Introduction
The Financial Accounting Standards Board (FASB) was founded in 1973. The organization establishes and improves standards for financial accounting within the US. The standards are regarded as laws by the Securities and Exchange Commission (SEC) and the American Institute of Certified Public Accountants (Lozada, 2014). The entity replaced the American Institute of Certified Public Accountants (AICPA) and the Accounting Principles Board (APB).
The mission of the organization is to set effective financial standards. It helps non-governmental bodies to provide investors with important monetary information. FASB has succeeded in its various projects by employing a comprehensive and independent approach to its endeavors. According to Stephens and Chopping (2004), self-governing means carrying out duties that foster extensive participation. The views of all stakeholders are well-thought-out by the board of trustees.
In this paper, the author will focus on an ongoing project by FASB. The undertaking selected for this analysis is the Insurance Targeted Improvements to the Accounting for Long-Duration Contracts. The author will discuss the project’s history, current status, and probable implications.
Overview of the Project
FAS-60 stipulates that insurance policies should be categorized as either short or long-term. Long duration contracts are considered to be non-cancellable indentures. Insurance entities are expected to renew them for an extended period of time. In the contracts, recognition of earnings takes place when premiums are due to the policyholder. Stephens and Chopping (2004) are of the view that there are two types of premiums.
They include net and gross premiums. The latter is the sum a policyholder pays. It is equal to the net premium plus profit made by the insurance entity. On its part, the former is the portion of the gross payment needed to cover future expenses of all policy benefits. Some insurance contracts classified as long term include life, non-cancellable disability income policies, and title insurance. According to Williams, Carcello, and Neal (2009), health or accident indemnity may be regarded as long-term depending on the term of coverage.
History of FASB’s Insurance Project on Long-term Contracts
The insurance project commenced in August 2007. It was a joint effort between FASB and the International Accounting Standards Board (IASB). The decision to include IASB was influenced by the 40 comment letters received by the FASB’s board. The primary goal of the project was to design a common and congregated standard to address the recognition, presentation, and disclosure required for all insurance contracts (Etheridge & Hsu, 2013).
In June 2013, FASN and IASB provided key stakeholders with exposure drafts highlighting the important issues. The drafts recommended the development of a new model to replace the existing US Generally Accepted Accounting Principles (GAAP). However, the proposal received negative feedback from the parties. Consequently, FASB limited the scope of the project what was described in the existing US GAAP. The organization also opted to concentrate on making appropriate improvements on the GAAP (Etheridge & Hsu, 2013). In addition, the board decided to limit enhancements of disclosures for long-term indentures.
The Status of the Insurance Project between 2014 and 2015
The discussions to enhance the long term insurance accounting contracts commenced in August 2014. They provided various guidelines and stipulations for insurance bodies. FASB required the parties to update all the postulations used to assess the accountability for future policy benefits for traditional long-term contracts, participating life insurance, and limited-payment indentures. In addition, the bodies were required to update the assumptions used to calculate the liability for universal life-type contracts. The updates were to be made annually in the fourth quarter (Stephens & Chopping, 2004).
Insurers were also requested to recognize the effects that adjustments on postulations had on the net income. The entities were asked not to include prerequisites for adverse deviation in their calculation of liability. In addition, they were prohibited from carrying out premium deficiency tests (Insurance, 2016).
In the August 2014 discussions, FASB requested a number of disclosures to be availed on a disaggregated basis. The board required insurance entities to reveal the liability balance and the weighted-average discount rates used to compute the equilibrium (Insurance, 2016).
The bodies were also mandated to disclose any other important information that may impact on the discount rates. In addition, insurance firms were required to unveil qualitative and quantitative information on accountability measurement techniques and inputs. Other information to be presented was on morbidity and expenses. The final disclosure needed was on the roll-forward settlement of liability balances. Aspects to be included in the reconciliation statement include new contracts, supposition changes, and benefit payments (Lozada, 2014).
In November 2015, FASB held another meeting to address the issue of discount rates. The conference’s primary purpose was to determine the right rate an insurer should use when appraising a contract. According to the existing US GAAP, insurers made discounts based on expected investment gains. However, FASB resolved that the markdown rates should be based on a portfolio of high-quality fixed-income outlays.
In February 2015, FASB reviewed three options for repaying Deferred Acquisition Costs (DACs) for long-duration insurance contracts. The board concluded that DACs should be paid off over the expected life of a book of indentures as a fraction of the insurance in force (Insurance, 2016). In addition, the board provided a solution for cases where the sum of insurance was found to be uneven or could not be correctly predicted. FASB proposed that in such instances, a straight-line technique in ratio to the number of contracts outstanding should be employed.
In May and June of 2015, the organization held a series of meetings to look into the issue of assumptions. FASB devised ways in which insurers should compute and record the upshots of yearly updating suppositions used to calculate the liability for future policy gains under traditional long-term insurance contracts. After reviewing different options, the board settled for the retrospective approach. According to the technique, the insurer should use an unlocked net premium ratio.
The ratio is calculated by dividing the current value of future policy benefits by the present worth of expected net premiums (Stephens & Chopping, 2004). Once the computation was made, the insurer should identify the impact of its changes on cash flow suppositions. Consequently, insurance entities would be able to document variations in discount rates.
The Current Status of the Project
FASB continues to issue discussion papers, exposure drafts, and other project documents to stakeholders for them to review and give opinions. The feedback helps in devising principles that provide important information for investors and other financial statement users (Insurance, 2016).
During the 2016 financial year, FASB has held a number of meetings. After the meeting held in February 2016, various decisions were made on long-duration insurance contracts. The FASB board called for the disclosure of certain information. The data include liability for future policy benefits and policyholders’ account balances, as well as market risk benefits. Other information to be revealed is on separate account liabilities and deferred acquisition costs.
Market Risk Benefits
In the February 2016 meeting, various decisions were made to improve the transparency of long-term contracts. Insurance entities are required to information about market risks benefits in both annual and interim monetary statements. They are also expected to disclose information on disaggregated tabular roll-forward of the opening to the closing balance (Insurance, 2016). For each set of roll-forward data presented, insurance entities should reveal the related net amount at risk and fees collected. In addition, they should disclose qualitative and quantitative data about the noteworthy inputs and suppositions used in measurement estimates. In addition, the entities should reveal any changes in qualitative and quantitative information and how the variations impact on calculations.
Insurers should provide information on the settlement of the disaggregated roll-forwards to the cumulative ending carrying amount disaggregated between in the money and out of the capital positions (Insurance, 2016). In addition, the entities should provide qualitative information about policies, objectives, and processes for controlling the dangers associated with market risk benefits.
Liability for Policyholders’ Account Balances
FASB calls for insurers to present tabular roll-forwards, just like in market risk benefits. However, some information varies between the two. In liability for policyholders’ account balances, insurance entities should provide data on cash surrender value, and net weighted-average earn rate and the weighted-average credit rate (Lozada, 2014). In terms of tabular information, insurers should present account balances based on the range of guaranteed minimum crediting rates and a related array of the disparity between ratios awarded to policyholders and the respective definite minimums. In addition, insurance firms should provide information on the objectives and ways of managing liability risks.
Separate Account Liabilities
Insurance bodies are required to provide detailed and accurate information on disaggregated tabular roll-forward of the opening to the closing balance (Etheridge & Hsu, 2013). For each roll forward presented, data on related monetary submitted values should be disclosed. In addition, a reconciliation report on the roll-forwards to the aggregated ending carrying sum of liability should be availed.
Liability for Future Policy Benefits
FASB requires all insurance firms to disclose disaggregated tabular roll-forwards of opening to the closing balance. However, there should be a separate presentation of anticipated future net premiums and gains. For each disaggregated roll-forward, insurers should reveal the sum of gross premiums, the amount of any related reinsurance recoverable, and undiscounted final balance for both the expected future net premiums and benefits. In addition, insurance entities should provide data on undesirable progress caused by net premium ratio surpassing 100%.
They should also ascertain the supplementary liability of a non-traditional long-duration contract (Insurance, 2016). In liability for future policy benefits, there are instances where insurers fail to recognize indentures accountability. The failure arises because no future losses are anticipated. In such cases, insurance firms should disclose information on important approximations, statements, and inputs used to make the conclusion that there were no losses anticipated.
Deferred Acquisition Costs
FASB calls for entities to reveal disaggregated tabular roll-forward of opening to the closing equilibrium of overdue purchase costs. In addition, the entities are required to disclose the postulations and inputs used to verify amortization. All the data is to be presented in interim and annual financial statements (Insurance, 2016).
The Implications of the Project on Long Duration Contracts
From 2014 to 2016, FASB has made various decisions on targeted improvements to the accounting of long term insurance indentures. The resolutions are an indication of the major changes realized in the course of FASB’s insurance projects. The amendments have led to the establishment of a US insurance accounting model. The approach deviates from the initial plan proposed by IASB (Lozada, 2014).
As a result of the project, FASB decided that insurers should update all cash flow postulations used to calculate liability for future policy benefits on an annual basis. In addition, it is now mandatory for the entities to revise the net premium ratio and review any changes over the life of the long-duration contract. The impacts of the alterations are to be recorded as cumulative catch-up modifications on net income (Etheridge & Hsu, 2013). Currently, insurers are also required to update the discount rate assumptions used to compute liability. In addition, they are supposed to analyze the effects of the changes on comprehensive income as opposed to net revenue. The decisions have led to reduced income statement volatility.
Liability for Future Policyholder Benefits
In the initial discussions held on 2014, FASB decided that all suppositions used to measure the liability of future policy benefits for traditional long-duration contracts should be updated on an annual basis in the fourth quarter. In addition, the assumptions were to be recognized in earnings (Insurance, 2016). However, during the meetings, FASB did not provide information on how the changes in assumptions should impact on net premium ratio.
According to the regulations that existed before the discussion, insurers were required to record liability for future policy benefits as the present worth of future gains to be remunerated to policyholders. The guideline had various implications on long-duration contracts. One of the effects is that profits from the indentures are recognized as level percentage of premiums over the life of the contract.
The net premium model was retained in the current project. In addition, insurers are still required to review annual updates of cash flow assumptions used to calculate liability for future policy benefits on long-term contracts. The review is made by evaluating net premium ratios retrospectively. The process entails unlocking net payment percentage and computing it as if the adjusted suppositions were recognized at the time (Insurance, 2016). In addition, insurers are required to determine the impacts that changes in discount rates have on OCI and not on net income.
The retrospective adjustment of net premium ratio for cash flow assumptions has various implications. The process will increase the volatility of income statements. However, there will be ‘less unpredictability’ compared to instantaneous identification of the impacts of the changes on net income. Annual updating of assumptions used to calculate liability will require insurance entities to change how they monitor and collect information (Williams et al., 2009). In addition, they will be forced to amend their existing processes, systems, and internal controls.
Deferred Acquisition Costs
FASB has made various changes to the laws governing deferred acquisition costs for long-duration insurance contracts. According to the current project, deferred purchase outlays are supposed to be amortized over the expected span of book of indentures in ratio to the retrospective sum of insurance in place. In cases where the amount of insurance is variable and cannot be determined, deferred acquisition costs are to be amortized using the straight-line approach (Insurance, 2016).
In addition, the current guidelines stipulate that insurance companies should not increase interest rates on undiscounted balance of deferred acquisition costs. An analysis of the decisions shows that the new guidelines will simplify the current techniques used in amortizing deferred acquisition costs. However, the detection of acquisition operating costs will no longer match the recognition of incomes.
Calculation of Liability for Future Policy Benefits
FASB has introduced various guidelines on how insurance firms should compute the liability for future policy gains. According to the current stipulations, insurers are no longer required to perform premium deficiency and loss recognition tests. The reason is because they will be updating their suppositions on an annual basis. It is also not mandatory for insurance entities to include provisions for unpleasant divergence on their liability for policy benefits (Stephens & Chopping, 2004).
In addition, the accountability for future policy benefits that is reduced using the expected investment yield technique would be discounted using a rate based on a reference portfolio of high quality and fixed-revenue outlays. Another guideline entails the disclosure of disaggregation of balance, information on different methods and assumptions used, and payment of balances.
The decision to make calculation changes has various implications. The reason is because insurers are required to regularly review their assumptions and make appropriate changes to the liability balance. The use of discount rate based approach on a reference portfolio of high-quality and fixed-income investment will force insurers to review their methods of data collection (Insurance, 2016). Another implication is that insurance firms will have to enhance their decisions on the suitable level of disaggregation for disclosures. In addition, the entities will have to develop new processes and internal controls needed to produce the disclosures.
Scope
In the August 2014 meeting, FASB opted to limit the scope of insurance project on long-duration contracts (Lozada, 2014). The decision reduced the number of companies that fall under the scale of the project. If the changes were not made, all companies that issued indentures would be within the scope of the proposed insurance standard project. In addition, the decision to limit the scale of the project affected IASB. The move increased the ‘non-convergence’ between FASB and IASB.
Accounting Models
FASB opted to focus its future efforts on making significant improvements on the existing US GAAP insurance accounting model. The board decided not to focus on the proposed ASU’s comprehensive changes. In initiating the insurance project, FASB took into consideration the feedback from US investors and ‘preparers’ who favored targeted enhancements to the existing US GAAP (Williams et al., 2009). In addition, the board took into consideration the potential implementation costs and the likelihood that FASB and IASB would not agree on the establishing of a converged accounting model.
The improvements on the long-duration contracts targeted by FASB were to take into account all the components of long-term accounting models. According to board members, the move would have various implications on the insurance project. One of the effects is that the new long-duration contract would resemble the Building Block Approach [BBA] (Insurance, 2016).
Conclusion
FASB has developed various standards that provide useful information to investors and other users of financial statements. In addition, the organization has implemented various projects. The Insurance-Targeted Improvements to the Accounting for Long-Duration Contracts is one of the projects. The primary objective of the venture was to make indenture processes more effective and transparent. The enhancements made over time have focused on addressing recognition, measurement, disclosure, and presentation. The project, which was initiated in 2007, is still ongoing. FASB will continue to deliberate on other targeted enhancements to the accounting for long-term indentures.
Annotated Bibliography
Etheridge, H., & Hsu, K. (2013). Financial instrument credit impairment models: A rift in the convergence of IASB and FASB accounting standards. Academy of Accounting and Financial Studies, 17(1), 119-126.
In this article, Etheridge and Hsu (2013) provide information on various financial models used by insurance companies. In addition, the authors focus on the move by FASB and IASB to join forces and carry out an insurance enhancement project. The information was used in this paper to support the arguments made by other scholars on the subject. The source was regarded as credible given that it is published in a popular and scholarly journal. In addition, Etheridge and Hsu (2013) are respected and renowned scholars in this field. The two scholars are also affiliated to reputable academic institutions. They have authored other articles related to the topic. Finally, the source contains updated information considering that it was published in 2013.
Insurance: Targeted improvements to the accounting for long-duration contracts. (2016). Web.
The authors of this article provide information on FABS’s Insurance-Targeted Improvements to the Accounting for Long-Duration Contracts project. The resource provided the writer of this paper with data on the resolutions made during the various meetings held by FASB in the course of implementing the project (Insurance, 2016). The online article was the major source of information for this paper. The credibility of the source is based on the fact that it is published on the official FASB’s site. In addition, the information published in the article can be verified using arguments from external sources.
Lozada, A. (2014). International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) convergence project: Where are they now?. Journal of Modern Accounting and Auditing, 10(10), 991-1004.
In this article, Lozada (2014) analyzes the convergence between IASB and FASB. In addition, the author assesses the decisions made during the various FASB annual conferences. The resource was used to support the information provided by the online article above. It is important to note that Lozada is a scholar from Puerto Rico University. The affiliation of the author to the institution makes this a credible source. It is also noted that Lozada was helped by his students to compile the information in the source. Such triangulation further strengthens the worthiness of the source.
Stephens, M., & Chopping, D. (2004). Applying GAAP: A practical guide to financial reporting (12th ed.). Kingston upon Thames: Croner CCH Group Ltd.
In this book, Stephens and Chopping (2004) provide readers with comprehensive information on a wide range of financial concepts. The data helped the writer of this paper to have an in-depth understanding of different financial reporting rules. The major weakness of the book was that it was published in 2004. As such, it was authored before the latest resolutions by FASB were made. What this means is that the information in the source may appear outdated. However, the writer of this paper deduced that the information provided by Stephens and Chopping (2004) was relevant to the project. It was especially important as it provided background literature on topic of FASB and its existence over time.
Williams, J., Carcello, J., & Neal, T. (2009). GAAP guide level A: Restatement and analysis of current FASB standards. New York: CCH Inc.
In this book, Williams et al. (2009) analyze information on GAAP level A. The text helped the writer to understand the decisions made by FASB in the course of the project analyzed in this paper. For example, Williams et al. (2009) examine a number of FASB’s statements and interpretations using practical illustrations and examples. The credibility of the source can be deduced from the fact that it was written by more than one scholar. In addition, the three scholars are affiliated to reputable academic institutions. However, the fact that the book was published in 2009 may make it a bit outdated. In spite of this, it is important to note that most of the data provided by the authors is still relevant to today’s accounting practices.