Accounting Standard Setters Propose Discounting Property Casualty Reserves

Unearned Premium Reserves and Deferred Acquisition Assets Also Affected

by Ralph S. Blanchard, Chairperson CAS Task Force on Fair Value Liabilities

In December 1999, both the Financial Accounting Standards Board (or FASB, the principal setter of accounting standards in the United States) and the International Accounting Standards Committee (or IASC, an international organization attempting to develop greater uniformity to accounting rules across the world) issued exposure drafts proposing "fair value" accounting for insurance liabilities. What is "fair value" accounting? It is market value accounting, except for situations when established markets don't exist. In those cases, the "fair value" is what the market price would be if a fair and efficient market existed. And it is generally understood that the market price will reflect the time value of money, i.e., be a discounted value. Therefore the proposal to have fair value accounting for insurance liabilities implies discounted values for insurance liabilities.

What insurance liabilities? Per the FASB, all those that are eventually settled via cash transactions. This would include loss (and loss expense) reserves, unearned premiums, contingent commissions, etc. As to deferred acquisition costs, the FASB does not see prepaid acquisition costs as a recognizable asset under fair value accounting, hence these assets would disappear under the proposals. Any benefit from prepaying expenses would instead be reflected by a reduced "fair value" of the obligations included in the unearned premium reserve.

What does this mean to actuaries? When is this going to happen? Currently, both the FASB and IASC initiatives are in a preliminary stage. The FASB proposal is included in what is called a "Preliminary Views" document (which can be downloaded free from their Web site at www.rutgers.edu/Accounting/raw/fasb.) outlining their preliminary views on how fair value accounting of financial instruments might work. (They include insurance liabilities in their definition of "financial instrument".) They are looking for comments by May 31, 2000, to help shape the future direction of the project. While the entire project currently includes many other liabilities (and assets) besides those of insurance, it is possible that insurance would eventually be broken off from the main project and handled separately. This is a mid- to long-term project, with no definite timetable as of yet.

The IASC project, meanwhile, is on a parallel track. They have published an "Issues Paper" dealing exclusively with insurance, including the proposal that insurance liabilities be reported at fair value, with a comment deadline also of May 31, 2000. (This document can be dowloaded free from their Web site at www.iasc.org.uk/frame/cen3_113.htm.)

A few caveats. These proposals affect GAAP accounting, the kind used in annual shareholder reports and prospectuses, not the kind used for tax or statutory accounting. The international accounting standards would also have to be adopted eventually by the local country accounting authorities. In the U.S., that would be the Securities and Exchange Commission, which delegates most of this task to FASB.

What is the CAS doing about this? A task force has been set up to study the issue and Steve Lowe has been appointed as the CAS representative to the International Actuarial Associations' IASC committee. The CAS Task Force on Fair Value Liabilities is charged with issuing a white paper on the issue, and providing input to Steve Lowe in his work. Parts of the white paper are also expected to be used in official American Academy of Actuaries responses to the FASB and IASC documents. (For more information, see the CAS Web Site at www.casact.org/research/tffvl/index.htm. Comments are welcome, and can be sent to those involved with the project.)