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This section addresses other adoption date and transition matters for the new long-duration insurance guidance, such as early adoption dates, method of transition for investees, method of transition for contracts sold prior to the effective date, and shadow transition adjustments.
Question IG 11-22
SEC filers reporting under US GAAP are permitted to adopt ASU 2018-12 early. Can an entity adopt the ASU in the second, third, or fourth quarters)?
PwC response
A public business entity that is adopting the ASU early should adopt the standard in its first fiscal quarter. The FASB indicated in ASC 250-10 that entities should adopt any accounting changes during the first interim period of a fiscal year whenever possible.
Question IG 11-23
At transition, must an investor and an equity method investee use the same transition method for the liability for future policy benefits and DAC?
PwC response
No. Upon adoption of the new standard, the method of transition for the investee does not need to be the same as the investor’s. However, the investor will need to consider the impact of the equity method investee’s election on its own financial statements. For example, if the equity method investee adopts the new guidance using the retrospective method for specified issue years but the investor used modified retrospective, the investor may need to recast the associated income or loss pickup for the prior periods presented, including all related metrics (e.g., earnings per share).
The investor may also need to recast the income or loss pickup for any market risk benefits given that the retrospective approach is required.

11.4.1 Shadow accounting adjustments upon adoption of ASU 2018-12

See IG 5.10 for a detailed explanation of “shadow” accounting, which requires that the carrying amount of certain assets and liabilities be adjusted to the amount that would have been reported if the unrealized holding gains and losses from AFS securities had been realized (often referred to as a “shadow” OCI adjustment). The new long duration guidance de-linked invested assets from the valuation of nonparticipating traditional insurance and limited payment contract liabilities and disconnected the amortization of certain assets and liabilities from the expected profit emergence pattern. Figure IG 11-3 analyzes accounts that may no longer require “shadow” adjustments based on the new guidance.
Figure IG 11-3
Balances that may no longer require “shadow” adjustments
Balance
Contract
Shadow required under the new guidance?
Reason
Deferred acquisition costs (DAC)
Universal-life type contracts
No
DAC is no longer amortized based on profit emergence
Long-duration participating products
No
Deferred sales inducements (DSI) amortization
Universal-life type contracts
No
DAC (and therefore DSI) is no longer amortized based on profit emergence
Certain investment contracts
No
Unearned revenue liability (URR) amortization
Universal life-type contracts
No
DAC (and therefore URR) is no longer amortized based on profit emergence
Other balances amortized on a basis consistent with the new DAC amortization model (e.g., present value of future profits (PVFP) and cost of reinsurance)
Universal-life type contracts
No
DAC (and therefore these other balances) are no longer amortized based on profit emergence
Long duration participating contracts
No
Other balances not amortized on a basis consistent with the new DAC amortization model (e.g., PVFP and cost of reinsurance)
Universal-life type contracts
Depends
If the policy election is to amortize balances based on profit emergence, “shadow” adjustments would still be required
Long duration participating contracts
Depends
PVFP loss recognition testing
Nonparticipating traditional and limited-payment contracts
Depends
The loss recognition test for the PVFP associated liability for future policy benefits will have a potential shadow adjustment only to the extent that investment yields continue to be used to project future cash flows available in the recovery analysis
Premium deficiency loss recognition testing
Nonparticipating traditional and limited-payment contracts
No
The loss recognition test for the liability for future policy benefits is based on a net premium ratio cap and no longer incorporates consideration of investment yield
Certain additional liabilities for annuitization, death or other insurance benefits (formerly SOP 03-1 liabilities) that are MRBs under ASU 2018-12
Guaranteed minimum benefits in addition to account balance in variable annuities, general account annuities, and other products
No
These features are now required to be carried at fair value rather than measured using a benefit ratio that references investment margins
Terminal dividends
Certain participating life insurance contracts
No
Terminal dividends are no longer amortized based on estimated gross margins
The DAC balance for all types of long-duration contracts, as well as deferred sales inducement assets and unearned revenue liabilities associated with universal life-type contracts, are required to be amortized on a constant level basis following the guidance in ASC 944-30-35-3A. In addition, certain other balances, such as PVFP and the cost of reinsurance, are not required to be amortized on the same basis as DAC, but insurance entities may have made an accounting policy choice to do so and may continue to do so upon adoption of the new guidance. Given that the new amortization method is not impacted by realized gains and losses on investments, any “shadow” accounting previously recognized for these balances would no longer be appropriate. However, other insurance entities may decide to retain an amortization method based on profit emergence for PVFP or cost of reinsurance, in which case these balances would still have a shadow adjustment to the extent they are supported by available-for-sale securities with unrealized gains/losses.
The existing premium deficiency test for nonparticipating traditional and limited-payment contracts incorporates “book” investment yields. The existing shadow premium deficiency test incorporates the hypothetical realization of gains/losses on available-for-sale securities that contribute to that book yield. However, under the new guidance, the premium deficiency test to determine the need for an additional liability is based on a comparison of the present value of benefits to the present value of future gross premiums using a liability-based rate. As a result, there is no shadow adjustment. However, a recoverability test of PVFP relating to nonparticipating traditional and limited-payment contracts is still required and may incorporate investment yields. In this situation, shadow PVFP may still result.
The new guidance introduces the term “market risk benefits (MRBs)” and requires the features that meet the MRB definition to be carried at fair value. Since the MRB asset or liability is already measured at fair value, shadow adjustments would not be appropriate. Under current GAAP, entities may have been recording the liability for these features as an additional liability for annuitization, death, or other insurance benefits (SOP 03-1 liability) under ASC 944-40-30-26 and ASC 944-40-30-20. For features that upon transition meet the definition of an MRB and were previously accounted for as an SOP 03-1 liability, any related shadow adjustment in these balances and in AOCI will need to be reversed. For those SOP 03-1 liabilities that remain SOP 03-1 liabilities (e.g., certain no lapse guarantees), shadow accounting would still apply, as discussed in IG 5.10.
Any shadow adjustments at the transition date in the asset or liability balance that will no longer be impacted by unrealized gains/losses on available-for-sale securities and the corresponding AOCI balance must be reversed. This applies whether the guidance is adopted retrospectively or using the modified retrospective transition approach. If an affected asset or liability is under the modified retrospective transition approach, the reversal of any shadow adjustments from the balance and from AOCI is done at the transition date in determining the transition date carrying amount.

11.4.2 Accounting for contracts sold prior to the effective date of ASU 2018-12

In December 2022, the FASB issued ASU 2022-05, Financial Services—Insurance (Topic 944): Transition for Sold Contracts, which allows insurance entities to make an accounting policy election to exclude certain contracts from the transition guidance of ASU 2018-12 if (1) the contracts are fully derecognized due to a sale or disposal prior to the effective date of ASU 2018-12 and (2) the insurance entity has no significant continuing involvement with the derecognized contracts. Eligible contracts may have been sold or disposed of individually, in a group, or through the disposal of a legal entity. Insurance entities are allowed to elect the accounting policy on a transaction-by-transaction basis.
In assessing whether the criterion of no significant continuing involvement is met, insurance entities should assess significant influence using the guidance in ASC 323-10-15-6 through ASC 323-10-15-11. As such, insurance entities with an investment in a limited partnership accounted for under ASC 323-30-S99-1 that acquired the derecognized contracts are eligible to apply the accounting policy election.
ASU 2022-05 requires insurance entities that elect the accounting policy to disclose a qualitative description of each sale or disposal transaction to which the accounting policy election was applied. In addition, disclosure requirements that existed prior to the adoption of ASU 2018-12 are still applicable to the contracts to which the accounting policy election was applied.
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