Targeted Improvements to the Accounting for Long-Duration Contracts
On August 15, 2018, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that changes some of the established methodology and assumption setting for financial reporting under US GAAP for insurance companies that issue long-duration contracts, such as life insurance, disability income, long-term care, and annuities. Commonly referred to as Targeted Improvements for GAAP, this update followed ten years of deliberation and consultation, including an initial effort to converge with International Financial Reporting Standards (IFRS), that was subsequently abandoned in favour of a more selective targeted improvements approach.
Highlights of the changes required under the ASU 2018-12 include:
- Current Assumptions
Assumptions used to measure the liability for traditional insurance contracts, which were previously determined at contract inception, and considered locked in, will now be reviewed - and, if there is a change, updated at least annually - with the effect recorded in net income.
- Discount Rate
A more prescribed approach will be applied to set the current discount rate for liability measurement. Previously companies established the discount rate for the calculation of liabilities based on the rates they expected to earn. The liability discount rate will now be a standardized, market-observable discount rate (upper-medium grade fixed-income instrument yield), with the effect of rate changes recorded in other comprehensive income.
- Market Risk Benefits
Greater consistency is now applied in measurement of market risk benefits among products. Market risk benefits are provisions in insurance contracts that protect against the impact of capital market losses. The two previous measurement models have been reduced to one measurement model (fair value), resulting in greater uniformity across similar market-based benefits and better alignment with the fair value measurement of derivatives used to hedge capital market risk.
- DAC Amortization
A simplified approach has been introduced for amortization of deferred acquisition costs. Previous earnings-based amortization methods have been replaced with a more level constant rate amortization over the expected life of the contract. The deferred amortization cost balances will not be subject to testing for recoverability but will be held as long as the related contracts remain in force.
- Enhanced Disclosures
New disclosures will be required to accompany financial statements. They include roll-forwards of liability balances that reveal the reasons for the change and information about significant assumptions and the effects of changes in those assumptions.
Effective Date of ASU 2018-12
When first published in 2018, the ASU called for the changes to be effective in 2021 for most publicly reported insurance companies, and in 2022 for others. However, a year later in August 2019, they announced a proposal to delay the effective date by at least one year, and in November, 2019, FASB issued ASU 2019-09 which deferred the effective date for larger publicly reporting entities until 2022, and consistent with a new philosophy to stagger effective dates between large publicly traded companies and all other companies and organizations, to delay the effective date for all other entities by three years until 2024.
Subsequently, in June 2020, FASB approved a proposal for a further one year delay in the effective date for all entities, until 2023 and 2025, according to type and size of the entity.
How will Moody's Analytics support ASU 2018-12?
The changes to US GAAP accounting for life insurance products are significant and have pervasive impact on both actuarial modeling software and the way that software must be used to support the valuation and financial reporting process. Moody's Analytics is extending the capabilities of AXIS and its existing liability modules to support the new requirements in the ASU for the determination of the various actuarial balances at the valuation date and to enable financial projections reflecting the new methodologies. Much of this work builds on valuation methodologies previously supported, with enhancements to system structure and new interfaces to address the new challenges in cohort definition and data requirements.
However the new standard also imposes a great deal more actuarial model calculations to support current period reporting, in the form of increased numbers of runs with recalculations of balances under multiple sets of assumptions and multiple input files. New US GAAP Link modules corresponding to each liability module, will help make the work to produce these runs and assemble the resulting report values smoother and more efficient, and will improve governance and controls on the process. Including the new US GAAP Link modules, the AXIS solution will support:
- The application of ASU 2018-12 to life insurance, annuity and disability products for both the calculation of current date accounting liabilities and the projection of those liabilities over future periods
- The accumulation of historical data by cohort needed to unlock the new net premium calculation at each future reporting period
- The derivation of appropriate amounts of profit or loss, and other comprehensive income for the current reporting period and for projecting future financial statements reflecting ASU 2018-12 and the accounting options available
- Efficient batch recalculation options and assumption management to facilitate extraction of results of the above calculations and the changes in balances over the reporting period to support analytics and disclosures
For more details on the Moody's Analytics solution for ASU 2018-12, refer to the AXIS Solution Strategy and other content available in this AXIS US GAAP ASU Project Microsite.