Fair Value of Insurance Liabilities - CAS White Paper 2000 CLRS - September 19th Fair Value White...

2000 CLRS - September 19th

Fair Value of Insurance Liabilities - CAS White Paper

Fair Value White PaperOverview

Ralph Blanchard



CAS Task Force on Fair Value Liabilities

Members:

Ralph Blanchard

Bob Butsic

Catherine Cresswell

Louise Francis

Aaron Halpert

Phil Heckman

Gerry Kirschner

ContributorsDavid Appel, Paul Brehm, Roger Hayne, Gary Josephson, Joe Lebens, Steve Lowe, Glenn Meyers, Elizabeth Smith, Pat Teufel, Gary Venter, COPLFR

Sarah Krutov

Mike McCarter

Gary Nickerson

Stewart Sawyer

Ernest Wilson

Bryan Young



•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 sectionFindings

•Next steps

Overview



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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)



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 investorsthat must rely on fair value estimates.

Loss reservesUnearned premium (“provision for unexpired risk”)

Items that disappear.Deferred acquisition cost (DAC) assetsPremium deficiency reserves

Open issues.Renewals, other intangibles, “credit standing”?

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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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Why a CAS white paper? Why now?

In December 1999, the FASB and the IASC issued proposalscalling 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 issuesneeded to be expanded, in order to assist the AAA in preparing a response to these proposals and any future developmentsin this area. (The initial CAS leadership focus was just the IASC proposal.)

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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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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 IASChttp://www.actuaries.org/Public/Committees/IASCI/indexe.htm

Become a general resource for CAS members and other partieson this issue, relative to P&C insurance liabilities.(Primary audience is actuaries.)

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CAS White Paper - FormatA. Background, including a definition and history of fair value

in generalB. Fair Value in the insurance contextC. Alternatives to Fair Value Accounting for p/c insurance liabilitiesD. Methods for Estimating Fair ValueE. 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. liabilitiesG. Accounting Concepts, or how well fair value accounting and the issues

discussed in the earlier sections would be viewed in the context of generalaccounting concepts (such as reliability, relevance and representationalfaithfulness).

H. Credit Standing and Fair Value Liabilities, a discussion of issues relatedto the reflection of credit standing in determining the fair value of liabilities.

I. Professional ReadinessJ. Summary and ObservationsK. Technical Appendices

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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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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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CAS White Paper - Preview - Methods

1 - CAPM2 - IRR3 - Single-period RAD (Risk-Adjusted Discount)4 - Methods Based on Underwriting Data5 - Actuarial Distribution-Based Risk Loads6 - Reinsurance market prices7 - Direct estimation of market values8 - Distribution Transform Method9 - “Rule of thumb” MethodsOthers?

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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?

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CAS White Paper - Preview - Implementation

What properties should risk margins have? Should they reflect process risk? Should they reflect value additivity?



CAS White Paper - Preview - Accounting Concepts

The desired traits of an accounting system are:• Relevance• Reliability• Comparability and Consistency• Neutrality• Cost Benefit

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CAS White Paper - Preview - Credit Standing

Should the fair value of a company’s liabilities reflectits credit standing?



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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CAS White Paper - findings

1) New requirement2) Alternatives for fair value3) Expected value versus best estimate4) Multiple methods5) Continuum from pricing methods6) “Typical” line/”typical” company limitation of most current

methods7) A fair value accounting standard would lead to new research8) When market prices and “fair value” estimates are in conflict

• Market disequilibrium• Market disruption• Information asymmetry• Significant intangibles

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CAS White Paper - findings Part 2

9) Implications of risk margin approaches without valueadditivity

10) Susceptibility to actuarial estimate11) Increased reliance on judgmental estimates in financials12) Historical comparisons13) Gross vs. net.14) Tax issues15) Credit standing reflection in valuing liabilities16) Actuarial workload requirements17) Professional Readiness18) Standards vs. Principles

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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?)

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SEC• Determine if statements filed under IASC standards will be

accepted in U.S.• Comment deadline on this question was May 15, 2000



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

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AAA, IAA• Monitor developments and respond accordingly• Enhance comment writing/consensus building process

CAS, SOA• Continue research and educational efforts



Speed of Accounting Pronouncements

“The Board’s Experience with Fair Value of Financial Instruments...

The accounting profession, the SEC, bank regulators, and someproviders of financial statement had urged the Board to deal with the subject comprehensively because the existing authoritativeguidance was incomplete and inadequate. …resulted in ad hocand 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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Fair Value of Insurance Liabilities - CAS White Paper 2000 CLRS - September 19th Fair Value White...

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