AM Best’s Special Report

U.S. Accounting Change May Lead to More Volatility in GAAP Results

Net unrealized gains, equity losses come under new standard

OLDWICK, N.J., November 8, 2018—Net income levels for publicly traded companies have the potential to swing sharply under a new accounting standard that requires net unrealized capital gains and losses on equity holdings to be reconciled within income statements, according to a new A.M. Best report.

While the exact impact on year-over-year results won’t be realized until after Dec. 31, 2018, a Best’s Special Report, titled, “U.S. Accounting Change May Lead to More Volatility in GAAP Results,” includes a preliminary analysis on the six-month 2018 results for a portfolio of 55 insurance companies across the United States, Canada and Bermuda, operating under Generally Accepted Accounting Principles. The impact of the new standard — Accounting Standards Update 2016-01 — reveals that recorded net income decreased overall by 50% in the first quarter for this group in aggregate, but then increased by 36.1% in the second quarter. The full impact on each company’s six-month performance under this new standard is detailed in the report, which takes note of a “seesaw potential.”

Not Always Transparent

The report also notes that these results are not always transparent. In many cases, unrealized equity gains will be reported within a larger number, such as other income, net investment income or as part of realized gains since they have effectively been recorded through the income statement as part of earnings. Companies with no holdings in equities will remain unaffected.

The key for analysts will be eliminating ‘noise’ when determining operating income

Some industry observers are concerned about the impact of this new accounting standard. On the one hand, the economics of the situation may not have changed—under both previous and current treatments, unrealized gains and losses ultimately end up within the equity section of the balance sheet. However, the fact that they are now recorded as part of net income results in a much higher profile, affecting such items as loan covenants, compensation and general investor awareness.

“The key for analysts will be eliminating ‘noise’ when determining operating income,” said Peter Walsh, Director, Corporate Data Management at A.M. Best.

The shift toward the new standard fits into the overall movement by the Financial Accounting Standards Board and the International Accounting Standards Board (IASB) toward global consistency and “fair value accounting.”

To access the full copy of this Best’s Special Report, please visit here.



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