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July 08, 2013 at 08:21 AM
A Federal Accounting Standards Board (FASB) proposal to change the way companies account for life insurance contracts is gathering steam and may change the way companies reserve for and value policies internally.
The FASB reform proposal is primarily designed to coordinate the way insurance policies are valued on financial statements worldwide. While there may be value in this coordination effort, some see the possibility of increasingly volatile profits for insurance companies on the horizon if the proposal is implemented in its current form. This has many in the industry wondering: Are today’s permanent life insurance premiums as cheap as they will ever be?
FASB proposal versus current GAAP rules
The FASB proposal would essentially change the way insurance companies — and other companies that issue contracts meeting the definition of “insurance contract” — report revenue and liabilities on their financial statements. Under the FASB proposal, any contract that transfers significant insurance risk would be impacted — not just traditional insurance contracts issued by insurance companies. For example, the standards will apply to banks, guarantors and service providers who issue insurance-like contracts, as well as traditional insurance companies.
See also: FASB proposes new accounting for insurance contracts
Currently, GAAP allows a company issuing insurance contracts to report income from premiums when the company receives those premiums. Under the FASB rules, a company would be required to revalue policies each quarter and recognize income from premiums as coverage is provided, over time, rather than when those premiums are actually received.
Further, the assumptions that companies use in setting up required reserves with respect to insurance contracts they issue — such as life expectancy data and the probability that a policy will lapse — will need to be revised on a quarterly basis, as well. Industry experts also anticipate that more assumptions will be added into the mix under the new FASB rules.
Property and casualty insurers will be subject to new rules, too. While they currently use the “most likely” result to calculate their reserves, under the FASB proposal they will be required to take an average of the possible results based on the probability that each of those results will occur.
Possible impact of the FASB proposal
