The Financial Accounting Standards Board is asking stakeholders for input on how to improve the accounting for insurance contracts in financial reports.

The discussion paper it has released is part of FASB's joint project with the International Accounting Standards Board, and is one of a number of standards that the two entities need to iron out before the previously agreed-upon June 2011 deadline for completing several major convergence projects.

In June, the IASB issued an exposure draft of a proposed international financial reporting standard that would apply to all insurance contracts written by both insurance companies and non-insurance companies.

The FASB discussion paper asks stakeholders to provide input about the following:

Whether the IASB's proposal would be a sufficient improvement to U.S. GAAP to justify the cost of change;

Whether the project goals of improvement, convergence and simplification would be more effectively achieved by making targeted improvements to existing U.S. GAAP (rather than issuing comprehensive new guidance); and,

Certain critical accounting issues for which the preliminary views of FASB differ from the IASB's draft.

In addition to soliciting written comments, FASB and the IASB plan to host a series of public roundtable meetings scheduled for December to hear stakeholders' views.

"It's important to gather as much information as possible at this stage of the project to help it decide the best way to improve the financial reporting for insurance contracts," said FASB member Marc Siegel. "This information will be helpful to both FASB and the IASB in our deliberations."

FASB's preliminary view, which is consistent with the IASB's ED, is that the proposal should apply to all entities that issue contracts that contain insurance risk, not solely insurance companies, according to a brief issued by Big Four firm PricewaterhouseCoopers.

Arriving at common requirements is likely to have a significant impact on the insurance industry, considering the current diversity under IFRS in accounting practices in different geographies.

The boards have proposed using the existing IFRS definition of an insurance contract, which states, "A contract under which one party accepts significant insurance risk from another party by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder."

According to PwC, the broad definition would result in contracts issued by non-insurers being subject to the guidance, such as certain financial guarantee contracts and loans with waivers upon death, as well as certain warranty contracts. The FASB and IASB proposals do not address the accounting by policyholders (other than reinsurance) entering into insurance contracts.

Insurance contracts often contain other elements, such as financial or service components.

"A change to a model that requires the contract liability (or asset) to be re-measured each period using updated assumptions regarding expected cash flows, current interest rates and other market-based inputs, where appropriate, will likely increase volatility in earnings and equity compared to current models, which generally do not reflect changing conditions and assumptions unless a loss is anticipated," said Mark Anderson, an assurance partner at PwC. "And because current systems are designed to capture information and model results in order to meet current accounting requirements, these changes are expected to result in significant systems changes."

Under both the FASB and IASB proposals, these items must be unbundled and accounted for separately if they are not closely related to the insurance coverage. In particular, embedded derivatives would be separated in accordance with derivatives guidance, and certain account balances would be unbundled and accounted for as financial instruments.

Both the FASB and IASB proposals would require insurance contracts to be accounted for using a current measurement model that reflects the present value of expected cash flows to fulfill the obligation, where estimates are re-measured at each reporting period.

The IASB proposal includes an explicit risk adjustment for the uncertainty about the amount and timing of future cash flows that would be separately estimated and re-measured each period.

However, experts contend that the proposals would likely result in increased volatility, and additional demands on data and modeling systems.

At least one insurance group filed an early comment letter last month criticizing some of the IASB proposals.

The Group of North American Insurance Enterprises said that the proposed exposure draft "failed in its original intent of advocating a simplified alternative measurement paradigm for certain short-term insurance contracts whose underlying attributes are best accounted for using a short-term revenue and expense model similar to that currently in use around the world."

Instead, according to the GNAIE, the draft proposes "an excessively complex model that ultimately results in a full, but indirect, application of the IASB building blocks model to both the pre-claims liability and post-claim reserves associated with short-term property/casualty insurance contracts."

Both boards' proposals would defer and amortize any excess of expected cash inflows over outflows existing at inception in order to eliminate any initial profit. Conversely, any losses would be recognized immediately.

The discussion paper, and information about the roundtables, is available at www.fasb.org.

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