F a i r Va l u at i o n o f I n s u r a n c e L i a b i l i t i e s : P r i n c i p l e s a n d M e t h o d s
Endnotes 1
The American Academy of Actuaries has taken no position on whether insurance contracts should fall within the definition of financial instruments. For purposes of this paper, the task force uses definitions currently proposed by accounting standard setters, under which many insurance contracts are treated as a type of financial instrument. 2 The Joint Working Group of standard setters (JWG) was formed in 1997 for the purpose of developing a coherent framework for accounting for financial instruments measured at fair value. The JWG consists of nominees of accounting standard setters or other professional organizations in Australia, Canada, France, Germany, Japan, New Zealand, five Nordic countries, the United Kingdom, and the United States, as well as the International Accounting Standards Board. In December 2000, it issued a draft standard for financial instruments and similar items that focused on fair value accounting. (FASB news release, “FASB Publishes Special Report of the Joint Working Group of Standard Setters on Financial Instruments,” Jan. 5, 2001.) 3 “The International Accounting Standards Board is an independent, privately funded accounting standard setter based in London, U.K. Board members come from nine countries and have a variety of functional backgrounds. The Board is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the Board cooperates with national accounting standard setters to achieve convergence in accounting standards around the world.” (IASB website, (http://www.iasb.org.uk/cmt/0001.asp, March 8, 2002.) 4 Principal exceptions are structured settlements and workers’ compensation lifetime indemnity (i.e., wage loss) claims, with some additional exceptions by state. In most cases, the allowable discount rate is locked in at a conservative level, and does not vary with general market interest rates. Throughout much of the world, property/casualty insurance (a.k.a. general insurance) claim liabilities are not allowed to be discounted for interest. 5 This hierarchy is described in the JWG December 2000 Draft Standard and Basis for Conclusions – Financial Instruments and Similar Items, page iii (top of page) and paragraphs 77 and 104, with clarifying discussion in paragraphs 77-121. 6 Paragraph 116 of the JWG December 2000 Draft Standard and Basis for Conclusions – Financial Instruments and Similar Items states: An enterprise should reflect the following information in the fair value estimate, either as a part of the present value computation or as an adjustment of the result: a) the price market participants are able to receive for bearing the uncertainty inherent in the financial instrument (the risk premium); and b) other factors market participants would be expected to consider in setting prices, including marketability and profit margins expected by market participants. 7 This assumes that such a contract would still have sufficient insurance risk to be labeled an insurance contract. The definition of an insurance contract put forward by the JWG is as follows: “An insurance contract is a contract under which one party (the insurer) accepts an insurance risk by agreeing with another party (the policyholder) to make payment if a specified uncertain future event occurs (other than an event that is only a change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index or similar variable).” 8 For insurance liabilities that involve delivery of goods and services, the costs of those goods and services can be determined and used in place of the cash flows to be discounted. 9 These principles may be superseded by explicit guidance in an accounting standard. If that happens, then the accounting standard will take precedence for valuations under that standard. 36