ASC

ASC 815-944

Financial Services—Insurance

815 Derivatives and Hedging

Download JSONDownload Markdown27 paragraphs · 6 sectionsJump to summary

Source downloaded: .Record version 99d41acd81ed. Effective date must be checked in the source.

In brief

AdvancedDerivatives and hedgingIndustry-specificFinancial instrumentsRecognition

This Subtopic applies Topic 815's derivative and hedging guidance to insurance entities, chiefly for long-duration contracts such as variable annuities. Its core rules are that a traditional variable annuity contract is not a hybrid instrument containing an embedded derivative requiring bifurcation (815-944-25-1 through 25-2), that the traditional variable annuity serves as the host contract for a nontraditional variable annuity whose other features (excluding market risk benefits) may be embedded derivatives (815-944-25-5), and that these conclusions are exceptions that may not be analogized to other structures (815-944-25-3, 25-6). It also illustrates when an insurer may apply cash flow hedge accounting to forecasted interest credited on surrenderable fixed-rate contracts.

Key points (7)
  • Paragraph 815-944-25-1 confirms that traditional variable annuity structures contain no embedded derivatives warranting separate accounting under Subtopic 815-15, even though the insurer (not the policyholder) legally owns the separate account assets.
  • Paragraph 815-944-25-2 lists indicators supporting non-hybrid treatment: special regulation of variable annuities, separate account assets insulated from general account liabilities, policyholder-directed investment and redirection, insurer required to invest in the referenced assets, account values based entirely on and all returns passed through from those investments, redeemability (subject to surrender charges), and voting rights in certain structures; and notes 944-80-25-3, 944-80-30-1, and 944-80-35-2 require a liability equal to the total fair value of separate account assets.
  • Under 815-944-25-3 and 25-6, entities shall not analogize the traditional or nontraditional variable annuity conclusions to other seemingly similar structures because they are exceptions for insurance entities.
  • Paragraph 815-944-25-5 treats the traditional variable annuity as the host contract of a nontraditional variable annuity; nontraditional features other than market risk benefits may be embedded derivatives subject to Subtopic 815-15.
  • Paragraphs 815-944-55-1 through 55-3 permit cash flow hedge accounting for the forecasted future interest credited on fixed-rate surrenderable contracts (including voluntarily increased rates on existing contracts and rates on replacement contracts), provided the hedged interest relates to a volume of contracts whose existence at future crediting dates is probable.
  • Per 815-944-55-4 (citing 815-20-25-16), the forecasted crediting of interest must be probable but the variability need only be possible; the derivative must still be highly effective at offsetting cash flows attributable to the hedged risk when variability occurs, and 815-944-55-5 warns effectiveness is hard to demonstrate because rate increases are discretionary.
  • Section 60 cross-references other guidance, including dual-trigger property and casualty and financial guarantee contracts (815-10-55-37 through 55-40; 815-10-55-32 through 55-36), synthetic GICs (815-10-55-63), market value annuity prepayment options (815-15-55-120 through 55-127), annuity payment alternatives (815-15-55-58), and modified coinsurance receivables (815-15-55-107 through 55-109).

For students. The exam trap is assuming the variable annuity "no embedded derivative" conclusion is a general principle: it is an explicit exception that cannot be analogized to lookalike products, and nontraditional features layered on top of the traditional annuity host still require bifurcation analysis (other than market risk benefits, which follow Topic 944).

embedded derivativetraditional variable annuitynontraditional variable annuityseparate accounthost contractcash flow hedgelong-duration contractmarket risk benefit

Machine-generated study aid for ASC 815-944. Check the source paragraphs below.

815-944-00Status

Source downloaded: .Record version d93fec9f5030. Effective date must be checked in the source.

815-944-05Overview and Background

Source downloaded: .Record version 6d3764d95520. Effective date must be checked in the source.

815-944-05-1
Topic 815 provides guidance on accounting for and financial reporting of derivative instruments and hedging activities. This Subtopic includes guidance on some specific issues. The guidance in this Subtopic is presented in the following two Subsections:
  1. a
    General
  2. b
    Long-Duration Contracts.
815-944-05-1A
The Short-Duration Contracts Subsections of this Subtopic provide insurance entities with references in Section 944-815-60 to guidance on accounting for and financial reporting of derivative instruments and hedging activities involving short-duration contracts.

Long-Duration Contracts

815-944-05-2
The Long-Duration Contracts Subsections of this Subtopic provide insurance entities guidance on accounting for and financial reporting of derivative instruments and hedging activities involving long-duration contracts.

815-944-15Scope and Scope Exceptions

Source downloaded: .Record version 30163d88db1b. Effective date must be checked in the source.

Overall Guidance

815-944-15-1
This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Section 944-10-15.

Long-Duration Contracts

815-944-15-2
The Long-Duration Contracts Subsections follow the same Scope and Scope Exceptions as outlined in the General Subsection of this Section, with specific instrument qualifications noted below.

Instruments

815-944-15-3
The guidance in the Long-Duration Contracts Subsections of this Subtopic applies only to long-duration insurance contracts. For guidance on identifying a long-duration insurance contract, see the Long-Duration Contracts Subsection of Section 944-20-15.

815-944-25Recognition

Source downloaded: .Record version 830d82adf292. Effective date must be checked in the source.

Long-Duration Contracts

Traditional Variable Annuity Product Structures

815-944-25-1
In concluding that certain traditional variable annuity product structures (see paragraph 944-20-05-18) do not contain embedded derivatives, paragraph 815-15-55-55(b) through (c) does not refer to ownership of the assets specifically resting with either the policyholder or the insurer. While the policyholder is entitled to direct the investment of premiums into various approved funds, the insurance entity actually owns the investments. The guidance in (b) and (c) in that paragraph that a traditional variable annuity contract contains no embedded derivatives that warrant separate accounting under Subtopic 815-15 remains valid even though the insurer, rather than the policyholder, actually owns the assets.
815-944-25-2
The following indicators provide the basis for concluding that a traditional variable annuity contract is not a hybrid instrument to be accounted for under paragraph 815-15-25-1:
  1. a
    The variable annuity contract is established, approved, and regulated under special rules applicable to variable annuities, such as state insurance laws, securities laws, and tax laws.
  2. b
    The assets underlying the contract are insulated from the general account liabilities of the insurance entity; that is, the policyholder is not subject to insurer default risk to the extent of the assets held in the separate account.
  3. c
    The policyholder's premium is invested in contract-approved separate accounts at the policyholder's direction.
  4. d
    The insurer must invest in the assets on which the account values are based.
  5. e
    The policyholder may redirect its investment among the contract-approved investment options.
  6. f
    The account values are based entirely on the performance of those directed investments.
  7. g
    All investment returns are passed through to the policyholder, including dividends, interest, gains, and losses.
  8. h
    The policyholder may redeem its interests at any time; however, it may be subject to surrender charges.
  9. i
    The policyholder has voting rights in certain separate account structures.
In addition, although the liability to policyholders is not specifically required by the Financial Services—Insurance Topic to be remeasured at fair value with changes reported in earnings, paragraphs 944-80-25-3, 944-80-30-1, and 944-80-35-2 require that an entity record a liability for traditional variable annuity contracts equal to the summary total of the fair value of the assets held in the separate account for the policyholders.
815-944-25-3
In determining the accounting for other seemingly similar structures, an entity shall not analogize to the guidance in the preceding paragraph due to the unique attributes of traditional variable annuity contracts and the fact that the guidance in that paragraph can be viewed as an exception for traditional variable annuity contracts issued by insurance entities.

Nontraditional Variable Annuity Contracts

815-944-25-5
The host contract in a nontraditional variable annuity contract would be considered the traditional variable annuity that, as described in paragraph 944-815-25-1, does not contain an embedded derivative that warrants separate accounting. Certain nontraditional features other than market risk benefits may be considered embedded derivatives subject to the requirements of Subtopic 815-15.
815-944-25-6
In determining the accounting for other seemingly similar structures, an entity shall not analogize to the guidance in the preceding paragraph due to the unique attributes of nontraditional variable annuity contracts and the fact that the guidance in that paragraph can be viewed as an exception for nontraditional variable annuity contracts issued by insurance entities.

815-944-55Implementation Guidance and Illustrations

Source downloaded: .Record version 47a6d3737ca5. Effective date must be checked in the source.

Long-Duration Contracts

Implementation Guidance

815-944-55-1
Some insurance contracts (for example, certain whole life policies, universal life policies, repetitive premium variable annuities, and single premium deferred annuities) contain an option allowing the policyholder to put (surrender) the contract to the issuer at contract value. Those contracts, which are not carried at fair value by the issuer, bear interest at a fixed rate.
815-944-55-2
The issuer is exposed to the risk that an increase in market interest rates will cause the policyholder to exercise its put. Accordingly, the issuer may voluntarily increase the contractual rate on the contract to forestall the policyholder's exercising its put. As a result, the issuer wants to hedge the risk of an increase in future interest cash flows due to an increase in interest rates associated with either of the following circumstances:
  1. a
    The issuer's voluntary increase in the contractual interest rate on existing fixed-rate contracts
  2. b
    The policyholder's exercise of its put option and the insurance entity's issuance of new higher fixed-rate contracts to new policyholders.
815-944-55-3
Subtopic 815-20 would permit an insurance entity to qualify for cash flow hedge accounting if it is hedging the possibility that it may need to voluntarily increase the interest rate used to credit interest on certain contract liabilities. Under the cash flow hedging model, the hedged forecasted transactions would be the future interest credited on its then-existing contracts. The hedged forecasted transactions for each interest crediting date could include both the future interest credited on older contracts whose contractual rate has been voluntarily increased and the future interest credited on new contracts with the current higher interest rate issued to new policyholders (which will have replaced older contracts that have been surrendered). In defining the forecasted transactions, the insurance entity shall ensure that the hedged interest relates to a volume of contracts whose existence at the future interest crediting dates is probable.
815-944-55-4
In designating the hedged risk, the insurance entity should decide whether it is hedging the total variability in those future interest payments or just the variability in the future interest attributable to changes in the designated benchmark interest rate. Although the occurrence of the forecasted transactions (that is, the crediting of interest) must be probable, paragraph 815-20-25-16 states that the cash flow hedging model does not require that it be probable that any variability in the hedged transaction will actually occur—that is, in a cash flow hedge, the variability in future cash flows must be a possibility, but not necessarily a probability. However, paragraph 815-20-25-16 states that the hedging derivative must be highly effective at achieving offsetting cash flows attributable to the hedged risk whenever that variability in future interest does occur.
815-944-55-5
An insurance entity may find it difficult to identify a derivative instrument that will qualify for cash flow hedge accounting, which requires that the hedging relationship be expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk. Because the decision to adjust the interest rate to match the change in interest rates is at the discretion of the insurance entity, it may be difficult to conclude that the changes in the hedged interest payments attributable to the hedged risk will be sufficiently correlated with changes in the cash flows of the hedging derivative.

815-944-60Relationships

Source downloaded: .Record version 2c151cc0daa1. Effective date must be checked in the source.

Short-Duration Contracts

Derivatives and Hedging

815-944-60-1
For guidance on property and casualty insurance contracts for which payment of a benefit or claim is triggered by the occurrence of both an insurable event and changes in a separate pre-identified variable that contain an embedded derivative instrument, see paragraphs
815-10-55-37 through 55-40
.
815-944-60-2
For guidance on applying the scope exception in paragraph 815-15-15-10 during the period between the inception of the contract and the loss occurrence, see paragraphs
815-15-55-1 through 55-4
.

Long-Duration Contracts

815-944-60-4
For guidance on synthetic guaranteed investment contracts, see paragraph 815-10-55-63.
815-944-60-5
For guidance on the economic characteristics and risks of the market adjusted value prepayment option in a market value annuity contract, see paragraphs
815-15-55-120 through 55-127
.
815-944-60-6
For guidance on common annuity payment alternatives, see paragraph 815-15-55-58.
815-944-60-8
For guidance on a reinsurer's receivable arising from a modified coinsurance arrangement, see paragraphs
815-15-55-107 through 55-109
.

Financial Guarantee Insurance Contracts

815-944-60-9
For guidance on the payment of a claim under a dual-trigger financial guarantee insurance contract, see paragraphs
815-10-55-32 through 55-36
.

Related subtopics