Market risk benefits (MRBs) can be present in contracts written by both insurers and reinsurers. A reinsurer may assume all or a portion of market risk benefits. ASC 944-40-25-40
clarifies that both the assuming reinsurer and the ceding entities are subject to the MRB guidance. For purposes of the assessment of whether the reinsurance contract is or contains an MRB in accordance with ASC 944-40-25-25D
, reference to the account balance refers to the underlying reinsured contract. Consistent with the guidance in ASC 944-40-30-19C(c)
, if there are multiple MRBs in the contract, they should be bundled into one compound MRB regardless of the differences in the individually identified MRB’s characteristics.
If the reinsurance contract does not meet the definition, in whole or in part, of an MRB, it would still be assessed to determine if it is or contains a derivative under ASC 815
. If it does not meet the definition of either an MRB or an embedded derivative, the guidance on death benefit or other insurance benefit features or annuitization benefits under ASC 944-40
should be considered.
Consistent with direct contracts, features in ceded reinsurance contracts that meet the definition of MRBs are required to be accounted for at fair value. At inception of the reinsurance contract, management must determine the terms of the purchased MRBs and, as described in ASC 944-40-30-19D
, whether a non-option (attributed fee method) or an option approach is appropriate. If the non-option method is used, the day 1 value of the MRB would generally be expected to be zero unless the fees in the contract are insufficient to fund the benefits as described in IG 5.6.1
. If the option method is used, the contractual terms under the reinsurance agreement must be considered in determining the fair value of the purchased MRB at inception, which would typically result in a day 1 non-zero value of the MRB.
When a reinsurance contract is in its entirety an MRB, for example because it only reinsures the direct contract’s MRB features, the fees used to determine the fair value of the purchased MRB are those defined in the reinsurance contract. This is in contrast to when an attributed fee method is used for hybrid contracts. Assuming the reinsurance contract represents an arm’s length transaction between a willing buyer and seller, neither party should be expected to have a gain or loss upon entering the contract because the reinsurance fee is a good indicator of the fair value of the MRB. In addition, the ceding entity should consider the reinsurance contract fair value in calibrating its MRB fair value models used for existing MRBs as it represents an observable data point of fair value.
On the ceded side, the fair value of the reinsurance MRB asset will be measured considering the counterparty credit risk of the reinsurer, while the direct contract MRB liabilities fair value will only include the instrument-specific credit risk of the insurer. As a result, the fair value of the direct and ceded contracts will be different even if the contracts are entered into simultaneously and contractual fees and benefits are the same. In addition, only fair value changes in MRBs (issued or purchased) attributable to a change in the instrument-specific credit risk of the reporting entity will be recognized in OCI. This will result in a potential accounting mismatch between the recording of the change in the fair value of MRBs on direct (and assumed) products and the MRB resulting from a ceded reinsurance transaction.
If a reinsurance agreement covers both the accumulation and payout phase, we believe that any MRBs related to the reinsurance contract should be derecognized at annuitization (for a GMIB) or extinguishment of the account balance (for a GMWB), and a reinsurance recoverable should be established for the payout annuities reinsured, which is consistent with the guidance for direct MRBs in ASC 944-40-35-8B
(described in IG 5.6.6
The “in substance” single pay premium for the reinsurance of the payout annuity will include the portion of the purchased MRB balance related to counterparty credit, as the derecognition guidance only allows amounts in AOCI related to instrument-specific credit risk to be reversed prior to the determination of the “in substance” single pay premium, and will result in either:
- A gain, which should be used to offset direct losses to the extent they are incurred on the direct MRB derecognition, or
- A loss, which would be deferred as a cost of reinsurance in line with ASC 944-605-30-4. We believe this cost of reinsurance is analogous to a ceded DPL, and should be amortized on a consistent basis with the direct DPL as described in Question IG 9-1.
Question IG 9-2
Is the reinsurance recoverable for a ceded reinsurance contract that meets the definition of an MRB outside the scope of ASC 326
, Financial Instruments – Credit Losses
Yes. A reinsurance contract that meets the definition of an MRB is required to be recognized at fair value with changes in fair value recognized in the income statement. Financial assets measured at fair value are outside the scope of the CECL model.