The National Association of Insurance Commissioners (NAIC) is weighing in on increasingly unpopular proposed financial statement accounting standards, saying proposed national and international accounting standards for insurance contracts would be bad for regulators’ ability to judge insurance companies' balance sheets.
The International Accounting Standards Board (IASB) is leading a global effort to reassess the foundation of insurance accounting and its work is considered and implemented domestically by the Financial Accounting Standards Board (FASB), which put out a propsoal in June.
The key features of the new proposals, as put forth by Sandler O’Neill + Partners, an investment banking firm and broker-dealer, are their redefinition of the term "insurance contract" based on the characteristics of the instrument rather than the identity of the issuer; the scope of the proposals, which would extend to issuers other than insurers, including banks; and the fair value measurement of insurance contracts, which would be recognized in a combination of net income or other comprehensive income, noted Sandler O‘Neill.
U.S. state regulators currently use U.S. GAAP financial statements to evaluate the consolidated positions of insurance company groups.
U.S. regulators agree with prohibiting immediate gain recognition for all insurance contracts, regardless if the insurance contract is direct or assumed by the reporting entity and regardless if the risk is retained or ceded.
In a draft letter being prepared for FASB Chair Russell Golden, U.S. regulators are saying that although they continue to support a single, high-quality global standard for insurance contracts, the FASB and IASB proposals for such contracts don’t manage to do that because they would not result in “decision-useful information necessary for financial statement users.”
Moreover, 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, alleged the draft letter prepared by the Statutory Accounting Principles Working Group (SAPWG) of the NAIC. This working group is responsible for the development and enhancement of Statements of Statutory Accounting Principles used by insurers in their statutory filings. It will host a conference call on the matter Oct. 23.
The NAIC is now joining in a fray that insurers from companies to trade associations, warned by institutional investors, have been vocal about for weeks now.
"The GAAP statements will be so convoluted that they will be worthless to investors and analysts," says one regulatory accounting expert at a major insurer.
"People like to denote the 'time value' of money, but there is also the 'time value, of usefulness." People use financial statements to make decisions in a timely fashion. The standards, as proposed, will lengthen the time it takes to dissect the financial statements in order to arrive at even a cursory opinion about the financial strength of an insurance enterprise and its historical performance. The lengthened time frame will render the process useless so investors will turn to other areas where they will be able to make timely cogent decisions," he warned.
FASB’s proposed accounting and reporting model is one that is largely untested, the SAPWG is writing. “The attempt to implement such an untested system would be extremely costly and time consuming for all insurers, but likely disproportionately so for the small and mid-sized companies, which compose the majority of insurance reporting entities,” argues the NAIC in its draft letter.
A spokeswoman for FASB noted it had not received the letter yet and does not comment on letters, but added, "I can say that the FASB will carefully consider input received from the NAIC and from other stakeholders as part of the due process we engage in before issuing a final standard."
The new approaches has been controversial with investment bankers and institutional investors, as well as insurers, and the NAIC is voicing some of these concerns now.
This accounting for “current value” was rejected for banks on the grounds that measuring loans and deposits at “current value” is inconsistent with their business model and would not provide information that is decision-useful to investors, argues the NAIC.
Granular information, measured consistently between SAP and U.S. GAAP, allows investors to obtain a better understanding of the operating financial performance and financial condition of insurers, the NAIC says.
“Statutory accounting and reporting has stood the test of time and has proven reliable under a variety of challenging circumstances and is well understood and supported by the investor community,” stated the NAIC group.
U.S. regulators support a converged method for calculating discount rates so are concerned that the proposed accounting standard will allow liabilities and supporting assets to be valued using different methods, thus potentially distorting financial results and conditions, and hindering comparisons.
The proposed accounting standards also incorporate a definition of “significant insurance risk” that differs from existing GAAP, and pulls in items that have not traditionally been considered insurance. It will also require non-insurers to apply the complex insurance standard, the NAIC says.
For reinsurance, the proposed guidance would incorporate a lower threshold for risk transfer, allowing insurance treatment for contracts that do not expose the reinsurer to the possibility of a significant loss.
The NAIC does support the FASB proposal for a single margin approach, resulting in no gain recognized at initial measurement but says the IASB proposal to calculate and separate margin into “risk” and “contractual service margin” components will result in financial statements completed with great uncertainty and higher risk for manipulation.
Last month, Sandler O’Neill penned a strongly worded letter to FASB and the IASB in London voicing opposition to their exposure drafts for insurance contracts and all but throwing up their hands with the process, saying it would basically hurt investment in life insurance companies.
The Bards turn a "blind eye" to the goal of an understanding of how fee and investment income is managed to fund the payout of policy obligations, the investment bank alleged.
"...the insurance contracts proposals would nullify the valuation metrics so important to investors. Book value would no longer exist as a stabilizing, smoothing frame of reference for earnings because the “fair value” of insurance liabilities would become the engine of both book value and earnings volatility. Particularly for life insurers, the volatility of the insurance liabilities component of book value would overwhelm other sources of equity and earnings, and in a financial crisis book value would become the eye of the storm rather than a port in it," Sandler O'Neill's letter stated.
The fair value of policy liabilities is of less concern to investors than the adequacy of claim reserves for P&C insurers and the credit quality of assets for life insurers and investors, the investment bank is saying.
Broadly, investors in life insurers tend to value these companies based on price/earnings multiples because of the relative stability of earnings compared to P&C insurers, whereas investors in P&C insurers tend to value them based on price/book value multiples relative to return on equity, Sandler O'Neill explained to the Boards. Investors in both sectors tend to look to operating earnings, or net income, excluding realized (and unrealized) gains and losses on investments, the investment bank stressed.
Also, because the contracts use the characteristics of the instrument and not the identity of the issuer, banks and other non-insurance financial institutions would need to apply the proposed accounting to many guarantees and indemnities not now deemed to be insurance contracts, Sandler O'Neill complained.
“Quite simply, we have come to this pass in the insurance contracts project because the boards have lost sight of their job description...It is deeply disheartening to contemplate the untold resources -- both human and monetary -- that the boards have wasted on this project over the years -- the IASB more so than the FASB,” the letter stated.
“Although U.S. GAAP for insurance contracts is not perfect, replacing an imperfect standard needing only minor adjustment with a far less perfect one -- because unreflective of insurance business models -- is neither rational nor consistent with due process. In short, the boards’ implication that investors support their model over U.S. GAAP is not credible because of the model’s unconscionable consequences for them,” Sandler O’Neill’s Sept. 18 letter alleged.