{"schema_version":2,"canonical_url":"https://asc.understandingaccounting.org/asc/944/20/#55-implementation-guidance-and-illustrations","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":"55","label":"55 Implementation Guidance and Illustrations","anchor":"55-implementation-guidance-and-illustrations","is_sec":false,"groups":[{"block":"Short-Duration Contracts","heading":"Implementation Guidance","paragraphs":[{"citation":"944-20-55-1","para":"55-1","html":"Examples of short-duration contracts within the scope of the Short-Duration Contracts Subsections of this Subtopic include both of the following: - a
Most property and liability insurance contracts
- b
Paragraph 944-20-55-5 states that accident and health insurance contracts may be short-duration or long-duration depending on whether the contracts are expected to remain in force for an extended period. Examples of long-duration contracts within the scope of the Long-Duration Contracts Subsections of this Subtopic include all of the following: - a
Whole-life contracts
- b
Guaranteed renewable term life contracts
- c
- d
Annuity contracts
- e
Title insurance contracts.
Title insurance contracts provide protection for an extended period and therefore are considered long-duration contracts.
Accident and health insurance contracts may be short-duration or long-duration depending on whether the contracts are expected to remain in force for an extended period. For example, individual and group insurance contracts that are noncancelable or guaranteed renewable (renewable at the option of the insured), or collectively renewable (individual contracts within a group are not cancelable), ordinarily are long-duration contracts. This implementation guidance discusses the nature of
mortality risk.
The risk that the guaranteed price of an annuity may prove to be unfavorable to the guaranteeing entity if the annuity is purchased is a price risk not unlike a guaranteed price of any commodity and does not create a mortality risk.
A mortality risk does not arise until the purchase provision is executed and the obligation to make life-contingent payments is present in an annuity contract. A nominal mortality risk—a risk of insignificant amount or of remote probability—is not sufficient to permit that a contract be accounted for as an insurance contract. The assets and liabilities related to market value adjusted annuities should be accounted for and reported as general account assets and liabilities because the insurance entity provides a fixed return for a specified period, market value adjusted annuities written through a separate account do not meet the criteria in paragraph 944-80-25-2. Under that paragraph, all investment performance, net of contract fees, must be required to be passed through to the contract holder to qualify for separate account treatment. Under the model described in paragraphs , the liability to be held for market value adjusted annuities is the accrued account balance using the contractually specified rate. The market value adjusted amount generally is available at surrender only and is not available at contract maturity; therefore, the market value adjustment is considered a surrender charge or credit. For group participating pension contracts not accounted for under the provisions of Subtopic 815-10, the liability for the contract holder account balance should be based on the fair value of the referenced pool of assets without regard to the accounting under generally accepted accounting principles (GAAP) for the assets in the referenced pool of assets, with any change in the liability recognized through earnings. A long-term care benefit should be evaluated and accounted for in accordance with paragraphs , , , , , and . An earnings protection benefit is a death benefit and should be evaluated and accounted for in accordance with paragraph 944-40-25-25B. This implementation guidance discusses, for purposes of evaluating whether a contract with a reinsurer transfers risk, what constitutes a contract, which is essentially a question of substance. It may be difficult in some circumstances to determine the boundaries of a contract. For instance, the profit-sharing provisions of one contract may refer to experience on other contracts and, therefore, raise the question of whether, in substance, one contract rather than several contracts exist.
The guidance in the Financial Services—Insurance Topic on reinsurance limits the inconsistency that could result from varying interpretations of the term contract by requiring that features of the contract or other contracts or agreements that directly or indirectly compensate the reinsurer or related reinsurers for losses be considered in evaluating whether a particular contract transfers risk. Therefore, if agreements with the reinsurer or related reinsurers, in the aggregate, do not transfer risk, the individual contracts that make up those agreements also would not be considered to transfer risk, regardless of how they are structured. Certain guidance relevant to determining the boundaries of a contract is provided in the accounting literature.
Paragraph 944-20-15-40 states that provisions of other related contracts may be considered part of the subject contract under certain circumstances. Different kinds of exposures combined in a program of reinsurance shall not be evaluated for risk transfer and accounted for together, because that would allow contracts that do not meet the conditions for reinsurance accounting to be accounted for as reinsurance by being designated as part of a program.
In addition, paragraph 944-20-15-65 refers to the fact that an amendment of a contract may create a new contract. The legal form and substance of a reinsurance contract generally will be the same, so that the risks reinsured under a single legal document would constitute a single contract for accounting purposes. However, that may not always be the case. Accordingly, careful judgment may be required to determine the boundaries of a contract for accounting purposes.
Paragraph 944-20-15-56 states that, if an agreement with a reinsurer consists of both risk transfer and nonrisk transfer coverages that have been combined into a single legal document, those coverages shall be considered separately for accounting purposes. This implementation guidance discusses how the guidance on multiple-year retrospectively rated contracts in the Reinsurance Contracts Subsections of this Subtopic is based on the concept that there is a substantive difference between a contract that contains an obligatory retrospective rating provision and one that does not. This distinction derives from Subtopic 450-20, which requires recognition of liabilities (which are defined as present obligations) as of a financial reporting date, but prohibits recognition of losses and expenses that will result from future events. For example, it may be a virtual certainty that an entity will pay employee salaries next year. But because there is no present obligation to pay those salaries, they are not recognized today. The guidance on multiple-year retrospectively rated contracts in the Reinsurance Contracts Subsections of this Subtopic does not permit recognition of the effects of retrospective rating provisions unless those provisions are obligatory.
This implementation guidance addresses circumstances in which the assessment of risk transfer changes after the initial assessment at contract inception.
Paragraph 944-20-15-43 states that the status of a contract should be determinable at inception and, absent amendment, subsequent changes shall be very rare. If the risk of significant loss was not deemed reasonably possible at inception, and a significant loss subsequently occurred, the initial assessment was not necessarily wrong, because remote events do occur. Likewise, once a reasonable possibility of significant loss has been established, such loss need not occur to maintain the contract's status as reinsurance. This Subtopic does not preclude reclassification if the initial assessment is later deemed incorrect. However, careful consideration would need to be given to whether the reclassification represents the correction of an error (see Subtopic 250-10). This implementation guidance discusses the definition of past insurable events that governs whether reinsurance coverage of short-duration insurance policies is prospective or retroactive. As described in paragraph 944-20-15-34B, the distinction between prospective and retroactive reinsurance is based on whether a contract reinsures future or past insured events covered by the underlying insurance contracts. The form of the reinsurance—whether claims-made or occurrence-based—does not determine whether the reinsurance is prospective or retroactive. Most reinsurance contracts covering calendar-year incurred losses combine coverage for insured events that occurred before entering into the reinsurance contract with coverage for future insured events and, therefore, include both prospective and retroactive elements.
A contract may be considered to have been substantively entered into even though regulatory approval of that contract has not taken place. The absence of agreement on significant terms, or the intention to establish or amend those terms at a later date based on experience or other factors, generally indicates that the parties to the contract have not entered into a reinsurance contract, but rather have agreed to enter into a reinsurance contract at a future date. If contractual provisions under a contract substantively entered into at a future date cover insurable events before that date, that coverage is retroactive.
For purposes of this guidance, assume a reinsurance contract covers losses from asbestos and pollution claims on occurrence-based insurance policies effective during previous periods and for which the reinsurance coverage is triggered by a court interpretation that a loss is covered within the terms of the underlying insurance policies. In this instance, the insured event is the occurrence of loss within the coverage of the underlying insurance contracts, not the finding of a court. Therefore, the fact that the asbestos exposure or pollution is covered under insurance policies effective during prior periods makes the reinsurance coverage in this instance retroactive.
This implementation guidance addresses classification of a contract to reinsure short-duration policies entered into after the contract's effective date. The portion of the contract related to the period of time between the effective date of the contract and the date the contract was entered into is retroactive because it covers insured events that occurred before entering into the reinsurance contract.
This implementation guidance explains that adjustments to future premiums or coverage may affect the accounting for a reinsurance contract. As discussed in paragraph 944-20-15-34B, whenever an adjustment results in a reinsurer providing new or additional coverage for past insurable events, that coverage is retroactive. For example, if subsequent years' premiums under a multiple accident year contract create additional coverage for previous accident years, the additional coverage is retroactive, even if the original coverage provided in the contract for those accident years was prospective.
Likewise, if current losses under a multiple-year contract eliminate coverage in future periods, some or all of the premiums to be paid in those future periods should be charged to the current period.
This implementation guidance discusses the application of the scope guidance for reinsurance of short-duration contracts beginning in paragraph
944-20-15-41.
A reasonable possibility of significant loss to the reinsurer does not necessarily indicate underwriting risk has been transferred. The tests are independent and the methods and assumptions used in the significant loss test in paragraph 944-20-15-41(b), such as comparing present value of cash flows to ceded premiums, are not relevant to the other test. It would be possible to demonstrate the reasonable possibility of significant loss on a contract that does not transfer underwriting risk for two reasons. First, if sufficient timing risk is present, the loss could be generated from timing risk alone. Second, judgments about what is significant and what is reasonably possible could differ.
Some features that can delay timely reimbursement violate the condition in paragraph 944-20-15-41(a)but could still result in the reasonable possibility of significant loss to the reinsurer. Examples are a payment schedule or accumulating retention.
Because both the condition in (a) in that paragraph and the condition in (b) in that paragraph must be met, failure to transfer significant timing and underwriting risk is not overcome by the possibility of significant loss to the reinsurer. Paragraph 944-20-15-40 refers to contractual features inherently designed to delay the timing of reimbursement to the ceding entity. Regardless of what a particular feature might be called, paragraphs 944-20-15-41 and 944-20-15-46 state that any feature that can delay timely reimbursement violates the conditions for reinsurance accounting. As indicated in those paragraphs, transfer of insurance risk requires that the reinsurer's payments to the ceding entity depend on and directly vary with the amount and timing of claims settled under the reinsured contracts. Contractual features that can delay timely reimbursement prevent that condition from being met. Therefore, any feature that may affect the timing of the reinsurer's reimbursement to the ceding entity should be closely scrutinized. Under very limited circumstances, the reinsurer need not be exposed to the reasonable possibility of significant loss for a contract to meet the conditions for reinsurance accounting. For example, applying the reasonable possibility of significant loss condition is problematic if the underlying insurance contracts themselves do not result in the reasonable possibility of significant loss to the ceding entity. If the reinsurer has assumed substantially all of the insurance risk in the reinsured portions of the underlying policies, even if that risk does not result in the reasonable possibility of significant loss, the transaction meets the conditions for reinsurance accounting. In this narrow circumstance, the reinsurer's economic position is virtually equivalent to having written the insurance contract directly. The risks retained by the ceding entity are insignificant, so that the reinsurer's exposure to loss is essentially the same as the insurer's. Most commonly, such a situation arises if an individual risk or insurance contract, rather than a group of risks or contracts, is reinsured. The probability of loss from any individual short-duration insurance contract generally is considered to be remote. Therefore, outcomes that would expose the assuming entity to risk of significant loss ordinarily could not be characterized as reasonably possible.
Assessing the economic position of the reinsurer in relation to that of the ceding entity under paragraph 944-20-15-53may be relatively easy for reinsurance of individual risks or for unlimited-risk quota-share reinsurance, because the premiums and losses on these types of reinsurance generally are the same as the premiums and losses on the reinsured portions of the underlying insurance policies. In other types of reinsurance, determining the reinsurer's net cash flows relative to the insurer is likely to be substantially more difficult. For example, it generally would be difficult to demonstrate that the ceding entity's premiums and losses for a particular layer of insurance are the same as the reinsurer's premiums and losses related to that layer. That paragraph states that, if the economic position of the reinsurer relative to the insurer cannot be determined, the contract would not qualify under the exception in that paragraph. A structured settlement transaction that does not legally replace one insurer by another and thereby extinguish the primary insurer's liability to the policyholder is accounted for as reinsurance if the annuity funding the settlement meets the conditions for reinsurance accounting. Otherwise, the transaction is accounted for as a deposit in accordance with paragraph 340-30-05-1. A contract does not meet the conditions for reinsurance accounting if features of the reinsurance contract or other contracts or agreements directly or indirectly compensate the reinsurer or related reinsurers for losses. That compensation may take many forms, and an understanding of the substance of the contracts or agreements is required to determine whether the ceding entity has been indemnified against loss or liability relating to insurance risk. For example, contractual features may limit the reinsurer's exposure to insurance risk or delay the reimbursement of claims so that investment income mitigates exposure to insurance risk. Examples of those contractual features, noted in paragraph 944-20-15-40(a) through (b), are not all-inclusive. This implementation guidance addresses a circumstance in which, under a multiple-year retrospectively rated reinsurance contract, the ceding entity has to make additional payments to the reinsurer, but the ceding entity also receives expanded coverage. The single payment is allocated to the two separate transactions. In one transaction, the ceding entity has acquired an asset by making a payment to the reinsurer in exchange for expanded coverage. In the other, the ceding entity has incurred a loss or liability to the extent that it is reimbursing the reinsurer for past losses. Because a variety of factors may affect the value of reinsurance coverage at any point in time, the most appropriate measure of the value of additional coverage generally is the price of the initial coverage. For example, if coverage of $6.00 was acquired for a $1.00 premium, and the ceding entity would pay $4.00 more for another $6.00 of coverage if a loss occurs, the most relevant measure of the amount of premium that relates to the new coverage would be $1.00. The other $3.00 presumably is a reimbursement for the loss that has been incurred.
This Example illustrates the application of the with-and-without method under paragraph
944-20-35-13. This Example assumes all of the following:
- a
The retrospectively rated contract reinsures risks arising from short-duration contracts.
- b
- c
Cash settlement is required upon termination of the contract. - d
The contract provides for deposit premiums of $1.00 per year for $6.00 of coverage in excess of a stipulated retention.
- e
Coverage is limited to one catastrophic event each year (that is, the ceding entity will not collect more than $6.00 per year from the reinsurer).
- f
If one or more losses occur, the ceding entity owes the reinsurer a single premium adjustment of $4.00 spread proportionately over the remaining contract term.
- g
If the ceding entity incurs a loss of $6.00 in the first year, the results in the fund balance will be negative $5.00 ($1.00 of premium to date less $6.00 of losses to date).
- h
In Years 2 and 3, the ceding entity must pay the assuming entity $3.00 each year ($1.00 of deposit premium and $2.00 of the premium adjustment).
Under the with-and-without method, the ceding entity would recognize a liability as the difference between the ceding entity's total contract costs before and after the experience under the contract loss ($4.00).
This Example illustrates the effect of termination. Assume a ceding entity enters into a three-year contract with an assuming entity.
If a loss occurs in the first year, the ceding entity is required to pay either of the following: - a
An additional $2.00 premium adjustment in each subsequent year that the contract is in force - b
If the ceding entity terminates the contract before the end of the third year, 90% of any remaining premium adjustment.
Under the guidance in this Subtopic, the ceding entity would recognize a liability at the end of the first year equal to the difference in the total contract costs before and after the loss unless the ceding entity has decided to terminate the contract at that time. In this Example, if the ceding entity decided to terminate the contract, it would recognize the cost of termination ($3.60). Otherwise, it would recognize the lesser of the amount assuming termination ($3.60) or the amount assuming no termination ($4.00).