OLDWICK, N.J.--(BUSINESS WIRE)--AM Best believes a new GAAP accounting rule that replaces the current standard for recognizing credit losses on certain assets will create more volatility on GAAP balance sheets, particularly in periods of economic change and on mortgage loan exposures.
A new Best’s Commentary, “New FASB Rule to Result in Earlier Recognition of Credit Losses,” notes that this newly issued standard by the Financial Accounting Standards Board (FASB) requires companies to determine current expected credit losses (CECL) based on past events and current conditions, using reasonable forecasts. As a result, the new requirements will lead to earlier recognition of potential credit losses, as opposed to the current methodology whereby companies can delay recognition of credit losses until a probable loss has been incurred. Under the new rule, the CECL is presented as an allowance rather than as a write-down, with reversals of credit losses recorded in current period’s net income.
The new rule is likely to affect GAAP earnings for insurers holding mortgage loans and other assets valued at an amortized cost. As CECLs will be treated as a valuation allowance, they will be deducted from the amortized cost, resulting in an amount expected to be collected on the assets. Increases and decreases in CECLs will flow through the income statement. AM Best believes initial credit losses determined under the new standard may not be significant given the current favorable economic environment and interest rates; however, CECLs may be more volatile, as expected credit losses must be recognized much earlier than in the past.
The briefing also notes that the NAIC is in the process of reviewing changes to account for credit losses that would be applicable to insurer statutory statements. While impacts to statutory balance sheets and earnings from the new GAAP standard likely will be minimal, forthcoming NAIC action could change AM Best’s expectation. AM Best also notes that insurers will need to improve existing reporting, systems and internal controls to establish a deeper understanding of data and to create more robust expected loss models.
The new standard takes effect Jan. 1, 2020, with an exception for certain smaller reporting companies, as defined by the Securities and Exchange Commission.
To access the full copy of this commentary, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=290619.
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