New Accounting Rules To Be Introduced For Insurance Companies

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The Financial Accounting Standards Board (FASB) is expected to propose new financial rules for U.S. insurance companies like AIG (NYSE:AIG), Prudential Financial (NYSE:PRU) and MetLife (NYSE:MET) today. [1] The FASB has suggested that the new standard for accounting will lead to greater consistency for contracts involving transfer of risk between parties. Apart from insurers, banks and mortgage guarantors might also be subject to the new regulations. The FASB has not yet issued a timeline for the implementation of the regulations, should they be approved. The proposal is similar to the guidelines announced by the International Accounting Standards Board last week.

See Full Analysis For : MetLife|Prudential Financial|AIG|Hartford Financial|The Travelers Companies

The New Rules

For life insurance companies like MetLife and Prudential, the main change would be regarding the recognition of premium revenue. Premiums will be recognized as revenues over a period of time, as the insurance services are provided. Expenses would also be similarly deferred, so the net income of insurers is not expected to be affected greatly, but companies might see a slowdown in revenue growth. [2]

Another change would be regarding the reserves maintained by insurance companies to back up their policies. Reserves are estimated by insurers on the basis of assumptions regarding factors like life expectancy of the insured party. The new regulations will require insurers to revise their assumptions each quarter. However, these changes would fall into a category named “other comprehensive income” and would not affect net income.

Property and casualty insurers like The Travelers Companies, Inc. (NYSE:TRV) and The Hartford Financial Services Group (NYSE:HIG), which issue short term insurance contracts will also have to change the way they estimate their reserves. The new rules will require companies to maintain a weighted average of estimates based on probabilities. For example, if a company estimates a 20% chance of a $3,000 insurance payout, a 30% probability of a $2,000 payout and a 50% chance of a $1,000 payout, then it would currently reserve the most probable amount, $1,000. However, under the new regulations, the company would have to reserve $1,700, the weighted average of the three amounts. The reserves would also be discounted using a rate based on time and interest rates.

We will keep a close eye on developments and update our models for insurance companies as required.

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Notes:
  1. Accounting Change for Insurers Could Make Profit More Volatile, The Wall Street Journal, June 27, 2013 []
  2. New Rules Expected for Insurance Accounting May Lead to Erratic Earnings, The New York Times, June 27 []
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