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.2354 Derivatives and embedded derivatives in insurance contracts
Publication date: 31 May 2022
us Insurance for insurers ARM 9632.2354
Insurance companies issue various types of insurance and investment contracts, and reinsurance contracts, with embedded derivatives. These include variable annuities with guarantee features such as guaranteed minimum accumulation and withdrawal benefits and payout annuities with minimum guarantees (referred to in practice as "GMxBs"), equity indexed life and annuity contracts, and reinsurance contracts with returns based on referenced investment portfolios. The guidance in this section remains applicable until an entity adopts the new guidance in ASU 2018-12 which introduces the term market risk benefits. For more information on the ASU, see IG 2.4.5 and IG 5.6.
The derivative accounting guidance provides a scope exception for certain insurance contracts from derivative accounting, and careful consideration is required to assess if the GMxB contract meets the scope criteria to be exempt or is required to be accounted for as an embedded derivative. Some of the products that were created before the guidance on embedded derivatives was finalized are explicitly described and concluded on. Products have continued to evolve since that time, and the variations that exist today do not match those described in the guidance. As a result, interpretations of and analogies to the existing guidance have emerged in the determination of whether or not a contract feature is exempt from derivative treatment under the insurance scope exception, creating diversity in practice.
The following table describes some common contracts and their accounting considerations:
Product type | Accounting summary | Other comments |
|---|---|---|
Variable annuity host with a guaranteed minimum accumulation benefit -- guarantees a minimum account balance that can be withdrawn at a specified date in the future. (GMAB) | Typically meets the definition of an embedded derivative required to be separated from the variable annuity host as described in ASC 944-815-25-5. | |
Variable annuity host with a guaranteed minimum income benefit -- provides a minimum amount available to annuitize at a future date. (GMIB) | Typically does not meet the net settlement criterion to be accounted for as a derivative because the policyholder must "invest" its account balance to receive the benefit. This is further described in ASC 815-15-55-59 through ASC 815-15-55-60 and ASC 815-10-15-100. | Reinsurance of GMIB meets the net settlement criteria because the ceding company does not "invest" the account balance to receive payments under the reinsurance contract. |
Variable annuity host with a guaranteed minimum withdrawal benefit -- guarantees annual withdrawal stream for a specified period of time. (GMWB) | While not described specifically in the guidance, this product typically meets the definition of an embedded derivative requiring separation from the host variable annuity. Unlike the GMIB above, the policyholder is not required to "invest" its account balance to receive the benefit. | This product is similar to the GMAB except the benefit is paid through periodic payments. |
Variable annuity host with a guaranteed minimum withdrawal benefit for life -- guarantees annual withdrawal stream for life. (GMWBL) | Typically meets the definition of an embedded derivative requiring separation from the variable annuity host contract. There is diversity in practice regarding the applicability of the insurance scope exception because the payments are life contingent. | We understand that the SEC's preferred approach is derivative accounting, but they acknowledge the diversity in practice and will accept either alternative. |
Equity indexed annuity contracts -- deferred fixed annuity with a guaranteed minimum interest rate plus interest crediting features tied to the performance of one or more indices. (EIA) | ASC 815-15-55-66 through ASC 815-15-55-69 requires that the equity-indexed return portion of the contract be separated from the host and accounted for as a derivative. | A variation on this product includes a guaranteed withdrawal feature which should be assessed relative to the deferred fixed annuity host rather than the entire equity indexed annuity contract when assessing whether the guarantee is clearly and closely related to the host contract. |
Consideration should be given to the measurement of the embedded derivatives and related guidance, including the issues identified in IG 5.7. For contracts not accounted for as derivatives, refer to ARM 9632.2351.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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