In August 2018, FASB issued Accounting Standards Update (ASU) 2018-12, Targeted Improvements to the Accounting for Long-Duration Contracts (LDTI), after 10 years of deliberation. While these changes represent “targeted improvements” to the existing long-duration insurance accounting guidance, they’re the most significant to long-duration contract insurance accounting since the introduction of Financial Accounting Standard 60 in 1982. By most measures, implementing LDTI is a multiyear endeavor for life insurance companies that prepare U.S. generally accepted accounting principles (GAAP) financial statements based on their unique facts and circumstances.
In summary, LDTI provides the following updates to the existing accounting guidance:
- Requires more current actuarial assumptions and an upper-medium-grade fixed-income instrument yield—discount rate to be used to estimate future policyholder benefit liabilities
- Introduces a simplified amortization methodology for deferred acquisition cost that’s expected to approximate straight-line amortization
- Introduces a new long-duration contract category called “market risk benefit” for insurance contracts that both provide protection to policyholders from capital market risk and expose the insurer to other-than-nominal capital market risk. It prescribes a fair market value measurement approach for such products to eliminate diversity in valuation approaches for products with similar benefit features
- Expands financial statement presentation and disclosure requirements
Rather than dismiss LDTI on the basis of effort and cost or because the implementation date is still a few years out, senior management (including chief actuaries) should evaluate FASB’s rationale for making these updates, as well as the process undertaken to arrive at these targeted improvements. According to ASU 2018-12’s Basis for Conclusions, FASB conducted extensive outreach1 to various stakeholders, including financial statement users and auditors, private and public companies and the actuarial community, to arrive at the targeted updates enumerated above. LDTI’s primary goal is to improve the decision usefulness of the financial statement of life insurers for financial statement users.2 In other words, the view of FASB, which was informed by preparers of financial statements, financial statement users and other interested parties, is that existing accounting doesn’t provide a current view of an insurance company’s obligation to its policyholders, nor does it provide sufficient information to aid users in making the most informed decisions.
While private life insurers aren’t required to prepare GAAP financial statements to comply with state insurance regulations, many do for various reasons but are contemplating whether the cost of adopting LDTI outweighs the benefits. Senior management and those charged with governance of private life insurers are presented with an opportunity to strategically evaluate their company’s current and future needs for GAAP financial information.
Outlined below are five questions board members, senior management and chief actuaries should consider in evaluating the cost/benefit analysis of creating an infrastructure that can produce LDTI-compliant GAAP financial statements as of the standard’s effective date (January 1, 2024, for private companies):
- How might a GAAP view of the company’s financial performance and results of operations be beneficial to shareholders, those charged with governance and executive management?
- Will senior management, those charged with governance and investors ever consider an initial public offering or other capital markets transactions to increase capital, where the preferred financial reporting framework could be GAAP?
- What are the internal uses, e.g., calculation of senior management compensation, key performance indicators, etc., for GAAP financial statements, and do the benefits of continuing to produce GAAP financial information after the LDTI’s effective date outweigh the implementation cost?
- Is the company required to furnish GAAP financial statements to outside parties? Would those outside parties accept statutory basis financial statements in lieu of GAAP financial statements? For example, under certain conditions, statutory financial statements can be furnished in connection with the registration of variable life and annuity products with the SEC.
- Finally, is the company currently going through any technological modernization initiative, or planning to soon, such that the initiative could be leveraged to cost-effectively implement the infrastructure for LDTI compliance? The more LDTI compliance is enabled by technology, the lesser the burden placed on the financial reporting process will be.
The answers to these questions and the ultimate decision on how to proceed should be based on an understanding of the benefits to users of the financial statements that LDTI provides, the various ways in which the company currently uses GAAP financial information and how the company might use GAAP financial statements in the future. Senior management should obtain a high-level understanding of LDTI’s benefits and then determine whether the cost and effort outweigh the benefits before dismissing LDTI as another implementation headache for the company.
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1 Online Comment Letters ↩
2 Basis for Conclusion 6 ↩