{"schema_version":2,"canonical_url":"https://asc.understandingaccounting.org/asc/944/20/","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.","number":"944-20","topic":"944","title":"Insurance Activities","area":"Industry","paragraphs":242,"summary":"ASC 944-20 sets the framework for insurance accounting based on the nature of the contract rather than the type of entity: contracts are classified at inception as short-duration (fixed short coverage period, insurer can cancel or reprice each period, 944-20-15-7) or long-duration (not subject to unilateral change, services rendered over an extended period, 944-20-15-10), with sub-models for traditional, universal life-type, participating, and financial guarantee contracts. It also defines when a contract with a reinsurer actually transfers insurance risk (significant insurance risk plus reasonable possibility of significant loss, 944-20-15-41) and prescribes recognition and with-and-without measurement for multiple-year retrospectively rated contracts. Contracts lacking indemnification or significant insurance risk are accounted for under the deposit method (340-30) or as investment contracts.","concepts":["short-duration contract","long-duration contract","universal life-type contract","investment contract","risk transfer","reinsurance","multiple-year retrospectively rated contract","financial guarantee insurance"],"categories":["Industry-specific","Recognition","Subsequent measurement","Contingencies and guarantees"],"level":"advanced","topic_title":"Financial Services—Insurance","sections":[{"number":"00","label":"00 Status","anchor":"00-status","is_sec":false,"groups":[{"block":null,"heading":null,"paragraphs":[{"citation":"944-20-00-1","para":"00-1","html":"The following table identifies the changes made to this Subtopic.
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.
This Subtopic establishes a framework for accounting by insurance entities based on the nature of insurance contracts rather than type of insurance entity.
Life insurance coverage encompasses the concepts of amounts at risk and the relative probability of mortality and morbidity events. The insurance model does not override, nor is it inconsistent with, the basic recognition and measurement principles of Subtopic 450-20. Rather, the insurance model is a specialized application of those principles that estimates and allocates revenues and costs that have a future economic benefit over the period in which services are provided or received. For example, that Subtopic prohibits recognition of a loss unless it is probable that a loss has been incurred, and requires recognition of the full amount of a loss that has been incurred in the period of the loss. Likewise, paragraphs 944-40-25-32, 944-60-25-2, 944-60-25-9, , and require recognition of losses in the period the loss occurs. A principal objective of the Reinsurance Contracts Subsections of this Subtopic is to account for an agreement with a reinsurer according to its substance. Difficulty in evaluating a contract under the Reinsurance Contracts Subsections of this Subtopic is an indication that the contract's form and substance may differ. For example, if complicated adjustable features or options are present in a contract, close analysis may be required to determine the effect of those contractual provisions on risk transfer. A retrospectively rated contract is a multiple-year contract in which events in one period of the contract create rights and obligations in another. The principal issues in accounting for a multiple-year retrospectively rated contract involve how to recognize and measure assets and liabilities resulting from the obligatory retrospective rating provisions. While it may be difficult for some types of retrospectively rated contracts to pass the risk transfer test, the recognition and measurement questions are present regardless of whether the contract transfers risk. In fact, the questions become clearly evident with contracts that meet the risk transfer test and are accounted for as reinsurance. This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Section
944-10-15, with other considerations noted below.
For instruments and transactions within its scope, the guidance in the Financial Guarantee Insurance Contracts Subsections take precedence to other guidance in this Subtopic.
Paragraph 720-20-25-1 states that, to the extent that an insurance contract or reinsurance contract does not, despite its form, provide for indemnification of the insured or the ceding entity by the issuer or reinsurer against loss or liability, the premium paid less the amount of the premium to be retained by the insurer or reinsurer shall be accounted for as a deposit by the insured or the ceding entity. See paragraph
340-30-05-1 for guidance on applying the deposit method of accounting. For guidance on long-duration contracts that do not incorporate significant insurance risk, see paragraph
944-20-15-14.
Insurance contracts, for purposes of this Subtopic, shall be classified as short-duration contracts (see paragraph 944-20-15-7) or long-duration contracts (see paragraph 944-20-15-10) depending on whether the contracts are expected to remain in force for an extended period. Certain guidance in the Long-Duration Subsections in this Subtopic (and other Subtopics within the Financial Services—Insurance Topic) applies only to certain long-duration participating life insurance contracts of mutual life insurance entities and certain stock life insurance entities. For purposes of that guidance:
- a
- b
Participating life insurance contracts denote those that have both of the following characteristics:
- 1
They are long-duration participating contracts that are expected to pay dividends to policyholders based on actual experience of the insurance entity. - 2
- a
Identifies divisible surplus
- b
Distributes that surplus in approximately the same proportion as the contracts are considered to have contributed to divisible surplus (commonly referred to in actuarial literature as the contribution principle).
Paragraph 944-20-15-11 states that stock life insurance entities with participating life insurance contracts that meet certain conditions are permitted to account for those contracts in accordance with the Long-Duration Contracts Subsections of this Subtopic. That paragraph explains that the same accounting policy shall be applied consistently to all those participating life insurance contracts. The Short-Duration Contracts Subsections follow the same Scope and Scope Exceptions as outlined in the
General Subsection of this Section, with specific instrument qualifications and exceptions noted below.
The guidance in the Short-Duration Contracts Subsections of this Subtopic applies only to short-duration contracts.
Paragraph 944-20-15-2 states that insurance contracts, for purposes of this Subtopic, shall be classified as short-duration contracts or long-duration contracts depending on whether the contracts are expected to remain in force for an extended period. The factors that shall be considered in determining whether a particular contract can be expected to remain in force for an extended period are as follows for a short-duration contract: - a
The contract provides insurance protection for a fixed period of short duration.
- b
The contract enables the insurer to cancel the contract or to adjust the provisions of the contract at the end of any contract period, such as adjusting the amount of premiums charged or coverage provided.
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 and exceptions and other considerations noted below.
The guidance in the Long-Duration Contracts Subsections of this Subtopic applies only to long-duration contracts.
Paragraph 944-20-15-2 states that insurance contracts, for purposes of this Subtopic, shall be classified as short-duration contracts or long-duration contracts depending on whether the contracts are expected to remain in force for an extended period. The factors that shall be considered in determining whether a particular contract can be expected to remain in force for an extended period are as follows for a long-duration contract: - a
The contract generally is not subject to unilateral changes in its provisions, such as a noncancelable or guaranteed renewable contract.
- b
The contract requires the performance of various functions and services (including insurance protection) for an extended period.
The guidance in the Long-Duration Contracts Subsections of this Subtopic applies, in part, to the following classes of long-duration contracts issued: - a
Universal life-type contracts, that is, long-duration insurance contracts with terms that are not fixed and guaranteed
- b
Limited-payment contracts, including limited-payment participating and limited-payment nonguaranteed-premium contracts that are not, in substance, universal life-type contracts - c
Except as noted in paragraph
944-20-15-3, participating life insurance contracts
- d
Whole-life contracts, that is, insurance contracts that may be kept in force for a person's entire life by paying one or more premiums - e
Term life insurance contracts, that is, insurance contracts that provide a benefit if the insured dies within the period specified in the contract.
Stock life insurance entities with participating life insurance contracts described in (c) are permitted to account for those contracts in accordance with the Long-Duration Contracts Subsections of this Subtopic. The same accounting policy shall be applied consistently to all those participating life insurance contracts. If insurance contracts have characteristics significant to the contracts cited in (a) or (b) of the preceding paragraph those contracts are within the scope of the Long-Duration Contracts Subsections of this Subtopic. For example, universal disability contracts that have many of the same characteristics as universal life-type contracts, with the exception of providing disability benefits instead of life insurance benefits, shall be accounted for in a manner consistent with universal life-type contracts.
The Long-Duration Subsections of this Subtopic also apply to certain contracts or features not covered elsewhere in the Codification, including asset, liability, revenue, and expense recognition. Examples of such contracts or features include the following: - a
Contracts offered through an insurance entity's separate accounts
- b
- c
- d
Contracts providing multiple account balances
- e
The guidance in the Long-Duration Subsections of this Subtopic does not apply to
investment contracts issued by an insurance entity that do not incorporate significant insurance risk and shall not be accounted for as insurance contracts. See paragraph
944-825-25-2 for investment contracts.
The following guidance addresses the scope application of the Long-Duration Subsections of this Subtopic:
- a
Distinguishing investment contracts from universal life-type insurance contracts
- b
Universal life-type contracts
- c
Embedded derivatives.
A mortality or morbidity risk is present if, under the terms of the contract, the entity is required to make payments or forego required premiums contingent on the death or disability (in the case of life insurance contracts) or the continued survival (in the case of annuity contracts) of a specific individual or group of individuals. A contract provision that allows the holder of a long-duration contract to purchase an annuity at a guaranteed price on settlement of the contract does not entail a mortality risk until the right to purchase is executed. If purchased, the annuity is a new contract to be evaluated on its own terms. Annuity contracts may require the insurance entity to make a number of payments that are not contingent on the survival of the beneficiary, followed by life-contingent payments. Such contracts are considered insurance contracts under this Subtopic unless either of the following conditions exist: - a
The probability that life-contingent payments will be made is remote. - b
The present value of the expected life-contingent payments relative to the present value of all expected payments under the contract is insignificant.
To determine the scope application for a contract that contains death or other insurance benefit features, the insurance entity shall first determine whether the contract is an investment contract or insurance contract. Classification of a contract as an investment contract or as an insurance contract shall be made at contract inception, and the classification shall not be reassessed during the accumulation phase of the contract. If the mortality and morbidity risk associated with insurance benefit features offered in a contract is deemed to be nominal—that is, a risk of insignificant amount or remote probability—the contract shall be classified as an investment contract; otherwise, it shall be considered an insurance contract. There is a rebuttable presumption that a contract has significant mortality risk if the additional insurance benefit would vary significantly in response to capital markets volatility.
If the mortality or morbidity risk is other than nominal and the fees assessed or insurance benefits are not fixed and guaranteed, the contract should be classified as a universal life-type contract by the insurance entity.
If the fees assessed on a contract and insurance benefits provided by the contract are fixed and guaranteed or if the contract is short duration, the contract should be classified as a traditional long-duration contract or short-duration contract, respectively.
The determination of the significance of mortality or morbidity risk shall be based on a comparison of the following amounts: - a
Excess payments. The present value of expected excess payments to be made under insurance benefit features—that is, insurance benefit amounts and related incremental claim adjustment expenses in excess of the account balances. - b
Revenue. The present value of all amounts expected to be assessed against the contract holder and the expected investment margin.
In performing the analysis, an insurance entity shall consider both frequency and severity under a full range of scenarios that considers the volatility inherent in the assumptions, rather than making a best estimate using one set of assumptions. For example, if the annuity contract is a variable annuity contract, the insurance entity shall consider a range of fund return scenarios. If considering a range of scenarios, the insurance entity shall consider historical investment returns, the volatility of those returns, and expected future returns, as applicable. For purposes of the scope application of the Long-Duration Subsections of this Subtopic, universal life-type contracts include contracts that provide either death or annuity benefits and are characterized by any of the following features: - a
One or more of the amounts assessed by the insurer against the policyholder—including amounts assessed for mortality coverage, contract administration, initiation, or surrender—are not fixed and guaranteed by the terms of the contract. - b
Amounts that accrue to the benefit of the policyholder—including interest accrued to policyholder balances—are not fixed and guaranteed by the terms of the contract.
- c
Premiums may be varied by the policyholder within contract limits and without consent of the insurer.
A participating or nonguaranteed-premium contract is within the scope of the Long-Duration Subsections of this Subtopic if the terms of the contract suggest that it is, in substance, a universal life-type contract. The determination that a contract is in substance a universal life-type contract requires judgment and a careful examination of all contract terms.
The following two paragraphs describe some circumstances in which a participating or nonguaranteed-premium contract shall be accounted for as a universal life-type contract. The provisions of the following two paragraphs are not intended to be either all-inclusive or limiting. Limited-payment participating and limited-payment nonguaranteed-premium contracts that are not, in substance, universal life-type contracts are limited-payment contracts because they are not conventional forms of participating or nonguaranteed-premium contracts.
A participating contract that includes any of the following features shall be considered a universal life-type contract: - a
The policyholder may vary premium payments within contract limits and without consent of the insurer.
- b
The contract has a stated account balance that is credited with policyholder premiums and interest and against which assessments are made for contract administration, mortality coverage, initiation, or surrender, and any of the amounts assessed or credited are not fixed and guaranteed.
- c
The insurer expects that changes in any contract element will be based primarily on changes in interest rates or other market conditions rather than on the experience of a group of similar contracts or the entity as a whole.
A nonguaranteed-premium contract that includes either of the features (b) or (c) in the preceding paragraph shall be considered a universal life-type contract.
For guidance on accounting for embedded derivatives contained in nontraditional and other contracts, see Subtopic 815-15. The Reinsurance Contracts Subsections follow the same Scope and Scope Exceptions as outlined in the
General Subsection of this Section, with specific entity and instrument qualifications and exceptions noted below.
Servicing carriers for involuntary risk pools also are included in the scope of the Reinsurance Contracts Subsections of this Subtopic because the servicing carrier business is indistinguishable effectively from other types of reinsurance for accounting purposes. The financial reporting for a contract with a reinsurer depends on whether the contract is considered to be reinsurance for purposes of applying this Subtopic. Financial reporting for a reinsurance contract also depends on whether the contract reinsures short-duration or long-duration insurance contracts and, for short-duration contracts, on whether the contract is considered prospective reinsurance or retroactive reinsurance. For contracts that reinsure long-duration contracts, characteristics of the reinsurance contract determine whether the contract is short- or long-duration. Determining whether a contract that reinsures a long-duration insurance contract is long-duration or short-duration in nature is a matter of judgment, considering all of the facts and circumstances. For example, some contracts described as yearly renewable term may be, in substance, long-duration contracts, depending on their terms and how they are priced.
The distinction between prospective and retroactive reinsurance contracts is based on whether the contract reinsures future or past insured events covered by the underlying contracts. For example, in occurrence-based insurance, the insured event is the occurrence of a loss covered by the insurance contract. In claims-made insurance, the insured event is the reporting to the insurer, within the period specified by the policy, of a claim for a loss covered by the insurance contract. A claims-made reinsurance contract that reinsures claims asserted to the reinsurer in a future period as a result of insured events that occurred before entering into the reinsurance contract is a retroactive contract. Reinsurance contracts may include both prospective and retroactive provisions. For example, a reinsurance contract that reinsures liabilities relating to contracts written during one or more prior years also may reinsure losses on contracts to be written during one or more future years. Reinsurance also may be acquired some time after the reinsured contract has been written, but before the close of the coverage period for that contract, and be made effective as of the beginning of the contract period. This may result in a reinsurance contract with prospective and retroactive provisions that relate to a single contract year. It is not uncommon for a reinsurance arrangement to be initiated before the beginning of a policy period but not finalized until after the policy period begins. Whether there was agreement in principle at the beginning of the policy period and, therefore, the contract is substantively prospective depends on the facts and circumstances. Paragraphs 944-605-30-4 and state that reinsurance of long-duration contracts can be either short- or long-duration. The fact that no similar guidance is provided for short-duration contracts is intentional, because it is not possible to reinsure more risk than was originally insured under the primary insurance contracts. The guidance in the Reinsurance Subsections of this Subtopic applies to the following instruments:
- a
Any transaction, regardless of its form, whose individual terms indemnify an insurer against loss or liability relating to insurance risk. That is, all contracts, including contracts that may not be structured or described as reinsurance, shall be accounted for as reinsurance if those conditions are met, including reinsurance contracts used to, in effect, sell a line of business by coinsuring all or substantially all of the risks related to the line. - b
All contract amendments.
The guidance in the Reinsurance Contracts Subsections of this Subtopic does not apply to the following instruments:
- a
Contracts that do not meet the conditions for reinsurance accounting
- b
Except as noted in the following paragraph, reinsurance assumed.
Only the following provisions of the Reinsurance Subsections in this Subtopic apply to reinsurance assumed:
- a
- b
Paragraphs require certain disclosures.
Determining under paragraph 944-20-15-37(a) whether a contract with a reinsurer provides indemnification against loss or liability relating to insurance risk requires a complete understanding of that contract and other contracts or agreements between the ceding entity and related reinsurers. A complete understanding includes an evaluation of all contractual features that do either of the following: - a
Limit the amount of insurance risk to which the reinsurer is subject (such as through experience refunds, cancellation provisions, adjustable features, or additions of profitable lines of business to the reinsurance contract)
- b
Delay the timely reimbursement of claims by the reinsurer (such as through payment schedules or accumulating retentions from multiple years).
This risk transfer assessment shall be made at contract inception, based on facts and circumstances known at the time. Reinsurance programs often entail the reinsurance of various layers of exposure through multiple reinsurance contracts. Indemnification against loss or liability relating to insurance risk shall be determined in relation to the provisions of the individual reinsurance contract being evaluated.
Unless the condition in paragraph 944-20-15-53 is met, indemnification of the ceding entity against loss or liability relating to insurance risk in reinsurance of short-duration contracts exists under paragraph 944-20-15-37(a) only if both of the following conditions are met: - a
Significant insurance risk. The reinsurer assumes significant insurance risk under the reinsured portions of the underlying insurance contracts. Implicit in this condition is the requirement that both the amount and timing of the reinsurer's payments depend on and directly vary with the amount and timing of claims settled under the reinsured contracts.
- b
Significant loss. It is reasonably possible that the reinsurer may realize a significant loss from the transaction.
The conditions are independent and the ability to meet one does not mean that the other has been met. A substantive demonstration that both conditions have been met is required for a short-duration contract to transfer risk. The reference in (a) in the preceding paragraph acknowledges that a ceding entity may reinsure only part of the risks associated with the underlying contracts. For example, a proportionate share of all risks or only specified risks may be reinsured. The conditions for reinsurance accounting are evaluated in relation to the reinsured portions of the underlying insurance contracts, rather than all aspects of those contracts.
The assessment of the criterion in paragraph 944-20-15-41 shall be applied from contract inception, considering the effect of any subsequent contract amendments. Careful evaluation and considered judgment is required to determine whether a significant loss to the reinsurer was reasonably possible at inception. The status of a contract should be determinable at inception and, absent amendment, subsequent changes shall be very rare. The assessment in paragraph 944-20-15-41 is applied to a particular scenario, not to the individual assumptions used in the scenario. Therefore, a scenario is not reasonably possible unless the likelihood of the entire set of assumptions used in the scenario occurring together is reasonably possible. Contracts that reinsure risks arising from short-duration contracts shall meet the definition of a short-duration contract in paragraph 944-20-15-2 to be accounted for as reinsurance, because reinsurance of short-duration contracts is inherently short-duration. Contracts that reinsure short-duration insurance risks over a significantly longer period are, in substance, financing transactions, because any of the following conditions exist: - a
Premiums are deferred over a period beyond the term of the underlying insurance contracts.
- b
Losses are recognized in a different period than the period in which the event causing the loss takes place.
- c
Both events (a) and (b) occur at different points in time.
A reinsurer shall not be considered under paragraph 944-20-15-37(a) to have assumed significant insurance risk under reinsured short-duration contracts if the probability of a significant variation in either the amount or timing of payments by the reinsurer is remote. Contractual provisions that delay timely reimbursement to the ceding entity would prevent this condition from being met because they prevent the reinsurer's payments from directly varying with the claims settled under the reinsured contracts. Whether underwriting risk has transferred to the reinsurer depends on how much uncertainty about the ultimate amount of net cash flows from premiums, commissions, claims, and claim settlement expenses paid under a contract has been transferred to the reinsurer. The preceding paragraph indicates that insurance risk transfer requires that both the amount and timing of the reinsurer's payments depend on, and directly vary with, the amount and timing of claims settled under the reinsured contracts. Accordingly, the significance of the amount of underwriting risk transferred shall be evaluated in relation to the ceding entity's claims payments. The word timely is used in paragraph 944-20-15-40 in the ordinary temporal sense to refer to the length of time between payment of the underlying reinsured claims and reimbursement by the reinsurer. While the test for reasonable possibility of significant loss to the reinsurer provides for a present-value-based assessment of the economic characteristics of the reinsurance contract, the concept of timely reimbursement relates to the transfer of insurance risk (the condition in paragraph 944-20-15-41[a]), not the reasonable possibility of significant loss (the condition in paragraph 944-20-15-41[b]). Accordingly, timely reimbursement shall be evaluated based solely on the length of time between payment of the underlying reinsured claims and reimbursement by the reinsurer. The ceding entity's evaluation of whether it is reasonably possible for a reinsurer to realize a significant loss from the transaction shall be based on the present value of all cash flows between the ceding and assuming entities under reasonably possible outcomes, without regard to how the individual cash flows are characterized. The same interest rate shall be used to compute the present value of cash flows for each reasonably possible outcome tested. To be reasonable and appropriate, that rate shall reflect both of the following: - a
The expected timing of payments to the reinsurer
- b
The duration over which those cash flows are expected to be invested by the reinsurer.
All cash flows are included in the calculation in the preceding paragraph because payments that effectively represent premiums or refunds of premiums may be described in various ways under the terms of a reinsurance contract. The way a cash flow is characterized does not affect whether it should be included in determining the reinsurer's exposure to loss. Only cash flows between the ceding and assuming entities are considered, therefore precluding consideration of other expenses of the reinsurer (such as taxes and operating expenses) in the calculation.
Significance of loss shall be evaluated by comparing the following: - a
The present value of all cash flows (determined as described in paragraph 944-20-15-49) - b
The present value of the amounts paid or deemed to have been paid to the reinsurer.
Determining (for purposes of [b]) the amounts paid or deemed to have been paid for reinsurance requires an understanding of all contract provisions. For example, payments and receipts under a reinsurance contract may be settled net. The ceding entity may withhold funds as collateral or may be entitled to compensation other than recovery of claims. Gross premiums shall be used—expenses shall not be deducted from premiums in evaluating the significance of a reasonably possible loss. Because the present value of cash flows shall be determined over the period in which cash flows are reasonably expected to occur, unless commutation (termination) is expected in the scenario being evaluated, commutation shall not be assumed in the calculation. Further, the assumptions used in a scenario shall be internally consistent and economically rational for that scenario's outcome to be considered reasonably possible. If, based on the comparison in paragraph 944-20-15-51, the reinsurer is not exposed to the reasonable possibility of significant loss, the ceding entity shall be considered indemnified against loss or liability relating to insurance risk only if substantially all of the insurance risk relating to the reinsured portions of the underlying insurance contracts has been assumed by the reinsurer. That condition is met only if insignificant insurance risk is retained by the ceding entity on the reinsured portions of the underlying insurance contracts. The assessment of that condition shall be made by comparing both of the following: - a
The net cash flows of the reinsurer under the reinsurance contract
- b
The net cash flows of the ceding entity on the reinsured portions of the underlying insurance contracts.
If the economic position of the reinsurer relative to the insurer cannot be determined, the contract shall not qualify under the exception in this paragraph. The extremely narrow and limited exemption in the preceding paragraph is for contracts that reinsure either an individual risk or an underlying book of business that is inherently profitable. To qualify under that exception, no more than trivial insurance risk on the reinsured portions of the underlying insurance contracts may be retained by the ceding entity. The reinsurer's economic position shall be virtually equivalent to having written the relevant portions of the reinsured contracts directly.
To be accounted for as reinsurance, a contract that reinsures risks arising from short-duration insurance contracts must meet all of the following conditions: - a
The contract shall qualify as a short-duration contract under paragraph 944-20-15-7. - b
The contract shall not contain features that prevent the risk transfer criteria in this Subsection from being reasonably applied and those risk transfer criteria shall be met.
- c
The ultimate premium expected to be paid or received under the contract shall be reasonably estimable and allocable in proportion to the reinsurance protection provided as required by paragraphs 944-605-25-2 and 944-605-35-8.
If any of these conditions are not met, a deposit method of accounting shall be applied by the ceding and assuming entities. Condition (b) in the preceding paragraph applies to a contract and determining the substance of a contract is a judgmental matter. 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 must be considered separately for accounting purposes. Section 944-20-15 does not intend for different kinds of exposures combined in a program of reinsurance to 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 that in total meets the conditions for reinsurance accounting. Because the retrospective rating provisions of single-year retrospectively rated contracts do not create benefits or obligations in a future accounting period, other guidance, including paragraphs 720-20-25-1, 944-605-25-2(a) through (b), 944-605-25-20, and 944-605-35-8, shall be applied to those contracts. If the retrospectively rated contract contains any of the characteristics of paragraph 460-10-15-4 and does not qualify for the scope exception in paragraph 460-10-15-7(d), the guarantor would be subject to the initial recognition, initial measurement, and disclosure provisions of Subtopic 460-10. The guarantor could be the ceding entity, assuming entity, or both, depending on the terms of the retrospectively rated contract. Indemnification of the ceding entity against loss or liability relating to insurance risk in reinsurance of long-duration contracts requires the reasonable possibility that the reinsurer may realize significant loss from assuming insurance risk.
Consistent with the definition of investment contract, a contract that does not subject the reinsurer to the reasonable possibility of significant loss from the events insured by the underlying insurance contracts does not indemnify the ceding entity against insurance risk. The evaluation of mortality risk or morbidity risk in contracts that reinsure universal life-type policies shall be consistent with the criteria in paragraphs . Evaluation of the presence of insurance risk in contracts that reinsure other long-duration contracts (such as those that reinsure ordinary life contracts or contracts that provide benefits related only to illness, physical injury, or disability) also shall be consistent with those criteria. Any change or adjustment of contractual terms is considered an amendment for purposes of applying this Subtopic, including all but the most trivial changes and without distinction between financial and nonfinancial terms.
Examples of amendments include but are not limited to the following: - a
Replacing one assuming entity with another (including an affiliated entity)
- b
Modifying the contract's limit, coverage, premium, commissions, or experience-related adjustable features.
If contractual terms are amended, risk transfer shall be reassessed. For example, a contract that, upon its inception, met the conditions for reinsurance accounting under this Subsection could later be amended so that it no longer meets those conditions. The contract shall be reclassified and accounted for as a deposit in accordance with the guidance in Subtopic 340-30. Whether an amended contract in substance transfers risk shall be determined considering all of the facts and circumstances in light of risk transfer requirements. Judgment also will be required to determine whether an amendment in effect creates a new contract.
The Financial Guarantee Insurance Contracts Subsections follow the same Scope and Scope Exceptions as outlined in the General Subsection of this Section, with specific instrument qualifications and exceptions noted below.
Except as noted in the following paragraph, the guidance in the Financial Guarantee Insurance Contract Subsections applies to all
financial guarantee insurance contracts and
financial guarantee reinsurance contract.
The guidance in the Financial Guarantee Insurance Contract Subsections does not apply to any of the following:
- a
An insurance contract that is similar to a financial guarantee insurance contract (for example, mortgage guaranty insurance and credit insurance on trade receivables)
- b
A financial guarantee insurance contract accounted for as a derivative instrument within the scope of Subtopic 815-10.
An insurance entity shall consider the application of the Financial Guarantee Insurance Contracts Subsections only if the contract is not within the scope of Subtopic 815-10 and is not accounted for as a derivative instrument.The recognition and measurement provisions of the Financial Guarantee Insurance Contracts Subsections shall be applied on a contract-by-contract basis.
To be accounted for as insurance, a multiple-year retrospectively rated insurance contract must indemnify the insured as required by paragraph 944-20-15-1B. For a multiple-year retrospectively rated insurance contract accounted for as insurance, the insurer shall both: - a
Recognize an asset to the extent that the insured has an obligation to pay cash (or other consideration) to the insurer that would not have been required absent experience under the contract
- b
Recognize a liability to the extent that any cash (or other consideration) would be payable by the insurer to the insured based on experience to date under the contract.
Deposit accounting shall not be used to avoid loss recognition that would otherwise be required (for example, if the insured has no future coverage relating to the deposit with the insurer and, therefore, the deposit is not recoverable). For contracts that meet all of the conditions described in paragraph 944-20-15-55: - a
The ceding entity shall recognize a liability and the assuming entity shall recognize an asset to the extent that the ceding entity has an obligation to pay cash (or other consideration) to the reinsurer that would not have been required absent experience under the contract (for example, payments that would not have been required if losses had not been experienced). - b
The ceding entity shall recognize an asset and the assuming entity shall recognize a liability to the extent that any cash (or other consideration) would be payable from the assuming entity to the ceding entity based on experience to date under the contract.
If either party entering into a new contract in consideration for canceling a retrospectively rated contract would not have agreed to cancel the existing retrospectively rated contract unless a new contract were entered into, the two contracts are in effect the same contract for purposes of measuring assets and liabilities and shall be accounted for that way.
Paragraph 944-20-25-6 states that if either party entering into a new contract in consideration for canceling a retrospectively rated contract would not have agreed to cancel the existing retrospectively rate contract unless a new contract were entered into, the two contracts are in effect the same contract for purposes of measuring assets and liabilities and shall be accounted for that way. As indicated in paragraph 944-20-25-2(a), certain amounts are recognized by the insurer and insured to the extent that the insured has an obligation to pay cash (or other consideration) to the insurer that would not have been required absent the experience under the contract.The amount recognized in the current period shall be computed, using a with-and-without method, as the difference between the insured's total contract costs before and after the experience under the contract as of the reporting date, including costs such as premium adjustments, settlement adjustments, and impairments of coverage. The amount of premium expense related to impairments of coverage shall be measured in relation to the original contract terms. Future experience under the contract (that is, future losses and future premiums that would be paid regardless of past experience) shall not be considered in measuring the amount to be recognized. An insurer shall account for changes in coverage in the same manner as changes in other contract costs. For example, the effects of decreases in coverage without a commensurate reduction in premium shall be recognized as a gain by the insurer when the event causing the decrease in coverage takes place.
The amount recognized under paragraph 944-20-25-4 in the current period shall be computed, using a with-and-without method, as the difference between the ceding entity's total contract costs before and after the experience under the contract as of the reporting date, including costs such as premium adjustments, settlement adjustments, and impairments of coverage. The amount of premium expense related to impairments of coverage shall be measured in relation to the original contract terms. Future experience under the contract (that is, future losses and future premiums that would be paid regardless of past experience) shall not be considered in measuring the amount to be recognized. Example 1 (see paragraph
944-20-55-60) illustrates the application of this guidance.
The amount of the asset to be recognized may be affected by credit risk, and appropriate valuation allowances shall be established for any amounts deemed uncollectible. However, the ceding entity shall not consider the likelihood of future losses in evaluating whether the asset is realizable at the financial reporting date. The effect of those future losses on the asset, if any, shall be recognized in the period of the loss. Potential future unfavorable development on the incurred losses covered by the contract shall not be considered in measuring the asset at the financial reporting date. The relevant recorded claim liability at that date represents the ceding entity's best estimate of the expected ultimate claim liability, and is the liability that must be used in measuring the refundable amount based on contract experience to date. Recognizing a smaller asset based on potential unfavorable loss development implies that claim liabilities are understated at the financial reporting date. Accordingly, changes in estimates of claim liabilities shall not be recognized in measuring the related asset until the change in estimate takes place.
The remainder of this Subsection addresses the following matters:
- a
Changes in coverage
- b
Loss recognition
- c
With-and-without method
- d
Multiple contingent contractual features
- e
Payment for continuation of contract
- f
Contract cancellation.
The ceding entity and the assuming entity shall account for changes in coverage in the same manner as changes in other contract costs.
For example, the effects of decreases in coverage without a commensurate reduction in premium shall be recognized as a loss by the ceding entity and as a gain by the assuming entity when the event causing the decrease in coverage takes place.
Changes in either the probability or amount of potential future recoveries are considered a change in coverage. For example, if the contract limit stayed the same, but the ceding entity could not receive any recoveries unless losses for the industry as a whole reached a certain level, coverage has been reduced. What matters is not the specific contract provisions regarding coverage, but whether the probability or amount of potential future recoveries has increased or decreased as a result of those provisions.
Deposit accounting shall not be used to avoid loss recognition that would otherwise be required; for example, if the ceding entity has no future coverage relating to the deposit with the reinsurer and therefore the deposit is not recoverable. In some circumstances, the ceding entity will be relieved of its obligation if the reinsurer cancels the contract, and only has to pay additional amounts if either: - a
- b
The ceding entity cancels before the end of the contract term.
Unless the reinsurer has terminated the contract, the ceding entity has an obligation for the additional amounts and must recognize the related liability. The effect of termination, which is to relieve the ceding entity of its liability, shall not be recognized until termination takes place. Cash or other compensation equal to all or part of the positive fund balance received from the reinsurer if the ceding entity's contract continues in force shall be recognized as an asset because the ceding entity controls whether termination takes place and, thus, controls realization of the future economic benefit.
Paragraph 944-20-25-6 states that, if either entity entering into a new contract in consideration for canceling a retrospectively rated contract would not have agreed to cancel the existing retrospectively rate contract unless a new contract were entered into, the two contracts are in effect the same contract for purposes of measuring assets and liabilities and shall be accounted for that way. The following paragraph applies to contracts having both of the following characteristics:
- a
The ceding entity could terminate the contract before the end of its term.
- b
Termination would change the amounts paid—for example, if terminating the contract would cost less than continuing the contract in force.
The liability resulting from a contract having the characteristics in the preceding paragraph shall be measured as follows: - a
If a decision to terminate has been made, the measurement shall be based on an assumption of termination and experience to date.
- b
If a decision to terminate has not been made, the measurement shall be based on the lesser of the following:
- 1
The total incremental cost that would be paid based on the with-and-without calculation assuming experience to date and assuming termination—that is, excluding the effects of future losses and future premiums that would have been paid regardless of experience to date
- 2
The total incremental cost that would be paid based on the with-and-without calculation assuming experience to date and assuming no termination—that is, excluding the effects of future losses and future premiums that would have been paid regardless of experience to date.
As indicated in paragraph 944-20-35-18, if a decision to terminate a contract has been made, the measurement of the liability shall be based on the assumption of termination and experience to date. Otherwise, the measurement of the liability shall be based on the lesser of the following: - a
The total incremental cost that would be paid based on the with-and-without method assuming experience to date and assuming termination
- b
The total incremental cost that would be paid based on the with-and-without method assuming experience to date and assuming no termination.
The effects of future losses and future premiums that would have been paid regardless of experience to date shall be excluded from both calculations. Costs associated with the decision not to terminate shall be recognized in the period in which the future coverage is provided because those costs are associated with that future coverage. Paragraph 944-20-25-6 states that, if either party entering into a new contract in consideration for canceling a retrospectively rated contract would not have agreed to cancel the existing retrospectively rated contract unless a new contract were entered into, the two contracts are in effect the same contract for purposes of measuring assets and liabilities and shall be accounted for that way. If a ceding entity loses an asset recognized under paragraph 944-20-35-15 because it terminates the contract, the loss shall be recognized in the period termination takes place. Reinsurance contracts that are legal replacements of one insurer by another (often referred to as assumption and novation) extinguish the ceding entity's liability to the policyholder and shall result in removal of related assets and liabilities from the financial statements of the ceding entity. Reinsurance contracts in which a ceding entity is not relieved of the legal liability to its policyholder shall not result in removal of the related assets and liabilities from the ceding entity's financial statements.
Whether the liability to the policyholder has been entirely extinguished essentially is a legal question, depending on all of the facts and circumstances. See Section 405-20-40 for guidance for determining if a liability has been extinguished. Payments to policyholders that represent a return of policyholder balances are not expenses of the insurance entity and shall not be reported as such in the statement of earnings.
Amounts reported as expenses shall include all of the following: - a
Benefit claims in excess of the related policyholder balances
- b
Expenses of contract administration
- c
Interest accrued to policyholders
- d
Various other paragraphs in this Topic address presentation-related matters associated with universal life-type contracts as follows:
- a
- b
Amounts assessed for compensation—see paragraph
944-605-25-6 - c
Amounts assessed against policyholders for initiation or front end fees—see paragraph
944-605-25-5 - d
- e
Amounts that may be assessed against policyholders in future periods—see paragraph
944-40-30-17 - f
For financial statement disclosures about limited-payment and universal life-type contracts, see paragraphs . Disclosure of the specific accounting policy applied to participating life insurance contracts that meet the criteria in paragraph 944-20-15-3 shall be made in accordance with Section 235-10-50. All insurance entities shall disclose the nature, purpose, and effect of ceded reinsurance transactions on the insurance entity's operations. Ceding entities also shall disclose the fact that the insurer is not relieved of its primary obligation to the policyholder in a reinsurance transaction.
Paragraph 944-310-45-6 states that, although amounts recoverable on unasserted claims shall be reported as reinsurance recoverables, details of the amounts comprising reinsurance recoverables may be presented separately. Separate presentation or disclosure of servicing carrier activity is not precluded.
An insurance entity shall disclose information that enables users of its financial statements to understand the factors affecting the present and future recognition and measurement of financial guarantee insurance contracts.
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).
Paragraph superseded on 07/01/2010 after the end of the transition period stated in FASB Statement No. 163, Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60.
The following table identifies the changes made to this Subtopic.
See paragraph 944-20-S99-1, SAB Topic 5.N, for SEC Staff views on discounting claims liabilities related to short-duration insurance contracts. See paragraph 944-20-S99-1, SAB Topic 5.N, for SEC Staff views on discounting claims liabilities related to short-duration insurance contracts. See paragraph 944-20-S99-2, SEC Observer Comment: Accounting for the Present Value of Future Profits Resulting from the Acquisition of a Life Insurance Company, for SEC Staff views on disclosures regarding present value of future profit assets. The following is the text of SAB Topic 5.N, Discounting by Property-Casualty Insurance Companies.
Facts: A registrant which is an insurance company discounts certain unpaid claims liabilities related to short-duration FN9 insurance contracts for purposes of reporting to state regulatory authorities, using discount rates permitted or prescribed by those authorities (\"statutory rates\") which approximate 3 1/2 percent. The registrant follows the same practice in preparing its financial statements in accordance with GAAP. It proposes to change for GAAP purposes, to using a discount rate related to the historical yield on its investment portfolio (\"investment related rate\") which is represented to approximate 7 percent, and to account for the change as a change in accounting estimate, applying the investment related rate to claims settled in the current and subsequent years while the statutory rate would continue to be applied to claims settled in all prior years.
FN9 The term \"short-duration\" refers to the period of coverage (see FASB ASC paragraph 944-20-15-7 (Financial Services—Insurance Topic), not the period that the liabilities are expected to be outstanding.
Question 1: What is the staff's position with respect to discounting claims liabilities related to short-duration insurance contracts?
Interpretive Response: The staff is aware of efforts by the accounting profession to assess the circumstances under which discounting may be appropriate in financial statements. Pending authoritative guidance resulting from those efforts however, the staff will raise no objection if a registrant follows a policy for GAAP reporting purposes of:
Discounting liabilities for unpaid claims and claim adjustment expenses at the same rates that it uses for reporting to state regulatory authorities with respect to the same claims liabilities, or
Discounting liabilities with respect to settled claims under the following circumstances:
(1) The payment pattern and ultimate cost are fixed and determinable on an individual claim basis, and
(2) The discount rate used is reasonable on the facts and circumstances applicable to the registrant at the time the claims are settled.
Question 2: Does the staff agree with the registrant's proposal that the change from a statutory rate to an investment related rate be accounted for as a change in accounting estimate?
Interpretive Response: No. The staff believes that such a change involves a change in the method of applying an accounting principle, i.e., the method of selecting the discount rate was changed. The staff therefore believes that the registrant should reflect the cumulative effect of the change in accounting by applying the new selection method retroactively to liabilities for claims settled in all prior years, in accordance with the requirements of FASB ASC Topic 250, Accounting Changes and Error Corrections. Initial adoption of discounting for GAAP purposes would be treated similarly. In either case, in addition to the disclosures required by FASB ASC Topic 250 concerning the change in accounting principle, a preferability letter from the registrant's independent accountant is required.
The following is the text of SEC Observer Comment: Accounting for Intangible Assets Arising from Insurance Contracts Acquired in a Business Combination.