FASB Advances Expansion of 'Portfolio Layer' Hedging Accounting Rules to Liabilities
The FASB voted 7-0 on Wednesday to add to its technical agenda an update project to expand 'portfolio layer' hedging accounting to liabilities, bringing the total number of active projects to 11. Under current generally accepted accounting principles (GAAP), this method applies only to portfolios, financial assets, and beneficial interests. Insurers and banks have long called for revised guidance to improve reporting of derivative hedges on interest rate-sensitive liabilities such as life insurance policies and certificates of deposit. FASB Vice Chair Hillary H. Salo and Chair Rich Jones both emphasized the need to carefully define the scope of liabilities to avoid excessive expansion of 'open pools.'
At a Glance
- The Financial Accounting Standards Board (FASB) this week unanimously voted to advance a standard-setting project that would allow companies to apply existing “portfolio layer” hedge accountingto liabilities。
- Under current generally accepted accounting principles (GAAP), the method applies only to portfolios, financial assets, and beneficial interests, a staff member told board members at Wednesday’s meeting. Insurers and banks have called for changes to the guidance because it affects how they report derivative hedges of interest-rate-sensitive liabilities such as life insurance policies and certificates of deposit.
- “Stakeholders noted that economic hedging strategies are widely used but do not qualify for hedge accounting, causing companies to rely on non-GAAP adjustments, particularly to explain earnings volatility from derivative gains and losses,” a staff member told the board.
In Depth
The board voted 7-0 to add the projectto its technical agenda, bringing its total standard-setting projects to 11.
The latest project is particularly long-awaited by insurers. In 2024,the American Council of Life Insurers (ACLI) highlightedits challenges in matching liability durations and accounting for derivatives used to hedge interest-rate-sensitive annuities, long-term care policies, and disability insurance.
“One of the industry’s tools for managing the duration of assets and liabilities is using derivatives to hedge risk,” Shannon Jones, ACLI’s senior director of financial reporting policy, wrote in a letter. “If hedge accounting cannot be achieved, it could result in significant earnings volatility, credit rating downgrades, and restricted access to credit markets.”
When used for assets, the portfolio layer method (PLM) provides a powerful tool for reporting preparers, allowing companiesto ignore prepayment risk in hedge accounting reporting, FASB meeting materials show. “Rather than hedging specific assets that may be prepaid, defaulted, or sold, a company designates one or more layers of a portfolio that it expects to remain outstanding,” the materials state.
One of the key questions to be clarified is the definition and scope of liabilities to which PLM could apply. At Wednesday’s meeting, several board members expressed concerns about allowing its application to “open pool” liabilities, while others said they were reluctant to craft a definition so narrow that it would exclude certain liabilities.
“Open pools are a big step to take at the outset,” FASB Vice Chair Hillary H. Salo said during the meeting. “I understand it very well and want to address these issues, but I think getting the scope right is critical.”
FASB Chair Rich Jones said applying hedge accounting to existing contractual relationships is “easy,” but extending the concept to pools where companies have no contractual rights would be a “different dynamic.” He voted to add the project to the agenda with an “initial direction” focused on PLM for financial liabilities, noting the board would explore the liability scope issue.
“So, we have a project on our agenda, and there’s an enthusiastic team, and there will be many issues to come back and discuss,” Jones said at the end of the meeting.