gaap insurance contracts project - iasa session papers... · iasa 86th annual educational...
TRANSCRIPT
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
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
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 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
IASA 86TH ANNUAL EDUCATIONAL CONFERENCE & BUSINESS SHOW
Please Complete the Session Evaluation Form on the Conference App and Include Your Conference Registration ID# to be Included in a Drawing for a Free Conference Registration for the 2014 Annual Conference!
NOTE: Your Conference Registration ID# is Located at the
Bottom Left Hand Corner of Your Badge.