The new UK GAAP in the Lloyd's market has provided greater transparency around the uncertainties inherent in profit estimates, and focused public attention on managing agents’ risk and capital management practices.
New UK GAAP came in force for the 2015 annual financial statements during a period when Lloyd’s managing agents were faced by numerous challenges. These included the increased demands on data granularity and quality, competing priorities for modelling capacity, and increasing pressures on operational resources and narrowing business margins. These challenges coincided with a reporting cycle when the new Solvency II regime went live.
To assess the impact which new UK GAAP transition had on the market, we analysed the financial statements of Lloyd's syndicates representing 75% of the market capacity and 50% of the entities.
We focused on aspects of the new UK GAAP transition which are of particular relevance. We did this to understand how members' balances change, and how risk management impacts the creation or erosion of value in syndicates' business.
What we observed
The syndicates reported the following top three areas of impact on transition to new UK GAAP:
- Treatment of deferred acquisition costs (DAC) and unearned premium reserve (UPR) as monetary items (49% of syndicates); change of functional currency (27% of syndicates). The choice of functional currency was split (49% each) between GBP or USD. Sterling is a presentational currency for 84% of syndicates
- Reporting foreign currency gains and losses within the Non-technical account of the Income Statement (13% of syndicates)
- Re-classifying investments as 'Cash and cash equivalents' (11% of syndicates)
Four per cent of the syndicates reported no impact on their financial statements.
Key judgements and uncertainties
The syndicates dedicated on average half a page (ranging from zero to just under two pages) to explain the key areas of judgement and the sources of estimation uncertainty. The top three areas were:
- Valuation of ultimate claims (80% of syndicates)
- Pipeline premiums (47%)
- Investments marked to model (38%).
The processes to derive estimates was explained but the syndicates rarely disclosed the sensitivity of valuation to changes in key assumptions.
Balances arising under insurance contracts
The completeness of disclosure was higher for technical provisions than for DAC or bad debt allowance on reinsurance balances. Approximately three quarters of syndicates used the transitional exemption to present only five years of development in the claims triangles, but only 18% explicitly disclosed the exemption.
Risk management disclosures
The notes on risk management added on average seven pages (ranging from three to 17 pages) to the syndicate accounts. Insurance, financial (credit, market and liquidity) and operational risks were noted as principal risks to syndicate strategic objectives. Only 7% of syndicates discussed emerging risks in their strategic reports.
As illustrated in the Graph 1 below, the syndicates identified the risk exposures and disclosed the sensitivity of members balances and profit or loss to reasonably possible changes in risk drivers.
The objectives of risk management policies and their alignment with business strategy were more comprehensively explained for risks not mitigated by capital buffers (eg liquidity).
Graph 1: Risk Management disclosures
Approximately a third of syndicates used the allowed option to follow IAS 39 measurement requirements for financial instruments. Only 13% of entities reported assets marked to model. Hedge accounting was applied by only 4% of syndicates.
New UK GAAP brought into the public domain judgmental and commercially sensitive matters that in the past were only discussed in internal documents addressed to the Audit Committee. Such transparency increases the accountability of senior management and provides a deeper insight into balances often viewed as a 'black box'.
As a result, the users’ ability to 'back test' the soundness of management judgments and estimates used in financial statements will improve, and enable them to respond accordingly. It is also an opportunity for managing agents to differentiate on quality of financial reporting and risk and capital management.
The detailed findings of our analysis are available in the related publication ‘Implementing new UK GAAP in the Lloyd's market. Grant Thornton’s observations on syndicates' 2015 annual accounts’.