Fair Value: Unfair?

[inexactuary]

Originally Posted by The Mad Hatter

So, just to be clear, you think that if Company A and Company B sell the exact same policy to the exact same customer save for one difference: A pays $100 in commission and B pays $200. Then B gets to capitalize $200 of profits up front but A only $100? And that makes sense to you?

And if the capitalized profits to be earned on the contract depend on earning credit spreads, the nonsense of traditional accounting only multiplies.

Assuming the premium is adequate to earn a profit, then both Company A and B have zero day one profit (assuming a traditional net premium style reserve), and both will earn profits over time, although Company A's will be higher.

If you don't capitalize the commissions, then the companies have day one losses of $100 and $200. So even though the policies issued have ecomonic value, the transaction incurs a loss. How does that make sense?

[Commodore64]

Originally Posted by inexactuary

If you don't capitalize the commissions, then the companies have day one losses of $100 and $200. So even though the policies issued have ecomonic value, the transaction incurs a loss. How does that make sense?

I agree and if this will effect the P&L so strongly, it could create havoc in stock prices.

Does anyone know how this is handled in other industries? For example, in the oil industry, can a company differ drilling costs to when the oil is pumped?

[JMO]

Originally Posted by Commodore64

I agree and if this will effect the P&L so strongly, it could create havoc in stock prices.

Actually, before FAS60, analysts were making adjustments to statutory P&L to adjust for this. (Statutory was the only basis at that time.) One of the arguments for FAS60 was to make the information more useful.
In Europe, I think that pretty much all insurers report something called Embedded Value, which basically up-fronts everything. So it's the PV of future profits on all their business. EV is still evolving, but if the accountants win the day, that will be the "real" number for analysts to look at.

On an EV basis, the current period P&L turns out to be the change in EV, reflecting an addition (one hopes) for new business and a lot of +/- on existing business as actual divereges from expected.

Originally Posted by JMO

Actually, before FAS60, analysts were making adjustments to statutory P&L to adjust for this. (Statutory was the only basis at that time.) One of the arguments for FAS60 was to make the information more useful.
In Europe, I think that pretty much all insurers report something called Embedded Value, which basically up-fronts everything. So it's the PV of future profits on all their business. EV is still evolving, but if the accountants win the day, that will be the "real" number for analysts to look at.

On an EV basis, the current period P&L turns out to be the change in EV, reflecting an addition (one hopes) for new business and a lot of +/- on existing business as actual divereges from expected.

Yup. It's evolving into a monster too. It basically up-fronts everything, unless there are losses due to severe market disruptions at the statement date, in which case you make up stuff like liquidity premia in order to make the bad look not so bad.

It's very much like what Enron was doing.

[JMO]

Originally Posted by Anonymouse

Yup. It's evolving into a monster too. It basically up-fronts everything, unless there are losses due to severe market disruptions at the statement date, in which case you make up stuff like liquidity premia in order to make the bad look not so bad.

It's very much like what Enron was doing.

LOL.

So if the accountants say don't DAC acquisition, you use another approach which front-ends all the profit forever. I hope somebody wakes the accountants up. (I think I said that in my OP.)

[MNSmith]

Acquisition costs are self-capitalizing when using gross premium reserves....like in Canada. The DAC "asset" is embedded in (i.e. lowers) the reserves.

If I'm not mistaken, GNAIE is objecting to an element of the risk margin, not the treatment of acquisition costs.

[The Mad Hatter]

Originally Posted by inexactuary

Assuming the premium is adequate to earn a profit, then both Company A and B have zero day one profit (assuming a traditional net premium style reserve), and both will earn profits over time, although Company A's will be higher.

If you don't capitalize the commissions, then the companies have day one losses of $100 and $200. So even though the policies issued have ecomonic value, the transaction incurs a loss. How does that make sense?

If the policies have economic value, that too should be capitalized and the acquisition costs expensed. If the EV >= 200, great for everyone. If not, loss at point of sale for B.

[PhildeTruth]

Dear AO,

Fair value accounting will surely cause more disasters than it prevents.

Regards,

PhildeTruth

[JMO]

Originally Posted by MNSmith

Acquisition costs are self-capitalizing when using gross premium reserves....like in Canada. The DAC "asset" is embedded in (i.e. lowers) the reserves.

I totally agree. But . . .

when IASB completes its work on Fair Value, Canadian companies will be forced into this new International Standard. Currently, the IASB is still planning to adopt in 2011, which means that the current Canadian method will no longer be used in 2012 and therafter.