Insurers are assessing how a recent public comment draft paper on insurance contracts issued by the International Accounting Standards Board, London, will impact the insurance business in the U.S.
The topic of insurance contracts is also being examined by the Financial Accounting Standards Board, Norwalk, Conn., in an attempt to decide whether to make the effort a joint project with the IASB.
The IASB draft proposes guidance that incorporates a fair value approach to recognizing liabilities. IASB cites 3 building blocks to its proposal:
Explicit, unbiased, market-consistent, probability-weighted and current estimates of the contractual cash flows.
Current market discount rates that adjust the estimated future cash flows for the time value of money.
An explicit and unbiased estimate of the margin that market participants require for bearing risk (a risk margin) and for providing other services, if any (a service margin).
Among the benefits that IASB says it believes will be accrued are:
Consistency with other International Financial Reporting Standards (IFRSs) that require current estimates of future cash flows in measuring non-financial liabilities and financial liabilities.
Clearer reporting of economic mismatches between insurance liabilities and related assets, and a reduction in accounting mismatches.
Consistency with observable current market prices, to the extent they are available. Such prices provide an understandable and credible benchmark for users, even though market prices are not available to support all inputs used in measuring insurance liabilities.
If FASB adds this to its agenda, then it will be a “revolution for insurance accounting,” says Doug Barnert, executive director of the Group of North American Insurance Enterprises, New York. GNAIE has been monitoring proposals that could impact international accounting requirements and impact both insurers’ international and domestic accounting.
Fair value impacts accounting measurement, deferred acquisition costs, classification of assets and liabilities as well as treatment of gains and losses, he notes. It is as important to accounting as the National Association of Insurance Commissioners’ development of a model investment law was to investments.
Barnert adds that when you go to an asset-liability model, then it is important that the P&L statement is “realistic and not unnecessarily volatile.” Looking at liabilities without also looking at assets will create volatility, he says.
The IASB draft examines whether insurers should be allowed to show future dividend payments for participating contracts when determining liabilities, Barnert says. Allowing such information to be shown is important because this is information that investors want to know, he adds.
However, while IASB says the changes will create benefits, insurers are less sure. They are expressing concerns about the impact such changes would have on their balance sheets. Although trade groups are still vetting the IASB document, released on May 3, they offered some initial thoughts. Comments are due by November 2007.
The American Council of Life Insurers, Washington, is currently monitoring these potential accounting changes through GNAIE, according to ACLI spokesperson Whit Cornman.
One concern is that many of these concepts are untested, says Phil Carson, assistant general counsel with the American Insurance Association, Washington. For instance, he notes concern over issues including risk margins and discounting, and the paper’s reference to market standards when there are currently none.
Additionally, the concept of fair value is being introduced without any guidance about how a company should reach fair value, he says.
The proposed treatment of liabilities could create variability of results, Carson cautions, adding that there is concern about the issue of risk margins–margins that are created to adjust for uncertainty regarding the liability’s value.
The proposal involves “radically different methods of recognizing insurer liabilities and reserves,” says Bill Boyd, financial regulation manager with the National Association of Mutual Insurance Companies, Indianapolis.
Currently, in the property-casualty industry, liabilities are recorded at nominal value and are not discounted for the time value of money, he says. The approach that p-c insurers use now is conservative and has worked well, Boyd says.
The IASB proposal is of concern to mutual companies because if recommendations in the proposal become standards for GAAP accounting, there is a good chance that they will be incorporated into statutory accounting, he explains.
Members of the Property Casualty Insurers Association of America are just starting to examine the IASB proposal paper, says Jim Olsen, director of insurance accounting and investments with the Des Plaines, Ill.-based trade group. Among the issues that PCI will examine, he says, are the creation of risk margins and how the exit value of reserves is reached.