Accounting standards for changing times
The financial crisis started in one corner of the US mortgage market, but the fallout from the collapse of the sub-prime lending bubble spread at an unprecedented pace and undermined the foundations of the entire global financial system. The Cayman Islands’ captive insurance industry was certainly not isolated from these events; many Cayman captives experienced an erosion of capital from shrinking asset values. While the unprecedented financial crisis of late 2008 will likely be felt at a profound level for a long time, the changes in regulations, investor preferences and the financial services industry itself will, nonetheless, provide a range of opportunities and threats that have never been experienced before, as the global economy transitions from survival mode to sustainable strategy.
The major accounting standard-setters, the US Financial Accounting Standards Board (FA SB) and the International Accounting Standards Board (IA SB), have been challenged to keep pace in responding to these economic developments. 2009 has seen precedents set regarding the speed at which new guidance and standards have been developed and issued, much of which has relevance for Cayman captive insurance companies. The changes also reflect, in places, the continued move towards the convergence of the Accounting Standards Generally Accepted in the United States (US GAA P) and the International Financial Reporting Standards (IFRS).
US GAAP
Codification: Before discussing the impact of recent developments in US accounting standards, it is appropriate to introduce the FA SB’s codification project, which has culminated in a single source of authoritative US GAA P. The FA SB’s long-standing project has brought together all key sources of US GAA P into a single reference work in order to make it easier to find and research GAA P applicable to particular transactions or specific accounting issues. The resulting standards are now referred to as Accounting Standards Codification (ASC) and Accounting Standards Update (ASU).
The financial crisis was the genesis for several new US standards and guidelines that address the measurement and disclosure of assets and liabilities recorded at fair value and also recognition of impairment:
Determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly (ASC 820.10.54-4): This guidance was issued to provide clarity in the approach to measuring the fair value of distressed assets and liabilities, including practical guidance and criteria that build on the measurement principles introduced in FA S 157. It also requires enhanceddisclosure of major classes of assets/liabilities carried at fair value and disclosure of the valuation techniques and inputs used.
Recognition and presentation of other-than-temporary impairments (ASC 320.10.65-1): Relevant to debt securities that are classified as available for sale or held to maturity, this new impairment model could potentially have a significant impact as it amends the basis for determining when a debt security is impaired and how to measure the impairment. The impairment recognition criteria differentiate between impairment losses related to credit events and those that relate to other circumstances such as the market sentiment prevalent through 2008 and into 2009. Where the new measurement basis is applicable, transitional rules apply to opening balances. Estimation of the credit loss portion and the subsequent accounting are potentially complex and warrant early attention. The guidance also expands on disclosure requirements for both debt and equity securities. The guidance will be of particular relevance to entities holding debt securities whose fair values are below cost at current and prior year reporting dates.
Investment in certain entities that calculate net asset value per share (ASU 2009.12): This ASU permits the industry practice that generally prevailed throughout the adoption of FA S 157, of using unadjusted net asset value per share as a practical expedient for the determination of fair value estimates of investments in mutual funds that are not exchange-traded. Adjustments to net asset values may still be appropriate in certain limited circumstances. The ASU also requires disclosure of major categories of mutual funds, investment strategies and key restrictions/redemption terms.
Fair value measurements and disclosures (proposed ASU on ASC 820): This proposes to introduce into US GAAP some concepts first required in IF RS 7, Financial instruments: Disclosures. The ASU proposes to add three new disclosures: (1) a sensitivity analysis for Level 3 measurements, (2) gross presentation of Level 3 activity, and (3) transfers in and out of Level 1 and 2 measurements. The proposal also includes clarifications to existing disclosure requirements on the level of disaggregation, and disclosures regarding inputs and valuation techniques. If the ASU is implemented as currently drafted, the sensitivity analysis will likely will be a requirement for calendar year 2010; the other disclosures may be requirements for calendar year 2009.
Other US GAA P developments relevant to captive insurance companies include:
Subsequent events (ASC 855): Among other requirements, this new ‘subsequent events’ standard requires disclosure of the date through which management has evaluated subsequent events and whether this is the date on which the financial statements were issued or were available to be issued.
ASC 740, Uncertain income tax positions (formerly FIN 48): FIN 48 has been deferred for several years for non-public entities but is set for implementation for the 2009 calendar year. The guidance has been revised for non-public entities but still uses the ‘more likely than not’ recognition threshold for uncertain tax positions. FIN 48 eliminated certain disclosure requirements. Disclosures still required include the following relative to uncertain tax positions: (1) interest and penalties; (2) estimate of amount of reasonably possible changes in the next 12 months; and (3) a description of open tax years by major jurisdiction.
International Financial Reporting Standards (IFRS)
The IASB likewise issued new guidance in response to the global economic crisis:
Amendment to IAS 39, Financial instruments: Reclassification of financial assets: Issued in October 2008, the amendment permits assets that meet the definition of loans and receivables to be reclassified out of the held-for-sale and available-for-sale categories into the loans and receivables category if the entity intends to and has the ability to hold the financial asset for the foreseeable future. The reclassification takes place at fair value on the date of reclassification.
Other recent IFRS developments relevant to captive insurance companies reporting under IF RS include:
IAS 1 (Revised), Presentation of financial statements: Revised IA S 1 will require entities to prepare a statement of comprehensive income—either as a separate statement or as part of the statement of income.
Amendment to IFRS 7, Financial instruments: Disclosures: Among other changes to IF RS 7, the amendment requires entities to disclose a three-level fair value measurement hierarchy (mirroring the requirements of FA S 157), including details of transfers between Levels 1 and 2 and a reconciliation of Level 3 movements on a gross basis.
Exposure draft ED/2009/7 on IAS 39, Financial instruments: Classification and measurement: The exposure draft proposes to eliminate the available-for-sale category for financial assets (e.g. debt securities) and would streamline the accounting treatment for equity securities categorised as available for sale.
IFRS for small and medium-sized entities (SMEs): The IASB has issued a single accounting standard accounting framework for the preparation of general-purpose financial statements of qualifying SMEs, including entities that are not publicly accountable. Use of the framework rests with the legislative and regulatory authorities, and the standard-setters of each individual jurisdiction. In the absence of an IF RS standard on insurance contracts, it is unclear at present whether or how this new accounting framework could be adopted by captive insurance companies.
FASB/IASB Insurance Contracts project
There are currently several ongoing joint FA SB/IA SB projects. The most relevant of these to captive insurance companies is the Insurance Contracts project. An exposure draft on insurance contracts is expected to be issued for comment in December 2009. The key terms of reference for the project are to establish a comprehensive framework, including the definition of insurance contracts, revenue recognition, treatment of acquisition costs, measurement of insurance liabilities, and disclosure and presentation of insurance transactions. The project proposes several conceptual changes to existing frameworks/industry practice, including the requirement for insurance liabilities to reflect the time value of money.
Conclusion
As is often the case, new and emerging accounting guidance can present challenges to the companies affected and their service providers. It is advisable to begin looking at these issues well in advance of the year-end audit process and, if you have not already done so, to begin open discussions with the relevant service providers. Greater details on the implementation of the abovereferenced accounting guidelines and reference sources can be found at: http://www.pwc.com/en_ky/ky/publications/cayman.jhtml
Damian Pentney is a director at PricewaterhouseCoopers in the Cayman Islands. He can be contacted at: damian.pentney@ky.pwc.com
