Aug. 15, 2017
By Ryan T. Deming, CPA; Heather L. Gagnon, CPA; and Glenn D. Saslow, CPA
The Financial Accounting Standards Board’s (FASB's) updated accounting standard for insurance companies that issue short-duration contracts takes effect for private companies at the end of 2017. As private companies gear up for newly required disclosures, they can take guidance from how public companies, for which the standard already has taken effect, have implemented the standard.
FASB Accounting Standards Update (ASU) No. 2015-09, “Financial Services – Insurance (Topic 944): Disclosures About Short-Duration Contracts,” will require several additional disclosures related to claim liabilities. The ASU has been in work for several years, and insurance companies understandably have been eager to learn how it will translate in practice. A review of the financial statements of 15 public insurance companies with $75 million to $500 million in premiums provides some clues.
The ASU’s Genesis
In October 2008, the FASB and the International Accounting Standards Board (IASB) launched a joint project to improve the accounting for insurance contracts, both long- and short-duration.
In June 2013, the two organizations issued separate proposed amendments that converged on most issues but still contained several differences. As issued, the FASB exposure draft would have resulted in a new accounting model for short-duration contracts. The draft received overwhelming feedback that supported the recognition and measurement guidance for short-duration contracts under existing U.S. generally accepted accounting principles (GAAP). As a result of this feedback, the FASB ultimately focused its changes to targeted improvements in existing U.S. GAAP. Financial statement users also indicated that additional disclosures about the claim liabilities would improve the transparency of significant estimates made in measuring those liabilities and give additional insight into an insurer’s ability to underwrite and anticipate costs associated with claims.
In response, the board issued guidance limited to enhancements to the required disclosures. ASU 2015-09 focuses on providing additional information about claim liabilities to help financial statement users better understand the nature, amount, timing, and uncertainty of cash flows related to claim liabilities and the development of the claim liability estimates.
With the effective date looming on the horizon, private insurance companies must familiarize themselves with the ASU’s requirements and potential alternatives.
The New Disclosure Requirements
The ASU imposes five new main requirements under three categories: claim development tables, frequency and severity, and claims duration.
Claim Development Tables
1. Tables presenting incurred and paid claims (see Exhibits 1 and 2), with allocated claim adjustment expense for each, by accident year. The tables must be presented on a disaggregated basis (for example, by line of business, product line, or geographic location), net of reinsurance, and without discounts. The disaggregation method chosen will determine how many tables a company must include as disclosures. The tables should cover the number of years for which claims incurred typically remain outstanding but need not exceed 10 years, including the most recent reporting period covered in the balance sheet. Each period before the current reporting period is considered to be required supplementary information.
The ASU is careful not to prescribe any specific factor that must be used as the basis for disaggregating this or any of the disclosures. It specifies only that insurance companies should aggregate or disaggregate disclosures so useful information is not obscured by 1) the inclusion of a large amount of insignificant detail or 2) the aggregation of items with significantly different characteristics.
The following information (in Exhibit 1 and 2) is about incurred and paid claims development as of Dec. 31, 20Y6, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts.
The information about incurred and paid claims development for the years ended Dec. 31, 20X7, to 20Y5, is presented as supplementary information.
In addition, most companies have presented 10 years of claims development information, with all the information appearing in financial statement footnotes. The footnotes include a narrative asterisk indicating that the previous years’ information is required supplementary information and is unaudited.
2. Incurred and paid claims development tables reconciled to the amount of the aggregate carrying liability for unpaid claims and claim adjustment expenses presented on the statement of financial position (Exhibit 3). Separate disclosures are required for the reinsurance recoverable on unpaid claims for each disaggregated category and for each period presented on the statement of financial position.
3. Total incurred-but-not reported (IBNR) liabilities. For each accident year in the incurred claims development information, companies should report the total IBNR liabilities plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses, accompanied by a description of reserve methodologies (as well as any changes to those methodologies). (Exhibit 1).
Frequency and Severity
4. Disaggregated quantitative information about the frequency of reported claims for each accident year in the claims development tables. (Exhibit 1). The company also must include a qualitative description of the methodologies used to determine claim frequency information, as well as any changes to the methodologies.
5. Disaggregated history of claims. For all claims except health insurance claims, an insurance company must provide a disaggregated history of claims duration, presented as the average annual percentage payout of incurred claims by age, for the same number of accident years presented in requirements 1 and 2. (Exhibit 4).
ASU 2015-09 also requires additional disclosures about the effect of discounting the claims liabilities reported at present value, including:
- For each period in the balance sheet, the aggregate amount of discount for the time value of money deducted to derive the liability for unpaid claims and claim adjustment expenses
- For each period in the income statement, the amount of interest accretion recognized
- The line item(s) in the income statement where the interest accretion is classified
At its spring 2017 meeting, after much deliberation and interested party feedback, the National Association of Insurance Commissioners Statutory Accounting Principles Working Group (NAIC SAPWG) voted to reject ASU 2015-09. However, the NAIC SAPWG did adopt revisions to Statutory Statement of Account Principle (SSAP) No. 55, “Unpaid Claims, Losses and Loss Adjustment Expenses,” and SSAP No. 65, “Property and Casualty Contracts,” that would incorporate some of the disclosure requirements required under U.S. GAAP in ASU 2015-09. Specifically, the disclosures adopted include the following:
- Information about significant changes in methodologies and assumptions used in calculating the liability for unpaid claims and claim adjustment expenses, including the reasons for the change and the effects on the financial statements for the most recent reporting period presented
- The amount of interest accretion recognized in the income statement and the line item(s) in the income statement where the interest accretion is classified
In addition to the NAIC’s rejection of ASU 2015-09, the American Institute of CPAs also has revised the audit standards under AU-C 800 related to an auditor’s evaluation of pertinent GAAP disclosures on special purpose financial statements such as NAIC statutory financial statements. Specifically, GAAP disclosure requirements that have been wholly or partially rejected by the NAIC would not need to be evaluated by the auditor in order to determine whether the annual audited statutory financial statements achieve fair presentation in accordance with the insurance statutory basis of accounting. However, if the NAIC has not finalized action on GAAP disclosure requirements, an auditor would need to assess whether informative disclosure in the annual audited financial statements would be needed to achieve fair presentation. As a result, insurance companies that file NAIC statutory basis financial statements and their auditors no longer will need to assess GAAP disclosure requirements that have been rejected by the NAIC.
Preparing for Year-End Close and Financial Statement Audit
Private insurance companies should begin preparing now for adoption of ASU 2015-09 disclosures. Compiling the necessary data will require collaboration among the claims department, actuaries, and others in the company. Procedures and processes must be developed to facilitate the capture of accurate data that can be disaggregated or aggregated as necessary and reconciled. Companies need to assess the level of disaggregation or aggregation appropriate for their businesses. This level will vary from company to company, but management should establish and consistently apply a policy that provides financial statement users with the most relevant information.
Insurance companies also should think about how the new standard will affect their annual audits. Audit preparation should include determining the amount of data to be audited and collecting disclosure-related information in a timely manner and what support the auditors will require.
Under the auditing standards of the Public Company Accounting Oversight Board (PCAOB) and the AICPA, the disclosures presented for all periods preceding the most recent period are considered required supplementary information. As such, auditors are required to perform only certain limited procedures to the information. The required supplementary information may be presented as supplementary information outside the financial statements or as part of the footnotes to the basic financials. If not audited, the required supplementary information should be marked as unaudited. The most recent period presented within the claims development tables is not considered required supplementary information, but it is subject to audit procedures.
If an insurance company prefers not to provide the requisite disclosures, the auditors could issue opinion modifications, assuming the company can secure appropriate regulator approval to omit the disclosures.
Most private insurance companies will need to include the various new disclosures regarding claims development and average annual payout very soon. Thus far, public companies have presented 10 years’ worth of data, with only the current year audited, all in the body of the footnotes. Private insurance companies can feel secure in following suit, but they should not underestimate the amount of time required to establish the necessary systems and processes and to compile the required information.