Residual value insurance guarantees that a properly maintained asset will not be worth less than a specified amount on a specified date, such as upon expiration of a lease. The insurance protects the insured from losses due to greater than expected declines in the market value of an asset. Premiums are typically paid at inception of the policy.

Settlement is usually based on comparing the insured value agreed upon at the inception of the policy to the amount determined by one of the following common settlement provisions:

Residual value insurance guarantee contracts are most likely accounted for as derivatives unless they qualify for the exception in ASC 815-10-15-59. Residual value contracts that meet the derivatives scope exception are typically accounted for using a short-duration insurance model by analogy because residual value guarantees do not meet the definition of either an insurance contract or a financial guarantee contract.

When payment under the residual value insurance contract is based on an index (e.g., the Blue Book value for automobiles), instead of the value of a specific nonfinancial asset, the contract would not qualify for the scope exception under ASC 815-10-15-59 and would be accounted for as a derivative. Conversely, settlement based on using the appraisal value or the sales proceeds of the specified asset owned by the party would meet the scope exception in ASC 815-10-15-59 and the contract would be accounted for as issued insurance. In situations when the appraisal value, sales proceeds, or the insured value is adjusted to reduce the amount of the required payment for factors such as the actual excess wear and tear and excess mileage of the asset, the contracts would still meet the exception as long as the price or value of the asset that is being referenced in the calculation is that of the actual specific asset. In that situation, the underlying on which settlement is based is still the sales price or appraisal value of the unique asset. The excess wear and tear provisions and similar adjustments only serve to reduce the amount of the claim payment when the asset is returned in a condition other than that specified in the contract.

In instances when settlement is based on the higher of multiple amounts (e.g., the higher of actual proceeds from sales or values established by referencing an asset valuation guide), the contract is considered to have multiple underlyings. The contract is subject to ASC 815 if all of the underlyings behave in a manner that is highly correlated with any of the underlyings that do not qualify for the scope exception. For example, a Blue Book value for automobiles and actual sales proceeds are deemed to be highly correlated as the Blue Book values are based on actual sales and transactions or new manufacturer price information. If a contract settles based on a comparison of the insured value with the higher of sales proceeds or asset valuation guide, the reporting entity would compare the results under the contract using the combined underlyings with the result using only the asset valuation guide. If the two underlyings are highly correlated, the contracts would not meet the ASC 815-10-15-59 scope exception and would be accounted for as a derivative and follow mark to market accounting.

See PwC's Guide to Derivatives and Hedging, for further information on the accounting and reporting of derivative instruments under ASC 815.