Many insurers and reinsurers are facing some earnings volatility in 2018 due to a change in accounting requirements for equity securities, Fitch Ratings said in new market commentary.

According to Fitch, companies with significant equity investments are particularly affected in terms of reporting their net earnings.

Here’s what created the volatility: A new requirement beginning Jan. 1, 2018 that companies recognize changes in the fair value of equity investments through their income statement. Before, companies could reflect the changes directly onto the balance sheet through accumulated other comprehensive income. As Fitch noted, gains and losses on equity investments were previously only recognized through the income statement when they were realized through a sale or impairment.

The Financial Accounting Standards Board said the change was meant to improve financial reporting “by providing relevant information about an entity’s equity investments and reducing the number of items that are recognized in other comprehensive income,” Fitch explained.

Fitch conducted an analysis of Q1 2018 financial results from 38 property/casualty insurers and reinsurers in order to better understand the trend. What it found:

• Reported pre-tax income of $6.3 billion in Q1 would have been $9 billion higher, save for the accounting change. The group also saw a 59 percent drop in reported pre-tax income between Q1 2018 and Q1 2017.
• Excluding the accounting change, pre-tax income jumped by 8 percent for the period compared to the 2017 first quarter.
• The equity markets mostly declined in Q1 2018, and 32 of 38 companies reviewed said a dip in the fair value of equities caused a reduction in earnings.
• Cincinnati Financial Group and Berkshire Hathaway had the largest changes in pre-tax income from their reported adjusted values, at negative 134 percent and negative 124 percent, respectively.

Fitch said that it would have been better for the requirement to focus on operating earnings rather than net earnings, because “equities are among the most volatile asset classes in insurers’ investment portfolios.”

“Fitch believes that operating earnings, rather than net earnings, will be an increasingly useful measure to observe relative company performance,” Fitch said. “Operating earnings remove the impact of realized and unrealized gains and losses that run through the income statement.”

Fitch said in its own calculations it will continue to focus on operating EBIT and exclude the change in fair value of equity securities as well as realized gains and losses.

Source: Fitch Ratings