Alert number: 08-04
Statement of Financial Accounting Standards No. 157 – Fair Value Measurements FAS 157 – Fair Value Measurement (“FAS 157”) FAS 157 was created to standardise the definition of fair value under US GAAP which had previously been covered over several unrelated standards, none of which were particularly specific in the application of fair value principles. The Standard not onlycovers the application of fair value but it also highlights the responsibility of management in its application for all financial assets and liabilities. Depending upon the nature of the underlying investments and the availability of regular quoted market prices, the Standard will not necessarily result in the restatement of fair value amounts where management had previously taken values directlyfrom statements provided by custodians, managers or pricing sources. It will, however, require disclosure of how management is comfortable with the fact that these sources and the values recorded are appropriate. Further disclosure is also required with regard to the degree of certainty that management has over whether the carrying value is an appropriate representation of the exit price for thatfinancial asset or liability. To differentiate between the varying degrees of certainty, the Standard identifies three Levels covering securities with a ready market (Level 1) to securities which may have a specific or illiquid market (Level 3).
Effective date: • FAS 157 is effective for all fiscal years beginning on or after November 15, 2007, with prospective application. Key changes: •Definition of a fair value – change in focus from an “entry” price to an “exit” price i.e. how much would be received to sell the asset or paid to transfer the liability instead of how much would be paid to acquire an asset or received to assume a liability? • Fair value measurement – the Standard prescribes the use of one or more of three acceptable valuation techniques (noted below). • Hierarchy –assets and liabilities carried at fair value have to be classified and disclosed in one of three Levels (1, 2 or 3), with additional disclosure required for Level 3 (the most complex) items. • Disclosures – move from generic fair value disclosures with little transparency of approach to an established hierarchy with required disclosures. Captive context: The key changes noted above will impactcaptive insurance companies reporting under US GAAP that hold financial assets and liabilities at fair value. Management will have to consider the inputs used to value the financial assets and liabilities and the disclosures made in the financial statements in respect of these, including position within the fair value hierarchy.
Most likely the principal impact will be on the valuation anddisclosure around investments. Depending on the complexity of the investment portfolio, the amount of work required by management to arrive at fair value may be substantially increased. Management will also need to provide support for the classification of financial assets and liabilities into the hierarchy noted on page 1 (under “Key Changes”). However, since in most instances the value of financialassets and liabilities is unlikely to change upon adoption of the Standard and the disclosure requirement is specific to US GAAP, we expect that this standard will have little to no impact on the Statutory Financial Statements and Returns filed by Bermuda based captives. Typical securities held by captive insurance companies: • Cash only – no FAS 157 impact. • Cash equivalents and short-term depositsat amortised cost: o if within the scope of FAS 115 (i.e. held at fair value), they are subject to FAS 157; and o if outside the scope of FAS 115 (i.e. not held at fair value), no FAS 157 impact. • Fixed income securities, equities (quoted / unquoted) and funds (for example, liquid reserve funds, alternative investments, etc) – subject to FAS 157. Fair value definition and basis for valuation:...
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