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FASB's proposed changes to accounting for insurance contracts - EY - United States

FASB's proposed changes to accounting for insurance contracts

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Insurance contracts timeline (based on expectations)

Insurance contracts timeline (based on expectations)
For many insurers, the anticipated standard could result in increased volatility exacerbating asset-liability mismatches and reduced GAAP earnings on previously profitable products.

Are you ready for FASB's proposed accounting change on insurance contracts?

The FASB's Exposure Draft (ED) is closer than many think and the implications are far-reaching and impactful. The FASB has been responsive to the concerns raised by preparers and users to date and both should continue to communicate remaining issues alongside workable solutions to produce the best possible final standard.

However, this requires an in-depth internal analysis that will take substantial time and resources and the period for impacting the final standard is running out.

The fundamental model being proposed has not changed significantly since the release of the Discussion Paper (DP) in September 2010. Contracts will likely be accounted for through one of the following methods:

  • Premium Allocation Approach (PAA), which an insurer is required to establish a Liability for Remaining Coverage (akin to unearned premiums) that is earned over a contract's coverage period. Also, a liability for claims incurred during the coverage period is initially recorded using the present value of non-premium net fulfillment cash flows and re-measured at each reporting date.
  • Building Block Approach (BBA), which requires insurers to initially record an asset or liability representing the net present value of future net fulfillment cash flows (all future inflows and outflows) that is re-measured at each reporting date, as well as a margin to eliminate any day-one gain that is earned over the life of the contract (a composite margin).

BBA measurement at inception

BBA measurement at inception

Under either model, where the present value of fulfillment cash outflows exceeds the present value of fulfillment cash inflows at inception, a loss is recorded immediately.

While tentative decisions have been made by the FASB, some of the most challenging topics remain unresolved:

  • Reducing accounting volatility
  • Accounting for participating features
  • Unbundling certain account balances and fees
  • Reinsurance
  • Presentation, transition and effective date

Far reaching impacts on data and systems expected

The concepts in the anticipated ED will have far reaching impacts on the data, systems and processes of many insurers. Accounting and finance departments will need to cope with the new accounting requirements.

Re-projecting future cash flows at each reporting date will require detailed and accurate data and models, and actuarial resources and systems may be strained by the need for current assumptions, current projections and analysis and attribution of earnings.

Linkages between front office, actuarial, finance, investment, tax and IT areas will likely require strengthening. Impacts on earnings will vary widely depending on the types of products issued.

For the Property & Casualty industry, which we expect to primarily apply the PAA, the two main changes will be the discounting of claims reserves and use of probability-weighted scenarios instead of best-estimate claim liabilities.

While some Life products will qualify for the PAA, most will be measured using the BBA model, under which the timing of earnings may change as a result of the use of a composite margin, changes in current economic and non-economic assumptions, and the use of probability-weighted scenarios to measure certain guarantees and options.

How well do you understand the impacts?

The use of current assumptions, including those consistent with observable market prices, is intended to lead to more transparent financial reporting (e.g., exposing duration mismatches between assets and liabilities). However, many insurers have argued that current, observable market prices incorporate accounting volatility that does not accurately reflect the economics of their business.

In response to these concerns, the FASB is investigating ways to record some movements in Other Comprehensive Income (OCI) instead of Net Income, but even if an OCI solution is developed, understanding and explaining the drivers of earnings, including attributing net results to multiple moving parts, will undoubtedly be a challenge for many preparers and users.

Those who best understand the impacts of the new standard are in a better position to react to challenges and capitalize on opportunities. Any strategic business decisions that result will need to be considered, developed and implemented as soon as possible. And the foundation is a strong underlying analysis.

Whether through education, gap analysis, pilot testing, model office or simply writing a comment letter, we have the professionals and experience to help companies navigate through the complexities and best position them for success.

Contact us to help you get started.

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