Update to accounting for long-term insurance to bring major changes

The Financial Accounting Standards Board (FASB) on Aug. 15, 2018, published a long-awaited update to U.S. generally accepted accounting principles’ (GAAP) guidance for long-term insurance policies that fundamentally changes the reporting practices that have been established for years.

Accounting Standards Update (ASU) No. 2018-12, Financial Services —Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, requires companies offering long-term insurance products, such as life, annuities, long-term health-care and disability insurance, to annually review the assumptions they make about their policyholders and update the liabilities on their balance sheets if the assumptions change. The result, the FASB says, will more accurately reflect the economics of how long-term insurance works and give a clearer picture of insurance companies’ financial obligations and risks.

“I do really believe this is a meaningful improvement to the accounting here,” said FASB Vice Chairman James Kroeker.

Insurers also will be required to measure these updated liabilities using a standardized, market-observable discount interest rate based upon the yield from an upper-medium-grade, fixed-income instrument. In the FASB’s view, the discount rate required by ASU No. 2018-12 is a more conservative approach than the discount rates typically used for insurance policies that may have been written years or decades ago.

“In the late to mid-70s, people would be using 12, 15 percent discount rates; that’s not even close to the economic environment we’re in,” Kroeker said.

The update calls for three other main changes: it attempts to simplify the way insurers amortize, or spread out, the cost of acquiring new customers, it adds a bevy of new disclosure requirements about the assumptions insurers use to measure their liabilities and how they may affect future cash flows and it requires fair value measurement of what the FASB calls market risk benefits — insurance policies with features that protect customers from losses.

Public companies must comply with the updated standard for fiscal years beginning after Dec. 15, 2020, and they will have to apply the changes in their first-quarter reports for 2021. Private companies will have to begin applying the changes to their fiscal years that start after Dec. 15, 2021. Private companies will have to apply the changes for interim reporting periods during fiscal years that start after Dec. 15, 2022. The FASB said the changes can be applied ahead of the effective date.

The FASB has labeled the accounting changes “targeted,” but some accounting professionals say they will bring on significant changes to financial reporting.

“It’s a bit of a misnomer that their changes are targeted,” said insurance industry leader for an international accounting firm Gregory Galaez. “This represents a pretty substantial change.”

Insurer financial statements have long been considered opaque and impenetrable for all but the most seasoned investors and analysts. The FASB’s insurance standard represents the board’s attempt to provide investors with more transparency about insurers’ financial condition.

ASU No. 2018-12 represents more than a decade of effort for the FASB. The board started work on the amendments in 2007. At the time the board was optimistic that it could catch the wave of enthusiasm for converging U.S. GAAP with International Financial Reporting Standards (IFRS) and write a single, global accounting standard for insurance.

The enthusiasm for writing a converged, international accounting standard was short-lived. The FASB and the International Accounting standards Board (IASB) quickly learned that insurance practices on each side of the Atlantic differed too much to let them write a common set of principles. U.S. accounting practices had been established for decades and were less in need of an overhaul. The IASB was faced with the challenge of writing, virtually from scratch, a uniform standard that had to be applied globally among more than 100 nations representing diverse financial reporting practices.

In 2013, the FASB proposed an insurance update that called for wide changes to U.S. GAAP, but insurance companies balked. The FASB retrenched, splitting the effort into two parts — one for short-term policies, such as theft and fire and one for long-term policies. In 2015, the FASB issued new disclosure requirements for short-term policies. In 2016, the board proposed what it called targeted improvements to the standards for long-term policies.

Now that the update is finalized, insurers expect a sea change to financial reporting. Many insurers, including the life insurance industry’s main trade group, have backed the central premise of the amended guidance, which calls for regularly unlocking assumptions to provide more real-time estimates of liabilities. But they have also worried about their ability to comply with the changes in time for the public company 2021 effective date. The American Council of Life Insurers (ACLI) in July called the prospect of a 2021 deadline “virtually impossible.”

While 2021 is more than two years away, because of the requirement to provide comparable results when the new accounting guidance is adopted, most companies will have to start implementing the new accounting the year before the effective date. In addition, to comply with the internal control requirements of the Sarbanes-Oxley Act of 2002, companies will have to test their systems at least a quarter before the new accounting goes live and fix the problems uncovered in the testing phase, the American Council of Life Insurers (ACLI) told the FASB.

The pervasiveness of the changes means companies cannot implement the new standard manually. The availability of software solutions also is an issue.

“The concern on the timeline is, are there the right kind of systems available to do this? The answer to that is no. Those will emerge. Vendors need to do a lot of work,” said Richard de Haan, a partner at an international accounting firm.

For multiline insurers that recently implemented the FASB’s separate new disclosure requirements for short-term insurance policies, such as theft, automobile and fire, ASU No. 2018-12 is another compliance challenge. Companies that operate outside the U.S. also have to consider the effects of the IASB’s IFRS 17, Insurance Contracts, which also goes into effect in 2021.

“People have day jobs; they don’t just sit around adopting standards,” said Paul Medini, senior vice president and chief accounting officer for Chubb Ltd. “We don’t have a closet full of accountants adopting changes.”

That said, Medini said the FASB’s long-term insurance update should lend more transparency to the industry’s financial reporting and that, overall, will benefit insurers.

“To get rid of the lock-in concept is more work, but that concept has come and gone — and I think that’s a positive,” Medini said.

The FASB says the improvements to insurance accounting will outweigh the costs for companies to get ready for the new requirements. The FASB has been considering the amendments for a decade, and completing the standard marks a major step for the accounting board.

“Any delay in moving forward just pushes out even further investors’ ability to get improved results,” Kroeker said, regarding the requests for an extension on the effective date. “So we’re keeping that in mind. We’re certainly not trying to be unreasonable.”

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