Dive Brief:

• The Financial Accounting Standards Board this week unanimously voted to move ahead with a project to update standards and permit companies to apply existing accounting rules for “portfolio layer” method hedge accounting to liabilities. 
• Under current Generally Accepted Accounting Principles, the method applies only to portfolios, financial assets and beneficial interests, a staff member told the board at a Wednesday meeting. Insurers and banks have called for a change in the guidance that affects how companies report their derivative hedging for such interest-rate sensitive liabilities as life insurance policies and certificates of deposit.
• “Stakeholders noted widespread use of economic hedging strategies that do not qualify for hedge accounting and the resulting reliance on non-GAAP adjustments particularly to explain earnings volatility arising from the use of derivative gains and losses,” a staff member told the board. 

Dive Insight:

The board voted (7-0)  to add the project to its technical agenda, bringing the total number of projects on its standard-setting plate to 11.   .  

The latest is one that insurers in particular have been clamoring to see for some time. In 2024, the American Council for Life Insurers noted the challenges it faces matching liability durations and accounting for the derivatives it uses to hedge against interest-rate sensitive annuities, long-term care policies and disability insurance. 

“One of the industry tools for dealing with managing asset and liability durations is using derivatives to hedge risks,” Shannon Jones, senior director of financial reporting policy for ACLI, wrote in the letter. “Failure to achieve hedge accounting can lead to volatile earning presentations, downgraded credit ratings and reduced access to credit markets.” 

The PLM, when used for assets, gives report preparers a powerful tool in that it allows companies to ignore prepayment risks for hedge accounting reporting purposes, according to the FASB meeting materials. “Rather than hedging specific assets that may be prepaid, default, or be sold, an entity designates the layer or layers of the portfolio that it expects will remain outstanding,” the meeting material states. 

Among the issues that will need to be hammered out is the definition and scope of liabilities to which the PLM could be applied. Many board members at the Wednesday meeting expressed concerns about allowing it to be applied to an “open pool” of liabilities, while others said they did also did not want to write a definition that is so narrow that it excludes liabilities. 

“Open pools are a bridge too far right off the bat,” FASB vice chair Hillary H. Salo said during the meeting. “I do have a lot of empathy and would like to be able to address those issues, but I do think getting the scope on this correct is really important.”  

FASB Chair Rich Jones said applying hedge accounting to existing contractual relationships is “easy,” but opening up the concept to pools that an entity doesn’t have a contractual right to would be a “different dynamic.” He voted to add the project with its “initial direction” focused on PLM for financial liabilities, noting the board would explore the liabilities scope issue.

“With that, we have a project on our agenda and we have an eager team with lots of issues to come back to,” Jones said, closing the meeting.