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Many nontraditional contract features have market risk, and would most likely be classified as MRBs or embedded derivatives. However, there are certain features that lack market risk or otherwise fail the criteria for MRB and embedded derivative classification but provide additional benefit beyond the account balance or base insurance coverage. Contract features that do not meet the criteria of market risk benefits (MRBs) or embedded derivatives are required to be accounted for under the guidance relating to death or other insurance benefits or annuitization benefits (see IG 2.4.5.2). These include certain two-tiered annuities, no-lapse guarantees on universal life-type insurance contracts, and waiver of premium policies.
A two-tiered annuity has two crediting rates: one used to calculate the account balance available for surrender and the other, typically higher, used to calculate the balance available to the contract holders if they elect to annuitize. A "no-lapse guarantee" is a contract provision whereby the life insurance protection is kept in force, even when the account balance is not sufficient to pay the cost of insurance or other charges. A waiver of premium benefit provides that in the event of disability, a contract holder's premium (the cost of insurance or COI charge) will be waived but the policy will remain in force.

5.8.1 Additional liability for death or other insurance benefit

For contracts with death or other insurance benefits, ASC 944-40-25-27A requires that if amounts assessed against the contract holder each period for an insurance benefit feature are assessed in a manner that is expected to result in profits in earlier years and losses in later years from the insurance benefit function, an insurer is required to establish an additional liability. The liability represents the portion of assessments that compensates the insurer for benefits to be provided in future periods (commonly referred to as an “SOP 03-1 liability” or “SOP 03-1 reserve”). The test for profits followed by losses is required to be performed on a contract-by-contract basis, at contract inception, and is not revisited.
Although ASC 944-40-25-27A uses the words "profits in earlier years and losses in subsequent years" ("profits followed by losses"), we believe the requirement also applies to situations when the feature creates losses followed by losses (i.e., situations in which charges that are attributable to an insurance-benefit feature are less than the expected cost of the insurance benefit in all periods.) This is consistent with the concept inherent in ASC 944-40-30-20, that the insurance entity is required to establish a liability if it provides an insurance benefit in future periods for which it charges amounts in such periods that are less than the expected value of the insurance benefits to be provided.
The profits followed by losses test should be applied separately to the base mortality or morbidity feature and, in addition, applied separately to each other mortality or morbidity feature. This applies when assessing products that have a base mortality feature (e.g., universal life insurance) but also have an additional insurance-benefit feature, such as a no-lapse guarantee or a long-term care benefit acceleration rider.
Question IG 5-30
What is meant by "amounts assessed against the contract holder for the insurance benefit feature" for purposes of the profits-followed-by-losses test in ASC 944-40-25-27A? That is, should such assessments be limited to those explicitly charged for the insurance benefit feature being tested, or, in certain instances, should fees from other contract elements be allocated as additional assessments supporting the insurance benefit feature?
PwC response
There is a rebuttable presumption that the explicit fee should be used for the profits followed by losses test. However, there may be circumstances in which the presumption may be overcome if evidence indicates that the substance of the agreement is not captured in the explicit terms of the contract. For example, in some universal life policies, the product's base mortality function is designed and priced on an integrated basis with the other functions. In other products, there may be no explicit fee; instead, the fee is implicit in the total contract charges. However, it is unlikely that the presumption can be rebutted when a contract has an explicit incremental assessment upon the election of a separate insurance benefit feature that is not payable if the election is not made.

Question IG 5-31
When determining whether "the amounts assessed against the contract holder each period for the insurance benefit feature are assessed in a manner that is expected to result in profits in earlier years and losses in subsequent years from the insurance benefit function," what is meant by "expected?"
PwC response
A range of scenarios should be analyzed to determine whether there are any scenarios in which profits are expected in earlier years and losses are expected in later years from the insurance benefit function. A single best estimate, a mean, a median, or a specified percentile of the scenarios should not be used.

When an additional liability is required, the death or other insurance benefit liability should be recognized in accordance with ASC 944-40-30-20 through ASC 944-40-30-25.

ASC 944-40-30-20

The amount of the additional liability recognized under paragraph 944-40-25-27A shall be determined based on the ratio (benefit ratio) of the following:

  1. Numerator. The present value of total expected excess payments over the life of the contract, discounted at the contract rate.
  2. Denominator. The present value of total expected assessments over the life of the contract, discounted at the contract rate.

Total expected assessments are the aggregate of all charges, including those for administration, mortality, expense, and surrender, regardless of how characterized.
The contract rate used to compute present value shall be either the rate in effect at the inception of the book of contracts or the latest revised rate applied to the remaining benefit period. The approach selected to compute the present value of revised estimates shall be applied consistently in subsequent revisions to computations of the benefit ratio.

The benefit ratio determined in ASC 944-40-30-20 may exceed 100%, resulting in a liability that exceeds cumulative assessments. This is different from the accounting for traditional and limited-payment contracts. The additional liability would be a component of the universal life-type contract premium deficiency test, which is typically performed at a higher level, and could yield a premium deficiency loss at that higher grouping level (see IG 7.3.2 for a discussion of premium deficiency).
For contracts in which the assets are reported in the general account, investment margins (i.e., amounts expected to be earned from the investment of policyholder balances less amounts credited to policyholder balances) are included with any other assessments for purposes of calculating total assessments in the ratio. However, ASC 944-40-30-22 clarifies that “policyholder balances” refers to the accrued account balance described in ASC 944-40-25-14, which excludes the death or other insurance benefit liability itself.  
Assessments for purposes of the ASC 944-40-30-20 benefit ratio denominator would also include the amount being amortized through income in each period relating to any unearned revenue liability (see IG 5.4.3 for a discussion of deferred revenue amortization) and exclude any fees deferred as an increase in the unearned revenue liability.
Question IG 5-32
What are considered to be the “excess payments” for a no-lapse guarantee contract feature?
PwC response
One interpretation is that the excess payments are the death benefit payments that are made, or are expected to be made, while the no-lapse-guarantee provision is activated (i.e., while the account balance is insufficient to pay the cost of the insurance).
In calculating the present value of expected excess payments and total assessments and investment margins, insurers should use a range of scenarios that consider the volatility inherent in the assumptions rather than a single set of best estimate assumptions. The number of scenarios should be sufficient such that increasing that number would yield a materially similar result. In addition, the scenarios should include the tails of the distribution rather than only reasonably possible and probable scenarios.

As required by ASC 944-40-35-9, these assumptions should be evaluated regularly and, if actual experience or other evidence suggests the need for revision, the liability should be adjusted on a retrospective catch up basis, with a related charge or credit to benefit expense. That is, the revised estimate of the present value of total expected excess payments and the present value of total expected assessments and investment margins should be calculated as of the balance sheet date using historical experience from the issue date to the balance sheet date and estimated experience thereafter. The revised benefit ratio would be considered the “current benefit ratio” referenced in the guidance in ASC 944-40-35-10 to be used in calculating the additional liability.

ASC 944-40-35-10

The additional liability at the balance sheet date shall be equal to:
  1. The current benefit ratio multiplied by the cumulative assessments (cumulative assessments shall be calculated as actual cumulative assessments, including investment margins, if applicable, recognized from contract inception through the balance sheet date)
  2. Less the cumulative excess payments (including amounts reflected in claims payable liabilities)
  3. Plus accreted interest.

However, in no event shall the additional liability balance be less than zero.

Question IG 5-33
Is the additional liability calculated at an individual contract level, or at some higher group level?
PwC response
Although the accounting for a universal life-type contract is typically done on an individual contract basis, the calculations required by ASC 944-40-35-9 and ASC 944-40-35-10 for the additional insurance benefit liability require analysis of actual experience, implicitly requiring the grouping of a block of similar contracts.

5.8.2 Additional liability for annuitization benefits

Contracts with benefits payable only upon annuitization that do not fall within the scope of accounting as MRBs or derivatives require the recognition of an additional liability for the contract feature if the present value of the expected annuitization payments at the expected annuitization date exceeds the expected account balance at the expected annuitization date. The liability should be recognized in accordance with ASC 944-40-30-26 through ASC 944-40-30-29. ASC 944-40-25-26 notes that examples include certain annuity purchase mortality guarantees and two-tier annuities. The test to determine if an additional liability is required is performed on a contract-by-contract basis, at contract inception, and is not revisited.

ASC 944-40-30-26

The additional liability required under paragraph 944-40-25-27 shall be measured initially based on the benefit ratio determined by the following numerator and denominator:
  1. Numerator. The present value of expected annuitization payments to be made and related incremental claim adjustment expenses, discounted at an upper-medium grade (low-credit-risk) fixed-income instrument yield applicable to the payout phase of the contract, minus the expected accrued account balance at the expected annuitization date (the excess payments). The excess of the present value payments to be made during the payout phase of the contract over the expected accrued account balance at the expected annuitization date shall be discounted at the contract rate.
  2. Denominator. The present value of total expected assessments during the accumulation phase of the contract, discounted at the contract rate.

Total expected assessments are the aggregate of all charges, including those for administration, mortality, expense, and surrender, regardless of how characterized.

Consistent with the guidance relating to the additional liability for death or other insurance benefits, in calculating the benefit ratio for contracts in which the assets are reported in the general account, investment margins (i.e., amounts expected to be earned from the investment of policyholder balances less amounts credited to policyholder balances) are included with any other assessments for purposes of calculating total assessments in the ratio. However, ASC 944-40-30-22 clarifies that policyholder balances refers to the accrued account balance described in ASC 944-40-25-14, which excludes the annuitization benefit liability itself.  
Excess payments are calculated as the present value of the expected annuitization payments to be made and related incremental claim adjustment expenses, less the expected accrued account balance on the expected annuitization date. The calculation should be based on expected experience, over a range of scenarios that considers the volatility inherent in the assumptions rather than a single set of best estimate assumptions. When determining expected excess payments, the expected annuitization rate is one of the assumptions. This annuitization rate should be dynamic, taking into account company and industry experience, as applicable, as well as the value of the benefit.
The periodic future annuitization benefits expected to be paid during the annuitization phase are discounted back to the future expected annuitization date using the upper-medium grade (low credit risk) fixed-income instrument yield to determine the excess benefit upon annuitization. This amount is then discounted to the current period using the contract liability discount rate.
The discount rate is not locked in for expected annuitization benefits subject to ASC 944-40-30-26. The rate is required to be updated each period consistent with other components of the annuitization benefit cash flows. Changes in the discount rate applied to the future annuitization payments will be reflected in the benefit ratio and recognized over time as the benefit ratio is applied to total assessments.
As required by ASC 944-40-35-12 and ASC 944-40-35-13, these assumptions should be evaluated regularly and, if actual experience or other evidence suggests the need for revision, the liability should be adjusted on a retrospective catch up basis, with a related charge or credit to benefit expense. That is, the revised estimate of the present value of total expected excess payments and the present value of total expected assessments and investment margins should be calculated as of the balance sheet date using historical experience from the issue date to the balance sheet date and estimated experience thereafter. The revised benefit ratio would be considered the “current benefit ratio” referred to in the guidance in ASC 944-40-35-14 to be used in calculating the additional liability.

ASC 944-40-35-14

The additional liability at the balance sheet date shall be equal to the sum of the following:
  1. The current benefit ratio multiplied by the cumulative assessments
  2. Accreted interest (an addition)
  3. At time of annuitization, the cumulative excess payments determined at annuitization (a deduction).

However, in no event shall the additional liability balance be less than zero.

At the actual date of annuitization of an individual policyholder, cumulative excess payments for that policyholder are calculated using assumptions specific to that policyholder and are deducted from the additional liability. Any remaining additional liability relating to the policyholder, along with the account balance and any other derecognized liabilities related to the contract upon annuitization, is the “in substance” single premium used in establishing the liability for future policy benefits for the new payout annuity. The payout annuity is a new contract for accounting purposes, the liability for which is subject to limited payment accounting described in IG 5.3. To the extent that the “in substance” premium exceeds the liability for future policy benefits, a deferred profit liability is recognized at the inception of the payout annuity. If the “in substance” premium was less than the liability for future policy benefits, an immediate loss would be recognized through earnings. 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.
See Example IG 5-7 for similar journal entries.
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