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2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
Fair Value White PaperOverview
Ralph Blanchard
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
•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
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
Slide 2 of 19
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)
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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”?
Slide 3 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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)
Slide 4 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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.)
Slide 5 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 6 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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.)
Slide 7 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 8 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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.
Slide 9 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 10 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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?
Slide 11 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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?
Slide 12 of 19
CAS White Paper - Preview - Implementation
What properties should risk margins have? Should they reflect process risk? Should they reflect value additivity?
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
CAS White Paper - Preview - Accounting Concepts
The desired traits of an accounting system are:• Relevance• Reliability• Comparability and Consistency• Neutrality• Cost Benefit
Slide 13 of 19
CAS White Paper - Preview - Credit Standing
Should the fair value of a company’s liabilities reflectits credit standing?
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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?
Slide 14 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 15 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 16 of 19
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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?)
Slide 17 of 19
SEC• Determine if statements filed under IASC standards will be
accepted in U.S.• Comment deadline on this question was May 15, 2000
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 18 of 19
AAA, IAA• Monitor developments and respond accordingly• Enhance comment writing/consensus building process
CAS, SOA• Continue research and educational efforts
2000 CLRS - September 19th
Fair Value of Insurance Liabilities - CAS White Paper
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
Slide 19 of 19