GAAP Insurance Contracts Project - Life Session Number 405 IASA 86 TH ANNUAL EDUCATIONAL CONFERENCE & BUSINESS SHOW
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 decisionuseful 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 Ongoing FASB/IASB deliberations FASB Only Implementation period Reporting FASB Considers Targeted Changes Potential effective date 1/1/18 FASB Discussion Paper FASB Exposure Draft 1H 2013 Potential FASB Accounting Standards Updates Potential start of comparative periods for SEC listed entities Potential first annual financial statements 2010 2011 2012 2013 2014 2015 2016 2017 2018 IASB Exposure Draft IASB targeted re-exposure document 1H 2013 Potential IASB Final Standard Potential effective date 1/1/17 / 1/1/18 Potential first annual financial statements Ongoing FASB/IASB deliberations IASB Only Implementation period Reporting
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 Building Block Approach Single margin Disaggregation Definition and scope Disclosure Discount rate Reinsurance Unbundling PV of future expected cash flows Transition Presentation Premium Allocation Approach Financial Instruments and other accounting changes
Building blocks Approach 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 Present value of cash inflows (premium) Single margin Present value of expected cash outflows 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 longduration 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
Potential Targeted Improvements Included in the Scope of Project 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
Potential Targeted Improvements Included in the Scope of Project 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.
FASB April 2014 Meeting Background Information 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.
FASB April 2014 Meeting Background Information 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.
FASB April 2014 Meeting Background Information 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.
FASB April 2014 Meeting Background Information 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.
FASB April 2014 Meeting Background Information 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 longduration 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 Expected Cash Flows -4 Release of Margin +2 Interest on the Liability +1 Unexpected Cash Flows and Changes in Estimates 14 Items in profit or loss Liability at Start of Year Non P &L changes Expected cash flows Cash receipts and payments that were expected Release of margin Changes that go through profit or loss 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 Liability at End of Year
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