Big Accounting Changes Loom for Long-Term Insurance Contracts

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By Denise Lugo

Feb. 19 — Life insurance companies should now have a clearer picture of what targeted change the Financial Accounting Standards Board will likely finalize about recognition and measurement of long-term insurance contracts.

Three key changes companies should keep on their radar relate to assumption updates, amortization of deferred acquisition costs (DAC), and accounting for market-risk benefits, according to Bloomberg BNA's research Feb. 19.

Among those topics, the most critical is the assumption update, a major change for traditional and participating life insurance contracts, an accounting practitioner who closely monitors the standards-setting process and declined to be quoted directly told Bloomberg BNA.

Assumption Update

Traditional life insurance contracts include whole life, term life, annuities in payout status, long-term care and disability income. Under FASB's forthcoming changes, instead of locking in the assumptions on day one and keeping them, insurers will be required to update their assumptions at least annually.

Assumptions refer to data for mortality, interest rates, lapses or other inputs that go into the models that insurers use to calculate their reserves.

Under today's accounting rules, when a contract is originated, those assumptions are locked in, meaning, they aren't changed over the life of the contract even though expectations may change.

In the case of long term care, for example, some companies have said they are facing challenges with increased medical costs, the practitioner said. Many older policies that were written in the 1990's assumed a lower rate of health care cost growth. However benefit payments under those contracts have been higher than originally expected. Because these assumptions are locked in, there's a separate testing mechanism that would then trigger the booking of a loss. One of the criticisms of that model is those losses end up being recorded too late in the life cycle. As a result, investors have said those losses have built up but they don't see them until it's too late. Some investors refer to this as a “cliff effect.”

FASB's changes will result in a more current measure of the liability based on the latest and greatest assumptions.

FASB's changes will result in a more current measure of the liability based on the latest and greatest assumptions. The impacts of any deterioration would be recorded earlier than is being done today, according to FASB's 2015 discussions.

The changes about updating assumptions apply only to traditional and participating life insurance contracts, which currently follow a “locked-in” accounting model. In contrast, nontraditional contracts are already updated on a regular basis.

Nontraditional contracts include universal life and variable annuity—insurance products with account balances that are more like investment or savings vehicles. Participating life contracts are issued by a mutual insurance company, which is a company owned by policyholders. The policyholders participate in the performance of the company and then they earn dividends.

All Contracts

FASB's decisions related to amortization of DAC and market risk benefits will affect all three long-term contracts—traditional, nontraditional and participating contracts.

Related to amortization of DAC, the existing amortization method for nontraditional contracts is complicated and causes the amortization pattern to fluctuate from period to period, making it difficult for investors to understand, FASB's stakeholders have said.

The accounting would therefore be simplified by requiring such costs to be expensed evenly over the entire term of a contract, according to FASB's discussions in February 2015 .

Also simplified would be rules related to market risk benefits—an impact on minimum benefit guarantees that are embedded in nontraditional contracts. These guarantees include guaranteed minimum death, accumulation, income and withdrawal benefits that are commonly offered in variable annuities.

There are two different models currently. Some guarantees are fair valued and some follow an insurance model, whereby a liability is gradually built up over time. To create consistency, FASB in November voted to do away with the gradual build-up model and therefore require that entities follow only one model—the fair value model .

High Level Backdrop

On Feb. 24 FASB will next tackle presentation and disclosure requirements for long term contracts, the board's current agenda states.

At a separate meeting, on a later date, the board will likely need to discuss transition and whether or not to issue a final standard for long term contracts or re-expose its decisions.

It would mean the board's third exposure on the issue, though not as broad as the initial discussion paper in 2010 or the later proposed ASU, Insurance Contracts in 2013.

FASB decided to limit the scope of its project because there are already rules in place under U.S. generally accepted accounting principles (GAAP) that companies say aren't in need of much revision.

At the initial stages of its insurance discussions, FASB considered revising GAAP and worked with the International Accounting Standard Board with a goal of issuing a converged insurance contracts standard. Ultimately the boards parted ways in 2013 on the project after U.S. companies protested strongly to FASB that current rules had stayed the test of time and weren't in need of any significant revisions, which could be costly.

IASB decided to move ahead solo with its work on a standard because there isn't an insurance contracts standard under international financial reporting standards (IFRS). IFRS 4 was issued only as a stop-gap measure until accounting rules could be developed. IASB has said it expects to issue to a final standard by year-end . That standard won't be converged with U.S. GAAP.

Following its decision not to move ahead with an overhaul for insurance contracts, FASB embarked on its work in phases, deciding to only provide disclosure requirements for short term contracts and to make targeted revisions to aspects of the accounting for long term contracts.

The new disclosure rules for short-term contracts were issued In May 2015. The board then began redeliberations on long-term contracts. It isn't readily apparent when that work will be completed.

To contact the reporter on this story: Denise Lugo in Norwalk, Conn., at

To contact the editor responsible for this story: Steven Marcy at

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