New Headwind for Insurers May Take the Wind Out of American International Group Inc (AIG)’s Sails

With just a few peaks in trading breaking the barrier between gains and losses today, American International Group Inc (NYSE:AIG) is set to close with a mild loss of 0.13%. The insurer and its investors have a few new variables to consider before the close of the week, and though some are not immediate pressures, it could make a big difference for the company in the long term.

Failure to mediate
Monday kicked off the renewed Article 77 hearing for Bank of America Corp (NYSE:BAC)‘s settlement with investors over mortgage-backed securities. Of course, American International Group Inc (NYSE:AIG) has been the loudest critic of the settlement, citing a similar case that was resolved with insurer MBIA Inc. (NYSE:MBI) that received $0.60 on the dollar, when the current $8.5 billion price tag from B of A is just a fraction of that. Investors may be concerned that the recent refusal of mediation between the parties by B of A signals that the bank firmly believes a decision will be made in its favor — thus signaling a loss for the insurer. As the hearing moves on, be sure to watch out for new signs that the deal will be approved. Though it may not end up being big enough to suit AIG, some money to recoup losses is better than none.

Law of averages
A new set of accounting standards from the Financial Accounting Standards Board proposed in the past two weeks may wreak havoc on the accounting departments in insurance providers’ headquarters. To standardize practices across the board, FASB has proposed that insurers change the way they recognize revenue and expanses related to their policies. Instead of recording your $100 car insurance premium on Aug. 1, when it’s received, your insurer will have to record the revenue over a length of time during which the insurance is being provided.

Right now, insurers are able to use one set of numbers for reporting purposes — the estimates they view as most likely to occur. Under the proposed changes, the insurer would have to use an average of estimated scenarios to derive the reported accounting entries. For example, if the insurer expected to pay out $10,000 in home insurance claims at a probability rate of 70%, it would report that figure under the current rules. But with the proposed standards, the insurer would have to average that $10,000 with the $20,000 estimate that is a 30% possibility — increasing the reported number to $13,000, the average of the two probable scenarios.

So why should investors care? One of the most common complaints about investing in financial institutions is how difficult it is to decipher the firms’ earnings reports and other data. Not only would the new changes create added difficulty for the insurers, with frequent adjustments required that could cause changes and revisions in one quarter to be reversed or otherwise changed at a later date, but it makes the black box of financials accounting harder for investors to figure out.

Though the proposed changes would probably generate little damage to the insurer’s bottom line (with the exception of greatly increased accounting expenses), the fluctuation in revenue will likely misrepresent organic growth in the company and display slower growth patterns in firms that are expanding like American International Group Inc (NYSE:AIG).