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Insurance Project Will Limit Focus to Life Policies

February 20, 2014

The FASB significantly scaled back its proposed changes for insurance accounting and won’t pursue a wide-ranging project to overhaul the accounting for all insurance contracts. Instead, the board plans to limit the changes to policies offered by insurance companies and leave some bank products and third-party warranties that perform like insurance contracts out of its amendments to U.S. GAAP.

Bowing to criticism from businesses, auditors, and some investors, the FASB on February 19, 2014, agreed to rethink major parts of its plan to overhaul the accounting for insurance contracts, indicating that it will pursue targeted improvements to U.S. GAAP and not revamp current accounting.

The decision was considered preliminary and could change, but the FASB took significant steps away from the draft of the amendments published in June 2013 with Proposed Accounting Standards Update (ASU) No. 2013-290, Insurance Contracts (Topic 834). The board also further dimmed the prospects of convergence with the IASB, which proposed its changes in Exposure Draft (ED) No. 2013-7, Insurance Contracts.

In a major shift from Proposed ASU No. 2013-290, the FASB agreed that the new accounting would apply only to insurance companies. Businesses from other industries that sell products that could be considered insurance policies would not be subject to the changes.

The proposal had defined insurance as an agreement to accept significant insurance risk from customers and cover them for losses arising from uncertain future events. The proposed changes would have applied to banking products, such as the guarantees banks provide on a broad range of instruments, including asset-backed securities, mortgages, and standby letters of credit. Warranties issued by third parties, catastrophe bonds and weather derivatives, and some types of roadside assistance also would have been covered.

In Proposed ASU No. 2013-290, the FASB addressed its changes to the type of contract because it didn’t want to create an industry-specific accounting standard, which analysts say makes it difficult to compare financial results for different types of companies. The principles-based definition of insurance, however, required the FASB to write two pages of exceptions to the rule, which some FASB members said defeated the point.

“Is it better to have a standard focused on a particular industry, or have a standard and a list that is two pages long with scope exceptions, which contributes more to complexity?” FASB Vice Chairman James Kroeker said.

The FASB agreed to focus on improving the accounting for long-term insurance products such as life insurance policies, which investors and analysts have likened to looking at a “black box.” The board agreed to place less emphasis on improving accounting for short-term policies such as theft, fire, and automobile, and said it would potentially review enhancing disclosures for the products.

Phil Carson, general counsel for the American Insurance Association, the main property-and-casualty insurance trade association in the U.S., said he was “thrilled” with this development. Many companies that specialize in short-term insurance products had railed against the FASB’s proposal, as well as the IASB’s.

“The project, as proposed originally by FASB and certainly by the IASB, really didn’t make a lot of sense for property-and-casualty carriers,” Carson said. “They were basically taking a long-duration model and trying to impose it on every type of contract out there, regardless of the fact that the business models differ. That had been our concern all along.”

As for improving life insurance accounting, the FASB said it would examine current practice and make targeted improvements. But some FASB members said this may not be simple.

“The biggest weaknesses with U.S. GAAP are in long-duration contracts,” FASB member Thomas Linsmeier said. “There are multiple models and, with those multiple models, the comparability across long-duration contracts is challenged… I cannot at this time understand what list of items we’d like to improve within that.”

It’s also unclear whether an effort to improve life insurance accounting will mean that the FASB adopts the so-called building-block accounting approach outlined by both the U.S. board and the IASB in their proposals.

“I certainly didn’t get any hint from them that when they said ‘targeted changes’ to life [insurance], it sounded like the ongoing assumption is the building-block [model] as written,” said Donald Doran, a partner with PricewaterhouseCoopers LLP.

The FASB decision diminishes the prospect for similar accounting for insurance companies on both sides of the Atlantic.

“I’m not surprised by what they did, given the feedback they got,” Doran said. “I’m slightly perplexed as to what it means on how they work with the IASB from here on. Maybe it’s that they don’t.”

Background

The FASB and IASB had been working for years to write a global accounting standard for insurance contracts, but the convergence process hit roadblocks almost from the beginning.

The IASB’s predecessor, the International Accounting Standards Committee, began writing an international standard for insurance in 1997. The IASB picked up where the IASC left off when it was formed in 2001. In 2004, the IASB issued IFRS 4, Insurance Contracts, a temporary standard that defined an insurance contract and offered some limited accounting requirements. The standard generally allowed existing regional accounting practices to remain until the international board wrote a replacement, but it remains in place a decade later.

Meanwhile, U.S. GAAP has had several product-specific insurance accounting standards for decades, and many insurance companies are satisfied with their accounting practices, especially for short-term policies, which don’t rely as much on up-and-down returns from the financial markets.

In 2012, the FASB and IASB agreed that they couldn’t come up with a global standard, but they largely agreed that they needed a fundamental change to long-term insurance accounting, which they called the “building block approach.”

Under both the FASB and IASB’s proposals, insurers offering long-term policies would have to report their liabilities each period based on the present value of projected cash flows. Changes in the cash flow projections would be recorded in net income. Changes in the discount rate or interest rates would be reflected in other comprehensive income.

The approach for short-term contracts, called the “premium allocation approach,” was similar to what insurers do today, but they would be required to discount the net present value of their expected liabilities. Many property-and-casualty insurance companies told the FASB this approach was still too complex for their business model.

“We’re very pleased and kind of surprised they acted so quickly and understood our concerns,” Carson said.