The Financial Accounting Standards Board is expected to issue a document Thursday proposing to improve the financial reporting of insurance contracts, including the measurement of insurance liabilities and the related effect on the statement of comprehensive income.
FASB’s proposed Accounting Standards Update, Insurance Contracts (Topic 834), would apply to all contracts that meet the definition of an insurance contract, not just those written by insurance companies.
The proposal comes a week after the International Accounting Standards Board released its own proposals for insurance accounting standards last week (see IASB Revises Proposals for Insurance Contract Accounting).
Insurance contracts were among the priority convergence projects that FASB and the IASB have been working on in as they seek to harmonize U.S. GAAP with International Financial Reporting Standards, but the two boards remain far apart as the revenue recognition, leasing and financial instruments convergence efforts have taken precedence. While U.S. GAAP already has detailed rules on insurance accounting, the IASB’s accounting principles for insurance contracts are viewed as comparatively underdeveloped.
U.S. GAAP has incrementally evolved over decades, resulting in more than one model of accounting for insurance contracts, FASB noted, some of which are inconsistent with other more recently issued guidance. International Financial Reporting Standards do not have a comprehensive standard relating to insurance contracts. These considerations, as well as overwhelming support from stakeholders, convinced FASB to work with the IASB on a joint insurance contracts project, not only to improve existing U.S. GAAP, but also to work towards a converged international standard.
“The proposed standard is intended to bring greater consistency and relevance to the accounting for contracts that transfer significant risk between parties,” said FASB Chairman Leslie F. Seidman, whose term ends this month. “Current U.S. standards on insurance have evolved over the years as new products have been introduced, leading to some inconsistencies in GAAP. The proposed standard would require a current measure of insurance contracts, including the use of updated assumptions and discounting. The proposal would provide decision-useful information about earnings, financial position and the drivers of performance for companies entering into these contracts.”
One of the most significant changes is that the guidance in the proposed update would require contracts that transfer significant insurance risk to be accounted for in a similar manner, regardless of the type of institution issuing the contract. In other words, the contractual features of the contract―not the type of insurer―would determine whether it is insurance. Consequently, the proposed standard would apply to banks, guarantors, service providers and other types of insurers, in addition to insurance companies.
The proposed accounting standard also would establish the principles that an insurer would apply in the recognition, measurement, presentation and disclosure of insurance contracts issued and reinsurance contracts held in its financial statements. It would increase the decision usefulness of the information about insurance liabilities, including the nature, amount, timing, and uncertainty of cash flows related to those liabilities, and the related effect on the statement of comprehensive income.
Under the proposal, an insurer would apply one of two measurement models based on the characteristics of the contract. The building block approach would be applied to most life, annuity and long-term health contracts, while the premium allocation approach would be applied to most property, liability and short-term health contracts, as well as some guarantees and service contracts.
Insurance contracts accounted for using the building block approach would be measured each reporting period based on the current present value of the fulfillment cash flows (the net of the expected cash inflows and cash outflows) based on the unbiased probability weighted estimate (expected value) that incorporates all relevant information and considers all features of the contract, including guarantees and options. The measurement would also include a margin that initially reflects the expected profitability of the contract.
Insurance contracts accounted for using the premium allocation approach would include a liability for remaining coverage that represents the premium written (gross cash inflows) that is not yet earned and is released in subsequent periods on the basis of the expected timing of incurred claims and benefits. A separate liability would be recorded when the claim is incurred and be measured based on the expected value of the present value of future cash flows to settle the claims and related expenses.
Under both approaches, changes in an insurer’s estimate of expected cash flows would be recorded to net income, except for the effect on the expected cash flows as a result of changes in the discount rates which would be recorded to other comprehensive income. Under both approaches, an insurer would recognize revenue in net income in proportion to the value of coverage or services provided. Claims and contract related expenses would be recognized when incurred. Any amounts received that are expected to be returned to the policyholder or the policyholder’s beneficiary regardless of whether an insured event occurs would be excluded from revenue and expenses.
FASB’s proposal was developed as part of its broader joint project with the IASB. The IASB issued its Exposure Draft on June 20, 2013. Both proposals contain similar fundamentals―most notably the use of current estimates―but differences exist. A comparison of the proposals is contained in the FASB’s proposed update.
Russ Golden, incoming chairman of FASB, noted, “The FASB will be monitoring comments received on both the IASB and the FASB Insurance Contracts proposals in order to identify ways to converge financial reporting standards in this critical area. We look forward to collaborating with the IASB as we deliberate input provided by stakeholders across the globe.”
Stakeholders are asked to review and provide comment on the proposal by Oct. 25, 2013. The proposed Accounting Standards Update includes instructions on how to submit written comments and is available at www.fasb.org. FASB In Focus documents and a podcast on the exposure document also are available on FASB’s Web site.
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