FASB Polishes Valuation Rules
For Life Settlements
By Allison Bell
Members of the Financial Accounting Standards Board are moving ahead with efforts to put major new life settlement accounting rules in place by mid-2006.
Board members discussed the mechanics of implementing the proposed rules and related topics during a board meeting earlier this month.
The proposed rules could increase sharply the carrying value of life settlement companies’ portfolios of life insurance policies, and some FASB members said they wish they could let life settlement companies apply the proposed rules to 2005 financial statements.
Today, in the life settlement industry, “the accounting that exists is not good,” said George Batavick, an FASB member who is a former comptroller of Texaco Inc., Harrison, N.Y.
FASB, Norwalk, Conn., is the organization responsible for developing U.S. financial accounting standards.
A life settlement accounting guide that FASB issued in 1985, Technical Bulletin 85-4, requires companies that buy life insurance contracts to treat the policies as assets with values equal to or less than their cash surrender values. Life settlement companies can record income related to the policies and bigger asset totals only when the insureds die and death benefits arrive.
Because policy purchasers end up recording losses when they buy the policies, most U.S. life settlement “providers” act mainly as facilitators for life settlement transactions. The actual policy purchasers are investors, according to a comment letter that Brad Thompson, an accountant who belongs to the Viatical and Life Settlement Association of America, Orlando, Fla., sent to FASB in July on behalf of the VLSAA.
FASB members decided in October that life settlement companies can choose between two valuation methods that may produce values that are higher than the cash surrender value: the investment method and a fair value approach.
If a life settlement company uses the investment method, it can take the price it pays for a policy, add the amount of premiums it pays to keep the policy in force and count the total as the policy’s value as an asset.
If a life settlement company uses the fair value approach, it can use an estimate of the market value of the purchased policy.
FASB has set up a project to update the rules for estimating the fair value of life insurance policies in many different contexts, and it hopes to release those rules in a few months.
Some life settlement company executives told FASB in comment letters that they prefer the investment method because the lack of an active “tertiary” resale market for life insurance policies complicates efforts to estimate policy market values.
Board members decided at the latest meeting that a life settlement company ought to decide whether to use the fair value approach or the investment method on an item-by-item basis.
Board members also decided that life settlement companies should attribute cash flows associated with life policy transactions as the result of investment activities rather than as the result of operating activities.
Although some board members said they liked the idea of letting life settlement companies apply the new valuation rules to their 2005 financial statements, they emphasized the dangers of setting a troubling precedent.
In this case, FASB members said, life settlement companies would have an incentive to apply the investment method or the fair value approach to a specific life insurance policy based on knowledge about which approach would give the policy the higher current value.
In the past, “we have established the principle that we don’t want retrospective application where there is a potential for hindsight bias,” said Katherine Schipper, an FASB member who previously was a business professor at Duke University.
FASB members also talked about the importance of finding ways to protect life settlement companies from burdensome, redundant reporting requirements.
Leslie Seidman, an FASB member who managed her own accounting consulting firm, suggested that a company using the investment method should have to adjust policy valuations to reflect significant problems, such as deterioration in the condition of the company that issued a life policy or a major improvement in the life expectancy of the insured.
But a company should not have to make an active effort to seek out medical updates or adjust policy values to reflect fluctuations in interest rates, Seidman and other FASB members agreed.
Doug Head, executive director of the VLSAA, says his group is pleased with FASB efforts to replace the current focus on policy cash surrender values. “Anything is better than the current method,” Head says.
“Anything is better than the current method,” said Doug Head, executive director of the Viatical and Life Settlement Association of America, in approving of FASB efforts to replace the current focus on policy cash surrender values.
The proposed rules could increase sharply the carrying value of life settlement companies’ portfolios of life insurance policies