GAAP Insurance Contracts Project - IASA Session Papers... · IASA 86TH ANNUAL EDUCATIONAL...

IASA 86TH ANNUAL EDUCATIONAL CONFERENCE & BUSINESS SHOW

GAAP Insurance Contracts Project - Life

Session Number 405

Today’s Speakers

John T. Kelley

AVP, Accounting Policy

Lincoln Financial Group

Gregory Hendler

Director, Corporate Accounting Policy

Genworth Financial

Agenda

Background and Timeline

Review of Existing U.S. GAAP

Overview Of 2013 FASB Exposure Draft

Summary of 2014 FASB Re-deliberations

Next Steps

Insurance Contracts Project Background

What is the project?

A joint effort between the International Accounting Standards Board

(IASB) and the U.S. based Financial Accounting Standards Board

(FASB) to create a comprehensive accounting standard for insurance

contracts which began in the fourth quarter of 2008.

What is the FASB objective of the project?

To improve U.S. GAAP for insurance contracts by developing high

quality guidance that addresses recognition, measurement,

presentation, and disclosure. Specifically, the project is intended to

improve, simplify, and achieve convergence of the financial reporting

requirements for insurance contracts to provide investors with decision-

useful information.

Existing Guidance for Insurance Contracts

Existing IFRS guidance on insurance contracts is found in IFRS 4 Insurance Contracts which was issued in 2004 during the first phase of the IASB’s insurance project. IFRS 4 was only intended to be a temporary solution as it permits a wide variety of existing local accounting practices to continue, hindering comparability for users.

Existing US GAAP guidance on insurance contracts has developed over time and was originally published in numerous pronouncements including FASB Statements (i.e., FAS 60, FAS 97, FAS 113, FAS 120), AICPA Practice Bulletins and Statements of Position, EITF Abstracts, etc.

Project Timeline

FASB Discussion

Paper

IASB Exposure

Draft

IASB targeted

re-exposure

document

1H 2013

FASB Exposure

Draft 1H 2013

Potential IASB

Final Standard

Potential

effective date

1/1/17 / 1/1/18

Potential first

annual financial

statements

Ongoing FASB/IASB deliberations Implementation period Reporting IASB Only

Ongoing FASB/IASB deliberations Implementation period Reporting FASB Only

FASB Considers

Targeted Changes

Potential FASB

Accounting

Standards

Updates

Potential effective

date 1/1/18

Potential start of

comparative

periods for SEC

listed entities

2010 2011 2012 2013 2014 2015 2016 2017 2018

Potential first

annual financial

statements

What’s Wrong With Insurance Accounting Today?

FASB View:

Multiple Models Make Insurance Accounting Difficult To Understand

Non-insurance entities excluded from scope

Current rules don’t fully reflect options & guarantees

Recognition of premiums inconsistent with recently issued revenue

recognition guidance

Investor/Analyst View:

Mixed-attribute accounting model results in accounting mismatches

without any economic substance

Rules based product-specific accounting liability measurement,

amortization of deferred acquisition costs, and recognition of certain

options and guarantees makes insurers difficult to analyze

Key Areas Of The Original FASB Exposure Draft

Definition

and scope

Unbundling

Discount rate

Single margin

PV of future

expected

cash flows

Bu

ild

ing

Blo

ck

Ap

pro

ac

h

Premium Allocation

Approach

Disaggregation

Reinsurance

Transition

Disclosure

Presentation

Financial Instruments and other accounting changes

Building blocks Approach

Present

value of

cash

inflows

(premium)

Single

margin

Present value

of expected

cash

outflows

Using current

market discount

rate

Impact of

changes in

discount rate

usually reflected

in equity

Impact of

changes in

future cash

flows spread

over contract

period

Eliminates day 1

profits

Recognized as

profit as insurer is

released from

exposure to risk

Acquisition costs

deferral offsets

Limited to zero

FASB February 2014 Meeting on the Insurance Contracts Project

The Board discussed whether the scope of the project should continue to include all

entities that issue insurance contracts as proposed in the Exposure Draft, and decided to

limit the scope to insurance entities consistent with current U.S. GAAP

• Vote: 6 to 1

The Board discussed a range of possible approaches the project could take, including

considering a comprehensive redeliberation of the project based on the Exposure Draft or

considering targeted improvements to existing U.S. GAAP. The Board decided the project

should focus on targeted improvements to existing U.S. GAAP.

• Vote: 5 to 2

For long-duration contracts, the Board concluded that decisions reached by the IASB in

its 2013 IASB Exposure Draft, Insurance Contracts, should be considered when

contemplating improvements to existing U.S. GAAP.

• Vote: 4 to 3

The Board directed the staff to perform an analysis of existing U.S. GAAP for long-

duration contracts to assess areas that should be considered for targeted improvements.

FASB April 2014 Meeting on the Insurance Contracts Project

In preparing for the April Board meeting, the FASB staff reviewed feedback

received through comment letters and outreach, to identify accounting issues

for long-duration contracts and targeted improvements to address those issues.

The Board decided to consider potential targeted improvements related to

recognition, measurement and disclosure of long-duration insurance contracts

in the following areas:

1. Liability for future policy benefits

2. Deferred acquisition costs

3. Premium deficiency and loss recognition

4. Revenue recognition disclosures

5. Unit of account

The Board decided not to consider accounting by mortgage guaranty insurance

entities or changes to the measurement of revenue

The Board also indicated they would consider reinsurance issues at a later date

Current U.S. GAAP

Liability for future policy benefits:

All liability assumptions for traditional contracts remain locked-in

unless a premium deficiency exists

Assumptions are updated based on current information with changes

recoded in net income for universal life-type contracts

Liabilities discounted based on expected investment yields (locked-in

or updated currently depending on the model)

Options & guarantees on universal life-type contracts accounted for as

an embedded derivative or insurance benefit

Potential Targeted Improvements Included in the Scope of Project

Liability for future policy benefits:

1. Whether assumptions should be updated periodically

2. How often assumptions should be updated

3. If assumptions should be updated, how the effects of the changes in

assumptions should be recognized in the financial statements

4. What discount rate should be used in measuring the liability for future

policy benefits for long-duration contracts

5. Whether entities should disclose specific information about the

methods and assumptions used in determining the liability for future

policy benefits, including the discount rates used

6. How reporting entities should measure certain options and guarantees

that do not meet the criteria to be accounted for under Subtopic 815-

10 or Subtopic 815-15 (Derivatives)

Current U.S. GAAP

Deferred acquisition cost models:

Direct costs associated with the acquisition of insurance products are

recorded as an asset and amortized into income over time

For traditional contracts, amortization is based on estimated gross

revenues; pattern locked-in unless premium deficiency test failed

For universal life-type contracts, amortization is based on estimated

gross profits and updated retrospectively based on current information

For limited-payment contracts, DAC is included in the benefit reserve

as part of the liability (not explicit)

For investment contracts, DAC is amortized using the interest method


Deferred acquisition costs:

1. How deferred acquisition costs should be amortized for long-duration

contracts

2. If deferred acquisition costs should be amortized using estimated

gross profits and estimated gross margins, whether adjustments

should be retrospective or prospective

3. If retrospective unlocking is required, whether reporting entities should

disclose information about the determination and future effects of

retrospective unlocking

4. Whether reporting entities should disclose a deferred-acquisition-cost

roll forward

Current U.S. GAAP

Unit of Account:

Acquisition costs and premium deficiency test aggregated consistant

with how an entity, acquires, services & measures the profitability of

insurance contracts

Level of aggregation not prescribed for other parts of model

Premium deficiency and loss recognition:

A premium deficiency test is performed to determine if there is a

probable loss on insurance contracts

If the test is failed, DAC is written down and liability increased to restore

margin to zero. Going forward, revised assumptions are used

The test is performed at a high level, consistant with unit of account

principle above


Unit of Account:

1. What the appropriate unit of account or level of aggregation should be

for various parts of the accounting model

Premium deficiency and loss recognition:

1. Whether the level of aggregation for performing the premium

deficiency analysis for long-duration contracts should be clarified

2. Whether certain disclosures should be required, such as the current

loss recognition margin, level of aggregation, significant assumptions,

and the amount of premium deficiency recorded during the period.

Potential Targeted Improvements Excluded from the Scope of Project

Revenue recognition

The board voted not to consider measurement changes for revenue;

items on the agenda for consideration had included:

• Whether revenue should be recognized when premiums are earned or when

premiums are due

• If revenue should be recognized when premiums are earned, whether

revenue should be recognized over the coverage period or over the service

period?

The FASB will consider new disclosures to clarify how insurance entity

revenue differs from other entities

Potential Targeted Improvements Excluded from the Scope of Project

Accounting by Mortgage Insurance Entities

The board voted not to consider accounting by mortgage insurance

entities, which is not explicitly addressed in current US GAAP

Mortgage insurers will continue to use a short-duration model for claim

liabilities and a long-duration model for revenue

May revisit at a later date

Accounting By Non-Insurance Entities

If February the board voted not to address accounting for insurance

products by non-insurance entities, retaining the entity-specific scope of

ASC 944. They may re-visit this decision at a later date

Timing and Next Steps

The FASB will likely begin re-deliberating accounting for long-duration

contracts after considering short-duration contract disclosures

• They may begin with education sessions on cash flows and other parts of the

model

• The FASB staff Project Lead will finish her term in June, so turnover may

slow progress

• Unlikely any significant changes will be made in 2014

The board will continue to monitor the IASB Insurance Contracts project

• The IASB is reacting to comment letters and considering targeted changes to

their exposure draft

• To the extent the IASB makes changes to parts of the model that address

U.S. stakeholders’ concerns, the FASB could revisit parts of the IASB model

Reinsurance likely to be discussed at a later date, but timing unclear

Appendix

FASB April 2014 Meeting Background Information

Liability for Future Policy Benefits

During outreach, the FASB staff noted that many of the issues with the current

accounting for the liability for future policy benefits related to assumptions that

are locked in at inception of the contract. The following issues were identified:

• The assumptions used to determine the liability for future policy benefits are locked in

at inception unless a premium deficiency exists. Because long-duration contracts may

remain in force for 30 years or longer, this may result in significant differences between

initial assumption estimates and current assumption estimates. For discount rate

assumptions, the differences between the initial expected investment yields and current

investment yields for the assets backing the liabilities create a mismatch, do not

necessarily reflect a reporting entity’s current asset-liability management strategy, and

are not required to be disclosed in a reporting entity’s financial statements.

• There is no requirement to disclose the discount rates used in the benefit reserve

calculations. This reduces the transparency and comparability of the amounts included

in the financial statements.


Liability for Future Policy Benefits (continued)

Additionally, the FASB staff noted that there were issues identified with the

accounting for the additional liability for contracts with death or other insurance

benefit features (for example, guaranteed minimum income benefits and

guaranteed minimum death benefits) as follows:

• Insurance entities are required to evaluate whether certain annuitization benefits are

accounted for under Subtopic 815-10, Derivatives and Hedging—Overall, or Subtopic

815-15, Derivatives and Hedging—Embedded Derivatives. If the contract feature is not

required to be accounted for under these provisions, an additional liability for the

contract feature is established. This results in some contract features that are

accounted for at fair value under Topic 815 and some contract features that are

accounted for using the guidance in Topic 944, Financial Services—Insurance.

• The calculation of the additional liability results in an amount that is recognized over

time and that may be significantly different from the fair value of the contract feature.

Reporting entities often hedge the exposure to these features, and while they are

economically hedged, an accounting mismatch is created because the derivative

instrument is accounted for under Topic 815 and the contract feature is accounted for

under Topic 944.


Deferred Acquisition Costs

The FASB staff noted that, overall, stakeholders were concerned that the

subsequent measurement of deferred acquisition costs is complex and not

transparent to users due to the following:

• There are multiple accounting models for deferred-acquisition-cost amortization. As a

result, amortization expense for different long-duration insurance contracts may not be

comparable.

• Amortizing deferred acquisition costs using estimated gross profits and estimated gross

margins is complex and can increase financial statement volatility due to the

requirement to update estimated gross profits and estimated gross margins with actual

amounts for the period and retrospectively adjust deferred acquisition costs by a

charge or credit to the statement of earnings if actual experience or other evidence

suggests that earlier estimates should be revised.

• Adjustments to deferred acquisition costs are complex and not well understood.

Existing U.S. GAAP does not require detailed disclosures about deferred acquisition

costs and the future effects of deferred-acquisition-cost adjustments in the current

period.


Premium Deficiency and Loss Recognition

The FASB staff noted that there are two issues with existing U.S. GAAP

guidance for premium deficiency and loss recognition testing as follows:

• There may be diversity in practice with how reporting entities aggregate information

when performing premium deficiency analyses, and since the level of aggregation can

have a significant effect on whether a premium deficiency is recorded, this can affect

financial statement comparability. Some stakeholders also have noted that the level of

aggregation used in the premium deficiency analysis for certain reporting entities may

be too high.

• There are no required disclosures about the premium deficiency analysis and the

amount of premium deficiency recorded. Users have indicated that disclosures about

how close an entity is to recording a premium deficiency (an “early warning

mechanism”) would be helpful in analyzing and comparing insurance entities and in

determining the risk profile of an insurance entity.


Revenue Recognition The exposure draft would have required entities to recognize revenue for long-duration

contracts over the coverage and settlement periods as the obligation to provide coverage

and other services is satisfied. Most stakeholders generally disagreed with that guidance

and noted that the premiums earned model would (a) eliminate volume information from

net income, (b) be costly and complex (c) not be meaningful, and (d) significantly

increase the complexity of users’ analyses of insurance entities.

However, the Board rejected the premiums due model as stated in paragraph BC299 of

the proposed Update as follows:

…the insurance contract revenue measure is an objective, tangible measure of new business and is a useful anchor in

facilitating analysis of ratios. However, the insurance contract revenue often would be recognized before the entity has

performed the related service, and, similarly, expenses often would be recognized before they have been incurred.

Under the premium due method, the amounts presented as insurance contract revenue and claims, benefits, and

contract-related expenses vary depending on the timing of when premium is due based on the contract versus when

services are provided. Consequently, economically similar contracts would be presented differently in the statement of

comprehensive income merely because the billing terms differ.

Additionally, the FASB staff noted some stakeholders stated the premiums due model

results in situations where revenue is not aligned with the period over which the related

service is provided. Finally, the existence of multiple models in existing U.S. GAAP

creates confusion for financial statement users.


Accounting by Mortgage Guarantee Insurance Entities

Paragraph 944-10-15-2 states that the guidance in Topic 944 applies to

mortgage guaranty insurance entities; however, the FASB staff noted that there

is no specific guidance for mortgage guaranty insurance entities included.

Practice has developed in which mortgage guaranty insurance entities apply the

short-duration contracts guidance in Subtopic 944-40, Financial Services—

Insurance—Claim Costs and Liabilities for Future Policy Benefits, and the long-

duration model in Subtopic 944-605, Financial Services—Insurance—Revenue

Recognition. A topic for the Board to consider is whether guidance should be

provided for mortgage guaranty insurance entities.

Building blocks approach release of earnings

20 -5

-4 +2

+1

14

Liability at

Start of Year

Liability at

End of Year

Expected

Cash Flows

Release of

Margin Interest on the

Liability

Unexpected

Cash Flows

and Changes

in Estimates

Expected cash flows

Cash receipts and

payments that were

expected

Release of margin

Profit is recognized as the insurer

satisfies its performance obligation

to stand ready to compensate the

policyholder in the event of an

occurrence of a specified event

that adversely affects the

policyholder.

Interest on liability

Interest on the liability

in the current period

Unexpected cash flows

and changes in estimates

Non – P &L changes Changes that go through profit or loss

Items in profit or loss

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GAAP Insurance Contracts Project - IASA Session Papers... · IASA 86TH ANNUAL EDUCATIONAL...

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