For short-duration contracts, both a liability for unpaid claims and a liability for claim adjustment expenses is established when insured events occur. ASC 944-40-25-2 requires that the liability for unpaid claims include both costs associated with reported claims, commonly referred to as “case reserves,” and costs associated with claims that have occurred but have not yet been reported to the insurance entity, commonly referred to as “incurred but not reported (IBNR) claims.” In practice, the IBNR liability component may also include an estimate for expected increases in case reserves but not yet allocated to case reserves (sometimes called incurred but not enough reserves, IBNER). When accounting for a claims-made insurance policy, the insurer should accrue claims as they are reported, with no provision for IBNR (see IG 4.4).
The liability for claim adjustment expenses, commonly referred to as “loss adjustment expense (LAE) reserves,” represents the expected costs to be incurred in conjunction with the adjudication and settlement of unpaid claims. Claims adjustment expenses directly related to a claim are called “allocated loss adjustment expenses” (ALAE) and include legal fees, claims adjusters’ fees, and other costs to record, process, adjust, and pay claims. Claim adjustment expenses also include other costs related to claims processing that cannot be associated with specific claims. These are commonly referred to as “unallocated loss adjustment expenses” (ULAE).
The liability for unpaid claims is based on the estimated ultimate cost of settling the claims, including the effects of both inflationary and socio-economic factors, as detailed in ASC 944-40-30-1. The ultimate cost is estimated using past experience adjusted for current trends and factors and most often involve the use of actuaries. In accordance with ASC 944-40-35-1, changes in estimates of claim costs resulting from the continuous review process and differences between estimates and payments for claims are recognized in income in the period in which the estimates are changed or payments are made.

4.3.1 Short-duration claim cost recoveries

Salvage and subrogation are defined in ASC 944.

Definitions from ASC 944-40-20

Salvage: The amount received by an insurer from the sale of property (usually damaged) on which the insurer has paid a total claim to the insured and has obtained title to the property.

Subrogation: The right of an insurer to pursue any course of recovery of damages, in its name or in the name of the policyholder, against a third party who is liable for costs relating to an insured event that have been paid by the insurer.

When an automobile insurance policyholder gets in an accident that results in a total loss of the insured vehicle, the insurance entity pays the policyholder for the total claim and obtains title to the insured vehicle. The amount received by the insurance entity for the vehicle upon sale is salvage. If it is determined another party was at fault for the accident, the insurance entity may seek to recover damages from that other party and the insurance entity of the other party, if applicable. The amount received by the insurance entity from the other party is subrogation.
Estimated recoveries on unsettled claims, such as salvage and subrogation, which could include a potential ownership interest in real estate, are recorded based on their estimated realizable value and are deducted from the liability for unpaid claims in accordance with ASC 944-40-30-2. ASC 944-40-30-3 requires estimated recoveries on settled claims to also be deducted from the liability for unpaid claims, except for claims arising from mortgage guaranty insurance and title insurance. Subsequent adjustments in the reported amounts of recoveries or realized gains and losses on the sale of real estate acquired in settling claims are recognized as an adjustment to claim costs incurred.

4.3.2 Discounting of short-duration claim costs

Discounting claim liabilities allows the insurance entity to incorporate the time value of money into estimates of expected future cash flows by recording the present value of the claim liabilities in the financial statements. Typical lines of business that may be discounted include workers’ compensation and other short-duration insurance policies with claim payment patterns that are expected to occur over a longer period.
ASC 944 does not provide any specific guidance on scope and measurement for the discounting of liabilities for unpaid claims and claim adjustment expenses related to short-duration insurance contracts. However, the SEC issued SAB Topic 5.N, Discounting by Property-Casualty Insurance Companies (codified in ASC 944-20-S99-1), stipulating the circumstances under which the SEC staff would not object to discounting.

Excerpt from ASC 944-20-S99-1

The following is the text of SAB Topic 5.N, Discounting by Property-Casualty Insurance Companies.
Facts: A registrant which is an insurance company discounts certain unpaid claims liabilities related to short-duration FN9 insurance contracts for purposes of reporting to state regulatory authorities, using discount rates permitted or prescribed by those authorities ("statutory rates") which approximate 3 1/2 percent. The registrant follows the same practice in preparing its financial statements in accordance with GAAP. It proposes to change for GAAP purposes, to using a discount rate related to the historical yield on its investment portfolio ("investment related rate") which is represented to approximate 7 percent, and to account for the change as a change in accounting estimate, applying the investment related rate to claims settled in the current and subsequent years while the statutory rate would continue to be applied to claims settled in all prior years.
FN9 The term "short-duration" refers to the period of coverage (see FASB ASC paragraph 944-20-15-7 (Financial Services—Insurance Topic), not the period that the liabilities are expected to be outstanding.
Question 1: What is the staff's position with respect to discounting claims liabilities related to short-duration insurance contracts?
Interpretive Response: The staff is aware of efforts by the accounting profession to assess the circumstances under which discounting may be appropriate in financial statements. Pending authoritative guidance resulting from those efforts however, the staff will raise no objection if a registrant follows a policy for GAAP reporting purposes of:
Discounting liabilities for unpaid claims and claim adjustment expenses at the same rates that it uses for reporting to state regulatory authorities with respect to the same claims liabilities, or
Discounting liabilities with respect to settled claims under the following circumstances:
(1) The payment pattern and ultimate cost are fixed and determinable on an individual claim basis, and
(2) The discount rate used is reasonable on the facts and circumstances applicable to the registrant at the time the claims are settled.

Although, the guidance in ASC 944-20-S99-1 is specifically applicable to SEC registrants, non-public insurance entities also follow the guidance in practice. Short-duration claim costs are an accounting estimate and, similar to other accounting estimates, there is the potential that actual future loss payment experience for existing incurred losses will be different from what is expected at the time the estimate is made. Discounting of short-duration claim costs is appropriate only when the amount and timing of future claim payments for a line of business can be estimated by management with a relatively high level of confidence and relatively low variability. Generally, management must demonstrate that past claims experience demonstrates a low variability and that the past claims experiences is a faithful representation of the current and expected future claims experience (i.e., no significant changes from the past claims experience). Additionally, the expected level of variability that would be acceptable (i.e., would be considered "relatively low") is, in part, a function of an entity's stockholders’equity. As the amount of the discount increases in relation to equity, the expected variability would need to decrease for discounting to be acceptable. Only in rare circumstances will management be able to demonstrate the required expectation of low variability for new insurance entities, new lines of business, existing lines of business with significantly increased volume, or existing lines of business with significant changes expected from relevant past claims experience.
In all circumstances, other than structured settlements when ASC 835-30-15-2 requires discounting, reporting the undiscounted ultimate claim cost is an acceptable but not required approach under US GAAP. Reporting undiscounted reserves is required when management is unable to support an expectation of relatively low variability in future loss payments. The decision to discount or not is an accounting policy election that should be consistently applied and disclosed.
See ASC 944-40-50-5 for the disclosure requirements when discounting claim liabilities.
In order for an insurance entity to change its policy from nondiscounting to discounting, it would need to justify the change as being preferable, as required by ASC 250, Accounting Changes and Error Corrections. ASC 250 requires that a change in accounting principle be reported through retrospective application to all prior periods, unless impracticable. Discounting of settled claims

Under ASC 944-20-S99-1, the first criteria for the discounting of settled claims is that the payment pattern and ultimate cost are fixed and determinable on an individual claim basis. An “individual claim basis” refers to those claims for which the claimant has agreed to the amount and frequency of payments, along with the period over which those payments are to be made. However, under certain circumstances, it would be appropriate to include as settled claims those based on actuarial estimates of the aggregate amount expected to be paid to a large number of individuals with similar claims. For example, personal liability settlements may be based on life expectancy. If the insurance entity has information that provides reliable estimates of the aggregate claims expected to be paid to a large number of claimants, as well as the timing of the payments, these claims may be discounted as settled claims. Determination of the discount rate

Diversity exists regarding the discount rate used to discount liabilities for unpaid claims and claim-adjustment expenses. In practice, short-duration insurance entities apply the guidance in ASC 944-20-S99-1 (SAB Topic 5.N) or ASC 450-20-S99-1 (SAB Topic 5.Y).
ASC 944-20-S99-1 provides that liabilities for unpaid claims and claim adjustment expenses can be discounted at the same rates used for reporting such claims liabilities to state regulatory authorities. The reference to “state regulatory authorities” is applied by analogy to geographic locations outside of the United States with significantly robust insurance regulations.
SAB Topic 5.Y, Accounting and Disclosures Relating to Loss Contingencies (codified in ASC 450-20-S99-1), which is applicable to environmental and product liabilities, and ASC 410-30, Environmental obligations, which is explicitly applicable to environmental liabilities, provide guidance on discounting. We believe this guidance can be applied to all types of short-duration insurance liabilities, not just environmental and product liabilities. ASC 450-20-S99-1 specifies that the discount rate used to discount the cash payments should be “the rate that will produce an amount at which the environmental or product liability could be settled in an arm's-length transaction with a third party.” ASC 450-20-S99-1 further states that the discount rate used to discount the cash payments should “not exceed the interest rate on monetary assets that are essentially risk free and have maturities comparable to that of the environmental or product liability.” This rate is referred to as a "settlement rate," even though it conceptually involves the transfer of the obligation to a third party instead of settlement with the claim counterparty. It is generally difficult to determine the settlement discount rate. As a result, in practice, a risk-free rate for monetary assets with comparable maturities is typically utilized even though the settlement/transfer rate would include a risk margin to compensate for the risk being assumed so would generally be less than the risk-free rate.
Conceptually, the discount rate applied to a liability should not change from period to period if the liability is not recorded at fair value. The effective rate on debt obligations and loans is not changed once established in an amortized cost model. Many liabilities recorded for contingencies consist of numerous claims that are being established and settled from period to period and keeping track of the period for which estimates for liabilities were recorded and later revised adds additional complexity when locking in discount rates. In practice, some insurance entities have discounted all estimated cash flows in the liability at a single current or blended rate (i.e., a blending of the rates at which the liabilities were initially established).
Changing the basis of the discount rate (e.g., statutory rate to risk free rate) would be considered a change in policy and would require preferability.

4.3.3 Fair value option

Short-duration insurance contracts are eligible for the fair value option election at inception of the contract. Claims incurred are not a separate contract and would not be eligible for the fair value option. ASC 825-10-15-4 allows the fair value election for financial instruments, including insurance contracts that meet the definition of a financial instrument. Additionally, in accordance with ASC 825-10-15-4(d), the fair value option is available for insurance contracts that are not financial instruments (because the contract requires or permits the insurer to provide goods or services rather than a cash settlement) if the contract terms permit the insurer to settle by paying a third party to provide those goods or services. In effect, the guidance allows the fair value option election when the insurer itself is not required to provide a good or service and can instead expend cash. If the insurer is required to provide the goods or services, it would not be eligible for the fair value election.
If the fair value option is elected, the guidance in ASC 825-10 should be followed.

Excerpt from ASC 825-10-25-7

The fair value option may be elected for a single eligible item without electing it for other identical items with the following four exceptions:
a. ...
b. ...
c. If the fair value option is applied to an eligible insurance or reinsurance contract, it shall be applied to all claims and obligations under the contract.
d. If the fair value option is elected for an insurance contract (base contract) for which integrated or nonintegrated contract features or coverages (some of which are called riders) are issued either concurrently or subsequently, the fair value option also must be applied to those features or coverages. The fair value option cannot be elected for only the nonintegrated contract features or coverages, even though those features or coverages are accounted for separately under Subtopic 944-30. Paragraph 944-30-35-30 defines a nonintegrated contract feature in an insurance contract. For purposes of applying this Subtopic, neither an integrated contract feature or coverage nor a nonintegrated contract feature or coverage qualifies as a separate instrument.

See FV 4 for further discussion of fair value measurements.
Expand Expand

Welcome to Viewpoint, the new platform that replaces Inform. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory.

signin option menu option suggested option contentmouse option displaycontent option contentpage option relatedlink option prevandafter option trending option searchicon option search option feedback option end slide