Change to “fair value” accounting may affect insurers’ financial reporting

Stung by the proliferating number of financial restatements over the past few years, the accounting industry is changing towards the use of “fair value” accounting measurements, which may have a future impact on insurance contracts.
Fitch Ratings notes the above phenomenon in a special report, posted online, entitled “Accounting and Financial Reporting: 2007 Global Outlook Measuring Up.”
“In the U.S., restatements have resulted largely from heightened scrutiny of financial reporting, while elsewhere the whole accounting framework is changing with the mounting prevalence of International Financial Reporting Standards (IFRS),” Fitch notes in its report. “Users’ reactions to restatements have been numbed by their frequency, especially as many confuse as much as inform.”
According to Fitch, “a solid conceptual framework developed jointly by the FASB [Financial Accounting Standards Board] and IASB [International Accounting Standards Board] should ensure that financial reporting for those applying these standards blends over time.”
This would include a clarification of what and how measurements are used in financial reporting.
The accounting world is somewhat skeptical about the use of “fair value” measurement in financial reporting, according to Fitch..
According to a paper by Jackson Day of the U.S. Securities and Exchange Commission (SEC), “under GAAP, the fair value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties, other than in a liquidation.”
The fair value of a liability, on the other hand, is “the amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in a liquidation.”
The key is, according to Day, “if available, a quoted market price in an active market is the best evidence of fair value and should be used as the basis for the measurement.” But if quoted prices are unavailable, “difficulties occur when making estimates of fair value.”
Fitch’s report notes that the IASB “is expected to publish a discussion paper in the first half of 2007 on Phase II of its accounting for insurance contracts project, and the FASB is expected to follow suit. The main part of the paper is expected to cover how a fair value for insurance reserves should be derived.”
Fitch notes that insurers can use higher equity to compensate for lower reserves and thereby obtain the same credit rating. “Therefore, any reduction in the reserves by the accounting will need to be met by the company retaining more equity, all things being equal, to ensure ratings are maintained at the same level.
“Fitch will also observe how regulators respond to accounting changes for insurance reserves.”