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Industry wary of direction on FASB insurance contracts

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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. 

“The proposed standard is intended to bring greater consistency and relevance to the accounting for contracts that transfer significant risk between parties,” stated then-FASB Chairman Leslie F. Seidman in a statement back when the rules were proposed. “Current U.S. standards on insurance have evolved over the years as new products have been introduced, leading to some inconsistencies in GAAP.”  

The contracts most used by life, annuity and long-term health insurers would use one approach, the so-called “building block” approach, and the contracts most used by property casualty insurers and short-term health writers would use another approach, the “premium allocation” approach. 

The building block approach would be measured each reporting period based on the current present value of the fulfillment cash flows. This would be based on the expected value that incorporates all relevant information and considers all features of the contract, including guarantees and options. The measurement would also include a margin that initially reflects the expected profitability of the contract. 

The National Association of Insurance Commissioners (NAIC), in its comment letter, noted a widespread agreement between preparers, investors and other users that existing statutory accounting principles (SAP) and financial reporting under current U.S. GAAP is very important in obtaining a comprehensive understanding of reporting entities. 

“The FASB’s proposal would jeopardize a comprehensive accounting and reporting system that has been in place for decades, and whose efficacy has been continuously validated over time in the face of extreme events and circumstances,” the NAIC accounting working group team stated. 

Meanwhile, NAIC standard-developing brethren, U.S. Federal Insurance Office (FIO) Director Michael McRaith and the International Association of Insurance Supervisors (IAIS) Executive Committee Chair Peter Braumüller do not appear to share the NAIC or typical U.S. investor approach.

On IAIS letterhead, the key committee leaders (McRaith is Technical Committee Chair of the IAIS) expressed concern about a lack of convergence between international and FASB approaches in the insurance contracts. ”We fully support a principle-based approach; however we are concerned that, in practice, there is too much flexibility or compromise reflected in the current valuation for insurance contracts,” the IAIS executives wrote.

The International Accounting Standards Board (IASB) and FASB continue working toward the converged insurance contracts accounting standard. 

“It would be unfortunate if the IAIS is forced to develop and use alternative valuation processes for its capital work. This is not our preferred solution as it will increase costs to insurance entities and may lessen the usefulness of general purpose financial statements, particularly if analysts and investors develop a preference for more comparable regulatory reporting. This is already the case in the U.S., where analysts tend to rely on NAIC reporting rather than financial statements,” McRaith and Braumüller wrote. 

The IAIS pair stated that comparability of both insurance liabilities and the assets is a lynchpin in the IAIS development of three new capital measures: Backstop capital requirements (higher loss absorbency requirements) to apply to global systemically important insurers (G-SIIs), and a risk-based global insurance capital standard that will apply to internationally active insurance groups. A key aspect of these capital measures is the desire for comparability of valuations across jurisdictions, reflecting both insurance liabilities and the assets supporting them. 

FASB spokeswoman Christine Klimek said the FASB is re-deliberating the proposal in light of the multitude of comments, and as part of its due process, which will continue into 2014, with no final date for standards to be issued yet. 

The Federal Reserve did not offer any comment. 


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