Casualty Actuarial Society
Annual Meeting
FASB Invitation to Comment
Bifurcation of Insurance and Reinsurance
Contracts
November 14, 2006
Joseph B. Sieverling
Reinsurance Association of America
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FASB Insurance Risk Transfer Project

First discussed at FASB meeting in April 2005

Initially focused on risk transfer in SFAS No. 113

Decided to expand project to insurance and
reinsurance contracts

Was initially intended to be a limited scope project

FASB Issued Invitation to Comment (ITC) on
Bifurcation of Insurance And Reinsurance Contracts
in May 2006
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FASB Bifurcation ITC

Scope
 Affects insurers, reinsurers and policyholders
 Applies to P&C, Life and A&H Insurance Contracts

Purpose
 Gather input from buyers and sellers about possible
bifurcation
 Intended as a Neutral document
 Will bifurcation result in financial reporting that is
more representationally faithful (i.e. Accounting =
Economic Substance)
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FASB Bifurcation ITC


Threshold questions

Is GAAP Definition of insurance and ins. risk
adequate?

Whether insurance and reinsurance contracts
should be bifurcated

Which contract should be bifurcated

How they should be bifurcated
Little discussion of whether insurance contract should
be bifurcated – (i.e is current GAAP broken?)
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FASB Bifurcation ITC


Two Approaches to determine which contracts to
Bifurcate (Both rules-based):

Based on existence or certain contract features

Bifurcate all contracts not identified as exclusively
insurance reinsurance or exclusively identified as
a financing transaction
Establishes concept of contracts that unequivocally
transfer insurance risk.
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FASB Bifurcation ITC
Unequivocal Insurance Risk - Idea is these have negligible noninsurance features – Examples:
 Single personal insurance contract for a single risk (whole or
term life)
 Group of similar coverages on a single asset (Home / Auto)
 Single risk reinsurance contract (i.e. Cat cover)
Characteristics of Unequivocal Insurance Risk
 Market equivalent premiums  prem. not a large portion of
coverage
 Deductibles and coverage limits are fixed
 No risk limiting features that adjust profit or loss (sliding
scale commissions, caps, corridors, etc.)
 Contract is not likely to result in any claims
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FASB Bifurcation ITC
Not Unequivocal
 Group contracts with one policyholder and multiple
insureds (Group Health/Group Life)
 Similar contracts that compensate for likely
payment of expected losses
 Portfolios or contracts that qualify individually b/c
have an expected level of claim activity (most
reinsurance)
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FASB Bifurcation ITC
Methods for Bifurcation (3 proposed)

Expected payout method – (Dollar trading)
 Focused on component or contract where there is an
expected loss

Proportional Method
 Measures degree of variability or cash flows with and without
the contract.
 Where result is the same - account for as a financing

Cash flow yield method
 Uses an implied (market) interest rate to isolate the financing
component from the insurance component
 Excess cash flow over that needed for a market yield is
considered insurance
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FASB Bifurcation ITC
Industry Comments

63 comment letters were submitted from all segments of the industry

Vast majority were critical of the ITC - General comments:
 The approaches described in the ITC would not provide users with
more decision useful and understandable information
 Instead, the FASB should develop improved practical guidance for
evaluating risk transfer and the FASB should improve and expand
GAAP disclosures, especially for insurance and reinsurance
contracts that transfer limited amounts of insurance risk
 Many believed the problem was one of compliance with existing
standards rather than a flaw in the existing standards
 The ITC fundamentally changes insurance and reinsurance
accounting – not necessary given the narrow scope of problems
 Timing wrong – Consider IASB Convergence
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FASB Bifurcation ITC
Industry Comments – Approach & Methods

Neither Approach A or Approach B is appropriate for identifying which contracts
should be bifurcated. Both are rules-based. Approach B is a fundamental and
comprehensive change to US GAAP since it would require bifurcation of
anything not specifically meeting unequivocal criteria

The criteria for unequivocally transferring insurance risk are flawed. Few
contracts would meet this standard. Most contracts have an expected loss.
Characteristics are too rules-based and limiting

Bifurcation methods proposed are unclear and likely too subjective to
produce reliable, comparable financial information

Data limitations would have a significant affect on the accounting
selected and it would be especially difficult for small insurers and
corporate insurance buyers to implement the proposals
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FASB Bifurcation ITC
Industry Comments – Approach & Methods

Disagree with the ITC assumption that no single individual risk contains
an expected loss component

Aggregating and reinsuring such risks would result in a different
accounting treatment under the ITC, even if all such risk was
transferred

Any aggregation of single risks would result in different accounting than
if the risks had been separately insured – form over substance

If the proposals contained in the ITC were implemented, reliability and
comparability would suffer, as entities with similar aggregate risk
profiles would report substantially different financial information solely
dependent on how their portfolio of risks was assembled
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FASB Bifurcation ITC
Industry Comments – Actuarial Profession

ITC expanded scope incorrect. Concentrate on “problematic contracts”

Bifurcation unlikely to result in more decision useful information. For
problematic contracts, consider instead deposit accounting in entirety,
more disclosure and other risk transfer approaches

Bifurcation inappropriate for insurance contracts, may be possible for
some reinsurance contracts

Don’t endorse any bifurcation method. Contract s/b bifurcated where
possible using one of potentially many different methods consistent
with the way in which the risks were assembled

Reference work of AAA and NAIC (reasonably self evident, risk transfer
methods, disclosure)
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FASB Bifurcation ITC
Industry Comments – Public Accounting Profession

Concerned the FASB ITC approach is too broad – it is more change
than is necessary

Prefer the FASB address divergence in practice concerns outlined in
AICPA Expert Panel letter of November 2003
 Para 9a test – clarify when significant risk has been assumed under
the reinsured portions of a contract
 What constitutes the reinsured portions of the contract
 What type of qualitative or quantitative analysis is required to
evaluate risk transfer
 Guidance on requirement that reinsurer’s payments vary directly
with amount and timing of cedant’s cash flows
 Clarification of the limited nature of the paragraph 11 exception
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FASB Bifurcation ITC
FASB Education Session – November 8,

Essentially abandoning the ITC & Bifurcation – “trial balloon was burst”

Way forward is not yet clear, but FASB won’t spend much time on this.
Some sentiment that 113 not broken / a compliance issue. Focus on
IASB convergence

Initially looking at 3 elements:
 Remove SFAS No 113 footnote regarding “remote” Will make 113
more principles based & solve low frequency/high severity
 Consider new disclosures – Possibly start with NAIC disclosures
 FAS 5 will govern Insurance contracts and FAS 113 will govern
reinsurance contracts (tentative understanding – could change)

Monitor discussion at Nov. 21 or Nov 29 Board meetings
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