Search within this section
Select a section below and enter your search term, or to search all click Insurance Contracts
Favorited Content
8.4 Overview of reinsurance accounting of short-duration contracts
Publication date: 30 Sep 2020
us Insurance guide
ASC 944 requires that the substance (and not the form) of the contract drive the accounting treatment. When significant insurance risk is transferred, reinsurance accounting is required. In contrast, contracts that do not transfer significant insurance risk are accounted for as deposits (i.e., financing arrangements).
Recording a contract as reinsurance will generally enable the financial statements of the ceding entity to match the recognition of benefits for claims covered by the reinsurance with the recognition of the claims expense from the underlying contracts both in timing and amount. In addition, the benefit is presented as a reduction in claims expense. Premiums paid to the reinsurer are presented as a reduction in premium revenue. Although the income statement presentation is netted, reinsurance contracts rarely achieve offset accounting on the balance sheet and therefore result in a reinsurance recoverable asset.
Deposit accounting treats the contract more like a financial instrument, with an effective interest rate effect and no net presentation on the income statement (i.e., ceding entities cannot net the impact of reinsurance against direct written insurance). If the reinsurance involves risks on claims that have already been incurred by the underlying direct contracts, then retroactive reinsurance accounting is appropriate. This is a hybrid between reinsurance and deposit accounting. An additional accounting model, multi-year retrospectively rated contract accounting, is appropriate for contracts that transfer significant insurance risk and have a deposit component.
Figure IG 8-3 is a summary of the prospective, retroactive, and deposit accounting models that would be applied by a ceding entity. The multi-year retrospectively rated contract accounting is discussed in IG 8.8.
Figure IG 8-3
Summary of the ceding entity accounting models
Summary of the ceding entity accounting models
Prospective reinsurance accounting
| Retroactive reinsurance accounting
| Deposit accounting
(timing risk only, or no timing or underwriting risk)
|
Premiums paid to the reinsurer are recorded as ceded premiums (a reduction to revenue attributable to direct insurance written) over the coverage period.
| Premiums paid to the reinsurer are reported as reinsurance receivables to the extent they do not exceed the recorded liabilities relating to the underlying reinsured contracts. No amount is recorded as ceded premium.
| Premiums paid to the reinsurer are recorded as a deposit asset with no effect on revenue.
|
Expected reimbursements for losses are recorded as a reduction in losses as the losses are incurred with a corresponding undiscounted reinsurance recoverable asset.
| If the recorded liabilities exceed the amounts paid, a reinsurance recoverable is increased to reflect the difference and the resulting gain deferred. The deferred gain is amortized over the estimated remaining settlement period using the interest method if cash flows are reasonably estimable, or based on the ratio of actual recoveries to total expected recoveries if they are not.
If the amounts paid for retroactive reinsurance exceed the recorded liabilities relating to the underlying reinsured contracts, the ceding entity should increase the related liabilities or reduce the reinsurance recoverable (or both) at the time the reinsurance contract is entered into. Any excess is charged to expense immediately.
Changes in the estimated amount of the liabilities relating to the underlying reinsured contracts are recognized in earnings in the period of the change, but the related increase in the reinsurance recoverable is not credited immediately to income to offset the loss. Instead, the gain is deferred and amortized over the settlement period.
| Nonrefundable fees paid are recorded as expense over period benefited. The period benefited is typically the settlement period of the deposit.
The asset is accreted using the interest method to the ultimate expected reimbursements.
Reimbursements for losses are recorded as reduction in deposit asset when cash is received.
|
Impacts premiums/surplus ratio
Impacts loss ratio (losses/premiums)
| Similar to deposit accounting.
| Recorded as a financing with no impact on premiums, losses incurred, or related insurance ratios. Any benefit to the ceding entity is recognized using the effective yield interest method over the settlement period.
|
The analysis required to determine the appropriate accounting method for reinsurance of short duration contracts is illustrated in Figure IG 8-4.
Figure IG 8-4
Reinsurance accounting short duration insurance contracts
Reinsurance accounting short duration insurance contracts
The evaluation of the significance of the risk being transferred in a reinsurance contract is the first step in identifying the appropriate method to account for the reinsurance contract. The second step is to assess when claims that are covered by the reinsurance contract were incurred in comparison to the date on which the reinsurance contract was negotiated to determine whether the contract should be accounted for under prospective or retroactive reinsurance accounting. The third step is to assess if there are any retrospective or experience adjustment provisions that may indicate a deposit component that will need to be accounted for. The appropriate accounting considerations are further complicated by various contract terms, industry practice, and business purpose. The following sections discuss these steps in more detail.
Receivables for amounts recoverable under reinsurance contracts are considered financial assets for impairment purposes and should be assessed for credit impairment. Prior to the adoption of ASC 326, Financial Instruments – Credit Losses, a loss is recorded when a credit loss is incurred.
New guidance
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The ASU also provides updated guidance regarding the impairment of available-for-sale debt securities and requires additional disclosures. Receivables for amounts recoverable under reinsurance contracts are included in the scope of ASU 2016-13.
Upon adoption of ASU 2016-13, the recording of credit losses will change to an “expected loss” model from an incurred loss model, in which a loss for expected credit losses would be recorded upon initial recognition of the reinsurance recoverable not measured at fair value. See LI 13.1 for the applicable effective date of ASU 2016-13 and see LI 7.8 for further information on the application the current expected credit losses model for reinsurance receivables.
1 Guidance on how to apply deposit accounting for insurance and reinsurance contracts, except long-duration life and health contracts, can be found in ASC 340-30, Other Assets and Deferred Costs- Insurance Contracts that Do Not Transfer Insurance Risk.
2 Deposit accounting when there is significant underwriting risk but no timing risk is uncommon. However, if that is the case, the premiums paid to the reinsurer would be recorded as a loss or expense, and reimbursements for losses would be recorded at present value as a reduction in losses as losses are incurred.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Link copied
