The FASB has issued its exposure draft (ED) on insurance contracts, which proposes transformational changes in the way that insurance contracts are measured and reported by those entities issuing such contracts. The FASB and the IASB have been jointly deliberating for several years. The IASB issued its revised targeted exposure draft on insurance contracts last week.
The FASB and IASB have been working together for several years toward the goal of developing a comprehensive standard on accounting for insurance contracts that would address recognition, measurement, presentation, and disclosure.
The proposed model
A “current value” discounted cash flow measurement would be required for the insurance contract liability, with assumptions updated each period with discounting based on a liability rate, rather than an investment or pricing rate. Any excess of expected premiums over expected claims and expenses would be deferred as "margin" and amortized into income over future periods. Expected losses would be recognized immediately. In an effort to address the volatility in net income from currently measuring the insurance contracts, changes in the liability due to changes in interest rates would be recognized in other comprehensive income. In a difference from the FASB’s approach, the IASB ED calls for the measurement to include an explicit risk adjustment.
A modified approach would apply for short-duration contracts (e.g., property/casualty contracts) meeting specified criteria, similar to today’s unearned premium approach. However, unlike current US GAAP, the proposed guidance would require discounting of incurred losses with limited exceptions.
Revenue recognition and presentation would also change. For example, premiums from life insurance would no longer be recognized as revenue when due. Under the FASB’s proposal, insurance revenue would be allocated to individual periods based on the expected pattern of incurred claims and release from risk. In addition, deposit elements such as cash surrender values in life insurance products and experience adjustments in property/casualty contracts would be excluded from premium and claim information presented in the income statement.
Under the proposed guidance, there would be changes to the earnings pattern of underwriting and net investment margins and changes in the pattern and amount of revenue. In addition, there would likely be increased income statement volatility due to the requirement to update assumptions each period.
Given the wide-ranging changes being considered, entities should begin assessing the potential impact to their products, systems, and investor reporting.
Based on the views expressed during deliberations and the expected differences in the respective exposure drafts, the FASB and IASB will likely not achieve a converged standard. While the boards share the view that insurance contracts should be measured at current value, their views differ in certain key areas that could have a significant impact on the timing of earnings recognition. Such differences include the IASB’s requirement for an explicit risk adjustment, the IASB provision that changes in estimates of future coverage and services adjust the margin rather than being recorded immediately in income, and the IASB’s capitalization of acquisition costs for unsuccessful as well as successful efforts.
The standards would affect all entities that issue “insurance contracts” as broadly defined. While there are a number of exceptions, the guidance would apply to contracts as opposed to a particular class of entities, and could have implications for non-insurers, including, for example, banks that write financial guarantee products or reverse mortgages.
The boards have not proposed an effective date; however, we anticipate that the final guidance would have an effective date no earlier than 2018. Adoption is expected to require retrospective restatement of all prior periods.
Both the FASB and IASB proposals have 120-day comment periods. The boards plan to separately redeliberate in 2014, with a goal of issuing final guidance in late 2014 or early 2015.
The likely ultimate outcome of the IASB project is an IFRS standard addressing all aspects of insurance contract accounting, given that IFRS currently has no comprehensive insurance standard. While the FASB exposure draft also proposes an entirely new model, the FASB could ultimately decide that only certain changes to existing US GAAP insurance guidance are warranted.
PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams that have questions should contact the Financial Instruments team in the National Professional Services Group (1-973-236-7803).
In addition, Dataline 2013-11, issued before the exposure draft was published, provides a detailed description of the FASB’s proposal. We also provided an overview of the proposal in a webcast on June 12 which is available for replay.