NEW YORK--Does the possible new accounting guidance for insurance contracts--issued by the Financial Accounting Standards Board June 27--represent a sufficient improvement to U.S. GAAP to justify issuing new guidance? Two members of the FASB, namely, Thomas Linsmeier and Daryl Buck, said no, and have offered alternative views in the “basis for conclusions” section of the proposal, insurance Contracts (Topic 834).
At a high level, the proposal would establish a principle that classifies insurance contracts under one of two measurement models: the building block approach (for most life, annuity, and long-term health contracts); and the premium allocation approach (for most property, liability, and short-term health contracts).
It would be applicable to any entity that issues contracts with insurance risk, and therefore is not limited to insurers. Banks, for example, would be impacted since the guidance focuses on the contract as opposed to the entity involved in the reporting. This would therefore be a change in practice under U.S. GAAP, which already has guidance that comprehensively addresses accounting for insurance contracts.
Buck, the FASB member who provides the private company user perspective for U.S. standard-setting, indicated his disagreement with the proposal is weighted by the lack of convergence between the FASB and the International Accounting Standards Board in their exposure documents. The IASB issued its second exposure draft June 20, but limited feedback on the document to five areas, which are expected to be quickly redeliberated and finalized. In contrast, the FASB issued its first exposure draft, which includes 48 questions and will follow a longer due process towards issuing a final standard.
Since insurance is a global industry and many U.S. insurers have a significant global presence, absent convergence, the FASB’s proposal does not yield a “sufficient overall improvement in decision-useful information to investors and other users of financial statements to justify the significant overall costs and complexity it will add,” Buck said.
Costly and Complex.
The magnitude of the costs and complexity that the proposed recognition and measurement models would add is not justified, said Buck. Specifically, it would be costly and complex for those entities required to use the proposed premium allocation approach (property-casualty insurance), since they would need to measure claims liabilities using expected values and to discount those claims liabilities before the amounts of the claims have become fixed and determinable.
In addition, financial statement users have expressed a strong desire for the current model for short-duration insurance contracts under U.S. GAAP to be retained, said Buck, instead of replacing it with the proposed premium allocation approach. “Contracts to which the proposed premium allocation approach would apply (for example, property-casualty insurance) are fundamentally different than contracts to which the proposed building block approach would apply (for example life insurance),” Buck said. “Investors analyze the respective financial statements of entities using these two types of contracts differently,” he said.
Inconsistent with Framework and GAAP.
Linsmeier, the academic on the board, lists three reasons for his dissent, which differ from Buck’s. Linsmeier’s objections stem from an underlying inconsistency (for how assets and liabilities would be recognized in the insurance proposal) with the conceptual framework of accounting literature and thus other U.S. GAAP. This inconsistency would come with knock on effects, he indicated in his alternative view.
Among some of the more nitty gritty accounting areas Linsmeier highlights surrounds the building block approach, the model to be used by those issuing life, annuity and long-term health contracts. Specifically, this resulting inconsistency with the conceptual framework and other U.S. GAAP topics, would “serve to retain the unique and very specialized nature of current insurance accounting,” he said.
This type of specialized accounting adds complexity, limits transparency, and hinders comparability, Linsmeier’s comments indicated. “The current, highly specialized nature of accounting for insurance contracts has resulted in only a narrow set of user specialists being able to understand and evaluate the accounting, which has hindered the comparison of the financial reports of insurance entities and other entities, limiting the decision usefulness of reported information,” he said.
He stated that “to make a real improvement to insurance accounting, any differences between the accounting for insurance and other revenue generating contracts should be minimized to facilitate comparisons between insurance and other entities and to enhance the efficient allocation of capital.”
Long Road Traveled.
The insurance contracts project is one of the four joint convergence projects left between the FASB and the IASB--an offshoot from their Memorandum of Understanding in 2006revised in 2008.The goal of the boards appeared to be one of obtaining a single set of high quality global insurance contracts guidance, an ambitious undertaking since they were starting from different mandates.
For the IASB, since 2002, it has been working towards developing a standard and therefore under a two-phased approach issued IFRS 4, Insurance Contract, in 2004. IFRS 4 was a stop-gap provision until the board could complete a comprehensive insurance contracts standard. It was this urgency that resulted in its first exposure document, which was issued in July 2010. Due to the revisions in five targeted areas, the board was forced--in line with its due process--to re-issue its exposure document for a second go round, but said it would move quickly to conclude it during 2014 and issue a final IFRS during 2015. Comments from some of its board members indicate no plans to wait for the FASB to converge, though at least one joint meeting is expected to take place.
For FASB, existing U.S. GAAP comprehensively addresses accounting for insurance contracts, and therefore its reasons for addressing the accounting rules differ substantially. Rather, its problems stem from the evolution of new insurance projects, new contract terms and features and the resulting multiple insurance models, which threaten comparability and transparency.
There isn't that same urgency towards finalizing a standard because whether the less costly approach would be targeted revisions is still up for debate. Thus, with the lack of convergence with the IASB, two dissenting FASB board members, and comments made by IASB members indicating no firm commitment to jointly redeliberate, the outcome of the FASB’s insurance contracts proposal seems hazier.
Generally it's feedback from its constituents that ultimately will be the determinant for whether the board will move ahead with the proposal or focus on improving GAAP in targeted areas only--i.e. scoping back on the project. That board’s constituents have until Oct. 25 to put forth their viewpoints. In the meantime, FASB has floated a timeline of 2018 as a potential effective date for the standard (if finalized).
By Denise Lugo
Bloomberg BNA Staff Correspondent
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