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New Variable Product Accounting Rules Approach

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NU Online News Service, Nov. 24, 2003, 8:39 p.m. EST – Some insurers are making announcements about charges that they expect to take once new accounting guidelines take effect.[@@]

The guidelines will apply mainly to variable annuities and variable life products.

Most insurance company executives contacted say the charges will not be significant. However, the executives note that the magnitude of the charges will depend on the types of contracts that a particular company writes.

The rules, which are included in Statement of Position 03-1, become effective Dec. 15. The SOP was developed by the American Institute of Certified Public Accountants, New York, and cleared by the Financial Accounting Standards Board, Norwalk, Conn. The new guidelines will apply at the beginning of an insurer’s fiscal year starting after the effective date.

The SOP addresses whether insurers should include information about the assets and liabilities associated with certain separate account insurance contracts in the insurers’ general accounts. The SOP also addresses whether related revenues and expenses should appear in the insurers’ income statements.

The SOP states that a separate account should be reported as a general account liability if it does not meet certain conditions. If an insurer wants to keep a separate account from becoming a general account liability:

1. The account must be legally recognized.

2. The account assets supporting the contract liabilities must be legally insulated from the general account liabilities.

3. The insurer must invest the contract holder’s funds within the separate account as directed by the contract holder in designated investment alternatives.

4. All investment performance, net of fees, must pass to the contract holder.

The SOP also offers reasons why, under certain conditions, an insurer must include a particular variable annuity in the general account.

For example, the SOP states that, because an insurer provides a fixed return for a specified period, a market value adjusted annuity written through a separate account does not meet the fourth standard and consequently must be treated as a general account contract.

The SOP also offers guidance on guaranteed minimum income benefits: If a GMIB is not accounted for under FAS 133, which addresses derivatives, an insurer should establish an additional liability if the present value of the expected annuitization payments at the annuitization date exceeds the expected account balance at the expected annuitization date.

Other types of products addressed in the SOP are two-tier annuities and variable annuities with guaranteed minimum accumulation benefits. The SOP also could affect accounting for variable life insurance.

Earlier this month, American International Group Inc., New York, announced that the SOP will require it to recognize a liability for guaranteed minimum death benefits and other living benefits related to its variable annuity and variable life contracts, and to modify certain disclosures and financial statement presentations for these products. AIG says it expects to take a charge of about $200 million after income taxes in the first quarter of 2004 to comply with the guidelines.

The charge will not be material to AIG’s financial condition or liquidity, AIG says.

In general, the SOP will affect the way that the industry recognizes liabilities for variable annuity guarantees, says Mark Thresher, chief financial officer at Nationwide Financial Services Inc., Columbus, Ohio.

But Nationwide maintains Generally Accepted Accounting Principles reserves for GMDBs and GMIBs, Thresher says. The company ended the third quarter with $22 million in reserves, net of reinsurance.

About 95% of the reserves back guaranteed death benefits, rather than guaranteed income benefits, Thresher says.

Before 2002, Nationwide reinsured most variable product guarantee risk. But guarantee reinsurance dried up in 2002, and now the company reinsures about 60% of the guarantee risk, Thresher says.

Thresher says the reserves Nationwide has established are consistent with the requirements in the new SOP.

Hartford Life Insurance Company, Simsbury, Conn., will establish a $30 million to $40 million reserve for products with guarantees, says Tom Campbell, a Hartford Life corporate actuary.

Campbell cites a Hartford Life modified guaranteed annuity as an example of a product affected by the SOP. Hartford thinks of the annuity as a separate account, but the new SOP may lead the company to put the annuity in the general account, Campbell says.

A fourth company, the U.S. arm of AXA S.A., Paris, established $33 million in reserves for variable annuity income and death benefit guarantees in January 2002. AXA also changed its method of accounting for liabilities associated with VA GMDBs and GMIBs. Before January 2002, AXA expensed the benefits as it incurred them.