Sometimes, reinsurers enter into reinsurance contracts that provide coverage for direct insurance contracts that are issued for a specified period of time subsequent to the inception date of the reinsurance contract. In addition, reinsurers may provide coverage for different types of cedant products in a single legal insurance contract. These situations require consideration of the unit of account for recognition and measurement purposes. In practice, there are two approaches for determining the unit of account.
Unit of account is the underlying direct contract
Some entities may recognize assumed reinsurance as the direct reinsured contracts are issued (“look through approach”).
Under a look through approach, the assuming entity is effectively looking through the legal contract to the reinsured contracts issued by the ceding entity as the contracts for accounting purposes. In accordance with
ASC 944-40-30-7, an entity must then determine the cohorts for its assumed contracts. In accordance with
ASC 944-40-30-7, and consistent with how the ceding entity calculates its liability, the assuming entity “shall not group contracts together from different issue years but shall group contracts into quarterly or annual groups.” In applying this guidance to assumed reinsurance under the look through approach, each underlying reinsured contract is the unit of account for recognition purposes. Therefore, an assuming entity’s annual grouping limitation should be based on underlying reinsured contract policy issue dates, not the reinsurance contract issue date. When the direct reinsured contracts are the units of account for recognition purposes, the discount rate used to calculate the net premium ratio for a cohort would take into consideration the discount rate (or curve) in effect at the dates that each underlying reinsured contract was issued.
Unit of account is the reinsurance contract
If the accounting unit for measurement is determined to be the reinsurance contract, we believe that the measurement of the net premium ratio would include all future cash inflows (premiums) and outflows (benefits and expenses) expected for the life of the noncancellable term of the reinsurance contract, including cash flows relating to contracts not yet written by the ceding entity, but subject to the treaty; this is consistent with
ASC 944-40-30-7. If the net premium ratio on policies to be written by the ceding entity and subject to the treaty are expected to be consistent with the assumptions used for direct contracts that have already been issued, the inclusion of the cash flows for direct contracts that have yet to be issued has no impact on the balance sheet or income statement. However, gross disclosures of benefits and net premiums would be required, taking into account the amounts relating to all of those future cash flows.
The discount rate for interest accretion purposes would be the rate (or curve) at the date on which the reinsurance contract is executed.
Additionally, provisions that allow either party to terminate the reinsurance contract for newly-written business, such as a reinsurer’s right to cancel the contract for new business without cause with 90 days notice, would be considered in determining the accounting term of the contract. When a termination provision shortens the accounting term of the reinsurance contract to annual periods or less, the differences in accounting results between the noncancellable term of the reinsurance contract approach and the look through approach may not be that significant.
Due to the complex nature of reinsurance, if the treaty is determined to be the unit of measurement, we strongly recommend consulting with auditors and regulators on the acceptability of such an accounting approach.
A single reinsurance contract may reinsure multiple coverage types, including whole life, disability, long-term care, and universal life insurance. In practice, different types of business are often separated into smaller units of account for recognition purposes within the larger reinsurance contract. As a result, if there are separate units of account for different products, they would be included in separate cohorts with a separate net premium ratio and liability for future policy benefits calculated for each cohort.