Insurers’ Biggest Writedowns May Be Yet to Come
August 24th, 2009Via: Bloomberg:
How many legs would a calf have if we called its tail a leg?
Four, of course. Calling a tail a leg wouldn’t make it a leg, as Abraham Lincoln famously said.
Nor does calling an expense an asset make it an asset. This brings us to the odd accounting rules for the insurance industry, including Lincoln National Corp., which uses Honest Abe as its corporate mascot.
Look at the asset side of Lincoln National’s balance sheet, and you’ll see a $10.5 billion item called “deferred acquisition costs,” without which the company’s shareholder equity of $9.1 billion would disappear. The figure also is larger than the company’s stock-market value, now at $7 billion.
These costs are just that — costs. They include sales commissions and other expenses related to acquiring and renewing customers’ insurance-policy contracts. At most companies, such costs would have to be recorded as expenses when they are incurred, hitting earnings immediately.
Because it’s an insurance company selling policies that may last a long time, however, Lincoln is allowed to put them on its books as an asset and write them down slowly — over periods as long as 30 years in some cases — under a decades-old set of accounting rules written exclusively for the industry.
Rule Overhaul
Those days may be numbered, under a unanimous decision in May by the U.S. Financial Accounting Standards Board that has received little attention in the press. The board is scheduled to release a proposal during the fourth quarter to overhaul its rules for insurance contracts. If all goes according to plan, insurers no longer would be allowed to defer policy-acquisition costs and treat them as assets.
