FAS 133 Rules Could Impact EIA Insurers And Marketplace

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La Costa, Calif.

No one really intended FAS 133 to impact equity index annuity insurers adversely, but thats just what could happen, said Michael J. OConnor at a meeting here recently.

FAS 133the moniker for Statement of Financial Accounting Standards No. 133–is the new set of rules on accounting for derivatives under Generally Accepted Accounting Principals. Though the new rules apply to all types of United States companies, they particularly affect EIA insurers, putting them into a new reserving environment, said OConnor.

A consultant at Tillinghast-Towers Perrin in Minneapolis, Mn., OConnor made his remarks at the annual meeting of National Association for Indexed Annuities, Maryland Heights, Mo.

The Financial Accounting Standards Board has worked on developing the FAS 133 rules for several years, and companies were required to adopt them in the first quarter of 2001, he told National Underwriter in a separate interview.

The goal is to establish uniform practices on derivatives accounting across all industries, he said, explaining that there had previously been “tremendous divergence in this accounting.”

However, OConnor said, it may turn out that the new rules will create some problems for EIA insurersones that could affect product availability and insurance company staying power in the EIA marketplace.

Under FAS 133, he explained, insurers have to value a portion of their EIAs as a derivative (since index products link their credited interest to an equity index). But interpretations on how to do these valuations vary, he said, and since most insurers are not audited until year-end, uncertainty is continuing about how auditing firms will handle this.

In OConnors view, the rules have introduced a type of “disconnect” between economics and accounting for certain EIAs. “The problem is, how much of a product the company will say is a derivative,” he said.

“Say that an annual guarantee EIA has a premium of $100, and the insurer buys a hedge for $4 that will support this guarantee. The implication of FAS 133 is that the insurer may have to establish, say, a $20 reserve for the equity-linked portion of the EIA–even though the $4 option fully hedges the insurer,” he explained.

For EIA customers and agents, this presents no direct or immediate implications, OConnor said. But indirectly, it could have marketplace impact.

For instance, he said, if EIA insurers start pricing for this accounting volatility, they might then decide to reduce the participation rates in their products. “That could affect the competitiveness of the products, and therefore sales overall,” he said.

“Meanwhile, “the EIA companies themselves could end up with more earnings volatility, even if they are hedging their EIA risks perfectly.”

Big public companies, in particular, will not like that, OConnor said, because “they hate earnings volatility.”

Also, FAS 133 could present too much volatility for medium-sized companies that currently have a lot of EIA volume, the consultant continued. “Furthermore, the rules could make it harder for smaller insurers to get going on new EIA products.”

Accounting firms have been warning EIA insurers about the implications of FAS 133, he added. But up to now, “insurers have not fully understood how much of an impact the rule could have, or why.”

Thats partly because the issue papers on FAS 133 and EIA calculations for some did not come out until December 2000, he said. Even now, some of those papers are still being digested.

Also, OConnor noted, only 12 insurers currently have sizeable blocks of EIA business. There arent enough of them to give a lot of attention to the issue, he said.

What can be done? “Until the interpretations are in black and white, it will be hard to determine the impact on particular companies,” OConnor said.

He suggested the best outcome would be to “remove the disconnect, so that earnings emerging from the product reflect the economics of the product and how the insurance company hedges its EIA guarantees.”

To start things moving in this direction, he said insurers and their accounting firms should consider discussing the issue jointly with the Derivatives Implementation Group, which helped FASB develop the issue papers put out last December.

At its annual meeting, NAIP discussed coordinating such an effort, but it did not decide whether it would do so.


Reproduced from National Underwriter Life & Health/Financial Services Edition, October 8, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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