FASB accounting changes: A solution in search of a problem?
US-listed insurers are digesting proposed new accounting rules expected to come into force by 2018, which critics say could make the industry less profitable and its financial statements harder to understand.
The proposed new regime has been drawn up by the Financial Accounting Standards Board (FASB), the body responsible for setting accounting rules for public US companies. It is intended to provide a more accurate picture of insurers' liabilities, revenues and cash flows, while making life and non-life insurers easier to compare.
The project also aims to iron out perceived inconsistencies in the current US Generally Accepted Accounting Principles (GAAP) standard.
The measures are still under discussion between the FASB and the industry, with the latest deadline for comments passing last Friday (25 October). But the latest version of the proposals, published in June, looks set to impose sweeping changes on the way the sector presents its financial performance to the outside world, and is coming under fire from within the industry.
"Simply put, we view these proposed changes as a solution in search of a problem," Barclays Capital insurance analyst Jay Gelb explained last week.
"If adopted, we anticipate the new accounting would result in increased volatility, lower RoEs and increased insurers' cost of capital.
"None of the insurers or investors we discussed this issue with are in favour of the changes."
The proposals include a requirement that carriers estimate their insurance liabilities every quarter using an updated market-consistent discount rate. This marks a departure from the current rules, which do not impose market-consistent discounting across insurers' whole portfolios. According to Gelb, the net effect will likely be an increase in shareholders' equity, making returns to investors lower but also more volatile.
The FASB also wants insurers to recognise revenues over the period that their policies are in force rather than when premiums are received. This could make it difficult for some carriers to present traditional performance measures such as combined ratios, depriving investors of one of their preferred yardsticks when deciding whether to buy insurance stocks.
"The way in which performance is communicated would be likely to change," accountants KPMG wrote in a July research note.
The new regime's tendency to undermine established performance criteria could prompt insurers to introduce changes to executives' performance targets and pay arrangements, KPMG said.
The FASB has been working on the proposed insurance accounting revamp since 2008 in collaboration with the International Accounting Standards Board (IASB) - the organisation that sets the International Financial Reporting Standards (IFRS) regime used by many European insurers.
The IASB is planning to issue a new IFRS blueprint for insurers that is expected to incorporate many of the measures adopted by the FASB.
The reforms drawn up by the FASB and IASB are the latest in a long line of accounting initiatives aimed in part at making the insurance industry more transparent and shareholder-friendly. Historically, the sector has been shunned by some investors because of its operational complexity and opaque bookkeeping.
Life insurers, whose profitability depends to a large extent on uncertain future revenue streams from long-term policies, have proved particularly unpopular, although investors are also wary of the P&C sub-sector because of its vulnerability to unpredictable spikes in claims.
For the moment, insurers and their existing shareholders appear unconvinced that the new rules will have the desired effect, and are focusing instead on their potentially disruptive impact.
"For me, accounting should truly mirror economic reality, and any improvement to what we have today ought to create better clarity and help to make things, the financials, more insightful for investors and investors to make decisions," Ace CEO Evan Greenberg said last week during the company's third quarter conference call.
"When I look at the changes that FASB is suggesting right now, I get the theoretical.
"But that is divorced from practical reality and what investors really use to judge, and what management really uses to judge, one company to another, or the health of a company. And the insurance accounting, as it stands today, has been around a long time, and it's been tested through all kinds of environments and it's reasonable," he continued.
"I don't know what kind of problem we're trying to chase here by making changes," Greenberg added.
Chubb's CFO, Richard G Spiro, echoed this sentiment during a discussion on the insurer's third quarter earnings.
"Like many other companies in our industry, we previously indicated to FASB that we believe the US GAAP accounting and reporting model for P&C companies works well, and is understandable for both preparers and users of the financial statements of insurance companies, and we continue to hold that same position," he commented when questioned about the new accounting system.
"We are concerned about the possible loss of usability and transparency that may result from this proposed guidance, and we'll continue to share our concerns on this proposal with FASB," Spiro concluded.
Travelers CEO Jay Fishman, however, struck a more conciliatory note.
"We'll always do what regulators ask us to do. And however we're asked to report, we'll report. We don't have a view. We follow directions," he told analysts.