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Traditional long-duration contracts provide a specified, fixed amount of insurance benefit in exchange for a fixed premium, paid either upfront, over a fixed number of years, or payable each year the policy is kept in force (e.g., whole-life insurance, guaranteed renewable term-life insurance, or long-term disability insurance).
Premiums on nonparticipating traditional long-duration insurance contracts are recognized in revenue when due. The liability for future policyholder benefits is recognized on the balance sheet using a net premium measurement approach whereby the liability is accrued as a proportion of premium revenue recognized. The period accruals are reported as benefit expense. If actual experience unfolds exactly as projected, reported underwriting profit in each year will be a constant percentage of premiums. The aggregate liability for future policy benefits reflects the insurance entity’s contractual obligations under insurance policies in force as of the balance sheet date using current assumptions. This calculation is performed by grouping similar contracts into cohorts and using specialized actuarial methods.

5.2.1 Estimating the liability for future policy benefits

ASC 944-40-25-8 outlines the income statement margin approach, which requires the liability for future policy benefits for nonparticipating traditional life insurance and limited-payment contracts to be determined such that expected insurance benefits (i.e., estimated future death, disability or other claims and any surrender benefits) are accrued in proportion to premium revenue recognized. This is accomplished through a method referred to as the “net premium” approach.
The liability is determined as the present value of future benefits and related claims expenses less the present value of future net premiums, where net premium is gross premium under the contract multiplied by the net premium ratio. As noted in ASC 944-40-35-7B, in no event should the liability for future policy benefits be less than zero at the level of aggregation at which liabilities are measured.
Figure IG 5-1 outlines the formula for determining the net premium ratio.
Figure IG 5-1
Formula for the net premium ratio
The net premium ratio is capped at 100% (i.e., net premiums cannot exceed gross premiums). The liability can also be thought of as premium revenue recognized from the inception of the contract multiplied by the net premium ratio, less benefits and expenses already paid as long as the net premium ratio is updated for actual experience and stays below the 100% cap. See IG 5.2.5 for further details on the measurement of loss contracts.
Related claim expenses include termination and settlement costs and exclude acquisition costs and non-claim related costs, such as costs relating to investments, general administration, policy maintenance, product development, market research, and general overhead or any other costs that are required to be expensed under ASC 944-720-25-2.
The premiums, benefits, and claims-related expenses cash flows are estimated using methods that include assumptions, such as estimates of mortality, morbidity, terminations, and claim-related expenses, and the possible impact of inflation on those expenses. Benefits include all guaranteed cash flows to the policyholder, including coupons, annual endowments, and conversion privileges. See IG 5.2.2 for additional details surrounding reserve assumptions utilized in the net premium ratio.
Example IG 5-1 illustrates the calculation of the net premium ratio at issue date for a cohort of policies and the resulting liability of future policy benefits.
EXAMPLE IG 5-1
Calculation of initial net premium ratio and liability of future policy benefits
Insurance Company A has a cohort of traditional life insurance contracts with estimated cash flows as detailed in the chart below. The example is based on Example 6 in ASC 944-40-55, Updating of Assumptions Used in the Measurement of the Liability for Future Policy Benefits.
How is the initial net premium ratio calculated and what journal entries should be recognized in Year 1?
Analysis
The net premium ratio is calculated based on the following cash flows, and then multiplied by the gross premium to yield the net premium in each period. Discounting of cash flows to derive the net premium ratio uses the original contract issuance discount rate, which for simplicity of illustration, is assumed to be 0%.
Year
Benefits
Gross premiums (A)
Net premiums (A*71.1%)
1
$200.0
$500.0
$355.4
2
208.8
474.5
337.2
3
216.1
450.3
320.0
4
222.2
427.3
303.6
5
227.0
405.4
288.1
6
230.7
384.6
273.3
7
233.5
364.8
259.2
8
235.3
346.0
245.9
9
236.3
328.1
233.2
10
236.5
311.2
221.1
11
236.0
295.1
209.7
12
235.0
279.7
198.8
13
233.4
265.2
188.5
14
231.3
251.4
178.6
15
228.7
238.3
169.3
16
225.8
225.8
160.5
17
222.5
214.0
152.1
18
219.0
202.8
144.1
19
215.1
192.1
136.5
20
211.1
182.0
129.3
Total
$4,504.4
$6,338.4
$4,504.4
Present value (0%)
$4,504.4
$6,338.4
$4,504.4
Net premium ratio
Present value of total benefits and expenses (for Years 1-20)
(A)
$4,504.4
Present value of total gross premiums (for Years 1-20)
(B)
$6,338.4
Net premium ratio (A)/(B)
(C)
71.1%
The Year 1 ending balance for the liability for future policy benefits would be as follows:
Year 1 calculation
Present value of future benefits (for Years 2-20)
$4,304.4
Less: Present value of future net premiums (for Years 2-20)
4,149.0
Liability for future policy benefits
$155.4
At the end of year 1, Insurance Company A would record the following journal entries to reflect the liability calculation and cash flows from premiums received ($500) and benefits paid ($200). In this example, actual amounts are equal to expected, and therefore benefit expense is equal to gross premiums of $500 multiplied by the net premium ratio of 71.1%.
Dr. Cash1
$300.0
Dr. Benefit expense2
355.4
Cr. Premium income
$500.0
Cr. Liability for future policy benefits
155.4

1Premiums collected of $500, less benefits paid of $200
2Benefits paid of $200, plus change in reserve of $155.4
See IG 5.3 for additional consideration for limited-payment contracts.

5.2.2 Liability assumptions in the net premium ratio

ASC 944-40-30-8 includes the assumptions required to be incorporated into the calculation of the net premium ratio used for the liability for future policy benefits:
  • Discount rate
  • Mortality
  • Morbidity
  • Termination
  • Expense

The discount rate is required to be an upper-medium grade (low credit risk) fixed-income corporate instrument yield (“single A”) that reflects the duration characteristics of the liability. See IG 5.2.3 for further information on the discount rate.
Mortality represents the likelihood of a policyholder dying at various ages. Mortality assumptions comprise an integral component of the calculation of long-duration life and annuity contract liabilities and should be based on estimates of expected mortality. Morbidity represents the likelihood of illness or sickness occurring, and thus morbidity assumptions are incorporated into coverages such as disability, long-term care, and accident and health. ASC 944-40-30-13 notes that expected incidences of disability and claim costs for various types of insurance and other factors, such as occupational class, waiting period, sex, age, and benefit period, should be considered in making morbidity assumptions, as well as the risk of antiselection or adverse selection, which is the risk of having a disproportionately higher number of higher risk policyholders. ASC 944-40-30-12 notes that morbidity assumptions should be based on estimates of expected incidences of disability and claim costs. The expected benefit cash payments for disability claims and not the incurred lump sum amount should be used in the expected benefits.
ASC 944-40-30-14 provides that termination assumptions should be based on estimates of expected terminations and nonforfeiture benefits, using expected termination rates and contractual nonforfeiture benefits (e.g., cash value, paid-up insurance value, or extended-term insurance value). Termination rates may vary by plan of insurance, age at issue, year of issue, frequency of premium payment, and other factors. Composite rates may be used, but only if the rates are representative of the entity's actual mix of business.
Claim-related expense assumptions represent the estimated costs to be incurred by the insurer to settle a claim of an in-force policy, considering the possible effect of inflation, and include such costs as termination or settlement costs. These estimates are generally expressed as a percent of premium or per policy, surrender, or claim processed. ASC 944-40-30-15 notes that non-claim related costs, including policy maintenance costs, are excluded from the net premium ratio and expensed as incurred.

Excerpt ASC 944-40-30-15

However, expense assumptions shall not include acquisition costs or any costs that are required to be charged to expense as incurred, such as those relating to investments, general administration, policy maintenance costs, product development, market research, and general overhead (see paragraph 944- 720-25-2).


Annual or more frequent updating of insurance assumptions is required, with the impact on the liability recognized on a retrospective catch up basis as a separate component of benefit expense. See IG 5.2.4 for details on the frequency of when the assumptions must be updated in the net premium ratio.

5.2.3 Discount rate assumption

Future cash flows used to estimate the liability for future policy benefits for nonparticipating traditional insurance contracts and limited-payment contracts must be discounted using an upper-medium grade (low credit risk) fixed-income instrument yield (interpreted as a “single A” interest yield) that reflects the duration characteristics of the contracts. The discount rate is required to be updated at each reporting date, with the effect of the discount rate changes on the liability recognized in OCI. The contract inception date discount rate is locked in for benefit expense purposes. See IG 5.2.3.1 for additional details.
The discount rate selection should maximize the use of current market observable inputs. The FASB chose the “single A” interest yield as being an objective standardized representation of a liability yield that reflects the characteristics of the liability.
An entity should not substitute its own estimates for observable market data unless the market data reflects transactions that are not orderly, as defined in the guidance on fair value measurement (ASC 820). For points on the yield curve with no or limited market observable data, an entity should use an estimate consistent with existing guidance on fair value measurements.
Question IG 5-1 addresses how to determine the upper-medium grade yield. Question IG 5-2 addresses whether adjustment can be made to the published yield. Question IG 5-3 addresses yield estimates beyond the observable period. Question IG 5-4 addresses non-US grade assessments. Question IG 5-5 addresses when foreign jurisdictions may not have an active market for single A rated securities. Question IG 5-6 addresses the development of a yield curve for a cohort of policies originated over a period of time. Question IG 5-7 addresses the application of different discount rates to individual contracts within a cohort.
Question IG 5-1
How is the upper-medium grade (low credit risk) fixed-income instrument yield determined?
PwC response
When available, observable market data should be used. For example, banks and rating agencies publish rates for corporate fixed-income debt instruments in various rating categories, one of which is characterized as the “upper-medium grade,” which corresponds to what is commonly referred to as a “single A” rating. Although these ratings are available for various classes of instruments (e.g., public debt, private placements, municipal debt, asset-backed securities), we believe the FASB’s intention is that the upper-medium grade rate be that of a public corporate debt security.
The concept of using a standardized rate in calculating a specific class of liability is consistent with the accounting for pension obligations, which requires discounting using a high-quality fixed-income yield. Therefore, although the yield required for insurance liabilities is upper-medium grade rather than the high-quality rate required for pensions, entities can use similar principles in developing the yield curve. For example, when determining an upper-medium grade yield from an available rating agency, considerations should include assessing whether they incorporate appropriate bonds and bond pricing, effectively match the expected cash flow stream, and incorporate reasonable assumptions about reinvestment of excess bond cash flows and yields for bond maturities in years when no bonds exist (e.g., beyond 30 years).

Question IG 5-2
May an entity adjust the single A yield if it believes the cash flows in its contracts differ in certain respects from a typical single A corporate credit. For example, if the insurer believes the cash flows in its contracts are less liquid than those of a single A-rated public debt of a non-insurance corporate entity, can the yield be adjusted?
PwC response
No. The FASB’s intention in requiring the use of an upper-medium grade (low credit risk) fixed-income instrument yield is to promote consistency and comparability between entities as well as to make it operationally easier for entities to apply. Therefore, the only adjustment from a single A-rated corporate debt instrument that would be permitted would be to adjust for differences in duration. The rate is a prescribed rate, unlike the discount rate required by other insurance models, such as IFRS 17, Insurance Contracts, under which a debt instrument yield can be the starting point to which further adjustments are made.

Question IG 5-3
An entity has contracts with cash flows expected to occur over the next 70 years. How would an entity develop a single A interest yield for points beyond the observable period?
PwC response
For points on the yield curve for which there is limited or no observable market data (e.g., when cash flows are expected to occur beyond the date when observable single A corporate rates are available), an entity should use estimates determined using techniques consistent with those that would be used for level 3 estimates of fair value under ASC 820. Under that guidance, points on the yield curve may need to be derived through extrapolation or interpolation consistent with what a market participant would use.

Question IG 5-4
What is a single A rate in a non-US territory, such as Japan or Brazil?
PwC response
We believe the FASB’s intention is the rate used would be equivalent to a single A interest yield (low credit risk) from a global rating agency for a corporate bond issued in the same currency in which the insurance contract is written.

Question IG 5-5
In foreign economies without an active market of public single A rated securities, how should an upper-medium grade (low credit risk) fixed-income instrument yield be determined?
PwC response
ASC 944-40-30-9 requires the liability for future policy benefits to be discounted using an upper-medium grade (low credit risk) fixed-income instrument yield (interpreted as a single A interest yield for corporate bonds) that reflects the duration characteristics of the contracts/cohorts. In situations when there is not an active market of public single A rated securities in a foreign jurisdiction, insurance entities should estimate a single A rate consistent with existing guidance on fair value measurement in ASC 820 and by maximizing observable data (as noted in ASC 944-40-15-13E). For example, if the foreign jurisdiction has government bonds that are rated above or below single A, it may be possible to derive a hypothetical single A rate corporate bond yield using the sovereign yield as an input to the curve and adjusting it (positive or negative adjustment) as appropriate.

Question IG 5-6
Cohorts may be established that represent particular contracts that are issued over a particular period. For example, a cohort may be defined to be certain term life insurance policies that originate during a particular calendar quarter. How should the curve be developed for this cohort given that interest rates will change over the quarter? For example, should the rate at the beginning of the quarter, end of the quarter or an average of the quarter be used?
PwC response
The objective of ASC 944-40-35-6A (b)(2) is to employ an interest accretion rate on the liability for future policy benefits that represents “the original discount rate used at contract issue date.” ASC 944-40-30-7 permits contracts to be aggregated into cohorts for purposes of measurement, and in so doing, implicitly permits entities to use judgment in developing an aggregate discount rate assumption appropriate at the cohort level. The ultimate rate selected should be representative of the cohort as a whole. For example, a reporting entity may determine that a curve as of a particular date in the quarter may best represent the cohort (e.g., beginning curve, mid period curve, or end of period curve) depending on the pattern of issuance, general trend in interest rates, and market availability. A weighted average of the daily curves could also be used.
It may be inappropriate to use a beginning of the period rate/curve without adjustment if there have been significant changes in the yield curve during the period and a significant portion of policies included in such cohort were issued during the latter half of this period.
Variability in yield curve and timing of issuance of policies may therefore be factors that reporting entities consider in determining the length of a cohort (i.e., how long of a period a cohort will cover).
If a cohort spans multiple reporting periods, for instance an annual cohort spanning quarters, a weighted average rate (or weighted average spot or forward curve, if a curve is used) could be developed and updated as each subsequent quarter’s activity is added until the annual period is closed. If done appropriately, the changes will be weighted by the new cash flows each quarter and be the approximate equivalent to locking each quarter. The disclosure of the weighted average rate will change each quarter as new insurance contracts are added to the cohort and the interest environment changes.

Question IG 5-7
May an entity apply different discount rates to individual contracts within a cohort?
PwC response
The objective of ASC 944-40-35-6A (b)(2) is to employ an interest accretion rate on the liability for future policy benefits that represents “the original discount rate used at contract issue date.” Although in many instances, entities may decide that use of an aggregate rate or curve for the cohort is appropriate (as illustrated in Question IG 5-6), in other instances, they may decide that it is not. For example, entities may write certain types of products for which large premium payments are received at inception on interest sensitively-priced products, such as pension risk transfer business. For these products, entities may decide that measuring the liability at the cohort level using discount rates appropriate for each contract within the cohort better meets the objective set out in ASC 944-40-35-6A (b)(2). We believe this approach and the rationale have merit. However, there continues to be dialogue on this issue in the insurance sector, with some interpreting the guidance as requiring a single curve or rate for a cohort.
Under this approach, a single net premium ratio would be determined for the cohort and would be subject to the 100% net premium ratio cap. The numerator would be the present value of benefits and the denominator would be the present value of premiums for the entire cohort, with each contract’s cash flows discounted using the yield curve or rate applicable for the issue date of each contract within the cohort. Similarly, when calculating benefit expense for each period, the ending liability would be calculated from the present value of benefits and present value of net premiums with each contract’s cash flows discounted using the yield curve or rate applicable for the issue date of each contract within the cohort.

5.2.3.1 Impact of discounting in the income statement and OCI

The liability for future policy benefits involves two separate present value of cash flows calculations. A locked-in discount rate is used for the purposes of generating the liability for future policy benefits for purposes of income statement interest accretion and updating the net premium ratio, while the liability for future policy benefits is remeasured to reflect current single A yields for purposes of balance sheet measurement, with the corresponding change recognized through other comprehensive income.
Locked-in discount rate – income statement interest accretion and updating the net premium ratio
When a contract (or cohort) is first issued, a net premium ratio is calculated that represents the present value of benefits and related claims expense divided by the present value of gross premiums. The discount rate used to derive the net premium ratio is representative of a single A yield curve at contract (or cohort, if applicable) issuance date. This present valuing calculation incorporates the time value of money concept into the determination of the contract margin (i.e., the difference between future premiums less benefits and claims expense) to be recognized over time. The cumulative income statement interest accretion at contract maturity will be equal to the difference in the net premiums and benefits on a discounted and undiscounted basis. Each period, the net premium ratio will be updated using new policyholder assumptions, but the discount rate/curve will be the locked-in rate, as described in ASC 944-40-35-6A.

Excerpt from ASC 944-40-35-6A (b)(2)

The interest accretion rate shall remain the original discount rate used at contract issue date.

Several approaches can be applied to calculate this accretion to the income statement over time. See IG 5.2.3.2 for further details.
Remeasurement of the liability for future policy benefits due to changes in discount rates recognized in OCI
A remeasurement of the liability for future policy benefits is required each period using the current single A discount curve. Updated future benefits and related claim expense cash flows and the updated future net premiums (using the revised net premium ratio) are discounted to the current reporting date using current discount rates (i.e., not the locked-in income statement interest accretion rate determined upon issuance of the contract, but rather the period end single A discount rate curve). The difference between the updated liability measured using the locked-in discount rate curve and the liability measured at the current discount rate curve is presented in accumulated other comprehensive income (AOCI), and the change in AOCI for the period is presented in OCI and not as an expense of the period. The liability for future policy benefits is required to be remeasured each reporting period using the current discount rate curve, even if the net premium ratio is not recalculated in the period.
Question IG 5-8 addresses the interest rate to use to discount cash flows.
Question IG 5-8
In discounting cash flows, does the guidance require the locking in of a yield curve or an equivalent level rate?

For purposes of calculating the balance sheet remeasurement and related OCI adjustment, should one apply a consistent methodology?
PwC response
The guidance does not specify whether an insurer should lock in a yield curve (i.e., use a different rate for each cash flow based upon the curve) or use an equivalent level rate that reflects the duration-specific spot rates from each point on the yield curve. At contract inception, a spot rate yield curve should be used to reflect the expected timing of the cash flows. A different rate on the curve would be used to discount cash flows expected to occur at each point on the yield curve.
The results of using the yield curve could potentially be translated to an equivalent level rate. As the guidance is silent, this equivalent level rate could be locked in and used for discounting all cash flows in future net premium ratio calculations and the income statement benefit expense for the cohort or the curve itself could be locked in with each future year’s cash flows using the applicable year rate on the curve.
At each reporting date, a new curve will be needed to remeasure the present value of the cash flows for purposes of calculating the AOCI adjustment (using current rates).
As the objective of discounting is to estimate the time value of money, the estimation techniques selected for a cohort should be used consistently throughout the life of a cohort. Use of a different technique for subsequent cohorts of the same product may be acceptable if a better estimate is achieved using another technique.
There may be different acceptable techniques for using a locked-in curve in subsequent periods that achieve the objective of isolating changes in market interest rates from the changes in locked-in time value of money. See IG 5.2.3.2 for further details.

5.2.3.2 Determining the income statement accretion discount rate

In practice, there are three approaches to determining the income statement accretion discount rate that could be utilized by insurance entities. They are the spot rate, forward rate, and equivalent level rate approaches. Given that the guidance is silent on the specific approach to be used, we believe that each is acceptable given their economic equivalency. If an insurance entity had perfect information, each of these approaches should theoretically produce substantially similar present values at inception of a contract (or cohort). However, the income statement accretion pattern for each subsequent period would be different. Question IG 5-9 discusses whether choosing the spot rate, forward rate, and equivalent level rate approaches must be applied entity wide.
Question IG 5-9
In choosing among the spot, forward and equivalent level rate approaches in determining the discount rate for benefit expense recognition for traditional and limited-payment long-duration contracts, is a reporting entity required to use a similar approach entity wide, or can a different approach be used based upon specific cohorts or products (i.e., can you use a spot rate approach for some products or cohorts and a forward or equivalent level rate for others)?
PwC response
The same approach is not required entity wide. However, we generally expect that the same approach will be used for groups of contracts (cohorts) with similar contract terms and characteristics. A reporting entity may use different approaches when, for example, the timing of cash flows varies between different products or different contracts (e.g., single pay premium versus installment premium life insurance contracts). Once an approach is selected, it should be applied consistently throughout the life of a cohort. Use of a different technique for subsequent cohorts of the same product may be acceptable if a better estimate is achieved using another technique.

Spot rate approach
Under a spot rate approach, each future cash flow used to calculate the net premium ratio is considered akin to a zero-coupon single A rated bond. As a result, each cash flow should be discounted at the rate on the spot rate curve equal to its respective expected payment date.
Under this approach, a spot interest rate curve would be constructed based on a zero-coupon single A corporate bond rate for each duration-specific cash flow, maximizing the use of market observable information. Since corporate bonds typically are not zero coupon instruments, but instead bear a coupon interest rate, the zero-coupon single A corporate bond rate for each duration-specific cash flow would first need to be derived from corporate interest bearing single A corporate bond rates. Once the spot rate curve is derived, each distinct future cash flow would be discounted at the rate specific to its duration point on the spot curve. As a result, each cash flow would be discounted using an individual, duration-specific spot discount rate for single A rated zero coupon bonds.
Forward rate approach
Under a forward rate approach, each future cash flow is considered to be represented by different rates for each period as if a zero coupon bond is being reinvested each period until its maturity. This approach acknowledges that market participants would be indifferent to purchasing (a) a zero coupon bond with a maturity that matches the future cash flow (i.e., the spot rate approach) or (b) a bond with a shorter term than the future cash flow and reinvesting it at today’s view of future rates. A forward curve represents a yield to maturity that would be demanded to purchase a zero coupon bond at some point in the future (for example, a cash flow in year 2 could be discounted at the 1 year spot rate for year 1 and for year 2 at the 1 year forward rate). The year 2 forward rate represents the rate at inception at which a market participant would expect to reinvest at the end of year 1 for a bond maturing in year 2 (i.e., the rate that the market would demand today for a one year bond issued one year from now).
Under the forward rate approach, the interest rate curve could be derived based on the spot yield curve. Each cash flow would be discounted at each period’s distinct forward rate on the curve. For example, a cash flow being discounted from year 3 would be discounted at a different rate for year 3, year 2, and year 1, whereas the spot rate approach would discount the cash flow expected at the end of year 3 back to inception using the 3-year spot rate.
Equivalent level rate approach (single rate approach)
Under an equivalent level rate approach, the single equivalent level rate would be determined that reflects the duration-specific spot rates from each point on the yield curve at policy inception. This approach determines a single effective yield considering the timing and amounts of the cash flows using the results of the spot curve approach. This single rate would be utilized for each cash flow regardless of changes in expected cash flow timing or amount in future cohort liability calculations. The single effective yield is determined by solving for the discount rate that produces the same net premium ratio as what would be produced if a curve were utilized (to avoid an immediate OCI impact). Note that solving for the same net premium ratio may result in different present values of net premiums and benefits than would be produced if a curve were utilized.
Each of the three approaches will begin with developing a yield curve for a single A rated corporate bond. Example IG 5-2 illustrates the economic concepts of using each of the three approaches for the purpose of calculating income statement interest accretion.
EXAMPLE IG 5-2
Illustration of different approaches for income statement accretion discount rates
Insurance Company has two cash flows. The first is a $1,000 cash outflow expected to occur at the end of year 2 and the second is a $1,000 cash outflow expected to occur at the end of year 3.
The yield curves for zero-coupon single A rated corporate bonds for years one to three are as follows:
Zero coupon curves
Year 1
Year 2
Year 3
Spot
1%
2%
3%
Forward (derived)
1%
3.01%
5.03%
The forward rates were derived from the spot rates. For example, the year 2 forward rate was determined based on the rate a zero coupon bond maturing after the initial year 1 period (which earned 1% in year 1) would need to earn in year 2 in order to get an overall 2% yield (the year 2 spot rate) over a two-year period. The year 3 forward rate was determined based on the rate a zero coupon bond maturing after the initial year 1 period (which earned 1%) and then reinvested at 3.01% in year 2 would need to earn in year 3 in order to get to an overall yield of 3% (the 3-year spot rate) over a 3-year period.
How would Insurance Company calculate each of the acceptable approaches (i.e., spot rate, forward rate and equivalent level rate) for the purposes of income statement interest accretion?
Analysis
As illustrated in the following tables, each of the approaches results in the same present value at inception ($961.17+915.14 = $1,876.31). Additionally, each one results in the same amount of total interest accretion ($123.69), although the annual amount varies. However, the amount of accretion each period can vary considerably amongst these approaches. This example illustrates the economic concepts of each approach rather than the actual net premium ratio calculation.
Spot rate approach
Cash flow at end of year 2
Cash flow at end of year 3
Annual interest accretion
Present value at issuance
$961.17 (1)
$915.14 (2)
End of year 1
980.39
942.59
$46.67 (3)
End of year 2
1,000.00
970.87
47.89
End of year 3
1,000.00
29.13
(1)Calculated by discounting the cash flow at the end of the year 2 based on the 2-year spot rate of 2% for 2 years ($1,000/(1.02)2)
(2)Calculated by discounting the cash flow at the end of year 3 based on the 3-year spot rate of 3% for 3 years ($1,000/(1.03)3)
(3)Represents the interest accretion resulting from applying the respective spot rate to each cash flow for the period (($961.17*2%) + ($915.14*3%))
Forward rate approach
Cash flow at end of year 2
Cash flow at end of year 3
Annual interest accretion
Present value at issuance
$961.17 (4)
$915.14 (5)
End of year 1
970.78
924.29
$18.76 (6)
End of year 2
1,000.00
952.11
57.04 (7)
End of year 3
1,000.00
47.89 (8)
(4)Calculated by discounting the cash flow at the end of year 2 to the end of year 1 using the 2-year forward rate of 3.01% and then discounting that total to issuance using the 1% forward rate (($1,000/1.0301)/1.01)
(5)Calculated by discounting the cash flow at the end of year 3 to the end of year 2 using the 3-year forward rate of 5.03%, and then discounting the total to the end of year 1 using the 2-year forward rate of 3.01%, and then discounting the total to issuance using the 1% forward rate ((($1,000/1.0503)/1.0301)/1.01)
(6)Represents the interest accretion resulting from applying the forward rate to each cash flow for the period (($961.17*1%) + ($915.14*1%))
(7)Represents the interest accretion resulting from applying the forward rate to each cash flow for the period. In year 2, the forward rate used for accretion would be 3.01%. Year 2 interest is ($970.78*3.01%) + ($924.29*3.01%)
(8)Represents the interest accretion resulting from applying the forward rate to each cash flow for the period. In year 3, the forward rate used for accretion would be 5.03%. Year 3 interest is ($952.11*5.03%)
Equivalent level rate approach
Cash flow at end of year 2
Cash flow at end of year 3
Annual interest accretion
Present value at issuance
$ 961.17 (9)
$ 915.14 (10)
End of year 1
$ 48.59 (11)
End of year 2
1,000.00
49.85
End of year 3
1,000.00
25.25
(9) Calculated by discounting the cash flow at the end of the year 2 based on the 2-year spot rate of 2% for 2 years ($1,000/(1.02)2)
(10)Calculated by discounting the cash flow at the end of year 3 based on the 3-year spot rate of 3% for 3 years ($1,000/(1.03)3)
(11)Represents the interest accretion resulting from discounting each cash flow for the period at the equivalent level rate based upon the spot curve. This rate was determined by calculating the internal rate of return for a bond with an inflow of $1,876.31 (the sum of the present values of each cash flow at issuance, ($961.17 + $915.14)) and an outflow of $1,000 at the end of year 2 and year 3. This rate is 2.59%. The calculation of the interest accretion for year 1 is ($961.17+$915.14)* 2.59%. This is a simplified example. As noted in IG 5.2.3.2, the equivalent level rate for the liability for future policy benefits is determined by solving for the discount rate that produces the same net premium ratio as would be produced if a curve were utilized.
When subsequently recalculating the net premium ratio and the liability for future policy benefits under the spot rate approach, the cash flows in years 2 and 3 should continue to be discounted at the same rate utilized at inception (i.e., 2% for year 2 and 3% for year 3 cash flow). Insurance Company should not move along/walk up/walk down the curve when calculating interest accretion (i.e., it should not discount the $1,000 cash flow at the end of year 2 at 1% (the 1-year zero coupon single A bond rate) given this cash flow is now only one year away). The zero-coupon yield curve applies a blended yield to maturity for each cash flow based upon a single A bond rate. Adjusting this rate to move along/walk down the curve would result in amounts that run counter to amortized cost accounting as it would assume reinvestment at the end of each period at an amount that is different from what has been accrued.
For example, the present value of the year 2 cash flow at inception was $961.17. At the end of year 1, this cash flow accreted by 2% based on the 2-year curve to $980.39. If at the end of year 1, the cash flow at the end of year 2 was discounted based on the 1% 1-year zero coupon rate, the present value of the $1,000 would be $990.10. As a result, the present value would not equal what had been accreted - a nonsensical result.
Alternatively, if Insurance Company had used the forward rate approach, it would accrete the present value amount of $961.17 (representing the present value of the $1,000 cash flow payable at the end of year 2) by 1% in the first year, and by 3.01% in the second year. Similarly, it would accrete the present value of the $915.14 (representing the present value of the $1,000 cash flow payable at the end of year 3) by 1% in the first year, by 3.01% in the second year, and by 5.03% in the third year.
Some might refer to this as “walking along” or “moving up the curve.” However, as noted in the spot rate approach, an insurance entity would not “move along/walk down the curve” as time goes on (i.e., at the end of year 1, an entity would not use the 2-year forward rate of 3.01% in place of the 3-year forward rate of 5.03% to discount the $1,000 payable in two years). The forward rate approach already takes into account market expectations of reinvestment at inception rates and market charges for the risk inherent in long term commitments. The same anomaly described above under the spot rate approach would also result if an entity walked down the curve.

Question IG 5-10 addresses the approach to reflecting current discount rates in the liability measurement.
Question IG 5-10
Which discounting approach should be used in the remeasurement of the liability for future policy benefits to reflect current discount rates and the corresponding amount to be recognized in OCI?
PwC response
In deriving the remeasurement of the liability for future policy benefits each period, a new interest rate yield curve representing yields at period end will need to be compiled to remeasure the cash flows for purposes of calculating the AOCI adjustment (using current rates). Such yield curve could be either the single A corporate bond zero coupon spot curve or forward curve. The method used to derive the discount rate for balance sheet remeasurement purposes should be consistent with the method used for interest accretion purposes.
While some insurance entities may want to discount the cash flows for balance sheet remeasurement purposes using an equivalent level rate approach, which mechanically achieves the same result as using a curve, we do not believe there is a practical benefit. This is because the equivalent level rate derived will change each period as the duration of the cash flow changes, and thus the equivalent level rate at the balance sheet date would need to be derived using an updated curve anyway. The measurement of the liability will be based on the projected cash flows and the curve at the measurement date.

5.2.3.3 Discount rate on claims liabilities

In certain product lines, such as disability and long-term care, claim payments may have a “long tail” (i.e., the payout of claims may be expected to occur over a number of years). Claim payments also exist for other traditional long-duration insurance contracts, such as life insurance, but the time period between the incurral and payment of a claim is typically short and results only from lags in reporting and processing of the claim. (Once such a claim is incurred, the benefit is immediately payable and does not depend on any further contingencies.) Based on established practice prior to ASU 2018-12, some entities implicitly think of the long-duration liability as being comprised of cash flows relating to potential future claims (the future benefits component of the liability) as well as cash flows relating to claims that have already been incurred (the claim liability component).
ASC 944-40-30-9 requires actual historical benefits to be included in the updated net premium ratio and discounted using the single A rate at contract (or cohort) inception, implicitly requiring that the claim liability amounts, from which the actual historical benefits will be derived, also be discounted at the inception single A rate. As a result, under the post ASU 2018-12 ASC 944-40 requirements, the “present value of estimated future benefits to be paid to or on behalf of policyholders and certain related expenses” referred to in ASC 944-40-25-8 represent all payments under the contract, including future expected claims and claims for which the disability, morbidity, or other insurance event has occurred but for which claims have not yet been paid. This obviates the need for a separate claim liability measurement. The total liability for measurement purposes includes future benefits, claim liabilities, claims in the course of settlement liabilities, as well as liabilities for incurred but not reported claims and has the same measurement whether presented in total or in components.
Under ASU 2018-12, based on the above changes to the measurement model, entities may present a single liability for future benefits in the statement of financial position. Alternatively, entities may continue their existing practice of presenting a claim liability separate from the future policy benefits liability in the statement of financial position or note disclosures to the extent they believe financial statement users would benefit from this separate presentation. See the claim liability guidance in the AICPA Life and Health Insurance Entities Audit and Accounting Guide, Appendix G.

5.2.4 Updating assumptions — liability for future policy benefits

All assumptions (except for claim-related expense assumptions) utilized in the calculation of the liability for future benefits, including mortality, morbidity, and terminations, are required to be reviewed (and updated, as necessary) on an annual basis (at the same time each year by product or by cohort) or more frequently if evidence suggests that assumptions should be revised. To ease the operational burden of allocating and updating claim-related expense assumptions on a periodic basis, insurance entities can make an entity-wide accounting policy election to lock-in these expense assumptions.
A revised net premium ratio is calculated using historical experience and the new assumptions for the future, as outlined in Figure IG 5-2. The revised net premium ratio is calculated as of contract inception, using the discount rate at inception.
Figure IG 5-2
Formula for the revised net premium ratio
The revised net premium ratio is used to update the liability for future policy benefits as of the beginning of the current reporting period, which is then compared to the liability for future policy benefits calculated as of the beginning of the current reporting period using the previous period's cash flow assumptions.
For traditional insurance contracts, the difference between the updated and previous liabilities is the “remeasurement gain/loss” (cumulative catch-up adjustment), which is presented as a separate line item (or parenthetically) in the current period statement of operations. See IG 5.3 for additional considerations for limited-payment contracts.
The revised net premium ratio applied as of the beginning of the current reporting period is also used to calculate the current period benefit expense based on current premium revenue. In subsequent periods, the revised net premium ratio will be used to accrue the liability for future policy benefits, absent future changes in the cash flow assumptions.
Question IG 5-11 addresses the meaning of the phrase “beginning of the current reporting period” as it relates to interim reporting.
Question IG 5-11
What is meant by “beginning of the current reporting period” for purposes of the remeasurement of the liability for future policy benefits for entities that report on an interim as well as an annual basis (e.g., SEC registrants with interim reporting)?
PwC response
In determining the remeasurement gain or loss to be reported when the net premium ratio is revised, the updated liability for future policy benefits must be compared to the carrying value before updating “as of the beginning of the current reporting period” (ASC 944-40-35-6A). For SEC registrants that issue interim financial statements, the “beginning of the current reporting period” is the beginning of the reporting period for which the financial reporting close process is being performed. In accordance with ASC 270-10-45-17, there is no restatement of previously reported interim financial information related to a change in an accounting estimate. That is, the remeasurement gain or loss would be calculated for the interim period as of the beginning of the interim period. This concept follows through to the annual financial statements (i.e., the beginning of the reporting period does not change to the beginning of the year in the annual financial statements). As a result, annual and year to date remeasurement gains or losses will be the sum of each interim (e.g., quarter) remeasurement gains or losses. This interpretation is consistent with the views expressed by the FASB staff on their November 2018 webcast, IN FOCUS: FASB Accounting Standards Update on Insurance and the guidance in the AICPA Life and Health Insurance Entities Audit and Accounting Guide, Appendix G. As an example, if the liability for future policy benefits is remeasured in conjunction with the third quarter Form 10-Q filing for a calendar year-end SEC registrant, the remeasurement is calculated as of July 1 for the quarter-to-date financial information. The year-to-date remeasurement would be the sum of the Q1, Q2, and Q3 quarterly remeasurement gains or losses.
Example IG 5-3 illustrates the calculation of the revised net premium ratio for a cohort of policies and the resulting liability of future policy benefits.
EXAMPLE IG 5-3
Calculation of the revised net premium ratio and liability of future policy benefits
Insurance Company has a cohort of traditional life insurance contracts. At the end of Year 6, Insurance Company updated its mortality assumption to reflect unfavorable experience in that year and its effect on estimated cash flows. The net premium ratio was revised from 71.1% to 71.8%. (See Example IG 5-1 for the calculation of the initial net premium ratio.)
At the end of Year 9, Insurance Company reviewed and updated its mortality assumption to reflect the unfavorable experience in that year and an increase in expected mortality in Years 10-20.
Under the retrospective catch up approach required by ASC 944-40-35-6A, actual historical cash flows received (gross premiums) and paid (benefits) are included from contract inception (Years 1-9) along with updated future cash flow assumptions for Years 10-20 to derive the revised net premium ratio. Refer to the following table for the updated cash flow estimate. Discounting of cash flows to derive the net premium ratio uses the original contract issuance discount rate, which for simplicity of illustration, is assumed to be 0%.
Year
Benefits
Gross premiums
1 (historical)
$200.0
$500.0
2 (historical)
208.8
474.5
3 (historical)
216.1
450.3
4 (historical)
222.2
427.3
5 (historical)
227.0
405.4
6 (historical)
276.9
384.6
7 (historical)
280.1
364.7
8 (historical)
282.2
345.8
9 (historical)
283.2
327.8
10
283.4
310.8
11
282.8
294.6
12
281.4
279.2
13
279.3
264.5
14
276.7
250.6
15
273.5
237.4
16
269.9
224.9
17
265.9
213.0
18
261.5
201.8
19
256.8
191.0
20
251.8
180.9
Total
5,179.5
6,329.1
Present value (0%)
$5,179.5
$6,329.1
How should the revised net premium ratio be calculated and what journal entries should be recognized in Year 9?
Analysis
The revised net premium ratio of 81.8% would be used to calculate revised net premiums.
Revised net premium ratio
Present value of total benefits and expenses (for Years 1-20)
(A)
$5,179.5
Present value of total gross premiums (for Years 1-20)
(B)
6,329.1
Net premium ratio (A)/(B)
(C)
81.8%
The remeasurement gain or loss (i.e., the retrospective catch up adjustment to the beginning of the period liability) is a loss in this case of $287.4, which is calculated by comparing the carrying amount of the liability at the beginning of the period ($542.9) with the updated liability calculated using revised cash flow assumptions ($830.3). The discount rate used in these computations is the original (contract issuance) discount rate.
Updated estimate
Year
Benefits
Gross premiums (A)
Net premiums (A*81.8%)
9
$283.2
$327.8
$268.3
10
283.4
310.8
254.3
11
282.8
294.6
241.1
12
281.4
279.2
228.4
13
279.3
264.5
216.5
14
276.7
250.6
205.1
15
273.5
237.4
194.3
16
269.9
224.9
184.1
17
265.9
213.0
174.3
18
261.5
201.8
165.1
19
256.8
191.0
156.3
20
251.8
180.9
148.0
Total
3,266.2
2,976.6
2,435.9
Present value (0%)
$3,266.2
$2,976.6
$2,435.9
Year 9 calculations (beginning of year)
Prior estimate
Updated estimate
Change
Present value of future benefits (for Years 9-20)
$2,728.1
$3,266.2
$538.1
Less: Present value of future net premiums (for Years 9-20)
2,185.2
2,435.9
250.7
Liability for future policy benefits
$542.9
$830.3
$287.4
The Year 9 ending liability for future policy benefits ($815.4) is computed as the present value of future benefits minus the present value of future net premiums, in this case using the revised amounts for Years 10-20.
Year 9 calculation (end of year)
Present value of future benefits (for Years 10-20)
$2,983.0
Less: Present value of future net premiums (for Years 10-20)
2,167.6
Liability for future policy benefits
$815.4
The amount of benefit expense for the period is recognized separate from the remeasurement loss. In this example, actual amounts are equal to expected, and therefore benefit expense ($268.3) is equal to gross premiums of $327.8 multiplied by the net premium ratio of 81.8%. The following entries would be recorded for Year 9.
Dr. Cash1
$44.6
Dr. Benefit expense2
268.3
Dr. Liability remeasurement loss
287.4
Cr. Premium income
$327.8
Cr. Liability for future policy benefits3
272.5

1 Premiums collected of $327.8, less benefits paid of $283.2
2 Benefits paid of $283.2, less change in reserve of $14.9 using current net premium ratio of 81.8%
3 Liability remeasurement of $287.4, less current period change in reserve of $14.9
The $272.5 is the sum of the benefit expense ($268.3) and liability remeasurement loss ($287.4) minus benefit payments of $283.2. From a liability perspective, the $272.5 is the difference between the prior estimate and revised estimate of the liability as of the beginning of the year ($287.4) plus the change in the liability for current year activity of $14.9 ($830.3 - $815.4).

5.2.4.1 Frequency of updating cash flow assumptions and updating for actual experience

As noted in IG 5.2.4, cash flow assumptions are required to be reviewed (and updated, as necessary) on an annual basis (at the same time each year by product or by cohort) or more frequently in interim reporting if evidence suggests that earlier cash flow assumptions should be revised. The liability for future policy benefits is also required to be updated for actual experience on an annual basis, but is only required to be updated between annual assessments if the cash flow assumptions are updated.
Question IG 5-12 discusses whether the net premium ratio can be updated more frequently. Question IG 5-13 addresses whether all assumptions need to be updated when revising cash flow assumptions outside of the annual process. Question IG 5-14 addresses whether you need to update the insurance in force when revising the net premium ratio.
Question IG 5-12
May an insurer update the net premium ratio more frequently than annually?
PwC response
The FASB’s intent in requiring an annual review (with more frequent updating if evidence suggests the need) was to ease the administrative burden of having to perform frequent revisions. However, an entity is not prohibited from updating the net premium ratio cash flows more frequently in the absence of a trigger. For example, some entities may have the capability to calculate the net premium ratio on a quarterly basis, and may even find it operationally easier and less costly than developing and monitoring triggers for reassessment. Updating the net premium ratio more frequently than annually for actual cash flow changes and changes to insurance in force will result in a better matching of experience variances in the periods in which they occur.
Whenever an entity performs an update, the entity should update all cash flow components, including actual cash flows, updated insurance in force, and potential future cash flow assumptions to produce a revised net premium ratio that uses the best information available at the measurement date. That is, an entity cannot choose to simply update the historical cash flows and the insurance in force. It should consider all information available in the interim period and have a reasonable basis to conclude that all applicable assumptions are still the entity’s best estimate, even though more detailed experience studies and a review of future assumptions may be scheduled for later in the year. Similarly, ASC 944-40-35-6 requires updating for actual experience whenever cash flow assumptions are changed.

Question IG 5-13
When updating cash flow assumptions in the net premium ratio calculation outside of the annual process, should all assumptions be assessed or can one assumption be updated without reviewing others? Similarly, when updating actual historical benefit and premium cash flows in the net premium ratio more frequently than annually, should remaining expected future benefit and premium cash flows also be assessed?
PwC response
Yes. All assumptions should be assessed. Whenever an insurance entity performs an update (either annually or more frequently), the entity should update all cash flow components (consisting of actual historical cash flows, updated insurance in force, and future cash flow assumptions) to produce a revised net premium ratio and revised liability for future policy benefits that uses the best information available at the measurement date. That is, an insurance entity cannot choose to simply update the historical cash flows and the insurance in force without considering the need to review its future projections, even though more detailed experience studies and detailed review of future assumptions may be scheduled for later in the year. Similarly, ASC 944-40-35-6 requires updating for actual experience whenever cash flow assumptions are changed. Additionally, when a cash flow assumption is updated for one cohort, consideration should be given to whether other cohorts require an update, including those normally subject to review at a different time of year.
This interpretation is consistent with the views expressed by the FASB staff on their November 2018 webcast, IN FOCUS: FASB Accounting Standards Update on Insurance, in which they stated that if an insurance entity concludes that one assumption needs to be updated or actual cash flows must be adjusted, the entity is unlocking the net premium ratio and needs to revalidate that all other assumptions are still appropriate. It is also consistent with the AICPA Life and Health Insurance Entities Audit and Accounting Guide, Appendix G.

Question IG 5-14
Assuming a reporting entity has determined that an update to the net premium ratio for the interim period is unnecessary (i.e., there is no evidence to suggest that cash flow assumptions should be revised under ASC 944-40-35-5 and ASC 944-40-35-6), does the guidance require an entity to update the insurance in force at the interim date?
PwC response
This fact pattern assumes that a reporting entity has determined that experience to date with the cash flow components (consisting of actual historical cash flows, updated insurance in force, and future cash flow assumptions) does not suggest a need to revise the net premium ratio for the interim period. That is, calculating the liability for future policy benefits using updated cash flow components would not result in a significant change from keeping the existing cash flow components.
Based on that determination, and the objective of reporting the best estimate of the liability for future policy benefits, an entity would not be prohibited from updating the actual insurance in force in a period in which it had not been required to update the net premium ratio based on actual experience, as it will result in a measurement of the liability that more closely approximates the measurement if all three cash flow components had been updated. It would therefore be assumed to not result in a significant impact to the liability for future policy benefits.

5.2.4.2 Updating the discount rate - liability for future policy benefits

When calculating the revised net premium ratio, the updated cash flows are discounted using the original contract issue date discount rate (See IG 5.2.3.1). The revised net premium ratio will be used to measure benefit expense based on recognized premium revenue in the period.
A remeasurement of the liability is also required using the current discount rate. The same updated cash flows are discounted to the current reporting date using the current liability discount rate. The difference between the liability measured using the locked-in discount rate and the liability measured at the current rate is reflected in AOCI, and the change for the period is presented in OCI and not as an expense of the period. The remeasurement of the liability for future policy benefits using the current discount rate is required each reporting period even if the net premium ratio is not recalculated in the period. Interest is accreted to the statement of operations using the original discount rate on the contract issue date. As the disabled claim liability is considered part of the liability for future benefits, the impact of remeasuring at current rates will also be reflected in AOCI.
Example IG 5-4 illustrates the calculation and impact of remeasuring the liability for future policy benefits at the current discount rate.
EXAMPLE IG 5-4
Remeasurement of the liability for future policy benefits at the current discount rate
Insurance Company has a locked-in (original issue date) discount rate of 3% and the current rate at the subsequent balance sheet date is 3.2%.
What is the balance sheet remeasurement adjustment for the liability for future policy benefits?
Analysis
Insurance Company would remeasure the liability for future policy benefits as follows:
Present value of updated future benefits and related claim expenses @ 3%
$1,200
Less: Present value of updated future net premiums @ 3%
(1,050)
Liability for future policy benefits @ 3%
$150 (A)
Present value of updated future benefits and related claim expenses @ 3.2%
$1,170
Less: Present value of updated future net premiums @ 3.2%
(1,030)
Liability for future policy benefits @ 3.2%
$140 (B)
Difference (A) - (B)
$10
Insurance Company A would record the following entry to recognize the remeasurement of the liability for future policy benefits. Company A has reversed the previous period AOCI adjustment, so the end of the period adjustment would be as follows:
Dr. Liability for future policy benefits
$10
Cr. AOCI
$10

Updating the discount rate through OCI will often mitigate the volatility in stockholders’ equity if the insurance entity invests in available-for-sale debt securities to fund the group of contracts at the inception of the contract. For example, when interest rates decline after contract issuance, there would be a charge to OCI for the related change in the liability for future policy benefits. This charge would potentially offset the OCI impact from the available-for-sale debt securities funding the product. Decreases in interest rates do not result in loss recognition through the income statement.
In certain increasing interest rate environments, a change in the interest rates could result in the remeasurement producing a liability for future policy benefits that is negative (present value of future benefits less present value of net premiums). However, ASC 944-40-35-7B states that the liability for future policy benefits on a cohort basis cannot be negative. This guidance applies both for balance sheet remeasurement and for measurement of the liability at the locked in discount rate.

ASC 944-40-35-7B

In no event shall the liability for future policy benefits balance be less than zero at the level of aggregation at which the reserves are calculated.

5.2.5 Loss contracts – future policy benefits

As cash flow assumptions are required to be updated regularly and the net premium ratio is capped at 100% (i.e., net premiums cannot exceed gross premiums), a premium deficiency test is not required for nonparticipating traditional insurance and limited-payment contracts. Expected benefits and claim-related costs in excess of premiums are expensed immediately. As the liability assumptions are updated at least annually, if conditions improve whereby the contracts are no longer expected to have net premiums in excess of gross premiums, the improvement would be captured in the remeasurement process and reflected in earnings in the period of improvement.

5.2.6 Level of aggregation – future policy benefits

ASC 944-40-30-7 prescribes that a group cannot contain contracts with different issue years, but does not provide any more specific guidance on grouping.

Excerpt ASC 944-40-30-7

In determining the level of aggregation at which reserves are calculated, an insurance entity shall not group contracts together from different issue years but shall group contracts into quarterly or annual groups.

Factors to consider in grouping contracts within issue years include the type of insurance benefit, the type of insurance risk, and how the contract is priced. The retrospective calculation for a cohort requires using historical information for contracts that have terminated as well as those in force.
Question IG 5-15 addresses grouping different products issued within the same year. Question IG 5-16 addresses whether there can be different cohorts for two contracts issued in the same year. Question IG 5-17 addresses whether the grouping can be based on something other than the year.
Question IG 5-15
Can an insurance entity group different products issued within the same year (e.g., a whole life contract and a term insurance contract, or a disability contract and a long-term care contract) for purposes of calculating the net premium ratio and the liability for future policy benefits?
PwC response
It is expected that these each grouping would be within a particular product line or a level below the product level. Grouping of a whole life product with disability or long-term care products usually would not meet this objective.

Question IG 5-16
Can an insurance entity have different cohorts for two term insurance contracts issued within the same quarter (e.g., a 10-year term insurance contract issued to a 20-year old male and 65-year old woman), for purposes of calculating the net premium ratio and the liability for future policy benefits?
PwC response
Potentially. As noted in Question IG 5-15, it is expected that cohort groupings be within a particular product line or a level below the product level. ASC 944-40-30-7 only specifies an upper bound to the cohort groupings, but does not provide more specific guidance. Judgment will have to be applied to determine whether contracts written within the same quarter or year have similar risks and should be within the same cohort. Factors to consider in grouping contracts within issue years include the type of insurance benefit, the type of insurance risk, and how the contract is priced. An insurance entity may argue that the two different term products were priced differently or that some aspect of their expected performance or risks warrants separate measurement.

Question IG 5-17
Can an annual contract grouping for measuring the liability for future policy benefits for nonparticipating traditional and limited-payment contracts be determined on something other than a calendar year basis (e.g., can it be the 12 months ending June 30 if the annual assumption update is done in the second quarter)? Can an insurance entity use different annual periods for different products, geographic locations, or foreign subsidiaries?
PwC response
The new guidance requires that contracts be grouped into quarterly or annual groups and prohibits grouping contracts with different issue years; however, it does not provide any more specific guidance. As a result, there is nothing that prohibits an entity from defining annual cohorts on other than a calendar-year basis, nor is there anything that requires an entity to make the grouping decision on an entity-wide basis.
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