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Classification of an issued contract (sometimes called a direct or written contract) as insurance or reinsurance requires that the contract have significant insurance risk. Contracts that fail to meet the significant insurance risk test are required to be classified as investment contracts. Classification is done at contract inception and is typically not reevaluated unless the contract is amended.
Explicit guidance on analyzing significant insurance risk in issued contracts is limited, but high-level guidance is found in the following references.

ASC 944-20-05-5

The primary purpose of insurance is to provide economic protection from identified risks occurring or discovered within a specified period.

ASC 944-20-05-6

Insurance contracts may be characterized generally by both of the following:

  1. the purchaser of an insurance contract makes an initial payment or deposit to the insurance entity in advance of the possible occurrence or discovery of the insured event.
  2. when the insurance contract is made, the insurance entity ordinarily does not know if, how much, or when amounts will be paid under the contract.

ASC 450-20-60-14

For contingencies related to an insurance contract or reinsurance contract that does not, despite its form, provide for indemnification of the insured or the ceding company by the insurer or reinsurer against loss or liability, see paragraph 720-20-25-1.

ASC 720-20-25-1

To the extent that an insurance contract or reinsurance contract does not, despite its form, provide for indemnification of the insured or the ceding entity by the insurer or reinsurer against loss or liability, the premium paid less the amount of the premium to be retained by the insurer or reinsurer shall be accounted for as a deposit by the insured or the ceding entity. Those contracts may be structured in various ways, but if, regardless of form, their substance is that all or part of the premium paid by the insured or the ceding entity is a deposit, it shall be accounted for as such.

Further guidance on the evaluation of insurance risk for short-duration and long-duration contracts is described below.
Risk transfer guidance for evaluating reinsurance ceded to an assuming reinsurer is more prescriptive and is discussed inIG 8.5 and IG 9.5.

1.3.1 Short-duration insurance risk assessment

The glossary in ASC 944-20-20 defines insurance risk and related terms.

Definition from ASC 944-20-20

Insurance risk: The risk arising from uncertainties about both underwriting risk and timing risk. Actual or imputed investment returns are not an element of insurance risk. Insurance risk is fortuitous; the possibility of adverse events occurring is outside the control of the insured.
Underwriting risk: The risk arising from uncertainties about the ultimate amount of net cash flows from premiums, commissions, claims, and claim settlement expenses paid under a contract.
Timing risk: The risk arising from uncertainties about the timing of the receipt and payments of the net cash flows from premiums, commissions, claims, and claim settlement expenses paid under a contract.

Guidance on what constitutes insurance risk for direct insurance contracts written between insurers and policyholders is limited to the definitions in ASC 944-20-20. These general concepts apply to insurance contracts as well as to reinsurance contracts written between insurers and reinsurers.
In addition, more explicit, qualitative and quantitative risk transfer criteria exist for short-duration reinsurance contracts as the cash flows of a single reinsurance contract combine the gains and losses of numerous issued insurance contracts, which may be highly predictable in total (see IG 8.5). For example, in order for a reinsurance contract to pass the risk transfer test, there generally must be a reasonable possibility that the reinsurer will recognize a significant loss on the transaction. This evaluation is made by comparing all cash flows between the parties with the amounts paid or deemed to have been paid to the reinsurer.
Because there is limited guidance on risk transfer for direct contracts, the guidance on reinsurance risk transfer may be used by analogy. The ASC 720, Other Expenses, guidance on the accounting for insurance contracts by policyholders acknowledges the concept of risk transfer and notes that entities may find the conditions outlined in ASC 944 for reinsurance useful in assessing whether an insurance contract transfers risk.

1.3.2 Long-duration insurance risk assessment

Insurance risk for long-duration life insurance and annuity contracts focuses on the significance of mortality or morbidity risk (ASC 944-20-15). Mortality risk relates to the obligation to make payments that are contingent upon the death or continued survival of a specific individual or group. Morbidity risk relates to the relative incidence of disability due to disease or physical impairment.
An annuity contract that allows the holder to purchase an annuity at a guaranteed price on the settlement of the contract does not contain mortality risk until the annuity is purchased.
Annuity contracts may require an insurance company to make a number of payments that are not contingent on the survival of the beneficiary followed by life contingent payments. These contracts are considered insurance contracts unless:
  1. the probability that the life contingent payments are made is remote, and
  2. the present value of the expected life-contingent payments relative to the present value of all expected payments under the contract is insignificant.
If the mortality and morbidity risk in a long-duration life insurance or annuity contract is other than nominal, the contract should be classified as insurance. Nominal risk is defined as a risk of insignificant amount or remote probability. If nominal, the contract is classified as an investment contract.
There is a rebuttable presumption that a contract has significant mortality risk if a mortality benefit would vary significantly in response to capital markets volatility (see ASC 944-20-15-21). These contract features with other-than-nominal capital market risk need to be assessed to see if they meet the definition of a market risk benefit or an embedded derivative and are required to be accounted for at fair value. See IG 2.4.5 and DH 4.6.2, respectively, for more information.
The risk transfer analysis for long duration reinsurance requires that there be a reasonable possibility of significant loss to the reinsurer from the events insured by the underlying direct insurance contracts (see IG 9.5). The analysis of significant mortality or morbidity risk is the same as the criteria for direct contracts.

1.3.3 Contracts that fail the significant insurance risk criteria

Contracts that are written as insurance or reinsurance but fail the significant insurance risk test are accounted for as deposits. The accounting for the deposit depends on whether the contract is short duration or long duration.

1.3.3.1 Short-duration contracts without significant insurance risk

At inception, a deposit asset or liability is recognized based on the consideration paid or received, less any explicitly identified premiums or fees to be retained by the insurer or reinsurer, irrespective of the experience of the contract.
Deposit contracts that lack underwriting risk follow a financial instrument effective yield model, with the effective yield being a function of the deposit and future projected cash flows. Those contracts that have underwriting risk, but lack timing risk, require a discounted claim estimation measurement. For contracts with indeterminate risk, the effects of the contracts are not included in the determination of net income until sufficient information becomes available to reasonably estimate and allocate premiums.
See IG 8.7 for further discussion on the accounting models for short-duration contracts that fail the risk transfer criteria.

1.3.3.2 Long-duration contracts without significant insurance risk

Long-duration life and health contracts that do not indemnify against mortality or morbidity risk are required to be accounted for as investment contracts. As noted in IG 2.5.1, deferred annuity contracts issued by insurers are typically classified as investment contracts during the accumulation phase. However, they may have longevity risk and thus ultimately be classified as an insurance contract if and when the contract holder elects life-contingent payments in the annuitization phase of the contract.
Any payments received for investment contracts are reported as liabilities and accounted for in a manner consistent with the accounting for interest-bearing or other financial instruments. While investment contract liabilities are accounted for as deposits, some of the provisions within ASC 944 nevertheless apply to investment contracts. Examples include the guidance on deferred acquisition costs, contract modifications, separate accounts, and valuing annuitization benefit options during the accumulation phase of the contract.
See IG 5.5 for further discussion on the accounting for investment contracts issued by a direct insurer. See IG 9.4 for further discussion on deposit accounting for life reinsurance contracts that fail risk transfer.
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