Insurers Challenged Over Accounting For Stock Options
Second only to the magnitude of premium rate changes, the hottest topic on this quarters property-casualty earnings conference calls was the question of whether insurers would start expensing stock options.
Among p-c company executives asked about the issue, Allstate Chairman Edward Liddy was the strongest proponent. But no executive would go on the record as saying his company would voluntarily step up to adopt the practice.
"Personally, I think Corporate America and the Financial Accounting Standards Board ought to just do it and get on with it. If its one of those things that will help restore confidence in Corporate America and in CEOs, we ought to justbe done with it," Mr. Liddy said.
Noting that the after-tax impact for Northbrook, Ill.-based Allstate would be roughly three- or four-cents-per-share, he said that while his instincts are that Corporate America ought to expense stock options, "we all ought to do it together. Because what you wouldnt want to have happen is that companies within the same industry have different cost structures because some people expense options and some do not."
He said he didnt expect Allstate to expense options voluntarily unless "many of the companies in [the insurance] industry" moved in that direction.
Given the trivial impact, why not be a leader, an analyst asked, suggesting that the symbolic impact would outweigh the income effect. Mr. Liddy responded that while the impact is minimal, it is often "the sum of all the minimal things" that a company does that causes its expense levels to be higher than competitors, at least on paper.
At Mayfield Village, Ohio-based Progressive, CEO Glenn Renwick said his carrier "absolutely thinks options are a form of compensation. Theres no debate on that in our minds. And it should be reflected in some way, shape or form to owners and those who are interested in analyzing the company."
But he and CFO Tom Forrester suggested that the companys present method of disclosing the value of stock options gives a better picture of the "true economic impact" than the expense accounting would, noting that such an expense item would in fact "understate" the actual impact on Progressive owners.
Progressive has recognized that "the true economic cost of options is ultimately the impact to owners in terms of dilution. And we have made a conscious effort to neutralize that," Mr. Renwick said, explaining that the company has "a policy of non-dilution"–buying back as much stock in any given year as it believes will be exercised in the form of stock options. (The term dilution generally describes the effect on earnings per share if all options are exercised.)
While "this is clearly reflected in the balance sheet, not in the income statement," he said, "by our reasoning, this anti-dilution is the best way to reflect the true economic impact of options."
Calling Progressive "a leader of transparency," Mr. Renwick said, "we may not choose not to be a leader in terms of saying well expense options."
Mr. Forrester noted that if options had been expensed in 2001, the after-tax impact would have been $15.4 million, $23.7 million on a pre-tax basis, or 0.3 points on the combined ratio, calling those accounting figures "relatively immaterial" for the company.
For "a company like Progressive that has had a lot of success,as its stock continues to rise, the economic impact is much, much greater," Mr. Bradley said, putting that "economic" figure for 2001 at $62 million.
Like the others, Jay Fishman, chairman and chief executive of The St. Paul Companies, said that the impact of expensing options would be minimal for his company, putting the figure at four- or five-cents-per-share for most years.
An exception was 2001, he said, noting that a higher figure–roughly 20-cents-per-share–would have been driven by a large option grant he received when he joined the company, and grants he recommended for some senior managers.
"We havent made any decision about what were going to do about expensing it or not. Its not an overwhelming or important part of our compensation structure," he said.
Warren Buffett, chairman of Berkshire Hathaway in Omaha, Neb., expressed his view on the subject in an opinion piece that ran in The New York Times on July 24.
"When a company gives something of value to its employees in return for their services, it is clearly a compensation expense. And if expenses dont belong in the earnings statement, where in the world do they belong?" he wrote.
Calling the crisis in confidence about corporate earnings reports "justified," he wrote: "Without blushing, almost all CEOs have told their shareholders that options are cost-free."
"For these CEOs, I have a proposition: Berkshire-Hathaway will sell you insurance, carpeting or any of our other products in exchange for options identical to those you grant yourselves. Itll all be cash-free."
"But do you really think your corporation will not have incurred a cost when you hand over the options in exchange for the carpeting?" he challenged.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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