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8.4 Overview of reinsurance accounting of short-duration contracts
Publication date: 31 May 2024
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).
The analysis required to determine the appropriate accounting method for reinsurance of short-duration contracts by a ceding entity is illustrated in Figure IG 8-3.
Figure IG 8-3
Reinsurance accounting short-duration insurance contracts
Reinsurance accounting short-duration insurance contracts
Step 1: Evaluate 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.
Step 2: Assess when claims that are covered by the reinsurance contract were incurred in comparison to the date on which the reinsurance contract was priced to determine whether the contract should be accounted for under prospective or retroactive reinsurance accounting.
Step 3: 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.
Recording a contract as reinsurance generally enables 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. See IG 10.4 for guidance on financial statement presentation for short-duration insurance and reinsurance contracts.
Deposit accounting treats the contract more like a financing, with recognition of an effective interest rate and the ceding entity cannot net the impact of reinsurance against direct written premiums or claims.
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 8-4 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 8-4
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.
|
Receivables for amounts recoverable under reinsurance contracts are considered financial assets for impairment purposes and should be assessed for credit impairment under ASC 326-20. See LI 7.8 for further information on the application the current expected credit losses model for reinsurance receivables.
Reinsurance contracts sometimes specify an effective date for coverage that is prior to the date on which the agreement has been finalized. Reinsurance contracts assumed (or ceded) should be reflected in the financial statements of the reinsurer (or cedant) on the date a legally enforceable contract is finalized. Any amounts exchanged that are characterized in form as assumed (or ceded) premium or assumed (or ceded) losses for periods prior to contract finalization should be viewed as an adjustment to the consideration received or paid that would form part of the price/cost of reinsurance and would not be presented in the income statement as premiums and claims.
1 Guidance on how to apply deposit accounting for insurance and reinsurance contracts, except long-duration life and health contracts, is 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.
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