FASB to Start Debate on Controversial Insurance Accounting

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By Steve Burkholder, BNA Staff Correspondent

NORWALK, Conn.—The Financial Accounting Standards Board is set to get down to business in coming weeks on a new long-term joint effort with its international counterpart to improve and make more consistent accounting about the increasingly global business of insurance.

Differences in views between insurers, on the one hand, and on the other security analysts, standard-setters, and insurance supervisors already have been staked out—at least tentatively— with the real deliberations of FASB and the International Accounting Standards Board only just starting. The divergent opinions are plain from comment letters on a 2007 discussion paper and other documents that form the backdrop for FASB tackling the project at its Feb. 25 meeting.

At that meeting, FASB plans to start off its side of the effort by seeking to narrow the field of five staff-proffered approaches on how to gauge insurance contracts and the liabilities they present. It does not plan to settle on any single approach and, in any event, a key decision on measurement would be tentative until a final standard is issued.

Speaking at a Feb. 11 education session, a staff accountant at the U.S. board called measurement “probably the best place to start because it will drive a lot of future discussions.”

The International Accounting Standards Board is set to consider Feb. 18 the same measurement-related issues that the U.S. board will be deciding a week later. IASB has been carrying out work on insurance contracts for many years and describes the joint FASB effort as part two of that project.

Phase one of the IASB project yielded International Financial Reporting Standard 4, Insurance Contracts, an interim set of rules “that permits a wide variety of accounting practices for insurance contracts,” according to the London-based board.

It is that variety of practices, and the resulting lack of comparability, that prompted FASB to join IASB last October in the insurance contracts project. In addition, the large role of U.S. companies and the U.S. market in the domestic and the increasingly international business of insurance played a role in the agenda decision by FASB Chairman Robert Herz (4 APPR 1002, 11/14/08).

“In that the United States is probably the most important insurance and capital market in the world,” the American Insurance Association wrote in comments to FASB in late 2007, “it makes sense for U.S. standard-setters to take up the challenge of developing a high-quality, global accounting standard that could eventually facilitate convergence of standards.”

Five ‘Candidate' Measurement Approaches

IASB and FASB plan to focus at their meetings on Feb. 18 and Feb. 25, respectively, on what the boards' staffs call the five “candidates for being selected as measurement approaches for insurance contracts,” as described in an October 2008 issues paper used at the London-based board:

• current exit value, as proposed in the discussion paper offering IASB's preliminary views on insurance contracts;

• current fulfillment value “including a risk margin based on the cost of bearing risk”;

• current fulfillment value “including a risk margin based on the cost of bearing risk and, separate from the risk margin, an additional margin as the difference between the premium and the expected value of the cash flows plus the margin for bearing risk”;

• current fulfillment value “including a single margin calibrated at inception to the premium”; and

• “unearned premium for the pre-claims liability of short-duration contracts.”
“To me, it seems like the exit price notion is not as valuable.”

FASB member Mark Siegel

At the FASB's Feb. 11 meeting, the board heard staff presentations cued to the first four candidate approaches and highlighting some of the possible differences and similarities in the approaches. It did not discuss the fifth candidate.

Among topics that the board touched on were the measurement objective, “day-one” profit or loss, and how tentative choices of paths in the insurance contract might or might not jibe with evolving rules being devised in other pending standard-setting efforts, especially the revenue recognition project.

On one key question having to do with the measurement objective, the four FASB members attending the education session—Herz, Leslie Seidman, Mark Siegel, and Lawrence Smith—registered their leanings toward an answer keyed to the fulfillment notion.

Seidman spoke of being solidly in that camp. Said Siegel, “To me, it seems like the exit price notion is not as valuable.”

Goal of a Single Global Standard in 2011

The timetable for completion of the IASB-FASB insurance contracts project is fairly long. The goal for issuance of a final, aligned standard is 2011, the same year that the FASB-IASB memorandum of understanding sets for alignment of a host of other projects being jointly pursued by the two boards. The insurance project is not included in the MoU, however.

The debate on the financial reporting of insurance contracts may be just as protracted. New global and U.S. standards for insurance accounting could portend significant changes. Standard & Poor's described the proposed changes as “radical” in generally supportive commentary on the 2007 IASB discussion paper. In that paper, the board put forward preliminary views on how to improve accounting for insurance contracts.

As made plain in comments from rulemakers meeting in Norwalk in January, the appropriate measurement approach for insurance contracts—exit value versus “current fulfillment value,” for example—is keyed to a view of insurance policies and contracts as either service contracts or financial instruments (5 APPR 85, 1/23/09).

A senior IASB director pointed to the issue of remeasurement of the insurance liability and suggested that people who view insurance contracts more as financial instruments are comfortable with such re-gauging. His counterpart at FASB said that if an insurance contract is seen to be an instrument, “mark it” (to market) and have it be subject to remeasurement. “If it's a service, you don't want to mark it,” suggested the technical director at the U.S. board, and its value essentially is spread out over time.

The boards plan to issue a draft standard in the second half of this year.

Is Current Insurance Accounting Adequate?

A number of security analysts use terms such as “broken,” “in chaos,” and resulting in “investor confusion”—at least in Europe—to describe current accounting for insurance and, more specifically, for life insurance contracts.
However, insurance trade groups claim that existing accounting for nonlife insurance products is adequate and that users of financial statements are not crying out for change.

Entities that are generally supportive of the IASB's preliminary views paper include a statutory accounting principles panel of the National Association of Insurance Commissioners, Standard & Poor's, and Moody's. These groups viewed the paper as a starting point for standard-setting—although the NAIC”s Statutory Accounting Principles Working Group had specific caveats.

In its preliminary views paper, IASB proposed a measurement attribute or approach for insurance liabilities built on “current exit value” (3 APPR 449, 5/18/07), which the S&P ratings agency, for example, equated with fair value .
In contrast, groups such as the American Insurance Association and Group of North American Insurance Enterprises, or GNAIE, oppose the exit value approach. The American Council of Life Insurers have raised concerns about the appropriateness of that as a measurement basis.

Groups such as GNAIE also faulted what they called “a single model for life and nonlife insurance contracts, as proposed in the IASB discussion paper, which we believe is conceptually flawed.”

FASB issued the IASB paper as its own “wrap-around” invitation to comment in August 2007, and sought comments on whether it should work with IASB on the project (3 APPR 723, 8/10/07).

Objections to IASB Approach

In a Nov. 21, 2007, letter to Herz, GNAIE's executive chairman called for IASB to reconsider key notions in each of the three “building blocks” proposed for gauging life insurance contracts. The boards have suggested the following building blocks for measuring the insurance liabilities: “unbiased probability-weighted cash flows, time value of money adjustments thereof, and a margin that would be demanded by market participants,” as described in the NAIC statutory accounting panel's Nov. 16, 2007 comment letter.

GNAIE also asked for the international panel to reconsider “the basic foundation of the proposed measurement approach for nonlife insurance contracts.

“Notwithstanding our specific concerns,” Jerry de St. Paer, GNAIE's chief and senior vice president for finance at American International Group, continued in the letter, “we also have more general concerns.” Those include the discussion paper's “comprehensive rejection of the most widely used and understood insurance accounting and reporting standards throughout the world (i.e., U.S. GAAP) and the proposal to replace them with an experimental approach based on untested, and even more concerning, unverifiable theoretical constructs.”

“Many insurers' financial statements are opaque and provide inadequate disclosures, causing many investors to mistrust the insurance sector and some to avoid it.”

Standard & Poor's analysts

Standard & Poor's, however, points to what it sees as serious problems in accounting by insurance companies.

Insurance Accounting Broken

“Global financial reporting of insurers is broken,” S&P analysts wrote in an 11-page collection of comments titled “Toward a Global Financial Reporting Standard for Insurance,’’ the firm's response to the IASB discussion paper.
“Consistency is lacking, not just between countries, but also within countries, and in some cases even within consolidated groups,” the analysts added.

“Furthermore, many insurers' financial statements are opaque and provide inadequate disclosures, causing many investors to mistrust the insurance sector and some to avoid it.” They described financial reporting for insurance businesses as “in chaos globally.”

S&P sticks the “broken” label on accounting by life insurers around the world. “While non-life financial reporting is not broken, it is not perfect.”

“It is fair to say that users are not lobbying for change, although liability adequacy is a big concern and is likely to remain so regardless of the accounting framework,” the S&P analysts continued in their comments. “Discount on non-life reserves is applied sporadically around the world, but not extensively or consistently. The absence of discount from the valuation of liabilities ignores economic reality and has allowed accounting arbitrage abuses in the past (e.g., finite contracts with predominant finance characteristics disguised as insurance contracts).”

IASB's discussion paper reflects the board's view that “discounting is appropriate for all insurance liabilities, including non-life claims liabilities,” according to the staff-written issue summary prepared for the international board's October 2008 meeting.

By contrast, the American Insurance Association stated its view “that it is inappropriate to simply discount these liabilities” to essentially compensate for situations in which “the insurer is unable to reliably estimate the post-claim liabilities due to the significant uncertainty of the risk margin and/or the underlying cash flows.”

NAIC Cites ‘Important Point' in Non-Negative View

On the question of whether the preliminary views voiced by IASB in the 2007 paper are “an appropriate starting point for a project to improve, simplify and converge U.S. financial reporting for insurance contracts,” the National Association of Insurance Commissioners' panel on statutory accounting principles said “yes”—especially in light of an important point made in the discussion paper.

The salient point pertains to the current exit value measurement attribute or approach and the building blocks. “The discussion paper acknowledges that the use of a measurement model using the three building blocks is not meant to imply that insurance liabilities can, will or should be transferred to another party,” according to the NAIC working group's comment letter.

The state insurance commissioners' working group “believes this point is important, and because this point is clear, we do not disagree with the approach for general purpose financial statements,” the NAIC panel stated in its letter.

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