This past Monday, I had the privilege of attending the National Investor Relations Institute’s (NIRI) annual liaison meeting with Financial Accounting Standards Board (FASB) board members and staff. FASB and NIRI organize the session each year to offer investor relations practitioners a chance to “discuss standards from the investor communications perspective.”
The Session was Excellent
FASB allotted three hours for the liaison meeting, giving us plenty of time for the formal agenda as well as informal conversation and Q&A. About 15 people attended from FASB, including two board members and staff members with a variety of responsibilities. The FASB group shared updates on their initiatives and projects. Among the subjects covered were convergence to international accounting standards (IFRS), the disclosure framework project, revenue recognition, leases and financial instruments.
Those of us attending with NIRI gave feedback to FASB about the challenges we face communicating with investors. Our comments generally focused on how the accounting framework helps or hinders our ability to present historical and prospective information so that investors can make informed investment decisions or recommendations.
Specific to the Insurance Industry
We had the opportunity during the session to spend a few minutes learning more about the work FASB is doing in conjunction with the IASB on proposed changes to the accounting for insurance contracts. (See the Update on Insurance Contracts – a Joint Project of the IASB and FASB – for full details of the project.)
I believe the discussion of the insurance contracts project was positive. It provided an opportunity to highlight – from the investor relations perspective – some of the potential problems the proposed changes might create for insurance-sector investor communications.
The FASB group was very interested in our input and acknowledged the high volume of investor feedback they have received about the insurance contract proposal. They stressed how open they remain to feedback on the topic.
Changing the accounting rules for insurance contracts has been under consideration by the FASB and IASB for a number of years (and is considered part of the ongoing discussion regarding convergence between IFRS and U.S. GAAP). At the present time, FASB and IASB are considering and reacting to issues raised in response to a September 2010 FASB Discussion Paper and an August 2010 IASB Exposure Draft. FASB currently anticipates taking its next step – issuing an Exposure Draft regarding Insurance Contracts – in the fourth quarter of 2011.
The FASB and IASB objectives for the project are noteworthy and reflect recognized concerns about shortcomings in the present method for accounting for insurance contracts. In its project, FASB is seeking:
“… to develop common, high-quality guidance that will address recognition, measurement, presentation, and disclosure requirements for insurance contracts (including reinsurance), even if the contracts are not issued by an insurance entity. Specifically, the project is intended to improve, simplify, and converge the financial reporting requirements for insurance contracts and to provide investors with decision-useful information.”
A number of insurance-sector investors have noted, however, that as currently envisioned, the FASB and IASB proposals would radically change the way insurance companies present their financial results. Investors with whom I have spoken believe the proposed changes would result in lower book values and more volatility in earnings and book values for insurance companies.
To offer a brief summary, both proposals rely on a highly technical/academic “building block” approach to insurance accounting. The building blocks include a reserve for the discounted expected cash flows of the insurance policy, a margin adjustment and a residual margin. On a quarterly basis, management would update these amounts, rather than carrying forward estimates made at contract inception, and would make those updates using inputs consistent with observable market data. (Please note that descriptions of the proposals and detailed analyses are available in a variety of analyst research reports and public accounting firm materials, among other sources.)
The good news is that FASB is considering modifications to the building block approach. However, under the building block approach, the new income statement principally would reflect quarter-to-quarter adjustments of those building blocks.
Investors have shared with me (and described in published research) a variety of concerns about this approach, including:
- Revision is so substantial that it would eliminate the usefulness of historical data
- Changes would require investors to value insurance companies in a fundamentally different manner
- New presentation would disconnect the accounting from the way the insurance industry is managed on a day-to-day basis
- Quarterly analysis of results in the new format would center on understanding changes in management’s assumption for interest rates and other market-driven metrics rather than business fundamentals and strategies (also, every company could be expected to make different assumptions, reducing comparability)
The insurance-sector investment community, individual insurance companies and industry groups have provided substantial feedback to FASB and IASB on the proposals and that effort continues through many different channels. In acknowledging that input, FASB noted that investors have expressed a strong need for premium volume data on the face of the income statement. The discussion on Monday indicated FASB was looking at ways to address that concern.
Is Radical Change Good or Bad
As various investors have pointed out to me, the proposed FASB and IASB changes have the potential to change radically the face of insurance-sector investing. If that occurs, it is likely that we would see a dramatic change in the role of the insurance-sector investor relations practitioner.
I have heard investors predict that the proposed changes – if adopted in their present form – could make the barrier to investing in insurance companies almost insurmountable. In their worst-case scenarios, investors envision insurance companies facing substantial increases in their cost of capital. They anticipate volatile book values – potentially swinging quarterly from positive to negative and back, solely on the basis of short-term fluctuations in external market measures. They believe few investors would take the time to look beyond complex accounting and a negative book value to see positive company fundamentals.
As a corollary, not many investor relations teams are prepared to successfully communicate a positive fundamental story when their time and energy is devoted to addressing highly volatile and difficult to understand short-term results.
Of course, it is too early to know exactly the form or timing for any future changes, or if they will occur at all. But even at this point in the process, insurance-sector investor relations teams can become familiar with the proposals.
And the opportunity exists for insurance-sector investor relations teams – separate from their companies’ accounting departments – to provide feedback to FASB and IASB. That feedback would be another important adjunct to the ongoing efforts by insurance-sector investors.
At Monday’s meeting, FASB encouraged feedback that focuses on whether or not the proposed plan will lead to “less transparency,” or “less comparability” or if their recommendations make it harder for companies to share with investors the economics of their business. (FASB indicated they don’t give much credence to feedback that appears to say “it will make my job harder” or “why do we have to change, we’ve always done it this way.”)
Even before the FASB Exposure Draft is issued (planned for fourth quarter 2011), feedback can be given to the individuals listed under Contact Information on the FASB’s Update on the project on their website.
I want to close by again thanking the FASB board members and staff for their time on Monday.
The session was excellent and they made it abundantly clear they welcomed hearing the perspectives of investor relations practitioners. I appreciated the opportunity to attend and the chance to hear their updates directly.
I know I gained a greater appreciation of the commitment of the board members and staff to the complex undertaking described in FASB’s mission statement:
“… to establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports. That mission is accomplished through a comprehensive and independent process that encourages broad participation, objectively considers all stakeholder views, and is subject to oversight by the Financial Accounting Foundation’s Board of Trustees.”
I hope to be able to attend the liaison meeting again in the future.