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Financial Reporting and the Law

If adopted, a proposed Accounting Standards Update from the FASB relating to accounting for insurance contracts would apply to many companies that are not insurance companies because of a broad proposed definition of an “insurance contract.” Contracts such as product warranties, financial guarantees, performance bonds, standby letters of credit, merger and acquisition guarantees, minimum revenue guarantees, and other contracts that are issued by banks, guarantors, service providers, and other non-insurance companies—in addition to contracts issued by insurance companies—would come within the scope of the definition.

The Accounting Standards Update defines an insurance contract as “a contract under which one party (the issuing entity) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder or its designated beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder.” “Insurance risk” is defined as the risk arising from uncertainties about the amount of net cash flows from premiums, commissions, claims, and claim settlement expenses paid under a contract, as opposed to “financial risk,” which is the risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable.

The main objective of the proposed Accounting Standards Update is to increase the available information about an entity’s insurance liabilities, including the nature, amount, timing, and uncertainty of cash flows related to those liabilities, and the related effect on the statement of comprehensive income. Another objective is to provide comparability for insurance contracts, regardless of the entity issuing the contract. Under the proposed Accounting Standards Update, any entity issuing an insurance contract, not just an insurance company, would apply the same accounting and reporting approach to the transaction and would be considered an insurer for the purposes of the accounting guidance.

The FASB’s project summary states that it expects to begin deliberations on all of the proposal’s significant issues during the first quarter of 2014.