Short-duration contract disclosures: Implementing ASU 2015-09 Prepared by: Joe Lee, Senior Manager, RSM US LLP joe.lee@rsmus.com, +1 515 281 9214 September 2017 Overview In October 2008, the Financial Accounting Standards Board (FASB) initially undertook an insurance contracts project jointly with the International Accounting Standards Board. After several years of discussions and analysis, the FASB issued a proposed Accounting Standards Update (ASU) in 2013. The FASB received 206 comment letters and also conducted extensive outreach with insurance industry stakeholders. Respondents overwhelmingly favored no changes to the existing recognition and measurement guidance for shortduration contracts. After further deliberation and analysis, the FASB instead focused on making targeted improvements to existing disclosure requirements and issued ASU 2015-09, Financial Services Insurance (Topic 944): Disclosures about Short-Duration Contracts. The FASB stated the following in paragraph BC2 in the Background Information and Basis for Conclusions section of the ASU: The objectives of the disclosures about short-duration contracts are to increase transparency of significant estimates made in measuring the liability for unpaid claims and claim adjustment expenses, improve comparability by requiring consistent disclosure of information, and provide financial statement users with information to facilitate analysis of the amount, timing and uncertainty of cash flows arising from contracts issued by insurance entities and the development of loss reserve estimates.
Key provisions The ASU requires insurance entities to disclose information about the liability for unpaid claims and claim adjustment expenses, including: Incurred and paid claims development information on a net basis, by accident year, for the number of years for which claims incurred typically remain outstanding (but need not exceed 10 years) A reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for unpaid claims and claim adjustment expenses For each accident year presented, the total incurred-butnot-reported (IBNR) liabilities plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses For each accident year presented, quantitative information about claim frequency A description of the reserving methodologies along with any significant changes to those methodologies A description of the methodologies used for determining claim frequency information along with any significant changes to those methodologies For all claims except health insurance claims, the average annual percentage payout of incurred claims by age The ASU does not prescribe the level of disaggregation required for these disclosures, but requires insurance entities to analyze their own data and determine the level of useful information based upon users of the financial statements. The objective is to not include a large amount of insignificant detail or aggregate individual items that have significantly different characteristics. Additional disclosures are required if an insurance entity reports its liabilities for unpaid claims and claim adjustment expenses at present value. Applicability The amendments within ASU 2015-09 apply to all insurance entities that issue financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) and issue short-duration contracts, including those insurance entities that issue both short- and long-duration contracts. For financial statements prepared on a statutory-basis of accounting, the National Association of Insurance Commissioners (NAIC) rejected ASU 2015-09 for statutory accounting at its spring 2017 meeting. However, the NAIC did incorporate two new disclosures within existing guidance: (a) disclosure of significant changes in methodologies and assumptions used in calculating the liability for unpaid claims and claim adjustment expenses, including reasons for the change and the effects on the financial statements for the most recent reporting period presented and (b) disclosure of the amount and line item classification of interest accretion recognized in the income statement when unpaid losses or unpaid loss adjustment expenses are discounted. Effective date For public business entities, the amendments were effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. For all other entities, the amendments are effective for annual periods beginning after December 15, 2016, and interim periods within annual periods beginning after December 15, 2017. For many middle market insurance entities, the amendments will first be effective for the December 31, 2017 financial statements. Disclosure requirements General disclosures An insurance entity is required to disclose the basis for estimating its unpaid claims and claim adjustments expenses. This is commonly seen as a significant accounting policy disclosure. In addition, for annual and interim reporting periods, an insurance entity is required to present, in tabular format, a roll forward that includes the following information: The balance in the liability for unpaid claims and claim adjustment expenses at the beginning of the year, and the related reinsurance recoverable Year-to-date incurred claims and claim adjustment expenses with separate disclosure of current-year and prior-year provisions for insured events Year-to-date payments of claims and claim adjustment expenses with separate disclosure of payments attributable to current-year and prior-year insured events The balance in the liability for unpaid claims and claim adjustment expenses at the end of the year, and the related reinsurance recoverable In addition to this tabular disclosure, an insurance entity is required to disclose the reasons for the change in incurred claims and claim adjustment expenses recognized in the income statement attributable to insured events of prior years (i.e., positive or negative developments) and whether additional or return premiums have been accrued as a result of prioryear effects. Finally, additional annual reporting disclosures are required if an insurance entity has difficult-to-estimate liabilities, such as those related to toxic waste cleanup, asbestos-related illnesses or other environmental remediation exposures. The preceding amended disclosures are fairly consistent with existing requirements, except that the guidance now requires (a) roll forward information to be in tabular format and (b) roll forward information to be presented for interim reporting periods. Short-duration contract disclosures Incurred and paid claims development information on a net basis, by accident year, for the number of years for which claims incurred typically remain outstanding (but need not exceed 10 years) 2
For annual reporting periods, an insurance entity is required to disclose in tabular format undiscounted information about claims development by accident year, net of reinsurance. The tabular format should present the information separately for (a) incurred claims and allocated claim adjustment expenses and (b) paid claims and allocated claim adjustment expenses. The following are examples of (a) the incurred claims and allocated claims adjustment expenses development table and (b) the paid claims and allocated claim adjustment expenses development table from Accounting Standards Codification (ASC) 944-40-55-9E: The preceding tabular disclosures should present information for the number of years for which claims typically remain outstanding; however, the disclosure need not exceed 10 years. For those outstanding liabilities that are older than 10 years, the amount should be disclosed as a reconciling item. 3
A reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for unpaid claims and claim adjustment expenses. Once an insurance entity has disclosed the previous claims development information, an insurance entity is required to reconcile that information to the aggregate carrying amount of the liability for unpaid claims and claim adjustment expenses for the most recent reporting period presented. The following is an example of the reconciliation from ASC 944-40-55-9E: For each accident year presented, quantitative information about claim frequency An insurance entity is required to disclose cumulative claim frequency information. Similar to the previous disclosure, ASC 944-40-55-9E combines this quantitative information with the incurred and paid claims development disclosures. If it is impracticable to disclose the claim frequency information, an insurance entity is required to disclose that fact and the reason why it is impracticable to disclose such information. A description of the reserving methodologies along with any significant changes to those methodologies An insurance entity is required to disclose the methodologies it utilized in determining the presented amounts of both IBNR liabilities and expected development on reported claims. An insurance entity may have already disclosed, at a high level, a description of its reserving methodologies; however, the revised guidance now has explicit requirements for preparers of financial statements. There is no specific guidance on the level of detail to include in the description(s), however. The guidance requires reinsurance recoverable on unpaid claims be presented using the same disaggregation as in the previously disclosed development tables. An insurance entity may have several reconciling items within the preceding table, including, but not limited to, (a) other insignificant short-duration contract liabilities, (b) long-duration contract liabilities, (c) unallocated claims adjustment expenses, (d) purchase accounting adjustments, (e) fronted business ceded, (f) ceded reinsurance reserves or allowances or (g) impact of discounting. For each accident year presented, the total IBNR liabilities plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses An insurance entity is required to disclose quantitative information about its IBNR liabilities plus expected development on reported claims. To reduce the number of tables within the notes to the financial statements, ASC 944-40-55-9E combines this quantitative information with the incurred and paid claims development disclosures illustrated in a preceding example. An insurance entity is not only required to disclose its methodologies, but also is required to disclose any significant changes to those methodologies, including reasons for the change and the related impact on the financial statements for the most recent reporting period presented. A description of the methodologies used for determining claim frequency information along with any significant changes to those methodologies An insurance entity is required to disclose its methodologies for determining the quantitative information about claim frequency previously discussed. This disclosure should include whether reported claim frequency is determined by claim event or individual claimant and how the insurance entity considers claims that do not result in a liability. For all claims except health insurance claims, the average annual percentage payout of incurred claims by age An insurance entity is required to disclose as supplemental information the history of claims duration by age as of the most recent reporting period. The following is an example of the disclosure from ASC 944-44-55-9F: 4
While this disclosure is concise, the underlying calculations may require considerable data collection. The following is an example of the supporting Year 1 and Year 2 calculations from ASC 944-44-55-9G: These calculations are not required to be disclosed, but will require an insurance entity to accumulate annual claims paid data from the initial accident year included in the claims development by accident year disclosure through the most recent reporting period. Key implementation considerations Level of disaggregation The new guidance does not prescribe the level of disaggregation an insurance entity should use in presenting certain disclosures. The level of information should be useful to the users of the financial statements. The disclosures should allow users to understand the amount, timing and uncertainty of cash flows arising from contracts issued by an insurance entity. An insurance entity should analyze how it presents information about its liability for unpaid claims and claim adjustment expenses in other documents or presentations. This may include earnings releases, annual reports, statutory filings or investor presentations. The FASB s guidance also suggests analyzing how information is used internally by key decision makers in evaluating an insurance entity s financial performance. Examples of categories included in the FASB guidance that an insurance entity should consider when selecting the type of category to use to aggregate or disaggregate disclosures include: Type of coverage (major product lines) Geography (country or region) Reportable segment (for public business entities) Market or type of customer (personal vs. commercial lines) Claim duration (short tail vs. long tail) The NAIC Annual Statement Instructions for Schedule P has 22 defined lines of business. The required disaggregation within Schedule P may not be appropriate when considering the level of disaggregation to include in the GAAP-basis financial statements. A commonly expected difference will be that insignificant short-duration lines of business requiring separate Schedule P reporting will be aggregated as a one-line reconciling item within the GAAP-basis disclosures. However, for some insurance entities, senior management may focus heavily on geographical considerations, which may require the insurance entity to accumulate separately presented Schedule P schedules and then disaggregate the information by geographical region for financial statement disclosure purposes. It is important for an insurance entity to decide early the level of disaggregation needed to meet the objectives of ASU 2015-09. It is expected that the cost of accumulating the data will be reduced if an insurance entity utilizes a disaggregation methodology that resembles how internal financial information is analyzed. This assumes senior management is disaggregating data internally that is meaningful for its business, and users of the financial statements would find similar disaggregation to be useful. By reviewing public entity financial statement disclosures within Form 10-Ks for the year ended December 31, 2016, preparers of financial statements for nonpublic insurance entities can analyze how the disclosure requirements were met and the extent of disaggregation included. The following information was obtained from a sample of Form 10-K financial statement disclosures for public property and casualty (P&C) insurance entities with less than $1 billion in gross written premium. Number of claim development Number of insurers % of total tables disclosed 1 12 41% 2 5 17% 3 7 24% 4 0 0% 5 2 7% 6 2 7% 7 1 4% Total 29 100% 5
While the level of disaggregation is unique to each insurer s financial statements, this analysis demonstrates that a majority of preparers determined three or fewer claims development tables were appropriate for disclosure of useful information to the users of the financial statements. In addition, the FASB s guidance allows for nonsignificant short-duration categories to be presented as a reconciling item. Only nine of the 29 insurer financial statements we reviewed had a reconciling line item for other short-duration categories, and the nonsignificant shortduration categories only comprised approximately 6 percent of the net claim liabilities for those nine insurers. Number of claim development years The FASB deliberated on the number of years to be disclosed in the claims development tables and ultimately decided that the benefits of requiring the presentation of up to 10 years of information justifies the cost for the following reasons: Changes in liability estimates and management s reserving practices would be less transparent if only two or three years of information about claims development were presented. Requiring only two or three years of information about claims development would increase costs to financial statement users because compiling information for a meaningful trend analysis may require information from multiple years. While the FASB determined the maximum number of years required to be included in the disclosure, it did not specifically prescribe the number of years to be disclosed. An insurance entity is required to analyze its own level of disaggregation and present the number of years for which claims incurred typically remain outstanding. This represents another difference between presentations within Schedule P and the GAAP-basis financial statements. The following information was obtained from a sample of Form 10-K financial statement disclosures for public P&C insurance entities with less than $1 billion in gross written premium. Number of years Number of claim development % of total tables disclosed 10 47 65% 9 1 1% 8 2 3% 7 3 4% 6 0 0% 5 7 10% 4 2 3% 3 6 9% 2 3 4% 1 1 1% Total 72 100% The majority of insurers determined that 10 years of claims development information was appropriate and useful for the users of the financial statements. Several of the insurers that had short-tail lines of coverage disclosed a minimum of five years of data. For those insurance entities that presented fewer than five years of data for certain categories, the circumstances were disclosed and pertained to newly acquired business, new coverage lines, isolated catastrophes or health coverage. The guidance states that the claims development information need not exceed 10 years, and any outstanding liabilities in older accident years be presented as a reconciling item. Twenty-four of the 29 insurers had a reconciling item for older accident years; however, this reconciling line item only comprised approximately 7 percent of net claim liabilities for those 24 insurers. Claim frequency An insurance entity is required to disclose cumulative claim frequency information along with the methodology utilized to determine those claim counts. An insurance entity may encounter implementation issues when accumulating the information for the disclosure, including, but not limited to: (a) changes in claim count methodologies in previous years, (b) information system changes, (c) introduction of new subcoverage types within a line of business, (d) an insured s use of a self-reporting incident mechanism, (e) previous mergers and acquisitions, (f) claims below certain attachment points, (g) limited information available on assumed business, (h) inclusion of claim counts on business that is 100 percent ceded, and (i) changes in an insurance entity s reinsurance program over time. These implementation issues will require an insurance entity to analyze its methodologies and determine the usefulness of the information disclosed. An insurance entity may determine it is impracticable to disclose certain claim frequency information; however, the reason for excluding this information is required to be disclosed. Certain claim frequency information may be available to an insurer; however, the inclusion of the data may distort the disclosure (e.g., previous mergers or acquisition). Therefore, an insurer may be required to separately disclose that claim frequency information. The FASB recognized there would be different approaches to accumulating and disclosing claim frequency information. Therefore, the disclosure of an insurer s methodologies and any significant changes to those methodologies will be a key component of this disclosure. IBNR methodologies An insurance entity is required to disclose the methodologies utilized in estimating its liability for unpaid claims and claim adjustment expenses; however, the new guidance does not offer any specific guidance on the level of detail to disclose. It is common for a property and casualty insurance entity to utilize an actuary to estimate an ultimate loss and then subtract the reported case-base reserves to arrive at the IBNR amount. However, users of the financial statements may not find that disclosure to be particularly useful based upon factors specific to that insurance entity, such as unique types of coverage or use of multiple methodologies. 6
An insurance entity should disclose the specific methodologies utilized, but should take care in not disclosing information at a level of extreme detail. The reason an insurance entity should carefully consider the extent of disclosure is that the guidance requires significant changes in methods and assumptions to be disclosed, along with the reason for the changes and the related effects on the income statement. In practice, a significant change may be defined differently based on the level of detail disclosed, so it may be difficult for an insurance entity to measure the income statement impact related to a significant change in a detailed assumption. Health insurance claims The new guidance includes a specific definition of a health insurance claim: claims related to the cost of medical treatments (other than claims related to liability insurance that covers claims against the insured for injury of or by others, such as, but not limited to, workers compensation, disability and general liability insurance). Although the guidance now defines a health insurance claim, financial statement preparers indicated disclosing up to 10 years of information on health claims typically settled within one year would not provide enough benefit to justify the cost of accumulating the data. However, the FASB did not exclude health insurance claims since some claims extend beyond a year, and users find the information to be useful. Additionally, an insurance entity is not required to disclose the historical average annual percentage payout of incurred claims by age, net of reinsurance, for health claims due to the short-tail nature of coverage. Health and(or) life insurance entities that issue accident and health insurance, and certain life insurance contracts may be subject to the new disclosure requirements. This may present challenges for certain insurance entities as certain coverage contracts may be classified as short-duration by one insurer and long-duration by another insurer. Coverage such as group long-term disability, group life or Medicare Supplement (issueage-rated vs. attained-age-rated) may present challenges in effectively scoping out long-duration contracts from the disclosures. As such, it may be more useful to the users of the financial statements if such coverage types are not excluded, but rather included in the disclosures to accurately show the full picture of the insurer s reserve development. The new guidance requires an insurance entity to disclose cumulative claim frequency information. For certain contracts, this information may be useful and easy to calculate and accumulate. However, for other health contracts, such as medical insurance, this information would be less meaningful, more difficult to accumulate and not pertinent to the liability valuation process. As such, the omission of the cumulative claim frequency information for medical insurance contracts may require an insurance entity to consider medical insurance contracts as its own category for purposes of disaggregation. Prior-year information The FASB realized the difficulty in presenting up to 10 years of claims development data that had not been specifically audited in previous years. As a result, the guidance allows for all periods preceding the most recent reporting period to be considered supplementary (unaudited) information. In addition, the disclosure of the average annual percentage payout of incurred claims by age is also considered to be supplementary (unaudited) information. Transition guidance for short-duration contract disclosures In the initial year of adoption, if an insurance entity determines that it is impracticable to obtain the information required for disclosure of claims development information, it may disclose five years of data. However, in each subsequent year following the year of initial adoption, the minimum required number of years will increase by at least one year, but need not exceed 10 years. Closing The implementation of ASU 2015-09 will pose a challenge to most insurers, but the information disclosed should allow users to better understand the amount, timing and uncertainty of cash flows arising from contracts issued by insurance entities and the development of loss reserve estimates. 7
+1 800 274 3978 rsmus.com This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional advice or services. This document does not constitute audit, tax, consulting, business, financial, investment, legal or other professional advice, and you should consult a qualified professional advisor before taking any action based on the information herein. RSM US LLP, its affiliates and related entities are not responsible for any loss resulting from or relating to reliance on this document by any person. Internal Revenue Service rules require us to inform you that this communication may be deemed a solicitation to provide tax services. This communication is being sent to individuals who have subscribed to receive it or who we believe would have an interest in the topics discussed. RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. RSM and the RSM logo are registered trademarks of RSM International Association. The power of being understood is a registered trademark of RSM US LLP. 2017 RSM US LLP. All Rights Reserved. em-nt-as-in-0917