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5.1 Investments in life insurance contracts
Publication date: 31 May 2022
us Loans & investments guide
The following sections describe some of the more common types of life insurance contracts and discuss a reporting entity’s accounting for its investment in these contracts.
5.1.1 Key-person life insurance
A reporting entity may purchase a life insurance policy to fund deferred compensation or post-retirement benefit arrangements, protect against the loss of key persons, or fund an obligation to redeem an ownership interest upon death. These types of insurance policies are referred to as corporate-owned life insurance (COLI), bank-owned life insurance (BOLI), and key-person life insurance. A life insurance contract provides an accumulated contract value that increases over time and an additional return upon the death of the insured. There are several types of life insurance that provide different levels of participation in investment performance, including whole life, universal life, and variable life insurance policies.
Death benefits are typically exempt from taxes. In addition, the accumulation of value is often tax deferred until withdrawal, which can give life insurance investments an economic advantage over more traditional debt and equity investments. Unless the conditions in ASC 210-20-45 are met, a reporting entity should not offset a deferred compensation liability and an investment in the life insurance contract even when the policy is purchased in contemplation of funding employee benefits.
5.1.1.1 Accounting for key-person life insurance
An investment in life insurance should be reported at the amount that could be realized under the contract at the balance sheet date, which includes the cash surrender value and any additional amounts realizable as discussed in ASC 325-30 less an allowance for credit losses. Insurance contracts are outside the scope of the embedded derivative guidance in ASC 815; therefore, embedded derivative features should not be accounted for separately. The change in cash surrender value during the period and the premium paid determine the expense or income to be recognized in the period.
Some life insurance policies adjust the realizable amount if certain conditions apply. For example, a BOLI contract may have a different surrender value if there is a change in control or a tax net operating loss is incurred. Also the cash surrender value may be adjusted in early years for the tax effects of insurance company acquisition costs. If it is probable that contractual terms will limit the amount that could be realized under the life insurance contract, these contractual limitations should be considered when determining the realizable amounts.
Reporting entities often purchase group life insurance policies that cover a number of individual employees. The amount realizable under the contract may differ depending on whether an individual policy or the entire group contract is surrendered. When determining the realizable amount at the balance sheet date, reporting entities should assume that policies will be surrendered on an individual policy basis, rather than as a group of policies. See ASC 325-30-55 for an illustration of the calculation of the cash surrender value of a group policy.
Discounting cash surrender value
Under ASC 325-30, amounts recoverable by the policyholder beyond one year from the surrender of the policy should be discounted. If the policyholder continues to participate in changes of the cash surrender value, the participation amounts should be projected and discounted using the rates that would have accrued if no surrender notice had been given. If the participation will be the same as before the surrender notice, no adjustment for discounting will be necessary. If the participation after the surrender notice is limited such as only in immunized or “safer” investments, discounting will be required.
5.1.2 Life settlement contracts
A life settlement contract is the sale of an existing life insurance policy to a third-party for more than its cash surrender value, but less than its net death benefit. A policy owner may choose to sell his or her life insurance policy because they no longer need or want their policy, wish to purchase a different kind of life insurance, or the premium payments are no longer affordable. The policy owner receives a cash payment, while the purchaser of the policy assumes the obligation to pay all future premium payments required to keep the policy in force and receives the death benefit upon the death of the insured. ASC 325-30-20 provides a definition of a life settlement contract.
Definition from ASC 325-30-20
Life Settlement Contract: A life settlement contract is a contract between the owner of a life insurance policy (the policy owner) and a third-party investor (investor), and has all of the following characteristics:
a. The investor does not have an insurable interest (an interest in the survival of the insured, which is required to support the issuance of an insurance policy).
b. The investor provides consideration to the policy owner of an amount in excess of the current cash surrender value of the life insurance policy.
c. The contract pays the face value of the life insurance policy to an investor when the insured dies.
5.1.2.1 Accounting for life settlement contracts
The accounting for investments in life settlement contracts differs from the accounting by the original purchasers of life insurance. ASC 325-30-25 states that a third-party investor should account for its investments in life settlement contracts using either the investment method or fair-value method. The policy election is irrevocable and is made on an instrument-by-instrument basis upon purchase.
Investment method
Based on a cost accumulation model, the investment method requires the life settlement contract to be initially recognized at the transaction price plus initial direct external costs paid to acquire the life settlement contract (e.g., broker fees, medical expenses) less expected credit losses. Continuing costs, such as premiums paid and any direct external costs to keep the policy in force, are capitalized.
An investor should test the life settlement contract for impairment if information or events indicate that the expected proceeds of the insurance policy will be less than the carrying amount of the investment plus anticipated undiscounted future premiums and capitalizable direct external costs. A factor that would trigger an impairment assessment would be a change in the expected mortality of the insured. A change in the creditworthiness of the issuer of the underlying insurance policy will change the allowance for credit losses. A change in interest rates would not require an investment in a life settlement contract to be tested for impairment. If an impairment loss is recognized, the investment should be written down to fair value. Any subsequent premiums would continue to be capitalized and added to the new basis and the contract would continue to be subject to impairment testing.
No investment income is recognized while the policy is in force. When the insured dies, the difference between the carrying amount of the life settlement contract and the proceeds of its underlying life insurance policy is recognized in net income.
Fair-value method
The fair-value method recognizes the initial investment in a life settlement contract at its transaction price, without regard to initial direct external costs, which are expensed as incurred. At each subsequent reporting period, the investment is remeasured at fair value and changes in fair value are recognized in net income.
5.1.3 Overview of split-dollar life insurance
Split-dollar life insurance is an arrangement between an employer and an employee to share the cost and benefits of a life insurance policy on the employee. The employer pays all or most of the policy premiums in exchange for an interest in the policy cash value and death benefit. The two most common forms of split-dollar arrangements are collateral assignment and endorsement. The ownership and control of the life insurance policy determines the type of arrangement.
In a collateral assignment split-dollar arrangement, the employee (or employee’s estate or trust) owns and controls the policy. The employer is reimbursed for premiums paid from the death benefits or cash surrender proceeds. A portion of the value of the insurance policy is assigned by the employee to the employer, which secures the employer’s right to be repaid for the premiums it paid on the policy.
In an endorsement arrangement, the employer owns and controls the insurance policy. The employer enters into a separate agreement to split the policy benefits between the employer and employee and endorses a portion of the death benefits to the employee. Upon death of the employee, the employee’s beneficiary typically receives the designated portion of the death benefits directly from the insurance entity and the employer receives the remainder.
5.1.3.1 Accounting for split-dollar life insurance
Under a collateral assignment arrangement, the cumulative premiums that an employer paid will be reimbursed from the death benefits or cash surrender proceeds. The employer does not control the surrender decision. ASC 325-30 does not allow a life insurance asset to exceed cash surrender value less an allowance for credit losses and also requires discounting if access to proceeds will be longer than a year. If the employer does not control the surrender decision, the employer should record an asset equal to the lesser of the following amounts:
- The cash surrender value, discounted only if restrictions exist as to the timing of cash receipts
- The net present value of the cumulative premiums paid by the reporting entity discounted over the life expectancy of the insured
This is based on the premise that surrender is not within the control of the employer and it is uncertain whether the employer will be reimbursed for cumulative premiums paid upon death or upon surrender. Premiums paid in excess of the asset should be treated as an expense in the income statement.
If the employer is able to unilaterally control the surrender decision, the employer may record an asset equal to the lesser of the following:
- The cash surrender value, discounted only if restrictions exist as to the timing of cash receipts
- The cumulative premiums paid
This is based on the premise that the employer can surrender the policy at its discretion and be reimbursed for cumulative premiums paid. This would also be appropriate under an endorsement arrangement as the employer owns the insurance policy and would be able to terminate the insurance policy at its discretion.
If the employee is a shareholder and the collateral assignment agreement does not require the insurance company to reimburse the employer directly, but requires the shareholder to reimburse the employer for its cumulative premiums paid, then, in essence, a secured loan has been provided to the shareholder. The secured loan may require treatment as a deduction from equity in the employer’s financial statements.
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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