Discussion of changes to insurance contract accounting has been going on for over a decade. With its newest proposal, the Financial Accounting Standards Board is asking for comments on an updated proposal for standards that likely would be effective on January 1, 2018.
That sure does seem very far away.
I think that extended time frame – and the number of times this topic has come up and then been relegated to the back burner – has contributed to a lower profile for this most recent update.
That said, I believe there is a strong argument in favor of insurance-sector IROs both paying attention to the proposal and taking a seat at the table for all internal and external discussion regarding these changes – or further changes in the proposals — and for interim implementation steps. You can jump directly to that discussion, but a bit of background seems appropriate.
FASB’s New Proposal
So back on June 27, right before the July 4 holiday break and the subsequent start of second-quarter earnings season, FASB issued the newest version of its proposed accounting standards for Insurance Contracts, with extensive information available at that link related to this topic.
(The IASB issued a related exposure draft on June 20 for their version of insurance contract accounting. These projects are both part of the broader objective of converging U.S. and international accounting standards, even though the current insurance contract proposals contain some key differences.)
You may recall that insurance accounting was the subject of much discussion among investors, insurance companies and others back in 2011. At that time, the post (Wow) Accounting Standards from the IR Perspective offered some background on the then-current proposals and talked about investor concerns. At some point later in 2011 or early 2012, the project was delayed and discussion on the subject died down.
But it is most definitely back, and in what may be a closer to workable form. And from what I am hearing, investors are no happier with the newest version than with the past proposals.
Since June 27, FASB has held several webinars on the proposals, has stated it plans to undertake additional outreach over the coming months, and has asked for comments on the newest exposure draft to be submitted by October 25, 2013 (details on all of these are available on the FASB website).
New Plan vs. Old – Do the changes address investor concerns?
From my perspective as an investor relations practitioner (let me reiterate that I am not an accountant), the new proposal does address certain concerns that investors had raised. Nonetheless, feedback indicates it has the potential to create the same level of significant chaos in the insurance-investing sector as prior versions, particularly during the transition period.
I do see a small improvement with the intent to reduce fears of volatility in earnings by moving certain quarterly interest-rate driven insurance liability adjustment to other comprehensive income from net income (to join similar adjustments to asset valuations). This addresses a very significant concern that the quarterly analysis of “earnings” would have centered on understanding changes in management’s assumption for interest rates and other market-driven metrics rather than business fundamentals and strategies. But book value may still fluctuate significantly, which would lead to a similar analysis.
In addition, the FASB proposal now includes a much-needed – simplified — system for accounting for short-duration contracts (primarily property and casualty and some health insurance) and changed the financial presentation format to accommodate something more similar to the current income statement. The new standard also would offer comparability across industries through a requirement that non-insurance companies writing insurance contracts use the same accounting methodologies. Interestingly, primary insurance and offsetting ceded reinsurance items would not be shown on a net basis, either in the revenue line or in expenses.
Further, the proposal now would require that the standards be applied retrospectively to the existing book of business (to the extent practical and most often through the use of simplified assumptions). I think this is a key improvement, as it would allow historical data for each entity to be used as a basis of comparison going forward.
And then there is quite a list of topics that pique my interest, but on which I will need more education to fully understand each proposed change and the potential implications. One appears to change the manner in which reserves are established (the proposal includes language such as the “unbiased, probability weighted estimate”). It also appears to include the ability to add a provision for anticipated catastrophe losses before an event occurs. Discounting of longer-tail reserves appears to become a requirement.
Another update indicates to me that property and casualty companies might find it more problematic to report investments as a separate segment. And the revenue recognition provisions appear to be tied to the probability of loss (e.g., seasonality) rather than contract timing. And I’m sure that is only a partial list. (I suggest reviewing the August 6 “Heads Up” from Deloitte for more insights. Note that you may have to register to access the document.)
The Investor View
Bottom line, while there may be some improvements over earlier proposals, investors continue to have significant concerns, concerns that largely are unchanged from the issues identified in 2011:
- Revision is so substantial – particularly for life insurance companies — that even with historical data, investors must re-learn how to understand, analyze and model insurance company financial results.
- Changes would require investors to value insurance companies in a fundamentally different manner.
- New presentation may disconnect the accounting from the way an insurance company is managed on a day-to-day basis (e.g., grouping policies for accounting and reporting on the basis of risk and pricing rather than manner in which they are acquired, serviced or measured).
While 2018 seems very far away, I obviously think IR teams should be paying attention now (or I wouldn’t have written this post). Why?
The “head it off” argument – The comment period for FASB’s current proposal ends October 25. By acting now, IR teams may be able to strengthen (or initiate) feedback from their organization. Persuasive arguments made to the FASB in the comment period represent one of the only opportunities left to influence the conceptual framework (and the manner in which the proposal is addressing the stated objective to provide more “decision useful” information to users of financial data) as well as any implementation technicalities.
The “opportunity” argument — It isn’t all that often that an IR practitioner – in any industry – has the opportunity to participate in the “clean slating” of the tools that their company uses for communications with investors. But if these (or similar) proposals are adopted, then I believe every disclosure document, every presentation, every financial/supplement handout, every website page with financial data, etc., is going to need to be reconsidered and – in many cases — rebuilt. At the same time, there may be implications for the manner in which the company tells its strategic story.
I encourage IROs to be there at the start rather than reacting at the end. For example, be at the table when the accounting team and the operating team are discussing how to “group” policies; you can share how investors view underwriting risk. You also would be in a position to consider how data might be best presented – in writing, orally and digitally – and to make sure that relevant supporting data that you know investors will need is being developed!
The “investor advocate” argument – If adopted, these proposals are going to take many insurance investors back to the drawing board. (Of course, insurance-sector analysts on both the sell- and buy-side will be devoting the time necessary to understand the new accounting.)
But many buy-side investors follow multiple industries – and have lots of choices for their investment dollars. I am concerned we may find those individuals use the changes as an excuse to ignore the insurance industry, greatly reducing the pool of potential investors. As the IRO, you would be the front line of defense for your company against this risk. I believe we all will find it much easier to be articulate on the new data if we have been part of the internal working team.
Said another way, insurance-sector IROs will never have a better opportunity to be the voice of investors internally. Investors are the users of the financial data, but you may be the only person internally who will be in a position to say “following the ‘letter’ of the proposal won’t be enough on topic XXX, how can we provide additional color to make it more useful for investors?”
So let me close by offering my appreciation for the finance and accounting teams that will need to do the heavy lifting if these sweeping changes are implemented.
But investor relations deserves a seat at the table as the internal voice for investors – one of the primary external user groups for financial data. And an audience that generally still prefers the current system over the sweeping changes that have been proposed.