Prudential, Lincoln: Coming Insurance Accounting Portends Trouble

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By Denise Lugo

Coming accounting changes for life insurance and annuities contracts will introduce periodic swings in income that could scare off investors, chief accountants of Lincoln National Corp. and Prudential Financial Inc., told Bloomberg Tax.

That increased volatility will make company results unpredictable, stifling capital growth in the life insurance sector, which requires large amounts of money to produce goods and services, the chief financial officers said.

“The fact that less capital would be interested in coming into our industry is a big deal,” Randal Freitag, executive vice president and CFO of Lincoln National in Radnor, Pa., said. “We are a capital intensive industry and less capital is not a good thing—and that makes this very important to us.”

The Financial Accounting Standards Board plans to issue the changes this year on accounting for long term insurance—contracts that protect against the risk of financial loss associated with death and provide income sources for retirement.

“Where analysts would expect to see volatility is when there’s a bad flu season, as happened this year,” Rob Falzon executive vice president and CFO of Prudential in Newark, N.J., told Bloomberg Tax. “They’re expecting that when life insurance companies report their results that we’re going to see elevated mortality,” Falzon said. “And if they don’t see that—which under the Financial Accounting Standards Board’s proposal they won’t see that—they’d say ‘what’s going on?’” he said.

The CFOs’ insights came from their joint survey of 80 users of insurance company financial statements about the pending changes. Half of the survey participants responded, including fixed income insurance analysts and asset managers with a combined total of more than $30 trillion of assets.

In an April 18 letter to FASB, the CFOs urged the board to do more outreach to insurance analysts and investors and conduct field testing.

“We are supportive of them going down the targeted improvements path—we do think there are ways to improve insurance accounting,” Rob Axel, senior vice president and controller at Prudential in Newark, N.J., told Bloomberg Tax. “We think the board should push the pause button and do field testing in order to understand the consequences of this in a much more quantitative and granular way than they or the industry currently understands.”

FASB Mulling Issue

FASB is currently evaluating the letter and welcomes all stakeholder input, a FASB spokesperson told Bloomberg Tax. The board conducted extensive outreach with a wide range of stakeholders, including investors, preparers and auditors, over the course of the multi-year project, Christine Klimek, FASB senior manager of media relations, said in an email.

“The need to improve the accounting and transparency of long-duration insurance contracts was a nearly universal theme we heard during that outreach,” Klimek said.

“While views vary among stakeholders about how to best implement improvements, the scope and solution for addressing this area of financial reporting was developed with that input in mind,” she said.

Seeking Transparency, Comparability

The changes come at a time when the economic outlook for the sector is relatively stable. The life and health insurance sectors were profitable in 2016, according to the U.S. Department of the Treasury’s September 2017 annual report on the sector.

In addition to Prudential and Lincoln, the top life insurance writers include Met Life Inc., American International Group Inc., AXA SA and Aegon NV.

The pending accounting changes would require market risk benefits—including guaranteed minimum death benefits—to be valued at market value with changes recorded through the income statement. Companies would retrospectively “unlock"—meaning adjust previous estimates—their assumptions on traditional and limited pay contracts.

Analysts don’t favor those changes, according to survey results.

Insurance analysts favored changes to require deferred acquisition costs (DAC) to be reported over a constant basis over the expected life of the contract. They also agreed with having future cash flows be discounted at a defined rate.

“What FASB is doing with these changes is that they are enhancing transparency and comparability by bringing about more consistency between the accounting for assets and liabilities and a more uniform standard across companies,” Kai Talarek, partner at Oliver Wyman in New York, told Bloomberg Tax. “Defining the proper discount rates for very long-dated liabilities is challenging, though,” he said.

Helping investors better understand insurers financial reports is also important, other accountants said. “Capital providers to the insurance industry are equity investors, mutual fund advisers, managers, investors or people who buy their insurance products,” William Hines, principal and consulting actuary, Milliman, Inc., in Wakefield, Mass., told Bloomberg Tax. “They want to understand, ‘is this company going to be around 30 or 40 years?’” Hines said.

To contact the reporter on this story: Denise Lugo in New York at dlugo@bloombergtax.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bloombergtax.com

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