“Temporary” Impairments

Posted by Matt Purdue

For those of us following the financial services space closely, particularly in the realm of insurance and/or portfolio valuation, will find the Fitch Ratings news as an interesting eye-opener.

There’s been a lot of controversy over fair-value accounting, particularly over mark-to-market accounting. In principle, mark-to-market requires companies to value assets on their books according to what they would be worth on the open market.  

The problem in today’s economy, however, is that companies hold billions of dollars worth of assets for which there is no market. Yet, they have to record the falling value of these assets as unrealized losses. These losses hurt their performance, and down they go. (Some very smart people have called for the temporary suspension of mark-to-market rules to give companies some breathing room.) 

Recently the SEC and the Financial Accounting Standards Board told companies they can use more management discretion when they value hard-to-value assets. According to Fitch that’s fine. It won’t affect the way they rate the creditworthiness of these companies. But will it help in the long run? Probably not, the ratings agency suggests. 

Some of these companies have been holding these assets on the books for a long time, but they’re still calling them “temporary” impairments. As these assets age, companies are going to have to admit that the bad assets are no longer “temporary,” and thus suffer more losses. It’s only a matter of time before these losses lower their capital levels and that’s bad news. 

This is why agencies like Fitch have a negative outlook on the life insurance industry. 

The good news is that Fitch realizes that as long as life insurance companies have enough capital and cash flow, they can hold these bad assets on their books for years until a market for them re-emerges. But who knows if we’ll ever have another market for sub-prime mortgage-backed securities again. And if we don’t, and investors begin to lose confidence in insurance companies carrying all these bad assets, the companies could be in big big trouble.