Draft accounting standards are “inappropriate”

By Kate McCaffery | January 28 2014 06:30PM

There are internationally-recognized standard-settings boards working in recent years to change accounting so investors can effectively compare companies around the world, regardless of their business, or where they operate.At a glance, this goal seems perfectly reasonable. Scratch the surface, however, and insurance companies have shown that adhering to the proposed accounting and valuation standards, particularly when applied to the interactive, and extremely long duration holdings that appear on a typical insurer's balance sheets, can cause an extraordinary amount of volatility, and a decidedly inaccurate portrayal of a company's actual fiscal health.

The IASB (International Accounting Standards Board), and the Financial Accounting Standards Board (FASB) released new proposed standards for insurance contract, and insurance company accounting in June and July 2013, and requested feedback on the proposed standards.

Ridiculous complexity

In response, Manulife Financial, along with Met Life, Prudential Financial, and the New York Life Insurance Company, conducted joint field testing, with the help of a third-party consultant to collect and review data in a way that would preserve confidentiality. The analysis examined nine products lines, representative of typical products available in North America, results from the December 2007-2012 period, and provided historic U.S. Generally Accepted Accounting Principles (U.S. GAAP) results for comparative purposes.

In the resulting whitepaper, the group says “we have concluded that many of the principles underlying the standard are sound, but once we looked into the details, there are a number of significant issues that need to be addressed.”

Speaking on his own at Citi Global Financial Conference in Hong Kong last month, Steve Roder, Manulife’s senior executive vice president and chief financial officer, was a little more pointed:

In short, the draft accounting standards, he says, are inappropriate. Moreover, if they are enacted in their present form, he says they will introduce “ridiculous complexity and produce unwelcome adverse consequences, for both consumers and society.”

“Let's talk about this crusade to make companies mark everything on the balance sheet to market,” he says. “Any suggestion to the IASB that mark-to-market accounting might be problematic or inappropriate are met with cries of blasphemy. The IASB's response? Market consistency promote transparency and comparability.”

In reality though, he says using a quarterly, market discount rate when reporting very long term cash flows, for example, produces valuation change worth billions.

“A 25 basis point, quarter-to-quarter change in interest rates does not inform my view of rates in 60 years time at all. There isn't even a market for these liabilities,” he says. "The results of our testing show that the proposals add massive, unwarranted volatility, complexity, and create a misalignment between accounting and the economics of the business. These proposals do not work.”

If the standards were enacted, he adds, they would result in financial statements that are even less intelligible than they are today, and the volatility would dissuade life companies from underwriting very long term products. In turn, as the industry underwrites less risk, it would need to pull away from investing in very long term investment assets, like infrastructure, to match their liabilities.

“I believe standard setters should be cognizant of these real world issues,” he says. “Surely this recognition that industries are different, and the use of accounting standards and disclosures appropriate to the industry is preferable to the blind pursuit of comparability across industries.”