Implications of COVID-19 – Statutory Accounting Principles
The effect of novel coronavirus disease 2019 (COVID-19) is far reaching, bringing devastating consequences for individuals, families, communities, companies, entire sectors, financial markets, etc. While the ultimate effect of COVID-19 is currently unknowable and financial statements are in the process of being finalized and submitted by many insurers to various insurance departments, management should evaluate the various effects on statutory basis financial statements now to allow for a more thorough assessment and proactive engagement with auditors and professional advisors.
For insurers that have yet to file their audited financial statements, we address several accounting implications of COVID-19 for December 2019 year-end that should be evaluated in the context of the following recent events:
- January 21, 2020 – First known U.S. COVID-19 case announced
- March 11, 2020 – The World Health Organization declares COVID-19 outbreak a pandemic
- March 13, 2020 – President Trump declares COVID-19 a national emergency
- Present – Turmoil in the financial markets and disruptions cascading through many sectors of the U.S. economy
Accounting Implications to Consider
The potential accounting implications of COVID-19 on statutory basis financial statements examined below aren’t all exhaustive and will be updated periodically as COVID-19’s effect unfolds:
- Subsequent events – An evaluation of the Statement of Statutory Accounting Principles (SSAP) No. 9—Subsequent Events requirements would indicate the effect of COVID-19 didn’t exist as of December 31, 2019, based on the dates of the events outlined above and, therefore, is likely not to be a recognized subsequent event (Type I). However, it’s important to consider whether COVID-19 will have a material effect on estimates made as of December 31, 2019, subsequent to the balance sheet date but before the financial statements are released that could trigger the requirement for robust Type II nonrecognized subsequent events1 disclosures. For example, it will be important to consider the effect on estimates, such as the valuation of uncollected premium balances given the expected adverse effect on the ability of policyholders from certain sectors to keep up with installment payments. While there will be many financial statement line items affected, another example common to most insurance companies includes the valuation of fixed-income securities, common stock, preferred shares, etc. Considering the significant declines in the major stock exchanges and the pervasive disruption in financial markets, a Type II subsequent event disclosure warrants consideration.
Our view: A Type II nonrecognized subsequent event disclosure is required if based on management’s analysis and judgment. COVID-19 is deemed to have a material effect on the financial statements subsequent to December 31, 2019, but prior to the issuance date.
- Going concern – Auditing standards require auditors to consider an entity’s ability to continue as a going concern. Given the unprecedented financial and societal disruption caused by COVID-19, auditors will require more robust documentation and analysis from management to support the going concern assumption. Such assumption requires considerable judgment “at a particular point in time, about inherently uncertain outcomes of conditions or events.”2 What makes this particularly challenging is that COVID-19’s impact is without precedent and the auditing standard specifically requires management to make “judgement about the future based on conditions or events that are known and reasonably knowable at the date that the financial statements are issued.” Given the fluidity of the current situation, it behooves management to monitor the effects carefully and granularly to allow for more informed judgment and analyses on COVID-19’s effect on the company’s going concern assumption. While the immediate shock to the insurance sector may be muted now, the effect to other sectors will reverberate back to the insurance sector given the U.S. economy’s interconnectedness.
Given the gravity of the adverse effect of COVID-19, the going concern assumption analysis shouldn’t be treated as a check-the-box exercise, and early engagement with auditors and professional advisors is encouraged.
Our view: Historically, going concern assessments have been an afterthought for most organizations. COVID-19 has changed that and will require considerable judgment and robust analysis about the future.
- Equity method of accounting – The equity method of accounting is generally applied to various types of investments, such as investments in partnerships, limited liability companies and subsidiary, controlled and affiliated (SCA) entities, and subject to SSAP No. 48—Investments in Joint Ventures, Partnerships and Limited Liability Companies and SSAP No. 97—Investments in SCAs, respectively. As of this article’s date, COVID-19’s effect is continuing to worsen as companies observe more stringent social distancing measures, and the blow to the financial markets continues unabated in spite of recent steps taken by the Federal Reserve and Congress. Experts are forecasting a global recession and have indicated the markets haven’t yet bottomed out. Management should evaluate what effect these events will have on underlying investments in SCAs, joint ventures, limited liability companies and partnerships, particularly on investees that are heavily invested in the financial market. Accordingly, management should immediately evaluate potential impairment-related issues of such investments that might require disclosures in the financial statements or potential admissibility issues related to underlying investments in investees with3 going concern-related issues.
Our view: Management should engage in discussions early with management of investees to inform its assessment of impairment and admissibility-related issues affecting investments in SCAs, joint ventures, limited liability companies and partnerships in which equity method accounting is applied.
- Valuation of deferred tax assets – SSAP No. 101—Income Taxes requires “gross deferred tax assets (DTA) to be reduced by a statutory valuation allowance adjustment if, based on the weight of available evidence, it is more likely than not that a portion or all of the gross DTAs will not be realized.”4 Given COVID-19’s effect on the financial markets, it’s likely that certain investment holdings that were in an unrealized gain position at the balance sheet date may have turned into unrealized losses as of the issuance date of the financial statements. For insurers that haven’t yet filed audited financial statements, a question may arise as to whether the change from an unrealized gain to unrealized loss position subsequent to the balance sheet date may trigger the need to re-evaluate statutory valuation allowance estimates or judgments made related to the realizability of capital DTAs prior to the December 31, 2019, audited financial statements’ release. The simple answer is “Yes,” since SSAP No. 9 requires insurers to “evaluate subsequent events through the date the financial statements are available to be issued” to ascertain whether the effect of recent events is material and represents either a Type I recognized or Type II nonrecognized subsequent event. While facts and circumstances will vary, we generally expect insurance companies to be able to support a position that the events that resulted in unrealized gain positions becoming unrealized losses didn’t exist at the balance sheet date such that the subsequent event shouldn’t result in an adjustment to or the establishment of a statutory valuation allowance as of December 31, 2019. However, both qualitative and quantitative analysis will likely be required to determine whether COVID-19’s effect is material, thereby requiring a Type II subsequent event disclosure.
Our view: It depends on facts and circumstances. In general, changes in unrealized gain positions used to support the realizability of capital DTAs isn’t likely to trigger a Type I subsequent event. However, both qualitative and quantitative analysis may be required to ascertain whether the impact of COVID-19 is material, which would require Type II subsequent event disclosures in the financial statements.
To connect on this or other effects of COVID-19, reach out to your BKD Trusted Advisor™ or use the Contact Us form below.
This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.
1 SSAP No. 9, par. 3 “Events or transactions that provide evidence with respect to conditions that did not exist at the balance sheet date but arose after that date.” ↩
2 AU-C Section 570, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern,” par .06. ↩
3 Par. 8 of SSAP No. 48, “The investment shall be nonadmitted if the audited financial statements include substantial doubt about the entity’s ability to continue as a going concern.” ↩
4 Par 7.e. of SSAP No. 101. ↩