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Journal entry — Insurance project — FASB tentatively decides on accounting for participating insurance contracts

Published on: Oct 29, 2015

At its meeting yesterday, the FASB tentatively decided to change the accounting model for certain types of participating contracts. Under the tentative decisions, insurers would be required to:

  • Expand the assumptions they use to measure the liability for future policy benefits to include investment yields, expected mortality, termination (lapse), expense, and dividend payments. 
  • Discount such liabilities by using a high-quality fixed-income instrument yield.
  • Calculate the effect of assumption updates by using a retrospective approach under which an insurer would (1) immediately recognize in earnings the effects of changes in cash flow assumptions and (2) initially record in other comprehensive income the effects of changes in the discount rate.

Yesterday’s tentative decisions are consistent with previous decisions reached by the Board on traditional long-duration contracts and would closely align the accounting models for these types of contracts.

As it would under the model the FASB tentatively approved for traditional long-duration contracts, an insurer that updates its assumptions for these participating contracts would calculate a revised net premium ratio (computed as the present value of future policy benefits as redefined above, divided by the present value of future net premiums) by using its actual historical experience and its updated cash flow projections based on the revised assumptions, excluding the impact of changes in the discount rate. It would then (1) recognize a cumulative catch-up adjustment in earnings for the current period to adjust its liability for future policy benefits to the amount that would have been recorded had the revised net premium ratio been applied since contract inception and (2) accrue the liability for future policy benefits in future periods on the basis of the revised net premium ratio. The changes in the liability attributable to changes in the discount rate would be (1) recognized immediately in other comprehensive income and (2) reclassified to earnings over the life of the liability. Further, an insurer’s revised net premium ratio could not exceed 100 percent, to preclude deferral of any anticipated losses into future periods.

The Board will continue to deliberate its project on long-duration insurance contracts at future meetings.

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