The event was organised as part of EFRAG’s public consultation on 'Is there a need for specific financial reporting for long-term investing activities business models?' and in the context of the debate on the Classification and Measurement: Limited Amendments to IFRS 9.
The first session focused on discussing the characteristics of a long-term investing business model from a financial reporting perspective and whether a long-term investing business model can be supported by appropriate objective and observable evidence.
The second session focused on the consequences that the business models and business strategies, described by the panellists in the first session, may have on financial reporting requirements. Panellists also provided views on whether fair value leads to short-termism as an answer to the question raised in the European Commission Green Paper on long-term financing, and the relevance of fair value for long-term investing business models.
The panellists, in particular the user panellists, discussed what information and which components of performance they found relevant in the assessment of companies with long-term investing business models, and provided their views about the relevance of fair value and cost measurement for long-term investing activities.
Long-term investing business model from insurers’ perspective
The panellists from the insurance industry highlighted the following key characteristics of a long-term investing business model:
(a) Stability of the insurance liabilities cash flows – the insurance liabilities profile was described as statistically stable with duration between 7 to 20 years, and illiquid. Results from stress tests performed on the insurance liabilities cash flows showed that there would be almost no risk of forced sales which is considered as a strong proof of the stability of insurers’ cash flows.
(b) The stability of the cash flows has been noted as a more important characteristic than the duration. Property and casualty insurers have shorter durations than life insurers, but the characteristic of having stable and predictable cash flows is what really matters. One observation was that insurers hold stable portfolios except (1) when their business is suffering from large redemption trends or (2) in the case of unanticipated events.
(b) Asset-Liability Management (ALM) – the ‘consistency’ of asset-liability management has been highlighted as a core aspect of the life-insurance business model. This consistency refers to an investment policy on the asset side to match the cash flow characteristics of the liabilities with the aim to fulfil the obligations towards policyholders, bondholders and shareholders in different market conditions.
The panellists from the insurance industry observed that for long-term investing activities the nature of the assets should not be taken into account to qualify them as institutional long-term investors.
A panellist explained that a long-term business model for insurers might be different depending on whether or not the contract includes options and guarantees. Usually options and guarantees lead to more variable cash flows, and when the latter are combined with more stable long-term cash flows, the combination results in hybrid business models. Such hybrid business models are more difficult to define a long-term strategy. A question that arises is whether policyholders will rely in the future on sustainability of returns on guarantees.
A user noted he was surprised to hear that insurers describe themselves as long-term investors when they need to change their portfolios due to Solvency II regulation. He wondered whether along-term investor should not be someone who sticks to an investment even in stressed conditions, both for equities and bonds. A panellist from the insurance industry responded that long-term investing from the insurers’ perspective was not about holding on to assets, but about matching durations on a portfolio basis, in order to fulfil the obligations of the liabilities.
Long-term investing business model from banking perspective
Panellists from the banking industry explained the ALM commonalities with the insurance industry, but indicated that the driver for public banks was the lending activities and the public mission of the bank as opposed to the insurance liabilities. The governance structure of this type of institution drives the limited risk appetite and the dividend distribution was not considered a short-term objective.
A user panellist noted that the definition of long-term assets and long-term investors should be stricter as many corporate groups could claim to be long-term investors based on the nature of the assets in which they invest.
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