ACHILLES: Remember that most of the controversy involving fair values has occurred in situations where reliable and
transparent prices aren’t available. In estimating a fair value,
observable prices that aren’t relevant or are based on a distressed sale shouldn’t be used. That myth was exposed recently
by both the FASB and the IASB. Unfortunately, transfer markets in which actuaries are involved have few, if any, relevant
and reliable prices. We need actuarial models, which I hope
will become more transparent and understandable in the
TORTOISE: Well, we have to agree to disagree on this one.
Maybe I’m just too practical to understand the theory. I can’t
see why an exit price or fair value for a liability should reflect
non-performance risk. Surely a transfer price can’t be affected
by the credit standing of the original party that would no longer
be responsible for paying the obligation, even theoretically. I
can’t imagine asking a company to provide a credit self-assess-ment. And we can’t just wait for a rating agency to notice that
a credit risk exists or rely on credit-default-swap values. Even
with disclosure, nobody understands it, and it’s tough to estimate in the first place. Users will end up backing it out, anyway.
What a system!
TORTOISE: Some of the concepts still don’t make much
sense. For example, how can we have a current exit value when
you can’t exit the business voluntarily?
ACHILLES: Well, you’re at least partly right. The labels aren’t
the greatest. The concept is based on an economically neutral
estimate of future cash flows by whoever would take over the
obligation. As for any equilibrium point, it’s not always easy to
understand, describe and quantify. Nevertheless, every attempt
should be made to develop estimates at market clearing point
where arbitrage opportunities will not exist and decisions can
be made on an economic basis rather than trying to take advantage of the accounting rules.
ACHILLES: I knew this would be a problem topic. Maybe one
day we’ll understand each other’s position. It’d be great if all
of the fair value concepts and implications would be explained
so more people can understand them. To make this system
really useful, we need better education, more disaggregation
and risk concepts that are soundly embedded in the preparer’s
TORTOISE: We haven’t touched on my favorite fair value
topic: The inexplicable non-performance risk for liabilities, or
what is sometimes called the “own-credit-standing” problem.
ACHILLES: I am constantly surprised how emotional you are
about this issue. Remember, almost everyone agrees this must
be reflected on the asset side. It’s just for liabilities that you
seem to have a problem. If you’re OK with using expected cash
flows, don’t you want to measure real expected cash flows using
all possible scenarios rather than rely on the hypothetical and
unrealistic scenario of a 100 percent chance of delivery of the
cash flows? You want to conveniently ignore some of the possible outcomes! Anyway, the price paid for a set of cash flows
would take into account the expected delivery of the cash flows,
wouldn’t it? Why should this credit risk be ignored? Do you
really want to adjust the initial entry price to back credit risk
out? I know that regulators or creditors don’t like it, but that’s
because they focus on solvency and assess the likelihood that an
insurer will settle the obligations, rather than focusing on economically related values. For those who want that information,
let’s provide it separately through disclosure. To really fix this,
we need to report the measurement of all assets and liabilities
on a completely consistent basis.