FASB changes accounting for long-duration insurance contracts

By Ken Tysiac

Financial reporting for insurance companies that issue long-duration contracts will change under an accounting standard issued Wednesday by FASB.

The targeted changes to the current reporting model affect accounting for companies that sell long-duration products such as life insurance, disability income insurance, long-term-care insurance, and annuities.

FASB issued the changes in Accounting Standards Update No. 2018-12, Financial Services — Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. The new standard:

  • Requires updated assumptions for liability measurement. Assumptions used to measure the liability for traditional insurance contracts, which typically are determined at contract inception, will now be reviewed. If there is a change, the liability will be updated at least annually, with the effect recorded in net income.
  • Standardizes the liability discount rate. The liability discount rate will be a standardized, market-observable discount rate (upper-medium grade fixed-income instrument yield), with the effect of rate changes recorded in other comprehensive income.
  • Provides more consistency in measurement of market risk benefits. FASB has cut the number of measurement models from two to one (fair value). This will create uniformity across similar market-based benefits and will better align with the fair value measurement of derivatives used to hedge capital market risk.
  • Simplifies amortization of deferred acquisition costs. A more level amortization basis replaces the previous earnings-based amortization methods.
  • Requires enhanced disclosures. These include rollforwards and information about significant assumptions and the effects of changes in those assumptions.

The standard will take effect in 2021 for public business entities for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2020. For all other entities, the standard will take effect for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022.

Early adoption will be permitted.

FASB’s work to improve accounting for insurance contracts began 10 years ago as a comprehensive convergence project with the International Accounting Standards Board (IASB). FASB later split with the IASB on the project, and initially proposed a comprehensive new standard that would have introduced new accounting models.

After outreach to constituents, FASB decided that a more targeted approach was needed for insurance contract accounting. Investors were pleased with the accounting model for short-duration contracts, FASB Vice Chairman James Kroeker said during a telephone interview. Meanwhile, constituents said accounting for long-duration contracts did not need a complete overhaul.

“The input was … ‘We already have practice that our systems are geared around, our data collection is geared around, and our investors already understand,’ ” Kroeker said.

What investors were seeking, Kroeker said, was more transparency about how assumptions change over time given that some of these contracts have a duration of 10, 20, or even 50 years. That led to the requirement for updating liability measurement assumptions.

Meanwhile, simplifying the amortization of deferred acquisition costs (DAC) was a priority for Kroeker and the board.

“It’s much easier, I think, for investors to understand what we’re doing now with DAC,” Kroeker said. “So, I think, we really scaled back to a much more moderate set of proposals. But I think even though the finalized changes are more moderate, the impact on financial reporting is still going to be meaningful.”

In the interest of simplification and ease of implementation, the board tried to leverage existing models. In cutting the number of market risk benefits measurement models from two to one, keeping one of the existing models (fair value) was a strategy that is expected to make transition easier.

FASB decided that an insurance entity should apply the guidance on the liability for future policy benefits and deferred acquisition costs to all contracts in force based on their existing carrying amounts at the transition date and updated future assumptions, adjusted for the removal of any related amounts in accumulated other comprehensive income.

Kroeker said this decision should help with the transition because preparers won’t have to go back to 1970 or 1980 and accumulate decades worth of data to figure out how assumptions emerged.

“We’re hopeful that while it isn’t without cost, it isn’t without effort, it’s much more scaled back than alternative models that the board looked at,” Kroeker said. “And we certainly think of that in terms of what benefits are derived. And without any hesitation, I think the board concluded that the benefits of updating that certainly justify the effort that goes into doing it.”

Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA’s editorial director.

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