The Financial Accounting Standards Board has proposed a rule change that could make insurers’ finances look worse now that interest rates are low but could make their finances look better when rates start to rise.

The Norwalk, Connecticut-based group has posted a draft of “Financial Services — Insurance (Topic 944),” a proposed accounting standards update that would affect accounting for long-duration contracts.

The draft standard change could affect accounting for annuities, life insurance, long-term care insurance, long-term disability insurance and any other products that involve promises to pay benefits far in the future.

The draft would change the rules governing discount rates, or the rate-of-return assumptions insurers use to estimate how much cash they will take in and how much they will have to pay out in connection with future policy benefits.

In the draft, which is based on comments on a document FASB posted in 2013, the board proposes requiring insurers to use a discount rate based on yields on high-quality bonds and other high-quality fixed-income investments when they report on their finances.

Related: FASB proposes new accounting for insurance contracts

An insurer would report on the amount of market risk benefits it has promised, calculate how changes in yields on high-grade bonds have affected the value of the market risk benefits, and include changes in the value in a figure called “other comprehensive income.”

The “other comprehensive income” figure is similar to the “net income” figure but includes the effects of some changes in investment asset values that a company can keep out of net income.

Today, an insurer locks in a discount rate assumption when it sells a long-duration product. An insurer is supposed to update the assumptions and create premium deficiency reserves when big changes in investment yields conflict with the original discount rate assumptions.

FASB is also proposing changes in the rules governing deferred acquisition costs.

FASB says it wants to use a new measuring tape for measuring insurer liabilities because the current approach relies on stale, speculative information. (Image: Thinkstock)

FASB says it wants to use a new measuring tape for measuring insurer liabilities because the current approach relies on stale, speculative information. (Image: Thinkstock)

FASB draft may start a new mark-to-market battle

Today, “for certain contracts, the insurance liability is measured using out-of-date assumptions,” FASB says in a bulletin discussing the draft. “Also, an expected investment portfolio yield is used to discount the liability.

The proposed approach would be based on real-life investment yields, rather than predictions, and insurers would update their discount-rate assumptions at least every year, FASB says.

Premium deficiency (or loss recognition) testing would be eliminated,” FASB says.

Interest rates have fallen sharply since the 1990s. The FASB proposal could lead to a cut in other comprehensive income for insurers that have sold large amounts of products such as long-term care insurance and long-term disability insurance without keeping discount rate assumptions up-to-date, but it could also push insurers’ other comprehensive income up rapidly if and when rates rise.

FASB and other bodies have often backed efforts to require companies to do more to mark the value of financial totals to reflect current market conditions.

In the past, the Washington-based American Council of Life Insurers and other insurance groups have suggested that applying broad mark-to-market accounting rules to insurers could lead to confusing fluctuations in insurers’ financial reports.

“We look forward to reviewing the proposed changes,” a company representative said in a statement about the new draft.

Comments on the draft are due Dec. 15.

Related:

Insurance Group Asks FASB and IASB to Withdraw Accounting Guidance

Insurance Accounting Proposals are “Flawed and Unworkable,” Says Trade Group

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