAVERMAN, SAM GUTTERMAN, DAVID SCHEINERMAN AND JIM BICHARD

What will the conclusions reached by the IASB mean to US insurers and what accounting issues should US insurancecompanies be focused on now and in the near future?

10

4

THE INSURANCE MARKET IN IRELAND • CHAND KOHLI AND GARVAN O’NEILL

Ireland enjoys a relatively mature, well-developed domestic insurance market. Furthermore, in recent years, Ireland hasbecome a leading European center for the transaction of cross-border insurance. Chand Kohli and Garvan O’Neillexamine the landscape of the Irish domestic and cross-border insurance markets as well as the factors behind Ireland’semergence as a leading cross-border insurance center.

30

2 Insurance Digest • PricewaterhouseCoopers

Welcome to the December 2003 edition of Americas Insurance Digest.

As companies release their third quarterearnings reports, a few trends seem to beemerging. Commercial insurance premiumrate increases discussed in the Septemberedition of Insurance Digest, while continuing,seem to be slowing as we enter the fourthquarter. The US casualty reinsurance marketseems to be under heavy scrutiny as a resultof reserve additions. Companies havecontinued to increase asbestos andenvironmental reserves particularly in thelarge account market. As the property CATindustry looks ahead to the January 1 renewalseason some are commenting that currentpricing should hold; however, the focus is more on sustainability/security. In thepersonal auto insurance market, results byand large have been good as the aggressiverate increases over the past three years are the key contributors to current profitability.Looking ahead, one does have to questionwhether this will continue or whether thecompetitive nature of this business will return as auto companies strive to buildmarket share. I would suspect that skilledunderwriting and claims management shouldremain a key focus as companies try tomaintain the improved combined ratios of recent months.

During the month of September, the M&Aactivity in the life insurance industry haspicked up significantly after being very quietfor well over two years. In early September,

AXA Financial announced it would acquireMONY in a cash transaction. Safecoannounced its intention to sell its life andasset management operations in order toconcentrate in the property-casualty market.On September 29, Manulife FinancialCorporation and John Hancock FinancialServices agreed to a stock-for-stock mergervalued at $11 billion on the date of theannouncement. This merger transaction is one of the largest to occur in the US life insurance industry. This recent acquisitionactivity coupled with the recent mergerannouncement in the US banking sector by Bank of America and Fleet Financial willreinvigorate the debate in the insuranceindustry as to the importance of scale inbeing able to compete effectively. In Canada,where there are fewer large life insurancecompanies with far greater concentration, it has been reported that these companies areable to reduce their costs and strengthen theirmargins. I guess only time will tell whether all of the predicted synergies, cost savingsand other benefits will be realized in thesemerger transactions in the life insuranceindustry. In December we will issue a whitepaper entitled, ‘Focus on restructuring: The drivers shaping the financial servicessector’, which will look at some reasonsbehind the increased focus on M&A andother methods of restructuring within thefinancial services industry.

All of this suggests that the insurance businessis cyclical. It is a cyclical business thatdemonstrates dramatic fluctuations in pricing.

Editor’s Comment

JOHN S. SCHEID CHAIRMAN, AMERICAS INSURANCE GROUP

3Insurance Digest • PricewaterhouseCoopers

General insurance, in some classes of business,has experienced extremely volatile pricing and difficulty, until recently, in making anunderwriting profit. With lack of historicalunderwriting profit, the industry has relied oninvestment income. Investment income andrealized capital gains have been the reliablesources of income growth until recently. The performance of the stock market over the past three years and in particular the level of interest rates over the last two years hasreminded us the investment income is not ableto always support a healthy P&L if underwritingperformance is substandard.

We do not, of course, have simple answers to any of the challenges facing management,but in this edition of Insurance Digest we havecommentary on some of the challenges andopportunities that lie ahead.

Given the importance of underwriting in today’scomplex business environment, in our firstarticle Leslie J. Hawkes discusses the increasinglyprominent role that loss control is taking on inmany insurers’ decisions to accept, price andprovide coverage. Leslie discusses the changingenvironment for loss control, development ofspecialized services and even ventures a guess asto what loss control will look like in the future.

With the importance of International FinancialReporting Standards (IFRS) increasing over theyears, recent editions of Digest have contained a series of articles on the continueddevelopments of IFRS and the impact on theindustry. In June 2003, the International

Accounting Standards Board published anexposure draft on insurance contractaccounting with a comment period open untilOctober 31, 2003. How this develops will beimportant to many companies. Much of thecommentary from the North Americanperspective to date has been at a generalindustry level. In this edition we have aninteresting article from our US colleagues Sam Gutterman, Marie Braverman, David Scheinerman and Jim Bichard discussingwhat this Phase I Exposure Draft means to USinsurers. While the product specific issues mayvary by country, the general message that therewill be detailed implementation challengesclearly has wider application.

The third article discusses recent developmentsin intercompany transfer pricing as a result ofthe Organization for Economic Cooperationand Development (OECD) draft guidelines.Although this article addresses intercompanypricing mainly from a US perspective, severalother countries have similar rules andregulations following the OECD generalprinciples and therefore we think it has someinterest to many readers during the 2004planning cycle.

We have two articles which consider relatedissues – value reporting financial results andenterprise risk management. Paul L. Horgan,Robert Lembach and Mike Willis discuss thechanges ahead for the insurance industry as it considers the use of XML and XBRL toprovide more information in less time to key company stakeholders. In the second

article, Paul L. Horgan, Shyam Venkat and Eric Gronningsater assess how widelyenterprise-wide risk management is recognizedas an important fundamental management tooland just where are most insurers in customizinga risk management program for their specificneeds of risk management and monitoring.

Finally, in a continuing series of articles on theinsurance industry in country specific markets,Chand Kohli and Garvan O’Neill provide abrief overview of the Irish insurance market.Ireland has a well-developed domestic market,but perhaps more significantly for many AmericasInsurance Digest readers, Ireland now is also a leading centre for European cross-borderinsurance. This article examines the prospectsfor both the domestic and cross-border sectorsand provides an overview of the factors thathave contributed to Ireland’s emergence as aleading cross-border insurance center.

Please continue to provide us with yourfeedback and topics you would like to seeaddressed in future issues. On-line copies ofboth this publication and the European andAsia Pacific editions are available from ourwebsite (www.pwc.com/financialservices).

John S. ScheidEditor-in-Chief

Tel: 1 646 471 5350E-mail: [email protected]

Loss control today:It’s not just about inspections and recommendations anymore

AUTHOR: LESLIE J. HAWKES


Today’s loss control professionals have deeper and broader training andbring specialized skills to the insured-insurer-loss control partnership.

A quiet yet prominent trend istaking place in the insuranceindustry today. Loss control istaking a more important role inmany insurers’ decisions to accept,price and provide coverage for awider variety of risks than everbefore. Additionally, many insurersare providing a better form of losscontrol service to their clients thanever before. Insurers that once usedloss control sparingly and for onlythe more complex and largerpremium risks are now using losscontrol more frequently, morecreatively and more wisely. The evolution has been dramaticover the past several years. The roleof loss control has finally evolvedas an integral part of the productand service portfolio thecommercial property and casualtyinsurer offers to its commercialinsureds. More importantly, losscontrol has become a truly criticalcomponent of the underwritingprocess. Some insurers have evenchanged the name of the servicethey provide from loss control torisk control, taking advantage of the recent movement toward sellingthe concept of enterprise riskmanagement. Many of theseinsurers offer loss control tips andtechniques to their insureds on aregular basis through the use oftheir Web sites.

The importance of coordinatingunderwriting and loss control

Underwriting in today’s complexbusiness environment is

increasingly challenging for theinsurer. An enormous amount ofcapital still exists in themarketplace today. All of thatcapital is chasing an almost fixedamount of premium dollars fromyear to year. An insurer and itsunderwriters must constantly be on top of their game if they are to make a profit on underwritingoperations. The underwriters’ abilityto learn about and understand allof the nuances of the manyvarieties of business they encounteron a daily basis is an enormoustask. Yet, at the same time,underwriting continues to be thepreeminently critical component of the insurer’s ability to make aprofit. Insurers have to be at peakperformance levels at all timeswhen it comes to underwriting andthe decisions they make on whatcoverages to offer as well as theprice to charge for those coverages.Insurance executives today realizethat poor underwriting and theimproper use of knowledgemanagement are more responsiblefor putting their capital at risk thanare unforeseen events.

Insurers that allow theirunderwriters to accept and writebusiness that they do not fullyunderstand are at a much greaterrisk of experiencing poor resultsthan are the insurers that are moredisciplined in writing only thebusiness that is within their realmof knowledge and experience.1 It isthis author’s opinion that, in order

for the insurer and its underwritersto fully understand the businessthey are writing, they must includethe services of skilled loss controlprofessionals in the equation. Theunderwriter must partner with thoseloss control professionals to fullyunderstand the insured’s exposuresto loss and match those exposuresto the insurance coverages they areproviding. Underwriters whopartner with skilled loss controlprofessionals and fully utilize theinformation that the loss controlprofessionals can provide are muchmore likely to be successful thanthose who do not. Likewise, agents,brokers and risk managers whostipulate that their insurer providethem with this benefit are providingtheir clients with a better servicethan those that do not.

The loss control of yesterday

In the past, even the recent past,loss control services were verydifferent from what they are today.The insurer’s loss controlrepresentatives, once actuallycalled inspectors, were employeeswho had some training in the areasof fire protection and life safety, but they were not the skilled andtrained professionals of today. The inspectors of the past weremuch more akin to governmentinspectors, looking for violations of certain codes or the existence of hazardous conditions and usingthat information to report back tothe underwriter.

Underwriting intoday’s complexbusinessenvironment is increasinglychallenging for the insurer.

LOSS CONTROL TODAY: IT’S NOT JUST ABOUT INSPECTIONS AND RECOMMENDATIONS ANYMORE


1 ‘Poor underwriting can put insurers at risk: CEO’, Business Insurance, Vol. 37, No. 20 (May 19, 2003).

The loss control procedure of thepast was a much more autocraticprocess than it is today, with theinsurer performing an inspectionand making recommendationsregarding the safety violations itfound. The process of loss controlwas that the loss control inspectorwould visit the insured’s premiseslooking for various conditions andthen provide a report back to theunderwriter describing what wasfound. The report would generallynot make any reference to thecoverages being provided. Theinspector would be looking for andusually would see only the obvioussafety violations, e.g., inadequatefire protection systems, locked exitdoors, fire ignition points nearflammable material, etc.

In many cases, recommendationswere made, but therecommendations simply wereinstructions for the insured tocorrect the condition found so that the property would then meet some predetermined code.Using the traditional approach, the insurer would send therecommendations to the insuredwith little if any instruction or advice regarding tactics theinsured could use to improve thesituation. Additionally, the insurerwould expect the insured to comply with the statedrecommendations in someunilaterally determined timeframe. If the insured did notcomply with the insurer’srecommendations in that

particular time frame, the insurerwould cancel the insured’scontract for ‘failure to comply withloss control recommendations’.

The problem with this form of losscontrol is that it is used by theinsurer only to protect its owninterests. This entire approach wasnot designed to assist the insurerand insured in reaching theirmutual goal of improving theinsured’s business and thereforeimproving the insurer’s and itsinsured’s chances for profitability.

Another problem with thisapproach was that it lackedcreativity and failed to be a trueservice to the commercial insured.The insured was not reallybenefiting from this practice andsaw the entire process as more ofa nuisance than as a service thatcould help it improve its ownbottom line.

The changing environment for loss control

A transformation in the area ofloss control started taking shape alittle over 10 years ago. Beginningin the late 1980s and continuinginto the early to mid 1990s, therewas an emergence of captives andgrowing self-insured retentions.These captives and self-insurerswere born mostly as a result of theliability crisis of the mid to late1980s. This phenomenon createda need for loss control servicesthat were not of the traditionalnature. Captive insurers and self-insurers, in taking on more of theirown risk, discovered the need forobtaining loss control services ontheir own. Since they were nolonger a part of the traditionalinsurance market, the traditionalloss control services they once

received as part of the insurancepackage were no longer availableto them.

Improvement of services becauseof unbundling and competition

In response to this growingnumber of businesses that neededloss control service separate froma traditional insurance program,insurers began to sell unbundledloss control services and wereable to charge a fee for theservice. Once that happened,insurers needed to improve theservice they were offering.

At the same time, the typicalcommercial insured was becomingsignificantly savvier about theentire insurance-buying process.Insureds became much morelearned about how losses, insuredor not, affected the bottom line.Insureds became more demandingabout the products and servicesexpected from insurers. Thoseexpectations continued to risethroughout the decade andcontinue to do so today.

A growing number of loss controlconsulting firms began to emergeand insurers were in the positionof having to compete with theseindependents. Although the trendtoward insurers selling unbundledservices has subsided somewhat,the trend toward improving theloss control service most insurersprovide has continued.

The savvy property-casualtyinsured makes insurance buyingdecisions based on a number offactors, including loss controlservices; therefore, the loss controlservices provided by the insurerare increasing in importance eventoday. The insureds of today

LOSS CONTROL TODAY: IT’S NOT JUST ABOUT INSPECTIONS AND RECOMMENDATIONS ANYMORE continued


realize that professional losscontrol consultants are able tohelp them run their businessesmore efficiently and effectively by helping them reduce theirexposure to a variety of types oflosses. Additionally, since losscontrol consultants see many risks in the same industries, theyare able to learn and shareindustry best practices with theirinsurance clients.

To respond to the changinglandscape and to the increaseddemand, as well as to better andmore efficiently use their ownknowledge base, many insurersbegan using loss control in amuch more meaningful way. Theseinsurers began to place muchmore emphasis on increasing theskills, the capabilities, and theprofessionalism of their losscontrol staff. They did this throughadditional training of their existingstaff and through the hiring of professionals schooled inengineering and safety.

Development of specializedservices

Many of these insurers evenchanged the complexion of theposition through such things aschanging the title from loss controlrepresentative to loss controlconsultant to reflect the newconsultative nature of the servicethey were offering. At the sametime the insurers also began aprocess of specialization. Nolonger did an insurer employgeneric loss control representativesand consultants – they nowemployed property specialists,fleet specialists, and ergonomicspecialists. Some insurers evenbegan to develop specialized loss

control staff to deal with specificindustry segments. This resulted instaff designated as manufacturingspecialists, real estate specialistsand the like.

Today this specializationcontinues, and loss controlprofessionals, however they are titled, are an integral part of the product and services theinsurer has to offer. Loss controlprofessionals get involved in amyriad of cutting-edge industrytrends. In many areas, such asconstruction defect and workzone, claims are on the rise. Losscontrol professionals have the dataand can analyze these trends anddevelop educational programs forthe benefit of the insurer’s clientsand its underwriters.

Likewise, mold and terrorism are very important topics in theindustry today and the loss controlprofessionals are equipped toassess the level of these exposuresto help the underwriter adjust theinsurance program in accordancewith insurer guidelines.Underwriting actions range fromno action to price change, limitschange or coverage exclusion.

Federal law now mandates that all companies offer terrorismcoverage to an insured. In thisarea, the loss control professionalis able to analyze issues such as the maximum number ofemployees at an insured locationduring a shift, the height of abuilding, the security afforded, the existence of adjoiningstructures, the number andproximity of historical landmarksin the area, etc. This level ofdetailed information is invaluable

to the underwriter inunderstanding the terrorismexposures, which is a must inunderwriting both property andworkers’ compensation risks.

At the same time, the loss controlprofessional is able to pass alongindustry best practices to the clientto help address the exposures that do exist. Some companies use cutting-edge technology, from infrared thermographiccameras that identify substandardconditions in equipment, to powerful laptop computers –linked worldwide – that canprovide technical manuals,resources, reports andrecommendations at the touch of a button. The loss controldepartment of one company, for example, provides hydraulicanalyses of fire protection systems,reviews of products liabilityexposure, assessments ofenvironmental protectionprograms and fire life safety andsecurity reviews. These are alldesigned to help prevent insuredlosses by involving customers in asset management and lossprevention activities.2

Partnership of insurer, insured and loss control

The new and improved losscontrol consultant of today needsto partner not only with theunderwriter to allow thatunderwriter to make a moreinformed and calculated decisionabout offering terms, conditions,and pricing, but also with themore informed risk manager, who now recognizes the need for protecting assets in every waypossible. This puts tremendouspressure on the loss control

professionals who provide theservice and on the insurers whotrain them. The skills individualsneed to become successful losscontrol professionals today aredeep and broad. They need to be very highly trained in theirrespective areas and need tocontinuously update theirknowledge as the ever-changing,complex business world changes.Additionally, they need improvedpeople skills to be able tocommunicate with the underwritersand insureds they service.

What will loss control look likein 2010?

What is the future trend for losscontrol? This author believes thatthe current trend towardemploying only a truly skilled andspecialized professional as a losscontrol consultant will continue.Additionally, loss controlprofessionals will have to becomemore and more integrated into theunderwriting process so thatunderwriters can envision lossscenarios before they happen. An insurer that takes its losscontrol training seriously and trulyconcentrates on building the skilllevel and underwriting know-howof its loss control consultants willbe truly successful.

Staying on top of trends will be vital

Loss control consultants will haveto stay on top of not only safetyand technology trends butexposure trends as well. The losscontrol professional needs topartner with the underwriter toanticipate what will be the nextbig exposure (such as the asbestosclaims explosion) before it actuallybecomes a critical exposure.



2 www.chubb.com/businesses/tsd/losscontrol.html.

This will enable the underwritingand loss control team to recognizethe exposures and mitigate thechances of associated loss. The loss control consultant oftomorrow will have to understandthe ramifications of the exposurespresented by the insured not onlyas they stand today but also asthey will look tomorrow.

Globalization will requiremulticultural skills

Globalization is another area thatis changing the complexity ofclaims and increasingly puttingpressure on the loss controlprofessional of tomorrow. No longer can loss controlprofessionals expect to besuccessful unless they are at leastbilingual and understand a myriadof cultures. For example, if theinsured hires Hispanic workerswho speak little or no English, loss control professionals who can communicate with theworkers to help them learn to dotheir jobs competently and safelyare a necessity.

This was an anticipated problem‘that was confronting Dallas/FortWorth International Airport whenit embarked on a $2.6 billion,five-year capital improvementproject last year. Of the almost10,000 workers expected to beinvolved in the project throughoutits duration, approximately halfwill be Spanish-speaking.Although accident and injury ratesfor Hispanic workers historicallyare higher than those for English-speaking workers, the project’srate of recordable injuries issignificantly better than the

industry average. What’s more,workers compensation claims forthe period thus far are less than 25 percent of the amount insurershad estimated. What made thedifference was a safety-trainingprogram designed by BESTInstitute, a vocational trainingfacility based in the Dallas suburbof Garland, Texas.’3

This case is an example of thetype of services loss controlprofessionals may need to supplyto truly provide the insured clientsthe services they expect.

Loss control has changed forever

Loss control as it was yesterday isgone forever. Today’s loss controlprofessionals need to be moreeducated, better trained and needto possess a variety of skills thatyesterday’s inspectors did not.Commercial insureds’ expectationsof their insurers will continue torise and the successful insurerswill be the ones that are willing to invest in obtaining and traininghighly skilled and specializedindividuals in order to offercomprehensive services to theirclients. Loss control will continueto be an invaluable tool to thesuccessful underwriter, agent,broker, risk manager and insured.

Leslie J. Hawkes is a manager in theActuarial & Insurance ManagementSolutions (AIMS) practice ofPricewaterhouseCoopers LLP. She has over 23 years ofexperience in the property-casualty insurance industry. Her expertise is in the area ofunderwriting, policy coverage,underwriting operations, loss control and distributionstrategies. Prior to joiningPricewaterhouseCoopers, Hawkes spent over 20 years withtwo major property and casualtyinsurance companies. She hasover two years’ experience with a Big 5 consulting firm, providingconsulting services to theinsurance industry. In her mostrecent insurance companyposition, Leslie was the regionalunderwriting manager for anational insurer’s large regionalproperty-casualty underwritingprofit center. Prior to thisassignment, Hawkes spent 18 years with the United StatesFidelity and Guaranty Companies,now a division of St. PaulInsurance, holding managementpositions in underwriting,distribution initiatives, reinsuranceand operations. Hawkes has anextensive background in the majorproduct lines of insurance in bothcommercial and personal lines,including general liability,

property, marine, workers’compensation, commercialautomobile and homeowners.Additionally, she has extensiveexperience in the use of losssensitive programs, retrospectiverating and deductible billings.Hawkes holds the CPCU and AUdesignations, and she has an MBAin finance from VillanovaUniversity and a bachelor ofscience degree in mathematicsfrom Michigan State University.



AUTHOR

Leslie J. HawkesManager, Actuarial and Insurance Management SolutionsTel: 1 646 471 [email protected]

3 ‘The Language of Safety,’ Rough Notes (April 30, 2003).

The preceding article wasoriginally printed in ‘The JohnLiner Review’, Vol. 17, No. 2(Summer 2003) and is reprintedhere with permission from The Standard Publishing Corp.

ED5 – What does the InternationalAccounting Standards Board’s Phase IExposure Draft mean to US insurers?

AUTHORS: MARIE BRAVERMAN, SAM GUTTERMAN, DAVID SCHEINERMAN AND JIM BICHARD


For companies listed on the stock exchanges of the European Union, the requirement to adopt International Financial Reporting Standards (IFRS) by 2005 appears right around the corner. To most US insurers, however, the convergence of the IFRS and US GAAP feels far away. What willconclusions reached by the IASB standard setters mean to US insurers?What accounting issues should US insurance companies focus on now and in the near future?

Last October in a joint press release,the Financial Accounting StandardsBoard (FASB) and the InternationalAccounting Standards Board (IASB)issued ‘The Norwalk Agreement’, a memorandum of understandingthat emerged from their jointmeeting in September 2002,reaffirming their commitment todevelop a single set of high qualityaccounting standards.

At that meeting the two standardsetters agreed to place a high priorityand commit resources to threesteps toward achieving that goal:

• Reduce through a joint short-term project the differencesbetween US GAAP and IASBstandards in certain areas notalready being addressed bymajor projects;

• Remove other differencesthrough the coordination offuture work programs andcontinued progress on the jointprojects already underway; and

• Encourage further coordinationof the separate activities of theirtwo interpretive bodies.

One of the projects being led bythe IASB, and followed by theFASB, is the development of a newaccounting standard for insurancecontracts. The current IFRS do notcontain specific accountingguidance for insurance contracts.Current US GAAP standards,developed under the matchingprinciple which tends to be income

statement driven, are inconsistentin many areas with the IASB’saccounting framework which ismoving more to a balance sheetorientation.

Due to the complexity of the issues(principally, how and if ‘fair value’should be used to measureinsurance liabilities, and if so howto measure it) and the long timelineto develop this guidance, the projecthas been divided into two parts:

• Phase I to provide initialguidance and facilitateconsistent compliance with IFRS in 2005; and

• Phase II which will incorporatethe more difficult recognitionand measurement concepts by 2007.

The Phase I Exposure Draft – alsoreferred to as ED 5 InsuranceContracts or more often ED5, isintended to be a bridge to Phase IIthat will allow most companies tocontinue their current accountingfor insurance contracts until thedifficult issues involved are morefully addressed. However, ED5 willeliminate certain ‘low-hangingaccounting fruit’ that won’t requiresignificant resources to change,such as European stabilization andJapanese catastrophe reserves thatare inconsistent with the IASBFramework. ED5, issued in June2003, was out for comment untilOctober 31, 2003. The IASB iscurrently evaluating the feedback it has received from around the

world, for adoption of this initialinsurance standard in the firstquarter of 2004. It is, however,becoming questionable whether theBoard will come to resolution onthe important and controversialissues for Phase II in its announcedtimeframe, as they most likelywon’t start their discussions inearnest until at least March 2004(see Figure 1 overleaf).

Key points for US insurers to note

• Insurance contract focusThe IASB’s new standard willprimarily address accounting for insurance contracts, ratherthan for insurance companies.The IASB has attempted to levelthe playing field for similarproducts between insurancecompanies and other financialservices industries, such asbanks. Separate standards IAS 39 and IAS 32 provideguidance related to accountingfor financial instruments,including invested assets held by insurance companies.

• Insurance definitionThe Exposure Draft defines aninsurance contract as a ‘contractunder which one party (theinsurer) accepts significantinsurance risk from anotherparty (the policyholder) byagreeing to compensate thepolicyholder or other beneficiaryif a specified uncertain futureevent (the insured event)adversely affects the

What willconclusionsreached by theIASB standardsetters mean to US insurers?

ED5 – WHAT DOES THE INTERNATIONAL ACCOUNTING STANDARDS BOARD’S PHASE I EXPOSURE DRAFT MEAN TO US INSURERS?


policyholder or otherbeneficiary’. These contractswill be subject to thedeveloping standard, but untilPhase II is complete, theirliabilities will be determined by GAAP rules under whichthey currently report.

While this definition will most likely result in limitedcategorization differences from US GAAP for US products, someinsurance company contracts willcertainly not contain sufficiently‘significant insurance risk’ underthe above definition, and will be subject to the IASB financialinstrument/investment contractstandard, IAS 39. Under thatstandard, such a contract will be carried at its fair value or itsamortized cost, elected by theinsurer prior to issue. Like USGAAP, no formula will beprovided to measure ‘significant’,but doubtless some ad hocbenchmark(s) will be developed in practice (see Figure 2 overleaf).

• Fair value disclosureControversially, ED5 requiresthe disclosure in the footnotesto the financial statements of the fair value of insuranceliabilities no later thanDecember 31, 2006. Thiscontrasts with US GAAP’s FAS107 which exempts insurancecompanies from suchdisclosures. The IASB hasindicated that it is their hopethat this disclosure requirementwill provide incentive forinsurers to better prepare fortheir inclusion of fair valueliability reporting in theirprimary accounting basisshortly thereafter. In fact, manyin the industry are asking theIASB to settle for disclosure offair value, rather than requiringit as a primary basis for liabilitymeasurement. A prime reasonfor this concern is the beliefthat insufficient guidance willbe available to practicallycalculate these values in time,as it is proving challenging to

determine a practical approachto determining ‘what is the fairvalue of insurance liabilities?’

• What to do with insurancecontracts?As mentioned, if a contract isdetermined to be an insurancecontract, insurers will applytheir current accountingstandards to insurancecontracts until the results ofPhase II are issued. Some of thepractices specifically allowedin Phase I but expected to beeliminated in Phase II that arecurrently followed by USinsurers are:

– Measuring insuranceproperty/casualty loss reserveson an undiscounted basis.Instead, these liabilities will bediscounted, with an as yetundefined adjustment for risk(referred to as a ‘market valuemargin’, reflecting themarket’s appetite for risk).

– Reflecting future investmentsmargins in the measurementof insurance liabilities by i) using the estimatedreturn on assets expected tobe held as a discount rate orii) projecting the yield onthose assets at an assumedrate of return, discounting the projected returns at adifferent rate andincorporating the result in themeasurement of the liability.This primarily affects lifeinsurance contracts with asavings element. The inabilityto reflect such margins,without other offsettingapproaches, could lead insome cases to recognition of a loss at issue.

• Fair valueThe elimination of both ofthese practices is consistentwith the IASB’s currentproposals for Phase II, whichinclude the measurement ofinsurance liabilities using a ‘fair value’ approach. In fact,Tom Jones, vice-chairman of the IASB, indicated inSeptember that fair value wasnot a ‘fait accompli’, but thatthe Board would keep an open mind in its upcomingdiscussions regarding the bestapproach to take. To be sure,the determination of whatconstitutes ‘fair value’ is thesubject of heated debate anddiscussion within the insuranceindustry and with standardsetters – if it comes to pass, this could be viewed as one of the most revolutionarychanges resulting from theimplementation of IFRS,whether that is in theimmediate or more distant

ED5 – WHAT DOES THE INTERNATIONAL ACCOUNTING STANDARDS BOARD’S PHASE I EXPOSURE DRAFT MEAN TO US INSURERS? continued


2003 2004 2005 2006

31 July 2003 Publication of

ED5

Early 2006 Publication of

Phase I accounts for year-end 2005

Spring 2004 Finalized Phase I standard issued (expected end March 2004)

31 October 2003 Consultations and industry

response closes

Year-end 2006 Fair value

of insurance contracts

Phase II Exposure draft

expected

January 2004 Opening

balance sheet on IFRS basis*

* The SEC may require US registrants to have an opening balance sheet in January 2003

Key timings – Phase I

Source: PricewaterhouseCoopers 10th Insurance Briefing Paper on IFRS; Insurance Contracts Phase I: A bridge to an uncertain future, August 2003

FIGURE 1

future. This will be the topic ofconsiderable debate during thecourse of the next year asPhase II is being developed.

• Measurement inconsistencyAn anomaly will be created formany companies who applyED5 in 2005, as they continueto follow what can be viewedas an amortized cost approachto valuing their liabilities butwill use fair value for most oftheir assets in accordance withIAS 39. This mismatch inmeasurement approach (i.e.,sensitivity to changes in theinterest rate environment)currently occurs under USGAAP due to the prevalence

of the bond classification of‘available for sale’ (in order to avoid the strict tainting rulesassociated with classifyingthese assets as ‘held-to-maturity’), but the impact isreduced by the booking ofmarket value changes throughOther Comprehensive Income(OCI). IFRS does not providefor booking of market valuechanges through OCI.

This concern has arisen inresponse to the possibility of reporting artificial losses in an increasing interest rateenvironment, where the valueof liabilities remains stable butthat of assets declines. The

industry has brought forthseveral proposals, including thepossibility of i) relaxing thetainting rules in IAS 39 (whichare generally consistent withFAS 115) to allow for easierclassification of assets as ‘held-to-maturity’, ii) allowing for theunlocking of the discount rateused to present value insuranceliabilities, or iii) providing for some type of shadowaccounting. Although none ofthese has been endorsed by theIASB, they are currently understudy. The second approachwould constitute a significantdeviation from current USGAAP, which calls for thelocking-in of these assumptions

at issue for FAS 60 and 120contracts and use of accountbalances for FAS 97 universallife or investment type contracts.If any of these alternatives areaccepted in the final ED5, asignificant difference betweenUS GAAP accounting and IFRSwill emerge, until the fair valueconcepts of Phase II aredeveloped. It is not yet clearwhat approach, if any, will be used.

• Loss recognition testingLoss recognition testing (orpossibly more appropriatelyreferred to as testing theadequacy of liabilities) isrequired under ED5. Aminimum standard for suchtesting will be required.Currently it looks likely that US GAAP testing for DACrecoverability and premiumdeficiency will meet theserequirements.

• Embedded derivativesThe proposed accounting underED5 for embedded derivativeswithin insurance contracts is inmost cases identical to USGAAP. If the embedded optionor derivative is insurance thenit will be valued under currentaccounting standards (in mostcases US GAAP). However, animportant difference is that thedefinition of a derivative underIFRS does not require that thecontract be ‘net settled’,potentially broadening thepopulation of contracts thatmay contain embeddedderivatives under IFRS. Thus, Guaranteed MinimumIncome Benefits (GMIBs, e.g.,enhanced annuitizationbenefits) are likely to beaccounted for at fair value.



Does contract contain

significant insurance risk?

Insurance features present

Yes No

No

Yes Yes

No YesInsuranceComponent

InsuranceContract

InvestmentContract

InvestmentContract with discretionary participation

features

Deposit Component

Does the contract need to be unbundled?

Are any discretionary participation

features present?

Investment features

only present

Contract classification

Source: PricewaterhouseCoopers10th Insurance Briefing Paper on IFRS; Insurance Contracts Phase I: A bridge to an uncertain future, August 2003

FIGURE 2

• UnbundlingAn area of general agreementwith US GAAP is the ED5requirement for unbundling ofa deposit element. Unbundlingwill be required if ‘the cashflows from the insurancecomponent do not affect thecash flows from the depositcomponent’. This will apply if, for example, a dissimilarcontract is ‘stapled’ onto a basecontract, such as through theuse of a rider or anothermechanism in an attempt toreceive favorable revenuerecognition treatment.

• ReinsuranceIn general, reinsuranceaccounting under ED5 appliesthe US GAAP FAS 113concepts. One difference thatcould occur is the indicatedrequirement for loss recognitiontesting of ceded reinsuranceassets. If this proposal is appliedto P&C loss reserves, while thedirectly written liability wouldbe undiscounted, the cededasset credit might have to becalculated on a discounted basis

and at the same time reflect thecredit standing of the reinsurer.Industry opposition to thisproposal has been significant,causing the final result to beuncertain at this time.

Next steps

The finalization of ED5, as abridge to Phase II, will provideguidance to those insurers,particularly the US subsidiaries ofEuropean groups, faced with IFRScompliance. ED5 sets out whatthey will need to achieve in theshort period remaining before2005 and also is a precursor towhat will be required a couple of years later in IASB insurancePhase II. For insurers that do notneed to implement Phase I thegreater challenge now lies aheadwith the discussions of ‘fair value’or whatever will be required in a final IASB insurance standardprojected in 2007 or 2008.

For US insurers, watching thesedevelopments will be imperativeas the FASB and IASB continue to work together towards greaterconvergence in the years to come.

While the timeline forconvergence is unclear now, the emergence of a new standardfor insurance contracts appearscertain. For those who thoughtthat fair value or its closeequivalent would never berequired in their lifetime, attentionto the upcoming developmentswill be very important.



AUTHORS

Marie BravermanPartner, Audit Business and Advisory ServicesTel: 1 212 314 [email protected]

David ScheinermanPrincipal Consultant, Actuarial and InsuranceManagement SolutionsTel: 1 860 240 [email protected]

Sam GuttermanDirector, Actuarial and InsuranceManagement SolutionsTel: 1 312 298 [email protected]

Jim BichardManager, Audit Business and Advisory ServicesTel: 1 646 471 [email protected]

Transfer Pricing at the forefront of tax compliance and planning for the insurance industry

AUTHORS: BARRY L. DENNIS AND HSIN HUNG


Recent major developments, by both the OECD and the US IRS, haveincreased the importance and visibility of transfer pricing for multinationalcompanies, including insurance companies. Given this increasedimportance of transfer pricing, and the fact that major changes are likelyin the near future, it is important that insurance tax practitioners have anunderstanding of how transfer pricing rules apply to insurance companies.

Introduction

Several recent major developmentshave pushed transfer pricing to theforefront of tax compliance andplanning for the insurance industry.While the focus of this article is on the application of US transferpricing rules to insurancecompanies, other countries such as Canada, Mexico and Argentinahave similar rules.

In early 2003, the IRSCommissioner for Large and Mid-Sized Business (LMSB) sent amemorandum to LMSB executives,managers and agents emphasizingthe priority of the complianceinitiative regarding transfer pricing.The memorandum emphasized thattransfer pricing documentationshould be requested at thebeginning of each audit, and thattransfer pricing documentationmust be in place at the time of tax return filing, or else penaltyprotection should be denied.

The Organization for EconomicCooperation and Development(OECD) recently issued a series of discussion drafts relating to theattribution of profits to permanentestablishments. These guidelineswould result in dramatic changes in certain areas, especially in thetreatment of capital. The OECD is currently working on guidelinesspecifically for insurancecompanies, which will likely be released in early 2004.

The proposed regulations pertainingto intercompany services representthe first wholesale modification oftransfer pricing for services in over30 years. As the majority of transferpricing issues faced by theinsurance industry relate to theprovision of services, the proposedregulations should be closelyexamined to address the potentialimplications once the regulationsbecome effective as law. Majordeviations from existing regulationsinclude significant limitation ofexisting cost safe harbor rules andthe emphasis on the renderedservice’s contribution of value andthe application of the Profit SplitMethod (PSM).

US transfer pricing regulations

Internal Revenue Code (IRC)Section 482 and the regulationsthereunder require that relatedparties set transfer prices at ‘arm’slength.’ In the US, in addition toIRC Section 482, the IRS also hasthe power to make adjustments,under IRC Section 845(a), betweenrelated parties in reinsurancearrangements to properly reflect the income source and character. In addition to the arm’s lengthstandard, key concepts that guideintercompany pricing include thebest method rule, comparabilityand the arm’s length range.

Treasury Regulations (Treas. Reg.)Treas. Reg. §1.482-1(b)(1) statesthat ‘the standard to be applied in every case is that of a taxpayerdealing at arm’s length with an

uncontrolled taxpayer.’ In otherwords, a controlled transactionmeets the arm’s length standard if the results of that transaction are consistent with the results that would have been realized if uncontrolled taxpayers hadengaged in a comparabletransaction under comparablecircumstances.

There are many methods that can be used to establish thatintercompany prices are arm’slength. The regulations require that the ‘best method’ be used to determine the most reliablemeasure of an arm’s length result.

In general, two transactions do not need to be identical to becomparable. For cases with inexactcomparables, adjustments must bemade to account for differencesbetween the controlled anduncontrolled transaction. Severalfactors determine comparability,including functions, risks borne,contractual terms, economicconditions and similarity ofproperty or services.

The IRS will not make an incomeallocation if the taxpayer’s resultsfall within an ‘arm’s length range’derived from two or moreappropriate uncontrolledtransactions. Use of theinterquartile range, the 25th to the 75th percentile of results, is astatistical method (and the methodmost often used by the IRS) thatcan increase the reliability of thearm’s length range.

OECD is currentlyworking onguidelinesspecifically for insurancecompanies...

TRANSFER PRICING AT THE FOREFRONT OF TAX COMPLIANCE AND PLANNING FOR THE INSURANCE INDUSTRY


Transfer pricing methods

The arm’s length character of acontrolled transaction must bedetermined by applying one of themethods specified for controlledtransactions.1 Some of thesemethods, i.e. Resale Price andCost Plus methods, are seldomapplied in the context of aninsurance company.2 We describebelow other more commonlyapplied specified methods forinsurance/reinsurance transactions.

Under the ComparableUncontrolled Price (CUP) method, the arm’s length price for the transfer of tangible propertybetween related parties isdetermined by the price paid for the same or similar property in a transaction between unrelated parties.3

The Comparable Profits Method(CPM) evaluates the arm’s lengthcharacter of a controlledtransaction based upon objectivemeasures of profitability (known asprofit level indicators) derived fromuncontrolled taxpayers that engagein similar business activities undersimilar circumstances.

The PSM evaluates whether the allocation of the combinedoperating profit or loss attributableto a controlled transaction is arm’slength by reference to the relativevalue of each controlled participant’scontribution to that combinedoperating profit or loss, determinedby the functions performed, risksassumed and resources employedby each participant in the relevantbusiness activity.

Transfer pricing rules of special interest to insurance/reinsurance companies

Most intercompany transactions in the insurance industry deal with the transfer of services.Intercompany loans or advances,as well as transfers of intangibleproperty, are also commonlyobserved among multinationalinsurance companies.

The IRS issued proposedregulations pertaining tointercompany services andintangible property ownership inSeptember 2003. These proposedregulations would implementnumerous significant changes in the transfer pricing treatment of services. However, as theseproposed regulations are proposedand not final, the followingdiscussions are based on theexisting regulations.

Intercompany services

The regulations permit adjustments to transfer prices if an entity renders service for the benefit of, or on behalf of, a related entity for chargesdeemed not to be arm’s length. In general, the regulations providethat no allocation of costs isallowed if the service providedduplicates a service that therecipient performs for itself, or isof a type for which the recipientwould not be expected to paywhen dealing at arm’s length.

For beneficial services, distinctionis made between ‘integral’ and‘non-integral’ services. ‘Integral’

services are typically required tobe compensated at arm’s lengthmarket returns, rather than justcost reimbursements. ‘Non-integral’ services may be allocatedamong the service recipients atcost without any markup.

Intercompany loans

The regulations give the IRSauthority to make appropriateallocations to reflect arm’s lengthcharges for direct or indirectintercompany loans or advances.Treas. Reg. §1.482-2(a)(2)(i)defines an arm’s length interestrate as ‘a rate of interest whichwas charged, or would have been charged, at the time theindebtedness arose, inindependent transactions with or between unrelated partiesunder similar circumstances’.

Transfers and development of intangible property

Valuable intangible property isusually needed to successfullyconduct an insurance/reinsuranceoperation. The arm’s lengthstandard requires the beneficiaryof such intangible property becharged an arm’s length price,royalty or license fee, unless theaffected members engage in aqualified cost sharing arrangement(CSA) to jointly develop, andeffectively own, the intangibleproperty. A qualified CSA limitsthe IRS’s ability to reallocateincome; that is, only costs inrelation to the anticipated benefitscan be reallocated.

Important insurance/reinsurance intercompanytransactions

We summarize below someexamples of transactions typicallyencountered in multinationalinsurance and reinsuranceoperations that may have transferpricing implications.

Reinsurance

Member companies often write reinsurance contracts withother members of the insurancegroup. Such transactions aregenerally complex in nature, andpremiums paid for the controlledtransactions can be difficult tobenchmark as each insurance andreinsurance contract has specificrisk levels, actuarial assumptionsand coverage.

Brokerage/underwriting

Brokerage and underwritingservices are integral functions of the industry. There are manyproviders that specialize ininsurance underwriting andbrokerage services, and financialdata from published industryresources may be readily availableto test the intercompanytransactions. However, such datais often reported at such anaggregate level that comparabilitycannot be readily established.

Asset management

The return earned on investing thepremium collected contributes tothe ability of insurance companiesto meet their claim obligations.

TRANSFER PRICING AT THE FOREFRONT OF TAX COMPLIANCE AND PLANNING FOR THE INSURANCE INDUSTRY continued


1 A taxpayer may select a method that is not specified in the regulations, provided the taxpayer can demonstrate that the unspecified method provides the most reliable measure of an arm’s length result.2 The Resale Price method is generally applied in distributor relationships, while the Cost Plus method is generally applied in situations involving manufacturing.3 The CUP method is analogous to the comparable uncontrolled transaction (CUT) method, which pertains to the transfers of intangible properties and is prescribed under Treas. Reg. §1.482-4(b).

To the extent that such investmentand asset management capabilitiesare concentrated in certain parts of the overall group, an arm’slength charge must be made forthe services provided to othermembers of the group. Specificfactors that may influence thepricing of such services includethe type of assets managed, levelof activities carried out, riskinvolved, volume of transactions,expected returns, and expenses of providing such services, etc.

Provision of financial guaranteesand services

The provision of financialguarantees is an important aspectof insurance transfer pricing. Such guarantees can includeclaims guarantees, loanguarantees, net worth maintenanceagreements, etc. Pertinent factorsthat need to be considered includethe type of security or collateralinvolved, the credit ratings ofguaranty providers and recipients,market conditions, and type andtiming of the guaranty.

The nature of the industry mayrequire a large volume ofintercompany lending andadvances. Careful analysis shouldalso be performed to ensure thatthe interest or fees charged arearm’s length. Factors to considerinclude the amount of the loan,duration of the contract,

underlying currency, the applicablemarket interest rates andborrower’s credit standing, etc.

Administrative support

Administrative services typicallyfall under the category of ‘non-integral’ services, often chargedout at cost. The major challenge isallocating the direct and indirectcosts associated with thoseservices that benefit more thanone specific affiliate. Generally,the IRS will respect the allocationfactors if they are reasonable,follow sound accounting practiceand are consistently applied.

Provision of intangible property

Insurance companies use valuableintangible assets such asproprietary pricing and riskanalysis/management programs,internally developed claimstracking systems and othercompany-specific industry know-how. Marketing intangibles,such as trademarks and brandnames, are also becomingincreasingly important forinsurance companies.

The very nature of intangibles –the uncertainties involved indevelopment and the lack of exact comparables – makes theirvaluation and the determination of associated arm’s length charge difficult.

Penalty provision andcontemporaneousdocumentation requirement

To the extent that additionalincome results from IRS transferpricing adjustments, the IRS mayimpose two different penalties on these amounts:

• Net adjustment penalty – if total overall IRC Section 482 adjustments exceed the

– lesser of $5 million or 10% of gross receipts – 20% ofunderpayment of tax

– lesser of $20 million or 20%of gross receipts – 40% ofunderpayment of tax; and

• Transactional penalty – if thevalue claimed on the return for a specific transaction was

– 200% or more (50% or less)than ‘correct price’ – 20% ofunderpayment of tax

– 400% or more (25% or less)than ‘correct price’ – 40% ofunderpayment of tax.

The penalties can be avoided if ataxpayer (i) reasonably applied aspecified or an unspecified transferpricing method (i.e., CUP method,CPM and PSM, etc.) and (ii) musthave contemporaneousdocumentation supporting thetransfer pricing methodology and

provide such to the IRS within 30 days of request.

Other Country Rules

Although this article addressesintercompany pricing mainly from a US perspective, othernations in the Americas havesimilar rules and regulations,following the general principles of the Organization for EconomicCooperation and DevelopmentTransfer Pricing Guidelines forMultinationals and TaxAdministrations. In someinstances, the requirements aremore stringent than prescribed. For example, the Canada Customsand Revenue Agency obligateseach taxpayer to annuallycomplete the Information Returnof Non-Arm’s Length Transactionswith Non-Residents (Form T106)and indicate on it whethercontemporaneous documentationhas been completed and thetransfer pricing methodologyapplied. In Latin America, Mexicorequires filing Information Returnfor Transactions with RelatedParties Abroad (Form 55), andArgentina requires two informationreturns (Forms 742 and 743) befiled each year, submitted to thetax authority along with thegeneral income tax return, copy of financial statements andcontemporaneous transfer pricingdocumentation – each page signedby an independent publicaccountant.


TRANSFER PRICING AT THE FOREFRONT OF TAX COMPLIANCE AND PLANNING FOR THE INSURANCE INDUSTRY continued

AUTHORS

Barry L. DennisPartner, Tax ServicesTel: 1 646 394 [email protected]

Hsin HungManager, Tax ServicesTel: 1 646 394 [email protected]

More effective reporting for insurancecompanies and their stakeholders

AUTHORS: PAUL L. HORGAN, ROBERT LEMBACH AND MIKE WILLIS


To achieve the critical goal of satisfying growing demands for more data in less time, the insurance industry is taking definitive steps to enable deploymentof Extensible Markup Languages (XML) including the eXtensible BusinessReporting Language (XBRL) across the insurance value chain. Collaborativeefforts that include major organizations within and between the insurancevalue chain and other sectors are the driving force behind the realization of enhanced reporting capabilities.

In today’s environment, in whichmanagers are under pressure toanalyze and communicate moreinformation in less time, leveragingtechnology has become a businessnecessity. Today, it is an exceptionfor a company not to post itsinformation on the corporate website as doing so saves costs andincreases distribution reach.Looking ahead, companies willlikely continue expanding their use of the Internet for corporatereporting: Extensible MarkupLanguage (XML) and its standardfor the corporate reporting supplychain, eXtensible BusinessReporting Language (XBRL), enable insurance companies toutilize Internet standards forstreamlining information collectionand dissemination, lowering costsand increasing the speed andaccuracy of information exchangeand aggregation for internal andexternal reporting.

The insurance industry is takingdefinitive steps to enabledeployment of XML and XBRLstandards across the insurance valuechain to achieve the critical goal of satisfying growing demands formore data in less time, whetherthose demands come from companymanagement itself, or fromstakeholders. Collaborative effortsthat include major organizationswithin the insurance value chainand between the insurance valuechain and other sectors are thedriving force behind the realizationof enhanced commerce andreporting capabilities.

Insurance industry chargingahead into the informationrevolution

The insurance industry has longrecognized the importance ofdocument standardization.However, until XML, no tool hasbeen useful for the exchange ofinformation within documents. This has become critical in light ofdramatic changes in the Internetenvironment. You may have heardthe term ‘Web Services’ but even ifyou haven’t, the important point isthat information exchange will nolonger be focused at the documentlevel, but rather, at the data level.Even if information appears in afamiliar document presentation, the critical difference is that it isnot locked into the document. Any information can be instantlyextracted and re-used in analyticalor reporting software without the need for manual searching,‘cutting and pasting’ or re-keying.

The reason information can movefrom file to file instead of from fileto hands to file is the Web Servicesuniversal language, XML. XML uses‘tags’ to describe and provide acontext for each piece of data andtext so that it can be shared andprocessed by disparate types andbrands of software, regardless ofwhich software sends or receivesthe information. These tags aregenerally grouped into one of agrowing number of taxonomies,which are basically ‘dictionaries’ ofterms that have universally agreeddefinitions. Applying XML tags to

data enables direct communicationbetween all software, promotinginstant information accessibilityand usability, regardless of whetherinformation is stored in a documentor in an application.

XML is an open standard thatanyone can use, which has apotential downside: the entirepurpose of facilitating direct dataexchange will be lost unless thereis agreement on common datadefinitions. A proliferation ofproprietary XML definitions willmake it difficult to share data. Inother words, the XML informationformat standard needs informationaldefinitional standards to promoteinformation exchange acrossindustries, nations and territories.

There are many organizationsworking on XML standards that will support transaction-levelinformation exchange within awide variety of supply chains. The insurance industry is ahead of many other business sectors in embracing the new Web Services capabilities. ACORD(http://www.acord.org) is a leaderin driving XML standards for theinsurance transaction layer. TheseXML standards will enable theexisting supply chain transactionmodel to function exponentiallymore efficiently in the WebServices Internet environment. This will increase the efficiency and effectiveness of informationexchange among all insurancevalue chain participants byproviding greater, cheaper and

The insuranceindustry has long recognized the importance of documentstandardization...

MORE EFFECTIVE REPORTING FOR INSURANCE COMPANIES AND THEIR STAKEHOLDERS


faster access to businesstransaction data.

For business reporting, there arecross-industry efforts focused on facilitating reporting ofcompany data using XBRL(http://www.xbrl.org), which isXML for the corporate reportingsupply chain. The corporatereporting supply chain involvescompanies in all industries, as well as regulators, investors,creditors, industry organizationsand all other capital marketstakeholders. The insurance sector is well represented in thecollaborative efforts of XBRLInternational, the consortiumdevoted to developing andpromoting XBRL’s global financial

reporting standards. An XBRLInternational working group, IGIS (Insurance GAAP InsuranceStatutory) is developing insuranceGAAP taxonomies, with the USGAAP taxonomy set for publiccomment by the end of 2003. It isexpected that XBRL Internationalworking groups will use the US taxonomies to developInternational Financial ReportingStandards (IFRS) taxonomies.

Insurance industry GAAP andStatutory financial reportingtaxonomies will enable insurancecompanies to provide capitalmarket stakeholders withinformation in a format thatfacilitates re-use for criticalpurposes, such as analysis for

investment decisions, creditdeterminations, regulatoryoversight and tighter integration of activities between insurancecompanies and their businesspartners. These taxonomies arealso expected to facilitate greaterefficiencies in insurance companyfinancial information productionand distribution.

Leading organizations from acrossthe insurance value chain are IGISparticipants. IGIS membershipreflects the insurance industry’srecognition of how critical XBRL is to the future conduct ofbusiness. The IGIS working grouphas reached out to the sector andis collaborating with several globalinsurance companies on taxonomy

development and other workinggroup activities. Organizationsinvolved in this effort include:ACORD, the US NationalAssociation of InsuranceCommissioners (NAIC), MetLife,Merrill Lynch, Eagle Technologyand other technology vendors andPricewaterhouseCoopers and otherinternational accounting firms.PwC partner Paul L. Horgan is co-chairman of IGIS and can becontacted by those interested injoining this effort.

As with other regulators aroundthe world, insurance sectorregulators are also evaluating the benefits of leveraging XML,particularly XBRL, for streamliningtheir processes. Currently, several

MORE EFFECTIVE REPORTING FOR INSURANCE COMPANIES AND THEIR STAKEHOLDERS continued


US state insurance commissionersand the NAIC are evaluating XBRL use within their filing andrelated regulatory processes. These regulators join a growing list of organizations turning to thenew Internet standards.

In this article, we will focus on thebenefits that XML and XBRL offerto insurance companies in termsof both information productionand consumption.

Benefits to insurance company informationproduction and consumption

By deploying XML standards,including XBRL, over existinginternal systems, insurancecompanies can migrate moreinformation production andconsumption to the Internet,eliminating manual processingand its costs. Current systems andsoftware can understand andprocess XML enabled information;therefore, deploying XMLstandards for financial reportingcould facilitate the followingefficiencies in the financialreporting process in a relativelyshort time:

• Re-deploying resources fromlow-value ‘data shoveling’ tasksto those more meaningful tothe business;

• Increasing data accuracy byminimizing the risk of manualtranscription errors;

• Preserving data integritythrough a ‘hands off’information environment andability to more easily traceinformation directly to itsoriginating source;

• Promoting instant internal and external report creation at any time;

• Facilitating management accessto more of the informationresident in company systemsdirectly through analytical tools for better, more informeddecisions;

• Strengthening managementcontrols by establishing directinformation feeds fromenterprise systems tomonitoring tools; and

• Facilitating the audit functionby providing a better audit trailof the flow of information.

XML and XBRL standards help totransform an insurance company’sinternal information environmentfrom a series of disparate systemsand sub-systems into a moreseamless network; information‘silos’ no longer exist. Data entersthe system ‘ready to re-use’ andmoves more accurately andreliably between operational areasand from transaction systems intoreporting systems via the Internet.

Re-engineering reportingprocesses

Within companies and betweencompanies and stakeholders, XMLand XBRL improve the timeliness,accessibility and, therefore, therelevance of company informationby making preparation andanalysis faster, easier, moreaccurate, more comprehensiveand cheaper. XBRL deploymentover existing reporting systemsprovides the framework forstreamlining reporting processesand makes information in

company reports more accessibleto stakeholders, who can instantlyextract precise data needed fortheir own analytical purposes.

To see what XBRL-enabledreporting looks like, access apublicly available demonstrationcreated by Microsoft,PricewaterhouseCoopers andNASDAQ at www.nasdaq.org/xbrl.This pilot contains XBRL-enabledfinancial statements from 21 companies for the last fiveyears. It enables you to extractspecific information for anyperiod, literally in seconds, rightinto an XBRL-enabled Excelanalytical spreadsheet. With theOctober 21st release of MicrosoftOffice 2003 and the scheduledrelease of the Microsoft XBRLAccelerator, XBRL capabilities forboth information production andconsumption will soon beavailable in your desktop suite. A recent survey of accountingsoftware vendors shows that two-thirds will XBRL-enable theiraccounting software solutions byyear-end 2004.1

While financial marketstakeholders do not yet expectXBRL-enabled reporting, insurancecompanies have good reason to consider planning XBRLdeployment: regulatory XBRLadoption. Many high-profileregulators around the world have already begun requiringcompanies to submit filingsutilizing XBRL and more will doso in the near future. US insuranceregulators, including the NAIC and several state insurancecommissioners, are also evaluatingXBRL use to enhance their currentprocesses. A sampling of global

regulators adopting XBRL includesthe US Federal FinancialInstitutions Examination Council(FDIC and Federal Reserve Board),the UK Inland Revenue, theDeutsche Bundesbank, Banco deEspana, the Tokyo Stock Exchangeand the Australian Tax Office.

The XBRL open standard helpsregulators achieve ‘e-government’goals and promote bettercommunication in industryreporting supply chains. For thesame reasons regulators areleveraging XBRL, companies canuse XBRL help to mechanize theirinternal reporting environments in the near term, without relianceon wholesale systems changes.While the regulatory push may be stronger for other industries, the insurance value chain hasanticipated the informationstandardization movement inwhich reporting supply chains are moving, as evidenced by theACORD and IGIS collaborations.

Empowering insurancecompany decision makers

By giving managers instant accessto more of the information incompany systems, XML and XBRLpromote faster turnaroundbetween events and decisions andenable managers to expand thescope of their analyses toincorporate data related to keyperformance indicators that weredifficult or impossible to trackbefore. These include customerpenetration, claims ratio, productinnovation and asset quality.

To illustrate how XML capabilitiescan be critical to managementdecision-making, we’ll use an



1 ‘XBRL-Enabled Accounting Software Solutions: A Study of Leading Vendors,’ August 2003: http://www.xbrl.org/resourcecenter/downloadwpapers.asp?rid=1&demos=XBRLSoftwareSurvey499.pdf

example that speaks directly tobottom-line performance. Of allthe decisions insurance companiesface, risk evaluation is perhaps the most fundamental. Yet, severalyears into the 21st Centuryinformation revolution, mostinsurance companies still use the manual, data-restricted, paper-based analytical processesin place for the past quartercentury. The upshot? The vitallyimportant task of risk evaluationitself is quite risky.

An XML environment candramatically reduce these risks by providing a moretransparent data platform thatfacilitates more timely, consistentand comprehensive analysis. Risk managers can immediatelyrecognize, manipulate and formatinformation directly from internalsources and customer-sourced files,such as application data and riskevaluations and periodic businessand financial reports. Exponentiallymore information can beincorporated into risk analysis

than was practical or possible withmanual information preparation.

For example, if a risk evaluationuses 70 data elements becausethat is all the informationattainable cost-effectively, then by expanding the scope and depthof available information at noincremental cost, XML and XBRLenable insurance risk managers toconsume, say, 1,000 data elementsmore easily, more quickly and atless cost.

Advanced risk assessment is alsoplaying out in the banking sector’scredit-management processes.Several banks have conductedpilot evaluations on the use ofXBRL-formatted financialstatements as an expandedplatform for risk analysis. Data re-usability within the XBRLdocuments enhances the breadthof data available for risk analysisand reduces the costs and timeassociated with credit decisions.Similarly, the insurance industrycould reap benefits by analyzing

XBRL-enabled financial statementsas part of its investing, credit-granting and underwritingfunctions. The quality of decisionsimproves and, consequently, risk can be substantially reduced,to the ultimate benefit ofstockholders, customers andmanagers themselves.

Moving up the insurance value chain

With Web Services capabilitiesalready incorporated into the most recent versions of businesssoftware insurance companies use, achieving faster access tomore information will soon beembedded in most insurancecompany informationenvironments. This more flexiblereporting and transparentinformation environment providesmanagement with advanced toolsto exponentially enhance dataaccess included in riskmanagement processes andincrease data flow formanagement reporting at

accelerating frequencies.Automating report production also eases the burden of externalreporting, through faster, moreconsistent reporting across thecompany at less cost. Insurancecompanies win at both ends of the supply chain, in consumingthe information for risk analysisand in producing the reports formanagement and stakeholders.

Paul L. Horgan is a partner atPricewaterhouseCoopers and amember of the Firm’s GlobalInsurance Leadership team. RobertLembach is a senior manager atPricewaterhouseCoopers and amember of the Insurance GAAPInsurance Statutory working groupof XBRL. Mike Willis is a partnerat PricewaterhouseCoopers andFounding Chairman of XBRLInternational.

If you are interested in learningmore about this topic, pleasecontact Paul L. Horgan [email protected]



AUTHORS

Paul L. HorganPartner, Audit Business and Advisory ServicesTel: 1 646 471 [email protected]

Mike WillisPartner, Audit Business and Advisory ServicesTel: 1 813 351 [email protected]

Robert LembachSenior Manager, Audit Business and Advisory ServicesTel: 1 312 298 [email protected]

Developing effectiveenterprise-wide risk management

AUTHORS: PAUL L HORGAN, SHYAM VENKAT AND ERIC GRONNINGSATER


Most insurers now recognize the value of enterprise-wide risk management(ERM) in safeguarding their businesses. The real question going forward is how to customize an ERM program to foster growth and optimize returnon capital. Paul L. Horgan, Shyam Venkat and Eric Gronningsater look athow companies are facing up to the challenge.

The events of 9/11 have proved to be a wake-up call for riskmanagement within the USinsurance industry, not only alertingcompanies to the scale of theirpotential losses in an increasinglyuncertain world, but also to thecorrelation of the multiple risksthey face. Financial marketvolatility, corporate governancescandals and, not least, relatedpressure from regulators and ratingagencies, ranging from theSarbanes-Oxley Act to widespreadcredit downgrades, are increasingthe pressure to improvegovernance, compliance and riskmanagement.

While the immediate response hasconcentrated on increasing productpricing and paying more attentionto risk aggregation within productlines, many insurers are nowlooking to develop a more holistic,firm-wide approach to riskmanagement. This includesstrengthening the focus on asset-liability management, credit andunderwriting risks, along withassessing less quantifiable, thoughequally hazardous non-financialrisks such as systems failure,reputational damage and breachesin compliance with regulatory andcorporate guidelines.

Insurers that have led the way inERM are already beginning to reapthe benefits. These benefits not onlyinclude helping to protect theirbusinesses from losses, earningssurprises and reputational damage,

but also providing a betterunderstanding of the trade-offsinherent in various risk and rewardalternatives, leading to smartercapital allocation and moresustainable shareholder valuecreation. However, most companiesare still very much at the designand building stage of ERM, as theygrapple with infrastructure issuesrelating to people, tools andtechnology (see Figure 1).

Guiding principles

A series of guiding principles is beginning to emerge. Our interaction with insurers acrossthe industry reveals a high degreeof consensus about the aims,implementation principles anddifferent functional roles in achievingthem. Within this framework,primary responsibility for riskmanagement rests squarely with

individual business units, whichshould be equipped with thenecessary tools and information to improve their ability to identify,quantify and control all forms of risk.

Compliance is no longer simplyabout conforming narrowly tospecific regulatory rules, but about how to work within agreedcorporate guidelines in areasranging from policy andgovernance to sales practices andauthority limits, and ultimately howto safeguard the franchise andcredibility of the company. Thisrequires insurers to move beyond anotion of compliance as a periodic‘check-the-box’ exercise and bringit into the heart of the business.

The ultimate goals of ERM are toestablish corporate-wide standardsfor managing risk within the

...most companiesare still very muchat the design andbuilding stage ofERM...

DEVELOPING EFFECTIVE ENTERPRISE-WIDE RISK MANAGEMENT


Infrastructure

• Tools• Systems• Management information• Limit structure

Strategy

• Direction• Objectives• Culture• Language

Processes

• Risk identification• Risk assessment• Risk measurement• Limit setting• Risk monitoring• Issue escalation

Organisation structure

• Department/committees• Reporting lines• Roles/responsibilities• Skills/resources

The way forward (Risk management framework)

Source: PricewaterhouseCoopers

FIGURE 1

business units and to instill anawareness of risk into day-to-daydecision-making and operations(see Figure 2). Ideally, these goalsshould be attainable by improvingthe linkage between andcoordination of existing processes,rather than by creating anadditional and potentiallyredundant tier of riskmanagement. This will require

breaking down the ‘silos’ formanaging risk through commongoals and greater coordinationacross different business units and risk-related functions such as audit, finance, underwriting,claims, compliance and riskmanagement. Above all, thedevelopment of a viable ERMprogram requires active executiveand business unit input and

support, especially in ensuring that ERM is embedded into andremains relevant to the overallstrategy and operations of theenterprise (see Figure 3).

Risk aggregation

Another frequent topic inbrainstorming sessions withindustry representatives has beenrisk aggregation, one of the keybuilding blocks of ERM. Duringthe 1990s, many firms hadfocused on developingsophisticated risk aggregation tools for their property classes of underwriting risks. In the wakeof 9/11, and the corporategovernance scandals and theircollective impact on financialmarkets, insurers have increasedtheir focus on developing similarmodels and approaches to assessand mitigate aggregation risks in their investment portfolios and with respect to liabilityunderwriting risks, such asdirectors and officers and medicaland professional liability coverage.

There have also been increasedefforts to correlate the risks acrossrisk categories, includinginvestment, underwriting andstructured products. Part of theimpetus has come from 9/11,which highlighted the need formore balanced probabilisticmeasures and realistic scenarioanalysis to augment currentdeterministic evaluations.However, achieving a genuinecompany-wide, cross-segmentaggregation capability is clearly a difficult challenge, especiallywhen seeking to incorporateoperational and other less-quantifiable risks. Leaders in thefield are constantly extending,refining and calibrating theiroperational risk monitoring andsetting up triggers to alertmanagement to potential errors.

The ability to measure sensitivityof earnings to changes in keyfinancial, actuarial or operationalassumptions is now a priority formany insurance companies. To theextent that a set of volatilities andcorrelations can be applied to thedifferent drivers of value and riskat different levels of the enterprise,a credible measure of ‘economic’(i.e. risk-based) capital can bedeveloped and applied to reflect its usage across differentbusinesses. While not everyonebelieves that a true company-wideeconomic capital model is entirelyfeasible, all agree that analysis ofaggregated risks could and shouldbe more timely, accurate andcomprehensive. There is also aconsensus that once ERMprograms mature, we are likely to see convergence in risk/capitalmeasures across the industry,though this is a long way off.

DEVELOPING EFFECTIVE ENTERPRISE-WIDE RISK MANAGEMENT continued


FSA’sregulatoryapproach

Statutoryobjectives

andprinciples

Dealing with scopechanges and major

new product developments

Decision onregulatory response

Allocatingresources

Using regulatorytools

Performanceevaluation

Riskidentification

Risk assessmentand prioritization

Risk, reward and creating value

Source: Financial Services Authority

FIGURE 2

Risk management must be integrated with strategic decisions.

Common objectives for management of risk must be articulated on a firm-wide basis.

Risk management must be a Board/CEO priority.

Risk management organization must have power, visibility and clear escalation lines to senior management.

Common approaches to measurement must be adopted to enable comparison and aggregation.

Policies and methodologies for controlling and managing risk must be re-engineered in line with firm-wide objectives.

Firm-wide risk management systems must be implemented to provide management information to support risk management objectives.

Strategy OrganizationStructure Processes Infrastructure

Senior management as the driver for ERMFIGURE 3

Source: PricewaterhouseCoopers

Rating approval

Our discussions withrepresentatives from leading rating agencies confirm theirendorsement of more robust andcomprehensive risk managementcapabilities, especially in helpingcompanies to deliver more stablefinancial returns. However, theagencies have a number ofresidual reservations about thereliability and consistency of some aspects of current riskmeasurement, especially inrelation to operational risk and complex product areas.Accordingly, the rating processwould continue to be based onfinancial performance and balancesheet strength – consistentearnings are delivered by skilledexecution of the business plan, of which the ERM program is anintegral part.

Global study

Many of these issues are beingexamined in more detail in a far-reaching global study currently being completed byPricewaterhouseCoopers into thestate of ERM among insurancecompanies. The latest researchaims to dig down below high-levelobjectives and find out about the components of actualimplementation programs,descriptions of the mostformidable obstacles and the

resources required to establish and maintain progress.

While the survey findingsexamined so far do not point to a single best approach to ERMimplementation, the initialanalysis does suggest that manyinsurers are accelerating thedevelopment of their ERMprograms. The study, which is duefor publication later this year, willalso include a consensus profile of the key enablers – people, toolsand technology – and how toweave them together into a viableERM framework.

Leading the way

Changes in the businessenvironment have promptedcompanies to allocate incrementalresources to improvingmeasurement of compliance andoperational risks while continuingto enhance models of risk-adjustedcapital usage. ERM provides thevehicle that combines thesedifferent initiatives in a singleprogram dedicated to optimizingfinancial performance andsafeguarding the franchise’sreputation. The development of effective ERM is always a

painstaking task that is seldomcompleted without a clearmandate from the board ofdirectors. We are seeing increasinginterest at the board level withininsurance companies in learningmore about the benefits of ERM.We will continue to share ourthoughts and insights on thisimportant topic in forums such as our surveys and discussionswith industry representatives.


DEVELOPING EFFECTIVE ENTERPRISE-WIDE RISK MANAGEMENT continued

AUTHORS

Paul L. HorganPartner, Audit Business andAdvisory ServicesTel: 1 646 471 [email protected]

Shyam VenkatPartner, Advisory ServicesTel: 1 646 471 [email protected]

Eric GronningsaterSenior Manager, Advisory ServicesTel: 1 646 471 [email protected]

The insurance market in Ireland

AUTHORS: CHAND KOHLI AND GARVAN O’NEILL


Ireland has a well-developed domestic insurance market. Perhaps moresignificantly, Ireland is now also a leading center for cross-border insurance.This article examines the prospects for both the domestic and cross-borderinsurance sectors and provides an overview of the factors that have contributedto Ireland’s emergence as a leading cross-border insurance center.

Overview

Ireland, with a population of 3.9 million, is one of the smallestcountries in the European Union.Nonetheless, the significance of the domestic Irish insurancemarket, both non-life and life, is much greater than one mightexpect. Based on 2001 statisticsfrom Swiss Re, this well-developed,relatively mature market was ranked:

• 18th globally in terms of totalinsurance premiums written;

• 5th globally in terms ofinsurance density (premiums per capita); and

• 9th globally in terms ofinsurance penetration (premiumsas a percentage of GDP).

Premiums written in the domesticmarket are split roughly 2:1 in favor of life assurance – total lifeand non-life premiums written in2001 amounted to €7.2 billion and€3.2 billion respectively (in respectof Irish-based risks only).

Perhaps more significantly, Ireland,in recent years, has become aleading European center for thetransaction of cross-borderinsurance. Overall, there are over330 insurance operations with theirhead office in Ireland. Of these,approximately 280 (200 of whichare captives) solely underwrite non-Irish based life and non-liferisks, evidencing how, in less than10 years, the Irish insurance market

has become a predominantly cross-border market.

The domestic non-life sector

The domestic non-life market isdominated by foreign groups and is highly consolidated – the Top 5players (Aviva, AXA, Allianz, Royal& SunAlliance and Eagle Star)control 73% of the market. There is a heavy focus on private motor andhousehold business, whichcomprises approximately 50% ofthe total market of €3.2 billion, as illustrated in Figure 1.

2001 saw strong growth (totalpremiums written increased by20%) in the non-life market.Significant rating increases wereintroduced in an attempt to stemthe heavy losses experienced in

prior years (the operating ratio forthe non-life market improved from118% in 2000 to 112% in 2001.The operating ratio combines theclaims, commission and expenseratios. The operating ratios formotor and liability were 110.5%and 139% respectively in 2001).These losses, primarily driven bycontinuing claims inflation inliability and personal injurymarkets, and exacerbated by fallinginvestment returns, saw a numberof insurers withdraw from thecommercial and liability marketsduring 2001.

Recently, a number of initiatives,including road safety awarenesscampaigns and the introduction of ‘penalty points’ for motoringoffences, have been introduced

Ireland, in recentyears, has becomea leading Europeancentre for thetransaction ofcross-borderinsurance.

THE INSURANCE MARKET IN IRELAND


Other 7%

Private motor 35%

Commercial motor 16%Household 13%

Commercial property 13%

Employers’ and public liability 16%

Non-life premium income – 2001FIGURE 1

Source: Irish Insurance Federation Factfile (2001)

in an attempt to reduce thenumber of motor accidentsoccurring. If successful, theseinitiatives should serve to decreasethe frequency, and therefore theoverall cost, of personal injuryclaims. Other initiatives includethe proposed establishment of aPersonal Injuries Assessment Board(PIAB), with the aim of reducingthe total cost of injury claims byincreasing the number of claimssettled outside the legal system –legal costs currently representapproximately 40% of the total(compensation) cost of injuryclaims. Views are mixed as towhether this will be achievable, or whether the introduction of anew body will simply add a newlayer to the system.

Nonetheless, the rating increasesin 2000 and 2001 appear to havehad the desired effect of reducingthe level of underwriting losses on motor insurance. The motorinsurance sector recorded netoperating profits (includinginvestment returns) of €183million – approximately 10% ofpremiums written – during 2002.This result is a significantturnaround for a sector that hasexperienced cumulative operatinglosses of nearly €200m in thepreceding three years. It isanticipated that these resultsshould lead to a period ofpremium stability for motorists.

The domestic life sector

Life assurance penetration inIreland is high. In 2001, based on Swiss Re/Sigma statistics,Ireland ranked:

• 7th globally in terms of lifepremium expenditure as a % of GDP (life assurance

premiums accounted for 6.3%of gross domestic product); and

• 4th globally based on lifepremium expenditure percapita (life assurance premiumper capita amounted to USD 1,700).

The life sector experienced hugegrowth in the late 1990s, drivenprimarily by Ireland’s economicprosperity during this period – real GDP growth averaged 9.2%per annum during the 5 years from 1997 to 2001. The strongeconomic performancecontributed to average premiumgrowth of 22% per annum in thelife sector over the correspondingperiod, even after taking a fall inlife premium income of 6% in2001 into account.

Four companies (Irish Life &Permanent, Bank of Ireland Life,Aviva and Ark Life) have anindividual market share in excessof 10% – the bancassurancemodel has proved to be verysuccessful in Ireland, with three of these four largest companiesutilising that particular model. In total, the largest four companiescontrol 63% of the market.However, the potential for furtherconsolidation of the market stillexists, as the remaining 37% is controlled by a further fourteencompanies (four of which have an individual market share inexcess of 5%). The main productsoffered by Irish life companies (as a percentage of gross premiumincome of €7.2 billion) areillustrated in Figure 2.

The Irish domestic life assurancemarket may be sub-divided intothree categories: traditional life,

savings/investments and pensions.Life companies are experiencingfalling margins in each of thesecategories which, combined withpressure on sales volumes,particularly in the savings andinvestment sector, is forcing themto examine ways of reducing theiroperating, in particular their back-office, costs.

Competitive pressures in the Irishmarkets have increasingly forcedmargins downwards on traditionallife products.

The Savings and Investmentssector enjoyed strong growthduring the economic boom of thelate 1990s, with strong sales ofboth single and regular premiumproducts. The regular savingssector was given a boost by theintroduction of the Special SavingsInvestment Accounts (SSIA), whichclosed to new business in April2002. The account must be keptopen for a period of 5 years toavail of the headline attraction:

the Irish government will ‘top-up’the account by one € for each four€ deposited, subject to a maximummonthly deposit of €254. Lifecompanies were successful incapturing approximately 25% ofthe Special Savings InvestmentAccounts opened. These accounts, while proving extremely popularwith the public, afforded relativelylow margins to life companies.Since the introduction of thisinitiative, sales of alternativeregular savings products havetapered off. Furthermore, thevolatile investment markets haveadversely impacted the sale ofsingle premium investment bonds,which were extremely popularduring the late 1990s.

Within the pensions sector, theintroduction of low cost PersonalRetirement Savings Accounts(PRSA) in early 2003, which aresimilar to the UK ‘stakeholder’pensions offering, has exerteddownward pressure on margins on alternative pension offerings.

THE INSURANCE MARKET IN IRELAND continued


Individual assurances and annuities 63%

Pension scheme business 24%

Permanent health insurance 2%

Industrial business 1%

Self-employed pensions 10%

Life assurance GPI – 2001FIGURE 2

Source: Irish Insurance Federation Factfile (2001)

To date, the take-up of PRSAs hasbeen relatively low, however, in overall terms, there arecontinued strong growth prospectsin the Irish pensions sector –primarily driven by demographicfactors (Ireland has a very youngpopulation relative to its Europeanneighbours) and likely further,albeit reduced, economic growth.

The cross-border insurance sector

Much has been written explaininghow and why Ireland has becomea centre for locating cross-borderlife and non-life insurance andreinsurance operations. Variousreasons have been put forward to explain the development,including:

• the creation of the InternationalFinancial Services Center (IFSC)and its associated lowcorporate tax rate (10%) in1987. The IFSC, and resultingaccess to the 10% corporationtax rate, is now closed to newentrants. However, a single EUapproved corporation tax rateof 12.5% applying to all Irishcompanies came into force on1 January 2003;

• the existence of professionalswith advanced insuranceproduct knowledge and of IT solutions for thesesophisticated products;

• a regulatory framework that encouraged businessdevelopment;

• the availability of well-educated and relatively cheap resources;

• the existence of the singlemarket created through the 3rd life and non-life directives;

• the availability of ‘gross roll-up’of investment funds –traditionally, ‘gross roll-up’ only applied to insurers sellingoverseas from the IFSC (underthe IFSC regime, no annualtaxes were levied upon thefund plus no tax was payableby the policyholder upon exitfrom the fund). Since 1 January2002, all new life assurancepolicies are also on a ‘grossroll-up’ basis – no annual tax ispayable by the fund; howeveran exit tax applies to Irish (butnot to foreign) policyholders;

• an extensive tax treaty network –double taxation treaties arecurrently in place with 40 countries (including theUnited States); and

• membership of the € zone(Ireland is the only Englishspeaking member).

All of these have, to some extent,been part of the decision criteriaused by companies that haveestablished their insuranceoperations in Ireland. The fivemost important factors that have enabled the successfuldevelopment of cross-border lifebusinesses in Ireland, based on the findings of a survey of Irish-based cross-border life insurancecompanies undertaken byPricewaterhouseCoopers in 2002,are illustrated in Figure 3.

Nature of cross-borderoperations

The flow of new entrants to thecross-border market in Irelandcontinues. No particular uniquefeature is identifiable amongstthese new entrants and severalhave features in common with the original entrants to the market10 years ago.

The largest operations, by grosswritten premium, in the Irishcross-border market are the cross-border life companies,



Flexibility of Irish regulator

Product development skills

Availability of relevant expertise in Ireland

Confidence of parent in cross-border concept

Irish taxation policy

% Of respondents0 10 20 30 40 50 60 70 80%

Key enabling factorsFIGURE 3

Source: PricewaterhouseCoopers/Financial Services Ireland (2002)

The flow of newentrants to thecross-bordermarket in Irelandcontinues.

which wrote over €6 billion inpremium during 2001. Currently,there are over 30 cross-border lifecompanies operating in Ireland.The successful products for thesecompanies have been the unit-linked single premium bond and single premium tracker bond,both of which require littleongoing maintenance and whichtypically yield good margins.Another product that hasdeveloped strongly in this sector is the Portfolio Bond, providingpolicyholders with a very flexibleproduct within which to hold awide variety of assets.

One noticeable feature in the newnon-life operations establishing is that several are niche playersoffering simple yet specialistproducts that may not be availablein some of the cross-bordermarkets and where thespecialization depends both onunderwriting capabilities as well as efficient back-office operations,most notably those that write thetraditionally profitable PaymentProtection Business. Including

direct writers, there are over 50 companies engaged in cross-border direct non-life andreinsurance business from Ireland.

In the reinsurance sector, the newentrants have tended to be mostlycaptive operations, established by groups from all parts of the EU and other major economiccentres. Captives represent thelargest number of cross-borderoperations located in Ireland –there are over 200 captiveinsurance and reinsurancecompanies established here. Thispopulation continues to grow and is expected to show strong growthduring 2003 as a consequence ofhigher insurance costs andreduced capacity in the globalmarket. In 2002, one of the largestinsurance captives was establishedin Dublin with shareholder funds of over €200 million.

Aside from the captive reinsurers,many of the largest globalreinsurers, transacting standard,financial and ART business, suchas Swiss Re, Munich Re, ACE, XL,

QBE, Centre and Hannover Rehave operations located in Ireland.The ranks of these companies have been increased with newreinsurance ventures formed in thelast 18 months to take advantageof hardening rates. The major newBermudan ventures – RenaissanceRe and Axis Speciality – havelocated their European operationsin Dublin and SCOR has locatedIrish Reinsurance Partners here.

The future

The domestic non-life sector isexpected to remain under strongmedia and government focus,primarily as a result of thesignificant premium ratingincreases introduced in the pastfew years. The effectiveness of thevarious initiatives to reduce thecost of settling personal injuryclaims is likely to be the subject of much debate.

It is anticipated that the domesticlife companies will struggle toregain the heady growth rates seenin the late 1990s and, faced withdeclining margins and increasing

pressure on sales volumes, willneed to examine ways in which to re-engineer their cost base.

Whilst it is currently perceivedthat the potential for futurecompetition into the Irish domesticmarket from abroad looks limited,there are very strong opportunitiesfor Irish and foreign companies toset up operations in Ireland towrite business across the EU.Ireland, with its strong domesticinsurance industry, favorable taxand regulatory regimes, extensivedouble taxation treaty networksplus an existing critical mass ofcross-border operations, willcontinue to be an extremelyattractive location for companieswishing to access the entire EUmarket from a single location.



AUTHORS

Chand KohliPartner-in-charge, Insurance Group, IrelandTel: 353 1 662 [email protected]

Garvan O’NeillPartner, Insurance Group, IrelandTel: 353 1 662 6218garvan.o’[email protected]

Further information

INSURANCE DIGEST

For further information about PricewaterhouseCoopers Americas Insurance Group, please call your usual contact atPricewaterhouseCoopers or one of the following:

GLOBAL INSURANCE GROUP

John S. Scheid*Global Insurance Assurance and Business Advisory Services Leader and Chairman, Americas Insurance GroupTel: 1 646 471 5350 E-mail: [email protected]

BERMUDA

Richard Patching*Bermuda Insurance LeaderTel: 1 441 299 7131 E-mail: [email protected]

CANADA

Bill BawdenCanadian Insurance LeaderTel: 1 416 947 8970 E-mail: [email protected]

SOUTH AMERICA

Leslie HemerySouth Americas Insurance LeaderTel: 56 2 940 0065 E-mail: [email protected]

US INSURANCE GROUP

James Scanlan*US Insurance Leader, Philadelphia, PATel: 1 267 330 2110 E-mail: [email protected]

J. Timothy Kelly*Tax Services, New York, NYTel: 1 646 471 8184 E-mail: [email protected]

Michael MarkmanFinancial Advisory Services, Chicago, ILTel: 1 312 298 2858 E-mail: [email protected]

Paul L. Horgan*Audit Business and Advisory Services, New York, NYTel: 1 646 471 8880 E-mail: [email protected]

Richard I. FeinActuarial and Insurance Management Solutions, New York, NYTel: 1 646 471 8150 E-mail: [email protected]

* Member of the Global Insurance Leadership Team

INSURANCE DIGEST

As part of our insurance publications portfolio, we also publish an Asia Pacific and a European edition of Insurance Digest. If you would like to receive copies of one or more of these editions,please contact one of the following, or alternatively visit us on-line atwww.pwcglobal.com for electronic copies.

AMERICAS INSURANCE DIGEST

Jeanne SafferTel: 1 646 471 3799 E-mail: [email protected]

ASIA PACIFIC INSURANCE DIGEST

Viki KeenTel: 61 3 8603 6125 E-mail: [email protected]

EUROPEAN INSURANCE DIGEST

Emma L. BrookesTel: 44 20 7804 7625 E-mail: [email protected]

PricewaterhouseCoopers (www.pwc.com) is the world’s largest professional servicesorganization. Drawing on the knowledge and skills of more than 124,000 people in 142

countries, we help our clients solve complex business problems and measurably enhance theirability to build value, manage risk and improve performance in an Internet-enabled world.

The Americas Insurance Digest is produced by experts in their particular field atPricewaterhouseCoopers, to address important issues affecting the insurance industry. It is not

intended to provide specific advice on any matter, nor is it intended to be comprehensive. If specific advice is required, or if you wish to receive further information on any matters referred

to in this publication, please speak to your usual contact at PricewaterhouseCoopers or thoselisted in this publication.

PricewaterhouseCoopers refers to the member firms of the worldwide PricewaterhouseCoopersorganization. If you would like any of your colleagues added to the mailing list, or if you do not

wish to receive further editions, please contact Jeanne Saffer on 1 646 471 3799 or e-mail at [email protected]

For information on the PricewaterhouseCoopers Global Financial Services and Insurance collateralplease contact Áine O’Connor, Director, Head of Global Financial Services Marketing,

on 44 20 7212 8839 or e-mail at [email protected]

Copyright©2003 PricewaterhouseCoopers LLP. PricewaterhouseCoopers refers to the US firm ofPricewaterhouseCoopers LLP and the other members of PricewaterhouseCoopers organization.

Designed by PricewaterhouseCoopers studio ec4 (15973 12/03).

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