Casualty Loss Reserve Seminar
Fair Value Accounting
Mike Grillaert
KPMG LLP
September 23, 2002
Fair Value at the FASB
 FASB began fair value project in 1986
 SFAS No. 107, Disclosures about Fair Value of Financial
Instruments, issued in 1991
 SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities, issued in 1993
 SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, issued in 1998
 FASB Concepts Statement No. 7, Using Cash Flow
Information and Present Value Accounting
Measurements, issued in 2000
 A comprehensive Exposure Draft to come, but when???
Fair Value: The FASB’s Ultimate Goal
Paragraph 334 of Statement 133 . . .
The Board is committed to work diligently toward resolving ,
in a timely manner, the conceptual and practical issues
related to determining the fair values of financial
instruments and portfolios of financial instruments.
Techniques for refining the measurement of the fair values
of all financial instruments continue to develop at a rapid
pace, and the Board believes that all financial instruments
should be carried in the statement of financial position at
fair value when the conceptual and measurement issues
are resolved.
Why Is Fair Value Relevant?
 Investors and Creditors are primarily interested in
assessing the amounts, timing, and uncertainty of future
net cash flows. Information is relevant if it helps with
such an assessment.
 Information based on prices that reflect the market’s
assessment, under current conditions, of the present
values of the future cash flows is more relevant than
information based on old market prices.
What is Fair Value?
 Since December of 2001, the FASB has made the following
decisions:
 Fair value of a financial instrument should be an estimated exit
price—the price that would have been received or paid if it had
been sold, exchanged, or settled on the measurement date.
 Commissions paid on acquisitions, originations, sales,
incurrences, or settlements of financial instruments should not be
included in the determination of fair value; they should be
reported as expense in the period in which they are incurred.
 The effects of changes in an entity’s own creditworthiness and
credit risk premium should be included in determining the fair
value of that entity’s liabilities.
Fair Value and Concept Statement No. 7
 February, 2000—FASB issued Concept Statement No.
107, Using Cash Flow Information and Present Value in
Accounting Measurements.
 Adopted expected value cash flow estimates rather than
“most likely” best estimates.
 Adopted fair value as measurement objective when
employing present value.
 Included impact of entity’s own credit standing in the
measurement of its liabilities.
Fair Value and Concept Statement No. 7
(cont.)
 Concept statement not an accounting standard, but used
to develop new and revised accounting standards.
 Concept Statement has been controversial.
 FASB has issued 4 “Understanding the Issues” papers to
explain its position.
FASB’s Next Steps
 In March 2002, the Board temporarily suspended
deliberations to focus on other, higher priority projects.
 In September 2002, the Board expects to recommence
deliberations on the scope of the proposed standard.
This issue includes:
 The definition of financial instruments
 Nonfinancial instruments that may be included in the
scope
 Financial instruments that may be excluded from the
scope
 Contracts that are very similar to specific financial
instruments.
FASB’s Next Steps (cont.)
 Other Issues to be addressed in the proposed Exposure
Draft:
 Form and content of the required disclosure including
presentation of changes in fair value
 Disclosure of other matters, for example risk
exposures, measurement sensitivity, and valuation
policies and methods.
Brief History of IAS
 International Accounting Standards Board (IASB) has
been working since the late 1980s to develop a financial
reporting model for all companies.
 Framework completed in 1989
 Standards (IAS) developed since then
 An insurance standard has not been issued




Insurance project started in 1997
“Issues Papers” delivered in 1999
Draft Statement of Principles (DSOP) developed end of 2001
DSOP revision targeted for 2002, most likely end of 2003
Possible Insurance Contract Treatment
 The treatment described in the following slides are mostly
the compilations of the thoughts surrounding the direction
of IAS for insurance contracts.
 Most of the items look to the Draft Statement of Principles
and also look to the general IAS Framework for
consistency with IAS objectives.
 The final insurance contract accounting will likely differ
from what is described herein and the differences could
be significant.
IAS Definition of Insurance Contract
An insurance contract is a contract that exposes the
insurer to identified risks of loss from events or
circumstances occurring or discovered within a specified
period, including death, survival (annuity), sickness,
disability, property damage, injury to others, and business
interruption.
Deferral & Matching vs Asset/Liability
Approach
Asset & Liability Approach
Deferral and
Matching
Supported in DSOP
Not supported
in DSOP
Entity Specific Value
Fair Value
Under each method, total profit is the same,
but the emergence of profit is markedly different
Comparison of Methods
Deferral & Matching
• Emphasis on income statement
• Expenses are deferred to match
future income
• Profit emerges over term of
contract
Asset & Liability
• Emphasis on balance sheet
• Profit or loss results from change in
value of assets & liabilities
• On initial recognition: provision for
risk and uncertainty
• No gain on sale
• Possible gain on sale
Entity Specific Value – IAS Approach
Fair Value – FASB Approach
• Value of asset/liability to the firm
that holds it
• May reflect factors not available or
relevant to the market
• PV = costs firm will incur in settling
liability with PH/beneficiaries
• Consistent with IAS 39
• Value for which asset/liability could
be exchanged between
knowledgeable persons in an arms
length transaction.
• PV = amount firm would have to
pay a third party to assume liability.
Asset/Liability - Entity Specific Valuation
Value of Insurance Contract =
PV (all future cash flows including policyholder dividends)

Best estimate assumptions
- Stochastic modeling techniques strongly implied
- Probability weighted approach
- Options measured using option pricing techniques
- No reference to underlying assets (except variable)
 Market value margins (MVM) added to best estimate to adjust for
risk and uncertainty.
- How to determine the level of MVM is being heavily debated
(level prescribed in insurance standard?, left to company to
decide?, left to company to decide?)

Discount rate should be the risk free rate.
Impact for US Companies

Which Companies are affected?
- Companies listed on EU or Australian exchanges
- Companies that report to EU or Australian parents
- Companies that report to parents where the regulators are
requiring IAS.
- Companies that wish to compare to their peer group, where
similar companies report on an IAS basis

Conversions to IAS are expected to take two phases
- IAS standards other than insurance, including IAS 39 work for
insurance companies (by year end 2005)

This work has already started at some companies -- now is the time
to get large projects started
- Insurance standard conversions once the standard has been set
(estimated effective at year end 2007)
FRR 60 – SEC Cautionary Advice Regarding
Disclosure About Critical Accounting Policies
 Describe “critical” accounting policies
 MD&A should be balanced and responsive, and linkages
to FS effects should be explained in plain English
 Audit committees should review accounting policy
selection, application, and disclosure before finalization
Proposed Rule – Critical Accounting
Policies
 Proposed rule released May 10, 2002
 Issued as follow-up to FRR 60 (still in effect)
 Would require a separate caption in MD&A section of
annual reports, registration statements and proxy and
information statements discussing critical accounting
estimates and initial adoption of accounting policies
What is Proposed Disclosure for Critical
Accounting Estimates?
 For each critical accounting estimate:
- identify and describe the estimate, assumptions and
reasonably likely changes
- Disclose significance to the financial statements and,
where material, identification of the line items affected
by the estimate;
- identify and discuss segments affected by the
estimate (if any);
What is Proposed Disclosure for Critical
Accounting Estimates?
 For each critical accounting estimate:
- provide a quantitative discussion of the sensitivity of
reported numbers to changes in estimates, either
using possible changes in assumption(s) or a range of
estimates;
- a quantitative and qualitative discussion of the
changes in estimates for the past three years; and
- Disclose whether or not senior management has
discussed the selection of estimates with the audit
committee.