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ASC 944-40-25-25C introduces the term “market risk benefits” The market risk benefit is an amount that a policyholder would receive in addition to the account balance upon the occurrence of a specific event or circumstance, such as death, annuitization, or periodic withdrawal. See IG 2.4.5 for further information on the assessment of contract features under the MRB guidance.
Features that meet the definition of MRBs are accounted for at fair value. The portion of the fair value change attributable to a change in the instrument-specific credit risk of the issued contract is recognized in other comprehensive income, while the remainder is recognized in net income. MRB balances and changes in their measurement are separately presented in the statement of financial position and the statement of operations.
MRBs can be present in variable and fixed annuity contracts and in certain life insurance contracts. MRB features in contracts include various GMXBs, such as GMDBs and GMIBs. MRB features also include GMABs and GMWBs previously accounted for as embedded derivatives, as well as GMWB for life benefits, for which there was previously diversity in accounting practice. For variable annuity contracts, the host contract will be measured excluding the separated features and may be further separated into different accounting units, consistent with where the policyholder elected the funds to be invested (the variable accounts or the fixed account) and if the contract contains an embedded derivative.
ASC 944-40-25-25D (b) notes that an MRB does not include the death benefit component of a life insurance contract (i.e., the difference between the account balance and the death benefit amount). However, an MRB may be present in a life insurance contract if it provides for protection from capital market risk for other benefits, for example, a GMAB or GMWB on the account balance component of a variable universal life insurance contract. MRBs may also be present in certain universal life insurance contracts that provide for an option to settle the contract upon surrender or death with an annuity determined using guaranteed fixed interest rates.

5.6.1 Initial measurement of MRBs

ASC 944-40-30-19C through ASC 944-40-30-19D require that market risk benefits be measured at fair value and provide further guidance on initial measurement of the MRB features, incorporating guidance from ASC 815-15, which relates to identifying and measuring embedded derivatives.

ASC 944-40-30-19C

A market risk benefit shall be measured at fair value. Total attributed fees used to calculate the fair value of the market risk benefit shall not be negative or exceed total contract fees and assessments collectible from the contract holder.

ASC 944-40-30-19D

In determining the terms of the market risk benefit, the insurance entity shall consider guidance on determining the terms of an embedded derivative that is required to be accounted for separately under Subtopic 815-15 on embedded derivatives, including the following:

  1. Consistent with paragraph 815-15-30-4, if a nonoption valuation approach is used, the terms of the market risk benefit shall be determined in a manner that results in its fair value generally being equal to zero at the inception of the contract.
  2. Consistent with paragraph 815-15-30-6, if an option-based valuation approach is used, the terms of the market risk benefit shall not be adjusted to result in the market risk benefit being equal to zero at the inception of the contract.
  3. Consistent with paragraph 815-15-25-7, if a contract contains multiple market risk benefits, those market risk benefits shall be bundled together as a single compound market risk benefit.

ASC 944-40-30-19D notes that in determining the terms of the market risk benefit, the guidance on determining the terms of the embedded derivative in ASC 815-15 should be considered. ASC 815-15-30-2 provides guidance on allocating the value of a hybrid instrument between the embedded derivative and the host contract. The market risk benefit is measured on the balance sheet at its fair value, and the remaining initial consideration is allocated to the host contract (net of any embedded derivatives also measured at fair value).
Question IG 5-27
What is the unit of measurement for determining the attributed fee for an MRB? How does it compare to the unit of measurement for fair value under the ASC 820 fair value framework?
PwC response
The unit of measurement for determining the attributed fee for an MRB is the individual contract. An entity is limited to fees and assessments collectible from “the contract holder,” meaning each individual contract holder. In principle, fees and assessments collectible from one contract holder cannot be attributed to another contract.
The unit of account may differ from the unit of measurement. The fair value of an MRB feature may, under ASC 820 fair value guidance, be determined for a group of MRBs (i.e., the group may be the unit of measurement). However, ASC 820 does not change the unit of account prescribed by ASC 944. To the extent components of the fair value of an MRB are measured at a higher level than the individual contract (e.g., risk margin), that component of the fair value would need to be allocated to the individual contracts in a systematic and rational manner. Additionally, certain insurance assumptions such as mortality rates and lapse rates may be determined based on the average experience of a group of policies. These averages will be applied at the contract level. For example, male attained age mortality assumptions may be set in aggregate but would apply to each policyholder based on their attained age. The attributed fee determined at inception of the contract is then calculated and set at the contract level based on the specific application of assumptions to that contract.
In practice, in determining the attributed fee at contract inception, it may be possible to group homogeneous contracts issued in the same period. For example, homogeneous groups of contracts could be accumulated for each product (such as all variable annuities with guaranteed minimum death benefits), by category of additional benefit (such as a return of premiums, premiums plus interest, or highest anniversary value), by type of fund offered, and for each issue age within these categories. When grouping contracts, entities should consider the likelihood and materiality of any potential misclassification due to insufficient fees of one group being made up with allocation of fees from another group of contracts.

In practice, the “attributed fee” method is a common approach for determining the terms of an MRB by defining how much of the contractual fees are attributable to the MRB. The attributed fee for a GMXB feature is typically determined at contract inception by estimating the fair value of expected future benefits and allocating a portion of the total fees expected to be assessed against the contract holder equal to the fair value of the expected benefits. The attributed fee may differ from the fee specified in the contract for the GMXB benefit. This approach generally results in a zero value for the feature at inception. However, ASC 944-40-30-19C provides that the attributed fee cannot exceed the total contract fees and assessments collectible from the contract holder and cannot be less than zero. Assessments collectible from the contract holder typically include explicit rider fees as well as those for administration, mortality, and expense. Investment spread/margin is excluded from the attributed fee determination as these amounts are not collected from contract holders.
Question IG 5-28
Can mutual fund fees or other fees that are received in conjunction with a contract (but are not directly collectible from the contract holder) be considered part of total contract fees and assessments collectible from the contract holder?
PwC response
No. Fees or assessments collectible under separate contracts that are not directly executed between the insurance entity and the contract holder do not qualify as “contract fees and assessments collectible from the contract holder.” Examples of fees that do not meet the description include mutual fund fees earned by an affiliate mutual fund provider and “revenue sharing” fees received from third-party mutual funds relating to an insurer’s separate account mutual fund investments. If these fees are contingently collectible from the policyholder (e.g., in the event the policyholder may have to pay a fee in the event the mutual fund option changes and fees are no longer collected), insurers could consider the probability of collecting the fees contingently collectible from the contract holder as part of the total contractual fees available to be attributed to the MRB.

The required attributed fee determined at contract inception is typically converted to a percentage of total fees, which is then applied to the total fees collectible from the contract holder. The percentage of the total fees is considered a fixed term of the MRB feature for accounting purposes and does not change over the life of the contract. At subsequent reporting dates, the fair value of the GMXB is determined based on the present value of future benefits to be paid to contract holders minus the present value of the future attributed fees (which are calculated using the inception attributed fee percentage).
For products without a fee stream or where fees are not attributed to the MRB, an option-based approach may be used. Under the option-based approach, the initial consideration allocated to the MRB is the initial fair value of expected future benefits, and the remaining consideration (assuming no embedded derivatives) is allocated to the host insurance or investment contract. This results in a discount on the host equal to the MRB consideration.
For products that only provide separate account investment options and have a fee stream, we would expect that an attributed fee method would be used, and if fees are insufficient, a day 1 loss would be incurred. For products that only provide general account investment options and do not have a fee stream, we expect that an option-based method would be used. If products offer both general and separate account investment options and the fund allocation determines the fee stream, companies should consider the relevant product features and policyholder behavior assumptions when developing their valuation approach. We believe that in keeping with the principle that in an arms-length transaction, there should not be a loss at inception of a contract. If fees are insufficient, to the extent there are available funds in the general account investment option, a host adjustment could generally be made as compensation for the fee insufficiency.
Example IG 5-5 and Example IG 5-6 illustrate the recognition and measurement of certain market risk benefits.
EXAMPLE IG 5-5
Recognition and measurement of an MRB in a variable annuity
A contract holder deposits $100,000 in a deferred variable annuity with GMAB and GMDB riders that provide that the contract holder’s benefit upon the year 5 anniversary date or upon death will be the greater of the account balance or the deposits less withdrawals accumulated at 3% interest compounded annually. The policy terms provide that fees equal to 200 basis points of the account balance will be deducted from the account balance each year. The insurance entity uses the attributed fee method to determine the fair value of the MRB. The insurance entity determines that the fair value of the total benefits for the GMAB and GMDB riders to be paid in excess of the account balance is $7,500 and the estimated total amount of fees is $20,000.
Under the attributed fee method (non-option method), how would the MRB and host contract be recognized and measured?
Analysis
The attributed fees for the compound MRB would be 37.5% (MRB attributed fee of $7,500/ total expected fees of $20,000), or 75 basis points of the annual fees of 200 basis points. These ascribed fees are less than the contractual fee. Going forward, the MRB fair value will be determined as the current fair value of the future excess benefits to be paid minus the current fair value of 75 basis points of the account balance. The remaining 125 basis points of contractual fees will be considered variable annuity host fees and recognized when deducted.
EXAMPLE IG 5-6
Recognition and measurement of an MRB in an equity indexed annuity
A contract holder deposits $100,000 in an equity indexed annuity with a GMDB rider that provides that the contract holder death benefit be credited an additional 25% of the S&P 500 positive returns beyond those credited to the account balance. At contract inception, the entity determines that the fair value of the benefits to be paid in excess of the account balance is $5,000 and the fair value of the embedded derivative for index crediting is $10,000.
Under the option method, how would the MRB, embedded derivative, and host contract be recognized and measured?
Analysis
In using the option method of identifying the MRB cash flows in determining its fair value, the insurance entity would recognize an MRB liability of $5,000, an embedded derivative of $10,000, and an account balance, less discount, host contract of $85,000. The host discount of $15,000 would be accreted through interest crediting expense over the life of the host contract to $100,000. The MRB and embedded derivative would be revalued each period to fair value.

5.6.2 Multiple market risk benefit features

ASC 944-40-30-19D(c) provides guidance on the accounting for multiple market risk benefits within a single long-duration contract.

ASC 944-40-30-19D(c)

Consistent with paragraph 815-15-25-7, if a contract contains multiple market risk benefits, those market risk benefits shall be bundled together as a single compound market risk benefit.

Accounting for market risk benefits within an insurance contract often becomes more complex when there are multiple MRBs. Each potential MRB should be analyzed separately to determine if it meets the scope criteria.
Once a conclusion is reached that multiple MRB features must be separated from the host contract, the value of the compound MRB is based on one unit of account rather than determining separate fair value measurements for each market risk benefit component and adding them together. A separate unit of account method is inconsistent with ASC 944-40-30-19D(c) and may produce an inappropriate valuation result since multiple MRBs within a single insurance contract will likely affect each other’s fair values.
In theory, the requirement to value the components together could yield different results than if each of the components was valued separately. For example, we expect that the volatility of the combined MRBs would be lower than the volatility when valuing the components separately, potentially resulting in a lower risk margin for the combined MRBs. Additionally, the interdependency of certain assumptions emphasizes the requirement to perform a combined valuation. Lapse assumptions for variable annuity products tend to be more dependent on the extent to which the guaranteed minimum living benefits are “in-the-money” than the factors affecting the GMDBs if the GMDB were valued separately.

5.6.3 MRB – instrument-specific credit risk

ASC 944-40-35-8A requires that changes in the fair value of market risk benefits be recognized in net income, except that fair value changes in MRBs (issued or purchased) attributable to a change in the instrument-specific credit risk of the reporting entity are required to be recognized in other comprehensive income. The requirement to report changes attributable to the instrument-specific credit risk in other comprehensive income rather than in earnings is consistent with the accounting for a change in fair value of a liability caused by a change in credit risk when the fair value option is elected under ASC 825, Financial Instruments. The FASB also understands that insurance entities typically exclude the risk of non-performance in the development of their hedging strategies.
Question IG 5-29
ASC 944-40-35-8A states “...The portion of a fair value change attributable to a change in the instrument-specific credit risk of market risk benefits in a liability position shall be recognized in other comprehensive income.” Does this imply that a reporting entity cannot include the portion of the change in fair value relating to its own credit risk (instrument-specific credit risk) in other comprehensive income if the market risk benefit fair value is in an asset position?
PwC response
No. Any changes in instrument-specific credit risk of the reporting entity included in the fair value of its market risk benefit, whether in an asset or liability position, and whether related to an issued or purchased MRB, should be recognized in OCI. The FASB included the word “liability” to emphasize that the only changes due to instrument specific credit risk recognized in other comprehensive income should be that of the reporting entity and should exclude nonperformance risk of a reinsurance entity or other counterparty to a market risk benefit.

Consistent with the liability fair value option guidance in ASC 825, instrument-specific credit risk for MRBs is measured as the portion of the periodic change in fair value that is not due to changes in a base market rate, such as a risk-free interest rate (the “base rate method”). There is no guidance provided in terms of what portion of the spread above risk-free constitutes “instrument-specific.” An alternative method may be used if it is considered to faithfully represent the portion of the total change in fair value resulting from a change in instrument-specific credit risk. Other potential choices may include the portion of the periodic change in fair value that is not due to changes in the risk-free rate plus or minus any combination of the following: (1) industry sector spread, (2) overall individual company credit standing, or (3) individual company credit standing for a specific product. The selected methodology is a policy election and will need to be disclosed, if material, and consistently applied to each financial liability from period to period.

5.6.4 Nonperformance risk – components of hybrid instruments

Determining the nonperformance risk relating to the components of an insurance contract containing an MRB that is bifurcated for financial reporting purposes (e.g., a variable annuity with a guaranteed minimum accumulation benefit) requires consideration of the nature of the hybrid instrument's contractual terms and whether payments under each of the contractual components (i.e., the host contract and the market risk benefit) have the same or different credit standings. Essentially, the individual components should be treated as separate liabilities of a single entity that may have different levels of nonperformance risk. For example, in the case of a variable annuity with a GMAB, the variable annuity host liability may be fully collateralized by related separate account assets, while the bifurcated minimum guarantee is not. In such a case, the nonperformance risk of the bifurcated market risk benefit would need to be considered separately based on its specific attributes. Additional data points in determining nonperformance risk may include credit spreads or credit default swaps spreads and should consider the issuing entity credit data when determining the nonperformance risk of regulated subsidiaries.

5.6.5 Guarantees related to future contract deposits

An insurance or investment contract, such as a variable annuity with a guarantee feature, may provide a guaranteed return on future potential deposits, in addition to existing deposits, for a specified fee that is other than a current market fee.
The guarantee, and the right to make future deposits that will be subject to the guarantee, are attributes of the existing contract. Therefore, such guarantees need to be incorporated into the valuation if a market participant would incorporate these attributes into the price at which it would be willing to execute the transaction.

5.6.6 MRB annuitization benefits

For contracts with guaranteed minimum annuitization or withdrawal benefits accounted for at fair value as MRBs, ASC 944-40-35-8B provides guidance on the accounting at the date of annuitization or extinguishment of the account balance. That date marks the end of one accounting contract (the deferred annuity contract with an MRB recognized at fair value) and the beginning of a new contract (the payout annuity). This is because the payout phase is viewed as a separate contract and is not combined with the accumulation phase, as noted in ASC 944-30-35-3. At the date of annuitization or account balance extinguishment (for withdrawal benefits), the MRB would be derecognized, and any amount in AOCI relating to changes in instrument-specific credit risk would be reversed through OCI. The derecognized MRB amount, along with the derecognized contract holder account balance (if any), would be the “in substance” single pay premium used to derive the deferred profit liability recognized at inception of the payout annuity when the “in substance” premium exceeds the liability for future policy benefits. The payout annuity is a new contract for accounting purposes, the liability for which is subject to limited payment accounting, as described in IG 5.3.
Example IG 5-7 and Example IG 5-8 illustrate the accounting upon the election of the annuitization option for a GMIB feature and upon the extinguishment of the account balance (i.e., when the account balance goes to zero) for a GMWB feature accounted for as an MRB, in accordance with ASC 944-40-35-8B.
EXAMPLE IG 5-7
Accounting upon the election of the annuitization option for a GMIB feature accounted for as an MRB, resulting in a deferred profit liability
Insurance Company issues a deferred annuity contract with a GMIB feature that is accounted for as an MRB. At the annuitization date, the contract holder account balance ($50) plus the MRB fair value ($49) is equal to $99, and a cumulative decrease in the MRB’s instrument-specific credit risk since the inception of the contract of $1 has resulted in an existing credit balance in AOCI. Upon annuitization, the liability for future policy benefits for the payout annuity is $90 (measured in accordance with the initial recognition guidance for limited payment contracts in ASC 944-40-30-7).
What is the accounting upon the election of the annuitization option for a GMIB feature accounted for as an MRB?
Analysis
In accordance with ASC 944-40-35-8B, Insurance Company would record the following journal entry to derecognize the unrealized instrument-specific credit risk through OCI. Insurance Company would not record a gain or loss in net income because there is no settlement of an obligation for an amount less than the contractual obligation amount (i.e., no realization of Insurance Company’s previously estimated nonperformance).
Dr. OCI
$1
Cr. MRB liability
$1
Insurance Company would record the following journal entry to reflect the annuitization using the derecognized contract holder account balance and the MRB liability as the “in substance” premium for the payout annuity.
Dr. Contract holder account balance liability
$50
Dr. MRB liability
$50
Cr. Liability for future policy benefits
$90
Cr. Deferred profit liability
$10
In this entry, a deferred profit liability is recognized at the inception of the payout annuity because the “in substance” premium exceeds the liability for future policy benefits. There is diversity in practice as to whether premium revenue and claims expense are separately recognized in the statement of operations in the period of annuitization or, since the transaction is not a new sale, the amounts are netted. This result would be the same for a GMWB where the account value is extinguished, except there is no debit to contract holder account balance as it has been reduced to zero.
EXAMPLE IG 5-8
Accounting upon the election of the annuitization option for a GMIB feature accounted for as an MRB, resulting in a loss
Insurance Company issues a deferred annuity contract with a GMIB feature that is accounted for as an MRB. At the date of extinguishment of the account balance, the contract holder account balance is $50, the MRB fair value is $34, and a cumulative decrease in the MRB’s instrument-specific credit risk since the inception of the contract of $1 has resulted in an existing credit balance in AOCI. Upon extinguishment, the liability for future policy benefits for the payout annuity is $90 (measured in accordance with the initial recognition guidance for limited payment contracts in ASC 944-40-30-7).
What is the accounting upon the election of the annuitization option for a GMIB feature accounted for as an MRB?
Analysis
In accordance with ASC 944-40-35-8B, Insurance Company would record the following journal entry to derecognize the unrealized instrument-specific credit risk through OCI. Insurance Company would not record a gain or loss in net income because there is no settlement of an obligation for an amount less than the contractual obligation amount (i.e., no realization of Insurance Company’s previously estimated nonperformance).
Dr. OCI
$1
Cr. MRB liability
$1
Insurance Company would record the following journal entry to reflect the extinguishment using the derecognized MRB liability as the “in substance” premium for the payout annuity.
Dr. Contract holder account balance liability
$50
Dr. MRB liability
$35
Dr. Loss
$5
Cr. Liability for future policy benefits
$90
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