The Financial Accounting Standards Board released a long-awaited
The new standard requires updated assumptions for liability measurement. The assumptions used to measure the liability for traditional insurance contracts, which are usually determined at contract inception, will now be reviewed—and, if there is a change, updated—at least annually, with the effect recorded in net income.
FASB has been working to update the accounting rules for insurance for 10 years, originally in tandem with the International Accounting Standards Board and eventually on its own before producing the accounting standards update.
“This finalization of the insurance ASU is really the culmination of a decade-long effort to improve the accounting for insurance,” FASB vice chairman James Kroeker told Accounting Today. “We looked through multiple exposure drafts and due process documents. It’s an area where I think there was almost universal agreement that there needed to be improvements to U.S. GAAP. Investors, preparers and auditors all looked at U.S. GAAP and said you need to improve insurance accounting. Based on that, and the fact that the IASB was looking to put an insurance standard into International Financial Reporting Standards for the first time, we initially embarked upon a project that would have comprehensively redone all of the accounting for insurance, not just for insurance companies but for any company that offered a product that had characteristics of an insurance contract.”
However, unlike the IASB, which didn’t have any insurance standard at all for IFRS, FASB decided not to totally redo the accounting for other types of insurance such as health insurance, home insurance and car insurance.
“The idea at that time was since we’re looking at GAAP, and the IASB is looking at finalizing a standard, it would be nice to do that on a global basis,” said Kroeker. “We did that through research efforts, EDs [exposure drafts], an initial due process document, roundtables and other means. The feedback in the U.S. was insurance accounting in the U.S. doesn’t need to be redone from A to Z. For short-duration insurance in the U.S., the accounting isn’t broken. The accounting works well, but what investors needed was more transparency around assumptions and loss development. We finalized that three years ago. The input we had on long duration was probably, first and foremost, the biggest weakness in U.S. GAAP was that assumptions are locked in when contracts are entered into and they’re not updated for accounting purposes unless and until a group of contracts is in a loss position.”
FASB conducted extensive outreach over the years, including more than 150 meetings with users and 250 meetings with preparers, auditors, industry groups, and others; 13 group meetings with 60 users; 14 conferences with more than 150 users; more than 450 comment letters from users, preparers, auditors, industry groups, and others; 13 public roundtables hosted or attended by FASB board members or their staff; along with numerous other discussions.
“The new ASU provides investors and other financial statement users with better and more timely and transparent information about long-term contracts issued by insurance companies,” said FASB chairman Russell G. Golden in a statement. “Featuring targeted improvements to the current reporting model for these contracts, it reflects the input we received from diverse insurance industry stakeholders over more than 10 years of extensive outreach.”
To improve this area of financial reporting, the new accounting standards update requires updated assumptions for liability measurement. Assumptions that are used to measure the liability for traditional insurance contracts, which are typically determined at contract inception, will now be reviewed—and, if there is a change, updated—at least annually, with the effect recorded in net income.
“That was an area where economically, as their very name indicates, they’re long-duration, meaning in some cases almost half a century or even longer could be the life of one of these products,” said Kroeker. “Using assumptions that are that outdated really doesn't provide particularly current and useful information to investors, and it’s an area where I think there was almost universal agreement that there was a need for improvement to update that.”
A second major change standardizes the liability discount rate. The liability discount rate will now be a market-observable discount rate (specifically, upper-medium grade fixed-income instrument yield), with the effect of rate changes recorded within other comprehensive income.
“There was diversity in practice,” Kroeker explained. “It’s not very standardized and not transparent to investors, how that rate is either determined or what that rate is. Many, if not most or all, entities were using a rate that was not independent of the assets they’re investing in. But economically the rate really is one that isn’t directly tied to the asset return, that is independent of the assets. You own the liability irrespective of asset performance, good or bad. In most, if not all, other areas of accounting, we don’t take a liability and say we’ll discount it at the rate of the assets. You discount it at the rate that has characteristics of that liability. So we did that and then also required that assumption to be updated.”
A third major change promises to provide more consistency in the measurement of market risk benefits. The two previous measurement models have been reduced to one measurement model (fair value), which should lead to greater uniformity across similar market-based benefits and better alignment with the fair value measurement of derivatives used to hedge capital market risk.
A fourth big change simplifies the amortization of deferred acquisition costs. Previous earnings-based amortization methods have been replaced with a more level amortization basis.
“The other area we addressed related to the accounting for acquisition costs of insurance,” said Kroeker. “This would be things like commissions paid upon the successful acquisition of a new contract. There were models, depending on the type or the product in the entity’s portfolio, that had different amortization methodologies, most of which were not straight-line, which is the way in almost any other area of GAAP if you have an acquisition cost or some other thing that feels more like an intangible, those amortization methodologies tend to be much more consistent over the life of the underlying transaction that you’ve entered into. Here we said to do it effectively straight-line over the life of the product. It’s more transparent to investors what’s going on and certainly much less complex than many of the methodologies in GAAP before.”
The new standard also requires enhanced disclosures, including rollforwards and information about significant assumptions and the effects of changes in those assumptions.
“There’s a lot of moving parts in an insurance net liability,” said Kroeker. “There are premium payments that come in and payments that go out to beneficiaries. There’s the impact of assumption changes, accretion because of the passage of time, all of which impact your net number, which is the net insurance liability. A rollforward of that will help investors understand much more easily how this number got from X to Y.”
FASB’s new accounting standards update for insurance differs in scope from the IASB’s in that FASB’s mainly changes the accounting for long-duration insurance contracts, such as life insurance.
“Their scope is all insurance contracts, both short-duration insurance and long-duration insurance, and products or transactions that that entities enter into that are other than insurance contracts, with I think some scope exceptions,” said Kroeker. “But by and large, if something has something has characteristics of their definition of insurance, it would then have to follow insurance accounting.”
There are also differences in how to bring in profit over time and the mechanics of how to account for different types of insurance products in the IASB's more principles-based standard for IFRS. FASB focused on the deficiencies that had been identified in the existing accounting under U.S. GAAP for long-term insurance, while the IASB more or less started with a blank sheet of paper in drawing up a whole new standard for insurance accounting under IFRS.
For calendar-year public companies, the changes will take effect in 2021. For all other calendar-year companies, the changes will be effective in 2022. Early adoption is permitted.
Because they’re regulated by the states, every insurer has to file statutory-basis financial statements with state regulators, but only publicly traded companies have to file GAAP financials. Many mutual insurers furnish statutory-based financial statements to their policyholders, and they won’t be affected by the new standard as they don’t produce GAAP-basis financial statements.
“Certain private insurance companies aren’t required to follow GAAP so to the extent that insurance company is not following GAAP but is following statutory accounting or other things, it doesn’t directly apply to them,” Kroeker explained. “They may voluntarily choose to use GAAP. For example, mutual insurers that meet our definition of a private company, this would apply to them if they produce GAAP financials. But to the extent that a company isn’t producing GAAP financials, then it doesn’t incur any change.”
FASB has posted the
