Re/insurance companies that report under U.S Generally Accepted Accounting Principles (GAAP) may be subject to earnings volatility over 2018 due to a change in accounting for equity securities, according to Fitch Ratings.
In an effort to promote convergence with international accounting practices, from January 1, 2018, companies have had to recognise changes in the fair value of equity investments through their income statement, rather than reflecting changes directly onto the balance sheet through accumulated other comprehensive income (AOCI).
These changes were intended to improve financial reporting by providing relevant information about an entity’s equity investments while reducing the number of items that are recognised in other comprehensive income.
Fitch analysed the financial results of 38 Property and Casualty (P&C) re/insurers, finding that the group’s $6.3 billion pre-tax income (PTI) at Q1 2018 would be approximately $9 billion higher if this accounting change were excluded.
Overall, the group reported a 59% decline in reported PTI between Q1 2017 and Q1 2018, but would have seen an 8% increase in PTI if their results were adjusted to exclude the new accounting changes.
Moreover, 32 of the reviewed companies reported a reduction in earnings due to a decline in fair value equities, with Cincinnati Financial Group (CINF) and Berkshire Hathaway (BRK) exhibiting the largest changes in PTI between reported and adjusted values, at -134% and -124% respectively.
However, if the accounting rule had been in effect over 2017, Fitch calculated that the group of 38 re/insurers would have experienced a 19.4% increase in earnings due to the strong performance of equities over the year, equating to a $33 billion boost to pre-tax earnings across the group.
Fitch also observed differences in the way companies presented the change in fair value of equities in their Q1 2018 income statements, with some listing the change as a separate line item, others including it with realised gains, and others embedding it in investment income.
Additionally, Fitch noted that the risk appetite for equity investments also has a strong influence on growth in shareholder’s equity and book value per share for insurers.
Most publicly held P&C re/insurers classify equity securities in their investment portfolios as available-for-sale, with the exception of several Bermuda reinsurers, ProAssurance Corporation and Mercury General Corporation, which already use their ‘Trading’ classification to report equity fair value changes through the income statement.
