Fair Value of Insurance Liabilities - CAS White Paper
Fair Value White Paper
Overview
Ralph Blanchard
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
CAS Task Force on Fair Value Liabilities
Members:
Ralph Blanchard
Bob Butsic
Catherine Cresswell
Louise Francis
Aaron Halpert
Phil Heckman
Gerry Kirschner
Sarah Krutov
Mike McCarter
Gary Nickerson
Stewart Sawyer
Ernest Wilson
Bryan Young
Contributors
David Appel, Paul Brehm, Roger Hayne, Gary Josephson, Joe Lebens, Steve
Lowe, Glenn Meyers, Elizabeth Smith, Pat Teufel, Gary Venter, COPLFR
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
Overview
•What is Fair Value? Why?
•What does it mean for insurance?
•Why a CAS white paper?
•Goals of the white paper
•CAS white paper
Format
Previews of each section
Findings
•Next steps
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
What is “Fair Value?”
Economic value - ideally the market value,
if a sufficiently active market exists.
Why the interest in “fair value?”
If accounting is not at economic value, results are
easy to manipulate via buying and selling
(e.g., Savings & Loan crisis of the 1980’s)
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Fair Value of Insurance Liabilities - CAS White Paper
What does it mean for insurance?
If a sufficiently active market does not exist, the fair value
must be estimated.
The biggest items of interest to actuaries and insurance investors
that must rely on fair value estimates.
Loss reserves
Unearned premium (“provision for unexpired risk”)
Items that disappear.
Deferred acquisition cost (DAC) assets
Premium deficiency reserves
Open issues.
Renewals, other intangibles, “credit standing”?
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Fair Value of Insurance Liabilities - CAS White Paper
What does it mean for insurance? - part 2
What’s involved in estimating a fair value?
present value of future expected cash flows, adjusted for:
• risk
• market imperfections
• “similar factors if market-based information is available
to estimate those adjustments” (FASB)
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Fair Value of Insurance Liabilities - CAS White Paper
Why a CAS white paper? Why now?
In December 1999, the FASB and the IASC issued proposals
calling for the reporting of insurance liabilities at fair value.
Both required comments by May 31, 2000.
CAS Leadership decided that the research into fair value issues
needed to be expanded, in order to assist the AAA in preparing
a response to these proposals and any future developments
in this area. (The initial CAS leadership focus was just the
IASC proposal.)
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Fair Value of Insurance Liabilities - CAS White Paper
Why a CAS white paper? Why now? - part 2
FASB: Preliminary Views - Financial Instruments at Fair Value
• Focus is financial instruments
• Insurance defined as financial instrument, usually
• Comment deadline was May 31st
• http://www.rutgers.edu/Accounting/raw/fasb/new/index.html
IASC: Insurance Issues Paper
• Focus is insurance
• Discount all insurance liabilities
• Fair value insurance liabilities IF all other
financial instruments at fair value
• Comment deadline was May 31st
• http://www.iasc.org.uk/frame/cen3_113.htm
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Fair Value of Insurance Liabilities - CAS White Paper
Goals of the white paper
Aid in the AAA Fair Value Task Force responses to
• FASB
• IASC
Assist CAS liaison (Steve Lowe) to the
International Actuarial Association (IAA)
and their response to the IASC
http://www.actuaries.org/Public/Committees/IASCI/indexe.htm
Become a general resource for CAS members and other parties
on this issue, relative to P&C insurance liabilities.
(Primary audience is actuaries.)
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Format
A. Background, including a definition and history of fair value
in general
B. Fair Value in the insurance context
C. Alternatives to Fair Value Accounting for p/c insurance liabilities
D. Methods for Estimating Fair Value
E. Accounting Presentation Issues, including alternative income statement
or balance sheet formats in a “fair value” world.
F. Implementation Issues surrounding the fair valuing of p/c ins. liabilities
G. Accounting Concepts, or how well fair value accounting and the issues
discussed in the earlier sections would be viewed in the context of general
accounting concepts (such as reliability, relevance and representational
faithfulness).
H. Credit Standing and Fair Value Liabilities, a discussion of issues related
to the reflection of credit standing in determining the fair value of liabilities.
I. Professional Readiness
J. Summary and Observations
K. Technical Appendices
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Preview - Introduction
Fair Value potential advantages
• Consistency with assets.
• Eliminate accounting arbitrage.
• Consistency with other financial instruments.
• Relevance.
Fair Value potential disadvantages
• Difficulty in measuring.
• Greater estimation reliance.
• Volatility in earnings.
• Cost.
• Unintended or unexpected consequences.
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Preview - Alternatives to Fair Value
• Undiscounted expected value
• Present value at a risk-free interest rate
• Present value using an industry-standard risk-adjustment
• Mixture of fair value and alternatives
• Entity-specific measurement
• Cost-accumulation measurement
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Preview - Methods
1 - CAPM
2 - IRR
3 - Single-period RAD (Risk-Adjusted Discount)
4 - Methods Based on Underwriting Data
5 - Actuarial Distribution-Based Risk Loads
6 - Reinsurance market prices
7 - Direct estimation of market values
8 - Distribution Transform Method
9 - “Rule of thumb” Methods
Others?
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Preview - Presentation
What would a reserve development triangle look like under a fair
value system.
Should it include risk margins?
Should it reflect changes in interest rates?
CAS White Paper - Preview - Implementation
What properties should risk margins have?
Should they reflect process risk?
Should they reflect value additivity?
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Preview - Accounting Concepts
The desired traits of an accounting system are:
•
•
•
•
•
Relevance
Reliability
Comparability and Consistency
Neutrality
Cost Benefit
CAS White Paper - Preview - Credit Standing
Should the fair value of a company’s liabilities reflect
its credit standing?
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Professional Readiness
• Do actuaries currently have a theoretical understanding of fair value
concepts adequate to estimate liabilities under a fair value standard?
• Are models currently available that can be used by actuaries to
estimate fair value liabilities?
• Are actuaries prepared to implement these models and make these
estimates in practice?
• What steps can the profession take to aid individual actuaries in
implementing effective processes for fair valuation of insurance
liabilities for their companies or their clients?
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - findings
1)
2)
3)
4)
5)
6)
New requirement
Alternatives for fair value
Expected value versus best estimate
Multiple methods
Continuum from pricing methods
“Typical” line/”typical” company limitation of most current
methods
7) A fair value accounting standard would lead to new research
8) When market prices and “fair value” estimates are in conflict
• Market disequilibrium
• Market disruption
• Information asymmetry
• Significant intangibles
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Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - findings Part 2
9) Implications of risk margin approaches without value
additivity
10) Susceptibility to actuarial estimate
11) Increased reliance on judgmental estimates in financials
12) Historical comparisons
13) Gross vs. net.
14) Tax issues
15) Credit standing reflection in valuing liabilities
16) Actuarial workload requirements
17) Professional Readiness
18) Standards vs. Principles
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Fair Value of Insurance Liabilities - CAS White Paper
Next Steps
IASC
•
•
•
•
Review comments (138 as of Aug. 23) this fall
Draft Statement of Principles
Final Statement of Principles
Exposure Draft of Proposed International Accounting
Standard
• International Accounting Standard (ETA of 2004?)
SEC
• Determine if statements filed under IASC standards will be
accepted in U.S.
• Comment deadline on this question was May 15, 2000
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Fair Value of Insurance Liabilities - CAS White Paper
Next Steps - (part 2)
FASB
• Review comments
• Next steps?
• Committed to fair value of financial assets
• Would like to have fair value of financial liabilities
AAA, IAA
• Monitor developments and respond accordingly
• Enhance comment writing/consensus building process
CAS, SOA
• Continue research and educational efforts
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Fair Value of Insurance Liabilities - CAS White Paper
Speed of Accounting Pronouncements
“The Board’s Experience with Fair Value of Financial Instruments...
The accounting profession, the SEC, bank regulators, and some
providers of financial statement had urged the Board to deal with
the subject comprehensively because the existing authoritative
guidance was incomplete and inadequate. …resulted in ad hoc
and inconsistent reporting practices. In 1986, the board agreed to
undertake a major project on financial instruments.”
(from FASB “Financial Accounting Series, No. 206-D/February 29, 2000, page 7)
bolded font not in the original text
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