{"schema_version":2,"canonical_url":"https://asc.understandingaccounting.org/asc/944/20/#05-overview-and-background","source":"FASB Accounting Standards Codification, Basic View","usage":"Study and research edition. Verify current requirements with the official source. Summaries, enrichment, and tags are machine-generated study aids. Paragraph html preserves source markup; snippet is abbreviated. Pending content is not necessarily effective.","topic":"944","topic_title":"Financial Services—Insurance","subtopic":"944-20","subtopic_title":"Insurance Activities","section":{"number":"05","label":"05 Overview and Background","anchor":"05-overview-and-background","is_sec":false,"groups":[{"block":null,"heading":null,"paragraphs":[{"citation":"944-20-05-1","para":"05-1","html":"The Financial Services—Insurance Topic contains the following Subtopics unique to the accounting for and financial reporting of insurance activities and insurance contracts:
- a
Insurance Activities
- b
Acquisition Costs
- c
Claim Costs and Liabilities for Future Policy Benefits
- d
Policyholder Dividends
- e
Separate Accounts.
This Subtopic provides a description of insurance activities and insurance contracts, provides guidance on accounting for multi-year retrospectively rated contracts, and contains other overarching industry-specific content.
In some cases an insurance contract or
reinsurance contract does not transfer
insurance risk. In those cases, Subtopic
340-30 provides guidance on applying the deposit method of accounting.
Four methods of premium revenue and contract liability recognition for insurance contracts have developed: short-duration contract accounting and three methods of long-duration contract accounting—Traditional, Universal Life, and Participating Contracts. Generally, the four methods reflect the nature of the insurance entity's obligations and policyholder rights under the provisions of the contract.
The accounting model for financial guarantee insurance contracts incorporates attributes of both the short-duration and the long-duration models. Financial guarantee insurance contracts provide insurance protection to the holder of the insured financial obligation. Therefore, premium revenue recognition issues are addressed in the context of the short-duration insurance accounting model. The claim liability recognition and measurement approach for financial guarantee insurance contracts incorporates aspects of the long-duration insurance accounting model.
The guidance in this Subtopic is presented in the following five Subsections:
- a
General
- b
Short-Duration Contracts
- c
Long-Duration Contracts
- d
Reinsurance Contracts
- e
Financial Guarantee Insurance Contracts.
The primary purpose of insurance is to provide economic protection from identified risks occurring or discovered within a specified period.
Insurance transactions may be characterized generally by both of the following: - a
The purchaser of an insurance contract makes an initial payment or deposit to the insurance entity in advance of the possible occurrence or discovery of an insured event.
- b
When the insurance contract is made, the insurance entity ordinarily does not know if, how much, or when amounts will be paid under the contract.
Examples of insured events include all of the following: - a
The death or disability of the insured
- b
The maturity of an endowment
- c
The incurrence of hospital or medical bills
- d
The destruction or damage of property and related deaths or injuries
- e
Defects in, liens on, or challenges to the title to real estate
- f
The occurrence of a surety loss
- g
Business interruption.
The insurance laws and regulations of most states require insurance entities domiciled in those states to comply with the guidance provided in the National Association of Insurance Commissioners' Accounting Practices and Procedures Manual, except as prescribed or permitted by state law.
Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance entities domiciled in a particular state. A state may adopt the revised Accounting Practices and Procedures Manual in whole, or in part, as an element of prescribed statutory accounting practices. If, however, the requirements of state laws, regulations, and administrative rules differ from the guidance provided in the revised Accounting Practices and Procedures Manual or subsequent revisions, those state laws, regulations, and administrative rules will take precedence.
Permitted statutory accounting practices include practices not prescribed by the domiciliary state as described in the preceding paragraph, but allowed by the domiciliary state regulatory authority. An insurance entity may request permission from the domiciliary state regulatory authority to use a specific accounting practice in the preparation of the entity's statutory financial statements in either of the following circumstances: - a
If it wishes to depart from the prescribed statutory accounting practices
- b
If prescribed statutory accounting practices do not address the accounting for the transaction.
Accordingly, permitted accounting practices differ from state to state, may differ from entity to entity within a state, and may change in the future. Subtopic
944-505 provides guidance to insurance entities on disclosure about statutory accounting practices.
The Short-Duration Contracts Subsections provide guidance on accounting for and financial reporting of short-duration insurance contracts.
Premiums from short-duration insurance contracts, such as most property and liability insurance contracts, are intended to cover expected claim costs resulting from insured events that occur during a fixed period of short duration. The insurance entity ordinarily has the ability to cancel the contract or to revise the premium at the beginning of each contract period to cover future insured events. The Long-Duration Contracts Subsections provide guidance on accounting for and financial reporting of long-duration insurance contracts. This section is organized as follows:
- a
Traditional fixed and variable annuity and life insurance contracts
- b
Universal life-type contracts
- c
Nontraditional fixed and variable annuity and life insurance contracts
- d
Participating life insurance contracts
- e
Group participating pension contracts.
Traditional fixed annuity and life insurance contracts, typically offered through an insurance entity's general account, provide for a fixed rate of interest over some specified period, with the insurance entity bearing the investment risk associated with the invested assets. Traditional variable annuity and variable life insurance contracts, by contrast, offered through an insurance entity's separate account, provide that all investment risks associated with the separate account assets are passed through to the contract holder, with no guarantees of return of principal, minimum crediting rates, or (for annuity contracts) minimum death benefits. For example, in a traditional variable annuity, the contract holder directs the allocation of the account value among various investment alternatives and bears the investment risk. The units may be surrendered for their current value in cash (usually less a surrender charge) or applied to purchase annuity income. The insurance entity periodically deducts mortality and expense charges from the account. A traditional variable annuity product structure, as that term is used in this Subtopic, includes the following attributes: - a
The policyholder's payments, after deduction of specified sales and administrative charges, are used to purchase units of a separate investment account (a separate account).
- b
The policyholder directs the allocation of the account value among various investment options (typically various mutual funds). The policyholder bears the investment risk (that is, the account value is based entirely on the performance of the directed investments).
- c
The units may be surrendered for their current value in cash, although there is often a small surrender charge, or the units may be applied to purchase annuity income.
- d
The insurer guarantees mortality and maximum expense charges, and amounts are deducted periodically from the separate account to cover these charges.
- e
Deferred annuity contracts typically provide a death benefit during the accumulation period under which the policyholder may receive the greater of the sum of premiums paid or the value of total units to the credit of the account at time of the policyholder's death.
Premiums from long-duration insurance contracts, including many life insurance contracts, generally are level even though the expected policy benefits and services do not occur evenly over the periods of the contracts. Functions and services provided by the insurer include insurance protection, sales, premium collection, claim payment, investment, and other services. No single function or service is predominant over the periods of most types of long-duration contracts. Premium revenue from long-duration contracts generally exceeds expected policy benefits in the early years of the contracts. Some long-duration insurance contracts have terms that are fixed and guaranteed but lack either level premiums (as discussed in paragraph 944-20-05-19) or insurance protection characteristics. The differences between universal life-type insurance contracts and other long-duration contracts is that universal life-type insurance contracts lack the fixed and guaranteed terms that are typical for other long-duration contracts. Policyholders are frequently granted significant discretion over the amount and timing of premium payments. Insurers are frequently granted significant discretion over amounts that accrue to and that are assessed against policyholders.
Annuity and life products with nontraditional terms may combine fixed and variable features and are sold as general account or separate account products. The features of such contracts are many and complex, and may be offered in different combinations, such that there are numerous variations of the same basic products being sold in the marketplace.
Insurance entities have developed a wide range of variable annuity contracts with nontraditional features. Nontraditional features of traditional variable annuity contracts result in a sharing of investment risk between the issuer and the holder. Nontraditional variable annuity contracts provide for some sort of minimum guarantee of the account value at a specified date. This minimum guarantee may be guaranteed through a minimum accumulation benefit or a guaranteed account value floor. For example, the floor guarantee might be that, at a specified anniversary date, the contract holder will be credited with the greater of the following: - a
The account value, as determined by the separate account assets
- b
All deposits that are made, plus 3 percent interest compounded annually.
While these nontraditional variable annuity contracts have distinguishing features, they possess a common characteristic: the investment risk associated with the assets backing the contract is shared by the issuer and the policyholder. That is, in contrast to traditional variable annuity contracts, the investment risk is, by virtue of the nontraditional product features, allocated between the two parties and not borne entirely by only one of the parties (the holder in the case of a traditional variable annuity contract).
Variable annuity contracts and variable life insurance contracts provide the contract holder with a number of investment alternatives. Many of those investment alternatives will be separate account funds, such as equity, aggressive equity, high-grade corporate bond, mortgage loan, real estate, and similar funds. Other investment alternatives could include guaranteed investment options and market value adjusted separate accounts as well as a general account fixed interest rate option. The remainder of this guidance addresses the following annuity contracts and features:
- a
Market value annuities
- b
Minimum guaranteed death benefit
- c
Minimum guaranteed income benefit
- d
No-lapse guarantee
- e
Sales inducements to contract holders
- f
Other features.
A market value annuity provides for a return of principal plus a fixed rate of return if held to maturity (book value), or, alternatively, a market-adjusted value if surrendered before maturity. The product is also sometimes referred to as a market value adjusted annuity or a modified guaranteed annuity. The product typically provides for a single premium that may be invested for a specified term, with typical terms of 1 to 10 years. A fixed interest rate is specified in the contract based on the term selected. The contract contains surrender values that are based on a market value adjustment formula if held for shorter periods. The formula typically is based on current crediting rates being offered for new market value annuity purchases with terms equal to the remaining term to maturity. The market value adjustment may be positive or negative, depending on crediting rates at surrender. A common feature in variable annuities is a minimum guaranteed death benefit, such as a return of premium death benefit or basic minimum guaranteed death benefit. Although the return-of-premium minimum guaranteed death benefit has become increasingly common in variable annuities, the trend has been for insurers to offer minimum guaranteed death benefits with more extensive benefit guarantees, such as any of the following: - a
Roll-up death benefit. A death benefit equal to the total of deposits made to the contract less an adjustment for partial withdrawals, accumulated at a specified interest rate. - b
Reset death benefit. A death benefit equal to the account balance on a specified anniversary date adjusted for deposits less partial withdrawals since the specified anniversary date.
- c
Ratchet death benefit. A death benefit equal to the highest account balance among prior specified anniversary dates adjusted for deposits less partial withdrawals since the specified anniversary date.
Some annuities may provide for potential benefits in addition to the account balance, payable only if annuitization is elected. For example, some deferred variable annuities provide that, regardless of separate account performance, a guaranteed minimum amount is available to annuitize after a specified period, thereby providing a guaranteed minimum income benefit if the contract holder elects to annuitize. This benefit is in addition to the guaranteed minimum annuity interest rate traditionally offered. Another insurance benefit feature is a no-lapse guarantee, in which the insurance entity agrees to keep the insurance policy in force even if the account balance is not sufficient to pay the cost of insurance. Sales inducements to contract holders may be offered with fixed and variable life insurance and annuity contracts. Sales inducements to contract holders typically can be characterized as one of the following types: - a
Immediate bonuses. In the case of the immediate bonus, the insurance entity is obligated to credit to the contract holder's account the sales inducement as a result of signing the contract. The contract holder account balance is increased for the full amount of the immediate bonus on the date that the bonus is contractually granted. - b
Persistency bonuses. A persistency bonus is credited to the contract holder account balance at the end of a specified period if the contract remains in force at that date. - c
Enhanced-crediting-rate bonuses. In an enhanced crediting rate sales inducement, the insurance entity offers customers a crediting rate for a stated period in excess of that currently being offered by the entity for other similar contracts. Pursuant to the contract, the enhanced crediting rate is applicable for a limited period of time, after which the rate is reset under the contractual provisions, typically at the discretion of the insurance entity.
A deferred annuity may provide multiple crediting rates throughout the life of the contract depending on whether the contract holder elects to terminate or annuitize the contract. An example is a contract that applies a lower rate to funds deposited if the contract holder elects to surrender the contract for cash, and a higher rate if the contract holder elects to annuitize, often referred to as a two-tier annuity. Contracts also exist that potentially may be viewed as providing multiple account balances; for example, a contract that provides a return based on a contractually referenced pool of real estate assets owned by the insurance entity but also provides for minimum investment return guarantees.
Mutual life insurance entities primarily issue participating life insurance contracts. Those contracts provide policyholders with certain guaranteed benefits and allow policyholders to share in the experience of the entity through dividends. Dividends are paid periodically and generally reflect the experience and performance of the entity for investment activity, mortality experience, and contract administration for each particular class of contracts. The determination and distribution of dividends distinguish participating life insurance contracts from nonparticipating life insurance contracts.
Group participating pension contracts between insurance entities and pension plans have account balance crediting provisions that give the contract holder the total return based on a referenced pool of assets over the life of the contract either through crediting rates or termination adjustments. The ongoing crediting to the account balance may be based on statutory, cash basis, or book value returns. The contracts may not have a maturity date but specify that upon surrender any remaining return on the referenced pool of assets on the termination date not yet credited will be a termination adjustment. The referenced pool of assets may include mortgage loans, real estate, and equity and debt securities. The Reinsurance Contracts Subsections provide guidance on accounting for and financial reporting of
reinsurance contracts, including those that reinsure short-duration insurance contracts and long-duration insurance contracts.
Insurers may enter into various types of contracts described as reinsurance, including those commonly referred to as fronting arrangements. An insurance entity may purchase reinsurance to reduce exposure to losses from the events it has agreed to insure, similar to a direct insurance contract purchased by an individual or noninsurance entity. The insurance entity also may contract with a reinsurer to facilitate the writing of contracts larger than those normally accepted, to obtain or provide assistance in entering new types of business, or to accomplish tax or regulatory objectives.
Insurance provides indemnification against loss or liability from specified events and circumstances that may occur or be discovered during a specified period. In exchange for a payment from the policyholder, an insurance entity agrees to pay the policyholder if specified events occur or are discovered. Similarly, the insurance entity may obtain indemnification against claims associated with contracts it has written by entering into a reinsurance contract with another insurance entity (the reinsurer or assuming entity). The insurer (or ceding entity) pays (cedes) an amount to the reinsurer, and the reinsurer agrees to reimburse the insurer for a specified portion of claims paid under the reinsured contracts. However, the policyholder usually is unaware of the reinsurance arrangement, and the insurer ordinarily is not relieved of its obligation to the policyholder. The reinsurer may, in turn, enter into reinsurance contracts with other reinsurers, a process known as retrocession. Many short-duration insurance and reinsurance contracts have retrospective rating provisions. A retrospectively rated contract is a multiple-year contract in which events in one period of the contract create rights and obligations in another. For example, if losses above a certain level occur in one contract year, premiums increase in future years unless the ceding entity compensates the reinsurer through a settlement adjustment. The ceding entity has an obligation because it must pay either the settlement adjustment or the higher future premiums.
An insurer (ceding entity) may enter into a multiple-year retrospectively rated reinsurance contract with a reinsurer (assuming entity). Examples of these contracts may include transactions referred to as funded catastrophe covers. These contracts include a retrospective rating provision that provides for at least one of the following based on contract experience: - a
Changes in the amount or timing of future contractual cash flows, including premium adjustments, settlement adjustments, or refunds to the ceding entity
- b
Changes in the contract's future coverage.
A critical distinguishing feature of these contracts is that part or all of the retrospective rating provision is obligatory such that the retrospective rating provision creates future rights and obligations as a result of past events. Therefore, a retrospectively rated contract that could be cancelled without further obligation (because it does not create rights and obligations that will be realized in a future period) is excluded.
The Financial Guarantee Insurance Contracts Subsections of this Subtopic provide guidance on accounting for and financial reporting of
financial guarantee insurance contracts and
financial guarantee reinsurance contracts.
Examples of such financial obligations include a municipal bond or an asset-backed security.Although the direct or indirect beneficiary of the contract is the holder of the insured financial obligation, the holder of the financial guarantee insurance contract (policyholder) will vary. In some cases, the policyholder will be the issuer (for example, a municipality or a corporation) of the insured financial obligation because it is seeking to increase the marketability of the insured financial obligation while reducing future interest costs (by attaining a higher credit standing for the insured financial obligation through the financial guarantee insurance contract). In other cases, the policyholder will be both the holder of the insured financial obligation and beneficiary because it has purchased a financial obligation in the secondary market and seeks to protect itself from a financial loss in the event of a default.