Insurance Contracts Project
Long-duration products
March 3, 2014
Jennifer M. Weiner , Ernst & Young LLP | Partner |
Professional Practice - Financial Services
Michael M. Monahan, American Council of Life
Insurers , Senior Director, Accounting Policy
Content


Key messages
Existing guidance vs. proposed – are the
changes improvements?

Impact of the changes on the financial
statements

Appendix: recent meetings and decisions
"The views expressed in this presentation are thoughts from the authors and do not necessarily
represent the views of, and should not be attributed to, the American Council of Life Insurers or its
members.
Insurance Contracts Project
Key messages
FASB
 Project NOT dead
 Change in focus from convergence to improvements
 Unclear what “improvements” means
 Could get back to building block approach adjusted
for constituent comments
IASB
 Moving forward – focusing on:
 Other comprehensive income
 Unlocking the contractual service margin
 Participating contracts
(probably biggest issue for Board to tackle)
 Insurance contract revenue
 Transition
 Plan on completing redeliberations in August and
releasing final standard in first half of 2015
Expected cash flow assumptions
Existing guidance
FAS 60 products:
 Locked in assumptions at the initial
contract recognition date and
perform loss recognition test
FAS 97 products:
▶ Record policyholder account
balance plus the value of some
guarantees
▶ Some guarantees and options not
accounted for under existing
guidance or accounted for using a
glide path formula under existing
guidance
Potential Improvements?
►
►
►
►
Update assumptions each reporting
date
Include expected: surrenders (and
surrender charges); fees (cost of
insurance mortality and expense
charges and asset management
fees); and, expenses (asset
management expenses)
Include expected value of all
guarantees and options
Recognize the change in those
assumptions (other than the impact
from the change in the discount rates)
► In the statement of
comprehensive income
► In the balance sheet against an
explicit margin
Insurance Contracts Project
Discount rate
Existing guidance
FAS 60 products: discount rate based on
estimates of investment yields (net of
related investment expenses) expected at
the time insurance contracts are made
consistent with circumstances, such as:
▶ Actual yields
▶ Trends in yields
▶ Portfolio mix and maturities, and
▶ The insurer’s general investment
experience (typically includes defaults
and reinvestment risks)
FAS 97 products: a discount rate is not
applied to the account value because the
liability is recorded at the account value
Potential Improvements?
►
►
►
Use discount rates that reflect the
characteristics of the liability
► Risk-free rate plus a liquidity
adjustment
► A replicating portfolio
► Actual portfolio (adjusted for
reinvestment risk) less items that
are not related to the liability
(i.e., expected and unexpected
default, etc.).
The impact from changes in the
discount rates would be recorded to
OCI
Contractual participating features:
ignore discount rate; record at
corresponding asset value
Insurance Contracts Project
Margin
Existing guidance
Potential Improvements?
►
FAS 60 products:
▶ Policyholder reserve includes
implicit margin; earned over life
of policies
FAS 97 products:
▶
Margin is not typically recorded;
recognized when fees are earned
▶
Margin recognized for unearned
revenue liability (gross premium >net
premium); recognized in constant
relationship with inforce (life) or the
amount of expected future benefit
payments (annuity)
▶
EGP’s used to determine DAC
amortization
►
►
►
Recognize an explicit margin for the difference
between the present value of the expected
premiums and the measurement of the liability
Recognize the margin as insurer satisfies its
performance obligation and therefore is released
from exposure to risk evidenced by a reduction in
the variability (uncertainty) of cash outflows
IASB: Recognize a risk adjustment for the
compensation required for bearing the uncertainty
about the amount and timing of future cash flows;
where the entity is indifferent between fulfilling or
selling the contract
IASB: Recognize contractual service margin for
remainder of difference between the present value
of the expected premiums and the measurement
of the liability; recognize as revenue over the
coverage period based on services provided
Insurance Contracts Project
Premiums and benefit expense
Existing guidance
Potential Improvements?
►
FAS 60 products:
▶ Recognize “premiums” and
“benefit expense” when
premiums are due
▶ Include all premium and benefit
payments in income statement
►
►
FAS 97 products:
▶ Recognize revenue when fees
and charges are due
▶ Exclude from revenue and
expenses account balances
Recognize revenue in proportion
to the value of coverage and any
other services provided,
including interest accretion on
cash inflows
Recognize claims and benefits
expense as well as other
fulfillment costs when incurred
Exclude from revenue (and
expenses) the amount of
premium that the insurer is
obligated to pay the policyholder
or a beneficiary regardless of
whether an insured event occurs
Insurance Contracts Project
What really changes if ED adopted
Long-duration contracts
Account
Change in Statement of
Financial Position
Impact on Statement of Comprehensive Income
Insurance
contract
liability /
asset
 Measurement includes all
features of the contract
including options and
guarantees not previously
accounted for or accounted
for at below present value
 Discount rates used may
differ
 Assumptions are updated
each reporting period
 Explicit margin is recognized
and not offset for changes in
expected cash flows
 Revenue recognition pattern will change from premiums
due to an earned pattern for the portion attributable to
the expected cash outflows and based on release from
risk for the portion attributable to the margin
 Revenue may increase as a result of interest accretion
on premiums
 Revenue may decrease for estimated returnable
amounts
 Interest accretion recognized in investment income
section rather than in underwriting section
 Impact on insurance liability as a result of changes in
discount rates from initially determined discount rates
recorded to OCI (unless contractually linked to assets
recorded at fair value through P/L or contractual
obligation is fair value)
For
contracts
measured
using
FAS 60
Insurance Contracts Project
What really changes if ED adopted
Long-duration contracts
Account
Change in Statement of
Financial Position
Insurance
contract
liability /
asset
 Liability is measured as the present value of
the probability weighted expected cash flows
rather than the policyholder account balance.
In addition to the account balance accounted
for today this will include:
 Expected surrenders (and surrender
charges)
 Expected fees (cost of insurance mortality
and expense charges and asset
management fees)
 Expenses (asset management expenses)
 Expected guarantees and options not
accounted for today or accounted for using a
smoothing mechanism
For
contracts
measured
using
FAS 97
Impact on Statement of Comprehensive
Income
 Changes in expected gross profits
transparent (rather than a mechanism for
determining DAC amortization)
 Could recognize more premium (gross
aggregate premiums less the amount that
can be paid to the policyholder regardless of
the insured event occurring)
 Recognize an explicit measurement of
expected profit (i.e., the margin)
Insurance Contracts Project
Product Implications if ED adopted
Products*
Current GAAP
Potential future GAAP
Term life
Future policy benefits and DAC (FAS 60 Long duration)
► PV
of net fulfillment cash flows:
mean of projections
of cash inflows and outflows
► Current assumptions with changes in
income (loss)
► Current discount rates for balance sheet
► Locked-in discount rates for income
statement, except when expectations of
crediting rates change and affect the
measurement of the liability
► Changes in discount rates in OCI
► Unamortized margin (deferred gain), if any
► Probability-weighted
Long-term care
Future policy benefits and DAC (FAS 60 Long duration)
Immediate annuities
Future policy benefits and DAC (FAS 60 Long duration)
Universal life
Policyholder account balances and DAC (FAS 97)
Deferred annuities
Policyholder account balances and DAC (FAS 97)
Closed blocks
Future policy benefits and DAC (FAS 120)
Guarantees w/ life
contingency
Future policy benefits (SOP 03-1)
Guarantees w/o life
contingencies
Other liabilities (FAS 133 embedded derivatives)
►
Accounted for under Financial Instruments
standard (no significant change)
Variable annuities
and VUL
Separate account assets and liabilities
►
Segregated accounts (no significant change)
Projection of base fees and benefits
Stable Value Funds
Policyholder account value with smoothed rate (FAS 97)
► Unclear
Stable Value Wrap
Fair valued as a derivative under FAS 133

►
– will depend on the types of
guaranteed settlement options available.
Unchanged
Note * - “Products” are generic. Each individual product requires consideration under both current and future GAAP
and does not indicate an EY view.
Insurance Contracts Project
Key performance indicators: long-duration contracts
Current
Significant KPI’s
Available from
proposed standard?
Investment returns

Benefit and
expense ratio

Premiums
written/due

Actual to expected
experience
measures for
mortality, morbidity

Disaggregation of information about the effect of experience adjustments and changes in
estimates required in the notes or in the P&L
Value of new
business

Information will be disclosed in the notes
Value of existing
book

Balance sheet amount recognized using current assumptions; may not align to current
definitions, which vary
FASB ED proposal
• Investment results highlighted separately from underwriting results on the face of the
income statement
• Interest accretion from unwinding of discount on liabilities included with investment
income; interest accretion on cash inflows included in revenue
• Investment income and expense for segregated fund accounts (i.e., separate
accounts) presented with respective accounts instead of net
• Premium recognition
• Based on an “earned” concept which will change earnings pattern
• Explicit margin earned based on release from risk offset by recognition of acquisition
cost expense
• Premiums written/due will be disclosed in the footnotes
• Will recognize less premiums (and expense) for contracts where an amount could be
paid to the policyholder regardless of the insured event occurring (e.g., whole life
contracts and immediate annuities with term certain)
• Could recognize more premiums for contracts with explicit account balances (i.e.,
universal life, variable annuities, etc.) for insurance component
• Ceded/assumed premiums (and loss recoverables/payables) reported separately
excluding returnable amounts not based on loss experience (i.e., ceding commissions,
overrides, etc.)
• Benefits and expense recognized when incurred; however; changes in assumptions
recognized when made
Insurance Contracts Project
Timeline
 IASB plans to complete deliberations by August 2014 and issue final
standard in first half of 2015
 Effective date not yet discussed BUT IFRS 9 mandatory effective date
for annual periods beginning on or after 1 January 2018
 Opportunity to progress its insurance contracts project and
potentially provide greater alignment between IFRS 9 and the new
insurance contracts standard
 FASB directed the staff to analyze existing US GAAP guidance for
insurance entities and identify potential areas for improvement for longduration contracts and potential disclosure improvements for shortduration contracts
 March 18-19 – joint meetings in Norwalk; FASB participation may be
limited
Insurance Contracts Project
January 22, 2014 joint board meeting

The FASB and the IASB discussed the feedback they received on their respective
insurance contracts proposals.

Some FASB members highlighted broad issues they would need to consider in
redeliberations, including:



Distinguishing between volatility, accounting mismatches and economic mismatch

When the benefits of making the accounting more complex would outweigh the co
Whether financial reporting comparability of insurers and other types of companies
including financial institutions is important
The IASB plans to address constituents’ concerns related to:



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

Other comprehensive income
Unlocking the contractual service margin
Participating contracts
Insurance contract revenue
Transition
The IASB will determine at a later date if any other issues will be redeliberated
February 19, 2014 FASB Meeting
February 19
Board decision
All contracts that meet
definition of insurance
regardless of industry
Scope
Insurance entity;
consider explicitly
including other
contracts later
Changes to
recognition,
measurement and
disclosures (premium
allocation approach)
Short-duration contracts
Improvements to
disclosures
Long-duration contracts
Improvements to
existing US GAAP for
recognition,
measurement and
disclosures
Exposure Draft
Changes to
recognition,
measurement and
disclosures (building
block approach)
Insurance Contracts Project