FAIR VALUE

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FAIR VALUE

• Ralph Blanchard

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Overview

• Definition of Fair Value
• Who is proposing it?
• Insurance application - significant issues
• Actuarial response
• CAS white paper
• Format
• Previews
• Findings
• Next steps - actuarial orgs
• Next steps - accounting standard setters

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What is Fair Value?
DICTIONARY DEFINITIONS an estimate of the
price an entity would have realized if it
had sold an asset or paid if it had been relieved
of a liability on the reporting date in an
arms-length exchange motivated by
normal business considerations. (FASB) the
amount for which an asset could be exchanged, or
a liability settled, between knowledgeable,
willing parties in an arms length transaction.
(IASC)
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What is Fair Value - Part 2
SHORT WORKING DEFINITION

• The market value, if a sufficiently active market
  exist, OR
• An estimated market value, otherwise

ESTIMATED MARKET VALUE
present value of future expected cash flows,
adjusted for

• risk
• market imperfections
• similar factors if market-based information is
  availableto estimate those adjustments (FASB)

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Who is Proposing It?
FASB Preliminary Views - Financial Instruments
at Fair Value

• Focus is financial instruments
• Insurance defined as financial instrument,
  usually
• Comment deadline is May 31st

IASC Insurance Issues Paper

• Focus is insurance
• Discount all insurance liabilities
• Fair value insurance liabilities IF all other
  financial instruments at fair value
• Comment deadline is May 31st

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Insurance Application - Significant issues?
All Insurance?

• Only indemnity contracts at fair value?
• What about services? (e.g., HMO)
• What about option of cash/service? (e.g.,
  Property)
• What about composite contracts? (e.g., WC)

Discounting
Risk Provision

• Reliably measurable?
• Market price
• Independent of holder?
• Diversifiable vs. non-diversifiable risk?

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Insurance Application - Significant Issues? Part
2
UPR replaced with unexpired contract reserve

• No premium deficiency reserve
• No Deferred Acquisition asset (DAC)
• Include renewals in the fair value?
• Return premium as a floor?

Credit standing

• Liability lower for shaky company?

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Actuarial Response
CAS special task force on fair value liabilities

• Research
• White paper (late May/early June)
• www.casact.org/research/tffvl/index.htm

AAA Fair Value Task Force

• Responses to FASB, IASC

International Actuarial Association (IAA)

• Response to IASC

CAS liaison to IAA (Steve Lowe)
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CAS White Paper - Format
A. Background, including a definition and history
of fair value in general B. Fair Value in the
insurance context C. Alternatives to Fair Value
Accounting for p/c insurance liabilities D. Method
s for Estimating Fair Value E. Implementation
Issues surrounding the fair valuing of p/c ins.
liabilities F. Accounting Presentation Issues,
including alternative income statement or
balance sheet formats in a fair value
world. G. Accounting Concepts, or how well fair
value accounting and the issues discussed in the
earlier sections would be viewed in the context
of general accounting concepts (such as
reliability, relevance and representational faith
fulness). H. Credit Standing and Fair Value
Liabilities, a discussion of issues related to
the reflection of credit standing in determining
the fair value of liabilities. I. Professional
Readiness J. Summary and Observations K. Technical
Appendices
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CAS White Paper - Preview - Fair Value Pros and
Cons

• Potential advantages - Fair Value
• Consistency with assets.
• Eliminate accounting arbitrage.
• Consistency with other financial instruments.
• Relevance.
• Potential disadvantages - Fair Value
• Difficulty in measuring.
• Greater estimation reliance.
• Volatility in earnings.
• Cost.
• Unintended or unexpected consequences.

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CAS White Paper - Preview - Methods
1 - CAPM 2 - IRR 3 - Single-period RAD
(Risk-Adjusted Discount) 4 - Methods Based on
Underwriting Data 5 - Actuarial
Distribution-Based Risk Loads 6 - Reinsurance
market prices 7 - Direct estimation of market
values 8 - Distribution Transform Method 9 -
Rule of thumb Methods Others?
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CAS White Paper - findings
1) New requirement 2) Alternatives for fair
value 3) Expected value versus best
estimate 4) Multiple methods 5) Typical
line/typical company limitation of most
current methods 6) A fair value accounting
standard would lead to new research 7) When
market prices and fair value estimates are in
conflict

• Market disequilibrium
• Market disruption
• Information asymmetry
• Significant intangibles

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CAS White Paper - findings Part 2
8) Implications of risk margin approaches
without value additivity 9) Increased reliance
on estimates in financial statements 10) Historica
l comparisons 11) Gross versus net
provisions? 12) Legal entity vs. consolidated
reporting. 13) Credit standing reflection in
valuing liabilities 14) Actuarial workload
requirements 15) Professional Readiness 16) Standa
rds vs. Principles
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Next Steps - Actuarial orgs.
CAS

• Draft workproducts to AAA, IAA
• Draft workproducts to CAS liaison to IAA
• White paper (late May/early June)

AAA

• Comment letter to FASB
• Comment letter to IASC
• Contribute to IAA
• Monograph (with CAS white paper?)

IAA

• Comment letter to IASC

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Next Steps - Accounting Standard Setters
IASC

• Review comments this fall
• Draft Statement of Principles
• Final Statement of Principles
• Exposure Draft of Proposed International
  AccountingStandard
• International Accounting Standard (ETA of 2004?)

SEC

• Determine if statements filed under IASC
  standards will be accepted in U.S.
• Comment deadline - May 15

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Next Steps - Accounting Standard Setters
FASB

• Review comments
• Next steps?
• Committed to fair value of financial assets
• Would like to have fair value of financial
  liabilities

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Speed of Accounting Pronouncements
The Boards Experience with Fair Value of
Financial Instruments...
The accounting profession, the SEC, bank
regulators, and some providers of financial
statement had urged the Board to deal with the
subject comprehensively because the existing
authoritative guidance was incomplete and
inadequate. resulted in ad hoc and inconsistent
reporting practices. In 1986, the board agreed
to undertake a major project on financial
instruments.
(from FASB Financial Accounting Series, No.
206-D/February 29, 2000, page 7) bolded font not
in the original text
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