FAS 159 - The latest Sword of Damocles
From those SEC lackeys, known as the FASB, comes the latest attempt to force mark to market accounting on us all. FAS 159 provides the option to report investments at fair value (using FAS 157 as your valuation guide). Initial implementation will allow a debit or credit to retained earnings for the unrealized loss/gain, while subsequent periods would effectively move the investments into the ‘trading’ bucket of FAS 115 and mark any change in unrealized loss/gain through the GAAP income statement. Normal adoption would be for accounting years beginning after Nov 15, 2007. Early adoption would require an insurer to elect by the time their first financial filing is due for Q1, 2007. (Read about FAS 159 in its accounting-speak text at www.fasb.org/pdf/fas159.pdf)
And the wolves of Wall Street are telling financial institutions to take advantage of early adoption and dump low yielding securities now for higher yielding ones, showing the debit in retained earnings and not as a drag on income…while pumping up net income with higher yielding securities. Alas, a wolf does not understand time too well, only what to do now. And certainly insurers who follow the wolves may eventually become dinner.
First, future changes in securities value under FAS 159 will significantly increase earnings volatility. Try explaining that to your friendly Wall Street analyst when they compare your company’s results to a peer who has not adopted 159. These are the same folks who give little or no credit for realized gains despite this item being important in judging overall investment performance.
Second, insurer regulatory accounting will remain unchanged and that means 159 will do nothing to hide the realized loss you might take from following the recommended Wall Street strategy.
Third, if enough insurers go down this path, our friends at the NAIC will start grumbling about how this might impact their latest stance on investment accounting, including OTTI, with unknown consequences. (Of course OTTI for GAAP disappears when using 159.)
We are not alone in continually stating the need to mark BOTH sides of the balance sheet to market, but little seems to happen in this respect. (In fact, certain insurance contracts will not be marked to market under current International Accounting Standards.)
With 159, FASB has added a Sword of Damocles over our heads. Who will adopt the fair value option? When? What will it mean for insurers? What will it mean for statutory accounting? How do we accurately compare our company’s results to others?
Something tells me this will be a close shave.
April 7th, 2007 at 5:38 am
From the other side of the Atlantic there is some mystification as to why our American cousins would want to persist with an arcane method of accounting, whose sole purpose seems to be to make investment income figures in the P&L look less volatile than they really are. The burden that this imposes in terms of accounting (and audit) costs, and in terms of accepting a less than optimal investment policy, seems very high.
Your competitors are probably quite happy for you to carry on investing with one hand tied behind your back, because it makes you easier to compete with, but you must surely ask whether this attempt to smooth earnings is worth the cost.
This is particularly so when you look at where earnings volatility really comes from. It comes from underwriting results. If you really want to smooth earnings then surely you’d be much better off looking at the underwriting side of the P&L account.
David
June 4th, 2007 at 7:47 am
The envelope please:
And the answer to the age-old question of who would adopt this method of accounting is, “When there are value/ market pockets that are ascending quickly and there is an upside to adopt a new Wall Street asset strategy.”