Fair Value Rule Could Flood RenaissanceRe Holdings with Losses

Looking to divert attention away from their own incompetence, many investment bankers on Wall Street are calling for the elimination of mark-to-market accounting, a framework adopted by companies to make more transparent the current values of certain (often illiquid) financial instruments. In my opinion, a likely critic of fair value, known as Financial Accounting Standard No. 157, would be RenaissanceRe Holdings, which the company adopted on January 1, 2008.

The Bermuda-based provider of reinsurance and individual and property risk insurance said Wednesday it held about $8.7 million (now worthless) investments in fixed income securities issued by erstwhile Lehman Brothers Holdings. Management stressed, however, that it held only insignificant investments of fixed maturity holdings issued by AIG and Washington Mutual; and, the company had no direct exposure to preferred or common shares issued by Fannie Mae or Freddie Mac.A due diligence reading of the second-quarter ended June 30 10-Q regulatory filing suggests, however, that contrary to management claims, some of the worst damage sustained in the company's investment portfolio (caused by the ongoing financial crisis) has yet to be reported by the company:

Level 3 inputs are based on unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In these cases, significant management assumptions can be used to establish management's best estimate of the assumptions used by other market participants in determining the fair value of the asset or liability. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the asset or liability.

At June 30, RenaissanceRe held more than $5 billion and $441 million in Level 2 and Level 3 assets, which in the aggregate represented almost 88 percent of its total investment portfolio value. Of note, "based on its own judgement" -- given Level 3 assets are illiquid -- the company wrote down a mere $22.6 million in certain (undisclosed) investments in certain private equity partnerships and senior bank loan funds.

Going forward, previously acknowledged premium rate declines and the effect of competitive pricing pressures on customer retention rates could prove to be of lesser concern to the company than its festering investment portfolio.

David Phillips

David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

More from CBS News