ASU 2018-12 Long Duration Standard – Implications and Peer Review for U.S. Life Insurers

In August 2018, the FASB issued ASU 2018-12, “Financial Services - Insurance, Targeted Improvements to the Accounting for Long-Duration Contracts” (The ASU).??The FASB’s objective was to improve, simplify and enhance the accounting and disclosure requirements for long-duration contracts.??The new guidance will significantly impact how insurers account for long-duration contracts including traditional life, term life, life-contingent immediate annuities and certain voluntary accident and health insurance products such as long-term care.??It will also materially change existing income recognition, reserve measurement, presentation, and disclosure requirements.??In a review of the year-end 2020 financial statements of 38 insurers, including five mutual and three foreign-owned U.S. insurers that publicly provide GAAP financial statements, 22 companies expect ASU 2018-12 to have a significant/material/pervasive impact on their consolidated financial statements.??The other 16 reported they were still assessing its potential impact.?

Key issues addressed in the new guidance include: 1) requirement to review and, if there is a change, update cash flow assumptions for the liability for future policy benefits at least annually, and to update the discount rate assumption quarterly, 2) accounting for market risk benefits at fair value, 3) simplified amortization for deferred acquisition costs, and 4) enhanced financial statement presentation and disclosures. Going forward, under ASU 2018-12 these will applied on a more uniform consistent basis across different product types as opposed to existing GAAP that mandates some products such as long-term care be reported using original historic “locked-in” pricing assumptions whereas others like variable annuities are valued based on current experience and market conditions.???

Beyond the initial balance sheet impact upon ASU 2018-12’s adoption, there will also be a change in the pattern of future profit emergence.??However, while the requirements of the new guidance represent a material change from existing GAAP, the underlying economics and related cash flows for insurance contracts are unchanged.??Also, as ASU 2018-12 is only applicable to the measurements of long-duration insurance liabilities under GAAP, it will not affect the accounting for insurance reserves or the levels of capital and surplus under statutory accounting practices.

Both conceptually and operationally, it poses the most significant change to accounting for insurance products since the FASB issued FAS 97 back in Dec. 1987.??However, compared to what insurers subject to International Accounting regulations and the pending implementation of IFRS 17 are facing, the implementation of 2018-12 will be a far less organizationally complex and substantially less costly process to implement.??IFRS 17 is also scheduled to take effect at the beginning of 2023 and will essentially entail a complete re-design/re-build of an insurer’s accounting and reporting systems.?

?Over the next year, insurers will need to make some key decisions including:??1) use of modified retrospective vs. full retrospective for traditional contracts; 2) level policy aggregation; 3) approach for reinsurance; 4) DAC/DSI)/Value of Business Acquired (VOBA) amortization approach (e.g., seriatim vs. cohort); and 5) sequencing of MRBs going forward.

For those that indicated they anticipated the impact to be significant, key areas included:

·??????transitioning from an original investment-based discount rate to one based on an upper-medium grade fixed income investment yield such as fixed annuities.

·??????updates to mortality/morbidity/experience assumptions on products for which these had previously been locked in at issuance such as LTC.

·??????requirement to measure all annuity guarantees at fair value which may also lead to changes in variable annuity exposure risk management strategies.??

·??????material decrease in stockholders’ equity which in turn could have an adverse effect on financial leverage ratios.

·??????increased market sensitivity of financial statements and operating results may lead some insurers to make significant changes to product offerings and business strategy.

·??????significant changes to accounting, reporting and risk management systems.??

Since its initial issuance, the FASB has deferred the ASU’s effective date for two years.??The amendments are now effective for SEC filers that are not small reporting companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022.??For all other entities the effective date is now for fiscal years beginning after December 15, 2024, or interim periods after December 15, 2025.