FASB Begins to Address Long- Duration Insurance Contracts

Transcription

1 Issues & Trends In Insurance August 2014, No FASB Begins to Address Long- Duration Insurance Contracts The FASB began discussions about targeted improvements to U.S. GAAP for long-duration insurance contracts. Decisions reached include the requirements to update assumptions annually in the fourth quarter. Additionally, the Board discussed the appropriate discount rate to use in accounting for these contracts, but did not reach a final decision. Contents Background of the Insurance Contracts Project... 2 Assumptions... 2 Discount Rates... 5 Key Facts The FASB decided to update all assumptions for traditional long-duration contracts, limited-payment contracts, and participating life insurance contracts, and recognize changes in contract liabilities and disclose information about the liability for future policy benefits and the assumptions used. There would not be a provision for adverse deviation in the assumptions. Annual assumption updates would be required and made only in the fourth quarter. This decision also would be applied to universal life-type contracts. The effects of changing all assumptions would be presented in net income. The premium deficiency test would be eliminated for traditional long-duration contracts, limited-payment contracts, and participating life insurance contracts. No decision was made about whether the discount rate assumption would be asset-based or reflect the characteristics of the insurance contract liability. Premium Deficiency and Loss Recognition... 6 network of independent member firms affiliated with KPMG International Cooperative, All

2 Background of the Insurance Contracts Project During 2014 meetings, the FASB decided to cease jointly deliberating insurance contracts with the IASB (the FASB joined the IASB s deliberations in 2008) to limit the scope of the project to insurance companies and to split the project into short-duration and long-duration phases. The short-duration phase will focus only on improvements to disclosures. The FASB decided not to pursue development of additional accounting guidance for reinsurance contracts. Earlier this month, the FASB concluded discussions about claim liabilities disclosures to improve financial reporting for short-duration insurance contracts. The FASB reached a decision to draft a final Accounting Standards Update subject to feedback from the fatal flaw review process. For long-duration contracts, the Board decided in April to consider potential targeted improvements for: Liability for future policy benefits; Deferred acquisition costs; Premium deficiency and loss recognition; and Disclosures about revenue recognition. During the August 27 meeting the FASB addressed assumptions used in the liability for future policy benefits, including updating them, what discount rates should be used, and premium deficiency and loss recognition. Assumptions The FASB discussed the following issues related to updating assumptions: Whether assumptions should be updated periodically; If assumptions should be updated, the frequency; If assumptions should be updated, how the effects of the changes in assumptions should be recognized in the financial statements; and If assumptions should be updated, whether the provision for adverse deviation should be included in the calculation of the liability for future policy benefits. Should Assumptions Be Updated Periodically? Current U.S. GAAP is not consistent in describing how updated assumptions should be used. 1 For traditional long-duration contracts, limited-payment contracts, and participating life insurance contracts, assumptions used for measuring future policy benefit liabilities (such as discount rate, mortality, morbidity, lapse, and expense assumptions) are established with a provision for adverse deviation and are locked in at policy inception. These assumptions are unlocked and updated only if a premium deficiency situation exists. On the other hand, assumptions are revised when actual experience or other evidence suggests the earlier assumptions should be revised for universal lifetype contracts pertaining to the amortization of acquisition costs, additional 1 FASB ASC Topic 944, Financial Services Insurance, available at 2 network of independent member firms affiliated with KPMG International Cooperative, All

3 liabilities for guarantees that are not accounted for as derivatives, and other liabilities when the contract holder assessments result in profits in earlier years followed by losses in later years. The assumptions used for universal life-type contracts do not include a provision for adverse deviation. The FASB staff identified the following three alternatives for the Board to consider related to whether assumptions should be updated for traditional longduration contracts, limited payment contracts, and participating life insurance contracts: Alternative A. An insurance entity should update all assumptions and recognize changes in the liability periodically and disclose information about the liability for future policy benefits and the assumptions used; Alternative B. An insurance entity should only update discount rates and recognize changes in the liability periodically and disclose information about the liability for future policy benefits and the assumptions used; and Alternative C. An insurance entity should disclose information about the liability for future policy benefits and compare the original assumptions with current information. The staff recommended Alternative A. The disclosures would include: Disaggregated balances of the liability for future policy benefits and the weighted-average discount rates used to measure the liability for future policy benefits in time bands and any additional information about amounts and rates within the time bands provided that significantly affect the discount rates; Disaggregated qualitative and quantitative information about the methods and inputs used to measure the liability for future policy benefits, including disclosure of assumptions used (such as discount rate, mortality, morbidity, termination, lapses, and expense assumptions); and Disaggregated reconciliations from opening to closing balances of the liability for future policy benefits, with separate disclosures for changes in the liability for future policy benefits due to new contracts, benefit payments, changes in assumptions, and derecognition of contracts. One Board member indicated that updating assumptions was the most important improvement that can be made to current accounting. There was limited discussion before the FASB decided to update all assumptions and recognize changes in the liability periodically and disclose the information described above about the liability for future policy benefits and the assumptions used. The impact of assumption changes on deferred acquisition costs is expected to be addressed at a future meeting. How Should Assumptions Be Updated? Once they decided to update assumptions, the Board addressed the frequency of updates, how to present the changes in assumptions in the financial statements, and inclusion of a provision for adverse deviation. The FASB staff identified the following three alternatives for the frequency with which insurance entities should update the assumptions: each reporting period, annually, and regularly evaluate and update assumptions if actual experience or other evidence suggests that revisions are necessary. The staff recommended annual updates. 3 network of independent member firms affiliated with KPMG International Cooperative, All

4 One Board member raised a variation based on a hybrid of annual updates with interim updates if actual experience or other evidence suggests that revisions are necessary. This was debated by Board members with some support for the hybrid proposal based on the desire to reflect significant changes in assumptions when they are identified. Other Board members felt that this hybrid approach might cause entities to assess quarterly whether there were significant changes, which would increase the cost and complexity of the targeted improvement. Some felt that interim changes in circumstances that would drive changes in assumptions should be disclosed, but not quantify the impact because that might lead to completing the entire unlocking process to determine the significance of the change. Also, it may be difficult to isolate the impact of an individual assumption change and the interaction between the assumptions if more than one assumption is updated. The discussion also addressed whether an interim change in assumptions results in an accounting policy election where changes would be needed in all future interim periods. An accounting policy election that occurred at least annually, with quarterly or semi-annual updates, was raised. Additionally, the Board debated whether the annual updates should be done in the same period every year, whether the timing of the updates can vary by product, and whether the same period should be specified for all entities. The key points in the debate centered on: The consistency of having all updates in the same period for all entities (primarily focused on having the updates in the fourth quarter); The potential cost and workload benefits of having updates spread through the year by product; Whether a change in the dates of the update for a product would be an accounting policy change requiring preferability; and Should additional disclosures be added for changes in circumstances in interim periods. After the discussion, the FASB decided to require annual updates only in the fourth quarter, which may be at a point in the quarter other than the end of the calendar year. There would not be a provision for adverse deviation in assumptions. Additionally, the Board would apply the same requirement for annual updating of assumptions in the fourth quarter to universal life-type contracts. A decision on potential additional disclosures in interim periods was deferred and will be revisited in a future meeting. The FASB also addressed presentation of the effects of the changes in assumptions in the financial statements. The Board discussed presenting the effects in net income, other comprehensive income (OCI), or an accounting policy election between the two. Concerns were raised over the complexity of using OCI, how to get the amounts out of OCI, and the lack of comparability of an accounting policy election. Some Board members also felt that the fair value option would be available to address accounting mismatches. The FASB decided, in a unanimous vote, to present the effects of changing assumptions in net income. 4 network of independent member firms affiliated with KPMG International Cooperative, All

5 Discount Rates Currently, U.S. GAAP requires insurance entities to use an asset-based rate when discounting the liability for future policy benefits. For example, traditional long-duration contracts and limited payment contracts use the expected investment yield as the discount rate to calculate the liability for future policy benefits. The expected investment yield is defined as the interest rate the entity expects to earn on the assets supporting the policies, net of investment expense. 2 That guidance does not specify whether the discount rate should be a single rate or a yield curve. The IASB s current position in its project on accounting for insurance contracts is to reflect the time value of money in the measurement of the fulfillment cash flows using discount rates (based on yield curves) that reflect the characteristics of the insurance contract liability and that: Are consistent with observable current market prices for instruments with cash flows whose characteristics reflect those of the insurance contract liability in terms of for example timing, currency, and liquidity; and Exclude any factors that influence the observed rates but that are not relevant to the insurance contract liability (e.g., risks that are not present in the liability but that are present in the instrument for which the market prices are observed). The FASB staff offered three alternatives: Alternative A. The discount rates should be asset rates, consistent with existing guidance in FASB ASC Topic 944; Alternative B. The discount rates should reflect the characteristics of the liability, consistent with the guidance in the IASB s insurance contracts project; and Alternative C. The discount rates should be an insurance entity s incremental borrowing rate. The staff recommended Alternative A, which would not change current guidance. The Board focused on the following issues: Whether there is diversity in what is an asset-based rate. The staff indicated the asset-based rate depends on the type of contract, such as the expected investment yield mentioned above. There was some discussion over whether additional guidance was needed to promote consistent application of an assetbased rate. Issues around a discount rate reflecting the characteristics of the liability (liability-based rate), such as the rate used in the IASB s insurance contracts project. Whether a liability-based rate can be made operational and is conceptually preferable to an asset-based rate. Additionally, there was concern that additional effort to develop an operational liability-based rate would not be successful. 2 FASB ASC Master Glossary, available at 5 network of independent member firms affiliated with KPMG International Cooperative, All

6 If updating the assumptions annually is the key targeted improvement and, with that change, whether leaving the discount rate assumption unchanged with additional disclosures is sufficient at this time. In the end the Board voted 4 to 3 to defer the decision and ask the staff to try to develop a practical approach to determining a liability-based rate within a month or so. Other considerations for the discount rate on disclosures and whether to use a single rate or a yield curve were also deferred. The Board will be addressing deferred acquisition costs in a future meeting and may consider discount rate in that context as well. Premium Deficiency and Loss Recognition Based on the decision to update all assumptions annually, the FASB decided without debate to eliminate the premium deficiency test for traditional longduration contracts, limited-payment contracts, and participating life insurance contracts. Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Jennifer D. Austin, Darryl S. Briley, Alan W. Goad, and Olga Menshch Earlier editions are available at: Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the proposed standard or any other potential or applicable requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Issues & Trends In Insurance is a registered trademark of KPMG LLP. 6 network of independent member firms affiliated with KPMG International Cooperative, All