Members of the Financial Accounting Standards Board agreed Thursday to change the way companies calculate asset values when markets are inactive.

FASB, Norwalk, Conn., decided to keep the objective that holders of certain classes of securities should be using the current market value, or fair value, of the holdings, rather than relying on the prices in effect when the securities were acquired,

But FASB agreed that holders can use valuation methods based on estimates of future streams of cash flow, rather than current market price data, when markets are disorderly.

The board has asked the FASB staff to develop a written draft of FASB Staff Position Financial Accounting Standard 157-e, Determining Whether a Market Is Not Active and a Transaction Is Not Distressed.

FASB members will vote on the draft by written ballot at a later date, FASB says.

FASB critics have argued for months that rigid adherence to mark-to-market accounting rules — in some cases, driven by accountants who are afraid of being punished for providing any but the most conservative value estimates — has been forcing banks, insurers and other financial services companies to post unrealistic writedowns on the assets in their
trading portfolios.

FASB has been working on changes in the mark-to-market rules since late 2008.

Several members of the House Financial Services capital market subcommittee accelerated the process in mid-March, by threatening at a hearing to pass a bill imposing new accounting rules if FASB failed to ease mark-to-market accounting requirements within the next 3 weeks.

Rep. Alan Grayson, D-Fla., accused mark-to-market critics of wanting to “shoot the messenger” for exposing serious problems in their investment portfolios, and many investors and investor groups have written to FASB in support of mark-to-market accounting, FASB officials said during the meeting today.

During the meeting, participants compared the conflict over mark-to-market accounting to a “religious war,” and one accused financial services company regulators of shirking their own responsibilities.

Rather than asking FASB to change asset valuation rules, financial services regulators should be changing the way they handle risk-based capital minimums, a FASB member said.

FASB members made some changes to the fair value FSP draft.

One change would eliminate the proposed assumption that all transactions are distressed unless proven otherwise.

“The FSP will instead require an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence,” FASB says.

Another change would require an entity to disclose a change in valuation technique (and the related inputs) resulting from the application of the FSP and to quantify its effects, if practicable.

FASB also decided to go ahead with drafting a final version of a batch of guidance on Recognition and Presentation of Other-Than-Temporary Impairments. That guidance would take effect for quarterly accounting periods, annual account periods and other accounting periods ending after June 15.

The American Council of Life Insurers, Washington, has put out a statement welcoming FASB’s action on the mark-to-market issue.

“Market values do not necessarily reflect ‘fair values’ in an illiquid or inactive market, and the use of some judgment is important when determining the value of securities in these economic conditions,” Steven Brostoff, an ACLI staffer, says in the statement. “Life insurers, being long term investors, can hold investments through short-term market price gyrations to capture the underlying economic value from fixed income securities, and the current asset valuations do not accurately reflect insurers’ ability to do so. As a matter of fact, we would like to see the FASB go even further and address the industry’s need for a broader use of the ‘held-to-maturity’ asset category.”

John Berlau, a FASB watcher at the Competitive Enterprise Institute, Washington, says Congress was right to prod FASB to act on the mark-to-market accounting rules.

The issue “affects all of us,” Berlau says.

Insurance Contract Valuations

FASB also considered an insurance contracts measure at today’s meeting.

FASB has been trying to work on the standard with the International Accounting Standards Board, London, which, in turn is seeking to replace of an “exit value” approach with a “fulfillment value approach.”

The exit value approach depends on the cost or gain from transferring obligations to another entity. Critics of the exit value approach have said that the approach is unrealistic, because insurers often have a hard time transferring all risk associated with contracts to other entities.

A contract’s “fulfillment value” is “the expected present value of the cost of fulfilling the obligation to the policy holder over time,” according to IASB.

Today, FASB members talked about which strategy for estimating cash flows an entity should use when measuring the fulfillment value of an insurance contract.

One approach would be to come up with a best estimate of future cash flows. Another approach, preferred by the FASB staff, would involve using models to the estimate the probability of various outcomes, then producing an estimate by adding up the “probability-weighted” amounts.

“The board agreed that a measurement of the fulfillment value of an insurance contract should use expected cash flows rather than a best estimate of cash flows,” FASB says. “The board also agreed that those expected cash flows should be updated each period.”

The measurement of future cash flows should include all available information that “represents the fulfillment of the contract,” including “industry data, historical data of an entity’s costs, and market inputs when those inputs are relevant to the fulfillment of the contract,” FASB says.

A FASB summary of the events that took place at today’s meeting is available here.