AICPA groups seek consistency in insurance contract standards

Comment letters to accounting standard setters submitted jointly by an AICPA committee and expert panel urge convergence on at least some critical issues in financial reporting rules for insurance contracts.

The AICPA Financial Reporting Executive Committee and Insurance Expert Panel advised FASB and the International Accounting Standards Board (IASB) that high-quality accounting standards should not be sacrificed in the name of convergence. But the letters listed five areas where convergence is important if FASB decides to follow through with the project and make significant changes to U.S GAAP.

Proposals issued by FASB and the IASB in June of this year are part of a convergence project that began in 2008, but they are not converged in several respects.

The letters from FinREC and the Insurance Expert Panel said the boards should seek convergence in the following five areas:

• Unlocking the margin. Changes in estimates of future cash flows, which are related to future coverages or services, should be recognized as adjustments to the margin.
• Fulfillment cash flows. These should include a measurement for uncertainty related to the allocation of probable outcomes.
• Definition of portfolio. When defining a portfolio of insurance contracts, the way entities manage their businesses should be taken into account.
• Acquisition costs. Different guidance on what qualifies as acquisition costs and the accounting for acquisition costs paid will confuse users of financial statements.
• Transition. Practical expedients should allow for the use of hindsight.

“We want [convergence] to happen,” Insurance Expert Panel Chair Richard Lynch, CPA, said in a telephone interview, “but if they’re not going to converge, there are five key areas … that they should at least try to get agreement on.”

FASB and the IASB are in quite different positions with respect to their standards for insurance contracts. U.S. GAAP standards address accounting for insurance contracts, but IFRS does not have comprehensive insurance guidance.

That puts the IASB in a position where developing a standard for insurance contracts is considered essential by many.

“It is unacceptable that we do not yet have a proper standard to account for insurance contracts,” IASB Chairman Hans Hoogervorst said in a speech in June. “As a result, there is huge diversity and complexity in how insurance companies report their numbers around the world.”

FASB, meanwhile, has not yet evaluated whether the benefits that are expected from the proposed changes would exceed the costs, according to the letters. Targeted improvements to U.S. GAAP may also be considered by FASB, and FinREC and the Insurance Expert Panel concede that this could make convergence challenging.

The letters from FinREC and the Insurance Expert Panel, though, merely provide feedback on the boards’ proposals. The recommendations include:

• Narrowing the definition of “insurance contract,” which the letters say is too broad because it includes arrangements that are predominantly based on credit risk and are not currently accounted for as insurance contracts. The proposed guidance applies to all entities that issue contracts that meet the definition of insurance contracts, not just insurance entities as under current U.S. GAAP.
• Allowing entities to make an accounting policy decision on whether changes in discount rates should be recognized in other comprehensive income or net income. This could help mitigate volatility in earnings by allowing for better matching with assets in conjunction with FASB’s financial instruments project.
• Asking FASB to reconsider including uncertainty in cash flows related to the allocation of probable outcomes. There is concern that using fulfillment cash flows (the present value of the explicit, unbiased, and probability-weighted estimates of the future cash flows), without including a measurement of the uncertainty related to the allocation of probable outcomes, may not accurately reflect the measurement of the insurance liability. 

Lynch said FASB might have a difficult decision to make because one of its key objectives in the project—convergence—may not occur if the current proposals are approved.

“If you’re not going to be converged globally, then you’ve got to take a step back … and if you’re not going to get [convergence] out of the project, the FASB has to decide what its next step should be.” Lynch said.

FASB may decide that updating current U.S. GAAP for issues uncovered—and not a total overhaul—may be a better path, Lynch said.

Despite the boards’ different starting points, FinREC and the Insurance Expert Panel are encouraging them to reach the same endpoint on at least a few key issues where the AICPA groups said consistency should be sought—if FASB decides to make changes.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.