Enquiry:

We would like to draw attention to the ICAP’s Technical Release (TR) – 22 which provides professional guidance for the computation of book value per share of a company. As per the TR – 22, shareholders’ equity is used as a basis to compute the book value per share and the components of shareholder’s equity are stated to include the following:

• Paid up capital
• Revenue reserves and retained earnings (less accumulated losses if any).
• Capital reserves
• Surplus created as a result of revaluation of fixed assets.

In a peculiar situation of Life Insurance Companies operating in Pakistan, the insurer is also required by law (the Insurance Ordinance 2000 and SECP Insurance Rules, 2002) to maintain separate Statutory Funds in respect of assets, liabilities, equity and profit or loss attributable to the life insurance business. The statutory funds so maintained are presented separately in the financial statements from the shareholder’s fund.

In order to comply with the solvency requirements under the applicable life insurance regulations, the life insurance companies are required to maintain required amount of equity balance (including capital contribution and retained earnings) in the statutory funds at all times. However, as the equity balance in the statutory fund is arrived at after deducting all liabilities including those pertaining to the policyholders, this equity by its nature and substance represents shareholder’s interests in the statutory fund which is held to meet the solvency requirements. Therefore, for the purposes of determining the book value or breakup value per share of a life insurance company, the equity balance in the statutory fund should be taken into account as otherwise the book value or the breakup value will not be reflective of the total shareholder’s interest in the entity.

The requirements to maintain capital for regulatory, solvency and risk management purposes is not only limited to insurance companies but also is common with other entities operating in the financial services sector such as banks. The capital retained and held by banks, for instance, to comply with the capital adequacy requirements set by the State Bank of Pakistan or to maintain statutory reserves, is always taken as part of the shareholder’s equity for all purposes.

It would be pertinent to mention that this conceptual position regarding the equity balance of statutory funds is also recognized under the draft insurance regulations issued by the SECP with the recommendation of ICAP. As per the draft regulations the equity of statutory funds and shareholder’s funds is combined to state a single equity position in the balance sheet which is also in line with the IFRSs and Practices.

In view of the above, we request the Committee to confirm our understanding that the equity balance appearing in the statutory fund should be included for breakup value calculation.

Opinion:

The life insurance companies are required to maintain statutory fund/(s) in accordance with the provisions of the Insurance Ordinance, 2000 and the related rules.

Further, the life insurance companies are also required to comply with the solvency requirements, and maintain an amount of the retained earnings in the above mentioned statutory fund/(s) at all times. Accordingly, the statutory fund/(s) of the insurance companies is an aggregation of the amount of the policyholder’s liabilities and amount of retained earnings locked-in the statutory fund/(s), pursuant to the solvency requirements applicable to the life insurance companies.

The currently applicable law to the insurance companies, i.e. Insurance Ordinance 2000, does not provide for the aggregation of equity balance of the statutory fund/(s) with the shareholder’s funds.

Presently, the life insurance companies are required to prepare their financial statements in accordance with the form/format prescribed by the SECP, in the SEC (Insurance) Rules 2002. In accordance with the above referred form/format of the financial statements, the statutory fund/(s) (containing the policyholder’s liabilities and amount of locked-in retained earnings) is presented separately after the net shareholder’s equity.

The Committee would also like to refer clause 14, ‘Shareholder interests in statutory funds’ contained in the Annexure II of the SEC (Insurance) Rules 2002, which states that:

(1) The shareholders’ fund shall not recognise as an asset any interest in, entitlement to the assets of or capital transfer provided to any statutory fund.

(2) A capital transfer provided to a statutory fund by the shareholders’ fund shall be recorded as a debit balance in shareholders’ equity, clearly identified as capital contributed to statutory fund, and changes in the amount of capital contributed to statutory funds shall not pass through the profit and loss account but shall be recorded in the financial statements of the shareholders’ fund as increases or decreases in that debit balance.

(3) No statutory fund shall recognise as a liability any amount due to the shareholder’s fund consisting of a capital transfer received from a shareholder’s fund, or retained profits attributable to shareholders, or any loan or advance, other than a current liability consisting of amounts due to the shareholder’s fund on account of expenses due to be reimbursed to the shareholder’s fund.

The Committee considers it pertinent to mention that the SECP has issued Insurance Rules 2017 and Insurance Accounting Regulations 2017 (Regulations 2017), on February 13, 2017. These rules and regulations supersede the SEC (Insurance) Rules 2002 and Insurance Rules, 2002. Further, the provision 6 of the Regulations 2017, applicable to the financial statements of life insurance companies, explain that the balances retained within the statutory funds over and above the insurance liabilities shall be treated as part of shareholder’s equity, and the balances in Ledger C and D shall be included as part of the Shareholder’s equity.

However, it is to be noted that the requirements of the Regulations 2017 are effective for the financial statements for the periods beginning on or after April 01, 2017. Consequently, the financial statements of the life insurance companies till the period ending March 31, 2017 should be prepared in accordance with the requirements of SEC (Insurance) Rules 2002.

In view of the above, the present applicable legal position makes it clear that shareholders’ fund/equity do not include any balance that is held in the statutory fund either on account of capital contribution or retained earnings.

The Conceptual Framework for Financial Reporting defines equity as the residual interest in the assets of the entity after deducting all its liabilities. Based on this, the above referred locked-in amount of the retained earnings in the statutory fund/s is ‘equity’; which will remain in the statutory fund/s to meet the solvency requirements and will not be available to the shareholders at the period end date.

However, it is to be noted that the provisions of the Companies Ordinance 1984, Insurance Ordinance, 2000 and SEC (Insurance) Rules 2002, regulations and directives will prevail over the IFRSs.

The Insurance Ordinance 2000, and related rules and guidelines do not provide the basis/mechanism for the computation of book/break-up value of life insurance companies. However, the Institute’s Accounting Technical Release (TR)-22 (Revised 2002), ‘Book Value per Share’, explains the basis for the computation of book/break-up value of shares. The relevant part of TR-22 is reproduced as under:

“Book value per share in the equity capital of the company is the amount each share is worth on the basis of carrying value per balance sheet, prepared in accordance with a framework of recognized accounting standards. Such standards provide that:-

(a) An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

(b) A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”

The computation of the book value per share under TR-22 is dependent on the recognition of the asset and liability in accordance with the framework of recognised accounting standards that provide the stated definitions.

However, TR-22 also outlines the basis for the computation of break-up value of share for the surplus on revaluation of fixed assets, as it is not a part of the equity on the balance sheet but is also not a liability. In case of revaluation surplus, TR-22 allows for the computation of an additional book value per share, though referring to the comparability purposes. The relevant part of TR-22 is reproduced as under:

“If the balance sheet of an entity includes balance of surplus on revaluation, the book value per share should be computed separately both, including and excluding such surplus, to enable comparability with those entities where fixed assets have not been revalued”.

Conclusion:

Based on the above, the Committee is of the view that the computation of break-up value per share of the life insurance company should be in accordance with the basis set out in TR-22. In view of the currently applicable financial reporting framework, in relation to the shareholders’ equity required to be maintained in the statutory funds, the life insurance company’s break-up value per share should be computed separately both, including and excluding such shareholders’ equity.

(February 15, 2017)