Thursday, January 27, 2011

S&P Parses Implications of Proposed Global Insurance Accounting Standards

A just released report from Standard & Poor’s Corp., New York, parses the credit implications of the recently proposed global accounting standards for insurance contracts.

The International Accounting Standards Board (IASB), London, and Financial Accounting Standards Board (FASB), Norwalk, Conn., published their proposed changes to insurance contract accounting on July 30, 2010, and Sept. 17, 2010, respectively. The boards intend to complete major joint projects by June 2011. The insurance contracts project is expected to be completed along with other components of the project and become effective in 2013 or 2014.

The proposed projects will have measurable consequences for insurers, according to S&P. These include:

--Volatility in financial results caused by changes in interest rates which could cause potentially significant swings in earnings and capital. The degree of volatility would depend on how well companies deployed asset-liability matching. If there is a mismatch, according to S&P, “we believe understanding the underlying accounting assumptions applied and sensitivities of those assumptions to changing credit and market conditions will be important to analyzing the financial condition.”
-- Earlier recognition of losses likely will occur because the proposed accounting would use an expected approach for recognizing losses, which results in recognition of a potential loss when it is probable to occur.
--Inconsistency between the decisions the IASB and FASB reach might occur if the two boards cannot achieve convergence on some key proposals. Lack of convergence would impede consistency in globally reported information and the ability to perform peer comparisons across jurisdictions.

S&P says that it believes:

--Overall, the IASB model is an improvement to the current accounting for insurance contracts because “the depiction of a risk adjustment can provide users with insight into management's perception of the risk in its business, and, in conjunction with robust disclosure, should allow users to perform peer comparisons across insurers on their approach to managing and mitigating insurance risk.”
--“Increased disclosures and a more detailed presentation of information may change how users of financial statements view the risk profiles of insurance companies where new information is provided. Users should find the breakdown of the underwriting margin, gains and losses at inception, changes in experience, and changes in estimates (similar to a source of earnings approach) helpful in understanding changes in the proposed measurement of an insurance contract.”
--“A discount rate that is equal to the risk-free rate plus an adjustment for illiquidity because it may result in many long-term contracts having a day-one loss. We do support a discount rate that reflects the contract's duration and currency and is not specific to a portfolio of assets.”
--A simplified approach for short-duration contracts (i.e., an approach that allows for the premium received to represent the measurement of the contract--similar to unearned premium under a short-duration model) is an approach that S&P supports. However, the rating agency expressed concerns about limiting the contracts eligible for the simplified approach to one-year contracts.

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