Review of Accounting Pronouncements presentation files

Cayman Islands Society of
Professional Accountants
Insurance Subcommittee of the
Public Practice Committee
Insurance Hot Topics
Risk transfer
Deposit accounting
Special purpose contracts (e.g. LPT, novation, commutation, etc.)
Premium deficiencies
U.S. GAAP update
Risk transfer
Risk transfer
Any transaction, regardless of its form, whose individual terms indemnify an
insured against loss or liability relating to insurance risk
Obtain a complete understanding of all contractual features that:
Limit the amount of insurance risk to which the insurer is subject
Delay the timely reimbursement of claims by the insurer
Agreement must transfer SIGNIFICANT insurance risk which includes BOTH underwriting risk and timing
Risk transfer
Short-duration contracts
Transfer of significant insurance risk;
 It is reasonably possible that the insurer may realize a significant loss from the transaction.
Risk transfer
Finite Reinsurance/Insurance – Does risk transfer?
Sliding scale commissions
Profit sharing formulae
Experience refunds
Loss corridors
Dual triggers
Retrospectively-rated premiums
Reinstatement premiums
Termination/commutation provisions
Funds withheld accounts
Thinly capitalized offshore reinsurance companies
Finite Reinsurance/Insurance
Reinsurance or insurance that transfers only a finite or limited amount of risk. Risk is reduced through
accounting or financial methods, along with the actual transfer of economic risk. By transferring less risk
to the reinsurer, the direct insurer or policyholder receives coverage on its potential claims at a lower cost
than “traditional” reinsurance or insurance.
Premium funding
The amount an insurer charges to provide the coverage described in the policy.
Parameters of funding
losses and
operating costs
- premium +
Risk transfer
Must be reasonably possible to
incur a significant loss (i.e.
10% chance of a 10% loss)
Use of
• Deposit accounting
Premium funding
Approaches for setting premium:
 Actuarial estimate for funding based on past loss experience.
 Industry rates, with a level of discounting to remove profit element.
Industry pressures:
 Growing bias due to cash flow needs to keep premium low, leading to a rise in
longer term liquidity and solvency problems.
 As a contrast, it was common in the past to set premium above maximum cap,
leading to risk transfer problems.
Premium funding
 Use “retrospective-rating” mechanism:
 Initial funding is set at predetermined level (this helps with cash flow needs,
as initial premium can be quite low).
 Both retrospectively-rated and swing-rated policies may have a mechanism to
assess additional funding (must be careful not to breach maximum cap, result
in risk transfer issues).
Deposit accounting
Deposit accounting
Deposit accounting is applied when:
Only timing risk is transferred
 Only underwriting risk is transferred
 No transfer of significant timing or underwriting risk
 The risk cannot be determined
U.S. GAAP guidance for deposit accounting:
ASC 944, Financial Services — Insurance
 ASC 340-30, Insurance contracts that do not transfer insurance risk (which includes guidance from
AICPA’s Statement of Position 98-7 Deposit Accounting)
Deposit accounting
What is recorded in the deposit liability account?
Deposit premiums/funding
 Subsequent premium adjustments/assessments
 Losses paid/payable
Depending on the terms of the contract, the following can also be recorded in the
deposit liability:
IBNR / case reserves
 Net investment income
 Administrative expenses
 Yield adjustment due to changes in actual and estimated timing and amounts of cash flows
Deposit accounting
Example calculation of effective yield adjustment:
Special purpose contracts (e.g. LPT, novation,
commutation, etc.)
Loss portfolio transfers
What is a loss portfolio transfer “LPT”?
A transaction where a ceding entity transfers a portfolio of claim liabilities (or book of business) to an
assuming company.
 It is a process, not a contract, but it requires underlying contractual agreements.
 The underlying contract specifies where the rights and obligation resides, and therefore dictates
accounting treatment.
Common Forms of LPT’s
Mergers/acquisitions – loss portfolios transfer on consolidation
 Reinsurance – transfer the risk of loss portfolio
 Commutation – cancellation and release of loss portfolio
 Novation – transfer of loss portfolio to another company
Loss portfolio transfers
Contract types:
(claims made)
Report date
Report date
Report date
Loss portfolio transfers
Retroactive contracts
Report date
Transfer of reported claim
Transfer risk of ALD
Onshore RRG
Offshore RRG
Assets: 100
Assets: 100
Funding for reported claim
Insurance reserves:
Insurance reserves:
Funding for risk of adverse
loss development
Equity: 20
Deferred gain: 20
Excess funding ????
Loss portfolio transfers
Accounting treatment
Liability funding
Loss reserves
Case reserves plus IBNR
Accounting Treatment
 Funding at expected level is credited to loss reserves in
the balance sheet.
 Subsequent movements flow through the income
Excess funding
Amount of funding in
excess of value of loss
 Technically, between third parties, the excess funding is
considered to be a gain on transfer and should be
amortized over the expected life of the underlying
contract. Any loss is recognized immediately in the
statement of income on Day 1.
Loss portfolio transfers
LPT type 1 – Retroactive insurance/reinsurance
 Ceding company transfers book of business by simply entering into a reinsurance
agreement with a third party reinsurer.
Two parties involved – ceding company and reinsurer.
Under FAS 113 the ceding company must still disclose the liabilities gross of
reinsurance as well as the reinsurance recoverable.
The ceding company is still responsible for these liabilities regardless of whether
they recover reinsurance or not.
Transaction scope is limited to liabilities (ie: IBNR and/or case reserves) as of the
valuation date.
Preferable to make transfer at expected level (net of gains).
Loss portfolio transfers
LPT type 2 – Commutation
 The ceding company passes the right and obligation of the underlying liabilities to
another party in return for consideration (two party transaction).
The ceding company therefore extinguishes their obligations and therefore does
not need to record any liability subsequent to the transaction date.
Assuming company must record liabilities under GAAP.
Captives are encouraged to use net-based pricing (ie: transfer liabilities at their
value at transaction date without any gains).
Any gains are deferred and amortized over the payout period.
Loss portfolio transfers
LPT type 3 – Novation
 A legal agreement where one insurer is being replaced by another insurer.
 Underlying insured must also be involved in agreement, therefore involves three
parties, insured, original insurer and replacement insurer.
Replacement insurer agrees to “stand in place” of the original insurer and assumes
rights and obligations under the initial contract.
The new contract maintains the same terms and conditions with the insured.
Original insured’s liabilities are extinguished.
Replacement insurer recognizes a premium.
Replacement insurer must assume all contractual responsibilities (example –
claims handling).
Loss portfolio transfers
 It is important to understand the purpose of the LPT and the intended outcome.
 The type of LPT and the supporting contract structure help dictate the appropriate
accounting treatment.
 There is no magic bullet approach with respect to accounting treatment for LPTs.
 The case specifics must be considered.
 Encourage the client to engage us in dialogue early on in the process.
Special purpose contracts – Tail coverage
Accounting guidance for tail liabilities on a claims made basis
Type and scope of coverage impacts type of accounting treatment as follows:
1. Commercial coverage – unlimited extended reporting period
 This is effectively an occurrence based policy.
 Premium recognized as 100% earned at inception of contract over the occurrence
 IBNR reserve is based on actuarial estimates.
2. Commercial coverage – limited extended reporting period
 Premium is deferred as UEP and earned pro-rata over risk period.
 Reserves established as claims are incurred.
Special purpose contracts – Tail coverage
Accounting guidance for tail liabilities, continued
Type and scope of coverage impacts type of accounting treatment as follows:
3. Retroactive insurance – unlimited reporting period
 Consideration received is credited to reserves, and movement flows through
income statement.
4. Deferred tail coverage triggered by physician withdrawal
 Premium is deferred as UEP until event is triggered (i.e. withdrawal)
 Premium is then earned over risk period.
 Reserves established as claims are incurred.
Special purpose contracts – Tail coverage
Accounting guidance for tail liabilities, continued
Insurance companies may offer separate policies providing only extended reporting
period coverage to insureds whose claims-made policies are expiring. The coverage
afforded by these policies is commonly referred to as “tail coverages”. Adding tail
coverage to a claims-made policy may, in substance, create an occurrence based
insurance policy. The tail coverage may be for a definite or an indefinite period of
If the policy gives the insured a unilateral option to purchase tail coverage at a
premium not to exceed a specified fixed maximum, we believe the Company should
record liabilities as if it was an occurrence based policy.
Premium deficiencies
Premium deficiencies
Recognize a premium deficiency if:
 Expected claims costs
 Claim adjustment
 Expected dividends to
 Unamortized
acquisition costs
 Maintenance costs
is greater than
Related unearned
Premium deficiencies
 Insurance contracts should be grouped consistent with the enterprise’s manner of
acquiring, servicing and measuring the profitability of its insurance contracts.
 Anticipated investment income may be considered when determining if premium
deficiency exists.
Recognized by:
 Charge unamortized acquisition costs to expense up to amount to eliminate
 If still not enough, accrue liability for excess deficiency.
U.S. GAAP update
U.S. GAAP update
2014 Update on the Insurance Project
 During February 2014, FASB limited the scope to insurance entities only.
 Short-duration contracts (focus on improvements to disclosures only).
 Long-duration contracts (focus on improvements to measurement and comparison with
 Likely to lead to further non-convergence between FASB and IASB.
Other new standards issued by FASB during 2014
 Going Concern (effective for periods ending after Dec 31, 2016)
2014 Update on the Insurance Project
February 19, 2014 FASB meeting
The FASB changed direction on its insurance contracts project, moving away from its joint
project with the IASB that would have resulted in a comprehensive change to the insurance
contract accounting model. The FASB decided instead to focus on making targeted
improvements to US GAAP accounting for long duration contracts (which principally consist
of certain life and annuity contracts), and enhancing disclosures for short duration insurance
contracts (which consist principally of property/casualty insurance contracts).
2014 Update on the Insurance Project
April 16, 2014 FASB meeting
The FASB developed the list of potential targeted improvements to long duration contract
accounting and short duration contract disclosures that it expects to deliberate at future
For short duration contracts, the FASB expects to consider potential enhanced disclosures in
the following areas:
 incurred and paid loss development tables;
 claim reserve duration in time bands;
 information about the frequency and severity of claims;
 qualitative and quantitative information about claims estimates;
 information about premium deficiency testing; and
 for those liabilities for which discounting is elected, the amount of the discount.
The FASB decided not to pursue potential changes to the existing “premiums due” revenue
recognition model.
2014 Update on the Insurance Project
August 13, 2014 FASB meeting
The FASB continued its discussions of disclosures about short-duration contracts and made
the following decisions:
Incurred and paid claims development tables: The Board affirmed its previous decision
that incurred and paid claims development tables should be disclosed in the financial
statement footnotes and that those disclosures need not go back more than 10 years,
but that they should present information for the number of years for which claims
incurred typically remain outstanding.
Health Insurance Claims: The Board decided that insurance entities that issue shortduration insurance contracts should disclose in their interim and annual financial
statements the incurred but not reported liabilities included in the liability for unpaid
claims and claim adjustment expenses for health insurance claims, either as a separate
disclosure or as a component of the rollforward of the liability for unpaid claims and
claim adjustment expenses. The rollforward should be disaggregated so that useful
information is not obscured by either the inclusion of a large amount of insignificant
detail or the aggregation of items that have different characteristics.
2014 Update on the Insurance Project
August 13, 2014 FASB meeting, continued
The FASB continued its discussions of disclosures about short-duration contracts and made
the following decisions:
Effective Date: The Board decided that for public business entities, the final guidance
should be effective for annual reporting periods beginning after December 15, 2014, and
interim reporting periods within annual reporting periods beginning after December 15,
2015. The Board decided on a one-year delay for all other entities. The Board also
decided to allow early adoption for all entities.
Next Step - The Board directed the staff to draft an Accounting Standards Update for vote by
written ballot with an extended time frame for external review by a broad range of
Contact information
Carrie Brown
[email protected]
Melanie Snyman
[email protected]
David Watt
[email protected]

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