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Fair Value Measurements: SSAP 100 versus ASC 820 (fka “FAS 157”)

[Updated: Oct.27, 2010 to reflect the NAIC's proposed disclosure changes]

Fair value accounting has been a part of US Generally Accepted Accounting Principles (GAAP) since the early 1990s. In its relatively brief history, fair value accounting, or “mark-to-market” accounting, has racked up quite a reputation. Read nearly any book covering the Enron scandal and, rest assured, there will be a section on mark-to-market accounting. More recently, fair value accounting, and its increased GAAP disclosure requirements, has taken heat for its role in the subprime-mortgage crises. For the past two years insurance companies have been wrestling with the statutory treatment of new GAAP fair value disclosures. The debate on whether to include the new “GAAP-like” fair value disclosures in statutory financial statements was settled at the National Association of Insurance Commissioners’ (NAIC) December 2009 meeting. The result? A new statutory pronouncement that follows its GAAP counterpart in many ways.

The recent history of accounting pronouncements for fair value measurements

During 2008, the Financial Accounting Standards Board (FASB) issued new GAAP on fair value measurements and disclosures for all financial assets and liabilities carried at fair value. Issued just prior to GAAP’s codification, this pronouncement was known as Statement of Financial Accounting Standards No. 157 (FAS 157), "Fair Value Measurements." The new guidance defined fair value, established a framework for measuring fair value, and expanded disclosures about fair value measurements. In 2009, the FASB issued GAAP guidance for nonrecurring fair value measurements of certain debt securities, which guidance had been previously deferred. The FASB has centralized all fair value GAAP in one convenient location in their FASB Accounting Standards Codification, ASC 820 (Topic 820 “Fair Value Measurements”).

Prior to 2009, Statutory Accounting Principles (SAP) had not adopted or rejected the GAAP disclosures for fair value measurements. In December 2009, the NAIC Statutory Accounting Principles Working Group (SAPWG) issued Statement of Statutory Accounting Principles No. 100, “Fair Value Measurements” (SSAP 100), which largely adopts the GAAPUSA guidance for fair value measurements, but with a few exceptions. SSAP 100 is effective for December 31, 2010 annual financial statements, with interim and annual financial statement reporting thereafter. Early adoption is permitted for December 31, 2009 annual financial statements, with interim and annual reporting thereafter.

Three-tier value hierarchy

SSAP 100 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

SSAP 100 describes three approaches to measuring the fair value of assets and liabilities: the market approach, the income approach, and the cost approach. Each approach includes multiple valuation techniques. SSAP 100 does not prescribe which valuation techniques should be used when measuring fair value, but does establish a fair value hierarchy that prioritizes the inputs used in applying the various techniques. Inputs broadly refer to the assumptions that market participants use to make pricing decisions, including assumptions about risk. Level 1 inputs are given the highest priority in the hierarchy while Level 3 inputs are given the lowest priority. Assets and liabilities carried at fair value are classified in one of the three categories based on the nature of the inputs to the valuation technique used.

• Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall generally be used to measure fair value whenever available.
• Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
• Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity's own data.

Compliance with SSAP 100

Many companies chose to include GAAP disclosures for fair value measurements in their statutory financial statements during 2009 and 2008. For those companies, the adoption of SSAP 100 will have little impact on their current reporting requirements for fair value measurements. For companies that chose to wait on the SAPWG to issue SSAP 100, the adoption is more onerous.

What should management do to prepare for SSAP 100 compliance?

• Set up or review controls and procedures to assist in fair value determination and disclosure.
• Have discussions with outside vendors, such as auditors, investment advisors, and investment custodians. If management intends to use its investment advisor or custodian for fair value measurements, it should inquire about obtaining a SAS 70 report on internal controls that covers the vendor's fair value pricing.
• Be able to demonstrate to external auditors that the company’s management understands their vendors’ SAS 70 reports, including their (user) control considerations.

Because these disclosures are likely to affect your financial statements, it would be prudent to consult with your Blackman Kallick accounting professional now to avoid any surprises at year-end.

Questions about fair value measurements?  Contact Andrew Rouse at 312-980-3236.

 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.