The IAS learning curve: the imminent arrival of international accounting standards has profound business implications for insurers.

Enormous challenges lie ahead as the life industry prepares to adopt international accounting standards, now officially known as international financial reporting standards. The standards will represent a fundamental new financial management framework for insurers--one that requires a redefinition of how management prices products, establishes investment strategy, manages asset/liability positions, measures performance, and communicates that performance to the marketplace. Most pressing in the near term is the need to execute a complex global project in which the rules and deadlines continue to change.

Without question, the industry expects IAS to produce significant changes in the pattern of reported earnings and in their volatility, as well as increased volatility in reported equity. In Phase I, executives will have to fundamentally change the way they think about the business and assess its performance. In Phase II, that challenge will be magnified by the anticipated requirement for fair-value reporting of liabilities.

At this point, however, insurers appear to be devoting little attention to the need to define and enhance their financial planning and analysis methodologies. Business planning, evaluations of the financial impact of major decisions, and strategy development are all conducted within the framework of a reasonably well-understood financial reporting structure. IAS changes all that--but companies have yet to realize it.

As we move into Phase II, reporting patterns and reported earnings volatility under IAS will undoubtedly lead to changes in product design and investment strategy. Investment strategies for products with book-value guarantees almost surely will move toward a tighter matching of assets and liabilities to avoid being hammered by earnings volatility. Products that rely on the broad smoothing of equity returns will become very difficult to manage, since earnings will be even more volatile. And investment strategies that are based on sustaining book returns to maintain reported earnings levels likely will be abandoned, since total return results will be all that counts under the IAS model. Clearly, a period of turmoil lies ahead as management adapts to these realities.

Another major challenge throughout the transition will be managing communications to analysts, investors, and rating agencies. Analysts are just beginning to understand the impact IAS will have on how they evaluate company performance. It appears that few companies have had anything but the most superficial IAS discussions with analysts, who have been making it known that they will look beyond the IAS financial statements for insights on performance. That reaction by analysts is disturbing, for it could be seen as indicating a major failure in the design of a system intended to provide useful information to investors.

This same problem will exist with ratings agencies. Over time, the methodologies and processes that currently underlie financial analysis, the setting and use of performance and operating ratios, and the establishment of target levels for capital and earnings all will have to be changed to accommodate IAS. All of this suggests that companies should begin now to educate analysts and ratings agencies about the coming changes and what they believe will be the important measures and standards that will emerge from the new reporting requirements.

Once Phase II arrives, communications with analysts will be even harder, given the continual changes in financial position and results built into the fair-value system. This will likely put further pressure on companies to move toward more frequent reporting and faster earnings releases. Finally, many believe that IAS will cause a complete cessation of the practice of providing earnings guidance, which is already on the wane. With results so heavily dependent on unpredictable market movements, estimating future results will become nearly impossible. This will make it even more difficult to manage investor expectations.

Our sense is that the market continues to be focused on near-term IAS implementation challenges. But given the huge learning curve that lies ahead, chief executive officers and chief financial officers must begin to look beyond implementation to the challenge of managing in an entirely different financial framework--one in which old measures of results and key performance indicators will no longer be relevant. Nothing less than a full redefinition of how the new financial information will be embedded in business management processes will be needed during the next several years.

Robert W. Stein, a Best's Review columnist, is chairman of Global Financial Services for Ernst & Young. He may be reached at [e-mail].