Change in the wind

It is nearly two years since goodwill and other intangible assets were banned by the Financial Services Authority from being used by insurance brokers in calculating their capital resources requirements.

Given that many insurance brokers had relied on the value of these assets, especially those that had been going through a period of consolidation, in valuing their businesses, the move presented them with a headache. There were several options available to mitigate the impact from recourse to investors' and owners' own resources for capital to make up any shortfall to selling the business. The use of holding companies was mooted, though the FSA clearly said at the time that such a move would be heavily scrutinised.

The regulator's actions placed complex accounting issues at the forefront of brokers' minds; even though the goodwill issue has been addressed (firms can still account for goodwill in their usual way, they just cannot add it to their regulatory returns) there are plenty of other matters keeping brokers and their accountants on their toes.

Broadly, these include whether it is appropriate to use International Financial Reporting Standards or the UK's system - known as the Generally Accepted Accounting Principles - though even here the waters are about to be muddied by the introduction of International Financial Reporting Standards for small and medium-sized enterprises. There is to be considered the impact that accounting standards can have on acquisitions and mergers, on acquiring additional finance and how proposals to changing accounting policies for insurance contracts could affect the products insurance companies are willing to sell. There is also the vexed issue of accounting for creditors, debtors and cash.

Concerning tax, there are implications for brokers following the hike in marginal income tax rates to 50% for those earning above £150,000. There has been the government's tinkering with the value-added tax rate - due to switch back to 17.5% in January 2010 - but at the same time there is the European Union initiative that will see VAT charged at the rate prevalent where a customer is established, not where the provider is based.

Even domicile is now on the agenda, with brokers looking to capitalise on more favourable tax rates in other jurisdictions.

Hunting goodwill

It is still worth looking at how the profession is dealing with accounting for goodwill because the spotlight has been shone so vigorously on this area in the past.

Last year, accountancy firm Littlejohn reviewed the accounting policies of the 50 largest insurance brokers to see how they accounted for intangibles and what impact a change in accounting policy might have on the brokers' books.

Under UK GAAP, Financial Reporting Standard 10 states that goodwill and other intangible assets should be recognised as an asset on the balance sheet and amortised - written down smoothly over a set period of time - on a systematic basis over their useful economic life, usually but not always over 20 years. However, International Financial Report Standards, IFRS 3 and International Accounting Standard 38 state that goodwill and other intangible assets should be recognised as an asset on the balance sheet, that it should be reviewed for impairment and revalued and written down as appropriate each year, or more frequently if events or changes in circumstances indicate that it might be impaired.

In the Littlejohn review, most of the firms report under UK GAAP with only seven having adopted IFRS. According to John Needham, insurance partner at Littlejohn, this situation remains today.

The review found there were significant intangible assets - predominantly goodwill - on the firms' balance sheets. In fact, 81% of the net assets of the 45 firms reviewed were goodwill.

Why should this matter? The Littlejohn analysis found that six firms would have net liabilities if intangible assets were removed from the balance sheet. It found that one firm would turn from profit to loss if the amortisation period were reduced from 20 to 10 years while three firms would halve their profits.

"There's no real consistency there, though no driver to change the situation," Needham comments.

The analysis raised the question of whether or not firms would benefit from a change to IFRS, where intangible assets are subject to annual impairment review rather than an annual amortisation, with such a change potentially improving future profits for some firms by a significant margin. It is worth considering, though of course there would be no going back if an insurance broker subsequently wanted to switch back to UK GAAP.

However, there would be implications for firms going down the consolidation route through the acquisition of other brokers.

"IFRS really makes you look a bit harder at what it is you are acquiring, so rather than just recognising big chunks of goodwill, it is broken up into different intangible assets such as customer lists," says Danny Clark, associate partner at KPMG's insurance practice. He continues: "Under UK GAAP, that would all be part of goodwill. Also, under IFRS, goodwill is not amortised, it stays on the balance sheet and is subjected to an impairment test every year, which means that in the good times the asset stays on the balance sheet, but in the bad times there is a risk that you take some lumpy impairment charges through your P&L account."

This will put pressure on some brokers. "Individually, they will have to look at the acquisitions they have made - it is inevitable that there will be some writedowns, depending on the multiple they paid and at what stage. There were higher multiples being paid towards the end of the boom period," Clark remarks.

Going international

The amortisation versus impairment debate is set to crop up again as the UK body responsible for setting accounting rules - the Accounting Standards Board - considers effectively ditching UK GAAP to replace it with a slimmed-down version of IFRS from 2012.

More than a hundred countries make use of IFRS but there has been a growing demand for the International Accounting Standards Board to produce a regime more suited to entities without public accountability, which finally led to the publication earlier this year of the IFRS for SMEs. Despite the title, the standard is applicable not only to SMEs but to all entities with no public accountability. This means that it will be suitable for most subsidiaries of listed companies as well as large private entities, as long as they are not publicly accountable.

IFRS for SMEs is a much-simplified version of full IFRS. It takes into account the needs of users of financial statements of non-publicly accountable entities and the costs and benefits of compliance. It is small in comparison to IFRS, with only a tenth of its larger sibling's 3,000 disclosure requirements.

Under IFRS for SMEs, acquired intangibles - including goodwill - must be amortised, with a default useful life set at 10 years. As mentioned above, UK GAAP also requires mandatory amortisation, with an assumed maximum useful life of 20 years while IFRS requires that goodwill be tested for impairment.

If a broker has an annual turnover of less than £6.5m, a balance sheet of less than £3.26m and no more than 50 employees - then there will be the option to use the ASB's existing Financial Reporting Standard for Smaller Entities. Otherwise, it would be as well to prepare for the arrival of IFRS for SMEs.

According to accountancy firm Deloitte, firms will have the benefit of learning from the experience of those larger, listed companies that switched to full-blown IFRS in 2005. "The concept of changing GAAP will be new to many," a spokesperson for the firm says, though planning in advance would mean that the transition should be paced, with costs kept under control and unwelcome, last-minute surprises kept to a minimum. "The year 2012 may sound like a long way off but remember that an opening balance sheet would be required in 2011," the spokesperson warns.

A relevant side issue is the ability of insurance brokers to use goodwill as an asset when taking on debt to acquire other businesses. There had been a fear that, following the FSA's changes at the beginning of last year, that such facilities would be more difficult to broker. Not so, says a leading lender, Australian bank Macquarie. "It has been business as usual for Macquarie," says associate director Aden Nguyen. He continues: "Our lending is not based on the balance-sheet value of goodwill but rather on the strength of the underlying recurring revenue streams and profitability that will ensure that the debt can be serviced comfortably." Nguyen anticipates continued consolidation in the market: "We have found that there are still many transactions to be done, particularly with sales multiples coming back in line after the peak of the market two years ago."

Creditors, debtors, cash

According to Steve White, head of compliance and training at the British Insurance Brokers' Association, how brokers account for client money and credit writebacks continues to be a key issue for brokers. This is a view shared by, among others, Littlejohn's Needham, who highlights: "How you recognise debtors and creditors is an ongoing debate."

According to Needham, under UK GAAP and guidance from the London Market Brokers Committee, it has become market practice for brokers to recognise the amounts due to and due from clients and insurers, even though in most cases those funds will be held in trust. "There's one school of thought that says these assets aren't those of the company and therefore it is wrong to put them on the balance sheet," Needham comments. He continues: "The other school of thought says that the broker earns interest and pays bank fees and so on in relation to these cash balances and will be entitled to earn interest on them. If you are earning interest then it meets the definition of being an asset and should be on the balance sheet."

IFRS tends not to recognise these balances as assets because it forces brokers to do an asset recognition test, yet market practice has remained the same. There are some implications should these balances are removed from the balance sheet. The first is that it could make the company appear much smaller and therefore fall under different rules and exemptions as set out in The Companies Act (2006), such as audit thresholds and accounts disclosures. "Presenting these balances in a different way can drop you from a medium-sized company to a small company," says Needham.

He explains: "The other issue is that it is a real pain to split all of your actual debtors, such as brokers' commission income, which creates more work and the need to change systems to produce the reports."

However, it is believed that millions of pounds is sitting in client accounts that cannot be appropriately accounted for, giving rise to the possibility of credit writebacks.

The FSA has issued guidance on how brokers can appropriately deal with writebacks, that is to say transfer money out of client accounts that cannot be accounted for or is unclaimed. For instance, balances held in the client money account may consist of longstanding legacy items created by data transfers or business acquisitions that do not permit firmly evidenced conclusions to be drawn as to their nature.

The regulator stresses that directors should assess whether or not there is sufficient persuasive evidence available to allow a writeback and states that this will include satisfying auditors in the context of fair presentation of financial statements in line with relevant GAAP.

The FSA says: "We expect that, when asked to do so, a firm should be able to confirm to us the basis on which it was able to satisfy itself that the credit writeback was appropriate."

Solvency too

Finally, brokers should be aware of how issues affecting insurance companies can have a knock-on effect for their own businesses. The IASB is discussing a standard for accounting for insurance contracts - an exposure draft of which is due to be published towards the end of this year. Experts believe there will be subsequent effects for brokers.

"Brokers are likely to be affected indirectly because the accounting for the underlying contracts changes the profit profiles, so there may be pressure on commission structures to change as well," says KPMG's Danny Clark. "It may well be in the life industry that certain contracts become far less attractive to insurance companies themselves and they may look to shift capital towards other sorts of business."

It is a similar situation with Solvency II; the Association of British Insurers is warning that insurance companies might need, collectively, an additional £50bn to maintain required capital levels. "Brokers need to keep on top of these changes," Clark advises.

As well as grappling with accounting issues, brokers are facing challenging tax changes. On the personal side, there is the effect of a new 50% income tax band for those earning more than £150,000, which is due to kick in from April 2010.

Changes to national insurance contributions and personal allowances at the same time will have an impact on those earning above £100,000. As well as the direct impact this will have on brokers' own pockets, it will present problems with attracting and retaining good-quality staff.

Then there is VAT - the switch back to a rate of 17.5% from the start of next year should be straightforward enough, assuming that brokers coped when it was reduced to 15% in December 2008. However, European rules to modernise VAT systems - due to start from the beginning of 2010 - will have an impact on those brokers doing business in other European countries because the rate will be that applicable in the country of consumption, not where the seller is established.

Finally, brokers' domiciles are on the agenda because both corporates and individuals investigate the advantages of moving to more favourable tax jurisdictions.

The increase in income tax rate to 50% for those earning above £150,000 is, according to David Powell, a director of corporate tax at KPMG, a "headline issue".

"Some of the brokers' star people are going to be in this bracket, so what are they doing about it?" Powell asks. He continues: "The problem is that the legislation is unlikely to be repealed and we can't rule out changes to income tax in the future. Short term, they need to consider how to secure the existing 40% tax rate, perhaps by accelerating income into this tax year. For the longer term, they need to look at how they structure their remuneration, perhaps delivering some reward in the form of capital, which should be subject to tax at 18% rather than 50%. It is not efficient to just have salary and a defined benefit pension scheme, that just doesn't work any more."

Areas that could help include tax-efficient share rewards, which would shift remuneration into the capital gains tax system, the rate for which stands at a comparatively small 18%.

However, Powell makes the point that it would not look good if brokers concentrated solely on their high earners when looking at remuneration planning. He suggests that employers could look at salary sacrifice schemes for their lower paid staff; some benefits can be treated as tax-free, which effectively increases take-home pay.

VAT back

In addition to the rate of VAT returning to 17.5%, which has an extra cost for partially exempt businesses, brokers also need to ensure they are on top of the European moves to modernise VAT next year. Powell warns: "There could be some nasty surprises for brokers. For example, where a broker has a large operation such as a call centre that is based in India, for example, these services would not have attracted a VAT charge ordinarily. From next year, because the customer is in the UK, a VAT charge is likely to be applied. Anyone with cross-border activities should take advice to explore whether the potential charge can be mitigated."

With the news that some insurance companies, such as Brit, are moving abroad to take advantage of more favourable corporate tax rates, it is not surprising that this is an issue that some brokers are exploring.