Transition Method for Insurance Accounting Changes Poses Challenges for FASB

Accounting changes that are in the works for life and annuities insurance companies are proving trickier than expected—especially when it comes to deciding how companies would apply the rules, according to FASB’s Feb. 8 discussions about long-term insurance contracts.

Determining the transition method companies will be required to use when applying the changes will be difficult, some members of the Financial Accounting Standards Board said. 

Finding Balance.

The difficulty stems from trying to find the right balance between requiring companies to provide the most useful information to financial statement users, but without them incurring excessive operational hurdles and cost, board discussions indicated. 

“I continue to think transition is one of the hardest parts of this project,” said FASB member Marc Siegel. “We call this targeted improvements and that creates a misperception that these are small changes—I think we understand these are big changes; it’s targeted in that there’s a small number of them and how we do the transition is going to be extremely important,” Siegel said.

Different Transition Approaches?

Will FASB therefore end up issuing final rules that require different transition approaches for different aspects of the proposal to deal with the cost versus benefits of the changes? That determination will likely be part of the March roundtables the board has planned.

Companies will likely be asked to weigh in on the benefits of a full retrospective (apply it to all prior periods) approach, a modified version of that or prospective (an approach that says “do such and such from now on.”

Mulling Cost-Benefits.

The application issue is one the board will have to continue to mull so that it can understand the cost versus benefit trade-offs, said Siegel, “I’m sure staff will come up with alternatives.”

Similarly, FASB Vice Chairman James Kroeker said though the reporting changes would significantly improve current accounting rules, “I have concern about whether we struck the right balance between operability and cost” in relation to transitioning them.

Rules Might be Finalized Later This Year.

The proposal, Financial Services—Insurance (ASC 944), was issued by FASB Sept. 29, 2016 to require a current and better measure of the obligations of long-duration insurance contracts.

FASB received 39 comment letters, about 43 percent of which came from insurance companies. The rest were from banks, accounting firms and trade organizations.

The proposal addresses four categories of long-term contracts:

• updating assumptions and discount rate in relation to the reserve for traditional contracts;

• deferred acquisition costs (DAC)—meaning large upfront costs, such as commissions to sales agents, incurred when acquiring new customers;

• market risk benefits; and

• disclosures.

If finalized, the revisions would likely modernize an accounting model that dates back more than 35 years. The existing model fosters differences in how accounting is applied and doesn’t adequately address new insurance products.

Mixed Bag of Methods.

The board proposed a mixed bag of methods to transition the rules in effort to help companies mitigate some of the potential cost hurdles and complexity.

The guidance on the liability for future policy benefits, for traditional limited payment and participating contracts, would be applied retrospectively to the contract issue date using actual historical information at the level of aggregation (the sum) at which reserves are calculated.

If actual historical information covering the entire contract period isn’t available at this level, the insurer can use estimates. If it’s impractical to apply the guidance retrospectively to the contract issue date, the insurer can apply a practical expedient—an exception to the rule—which allows for use of a prospective approach.

Market Risk Benefits and DAC.

For market risk benefits, insurers would apply the rules retrospectively to all previous periods at the transition date.

 For deferred acquisition costs (DAC) they would apply the guidance prospectively at the transition date. At this date, the insurer would apply the guidance to the existing carrying amount for DAC, adjusted for the removal of any related amounts in accumulated other comprehensive income (referred to as shadow DAC). This transition method would apply to all other balances that are amortized (spread out) on a basis consistent with amortization of DAC.

Some comment letter respondents agreed with the transition package, but several felt it’s inoperable and would result in increased costs and efforts, according to FASB staff accountants’ comments to the board.

Next Steps.

FASB plans to hold its roundtable March 15, following which it will redeliberate aspects of the proposal.   

In addition, the board still has to determine an effective date for the changes.  Some companies said they would need about 3-5 years from issuance to apply the rules—unless FASB considers another transition method—such as prospective application in some areas. The rules are expected to be finalized during the fourth quarter of this year.