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New Results Expected for Insurance Accounting May Affect Earnings

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The Financial Accounting Standards Board will propose new rules for insurance accounting on Thursday. The rules seem likely to increase the volatility in reported profits for many insurers and may even lower reported revenue for companies that are rapidly growing. Some of the largest issues may come from companies that have thought insurance accounting rules were not privy to them. The new rules would cover any company that issues contracts which are seen as insurance or similar to insurance in the long run. Insurance is being defined as “accepting significant risk” from another party by agreeing to pay some compensation “if a specified uncertain future event adversely affects the policyholder.” This could possibly include residual value guarantees, mortgage guarantees, and product warranties that are issued by third parties.

However, not all products that seem like insurance would be covered. The accounting for credit default swaps, which would pay if a borrower like a company or a country would default, would never change. The logic is that these types of swaps are sold to speculators who are generally thinking that a default will be more likely to come, as well as bondholders who would suffer from these circumstances. “The proposed standard is intended to bring greater consistency and relevance to the accounting for contracts that transfer significant risk between parties,” said Leslie F. Seidman, the FASB chairwoman. “Current U.S. standards on insurance have evolved over the years as new products have been introduced, leading to some inconsistencies” in insurance accounting.

One major change for some life insurance companies would be timing associated with recognizing revenue. Instead of recognizing the premiums when they are received, premiums would be recognized over a period of time when the insurance is being provided. Expenses in these circumstances would be delayed. This means that the effect on net income wouldn’t be huge, but revenue growth might seem to be slower for some companies.Life insurance companies generally now set up reserves when policies are sold, based on the estimates of the factors like life expectancy. Under the new rules, the assumptions would have to be revised every three months instead, which would lead to changes in the book value of the policies overall. Many of those changes would go into a category that is called “other comprehensive income” and doesn’t affect the new income figures as a whole.

Another noticeable change is that the reserves would be subject to discounting based on time and interest rates. Under the proposal, the reserve for the claim that is not expected to be paid for 10 years would actually be discounted and would rise every year as the expected payment date would come closer. The new rules would affect only the companies that are issuing insurance. Purchasers of insurance, which are most companies, would not have to change their current accounting at all. The proposal is similar to one that was recently issued by the International Accounting Standards Board last week.