Industry wary of direction on FASB insurance contracts

Some investors and insurers are concerned that the Federal Reserve Board may be backing the wrong horse in insurance contract accounting standards while others representing U.S. and global interests are worried about fast-tracking convergence of these standards in pursuit of global capital standards. 

And you thought something called FASB Topic 834 would be boring. 

The issue concerns the Financial Accounting Standards Board’s (FASB) proposed accounting for insurance contracts – FASB Topic 834 — which says that insurers should carry insurance liabilities at fair value, with all up-to-date market information included in their valuation. Some worry this will lead the Fed to take the exact opposite of actions it should take when markets inordinately increase or decrease, and result in unearned surplus gains or losses.

Investors and life insurers worry that if interest rates move upwards, the value will decrease and if they move downward, the opposite will occur even if the securities are not sold but are held to secure the cash flows they were expected to produce for long term liabilities.

“We believe the Board needs to more clearly articulate the difference between a financial risk and an insurance risk,” one accounting firm told the FASB in a recent comment letter.

“Traditionally, the Fed has come out against the use of fair value because it does not protect the depositors and it would be interesting if this represents a shift on their part or an internal battle as to whether or not Dodd-Frank requires a different approach,” said Douglas Barnert of Barnert Global Ltd. “These are are all insurance company resolution issues; it is bigger than insurance accounting,” he added. “Resolution is a public policy issue.”  

“The disconnect between the supervisory perspective on the appropriateness of fair value accounting for banks versus insurers is striking, revealing that the Federal Reserve has not yet fully found its footing as a supervisor of insurers,” according to a note from the Investment Strategy Group of Sandler O’Neill + Partners, L.P., a registered broker-dealer.

Sandler O’Neill principal Joseph Longino asserts in the Dec. 4 client note that the FASB’s proposal could easily cause the failure of insurers in the next financial crisis if the new accounting were to paint an unrealistically negative portrait of insurers in a crisis, leading to rating agency downgrades and then runoff. Longino expresses concern that the Fed seems generally supportive of the measure. It asserts that “incorporating current information in the measurement of it would increase the transparency of insurers’ financial statements.”

Based on the proposal, supervising its insurers, both those deemed systemically important financial institutions (SIFI) and those with thrifts, would deprive the Fed of meaningful financial reporting upon which to base supervisory assessment and action, the note said.

Sandler O’Neill’s note said the FASB proposal is actually risk analysis masquerading as financial accounting, “creating a dystopian reporting landscape” where volatile changes in ephemeral fair value marks of insurance liabilities drive earnings rather than earnings driving changes in a more stable equity account, as they do in the recognizable landscape of real financial reporting.

Barnert, who has long represented insurers on accounting issues, has raised the call to stop the movement toward best estimated value based on market consistent approaches. That will cause the market to relive the 2008 crises over and over again, he said, noting that in 2007, they got the accounting wrong and then the valuations premised upon them were wrong. “So, when the system burped, there was no underlying correctness in the system and everything rolled downhill,” Barnert said after a conference on systemic risk held by the U.S. Chamber of Commerce in Washington last week.  

Only after they fixed the accounting and reversed the absolute fair value method of valuation could policy makers start the process of fixing the system, he said.

“We are now going through a similar exercise. We are getting the accounting wrong; panels working on valuation using a market consistent methodology are getting the valuation principles wrong. So, any slippage in perceived value will result in another avalanche,”  Barnert last week.

The accounting convergence work got underway more than a decade ago, at least, but in the past few years it has taken on a greater urgency as the international community, led by Europe, pressures for commonality and convergence on a great number of financial work streams in the wake of the global economic crisis.