The Financial Accounting Standards Board added a project to its technical agenda to allow insurance companies to use the “portfolio layer method” when doing hedge accounting on their financial liabilities.
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The project would extend the PLM to liabilities to better align companies’ financial reporting with their risk management activities. According to a
The hedged item represents the portion of the portfolio that the entity expects to remain outstanding throughout the designated hedge period. Although the PLM was developed mainly to address the challenges of hedging prepayable mortgage loans and mortgage-backed securities, the guidance can apply more broadly to other financial assets and allows closed portfolios to include both prepayable and nonprepayable instruments. It seems to have attracted the interest of the insurance industry.
One of the main features of the PLM is it allows entities to effectively ignore prepayment risk for hedge accounting purposes. Rather than hedging specific assets that can be prepaid, default, or be sold, an entity designates the layer or layers of the portfolio that it expects will remain outstanding. Prepayments and other reductions in the portfolio are assumed to affect the unhedged portion first, as long as sufficient assets remain to support the designated hedged layer(s).
FASB received two agenda requests related to the PLM from the American Council for Life Insurers and the American Academy of Actuaries.
The ACLI noted back in October 2024 that achieving hedge accounting would help insurance companies mitigate interest rate risk by more closely matching liability duration with asset duration using interest rate derivatives across many life insurance products. ACLI also noted that the PLM would provide a tool to hedge interest rate exposure associated with products that contain interest rate guarantees. Those guarantees subject insurance companies to minimum interest rates that remain in effect for the life of the contract, making the products highly sensitive to changes in market interest rates. ACLI indicated that expanding the PLM to liabilities would better reflect insurance companies’ risk management activities and the economics of related hedging transactions in their financial statements, reduce reliance on non-GAAP adjustments, and provide investors with more decision-useful information.
Similarly, the AAA submitted an agenda request in February 2025 asking FASB to consider extending the PLM to liabilities. AAA noted that the PLM for liabilities would better reflect insurance companies’ current risk management practices, further align GAAP with the insurance industry, and reduce reliance on non-GAAP measures.
Many of the respondents to FASB’s invitation last year to comment on its agenda generally supported a project to extend the application of the PLM to liabilities. They noted that the PLM currently applies only to financial assets and beneficial interests, even though many of the same challenges exist in applying fair value hedge to a portfolio of liabilities.
“One of the appeals of the portfolio approach, in my mind, is it takes ‘breakage,’ I’ll call it, out of the equation,” said FASB chair Richard Jones. “You know something’s going to be out there, but you just don’t know which one, so you can pull breakage out of the equation. As we consider hedging portfolios of transactions, what would be helpful to me is understanding how hedge accounting would work if there weren’t a breakage issue on the underlying individual transaction. Aligning those two, I think that it would certainly help me on the asset side, and I think it would help me on the liability side, particularly as we get into some of the more complex arrangements in the insurance industry.”
During the meeting, FASB board members discussed whether the changes should apply just to financial liabilities or other types of liabilities, as well as whether they should apply to other types of companies besides long-term insurance businesses.
“I’m not necessarily supporting that all financial liabilities would necessarily be addressed,” said FASB board member Joyce Joseph. “Of course, your research will address the pros and cons and the advantages and shortfalls in addressing different types of liabilities, but there are ones where we’ve received strong stakeholder feedback, and I think that should be the priority. Certainly, investors would benefit from what potentially would be more widespread use of hedging, resulting in improved hedge accounting alignment and reduced volatility in the financial reporting outcomes. They’ll have a more straightforward depiction in the financial statements, especially with the potential reduction of non-GAAP adjustments, and a more economic view of how financial institutions manage their risks, notably interest rate risks and potentially early redemption risks.”
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