A copy here of the letter I sent to Hans Hoogervorst on 10th October. I sent a similar letter to Stephen Haddrill of the Financial Reporting Council.
The reason is to understand whether the valuation issue of ERM firms is a problem with IFRS accounting standards themselves, or whether the standards are perfectly fine, but the problem was failure to comply with those standards
Let’s start off by noting that the standards are not regulatory ones. As I pointed out a while ago, there is a regulatory balance sheet, which the PRA keeps an eye on, quite a close eye in some cases, and there is the statutory (‘IFRS’) balance sheet, which the auditor (KPMG) audits. Today we are talking about the statutory balance sheet.
Statutory and regulatory balance sheets are pretty close, and the SFCR actually has a page, if you are lucky enough to find it, which reconciles the two, sometimes by means of the item ‘other differences’.
But if the PRA has its way on CP 13/18, the two balance sheets will quickly diverge. Moreover, the divergence will occur because the PRA is saying firms haven’t valued an embedded guarantee correctly. We will have the situation where one capital number (Solvency II) represents the correct valuation and the other reflects the incorrect one. (Well I suppose it could be argued that there is no such thing as correct when it comes to accounting, and both numbers are equally correct or incorrect, but then you have to question the purpose of accounting, i.e. giving an objective view of the firm’s financial condition).
If you accept this is some kind of failure, you have to ask, as I suggested at the beginning, whether this is failure of compliance, or failure of standards.
It is arguably not a failure of standards, but you could question whether it is a failure of honest accounting. The expression ‘fair value’ appears 135 times in Just Group’s 2017 Financial Statement. The concept of fair value belongs to IFRS. A fair value price is
the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions.1
Given that the expression ‘fair value’ occurs as many times in the report as it does, you would naturally expect that all values reported on the balance sheet would be fair in that sense. Not so. If you look carefully, you see that it is absent in all cases of insurance liabilities. Insurance liabilities are covered not by IFRS 13, but IFRS 4, where
… there is a rebuttable presumption that an insurer’s financial statements will become less relevant and reliable if it introduces an accounting policy that reflects future investment margins in the measurement of insurance contracts, unless those margins affect the contractual payments. 2
Such a ‘rebuttable presumption’ (i.e. a sort of working assumption that is open to challenge) would be ‘projecting the returns on those assets at an estimated rate of return, discounting those projected returns at a different rate and including the result in the measurement of the liability’, which is precisely how ERM assets are valued, namely by recognising some of the value as a sort of weird negative liability. This is obviously not ‘fair value’, given that no rational knowledgeable investor would take on any obligation at less than its present value, discounted at risk free. Nor does this weird valuation method make the financial statements any more ‘relevant and reliable’, in my view at least.
We will be discussing weird valuation methods later this year. The question for now is whether omitting the reference to fair value in key parts of the financial statements is honest. The legal standard is whether according to the ordinary standards of reasonable and honest people it is honest. The contact form is open, any reasonable and honest people reading this are free to use it.