OR WAIT 15 SECS
Major changes are under way in global accounting standards, and all U.S. insurance companies will be affected.
Major changes are under way in global accounting standards, and all U.S. insurance companies will be affected. The International Accounting Standards Board (IASB) is developing a comprehensive new generation of International Financial Reporting Standards (IFRS). The IASB has specifically addressed the issue of a new accounting treatment for insurance contracts in its initial discussion paper, "Preliminary Views on Insurance Contracts." In the paper, the IASB laid out the guidelines of a new global framework for insurance contracts, which could take effect within the next four to seven years. Managed care companies must follow these developments as the Financial Accounting Standards Board (FASB) has signaled its interest in bringing US Generally Accepted Accounting Principles (US GAAP) into convergence with IFRS requirements, which would include insurance contract accounting guidance. Adoption of these new accounting standards would impact how all insurers report liabilities and profits.
Liability estimation issues
An important goal of the IASB paper is to develop a principles-based model for liability estimation that applies to all types of insurance contracts. The IASB classifies insurance liabilities into two types: pre-claims liability and claims liability. The IASB valuation approach, known as current exit value (CXV), is intended to apply equally to both types of liabilities.
The IASB prescribes that an estimate of the CXV of any insurance liability should be viewed as comprising three building blocks: estimate of future cash flows; time value of money; and margin (for risk and service).
With the exception of adjusting for the time value of money, the essence of the requirement seems consistent with current practice among managed care plans. However, further review of the proposed details of each building block points to several issues for managed care plans to address.
Cash flows – one issue concerning estimates of cash flows is that the new IASB guidelines would require excluding entity-specific cash flows. If cash flows would not arise for other entities holding an identical obligation, they are deemed entity specific. Another issue regarding cash flow estimates is determining which future cash flows should be included in the pre-claims liability. One of the conditions the IASB stipulates for the inclusion of future premiums and associated future benefits is that the policyholder must pay the premiums to retain guaranteed insurability (GI). The IASB defines GI as "a right that permits continued coverage without reconfirmation of the policyholder's risk profile and at a price that is contractually constrained."
Time value of money – the proposed IASB guidance stipulates that all insurance liabilities should be discounted and that the discount rates used in measuring insurance liabilities should be consistent with market prices of other cash flows with similar characteristics.
Risk margin – the IASB defines a risk margin as "an input to the liability estimate that reflects the degree of uncertainty that exists in the estimation of cash flows." The IASB says that the risk margin is intended to be an explicit and unbiased estimate of the compensation that market participants demand for bearing risk. The risk margin should be based on the margin market participants require, which would not necessarily be calibrated to premium at the inception of the contract. This implies that the insurer could, in some circumstances, immediately recognize some profit or loss upon policy issuance, which would not occur if the risk margin at policy issuance were always calibrated to premiums.