American Insurance Association
December 20, 2002
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Jonathan G. Katz
Re: Conditions for Use of Non-GAAP Financial Measures
Dear Mr. Katz:
The American Insurance Association (AIA) is a trade association of 410 property-casualty insurance companies that write policies throughout the United States and around the world. Most of our members are affiliates of publicly held groups that are registrants with the Securities and Exchange Commission (SEC).
AIA is concerned about the effects that the proposed rule, Conditions for Use of Non-GAAP Financial Measures, will have on the property-casualty industry's financial reporting. Many of the disclosures and performance/leverage measures that are required to be disclosed by the accounting principles generally accepted in the United States (GAAP) are based on the accounting rules that insurers are required to use in reporting to state insurance regulators, i.e., statutory accounting practices (SAP)
Importance of Statutory Accounting
Insurance enterprises are regulated by state insurance departments in accordance with state law, including the requirement to utilize SAP. Because of the importance of SAP to the operation of an insurance enterprise, GAAP currently requires disclosure of key SAP information in GAAP financial statements. SFAS No. 60, Accounting and Reporting by Insurance Enterprises, requires:
"60. Insurance enterprises shall disclose the following in their financial statements:
. . .
(h) The following information relating to stockholders' equity, statutory capital and surplus and the effects of statutory accounting practices on the enterprise's ability to pay dividends to stockholders:
(1) The amount of statutory capital and surplus
(2) The amount of statutory capital and surplus necessary to satisfy regulatory requirements (based on the enterprise's current operations) if significant in relation to the enterprise's capital and surplus
(3) The nature of statutory restrictions on the payment of dividends and the amount of retained earnings that is not available for the payment of dividends to stockholders"
In the Appendix to SFAS No. 60, the FASB discussed the comments it had received from respondents related to whether or not it would be desirable to require a reconciliation between financial reporting and statutory capital and income. It concluded:
"86. The Board believes that the disclosure in paragraph 60(h) relating to statutory requirements is sufficient for the general-purpose financial statements of insurance enterprises."
Accordingly, AIA recommends that statutory surplus for insurance companies should not require reconciliation to GAAP because statutory surplus is determined in accordance with the comprehensive accounting rules contained in SAP, and GAAP literature currently requires that the amount be disclosed in the context of the effects that SAP has on the enterprise's ability to pay dividends to stockholders. We believe that the FASB's conclusion to not require a reconciliation to GAAP is appropriate because it is more relevant for the reader to understand the enterprise's ability to pay dividends than it is to understand how statutory capital and surplus differs from GAAP equity. Similarly, common performance and leverage ratios for insurance companies, such as premium to surplus and combined ratios, are based upon SAP, are the basis for Financial Analysis Solvency Tools utilized by state insurance regulators, and should not require reconciliation to GAAP because it is more important for the reader of the financial statement to understand the possible regulatory effects of the ratios than it is to understand how the numbers used in those ratios differ from GAAP.
The National Association of Insurance Commissioners' (NAIC) Insurance Regulatory Information System - Property/Casualty Edition, includes a series of twelve ratios that are used to help regulators and others in the financial analysis of property-casualty insurance companies. There are three ratios related to profitability: Investment Yield (Ratio 6), Change in Policyholders' Surplus (Ratio 7) and Two-Year Overall Operating (Ratio 5). The Investment Yield Ratio pertains to the investment return of the enterprise, the Change in Policyholders' Surplus Ratio pertains to all elements that affect surplus, and the Two-Year Operating Ratio measures the profitability of the enterprise. It is a combination of the loss ratio, the expense ratio and the investment income ratio. When the ratio is below 100 percent, it indicates an operating profit and when it is above 100 percent, it indicates an operating loss.
Importance of Operating Income
Financial analysts and others who use the financial statements of property-casualty insurance companies have relied on operating income as a key component of an insurer's results for many years. Because insurers' financial results include the effects of catastrophes and other infrequent occurrences, analysts, rating agencies and others have had a desire to understand the effects of such occurrences on income and earnings per share. As currently drafted, the proposed rule would effectively reduce insurers' ability to provide the type of information that readers have come to rely upon. Accordingly, AIA also recommends that rather than curtailing the use of operating income as a performance measurement for property-casualty insurance companies, the SEC should consider allowing the use of operating income as a traditional performance measure for the industry. For the same reasons, operating income per share should not be prohibited, but should be available to all those who have come to rely upon its analytical value.