The Financial Accounting Standards Board could respond to the finite reinsurance controversy by forcing policyholders to treat a portion of many types of policies, including group life and group health policies, as a deposit.

FASB, Norwalk, Conn., has released an “invitation to comment” on the idea of “bifurcating,” or splitting, financial reporting of what it describes as the “insurance risk transfer components” and the “financing components” built into insurance and reinsurance contracts.

Organizations could use existing accounting guidelines to report transfers of traditional insurance risk. Policyholders could record premiums for those transfers as expenses and record any insurance recoveries as gains in income, the authors of the invitation to comment write.

If that proposal took effect as is, organizations would have to treat financing components as deposits and include those components in reporting of assets. When the holder of a policy with a financing component collected on a claim, “any recovery from an insured event would reduce the deposit and not have a significant income statement benefit,” the authors write.

FASB would allow organizations to stick automatically with traditional expense accounting rules for policies that “unequivocally transfer significant insurance risk,” according to the invitation authors.

Those policies might include individual life insurance policies and “a single-risk reinsurance contract under which all the insurance risk in the reinsured portion of an underlying insurance contract is reviewed by the reinsurer, who may decline coverage for that risk.”

But FASB is thinking about the possibility of requiring a split in reporting for typical group health and group life insurance contracts.

“A portion of the premium for group and similar contracts compensates the insurer for the likely payment of expected claim losses,” the invitation authors write. “That arrangement is adaptable to bifurcation and deposit accounting. Similarly, portfolios of contracts that qualify individually as unequivocal insurance contracts would have expected losses. Contracts that reinsure these portfolios would not meet the unequivocal test because those contracts also would have an expected level of claim activity. Accordingly, arrangements that provide for reinsurance of any portion of business written by the reinsured would be subject to further bifurcation testing.”

In the invitation to comment, FASB is asking members of the public to discuss the definition of insurance risk and whether they like the idea of bifurcation of reporting.

FASB also is asking for comments about which contracts should be bifurcated and how contracts should be bifurcated.

FASB board members have been looking into the possibility of updating insurance and reinsurance financial reporting rules because of tales of companies using complicated finite reinsurance arrangements that appeared to transfer little insurance risk to spruce up financial statements.

FASB board members began considering the topic of bifurcation at a December 2005 board meeting.

The American Council of Life Insurers, Washington, is greeting the release of the FASB invitation to comment with skepticism.

ACLI committees still are reviewing the invitation, but in the past, “ACLI has made it clear that an insurance contract has to be viewed in its entirety, not in separate parts,” says Jim Renz, the ACLI accounting policy director. “We anticipate taking that same approach in our filing with the FASB on its bifurcation proposal.”

Jonathan Woodruff, a lawyer at Wiley Rein & Fielding L.L.P., Washington, says insurers and insurance buyers should pay close attention to the FASB bifurcation proposal even if they have no contact with finite reinsurance. “FASB’s invitation casts a wide net,” Woodruff says.

The FASB bifurcation proposal could require some use of deposit accounting for quota reinsurance arrangements and a variety of commercial property-casualty insurance arrangements as well as group life and group health policies and finite reinsurance arrangements, Woodruff says.

“We expect there to be significant industry reaction to the invitation by policyholders, insurers and accountants,” Woodruff says.

Much of the reaction likely will focus on whether the expense and complexity of bifurcation will outweigh the anticipated benefits, Woodruff says.