Blue Book 2012: Improvements to the measurement of insurance services Author Name(s): Abbe Williams, Stephanie Duff and Daniel Wisniewski Office for National Statistics 1. SUMMARY Financial intermediation in the national accounts is among the most difficult areas to measure. Insurance services output cannot be measured directly and is therefore measured in accordance with international national accounts guidance using a model based approach. Following an extensive research and development project improved insurance services output methods and sources of data have been developed. These will improve comparability between derived insurance services outputs and international standards, as in the European System of Accounts (ESA). This article provides: A description of the methods and sources improvements that will be made to the measurement of insurance services. An indication of the impact that these improvements will have within the UK National Accounts. 2. INTRODUCTION Objective As discussed later in the article, output for insurance services cannot be measured directly, instead in national accounts a model based approach is followed. The objective of this research and development work was to create a new series of annual data, consistent with ESA 1995 and Eurostat guidance, that would better interpret the model based approach for measuring insurance output. The new series will be introduced in the Quarterly National Accounts consistent with Blue Book 2012 publication on the 28 June 2012. Special features of the UK insurance industry The UK insurance industry is the third largest in the world and the largest in Europe. It is a vital part of the UK economy, and is also one of this country s major exporters. Uniquely in the UK we have the Lloyd s of London (Lloyd s) market, which is distinctive in its method of operation through independent syndicates, and for its specialisation in direct insurance and reinsurance of very large risks. Lloyd s syndicates (forming an insurance market conducting both direct insurance of large risks and reinsurance) are juxtaposed with the UK insurance companies, which also conduct direct insurance and reinsurance. There is a large export market in both direct insurance and reinsurance services, especially but not entirely by Lloyd s, coupled with the usual imports of reinsurance services. 1
Most insurance companies are confined to either life insurance or non-life insurance. In some cases, the separated life and non-life companies are under common ownership and may share some elements of operating costs, through a common service company set up by the parent company of the group. There are still a few composite companies, which operate both life and non-life insurance activities through separate divisions of a single company, but there must be full separation of the annual accounts of the two divisions. Legislative background There is a range of legislation that has a direct impact on the methods and sources for insurance services: EU legislation a. Third Directives on life and non-life insurance b. 1991 Directive on the content and format of the annual accounts of insurance undertakings c. European System of Accounts ESA 1995 UK legislation a. Companies Acts b. Adaptation of 1991 Directive to UK situation, where options available c. Financial Services Authority (FSA) regulations Financial Services and Markets Act 2000 d. The Lloyds Act 1982 UK administrative data The FSA regulatory insurance returns were chosen as the main data source for UK companies. This data source was chosen as the returns are on an accruals basis, consistent with the published accounts, and includes additional information that enables closer consistency with ESA. The returns are also available, company by company, and in computerised form. A disadvantage of published accounts is that some may be consolidated covering world-wide activities. Data for Lloyd s syndicates are based on their published aggregated annual accounts in so far as these exist. Returns by the UK insurance companies to the FSA are generally consistent with their published accounts, as in the 1991 Directive. In the transition from the technical to the non-technical parts of the profit and loss account, the FSA returns identify prior year adjustments and other adjustments from an underwriting year accounting basis. Balance sheet fully at fair values, so all capital gains, realised and unrealised, are carried through the profit and loss account. Also, claims management costs are separated from claims due to policyholders; and changes in an equalisation provision exist and are identified. Lloyd s aggregated Syndicate accounts, complete with Notes to the Accounts, exist from 2004 only. However, back data are provided by Lloyd s on the same basis for the period 2000 2003, with annualised data for the period 1995 1999. 2
The FSA does not request separation of non-life transactions with non-residents, but does for life insurance. Lloyd s, whose business is almost exclusively non-life insurance, have supplied estimates of transactions with non-residents. Gross recording with full separation of direct insurance services and reinsurance services In national accounts, production includes the service charge made by insurers to their policyholders. This is called output (also see section 4). The term net of reinsurance is used when the part of the risks which is reinsured is not included; the term gross of reinsurance refers to the full amount of the risks accepted by the insurer. The improved methodology includes the replacement of net of reinsurance measurement with gross of reinsurance measurement, which is the preferred approach internationally. Direct insurance services represent the services provided by insurers to customers who are not themselves insurers. The direct insurer agrees to indemnify their non-insurance customer from the financial or other consequences of specified events, known as risks. The services produced by direct insurers are consumed as either final or intermediate consumption of the customers. Reinsurance services are the services produced by one insurer for another, where one, called the reinsurer, accepts part of the risks which the other, the direct insurer, cedes to them. The full separation of these two types of service, which have distinct patterns of supply and use, follows System of National Accounts (SNA) 2008 and anticipates ESA 2010; in ESA 1995 it was not required but in effect was permitted. It should be noted that the same insurance entity often acts both as direct insurer and as reinsurer. In the separation of the supply and use of direct insurance services from the supply and use of reinsurance services, all reinsurance services are used as intermediate consumption, but only some direct insurance services are used as intermediate consumption. The separation of reinsurance services from direct insurance services implies that the invested premium income of the reinsurer, who may well be non-resident, generates property income which should be attributed to the policy-holder, the ceding direct insurer, which is then returned by the ceding direct insurer as premium supplements. These amounts have been estimated. The separation of reinsurance services from direct insurance services also implies that commissions flowing between insurers acting as direct insurers and insurers acting as reinsurers should be separated from commissions paid by direct insurers to financial auxiliaries. Coverage issues Annual data from 1995 to 2010 was examined in detail. Insurance companies are part of the financial corporations institutional sector in the national accounts. Any non-insurance activities such as real estate management, estate agencies, etc. are usually conducted by separate institutional units, so that the insurance sub-sector of financial corporations largely coincides with the insurance industry. Independent insurance brokers are financial auxiliaries and are not part of the insurance industry. The data relating to imports and exports of insurance services are scarce, particularly for non-life insurance. So to supplement the FSA data figures were taken from the Office for National Statistics (ONS) insurance surveys and the Association of British Insurers (ABI) publications. 3
FSA data may include premiums etc. of overseas branches in the EU as if they were direct exports, at present adjustments have been made for this as far as possible utilising ONS data to estimate and remove any over-coverage. Marine mutuals are included within the estimates although in the absence of further information output has been calculated as the sum of costs. Lloyd s has provided estimates, in terms of premiums, of the proportion of overall business which is exported. Imports of direct insurance services are thought to be small. 3. CONSISTENCY WITH ESA 1995 In December 2002 Eurostat called a Task Force of experts with a mandate to analyse the sources and methods used by Member States for the recording of life and non-life insurance transactions to ensure consistency with ESA 1995 methodology and a better comparability of national accounts aggregates. The recommendations of the Task Force were reported to the Gross National Product (GNP) Committee in July 2003. Here is the summary of the Task Force s recommendations together with information on the way in which the recommendations have been followed: Recommendation 1. Treat reinsurance commissions as negative reinsurance premiums. UK companies: complete, and with the full separation of reinsurance services from direct insurance services applied to reinsurance premiums accepted as well as to premiums ceded, on the assumption, for want of better information, that the given ratio of reinsurers commissions to premiums ceded reported by each insurer applies also to the reinsurance premiums accepted by the same insurer. Lloyd s syndicates: done so far as present data permit. Recommendation 2. Exclude, from premium supplements, income earned by the investment of own funds. In the absence of direct information the split can be achieved on the basis of the ratio own funds/own funds plus technical reserves. Non-life, UK companies: complete on the basis of this ratio, with exclusion of resident affiliates from the balance sheet total, so as to avoid double counting. Lloyd s syndicates (almost entirely non-life): for years with annual accounting information, there is specific information on the level of policyholders funds held by the syndicates. Earlier years are estimated as best possible. Life, UK companies: given the preponderance of linked business, where all investment income is attributed to policy-holders (D.44) and so returned as premiums supplements, the separation applies only to non-linked business. Here the separation, between investment income arising on non-linked policies (attributed to policy-holders) and that attributed to own funds, was taken from the separation between the technical and non technical parts of the profit and loss account the amount excluding capital gains 4
transferred to the non-technical account being regarded as mainly income arising on the investment of own funds. Recommendation 3. Include the equalisation provision in the output algorithm (as part of claims due). Complete, with separation of balances with and without inclusion of changes in the equalisation provision. (Not applicable, for Lloyd s.) Recommendation 4. Exclude claims management costs in the calculation of claims due to policyholders. Complete, on the basis of firm data supplied by both the UK companies and Lloyd s. Recommendation 5. Exclude holding gains/losses (realised and unrealised) from the insurance output calculation (from premiums supplements and from the change in life insurance provision). In the sources, where fair value accounting is used throughout, all capital gains and losses, realised and unrealised, pass through the profit and loss account, but are always separated from investment income proper (e.g., dividends and coupon interest.) As regards the change in the life insurance provision, for linked business the same amounts as for the determination of premium supplements were excluded. For non-linked business, the advice given was that the internal discount rates used by the UK companies to assess the present value of obligations to policy-holders usually followed current market rates of investment yield; in consequence, the holding gains element of the change from opening to closing value of such obligations was also taken to be the actual realised plus unrealised holding gains in the year, the same basis as for linked business. Recommendation 6. Allocate the final use (FC/IC) of the insurance output by analysing the insurance products and identifying the final user sectors. A possible product breakdown is the accounting directive s classification of 10 classes of [non-life] business set out in article 63. For non-life direct business, the sources give a far more detailed product breakdown, in terms of premiums, which enables an estimated final consumption and intermediate consumption split to be made of premiums received from residents. Lloyd s has provided estimates, in terms of premiums, of the proportion of overall business. Recommendation 7. Calculate premiums supplements on transactions between direct insurers and reinsurers, and on imports of direct insurance services. The estimation of premium supplements can be restricted to cases of significant cross-border insurance transactions. Complete, but following the System of National Accounts 2008, the calculation of premium supplements on transactions between direct insurers and reinsurers is not confined to cross-border transactions. In all cases, the calculation of output gross of all reinsurance is followed by the deduction of the intermediate consumption of reinsurance services (separated from other intermediate consumption) so that, for every institutional unit, a balance representing output net of reinsurance can be calculated. 5
4. OUTPUT ALGORITHM AND ALLOCATION Measuring output There is sometimes confusion as to what is meant by the output of an insurer, otherwise known as the insurance service charge. Claims due and the part of premiums which matches claims payable are treated in the national accounts either as current transfers between policy-holders and beneficiaries (in the case of non-life insurance) or as financial transactions mainly reflecting saving (in the case of life insurance). To make this pooling of risks possible, the companies levy, in effect, a service charge, which covers their operating costs and leaves them operating profit or loss; but, like all figures of profit this is best measured top down, as the balance of the production and generation of income accounts. Thus, we have the production algorithm: [gross] premiums earned, + [gross] premium supplements, based on investment income, see below - [gross] claims due to policy-holders (excluding claims managements expenses) - [gross] increase (plus decrease) in the life assurance provision and in any other technical provisions (those not subsumed in premiums earned or claims due) This takes account of the property (investment) income held by insurers on behalf of their policyholders, on the basis that the existence of this property income reduces the premiums actually paid by the policyholders, and so is tantamount to a supplement to the actual premiums. Allocation of output Once output has been calculated, following the above output algorithm, it is allocated to where it is consumed, as outlined in Recommendation 6 above. The amount of non-life output allocated to household final consumption expenditure (P.3) is based on the detailed product split of premiums available in the FSA dataset. Exports of non-life are not specified in FSA data, these instead are based on ONS survey data. Lloyd s exports are based on estimates for total, direct plus reinsurance, percentage of export business for each consecutive year supplied by Lloyd s. An estimate of the use by resident although small was also supplied. Due to the nature of the Lloyd s market the use by unincorporated business is estimated to be small with the residual use being resident corporations. For life exports an overseas component was identified in the FSA data, therefore, this has been replaced by home/foreign data, as identified in the ONS surveys and the difference between the FSA and ONS overseas component used to reduce all other figures. The remainder has been allocated to resident households. UK companies provide reinsurance services to other UK companies, perhaps to Lloyd s, and to nonresidents; Lloyd s syndicates provide reinsurance services to each other, to the UK companies and to non-residents; and non-resident reinsurers provide services to: UK companies and to Lloyd s. 6
Reinsurance exports by Lloyd s are based on estimates for total business supplied by Lloyd s. We have concentrated therefore on estimating the imports and exports of reinsurance services by the UK companies. The juxtaposition of UK companies suggests that, if they receive many reinsurance services from Lloyd s, they must also export a material amount of reinsurance services. In addition, we have also incorporated imports of insurance services identified through ONS International Trade in Services survey. 5. IMPACT ON THE UK NATIONAL ACCOUNTS Once output has been calculated and allocated as described above, the series enter the UK National Accounts through the supply and use tables (SUT). The annual level of Gross Domestic Product (GDP) at current prices is generated through the SUT process of balancing information on production, income and expenditure. Insurance services will be fully calculated and not be changed through the balancing process; this approach will continue into the future. Below are outlined the key areas of change to the UK National Accounts along with the ESA 1995 transaction codes in brackets. Production, generation of income accounts and external account of goods and services key changes The improved methods and data sources impact on a number of sectors, and in a number of accounts within the national accounts sequence of accounts. Where appropriate these accounts feed from SUT series, as below: 1. Production account: Output (P.1); Intermediate consumption (P.2); Gross Value Added (B.1g). 2. External account of goods and services: Exports of services (P.62); Imports of services (P.72). 3. Generation of income account: Gross Operating Surplus (B.2g). 4. Use of disposable income account: Final consumption expenditure (P.3). As a consequence of the introduction of improved methods and source data for insurance into the production and generation of income accounts, these are the key changes we see in the UK National Accounts: 1. Output (P.1) is now measured on a gross basis. 2. Output (P.1) of direct insurance services is lower. 3. Intermediate consumption (P.2) by other industries of direct insurance services is lower. 4. Intermediate consumption (P.2) by the insurance industry has changed. 5. Reinsurance becomes more prevalent in more recent years. This can be seen in output (P.1) and intermediate consumption (P.2). 6. Exports (P.62) and imports (P.72) of insurance services have increased. 7. Household final consumption expenditure (P.3) has changed. However, the levels are of a similar magnitude. 8. Gross value added (B.1g) for the insurance industry has changed. 9. Gross operating surplus (B.2g) for the insurance industry has changed. 10. P.1, P.2, B.1g and B.2g for other industries has changed. 11. Overall GDP has changed. 7
Other accounts key changes As a consequence of the introduction of new insurance output estimates, we have changed three distributive transactions in the UK National Accounts: 1. Allocation of primary income account and external account of primary incomes and current transfers (for rest of world): Property income attributed to insurance policy holders (D.44). 2. Secondary distribution of income account and external account of primary incomes and current transfers (for rest of world): Net non-life insurance premiums (D.71); Non-life insurance claims (D.72). These data will be revised so that they are consistent with the new output data, otherwise inconsistency would be introduced in the non-financial account. Also, D.44, D.71 and D.72 need to reflect the transactions between direct insurers and reinsurers. Improved D.44 estimates will affect balancing items in the accounts starting with balance of primary incomes (B.5g), and flow down the accounts. The improved D.71 and D.72 estimates, though different, do not change any balancing items. 6. CONTACT fincos@ons.gsi.gov.uk 8