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?
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?"
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.
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:
- Numerator. The present value of total expected excess payments over the life of the contract, discounted at the contract rate.
- 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?
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.
The additional liability at the balance sheet date shall be equal to:
- 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)
- Less the cumulative excess payments (including amounts reflected in claims payable liabilities)
- 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?
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.