July 31, 2002
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
RE: FILE NO. S7-16-02
PROPOSED RULE: DISCLOSURE IN MANAGEMENT'S DISCUSSION AND ANALYSIS ABOUT THE APPLICATION OF CRITICAL ACCOUNTING POLICIES
Dear Mr. Katz:
The Chubb Corporation (Chubb) is a holding company with subsidiaries principally engaged in the property and casualty insurance business. We appreciate the opportunity to respond to the proposed rule on disclosure in Management's Discussion and Analysis (MD&A) about the application of critical accounting policies.
We support the Commission's objectives to enhance investors' understanding of the important estimates that are particularly difficult for management to determine and for which management therefore exercises significant judgment, and to give investors an understanding of the impact those estimates have on a company's financial performance. We believe that these objectives can be best achieved through improved qualitative disclosures that focus on the uncertainties surrounding the estimates and the implications to the financial statements should future experience differ from that assumed. We do not support, however, the proposed quantitative disclosures relating to the sensitivity of each critical accounting estimate to possible changes because we believe that such disclosures would confuse rather than inform most readers of the MD&A.
We support the Commission's objective to give investors an understanding of accounting policies that have a material impact on a company's financial results. However, we would modify the proposed disclosure requirements to eliminate the focus on newly adopted accounting policies. Accounting policies should be discussed whenever they are critical to an understanding of a company's financial performance.
In the remainder of this letter, we will expand upon these issues and will comment on certain other issues on which the Commission is seeking comment.
Definition of critical accounting estimates
We believe that the proposed definition of a critical accounting estimate is appropriately designed to identify those accounting estimates that require management to use significant judgment and that involve a high potential to result in a material impact on a company's financial presentation.
Identification and analysis of changes in critical accounting estimates
We support the proposed qualitative disclosures regarding critical accounting estimates and the assumptions underlying the estimates. However, as noted above, we do not support the proposed quantitative disclosures relating to the sensitivity of each critical accounting estimate to possible changes.
The most critical accounting estimates for property and casualty insurance companies relate to the adequacy of their loss reserves. For many insurance companies, including Chubb, most loss reserves relate to liability classes of business. For many liability claims, significant periods of time may elapse between the occurrence of the loss, the reporting of the loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary. An understanding of the complexity of the loss reserving process and the inherent imprecision in that process is crucial for an investor. For this reason, insurance companies provide extensive qualitative information in the Form 10-K about the significant uncertainties involved in the loss reserving process. Insurance companies also provide quantitative disclosures about the development of prior years' loss reserves to give investors some guidance in their evaluation of the reasonableness of current loss reserve estimates. We believe this is the most meaningful information to provide investors related to loss reserve estimates.
The determination of loss reserves utilizes a variety of complex actuarial methods that involve numerous estimates and assumptions. To provide the quantitative disclosures regarding the sensitivity of the reported loss reserves, an insurance company would need to address each of the individual estimates and assumptions that were considered to be critical in the loss reserving process. We question whether such voluminous quantitative information would assist investors in understanding the company's financial performance. In fact, we believe that such disclosures about loss reserves would be extremely confusing to most readers of financial statements who would have difficulty discerning the "what if" disclosures from the actual reported results.
We believe that similar issues would exist for many other critical accounting estimates that involve significant judgment. Therefore, we recommend that any final rule not require a quantitative discussion of changes in financial performance that would result from changes in the material assumptions underlying the critical accounting estimates.
Disclosure of past material changes in critical accounting estimates
Companies are already required under existing MD&A rules to discuss the effects of significant changes in accounting estimates made in prior years where those changes are material to an investor's understanding of financial position or results of operations. For example, property and casualty insurance companies include disclosure in the MD&A related to the estimates of loss reserves made in prior years and how those estimates have developed in subsequent years. We believe that the guidance under current MD&A requirements is sufficient.
If the Commission decides to include in any final rule the requirement to discuss material past changes made to critical accounting estimates, we do not believe that the Commission should mandate a standardized format for quantitative disclosures.
Independent auditor examinations of the proposed MD&A disclosure
A company's independent auditor currently is responsible for evaluating the reasonableness of the accounting estimates made by management. The independent auditor is also required to read the MD&A and consider whether the information presented is materially consistent with information appearing in the financial statements.
We believe that these procedures are adequate to ensure the accuracy and reliability of the proposed MD&A disclosure. We do not believe that requiring the disclosure relating to critical accounting estimates to undergo an auditor examination would significantly improve that disclosure. Therefore, such a requirement could not be cost justified.
Disclosures related to initial adoption of accounting policies
The proposed rule would require disclosures regarding newly adopted accounting policies that have a material impact on a company's financial performance. We agree with the fundamental requirement that MD&A should include a meaningful discussion of any significant matter that will enhance an investor's understanding of the financial condition and results of operations of a company.
Therefore, we believe that whenever an understanding of an accounting policy, as opposed to an accounting estimate, is considered critical to an understanding of a company's financial position and results of operations, such accounting policy should be discussed in the MD&A so that the reader understands the impact of the accounting policy on the financial performance of the company. Such discussion should not be limited to the year that the accounting policy is adopted. We suggest that the proposed rule be modified to require disclosures regarding critical accounting policies, which would be defined as policies where the application of alternative acceptable policies would have a material impact on the financial statements.
Presentation aspects of the proposal
The proposed rule would require that the disclosures about critical accounting policies and estimates be presented in a separate section of the MD&A. Many companies already include disclosures about accounting policies and estimates throughout their MD&A. We believe that such disclosures are most useful when they are integrated into related discussions in the MD&A. We therefore suggest that the proposed rule be modified to permit companies to identify their critical accounting policies and estimates in a separate section of the MD&A with a reference to where in the MD&A the detailed disclosures about those policies and estimates are made. This would provide companies more flexibility in complying with the proposed rule and would result in disclosure that is most understandable by and useful to the reader.
General aspects of the proposal
The proposed requirement to provide detailed disclosures about critical accounting estimates could result in competitive harm for companies. Certain loss contingencies, as defined by Statement of Financial Accounting Standards No. 5, Accounting for Contingencies, may meet the definition of a critical accounting estimate. Therefore, companies might be required to provide specific disclosures about estimates involving specific loss contingencies, such as those arising from litigation, tax or environmental matters.
We disagree with the Commission's assertion that concerns about competitive harm are mitigated because all registrants would be required to make similar disclosures. The proposed disclosures could influence and jeopardize the resolution and outcome of these matters, which could adversely impact a company's financial position and results of operations. We recommend that specific loss contingencies should be excluded from the scope of any MD&A disclosures about critical accounting estimates.
We are also concerned about the additional time and resources that would be needed to comply with the proposed rule, especially in light of the Commission's pending proposal to accelerate periodic report filing dates. We are hopeful that the Commission considers the expanded financial reporting requirements when it decides whether to accelerate the report filing dates.
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In summary, we support the Commission's objective of enhancing investors' understanding of critical accounting estimates, and believe this can be accomplished through improved qualitative disclosures that focus on the uncertainties surrounding the estimates and the implications to the financial statements should future experience differ from that assumed. However, we believe that quantitative disclosures relating to the sensitivity of critical accounting estimates to possible changes would result in a proliferation of "what if" financial information that would be more confusing than informative to readers of the MD&A.
We would be pleased to discuss our comments with the Commission or its staff.
Very truly yours,
Henry B. Schram
Senior Vice President and
Chief Accounting Officer
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