Europe

• Standard setters determined to sort out insurance accounting
• �Fat slugs� tell Italy to stick to lettuce

Standard setters determined to sort out insurance accounting

In publishing its IFRS 4 on insurance contracts, the IASB has announced that this �marks the first step in the IASB�s project to achieve the convergence of widely varying insurance industry accounting practices around the world�. Insurers will continue to be exempted, on a temporary basis, from some requirements of other IFRSs.

Over recent years, some insurers have been heavily criticised by analysts for using accounting practices which have in some instances been described as opaque and misleading. This has been especially true in the UK, where the mutual life assurers Equitable Life and Standard Life have had varying degrees of problems which were largely hidden from policyholders.

Richard Martin, ACCA�s head of financial reporting, said that in many respects there was general international agreement on accounting practices in the sector. �A lot of countries will use a sort of estimation of insurers� spreading the liabilities, but also spread some of the costs, such as the cost of getting the business in the first place,� he said. �There are some differences in how these are recognised.�

Martin said that unlike some sectors, the issue of revenue recognition was not particularly significant in insurance, with no obvious history of insurers booking revenue too early. He argued that problems came more with the treatment and estimation of potential liabilities, as had been the case with Equitable Life.

But where there were significant differences internationally, said Martin, were in the requirements laid down by national regulators and trade bodies. In the UK, the Statement of Recommended Practice is the responsibility of the Association of British Insurers (ABI). �Insurers� reporting has been very influenced by local prudential regulation,� he suggested.

It is in the UK life insurance sector where there are some obvious variations in reporting practice. The concept of �embedded value� - booking in the balance sheet the estimated value of life business going forward - has been heavily criticised by some analysts. �I don�t think that has been used elsewhere in the world,� pointed out Martin.

The ABI has just announced that it is to conduct an urgent study into accounting by life assurers of their with-profit business, flowing from the Penrose review into the Equitable Life crisis. An advisory panel has been established to support the study, containing Andrew Lennard, the new technical director at the ASB, Paul Sharma, the head of prudential risks and accounting at the Financial Services Authority, key figures from the life industry and observers from the Treasury and DTI.

But IFRS 4 is by no means the end of the story regarding international standards, as it is merely an interim measure to provide an international standard for use from 2005, while recognising that this - along with accounting for the exploration industries - requires comprehensive reform and regulatory consolidation in the future. �The IASB will follow on at some time with a more comprehensive new treatment,� predicted Martin. �And then embedded value probably won�t survive. This is unfinished business.�

Peter Vipond, head of financial regulation and taxation at the ABI agreed, saying: �We welcome the publication of the new standard which will remove many of the uncertainties on how insurers should prepare their financial statements under IAS from 2005, provided it is endorsed by the EU Commission. As an interim measure however, IFRS 4 does not address the fundamental issue of valuing insurance liabilities, and we look forward to participating in the debate with IASB on how this should be resolved under phase 2 of the IASB insurance project.�

Sir David Tweedie, IASB chairman, explained: �At the urging of users, insurers and regulators, we have developed IFRS 4 to provide interim guidance on insurance accounting practices without imposing on the insurance industry significant costs that could prove to be wasted when we complete the more comprehensive project.�

�Fat slugs� tell Italy to stick to lettuce

Italy has been publicly humiliated by the European Commission for breaching the Stability and Growth Pact rules of limiting budget deficits to 3% of GDP. The eurozone�s third largest economy has now joined the largest two - Germany and France - while the largest EU member state outside euroland, the UK, also breached the 3% limit. Although the UK has not adopted the euro it is still required to abide by the 3% rule, but unlike countries within the monetary union there is no sanction available against it for breaching the requirement.

Silvio Berlusconi, the Italian prime minister, took the slap down badly and showed his contempt for Commission officials and its politicians. Hearing that the country�s plans for improved transport infrastructure had meanwhile been approved, Berlusconi said: �We have managed to make those big fat European slugs take steps forward.� He added: �If there is one dedicated European, then it�s me. I have always been. And if there is one European country, it�s Italy. This absolutely does not mean that it�s impossible to criticise those who occupy posts for which they are unqualified.�

That was taken as a reference to Commission President Romano Prodi, who is expected to lead the centre left opposition in Italy after completing his term of European office in October. Relations between Prodi and Berlusconi are about as poor as is possible without the two men actually hitting each other.

But the Commission�s criticism of Italy has justification. While the Italian budget deficit is smaller than that of France and Germany, its economic situation is more parlous and ingrained. Germany is expected to again comply with the deficit rules within the next one or two years, despite its Government�s tax cutting programme.

Italy�s budget deficit would actually be more severe if it had not been aided by one-off privatisation receipts and short-term emergency measures. The Commission warned that the impact of temporary economic measures would halve this year compared with 2003, with the budget deficit set to worsen. This will be exacerbated by steps being taken by Berlusconi to provide tax cuts aimed at stimulating the economy.

Many economists argue that the annual deficit is a less important symptom of economic strength than the total outstanding public debt as a percentage of GDP. Here, Italy shows itself as very weak. While the UK has a public debt of 40.1% of GDP, Germany has 64.2%, France 64.6% and Italy has 106%. Greece, of the established member states, is the only other country to operate in the same danger zone at 103%.

The economic problems faced by Italy are also illustrated by its current economic performance being the worst of the eurozone. While the German economy is virtually stagnant, Italy is literally showing no growth. Unemployment has marginally improved over the last year, but there is widespread public anger and there was a day long �general strike� in March in protest at the economic failure of Berlusconi�s Government. There is also hostility at plans to reduce pension entitlements, which have led to the administration delaying implementation of the measure in the run-up to elections next month.

Berlusconi�s plans for stimulating the economy include cutting top rate taxes from 45% to 33% and ending the practice of having some bank holidays falling in the middle of the week. But perhaps significantly, the European Commission has no confidence that Italy�s proposals for cutting public expenditure by 6bn euros will be sufficient to bring the budget within the 3% deficit limit.

Despite the Commission�s reference to privatisation receipts helping out Italy�s public finances in the short-term, there is widespread criticism of Berlusconi for stalling the rather half-hearted privatisation programme he inherited from the previous centre left government.

Alberto Mingardi, director of the Italian right-wing think-tank Istituto Bruno Leoni, and a visiting fellow at the Centre for the New Europe, says that the Italian Government has failed to implement the type and scale of reforms necessary to modernise its economy. �Berlusconi�s Government has on many occasions talked about the privatisation programme. But the only thing it has done of any importance has been tobacco; it has not dealt with the government monopolies in vital sectors - such as [the airline] Alitalia, which is bankrupt in real terms. Berlusconi has talked many times about there being no need to privatise or part-privatise Alitalia. Instead, in this pre-election period he is offering tax cuts which will cause Italy to breach the Stability Pact.�

Mingardi says that Italy should have done much more than privatise the government-owned Italian tobacco firm Ente Tabacchi Italiano (ETI) - sold last year to British American Tobacco for 2.3bn euros - and sell-off a small amount of housing and government buildings. He suggests that, as well as Alitalia, Italy should have sold the state television RAI, which would also have assisted Berlusconi in dealing with accusations of serious conflicts of interest as he personally owns much of the country�s media. Mingardi argues that Italy also needs to reduce its vast subsidy of manufacturing and the service sector, such as assistance to cinemas.

Yet, much of Italy�s privatisation debate is dominated about what to do about the culture sector. Legislation has been passed to enable the private sector to become more involved in the maintenance, management and marketing of the country�s heritage. Widespread opposition has helped to derail action towards greater private sector involvement in museums and galleries, aided by what Mingardi describes as �a major fight within government�. Mingardi doubts whether, ultimately, the moves towards what are termed privatisation will involve the sale of any state cultural assets.

But a state agency, Patrimonio dello Stato, was established to decide what of Italy�s cultural heritage should be sold, leased or securitised. Berlusconi has promised not to sell the most important items of Italian heritage - the Colosseum, the leaning tower of Pisa and the Uffizi. Confusion over what the Italian Government intends to do has been aided by the slow speed at which any legislation in Italy is passed and implemented, along with the vagueness of the Act. Despite Berlusconi�s promise, the sale of the most important treasures is not precluded under the Act.

Last summer Patrimonio published its first list of items that might be sold. These included a Tuscan island, a Milanese prison and the remains of a villa on Capri, where Emperor Tiberius stayed, which is earmarked for sale at the apparent giveaway price of 90,000 euros. Plans have provoked Berlusconi�s former culture minister Vittorio Sgarbi to set-up his own political movement, �the Party of Beauty and Reason�, in opposition to the cultural sales. But total receipts from culture sales are likely, in any case, to be in the millions of euro, not the billions needed for even the short-term - and which in any case do nothing to assist with Italy�s underlying structural deficit.

The structural problem that Italy is not really addressing is not just about its continuation of industrial subsidies and unprofitable state-owned monopolies. Italy also has a severe problem of an ageing population, which is storing up potentially the worst pension funding deficit of any European nation. The over 65s already account for close to 20% of the population, compared with half that in many European countries. Italy is the only sovereign nation within the EU to have a falling population. (Scotland also has a reducing citizenship, which is why it is particularly keen to see more migrant workers arrive from the EU�s new member states.)

Last year�s Economic Survey of Italy from the OECD concluded that Italy had deep-seated problems. It said that while tax cuts were desirable, they reduced fiscal policy flexibility and meant that additional corrective measures would be required for years to come, with the focus on bringing down the cost of public pensions and health care, and increasing public sector efficiency. Overall economic performance needed to improve by addressing competitiveness issues, such as reducing employment protection, requiring employees to agree more flexible contracts, raising the skills and educational level of the workforce and speeding up bankruptcy proceedings to enable quicker reallocation of commercial resources.

It should also be remembered that one of the priorities of Berlusconi when he entered government three years ago was to change the criminal law regarding fraud, which reduced the penalties for false accounting. In the wake of the Parmalat scandal it is instructive to note the judgement of Salvatore Bragantini, a former commissioner of stock market and accounting regulator Consob. �Italian book-keeping was never renowned for being correct in the past,� he was quoted as saying. �The changes encourage dishonesty. It is astonishing that the legislation arrived just a few months before scandals erupted that showed the need for tougher action on accounting crimes.�

New members to drive eurozone growth

As the size of the EU jumps by 10 this month, one important question is whether the euro currency will be able to cope with the new member states also eventually joining the eurozone. Average budget deficits amongst the new member states is 4.2% of GDP - above that predicted even for Italy. Nor are all the new member states� public finances moving into line with the Commission�s requirements. The Baltic States� deficits are growing, despite strong and prolonged economic growth. Hungary - perhaps the most economically advanced of the former Soviet new member states - has accepted that it cannot join the euro until 2009 at the earliest, and other countries may be forced to adopt the euro even later.

But the economic growth induced by enlargement could provide a stimulus which will drive an improved economic performance over much of the existing eurozone, believes the Commission. New members� growth rates are double those of established states. But the Commission�s latest economic outlook report suggests that it could take many years for all economic indicators to become favourable. Unemployment is expected to remain high in the former Communist states - it is currently hovering at about 14% - inflation is predicted to rise and fiscal deficits are expected to take some years to conform to the Stability Pact rules.

Nor is there consistency in economic performance between the new member states. Malta is quite prosperous, as is Cyprus - except for the Turkish occupied half of the island. At the time of accounting & business going to press it was still unclear whether only Greek Cyprus or the whole of the island would accede to membership. If Turkish Cyprus also joins, this will become one of the poorest regions of the enlarged EU.

The ex-Communist countries, too, contain significant poverty. But the picture is one of enormous divergence. Slovenia - always the most Westernised region of former Yugoslavia - is already approaching the income per head of existing EU member states and is almost equal that of Malta, at three-quarters of average EU GDP per head. Both the Czech Republic and Hungary are relatively affluent - at more than half the average GDP per head of the enlarged union. But Slovakia, Poland and the Baltic States all have severe economic problems, with Latvia showing GDP per head at little more than a third of the EU average.

And this is after a decade and a half of major Western investment, particularly in the Czech Republic, Hungary, Poland and the Baltic States. Investment flows continue to increase, with an expansion of 5.75% this year and 7.25% expected for 2005.

Recognising the challenge of integrating the new member states into the union, and the need for them to achieve economic improvement quickly, the Commission has published updated Broad Economic Policy Guidelines which are intended to provide further stimulus. The bedrock of this is stability in fiscal policy, with moves towards reducing budget deficits and wage rises geared to price stability and productivity gains.

The new member states are also expected to implement economic reforms which assist with the growth potential of Europe as a whole, assisting structural changes in the labour market, improved productivity, reductions in regulation, higher R&D and better developed capital markets. New members will also have to consider policies for social stability, enabling them to cope with ageing populations and to assist labour opportunities as the primary means of lifting citizens out of poverty. Governments should stimulate major investment programmes in the transport and energy sectors, promoting better environmental performance, while labour reform should include introducing more people into the labour market, raising training standards and vocational skills within the labour force, says the Commission.

Enlargement is not a guaranteed success, but the Commission - contrary to the mood of domestic politics in many member states - is strongly confident that it will provide real economic benefit across the whole of the EU.