Urging property/casualty insurance company investors to respond to a request for comment about a proposed accounting standard before the looming deadline, a carrier CFO said the proposal is destined to make loss reserve reporting more complex.
“It really almost turns it upside down,” Michael J. Sewell, chief financial of The Cincinnati Financial Corporation, referring to impact that a proposal published by the U.S. Financial Accounting Standards Board at the end of June will have on the current system of carrier financial reporting for loss reserves and premium income.
“It’s already complex setting reserves today but [this] will be adding complexity on top of complexity,” Sewell said, during a presentation he gave at the Keefe, Bruyette & Woods Insurance Conference in New York.
For most of the KBW session, Sewell and Cincinnati Financial’s President and Chief Executive Officer Steven Johnston discussed their company’s track record of paying dividends, recording underwriting profits and investment income, as well as strategic drivers that fuel the good results, which include investing in data analytics and a focus on the carrier’s field staff. But during the question-and-answer part of the presentation, KBW Analyst Vincent DeAugustino asked Sewell to expand on comment he made along the way—that the FASB proposal will make it more difficult for investors to compare the financial performance of carriers in the future, particularly with respect to loss reserves.
Sewell noted that P/C insurers currently set case reserves and reserves for incurred by not reported losses. “In the future, it’s going to be more on projected cash flows. So you’re really looking at future cash flows versus what has incurred,” he said, noting that there are two methods for reporting these reserves under the proposed method—with the difference depending on whether the duration of the contracts is one year or less, or a year or more.
“You may have two companies that have similar products, but one might account for [it] saying it’s a 12-months or less [product]; another company may account for it under the long-term” method. That means one company will not discount while another will under the proposed FASB rules, Sewell explained.
He added that even if both companies discount, there will be other questions—what is the discount rate, what are the periods over which the discounting takes place, for example.
“It’s going to be really adding complexity.”
Turning to premium income, Sewell provided a very clear example of how his company’s reporting might change for the homeowners line, and how it might differ from a similar insurer in the Northeast.
Under the current standards, one-twelfth of an annual policy might be recorded into income as each month passes.
Under the new proposed standard, the company has to consider the underlying risk that the policy is covering in capturing the premium income, he said.
Cincinnati writes many policies in the Midwest, where properties are more prone to tornadoes in the second quarter. That means that to comply with the proposed standard, Cincinnati might record the bulk of its premium in the second quarter.
So instead of 25 percent of the premium recorded in each quarter, the reporting might change to recognize 20 percent in the first quarter, 40 percent in the second quarter, 30 percent in the third quarter and 10 percent in the fourth quarter.
On the other hand, a carrier writing more policies on the East Coast, might recognize the bulk of its premium income in the third quarter—during hurricane season, he said, suggesting that the premium income recording might be 15 percent in each of the first two quarters, 50 percent in the third and 20 percent in the fourth quarter.
The models that insurance analysts are now using to compare carriers will not longer be valid, he suggested. “Any models that investors like you all are using, you really will not have data that will go back,” he added.
“There is only one more month where you are able to respond” the FASB proposal, he said encouraging investors and analysts to study the matter and respond to FASB in advance of the accounting board’s Oct. 25, 2013 deadline for comment.
“This new accounting pronouncement is going to fundamentally change the way insurance companies report to the public and to investors,” Sewell said, characterizing the changes as “drastic” rather than small adjustments.