Article
Accounting update to long-duration insurance contracts
Nov. 15, 2023 · Authored by Brian P. Rozek, Eric M. Kegler
In 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-12, Financial Services – Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, also known as long-duration targeted improvements (LDTI), which impacts all insurers that issue long-duration contracts (life insurance, long term disability, etc.).
LDTI is a set of focused changes to improve, simplify and enhance aspects of accounting for long-duration contracts generally issued by life and annuity insurance organizations. The implementation effort will require significant changes to systems, processes and controls and will also require the accumulation of data that has not been previously captured and included in actuarial models. It is expected that there could be a significant impact on reported earnings with increased earnings volatility.
The changes to the ASU are intended to result in improvements to accounting records in the following ways:
In the new model, cash flow assumptions utilized in determining the liability for future policy holder benefits for non-participating traditional and limited-payment insurance contracts are required to be updated at the same time each year on at least an annual basis. This varies from the current model which only requires the insurer to update the assumptions if a triggering event occurs, like if a premium deficiency is recognized. As such, LDTI eliminates the need for premium deficiency or loss recognition testing, as the assumptions. These changes to the reporting updates will be applied retrospectively through the current year earnings.
Furthermore, the new ASU will also standardize the discount rate used in determining the liability for future policy holder benefits. The discount rate will be based on upper medium grade (low credit risk) fixed income instruments. The effect of discount rate changes is recorded immediately through other comprehensive income.
The ASU defines market risk benefits (MRBs) as “benefits offered by an insurer that protects a contract holder from capital market risk” (investment losses due to market downturns). The MRB can be either an insurance liability or an asset in the financial statement. MRBs principally include guaranteed minimum benefits (GMXBs) on variable products and possibly some general account annuities. MRBs will be required to be accounted for at fair value, with changes in fair value related to MRBs being recognized in net income; however, the portion of changes resulting from a change in the instrument-specific credit risk of MRBs in a liability position should be recognized in OCI.
Deferred acquisition costs (DACs) will be required to be amortized on a constant basis over the expected life of the contract, therefore eliminating the current amortization methods such as proportion to premium (traditional life), estimated gross profit (nontraditional) or estimated gross margin (participating life). Additionally, amortization rates should be updated prospectively with DACs being reduced when actual terminations and lapses are greater than expected. By conducting this change, the interest accretion and impairment assessment will be eliminated.
The ASU requires significant additional disclosures for all insurance liabilities and DACs. The disclosures will include disaggregated roll forwards, qualitative and quantitative information about assumptions and estimates and reconciliation to the carry amount of certain income statement activity.
