Best’s Commentary: Life/Health Insurers Daunted by Financial Accounting

OLDWICK, N.J.–(BUSINESS WIRE)–Changes to the Financial Accounting Standards Board (FASB) requirements
for insurance companies to report GAAP financials for long-duration
contracts could become costly for companies transitioning to the new
accounting standards and could create earnings and reserving volatility,
according to a new AM Best commentary.

The Best’s Commentary, titled, “Life/Health Insurers Daunted by
FASB Long Duration Contract Changes,” states that the FASB’s new
accounting standards, which become effective in 2021, include detailed
disclosure requirements to increase transparency to investors and other
users of GAAP financial statements. Since assumptions must be updated
annually at least, insurers will be challenged to represent sources of
changes effectively. While greater transparency undoubtedly will
increase understanding of results by investors, the complexity of the
calculations makes comparison difficult. In addition, companies will be
challenged from an information technology perspective, as so-called
disaggregated roll-forwards will be based each year on annual cohorts,
with potentially varying assumptions, and must be shown reconciling
beginning and ending period balances. As a result, insurers will need to
change processes and system controls to track actual experience going
back to original issue dates. Insurers that have a variety of products
that were written several years ago also may be challenged when
attempting to gather historical information in order to establish
transition methods to the new regime, especially if blocks of business
have been moved to newer systems.

The FASB changes not only affect long-duration life and annuity
contracts, but also health insurance contracts, particularly long-term
care and long-term disability. Variable annuities will be affected more
so due to market value valuations of liabilities and hedging
instruments, increasing the potential for more volatile earnings.
Reserves also will become more volatile as the assumptions used to
measure present values of cash flows will be updated annually, or more
frequently, if experience warrants material changes. Additionally,
amortization schedules on deferred acquisition costs (DAC) will become
much more consistent, reflecting the actual length of the coverages, as
well as be more transparent and easier to understand. DAC asset balances
also will no longer accrue interest, another key change in the treatment
of DAC balances. Lack of interest accruals on the DAC balance may push
earnings patterns to later years as there could be more DAC amortization
in earlier years. As a result, for most products, earnings patterns may
be more sensitive to product designs than before.

Companies transitioning to the new accounting standards can choose how
prior years’ results get adjusted. Companies electing retrospective
transitioning will begin restating financials as early as 2019 if they
are reporting three years of results in their filings. While this may
give time for smoother transitions to the ultimate adoption date of
2021, it may be offset by the myriad disclosures required. Key aspects
of AM Best’s holding company analysis include the ability to service
debt through earnings, the level of leverage within the holding company
debt structure and the ability to service debt either through earnings
or dividends from subsidiaries. AM Best does not believe accounting
changes in and of themselves change the economic health of the companies
it rates, although the proposed long-duration accounting standards may
create short-term swings in the consolidated equity and leverage ratios.
Additionally, the extensive changes being proposed could lead to
significant costs incurred as companies need to go back in time and
establish assumptions used for reserves from annual cohorts.

To access the full copy of this commentary, please visit

AM Best is a global rating agency and information provider with a
unique focus on the insurance industry. Visit
for more information

Copyright © 2019 by A.M. Best Rating Services, Inc. and/or its

Read More:Best’s Commentary: Life/Health Insurers Daunted by Financial Accounting