Implementing FASB’s Targeted Improvements: Short-Duration Contracts’ Disclosures and Beyond

Eve Pastor, CPA, CGMAAugust 30, 2016

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Introduction, Overview, Best Practices, and Beyond

Introduction and Overview• Speakers and purpose of presentation• Requirements for Disclosures about Short-

Duration Contracts • Work with accountants to determine what is

impracticable and what are insignificant categories• Ultimately do the disclosures provide

meaningful decision useful information to financial statement users?

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Best Practices for Collaborating with Accountants• Actuaries and accountants are trusted

advisors who succeed together through demonstrating trust, cooperation, and respect• Express gratitude and appreciation• Be patient and kind when accountants don’t know

what you know. Consider that you don’t know what they know either. Working together is a terrific opportunity to broaden everyone’s perspective and understanding.

• Familiarize yourself with technical accounting policies especially for product classification

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Importance of Documentation• Documentation is not an afterthought,

busywork, or only nice to have if there’s time. Documentation is an essential component of the work.• “Stands on its own”: Can another actuary

follow your documentation alone, reperform your work, and reach the same conclusions and recommendations? Can an auditor?• “If you didn’t document, you didn’t do it!”

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And beyond…

• Targeted Improvements to the Accounting for Long-Duration Contracts • Review Tentative Board Decisions to Date as

of March 23, 2016

• Exposure draft expected in the fall• Actuaries can provide critically important

input for comment letters on both the technical and operational aspects of the proposed accounting.

Implementing FASB’s Targeted Improvements: Short-Duration Contracts’ Disclosures and Beyond

Laurel Kastrup, FSA, MAAA August 30, 2016

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FASB Short Duration Issues for Health Insurance

FASB Short-Duration Contracts• The Board issued ASU 2015‑09, Disclosures about Short‑Duration

Contracts, to improve financial reporting for short‑duration insurance contracts by providing financial statement users with disclosures about significant estimates of claim liabilities

• Expanded Disclosure Requirements Include:• Incurred and paid loss development tables• Information about the frequency of claims and incurred but not reported claims• Discounted claim reserves• Estimation and changes in methodologies and assumptions• Claim duration information• Rollforwards of claims liabilities• Health insurance contracts

• American Academy of Actuaries (AAA) White Paper on Challenges and Issues Implementing the FASB Short-Duration Contract Disclosures• Exposure Draft, final coming later this year

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Applicability• Disclosure requirements, EXCEPT the

reserve roll-forward, apply only to contracts that are classified as short-duration under GAAP• Some health products may be classified as

short-duration in some cases and long-duration in others, even by the same carrier:• Group long-term disability (GLTD) and Group life• Medicare Supplement

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Aggregation• Aggregate or disaggregate information so that useful

information is not obscured by either the inclusion of large amount of insignificant detail or the aggregation of items that have different characteristics

• The aggregation or disaggregation determination is facts and circumstances based and considers other presentation of the claim liabilities, including:• Disclosures outside the financial statements• Information regularly viewed for evaluating financial performance by the

chief operating decision maker• Other similar information used by the entity or financial statement users to

evaluate financial performance or make resource allocation decisions• The aggregation or disaggregation may differ from how

information is currently aggregated, which may cause reconsideration of systems, financial reporting processes, and internal controls

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Aggregation (continued)• Need to consider:• Coverage type • Geography • Reportable segment• Market• Claim duration

• May not aggregate among different reporting segments• F/X and merger activity may also influence• May result in many segments

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Aggregation(continued)• ASC 944-40-55-9C implies that the minimum disaggregation is the segment level• Disaggregation by reportable segment is a

minimum requirement for companies with reportable segments

• Not a safe harbor•Medical and GLTD claim reserves may have “significantly different characteristics” and may warrant disaggregation even though they are In the same reporting segment

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Aggregation(continued)• Consider the types of disclosures already made

within statutory filings• Business in a reported segment may be spread across

many statutory entities• Underwriting and Investment Exhibit Part 2C of the

NAIC Health Blank provides reserve development for several defined lines of business:• Hospital & medical• Medicare Supplement• Dental only• Vision only• Federal Employees Health Benefits Program• Medicare• Medicaid• Other health, including GLTD, long-term care (LTC), and stop loss

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Claims Development Information• Disaggregated net incurred and paid claim and allocated

claim adjustment expense development must be disclosed by accident year• Information for period of time claims typically remain outstanding• Period of time does not need to exceed 10 years—for medical

coverage will be much shorter• Net outstanding amount for all accident years not separately

presented must be disclosed• Accident year may be a challenge for stop loss coverage

• A reconciliation of the total net amount for all tables presented to the amounts in each statement of financial position presented is required with disclosure of disaggregated reinsurance balances• Aggregate amounts for other reconciling items such as

unallocated claim adjustment expense must be presented

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Presentation as Supplementary Information• Claims development information, including claims duration

information, for the current reporting period must be presented in the notes to the financial statements

• Disclosure of all years that proceed the current reporting period will be presented as supplementary information

• Board members have previously stated they expect to see all periods presented together within the financial statements

• As the supplementary information is required by the accounting standard, the information is considered by the auditing standards to be required supplementary information

• Auditing standards require specific procedures to be performed with respect to required supplementary information and the auditor to report on the performance of the specific procedures

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Claim Frequency Information• Disclosure providing information about claim frequency,

unless it is impracticable to do so, is required and should include:• Quantitative claim frequency information (i.e., number of

reported claims that effect incurred claims and allocated claims adjustment expenses)

• Explanation of the methodologies used to determine claim frequency as there is no prescribed format as information may be tracked differently by organizations or type of business within an organization (e.g., by insured event, by separate claimant by insured event)

• If it is impracticable to disclose claim frequency information, such as in some reinsurance arrangements or participation in residual market pools, disclosure shall describe why it is impracticable

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Claim Frequency Information (continued)• Several issues around claim counts disclosure

noted in AAA paper (some may be specific to P& issues)• Different definitions of what constitutes a

claim, even within a company• Inhibits comparability

• Reinsurance issues• How to deal with claims ceded 100%• Lack of data on some assumed claims• Changes in ceded reinsurance over time

• Changes in portfolio over time

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Claim Frequency Information (continued)• For seriatim claim reserves, such as GLTC

or GLTC this should be straightforward• For claim reserves not set on a seriatim

basis, such as medical insurance, this may be less meaningful and challenging to assemble• Aggregation criteria apply to the claims

frequency information• May influence aggregation choice if different

claim frequency information is used

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Discounted Claim Reserves• When the liability for unpaid claims and claim

adjustment expenses is discounted, disclose the effects of discounting on the financial statements including:• Aggregate amount of the discount deducted from the

liability for unpaid claims and claims adjustment expenses

• Interest accretion recognized during the period• Line item(s) in which the interest accretion is classified

• Medical claim reserves not discounted• Would only apply to seriatim reserves (GLTD,

GLTC)

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Estimation and Changes in Methods and Assumptions• Disclosure, in both interim and annual financial

statements, the incurred-but-not reported liabilities combined with the reserve for expected development on reported claims, included in the liability for unpaid claims and claim adjustment expenses• Presented as a combined single amount for each accident year in

the development of reported claims• Either as a separate disclosure or as a component of the

rollforward of the liabilities for unpaid claims and claim adjustment expenses

• Description of the reserving methodology used to determine the amount disclosed• Need to disclose changes• Experience studies may need to be disclosed for tabular reserve

assumption changes—GLTD, GLTC

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Estimation and Changes in Methods and Assumptions (continued)• “Expected development on reported claims” is not a

familiar concept to health actuaries• Medical coverage:

• Determine the IBNP (incurred but not paid) liability in total, with the following components:• IBNR (Incurred but not reported)• ICOS (In course of settlement) reported but not yet adjudicated• D&U (Due & Unpaid) reported and adjudicated but not yet paid

• Challenging to allocate to each “bucket” as they are not calculated separately• Use approximations

• Other health coverage:• Claim reserves calculated on seriatim basis• Still no concept of “expected development on reported claims”

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Quarterly Reserve Rollforward• The rollforward of the liability for unpaid claims and

claim adjustment expenses required in paragraph 944-40-50-3 will be required for interim periods as well as for the annual reporting periods• For calendar year-end public companies this would be

effective first quarter 2017• For health insurance the rollforward is to be

aggregated or disaggregated so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of times that have different characteristics• Only health requires disaggregation of the rollforward

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Claim Duration Information• Disclose the average annual percentage paid claims

by age based on the information in the paid claims development table

• Cover the same number of accident years presented in the claims and claim expense development tables

• Disaggregate consistent with the claims and claim expense development tables

• Disclosure is not required for health insurance claims• Claims related to the cost of medical treatments• GLTD and GLTC may not qualify

• The ASU’s implementation guidance includes example claims duration calculations and disclosure

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Transition & Effective Date• Comparative disclosures for each prior period presented except:

• Incurred and paid development tables• Material changes in judgment

• Loss development tables need not exceed 5 years in the year of transition, growing to a period of time that does not need to exceed 10 years

• Application of transition disclosure guidance in Subtopic 250-10 on accounting changes and error corrections is not required

• Effective for public business entities for annual reporting periods beginning after December 15, 2015 and interim reporting periods within annual reporting periods beginning after December 15, 2015• Once year deferral for other entities• Early adoption is allowed

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Implementing FASB’s Targeted Improvements: Short-Duration Contracts’ Disclosures and Beyond

Leonard Reback, FSA, MAAAAugust 30, 2016

Agenda

• Short-Duration Contracts Disclosures• Short-duration contracts issues for life

contracts• Some issues from the AAA draft white paper

• And Beyond• Brief overview of FASB long-duration

contracts project• FASB financial instruments issues

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Short-Duration Life Impacts

Short-Duration Contracts Issues for Life Actuaries• Many group insurance contracts• Many credit insurance contracts• Some term insurance• Certain contracts in countries outside the

US• Life companies that own a health or P&C

subsidiary

Claim development tables

• May not be an issue for life insurance contracts• Enough of the claim may be paid in first year

to avoid needing a claim development table• Even if a table is needed it may be able to be

truncated to less than 10 years• May be an issue for disability insurance

and other long tailed claims• E.g., group long term care

Disclosure of undiscounted claims• If the claim reserve in the financial statements is

discounted, there is a requirement to disclose the undiscounted claim amounts (i.e., impact of discounting)• Likely an issue for long-tailed claim coverages such

as disability• Presumably not a huge burden but may require

some effort to prepare• E.g., calculate reserve using a valuation rate of 0%

• Additional information required includes:• Range of discount rates used• Amount of interest accretion recognized each period• Where in the income statement the interest accretion is

reported

Quarterly Claim Reserve Rollforward• The way the new rules were written one provision

impacts both short and long-duration contracts• Currently, the claim reserve rollforward is only

disclosed annually in the 10-K• Under the new rules, the claim reserve rollforward

will have to be provided quarterly on a year-to-date basis• New language explicitly requires a “tabular rollforward”

• Presumably systems are already in place to provide this disclosure since it is already required annually• May need some reformatting if not already presented in

tabular form

Quarterly Claim Reserve Rollforward• Beginning liability for claims & claim expenses

+ Claims & claim expenses incurred- Claims paid- Claim expenses paid= Ending liability for claims & claim expenses• Disclose reason for changes in incurred claims

& claim expenses related to prior years• Disclosure of policies and methodologies for

determining difficult-to-estimate liabilities (e.g., asbestos, toxic waste clean-up) remains annual

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Some AAA white paper Issues

Mergers/acquisitions/divestitures• No explicit guidance for addressing mergers or

divestitures in claim rollforward table• The paper suggests several possible

approaches:• Restate history• Simply add the acquired business from the

acquisition date• Or treat a divestiture as a paid loss as of the divestiture

date• Use a separate triangle for the acquired business• Deem acquired business as insignificant

• If insignificant

Foreign exchange• No explicit guidance for how to deal with movements

in F/X rates over time• Several approaches are suggested in the paper:

• Convert all history to USD using the current year’s F/X rates• Report all triangles in original currency and treat F/X as a

reconciling item• Lock in F/X rates for each accident year• Use F/X rates consistent with financial statements, i.e., paid

values converted at F/X rate on date of payment; outstanding values use balance sheet F/X rate

• Use a separate line to record a “Foreign Exchange Paid Loss” for each accident year, reflecting the impact of F/X movement

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Overview of Long-Duration Contracts Project

Long-duration insurance project• FASB has been engaged in providing targeted

improvements to accounting for long-duration insurance contracts• Exposure draft of proposed guidance expected

in late August/early September• Five areas of focus

• Assumption updates for traditional contracts, including limited-payment and participating contracts

• DAC amortization• Market risk benefits• Disclosures• Transition

Traditional contracts

• Unlock cash flow assumptions annually in a consistent quarter• Net premium ratio is retrospectively

unlocked when assumptions change• Similar to UL-type DAC amortization• Net premium ratio capped at 100%

• No provision for adverse deviation (PAD)• No loss recognition testing or profits

followed by losses testing

Traditional contracts• Discount rate updated each reporting

period• Current market rate consistent with “high-

quality fixed-income” assets• Change in discount rate reported in OCI

Participating contracts• Traditional methodology applied to participating

contracts• No more explicit distinction between FAS 60 contracts

and FAS 120 contracts• Methodology doesn’t really fit the floating rate

nature of participating contracts• Discount rate not necessarily aligned with dividend

credited rate• OCI calculation for discount rate changes does not

account for “floating” nature of credited rate• Distinct treatment for change in discount rates change

versus the related change in dividend cash flows

DAC & SOP 03-1• DAC amortized in proportion to amount

inforce, or straight line for contracts in force• No interest on DAC• Exception for investment contracts which use

effective yield approach to amortization• No DAC recoverability test• SOP 03-1 reserves can be initiated on in

force contracts• Replaces loss recognition & profits followed by

losses testing on UL-type contracts

Market risk benefits

• Guarantees with more than insignificant capital market risk on variable (and some other) contracts• E.g., variable annuity GMxBs, VUL no-lapse

guarantees• Market risk benefits reported at fair value• Change in fair value reported in net

income• Except change related to change in “own

credit” reported in OCI

Disclosures• Lots of new disclosures, including:• Disaggregated rollforwards of reserve and DAC

balances, reconciled to balance sheet amounts• Information about assumptions

• In some cases including weighted averages and ranges

• Discussion of judgments used and their impact• Information about risk management and

hedging• Cash surrender values and net amounts at risk

Disclosures• Also:• For account balance products

• Tabular disclosure of crediting rates and guaranteed rates • Weighted average earned & credited rate• Information about situations where an SOP 03-1 is established

on in force contracts• For traditional contracts

• Undiscounted net premiums and benefits• Information about reinsurance receivables and gross premiums• Information about situations where net premium exceeds gross

premium• For market risk benefits

• Fees collected • Rollforward split between in-the-money and out-of-the-money

benefits

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FASB Financial Instruments

FASB Financial Instruments Project

• FASB has completed two projects on accounting for financial instruments:• Recognition and measurement (ASU 2016-

01) effective in 2018 for public entities• Financial instruments credit losses (ASU

2016-13) effective in 2020 for public entities• Also working on simplifying hedge

accounting requirements

Recognition and measurement

• Two provisions may be particularly important to actuaries• Equity securities no longer eligible for OCI

• Change in value of equity investments reported in net income

• Some practical expedients• Exception if investment is consolidated or

accounted for using the equity approach• For liabilities that elect fair value option the

impact of changes in own credit reported in OCI

Credit losses• Different impairment models used for assets

held at amortized cost versus for assets at FV-OCI• Reinsurance receivables will need to

calculate an impairment allowance using the approach used for amortized cost assets• Current expected credit loss (CECL) model• Estimates present value of all future projected

credit losses on the reinsurance• Does not impact losses due to disputed claims

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Q&A