Authored by Matthew Johnson
For insurance organizations accounting under Generally Accepted Accounting Principles in the United States (GAAP), many changes to your accounting will impact in 2018. Understand what changes are coming and prepare your organization for those in the future.
GAAP: Key changes
Revenue from Contracts with Customers, Accountings Standards Codification Topic (ASC) 606
To whom does this apply? Organizations who prepares GAAP financial statements and those insurers who have revenues from premiums other than the explicitly excluded insurance contracts.
Many insurance organizations initially believed ASC 606, Revenue from Contracts with Customers would not affect them since insurance contracts are out of scope. However, many insurers have additional revenue streams that fall under the new accounting standard. Insurance entities that have revenues not explicitly excluded will need to complete the five-step approach to revenue recognition, which includes:
- Identify the contract with the customer
- Identify the performance obligation in the contract
- Determine the transaction price
- Allocate the transaction price to each performance obligation
- Recognize revenue as the entity satisfied the performance obligation
Insurers will also be required to add more detailed disclosures to help financial statement users understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
This might include insurance related entities (managing general agents, agents, brokers and third-party administrators), administrative services only contracts, asset management contracts, and insurance or reinsurance brokerage arrangements.
The changes to ASC 606 are effective for public business entities for annual reporting periods beginning after Dec. 15, 2017 and all other organizations for annual reporting periods beginning after Dec. 15, 2018. Implementation is permitted using either full retrospective or modified retrospective approaches, as described further in the standard. Because of the retrospective nature of adoption, entities need to do much of the work surrounding this standard earlier to ensure appropriate accounting in the period and reduce rework or potential adjustments down the road.
Baker Tilly has a variety of resources to aid entities with implementation of this standard.
Short-Duration Contacts, ASC 944
To whom does this apply? Anyone who prepares GAAP financial statements and those insurers that issue short-duration contracts (typically property and casualty and/or accident and health insurance contracts).
ASC 944, Disclosures about Short-Duration Contracts requires insurance entities to disaggregate disclosures about the liability for unpaid claims and claims adjustment expenses for short-duration contracts. It also entails adding disclosures to the footnotes to the financial statements designed to increase transparency of significant estimates made in measuring claims liabilities and provide users more information to facilitate their analysis of nature, timing, amount and uncertainty of claim cash flows.
In implementing this new standard, entities have come across a number of issues largely related to the sufficiency of the disaggregated detail required. Some of this has come from typical first year issues (e.g., deciding what level of disaggregation is appropriate). Others are caused by acquisition or disposal of businesses, treatment of reinsurance transactions and foreign currency translation adjustments.
These changes are effective for public business entities’ 2016 annual reporting period and all other organizations’ 2017 annual reporting period. Early adoption was also permitted.
Long-Duration Contracts (exposure draft only)
To whom does this apply? Anyone who prepares GAAP financial statements and those insurers that issue long-duration contracts.
The current exposure draft from the Financial Accounting Standards Board (FASB) includes four main areas of focus:
- Liability for future policyholder benefits
- Deferred acquisition costs
- Additional liability for benefit features
For the liability for future policyholder benefits, the cash flow assumptions in the net premium model should be reviewed and updated on an annual basis at the same time every year. Updates should also be applied retrospectively through earnings. In addition, the net premium model would be restricted, capping the net premium ratio at 100 percent with the liability never being less than zero.
Deferred acquisition costs (DAC) are to be amortized over the expected life of the book of contracts in proportion to the undiscounted amount of insurance in-force. If this amount in-force cannot be reasonably estimated, it should be amortized on a straight-line basis. Amortization rates should be updated prospectively and DAC should be reduced when actual terminations and lapses are greater than expected. This will eliminate the interest accretion and impairment assessment.
FASB is working to simplify and improve accounting around certain benefits embedded in variable contracts. Fair value accounting would be required for guarantees with other-than-nominal capital market risk that are associated with separate account products, including guaranteed minimum death benefits. Changes in fair value recognized in earnings except for changes related to instrument-specific credit risk recorded in other comprehensive income (OCI).
The exposure draft would require the following for all insurance liabilities and DAC: disaggregated rollforwards, qualitative and quantitative information about assumptions and estimates, and reconciliation to the carrying amount and certain income statement activity.
Comment letters were received in 2016 followed by a public roundtable that was held in April 2017. The draft is currently being discussed by FASB, with the anticipated effective date of 2021 appearing likely.
Consolidation, Accounting Standards Update (ASU) 2015-02
To whom does this apply? Anyone who prepares GAAP financial statements and does any of the following:
- Holds investments in partnerships or similar entities (often called “alternative investments”)
- Limited partnership agreements that include substantive kick-out rights, significant cash transactions between their entity and the partnership beyond normal fees, and other related party relationships.
Under ASU 2015-02, Consolidation, a new consolidation analysis must be completed using two different models: voting interest and variable interest. There is also a specialized consolidation model and guidance for limited partnerships and similar entities. In addition, there is no longer a presumption that the general partner will consolidate the limited partnership.
ASU 2015-02 eliminated three of the previous six criteria that needed to be evaluated to determine whether an entity has a variable interest. If the entity concludes fees paid represent an interest in a variable interest entity (VIE), it must evaluate whether the interest represents a controlling financial interest.
For single decision makers, related party relationships are considered indirectly on a proportionate basis, rather than in their entirety. Consideration in entirety is required for entities under common control only if the common control group has the characteristics of a primary beneficiary. If the second assessment is not applicable, but substantially all activities of the VIE are conducted on behalf of a single variable interest holder, excluding the decision maker, in a related party group that has the characteristics of a primary beneficiary, that single variable interest holder must consolidate the VIE.
These changes were effective for public business entities for annual reporting periods beginning after Dec. 15, 2015 and all other organizations for annual reporting periods beginning after Dec. 15, 2016.
Financial Instruments, ASU 2016-01
To whom does this apply? Anyone who prepares GAAP financial statements and holds investments in common stocks or alternative investments such as partnerships, LLPs, LLCs, hedge funds, private equity funds, etc.
ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities requires equity investments to be measured at fair value with changes in fair value recognized through net income. Additionally, separate presentation in other comprehensive income of the portion of total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value. Certain fair value disclosure requirements are also eliminated.
Investments in scope are equity investments in securities and other ownership interests. Also, rights to acquire or dispose of an ownership interest at a fixed or determinable price are included in scope. Those investments accounted for with equity method and derivative instruments under ASC 815, Derivatives and Hedging are out of scope.
These changes are effective for public business entities for annual reporting periods beginning after Dec. 15, 2017 and all other organizations for annual reporting periods beginning after Dec. 15, 2018.
Leases, ASU 2016-02
To whom does this apply? Anyone who prepares GAAP financial statements and holds material leases greater than one year.
Under ASU 2016-02, Leases (Topic 842), lessees are required to recognize assets and liabilities for most leases that are now being recorded as operating leases. Existing real estate-specific guidance were eliminated with certain new presentation and disclosure requirements added.
These changes are effective for public business entities for annual reporting periods beginning after Dec. 15, 2018 and all other organizations for annual reporting periods beginning after Dec. 15, 2019.
Credit Losses, ASU 2016-13
To whom does this apply? Anyone who prepares GAAP financial statements and has assets with a component of credit losses.
Under ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measure of Credit Losses on Financial Instruments, trade and other receivables (including reinsurance), held-to-maturity debt securities, loans and other instruments, entities will be required to use a new forward-looking “expected loss” model that generally will result in the earlier recognition of allowances for losses.
For available-for-sale debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities.
Entities will have to disclose significantly more information, including what they use to track credit quality by year of origination for most financing receivables.
These changes are effective for SEC filers for annual reporting periods beginning after Dec. 15, 2019 and all other organizations for annual reporting periods beginning after Dec. 15, 2020.
Additional GAAP updates to consider
Below are two additional accounting updates to pay attention to as we move into 2018:
- ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
- ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
For more information on this topic, or to learn how Baker Tilly's team of industry specialists can help, contact our team.