A unanimous FASB on August 2, 2017, confirmed that life insurance companies must update at least once a year their assumptions from mortality tables, morbidity rates, and customer policy lapses when measuring liabilities for policyholder payouts. This will be a significant shift from current U.S. GAAP, which lets insurers retain the assumptions they used about customers from the time the policies were issued. Critics have long contended that investors and analysts could be reading information in an insurance company financial statement that is years, perhaps decades, out of date, which makes it difficult to evaluate an insurer’s financial health.
The August 2 decision confirmed the crux of the FASB’s September 2016 Proposed Accounting Standards (ASU) No. 2016-330, Financial Services — Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. Insurers will be required to update assumptions at least annually, but the FASB agreed to clarify that quarterly updates will be necessary only when new information materializes that warrants a recalculation.
To calculate the cash flow changes from updating the assumptions, a 6-1 majority of the board agreed to confirm what the proposal called a catch-up adjustment through earnings. The adjustment will remeasure the liability using historical experience and updated cash flow assumptions. Insurers told the FASB that this method would be costly and complicated to use, but six of seven FASB members said it was important to keep intact as the adjustments would signal important changes and could lend more insight into future profitability.
“I’m sympathetic to the costs and think we need to do whatever we can to reduce the cost of transition and the cost of application, but really, what we’re trying to do is here is improve the transparency, which is not only going to be better for the users, but is also going to be better for the industry”, FASB member Christine Botosan said. “Because one of the things that I’ve heard as we’ve gone through the discussions is that this is an industry that faces a higher cost of capital and has a harder time raising capital because people don’t understand their accounting.”
FASB Vice Chairman James Kroeker cast the dissenting vote, siding with insurers who called for a method that did not require accessing historical data. In his view, his preferred approach would still provide an improvement over current accounting.
The board also agreed to revise a significant part of the proposal that caused consternation among insurers. The proposal said cash flow forecasts must be discounted using the yield from a current, high-quality fixed-income instrument that is updated each reporting period with the effect of the discount rate change recognized in other comprehensive income. Insurers said the interpretation of “high quality” would force them to use AA-rated instruments and overstate liabilities. In practice they usually use A- or BB-rated bonds, and the FASB agreed to clarify that an A-rated instrument was sufficient.
In addition, the FASB acquiesced to requests to make it easier for insurers to make the transition to the new accounting requirements when they become effective.
The proposal said insurers should use what standard-setters call retrospective application, meaning the new accounting methods would have to be applied to previously reported periods so investors have clear comparisons once the new requirements are effective. The proposal said if it was impracticable to apply retrospective accounting to contracts in force, an insurer could apply the proposed amendments to the contracts based on their existing book value.
But insurers said it would be difficult to revise their reported results from prior years, and the board agreed that it would allow the use of prospective application, which means that the new guidance has to be applied only for the current reporting period in which the standard becomes effective. Insurers will have the option of using the retrospective method.
The August 2 decisions applied to traditional life insurance policies and not what the industry refers to as “participating” insurance products that pay customers a portion of an insurer’s profits, which the FASB intends to discuss in the coming months.
For more information on how these changes affect your insurance company, contact Karsten Hatch at 801-313-1900.