Jun 29

Mark to Model: A Reality for Insurers?


According to Barnert Reports it appears that the NAIC has adopted the “Application of the Fair Value Definition” (INT 09-04 T, if you are keeping score).  Although it may be further changed by work done at the Statutory Accounting working group, this new accounting pronouncement for statutory financials opens up a new world for many insurers.

Securities where ‘fair value’ is difficult to ascertain due to illiquidity or related reasons could now be priced based upon a ‘modeled’ value instead of the incredibly low, low price provided by independent third party pricing services.  This will be especially useful for insurers holding structured securities showing values that make no sense at all when reviewed on an economic, ‘worst’ case basis. 

Although insurers generally hold bonds at amortized cost (book value), those ugly Other Than Temporary Impairment (OTTI) rules rear their ugly heads when ‘fair value’ is materially below book value for a period of time.  But, under INT 09-04 T, fair value could be modeled value — albeit based upon a discounted present value under another new rule, SSAP 98, for structured securities.

This raises lots of interesting issues like:

1 – Comparability of statutory financials – my valuation of the same bond may be different from yours, and that can directly impact my bottom line…and yours.  Why does this have the possibility of becoming a ‘race to the bottom’ in modeling quality?

2 – What role will the SVO have in all of this?  Doesn’t the SVO post pricing that must be followed by all insurers?  Now, your company can act as its own SVO when it comes to fair value.

3 – Since all of this ultimately impacts measures like BCAR, regulatory capital, etc, will companies on the financially weak end of the spectrum be able to look better with a few changes to a spreadsheet?

4 – Until we see the pronouncement in final form, we are uncertain as to implementation date, but if might be ASAP.  Given the last minute nature of this change, are all insurers aware of this?

Just as in the recently issued GAAP pronouncements on fair value that allowed banks to pump up their results and capital, this STAT change may have some very interesting side effects.  Everyone wanted a better way to value securities fairly, but sometimes we should be careful what we wish for…we just might get it.