Accounting is the systematic and comprehensive recording of financial transactions pertaining to a business, or so one dictionary would have you believe.
In fact, when it comes to global insurance, reinsurance and annuities markets, things are working out a lot different.
Way back in the 1860’s, on a visit to London, Elizur Wright was so shocked at the sight of elderly men auctioning off their life policies to speculators that he set out on a mission to establish the foundations of the modern insurance industry.
For so long, insurance was governed with some very important yet straightforward rules; assets should at least cover liabilities. In real terms that insurers sold policies, accepted policy premiums and made sure that they would always have enough funds on hand to pay out policy benefits. And, in order to achieve this, they invested money wisely, in safe investments, including bonds.
But time moved on and many of the original Life insurance companies moved on from being mutual in nature to becoming publicly traded organisations where profits trump prudence.
Across the US, insurance companies are increasingly taking greater risks in how they invest funds; this includes Life insurance as well as annuities which millions of people rely on for retirement income.
Hollow assets and creative accounting
Various state requirements and so-called ‘permitted practices’ are creating more and more shell games and increasingly creative accounting where assets that are supposed to underpin the financial structure of various insurance companies are little more than worthless I.O.U’s, in effect, they are underpinned by hollow assets.
Aside from denying state’s of tax revenue, this creative accounting is also at risk of undermining the very nature of the foundations that Mr. Wright fought for.
Glass-Steagall all over
The repeal of the Glass-Steagall Act is widely cited as the catalyst that eventually led to the financial crisis of 2008. Under Glass-Steagall, banks commercial and investment activities were strictly separated. Some observers, especially those in banking dispute this but overwhelming opinion agrees that the repeal was a disaster. The bottom line was old-fashioned banking was safe banking and reforming a law that had served so many for so long was ever only going to serve a few and hurt many. This is exactly what happened and it has had massive global implications.
Something similar now seems to be taking place in the global insurance markets where ‘black box’ activities, shell games, propping up of balance sheets, hollow assets, permitted practices and financial alchemy are all taking the place of safe investing strategies. And we all know what happens when creative accounting replaces the time-proven practice of safe investing; the tax payer generally ends up paying!
When it comes to investing for the future, reading and interpreting key financial data is key to your investing success. If you cannot read the accounts of companies you invest in then your chances of success will be limited by lack of core information.
Frank Conway is a qualified financial advisor and author of Cents & Sensibility – a financial guide for young adults. He provides corporate financial training and personal investment advice.