March 2012

NAIC Update

Dear Clients and Friends:

ParenteBeard LLC recently attended the NAIC Spring Meetings in New Orleans and have highlighted some important regulatory and statutory accounting proposals below. We hope you will find the following meeting summary beneficial.  We have also included an update on the FASB/IASB Insurance Contracts proposal.

Notes from the 2012 NAIC Spring Meeting in New Orleans
Statutory Accounting Principles (SAP) Working Group

SSAP No. 101 – Income Taxes – A Replacement of SSAP No. 10 and 10R Q&A Implementation Guide (the Implementation Guide)

The SAP Working Group voted to extend the comment period on the Implementation Guide until March 23, 2012.  The NAIC previously issued a draft Implementation Guide available on the NAIC website at www.naic.org. The Implementation Guide provides numerous examples including application of the valuation allowance and reference to the four sources of income to be analyzed when determining whether a valuation allowance is needed or not.

SSAP No. 92 – Accounting for Postretirement Benefits Other Than Pensions (SSAP No. 92) and SSAP 102 – Accounting for Pensions (SSAP No. 102)

The SAP Working Group approved issuance of SSAP No. 92 and SSAP No. 102 which would be effective on January 1, 2022 with a ten year transition period to mitigate the impact on surplus.  SSAP No. 92 and 102, with minor exceptions, adopt the guidance in FASB Accounting Standards Codification (ASC) included in ASC 710-30 (formerly SFAS No. 158) and ASC 710-60.  Early adoption is permitted.   

Issue Paper No. 129 – Share-Based Payments

The SAP Working Group exposed for comment Issue Paper No. 129 which adopts with minor differences ASC 505-20 (formerly SFAS No. 123R) on share-based payments including stock option and other incentive compensation plans.

SSAP No. 103 – Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SSAP No. 103)

The SAP Working Group approved SSAP No. 103 which adopts with minor differences ASC 860 (formerly SFAS No. 166) regarding transfers and servicing of financial assets and extinguishments of liabilities, including sales of financial assets, secured borrowings and collateral and servicing assets and liabilities.  The effective date of SSAP No. 103 would be January 1, 2022 with prospective application.

Annual Fee Mandated by the Federal Patient Protection and Affordable Care Act (PPACA)

Effective in 2014, health insurers will be paying a fee to the federal government under PPACA based on direct premiums written in 2013 compared to the total direct premiums written in the entire health insurance industry.  Under U.S. GAAP, the fees assessed from the federal government will be recorded in 2014 when it is probable that there will be assessment (i.e., if the health insurer wrote any premiums in 2013) and amortized over the remainder of the year into income.  Under SSAP No. 35R, the fees are considered to be a retrospective guaranty fund assessment, the liability (and offsetting non-admitted prepaid asset) is recorded at December 31, 2013.  Certain health insurers expressed displeasure at the differences between GAAP and SAP methodology.  The SAP Working Group asked for additional data regarding the impact of the fee and related accounting treatment on various metrics including the Medical Loss Ratio before determining the next course of action.

Own Risk and Solvency Assessment (ORSA) Subgroup

The Subgroup is developing the first training on ORSA to be presented at the May 30, 2022 NAIC Financial Summit to be held in Washington, D.C.  The Subgroup is also finalizing a glossary for the NAIC publication, NAIC Own Risk and Solvency Assessment.  Finally, interested parties encouraged the Subgroup to continue to be very deliberative and not issue guidance that has not been fully vetted and debated as occurred in the financial services industry.

Blanks Working Group

Some of the proposals the Blanks Working Group are working on include:

  1. Modifying the instructions to the notes to the Annual Statement to indicate that certain disclosures that are data-captured in the electronic notes should be presented as shown in the NAIC illustration.
  2. Adding new instructions to the Annual and Quarterly General Instructions stating the need to report certain U.S. GAAP items that are inconsistent with SAP, and where the specific items can be found.
  3. Modifying the instructions and illustrations for Note 9A to reflect the disclosures required in SSAP No. 101.

The IASB and FASB Insurance Contracts Project

The IASB and FASB continue to discuss and debate various differences regarding Insurance Contracts.  Both IASB and FASB still have a goal of issuing exposure drafts in 2012.

Per the FASB website, the following is a summary of the FASB and IASB’s proposals under Insurance Contracts:

The IASB and the FASB continued their discussions on the insurance contracts project by considering the following topics: eligibility criteria and mechanics for the premium allocation approach; measurement of liabilities for infrequent, high-severity events; onerous contracts; unbundling goods and services components; and financial instruments with discretionary participation features.

Eligibility Criteria for the Premium Allocation Approach

The IASB tentatively decided that:

  1. Contracts should be eligible for the premium allocation approach if that approach would produce measurements that are a reasonable approximation to those that would be produced by the building-block approach.
  2. A contract should be deemed to meet the condition in (1) without further work if the coverage period is one year or less.
  3. To provide application guidance that contracts would not produce measurements that are a reasonable approximation to those that would be produced by the building-block approach if, at the contract inception date:
    1. It is likely that, during the period before a claim is incurred, there will be a significant change in the expectations of net cash flows required to fulfill the contract; or
    2. Significant judgment is required to allocate the premium to the insurer's performance obligations for each reporting period. This may be the case if, for example, significant uncertainty exists about:
      1. The premium that would reflect the exposure and risk that the insurer has for each reporting period; or
      2. The length of the coverage period.

The IASB noted that it would review whether it will need to update these criteria after its future discussions on the building-block approach.

  1. An insurer should be permitted but not required to apply the premium allocation approach to contracts that are eligible for that approach.

The FASB tentatively decided that:

  1. Insurers should apply the building-block approach rather than the premium allocation approach if, at the contract inception date, either of the following conditions is met:
    1. It is likely that, during the period before a claim is incurred, there will be a significant change in the expectations of net cash flows required to fulfill the contract; or
    2. Significant judgment is required to allocate the premium to the insurer's obligation to each reporting period. This may be the case if, for example, significant uncertainty exists about:
      1. The premium that would reflect the exposure and risk that the insurer has for each reporting period; or
      2. The length of the coverage period.
  2. A contract should fall within the scope of the premium allocation approach without further evaluation if the coverage period is one year or less.
  3. The premium allocation approach should be required for contracts that qualify for that approach.

Mechanics for the Premium Allocation Approach

The Boards tentatively decided that discounting and interest accretion to reflect the time value of money should be required in measuring the liability for remaining coverage for contracts that have a significant financing component, as defined according to the characteristics of a significant financing component under the revenue recognition proposals. However, as a practical expedient, insurers need not apply discounting or interest accretion in measuring the liability for remaining coverage if the insurer expects at contract inception that the period of time between payment by the policyholder of all or substantially all of the premium and the satisfaction of the insurer's corresponding obligation to provide insurance coverage will be one year or less.

The Boards also tentatively decided that:

  1. The measurement of acquisition costs should include directly attributable costs (for the FASB, limited to successful acquisition efforts only); this is consistent with the decision made for the building-block approach.
  2. Insurers should be permitted to recognize all acquisition costs as an expense if the contract coverage period is one year or less.

The Boards also agreed to explore an approach in which acquisition costs would be netted against the single/residual margin applying the building-block approach, and netted against the liability for remaining coverage applying the premium allocation approach. That amount could be separately presented from the present value of expected cash flows (plus a risk margin, for the IASB).

Measurement of Liabilities for Infrequent, High-Severity Events

The Boards tentatively confirmed that insurers should measure both an insurance contract liability by applying the building-block approach and an onerous contract liability by applying the premium allocation approach, taking into account estimates of expected cash flows at the balance sheet date.

The Boards tentatively decided to provide application guidance to clarify that an insured event (for example, an infrequent, high-severity event such as a hurricane) that was impending at the end of the reporting period does not constitute evidence of a condition that existed at the end of the reporting period when it occurs or does not occur after that date. Consequently, such an event is a non-adjusting event, to which IAS 10, Events after the Reporting Period, applies, and a non-recognized event to which FASB Accounting Standards Codification® Topic 855, Subsequent Events, applies.

Onerous Contracts

The Boards tentatively decided that the measurement of the liability for onerous contracts should be updated at the end of each reporting period.

The IASB tentatively decided that risk adjustment should be considered when identifying onerous contracts and that the measurement of an onerous contract liability should include a risk adjustment.

The Boards tentatively decided that if an insurer elects not to discount the liability for incurred claims that are expected to be paid within 12 months, the insurer should use an undiscounted basis in identifying whether contracts are onerous and in measuring the liability for onerous contracts.

Unbundling Goods and Services Components

The Boards tentatively decided on the following criteria for unbundling goods and services:

  1. An insurer shall identify whether any promises to provide goods or services in an insurance contract would be performance obligations as defined in the Exposure Draft, Revenue from Contracts with Customers. If a performance obligation to provide goods or services is distinct, an insurer shall apply the applicable IFRSs or U.S. GAAP in accounting for that performance obligation.
  2. A performance obligation is a promise in a contract with a policyholder to transfer a good or service to the policyholder. Performance obligations include promises that are implied by an insurer's customary business practices, published policies, or specific statements if those promises create a valid expectation by the policyholder that the insurer will transfer a good or service. Performance obligations do not include activities that an insurer must undertake to fulfill a contract unless the insurer transfers a good or service to a policyholder as those activities occur. For example, an insurer may need to perform various administrative tasks to set up a contract. The performance of those tasks does not transfer a service to the policyholder as the services are performed. Hence, those promised setup activities are not a performance obligation.
  3. Except as specified in the following paragraph, a good or service is distinct if either of the following criteria is met:
    1. The insurer regularly sells the good or service separately.
    2. The policyholder can benefit from the good or service either on its own or together with other resources that are readily available to the policyholder. Readily available resources are goods or services that are sold separately (by the insurer or another entity), or resources that the policyholder has already obtained (from the insurer or from other transactions or events).
  4. Notwithstanding the requirements in the previous paragraph, a good or service in an insurance contract is not distinct and the insurer shall therefore account for the good or service together with the insurance component under the insurance contracts standard if both of the following criteria are met:
    1. The good or service is highly interrelated with the insurance component and transferring them to the policyholder requires the insurer also to provide a significant service of integrating the good or service into the combined insurance contract that the insurer has entered into with the policyholder.
    2. The good or service is significantly modified or customized in order to fulfill the contract.

Financial Instruments with Discretionary Participation Features

The IASB considered the applicable standard for financial instruments that are not insurance contracts but that have discretionary participation features similar to those found in many insurance contracts. The discussion was not held jointly with the FASB because of the different considerations for the Boards.

The IASB tentatively decided that the forthcoming insurance contracts standard should apply to financial instruments with discretionary participation features that are issued by insurers. It should not apply to any financial instruments issued by entities other than insurers.

Next Steps

The FASB intends to discuss the applicable standard for financial instruments with discretionary participation features at its meeting on March 7, 2012. Both Boards will continue their discussion on insurance contracts in March 2012.

If you have any questions regarding this e-mail blast, please contact Ken Hugendubler, partner and head of ParenteBeard’s Insurance Practice at 717.236.1100 or Ken.Hugendubler@ParenteBeard.com.

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