Figure LI 7-4 illustrates common insurance-related assets and whether they are in the scope of CECL.

Figure LI 7-4
Common insurance-related balances included/excluded from CECL

As discussed in LI 7.2, reinsurance recoverables are within the scope of the CECL model. The insurance company estimates a reinsurance receivable, which represents all amounts recoverable from reinsurers for paid and unpaid claims and claim settlement expenses, including estimated amounts receivable for unsettled claims, claims incurred but not reported, and for long duration contracts, future policy benefits.

For reinsurance contracts, an insurance company should consider factors such as the reinsurer’s ability to pay and collateral arrangements in determining its expected losses. In accordance with ASC 326-20-30-2, when similar risk characteristics exist, expected credit losses should be measured on a pooled basis. The criteria for pooling may be met when reinsurance counterparties have one or a combination of the following characteristics in common; (1) credit ratings, (2) geographic concentrations, (3) size of the business, and (4) types of agreements written.

Insurance receivables that arise due to salvage and subrogation rights (“the rights”) should also be evaluated for impairment under CECL. The rights are not separate financial assets, but instead are rights/potential cash inflows of an insurance contract that consider both estimated claim payments and expected recoveries from an existing insurance contract. During the life of the insurance contract, multiple claim payments may be made, all of which could generate the rights. When the insurer receives payment in satisfaction of the rights (e.g., in the form of cash, a financial asset, or some other asset), it would reduce the rights’ component of the claim liability and account for the newly obtained asset. Assets received that are financial assets subsequently measured at amortized cost are within the scope of CECL upon initial recognition.

As required by ASC 326-20-30-7, an entity should consider available information about past events, current conditions, and reasonable and supportable forecasts to assess the collectability of cash flows to develop an estimate of the allowance for credit losses of reinsurance recoverables. Factors to consider include:

An entity must also decide the appropriate level of aggregation at which to measure the expected credit losses by either grouping reinsurance recoverables on a collective pool basis or assessing on an individual basis. Some of the factors to consider when determining the appropriate level of aggregation include:

The premium receivable asset is required to be evaluated for credit losses in accordance with ASC 326. In certain instances, an insurance entity will record written premiums and a premium receivable from the policyholder as of the effective date of the insurance contract to reflect the entire amount of premium due under the contract for the period of coverage. The insurance entity will also record an unearned premium reserve liability for the portion of the written premium that has not yet been earned. This generally results in no income being recorded as of the effective date of the contract but an equivalent premium receivable asset and unearned premium reserve liability being recorded.

Most insurance policies allow the insurance company to unilaterally cancel the policy if the policyholder fails to pay the contractual premium due. The insurance policy will generally allow for a 30- to 60-day legal grace period for the policyholder to pay the premium before the coverage is cancelled and the insurance entity is no longer under any obligation to perform. If a policy is cancelled, any remaining premium receivable balance and unearned premium lability would be written off, limiting the insurance company’s exposure to the unpaid earned premium that had already been recognized in earnings prior to the cancellation date.

We believe that when measuring expected credit losses related to premium receivables, an insurer should consider the contractual provisions that allow them to cancel the policy following a legal grace period if the policyholder fails to pay the contractual premium. These cancellation provisions can reduce the exposure to credit losses as the write off of any premium balances, including the premium receivable and unearned premium reserve upon cancellation, does not represent a credit loss that needs to be captured in the CECL calculation. If laws and regulations state that coverage must be provided for the remaining term despite a delinquency or default by the policyholder, we believe that an insurer should consider credit losses on the entire premium receivable without consideration of the unearned premium.