FASB Update 2018-12 and The Future of Life Insurance - A Conversation With Colin Devine

We're pleased to have Colin Devine, of C. Devine and Associates, join us today for a very timely and important Windsor blog about a topic that could have a significant impact upon the type and price of the products you'll be selling in the not too distant future.

Colin, in August, 2018, the Financial Accounting Standards Board issued Accounting Update 2018-12 (ASU 2018-12), an update that affects all insurance entities that issue long-duration contracts – including life insurance and annuities. Earlier this year, C. Devine and Associates published an exhaustive industry peer review on the implications of ASU 2018-12 for US life insurers, and considered the impact of this change in accounting standards and how it could significantly affect a wide range of products and require increased administrative expenses.

First question, why the need for the update?  What is the objective of ASU 2018-12?

The FASB's objective in issuing ASU 2018-12 was to improve, simplify and enhance the accounting and disclosure requirements for long-duration insurance contracts. The aim is to provide investors and other financial statement users with better, more timely and transparent information about life insurance and annuity contracts.

ASU 2018-12 will change existing income recognition, reserve measurement, presentation, and disclosure requirements. Going forward, these will applied on a more uniform and consistent basis across different product types, as opposed to existing GAAP that mandates some such as long-term care be reported using original historic "locked-in" pricing assumptions, whereas others such as variable annuities are valued based on current experience and market conditions.

"The FASB's objective was to improve, simplify and enhance the accounting and disclosure requirements for long-duration insurance contracts."

What are the primary changes required by ASU 2018-12, and what's different compared to what companies are doing now?

The changes target four areas:

  1. The timeliness of recognizing changes in the reserve liability assumptions for future policy benefits and the rate used to discount future cash flows
  2. Accounting for certain market-based options or guarantees (Market Risk Benefits – MRBs) associated with deposit (or account balance) contracts
  3. Deferred acquisition costs (sales commissions and other policy issuance expenses) amortization
  4. Enhanced and more transparent reporting disclosures 

For example, the updated guidance requires insurers to regularly review and update the assumptions they use to measure the liability of future policy benefits, which were previously locked at contract inception and held constant over the contract term.

Assumptions used to measure discounted cash flows must also be reviewed at least annually.  And the discount rate assumption must be updated at each reporting date based on a standardized, market-observable discount rate, using an upper medium grade (low-credit risk) fixed income instrument yield, i.e. an "A" rated corporate bond.

What changes will ASU 2018-12 require at the carrier level?  How easy or difficult will it be for companies to implement those changes?

The amendments prescribed by ASU 2018-12 will significantly impact how insurers account for long-duration contracts including term life insurance, traditional life, life-contingent immediate annuities, and annuities with living benefit features as well as certain voluntary accident and health insurance.

Both conceptually and operationally, ASU 2018-12 poses the most significant change to accounting for insurance products since the FASB issued FAS 97 back in Dec. 1987.  Because of this, on July 17 2019 the FASB voted to defer implementation for smaller reporting companies, private companies and nonprofits by two years, from 2022 to 2024, and one year, from 2021 to 2022, for calendar-year-end public companies.

"17 companies stated they expect ASU 2018-12 to have significant/material/pervasive impact . . . "

Your Peer Review report provides responses from many of the largest and most influential insurers in the nation.  What do they have to say about ASU 2018-12?

In a review of the year-end 2018 financial statements of 34 insurers, including five mutual and three foreign-owned U.S. insurers that publicly provide GAAP financial statements, 17 companies stated they expect ASU 2018-12 to have a significant/material/pervasive impact on their consolidated financial statements. The other 17 reported they were still assessing its potential impact.

Will there be any impact be on the type of products offered, and the pricing of those products?  Could ASU 2019-12 influence decisions on whether companies enter or exit certain markets?

Multiple companies indicated that increased market sensitivity of financial statements and operating results may lead them to consider significant changes to their product offerings and business strategy.

Some noted they anticipated a material decrease in stockholders' equity which in turn could have an adverse effect on financial leverage ratios and could consequently impact financial strength ratings.

Based on our discussions with multiple insurers the impact of ASU 2018-12 may be far more extensive with regard to the range of products impacted and costlier to implement than originally estimated.

How about the bottom line?  How will company profits be affected, if at all?

Different accounting methodologies such as GAAP and statutory impact the timing of when earnings emerge, but ultimately over a product's lifetime the earnings will be the same. Similarly, changes to accounting methodologies can affect the timing of earnings emergence and the transparency of how results are reported, but they do not impact what an insurer ultimately earns from the sale of a product.

Investors should expect ASU 2018-12 will produce results that are more reflective of current economic conditions, such as low interest rates as well as updated actuarial experience for factors such as mortality, morbidity, lapses and expenses. All of these should be far more consistent across products and between companies.  But this will come with increased earnings volatility that in turn may cause insurers to re-think their pricing, risk management and even continued presence in some product lines.

So the message is that the ride may get bumpy.  It will be interesting to see how this all plays out. Thanks, Colin.

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