Product Classification

Question 1

ASC 844 Contract Classificaton ( Accounting Standard Codification)

Answer 1

ASC 944 applies only to insurance entities. Insurance contracts issued by non-insurance entities (e.g. a manufacturer’s warrenty) are accounted for under a different standard

** Contracts issued by insurance entities are classified as either short-or long duration **

Short-duration contracts have a single measurement model
Long-duration contracts have multiple models based on the type of insurance contract
Reinsurance contracts are also classified as either short- or long-duration

Question 2

Contract Classification

Answer 2

Contracs should be assessed individually ( not in group) and only at issue
the contract must transfer other-than-nominal insurance risk
Insurance risk = underwriting risk + timing risk

** It is possible for a contract to be classified as insurance under GAAP but not other accounting standards ( IFRS, statutory, etc)**

Question 3

Significance of Insurance Risk in Life and Health Contracts

Answer 3

UL contracts with higher PHABs may require additional analysis:
1. Determine a significance ration = PV (Excess Payment) / PV ( Assessments)
where Excess payments = benefit paymetns in excess of the policyholder account balance (PHAB)
Assessements = amounts assessed to the contract including investment margins

• investment margin = (net inv rate - credited rate ) x PHAB

** There is no specific threshold for the significance ratio (judgement required), but the higher the ratio, the more signficant the mortality/morbidity risk. If the ratio is too low, it is not insurance **

A single premium UL (SPUL) policy would have a very high initial PHAB, which would generate large investment margins for the life of the contract - ( e.g. 4% significance ratio - authors says too low but no specific cutoff)

** Since the 1980s, tax law required UL DBs to be sufficiently larger than PBABs to receive favorable tax status ** - A single premium UL policy would most likely not qualify as life insurance for tax purposes.Tax law requires the DB to ratchet up if the policyholder pays in a lot of premium which indirectly limits the investment margin.

Question 4

Significance of Insurance Risk in Annuity Contracts

Answer 4

** There is no prescribed approach for assessing the remoteness of life-contingent payment**

PV ( Life-contingent Payments) / PV ( Total Payments)

As long as this ratio exceeds 5% to 10% , the annuity should be classified as an insurnace contract. The ratio will be lower for older issue ages, and longer certain periods ( e.g. 30 year certain and life annuity issued to a 65 year old would have a very low probability of LC payments - would be considered an investment contract)

Question 5

Additional Accounting Model

Answer 5

1. ASC 944 market risk benefit (MRBs) -most common GMxBs on VAs
   MRB = contract or contract feature that both provides protection to the policyholder from capital market risk and exposes the insurer to other-than-nominal capital market risk

Accounted for at FV (fair value) and shown separately from other items in financial statments.
Change in FV goes through income except for the portion attributable to a change in the insurer’s own credit risk, which is reported in OCI

2. ASC 815 embedded derivatives
   A contract is a derivative if all 3 ASC 815 criteria are met:
   a) contains an underlying and one or more notional amounts or payment provisions
   b) does not require an initial net investment to enter the contract
   c) contract terms permit/ require net settlment or allow for delivery of an asset of similar value
   ** some insurance contracts have embedded derivatives that can be separated from the hos contract ( IUL or indexed annuities) - Account for the embedded derivative under ASC 815 and the host contract under ASC 944**

ASC 606 Revenue recognition for non-financial goods or services
Road side assistance, cybersecurity activities, title insurance, fee-for-service arrangements, pension administration

Question 6

Short Duration Measurement Model

Answer 6

Only one short-duration measurement model under ASC 944

1. Recognize premiums as revenue over the coverage period to the amount of insurance protection provided

Liability = gross unearned premium reserve whether the premium is eanred ratably over the premium period
Usually done on a straight-line basis: if an annual premium is paid BOY, the liability at Q1 =75%

Establish cliam liabilities for ICOS, IBNR, etc. using current estimates of future claims payments

Question 7

Assessment of Contract Duration

Answer 7

Noncancelable - insurer is not allowed to cancel the policy or increase premiums for any reason

Guaranteed renewable - insurer cannot unilaterally cancel the polcy, but the premium rates may be increased subject to certain conditions (e.g. regulatory approval or adverse experience)
- YRT reinsurance on long-duration life insurance is generally considered long-duration as well.

Question 8

Long Duration Measurement Models

Answer 8

1. Traditional and limited-payment contracts
2. UL-type and non-traditional contracts
3. Certain participating life insurnace contracts

Question 9

Traditional and Limited Payment Contracts

Answer 9

Traditional and Limited Payment Contracts
* for all - liability for future policyholder benefits (LFPB) uses a net premium ratio approach
* Update liability assumptions at least annually using current estimates
* Measure LFPB at both the original and current discount rate ( an upper-medium grade yield)
* Establish claim liabilities for pending, resisted and IBNR

Limited Payment contracts: also establish a deferred profit liability (DPL)

Defers the GP in excess of NP used in the benefit liability
Amortize against insurance inforce ( or benefit payments for annuities)

Question 10

UL-Type and Non-Traditional Contracts

Answer 10

Liability is sum of
1. policyholder account balance (most significant)
2. Additional liability for excess benefits or profits followed by losses
3. Sales inducement liabilities and assets (SILs and SIAs) - immediate bonuses, persistency bonuses, enhanced crediting rates
4. Unearned revenue liability (URL)
5. Premium deficiency liability

Question 11

Certain Participating Life Insurance Contracts

Answer 11

par policies follows contribution principle have
1. long-duration contracts expected to pay policyholder dividends based on the insurer’s actual experience
2. Annual policyholder dividends are paid in a manner that both a)identifies divisible surplus b) distributes surplus according to the contribution principle

Liabilities are
1. NLP reserve for death and endowment benefits +
2. Terminal dividend liability +
3. Liability for loss recognition (premium deficiency)
4. Policyholder dividend obligation for closed blocks resulting from demutualization

ICOS and IBNR have no prescribed approaches under GAAP.

Question 12

Investment Contracts

Answer 12

ASC 944 guidance says to treat investment contracts similarly to interest bearing or other financial instruments
1. Non-account value investment contracts, non-life contingnet payout annuities, follow the interest method and liability = PV of benefits using an effective yield that equates actual deposits and expected future deposits with the actual payments and expected future payments on the contract over its lifetime

2. Account value investment contracts
   Follow deposit accounting (similar to bank deposits, loan) and liability = account value

Reinsurance agreements that do not transfer sufficient insurance risk also follow deposit accounting, such product like a surplus relief contract