Moody’s: New Accounting Rules Alone Should Not Impact Insurers’ Ratings

NU Online News Service, Oct. 20, 1:57 p.m. EDT

New accounting rules effective in the 2012 first quarter will impact life insurers more than property and casualty companies, says Moody's Investors Service, and the rules, by themselves, will not impact the rating agency's view of insurers' creditworthiness.

But Moody's adds,  "However, the adoption of the new rules could have secondary effects, for example if they reveal that a firm's previous DAC [deferred acquisition costs] policies have been more aggressive than those of peers, or if their impact on equity or earnings negatively affects an insurer's bank covenants, investor demand or access to capital."

Moody's says the new rules, alternatively referred to as ASU 2010-26 or EITF 09-G, pertain to insurance companies' capitalization of acquisition costs. "The amended rules will address insurers' currently diverse practices with respect to the capitalization of DAC, and result in fewer expenses being deferred," says Moody's, adding that it expects the new rules to lead to greater consistency in financial reporting, which should benefit investors and other users of financial statements.

Explaining what changes under the new rules, Moody's explains, "Under U.S. GAAP, insurers are permitted to capitalize certain costs incurred in the acquisition of new and renewal insurance contracts. Acquisition costs are defined as those that 'vary with and are primarily related to the acquisition of insurance contracts.'"

But the rating agency notes that various interpretations of the phrase "vary with and are primarily related to" have led to different capitalization policies among insurers.

The new rules, says Moody's, are the U.S. Financial Accounting Standards Board's (FASB) attempt to minimize the differences and more specifically define the costs that can be capitalized.

The rating agency notes that firms will have the option of adopting the new rules prospectively or retrospectively. "We believe most firms will adopt them retrospectively," says Moody's, which will mean insurers will have to recalculate DAC assets on balance sheets as if the new rules had been in effect in all prior periods.

"Few firms have disclosed the expected effect of adoption to this point," says Moody's, "however those that have disclosed have said that DAC balances will be reduced by up to 40 percent, and equity reduced by up to 8 percent.

While the rules will impact the ratios and metrics Moody's uses in analyzing insurers, the rating agency says it does not anticipate any direct ratings impact from the application of more restrictive DAC policies.

Moody's says it believes the impact on P&C insurers will be less material than the life industry, "however diversity in practice exists and therefore the reduction in DAC will vary significantly among P&C companies."

The rating agency says most P&C firms that it reviewed say they are still evaluating the impact of the new rules. "Two companies, Travelers and W.R. Berkley, said they did not expect any material impact from the new policies," says Moody's "Selective Insurance was the only P&C insurer that quantified the expected effect of adoption, indicating that it anticipated an after-tax impact on shareholders' equity of approximately $55 million, or 5 percent of equity. This translates to a reduction of nearly 40 percent in reported DAC as of June 30, 2011."

Moody's says other firms have said their DAC asset will be reduced by a similar percentage.