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13.9 SAP for contract liabilities
Publication date: 31 Jan 2021
us Insurance guide
Accounting for loss and loss adjustment expense liabilities for statutory financial statements is discussed in SSAP 55.
Claims, losses, and loss/claim adjustment expenses are recognized when the covered or insured event occurs. In most circumstances, payments are made after the event's occurrence and, therefore, a liability is recorded. Generally, the liability is based on the ultimate cost of settling the claims (including the effects of inflation and other societal and economic factors), using past experience adjusted for current trends and any other factors that would modify past experience. See further details regarding recording claim liabilities at present value (i.e., discounting) in IG 4.3.3 as this guidance is specific to the type of contract.
When determining the amount of the liability for claims, management must accrue their best estimate. In very rare circumstances, if management cannot identify a best estimate and they have identified a range, and no point within that range is a better estimate than any other point, then the midpoint of the range should be recorded. Multiple equally likely outcomes do not constitute a reasonable range; in this scenario, management must determine that one of these is its best estimate.
If management chooses to anticipate salvage and subrogation recoveries in estimating its total claims liabilities, then they should be estimated in a fashion similar to the estimation for future claims costs. The expected future receipts are deducted from the liability for unpaid claims. The total amount of anticipated salvage and subrogation recoveries should be disclosed in the footnotes.
13.9.1 SAP for property and casualty contracts
SAP accounting for property and casualty contract liabilities (other than financial guaranty and mortgage guaranty insurance contracts and title insurance) is similar to that of GAAP accounting for claim liabilities related to short-duration contracts. See SSAP 60, SSAP 58, and SSAP 57, respectively, for guidance on financial guaranty, mortgage guaranty, and title insurance.
SSAP 55 provides a list of costs that should be included in the claims reserve liability. Such costs include reported losses, incurred but not reported losses, and loss adjustment expenses. Loss adjustment expenses (LAE) are divided into two broad categories: defense and containment costs (DCC) and adjusting and other (AO). SSAP 55, paragraph 6, provides a list of expenses that are included in each category.
Many insurance entities that use third party administrators (TPAs) or similar companies to process claims pay the TPA a set percentage of written premiums to cover the cost of settling claims (e.g., 8% of written premiums). Paragraph 5 of SSAP 55 prescribes that the insurer cannot offset its LAE reserves with the amounts paid to the TPAs (to cover the cost of settling claims that will be disbursed by the TPA in the future). Instead, the insurer must treat the payments as a prepaid asset. Amounts paid to the TPAs are nonadmitted as they represent "prepaid expenses" under SSAP 29. Although SSAP 55 does not provide any guidance on when to reduce the LAE reserve, we believe the guidance implies this would happen when the direct adjusting service on the obligation to the claimant has been paid.
SSAP 9, Subsequent Events, specifies that the period for assessing subsequent events and related disclosures extends to the issuance of the audit opinion. Paragraph 15 of SSAP 55, Unpaid Losses, states that additional information regarding year-end loss reserve development obtained subsequent to the filing of the Annual Statement, which is not the result of an error in the estimation process, should not result in adjustment to the audited financial statements. Therefore, loss reserve development is exempt from being considered a recognized subsequent event. NAIC staff has informed us that by analogy, other policyholder liabilities, including additional reserves resulting from asset adequacy tests, are also exempt. If material, the loss reserve development would be disclosed in a note to the audited financial statements. However, this guidance is limited to loss reserve development; consequently, other events that occur after the filing of the Annual Statement may still require adjustment to the audited statutory financial statements (and could trigger an Adverse Financial Condition letter if the requirements are met). For unpaid claims, losses, and LAE, insurers must still consider information obtained through the Annual Statement filing date.
13.9.1.1 SAP for discounting property and casualty loss reserves
SSAP 65, paragraph 10, does not allow discounted loss reserves except in cases when the payments are fixed and reasonably determinable, such as those emanating from workers' compensation tabular indemnity reserves and long-term disability claims. However, individual states have prescribed or permitted discounted reserves. When calculating the discounted reserves, some states require the reporting entity to use a discount rate that is the lower of:
- The reporting entity's return on invested assets less 1.5% if the entity's statutory invested assets are at least equal to policyholder reserves; otherwise, the reporting entity's average net portfolio rate less 1.5%. Net portfolio rate is calculated by dividing the net investment income earned by the average of the current and prior year total assets.
- The current yield to maturity on a US Treasury debt instrument with maturities consistent with the expected payout of the liabilities.
In addition, companies who obtain a permitted practice to discount loss reserves are subject to the disclosure requirements of SSAP 1, paragraph 7, including the requirement of the entity to disclose the monetary effect on statutory surplus and net income of using an accounting practice that differs from NAIC statutory accounting practices and procedures. Companies should also disclose the rate and basis for rate used, amount of non-tabular discount by line of business and reserve category, and the amount of non-tabular reserve reported in the statement. In addition, companies should disclose whether the practice of discounting is prescribed or permitted by the domiciliary regulator. If it is a permitted practice, companies are required to disclose the date that the domiciliary state issued the permitted practice and the expiration date of such practice (if any). A change in the discount rate should be accounted for as a change in estimate and recorded in income in the period of change in accordance with SSAP 3. The change should be disclosed in accordance with SSAP 65, paragraph 15.
13.9.1.2 SAP for claims-made contracts
SSAP 55, paragraph 4, states that for claims-made coverage, the covered or insured event is the reporting to the reporting entity of the incident that gives rise to a claim.
When a reporting entity issues an extended reporting endorsement or contract and the preceding claims-made policy terminates, the reporting entity assumes the liability for the unreported claims and expense. For statutory purposes, the accounting for premium and losses when contracts have extended periods is determined based on whether the extended reporting period is for a specified period of time or indefinite. For an indefinite reporting period, the insurer fully earns the premium and a liability for unpaid loss and loss adjustment expenses is recorded immediately. For coverage of a fixed period, the premium is earned over the fixed period (resulting in an unearned premium reserve) and losses are recoded as reported.
13.9.1.3 Unearned premium reserve for policies greater than 13 months
For contracts that are written for coverage periods that equal or exceed 13 months (most commonly home warranty and mechanical breakdown policies), revenues are generally not received in proportion to the level or period of exposure. To account for this, SSAP 65 describes the methods entities with these contracts should use to establish their unearned premium reserves.
For each of the three most recent policy years, the unearned premium must be the largest amount as calculated by three tests described in SSAP 65:
- Best estimate of refundable amounts to the policyholder at the reporting date,
- Gross premium multiplied by the ratio of projected future gross losses and expenses to be incurred during the unexpired term of the contracts to projected total gross losses and expenses, and
- Projected future gross losses and expenses to be incurred during the unexpired term reduced by present value of future guaranteed gross premium.
There is a separate calculation for years prior to the three most recent years.
13.9.1.4 SAP for structured settlements
In accordance with SSAP 65, paragraphs 17-20, when annuities are purchased to fund structured settlement periodic fixed payments and the insurance company is the payee, no decrease in the liability to the policyholder is recorded. The annuity is recorded at its present value and reported as an other-than-invested asset. However, when the claimant is the payee, loss reserves are reduced to the extent that the annuity provides funding for future payments and a gain or loss is recognized. US GAAP requires gain deferral in instances when the insurance company purchases a structured settlement annuity for the claimant, but the insurer has not been legally released from its obligation.
13.9.1.5 SAP for high deductible policies
The accounting for high deductible policies is discussed in SSAP 65, paragraphs 34-39. Specific guidance was provided for these types of policies because state laws generally require the insurer to fund the deductible and periodically review the financial viability of the insured to make an assessment of the suitability of the deductible plan to the insured. Highlights of the statutory accounting for these policies include the following:
- Reserve for losses should be established throughout the policy period, not over the period after the deductible has been reached. The reserve should be net of the deductible unless the deductible is determined to be uncollectible.
- If the policy requires the insurer to fund all losses, including those under the deductible limit, reimbursement of the deductible is accrued and recorded as a reduction of paid losses simultaneously with the recording of the paid loss by the reporting entity.
- The amount accrued for reimbursement of the deductible is aged from the contractual due date.
- 10% of the deductible recoverable in excess of collateral held is reported as a nonadmitted asset. If more than 10% is deemed unrecoverable, the total unrecoverable amount is considered non-admitted.
- SSAP 65 allows a single collateral deposit to satisfy collateral requirements for multiple high-deductible policies, subject to a "fair and equitable" allocation agreement.
- SSAP 65 requires detailed disclosures of loss reserves related to high deductible policies and the related credit risk of such policies.
13.9.2 SAP for life contracts
SSAP 51 discusses the statutory accounting for life reserves. SSAP 51 rejects GAAP guidance for universal life-type contracts and, instead, requires contracts to be classified as either life insurance or a deposit. SSAP 50 provides definitions for each. Generally, contracts that include any mortality or morbidity risk are considered life insurance. Contracts with no mortality or morbidity risk are deemed to be deposit contracts. Reserves for life contracts should be determined based on the statutory tables included in Appendices A-820 and A-822 of SSAP 51.
SSAP 55, paragraph 7, provides a list of costs that should be included in the claims reserve liability.
SSAP 51, paragraph 49, requires that when an insurer's state of domicile requires reserves to be held in excess of the minimum standards of the NAIC, or when the insurer chooses to hold in excess of minimum reserves, the excess be disclosed in the reconciliation of state prescribed or permitted practices to NAIC prescribed practices, as required by SSAP 1. This disclosure requirement is specific to life insurance contracts and would only be required, when material, based on contracts issued on or after January 1, 2001.
In addition, if an insurer holds reserves in excess of its state of domicile's required reserve, e.g., funds are held in a "claim fluctuation reserve" that is not calculated in accordance with established actuarial standards, this fact would also be discussed in the reconciliation between NAIC-prescribed to state-prescribed and permitted statutory accounting practices.
For SAP, no premium deficiency is calculated for life contracts. However, asset adequacy analysis, including cash flow testing, must be performed by life insurers that meet certain requirements, as specified in Appendix A-822 of the NAIC’s Accounting Practice and Procedures Manual.
13.9.3 SAP for health contracts
The accounting for the liabilities related to health contracts is described in SSAP 54R and SSAP 55, Unpaid Claims, Losses and Loss Adjustment Expenses, and Claim Adjustment Expenses.
SSAP 55, paragraph 9, provides a list of costs that should be included in the claims reserve liability. Paragraph 12 of SSAP 55 discusses the concept of conservatism in determining claim reserves but notes that there is not a specific requirement to include a provision for adverse deviation in claim reserves (nor is it prohibited).
13.9.4 SAP for loss recognition (premium deficiency)
Statutory accounting for premium deficiencies is described in SSAP 53 (P&C), SSAP 54R (Accident & Health), SSAP 58 (Mortgage), SSAP 59 (Credit Life and Health), and SSAP 60 (Financial Guaranty). Generally, the calculation of a premium deficiency for SAP is the same as that performed for short-duration GAAP contracts. However, for SAP, the determination is made on a legal entity basis instead of a consolidated entity basis. Therefore, a separate analysis is required. As it is not part of loss reserves, the liability is not allocated to each line of business. In addition, it cannot be recorded as a direct adjustment to surplus. The premium deficiency reserve is presented on the Annual Statement as an aggregate write-in for liabilities.
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