Feedback on Long-Duration Insurance Proposal
Author: Anne Coughlan
In September 2016, the Financial Accounting Standards Board (FASB) released proposed updates to the recognition, measurement and disclosures for long-duration insurance contracts. The proposal contained targeted—but significant—updates rather than a complete overhaul of existing insurance guidance.
Insurers, industry groups and accounting firms recently offered their opinions, highlighting areas for FASB’s 2017 redeliberations before a final standard can be issued. In addition, four of the largest domestic insurers—Manulife, MetLife, New York Life and Prudential Financial—jointly field-tested the proposal on nine product lines using actual experience from 2007 to 2012. This group holds 25 percent of total net admitted assets in the U.S. life insurance industry. The field testing, while comprehensive, was unable to test several of the targeted improvements because the necessary information was not available in current systems and would involve major system changes. This real-life evidence heavily factors into FASB redeliberations.
Updating Cash Flow Assumptions
Updating the cash flow assumptions was seen as a positive development providing more meaningful information to financial statement users. The proposal would require a retrospective approach. Respondents suggested a prospective option also could produce a reasonable liability measure, with fewer operational challenges and less complexity. Field testing demonstrated the results for retrospective and prospective methods were generally similar. Several insurers also suggested a mandatory annual review with materiality threshold before updating assumptions.
Market Risk Benefits
Most insurers agreed with the targeted improvement to report the effect of changes in instrument-specific credit risk through other comprehensive income rather than net income. The scope of the proposal related to market-based benefits was limited only to variable product contracts. Similar features exist in nonvariable contracts, and the resulting recognition and measurement would be different. These were among the alternative approaches suggested:
- Consider a single principle-based approach for all market risk benefits
- Create an irrevocable fair value election for certain products
Respondents generally applauded FASB’s simplification of the amortization of deferred acquisition costs (DAC), but cautioned against abandoning DAC impairment testing. Eliminating the impairment test could result in an insurer continuing to amortize even when the future gross premiums might be insufficient to cover the future benefit and unamortized DAC.
Most respondents felt using the same model for participating and nonparticipating contracts would not reflect the unique characteristics of each contract or the underlying economics. Insurers noted that close blocks are significantly different than other participating contracts, which would warrant different accounting treatment. Insurers also were concerned about the treatment of dividends. Mutual companies felt that dividends based on ownership, rather than mortality or investment risk, should be excluded from cash flow assumptions.
Respondents challenged the proposal’s requirement that a high-quality, fixed-income instrument yield—generally interpreted as an AA-rate—be used as the discount rate for measuring the liability for future policy benefits. Insurers noted that this may not be the most appropriate proxy for certain contracts, i.e., traditional and limited pay policies. Using such a conservative rate for certain contracts could result in an initial loss. Respondents felt an A-rated corporate bond yield would be more consistent with the insurance industry’s typical investment portfolio.
While respondents conceded current required disclosures are too limited, they felt the proposed disclosures would be overwhelming. Given the long-term nature of the disclosure information, preparers worried that interim disclosures would be costly to prepare and add little incremental value to financial statement users. Insurers were concerned the extent of the disclosures and level of detail required could affect the timeliness of interim and annual reporting.
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