Life Insurance Accounting IABA final by fionan

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									Life insurance company
accounting
Mark Freedman, FSA, MAAA
International Association of Black Actuaries

July 31, 2009
Agenda


Basic concepts
 ►    Reserves
 ►    Life insurance accounting in the United States


Advanced concepts
 ►    Differences between GAAP and Statutory accounting
 ►    Where insurance accounting is headed




Page 2                Life Insurance Company Accounting
Some key phrases you need to know


►    CARVM                                       ►    Active life reserves
►    DAC                                         ►    Unlock
►    Deferred annuities                          ►    FASB
►    IASB                                        ►    ICOS
►    Claims reserves                             ►    SEC
►    IFRS                                        ►    Surplus
►    Variable annuities                          ►    GAAP
►    VACARVM                                     ►    Universal life
►    RBC                                         ►    IBNR
►    Statutory                                   ►    CRVM
►    PAD                                         ►    LTC
►    Equity                                      ►    DI


Page 3                Life Insurance Company Accounting
The language of insurance accounting


1.    The IASB and FASB are fighting for the key to universal
      life.
2.    “Doctor, the GAAP in my teeth are so large that I might
      need braces to stop them from unlocking.”
3.    The reserves are leading an active life.




Page 4             Life Insurance Company Accounting
Basic concepts




Page 5   Life Insurance Company Accounting
Reserves




Page 6     Life Insurance Company Accounting
Yearly renewable term (YRT)


►    Most simple form of insurance

►    A term life insurance policy that is
     renewed at the end of each year
     without evidence of insurability

►    The premium usually increases
     each year

►    Will pay a death benefit if
     policyholder dies during the
     coverage period

►    Need an unearned premium reserve
     (UPR)



Page 7                    Life Insurance Company Accounting
Unearned premium reserve (UPR)

►    UPR is based upon the concept of a
     premium driven reserve- an
     approach to determining policy
     reserves which is based on
     prorating premiums over the period
     of coverage                        $

►    The statutory accrual of premium
     has the effect of always including a
     full annual premium in income, even
     if the policy premiums are payable
     more frequently                                 Issue of              Termination of
                                                     the contract            the contract
                                                                    Time
►    The UPR therefore represents that
     portion of a premium on a short-
     duration contract that provides for
     coverage beyond the end of the
     financial reporting period


Page 8                  Life Insurance Company Accounting
Level term

►    Level term insurance provides life
     insurance protection that remains
     level for a term the policyholder
     selects

►    The premium remains the same
     throughout the duration of the
     contract.

►    The premium paid on this type of
     policy will be higher at the beginning
     of its life, but lower towards the end
     of its life, when compared to term
     policies that have rising premium
     rates

►    Usually a guaranteed rate for 10
     years

Page 9                   Life Insurance Company Accounting
Whole life


►    Life insurance which provides
     coverage for an individual's whole
     life, rather than a specified term. A
     savings component, called cash
     value or loan value, builds over time
     and can be used for wealth
     accumulation.

►    Premiums are fixed throughout the
     life of the policy even though the
     breakdown between insurance and
     savings swings toward the
     insurance over time.
                                                             Premiums
                                                             Mortality
►    Pays a fixed death benefit when you
     die

                                                                         (continued)


Page 10                  Life Insurance Company Accounting
Whole life


►    Can be a limited-pay contract
     ►    Premiums that are paid over a shorter period of time than
          the coverage period (no additional premiums are required
          to keep the policy in force)


►    Many variations of this theme
     ►    Increasing term
     ►    Decreasing term
     ►    First-to-die
     ►    Second-to-die




Page 11                 Life Insurance Company Accounting
Other types of coverage in life insurance companies

►    Long Term Care (LTC) - pays a specified periodic amount
     if the insured requires long-term home nursing care or
     long-term confinement in a custodial institution (hospital)

►    Disability Insurance (DI) - pays benefits in the event that
     the policyholder becomes incapable of working

►    Accidental Death or Dismemberment (AD&D) - provides a
     benefit if an injury resulting from an accident occurs that
     causes the death or other covered losses to the insured



                                                             (continued)


Page 12             Life Insurance Company Accounting
Other types of coverage in life insurance companies


LTC, DI, and AD&D policies are in case of accident
or sickness and provide the following coverage:
 ►  Medical expense coverage pays hospital and doctor bills
 ►  Disability income coverage provides payments while
    disabled
 ►  Long-term care coverage provides for the cost of nursing
    home care




Page 13          Life Insurance Company Accounting
Active life reserves


►    Represents an estimate of the excess of future benefit
     payments over future premiums that will arise because of
     an insured event that has not yet happened:
     ►    Death
     ►    Accident or disability that has not occurred
     ►    Survival, on an annuity or endowment


►    Active life reserves are commonly needed on level
     premium products where the risk of loss (benefits)
     increases over time (e.g., whole life insurance)




Page 14                  Life Insurance Company Accounting
Active life reserves

►    The reserves represent an amount set aside to pay future
     claims for non-cancellable and guaranteed renewable
     policies and for disability waiver of premium benefits

►    Reserves do not change actual cash flows or the ultimate
     amount of profits, but only the allocation of net income
     (profit) to specific time periods




                                                         (continued)


Page 15            Life Insurance Company Accounting
Active life reserves


►    Different methods of active life reserving (prescribed
     based on each accounting and reporting system for each
     type of product):
     ►    Premium driven – based on some % of premium
     ►    Account balance – how much the insured has on deposit to apply
          toward future benefits
     ►    Calculated using assumptions as to future benefit costs
          (an “experience table”) and interest rates




Page 16                 Life Insurance Company Accounting
What happens when a premium is received?


►    Premiums (assumed equal to 50) are paid and reserves (assumed
     equal to 45) are set up

            DR     Cash                                  50

                   CR          Premiums                  50


            DR     Change in reserves                    45

                   CR          Reserves                  45




Page 17              Life Insurance Company Accounting
What happens when someone dies?


►    Reserves (assumed equal to 100) are released and benefit is paid
     (assumed equal to 1,000)

            DR      Reserves                               100

                    CR          Change in reserves         100


            DR      Death benefit                         1,000

                    CR          Claims payable            1,000




Page 18               Life Insurance Company Accounting
Life insurance IBNR

►    A company is liable for a benefit payment on the date of
     death, even if it has not yet been notified of the death.
     Therefore, a reserve must be put up for those deaths that
     are incurred but not reported

►    The liability on the books is an estimate, by statistical
     means, of claims presumed to have been incurred during
     the statement year but not reported until the following year




Page 19             Life Insurance Company Accounting
Claim reserves/liabilities

►    An estimate of the unpaid amount of claim for an insured
     event that has already happened

►    Present value of future benefits using assumptions of
     interest and morbidity

►    Claim liability versus claim reserve – a statutory concept
     (in GAAP, these concepts are combined):
     ►  Liability – estimate of benefit amounts incurred and due at the end
         of the financial reporting period; includes In Course of Settlement
         (ICOS) and IBNR
     ►  Reserve – estimate of benefit amounts incurred but not yet due at
         the end of the financial reporting period; includes reported and
         unreported components

Page 20                Life Insurance Company Accounting
Traditional annuities

A contract sold by an insurance company designed to provide payments
to the holder at specified intervals, usually after retirement. These
annuities are common features of pension plans.

Immediate annuity payments begin now:
 ►    Fixed - guarantee a certain payment amount
 ►    Variable - changes based on the performance of the underlying investment
      options (Separate Accounts)


Deferred annuity payments begin at a future date:
 ►    Fixed - guarantee a certain payment amount and interest rate
 ►    Variable - changes based on the performance of the underlying investment
      options


                                                                         (continued)


Page 21                Life Insurance Company Accounting
Traditional annuities


►    With life contingency - payments cease upon the date of
     death of the annuitant
     ►    Payments may continue, potentially at a reduced level, throughout
          the lifetime of the co-annuitant


►    Without life contingency - payments are for a defined time
     period, irrespective of whether annuitant lives or dies.
     Payments pass to a beneficiary upon death of the
     annuitant.




Page 22                 Life Insurance Company Accounting
Immediate annuities


►    Reserve equal to the Present
     Value of Future Benefits




                                                  Benefit Payment

                                                  Future Payment After Expectation of Mortality




Page 23              Life Insurance Company Accounting
Deferred annuities


►    Fixed deferred annuities
     ►    Account value = Accumulation of premium plus interest credited (at
          discretion of insurer, subject to guaranteed minimums)
     ►    Surrender charge usually declines by duration
►    Variable deferred annuities
     ►    Account Value = Accumulation of premium plus market return on
          assets in separate account less contractual “M&E fees”
     ►    Surrender charge usually declines by duration
     ►    There are significant supplementary living and death benefit
          guarantees in this product, currently causing severe strain on
          many insurers




Page 24                 Life Insurance Company Accounting
Universal life

►    A flexible-premium, current-assumption, adjustable death benefit
     policy

►    Similar to traditional life insurance policies, universal life pays a death
     benefit and accumulates cash value; however, unlike traditional life
     insurance products, a universal life policy allows the policyowner to
     adjust the death benefit and to vary the amount and/or frequency of
     premium payments.

►    Combines a deposit-based account balance with term insurance to
     create an account balance reserve concept

►    Account balance = accumulation of premiums, less policy charges
     (front-end loads), plus interest credited, less cost of insurance
     charges; generally declining surrender charge                     (continued)


Page 25                 Life Insurance Company Accounting
Life insurance accounting in the
United States




Page 26    Life Insurance Company Accounting
Statutory accounting


►    Focus is more on solvency and balance sheet than on income
     statement

►    Key actuarial concepts
     ►    Expenses are not deferred
     ►    Reserves tend to be established, using conservative techniques/
          assumptions


►    Risk-based capital (RBC)
     ►    RBC can be viewed as a measure of how much capital (surplus) that
          should be held to avoid insolvency
     ►    Accordingly, a higher ratios of actual surplus to RBC should imply
          company is healthier
     ►    Low levels may place insurer in supervision or receivership proceedings

Page 27                  Life Insurance Company Accounting
US generally accepted accounting principles
(GAAP)

Objectives of GAAP
    “Generally Accepted Accounting Principles”
    Appropriate, timely and accurate reporting
    Earnings versus solvency focus
    Seeks to match revenues and expenses

Revenue and expense matching
    For insurance contracts, expenses are matched to revenues through a process
     known as “amortization”
    First, up-front expenses are converted into an asset
    Then, as revenue is earned, the asset is amortized – or decreased – and
     expenses are gradually recognized
    Up-front product charges (front-end loads) are handed similarly.
    Reserves on traditional products are handled similary.


Page 28                Life Insurance Company Accounting
Statutory balance sheet example



                                           Beginning      End of
                                              of year       year

          Invested assets                           100     180

          Liabilities

          Reserves                                   90     120

          Surplus                                    10      60




Page 29         Life Insurance Company Accounting
Statutory income statement example



              Premium                            100

              Investment Income                   10

              Expenses                           (20)

              Claims                             (10)

              Increase in reserve                (30)

              Pre-tax profit                      50




Page 30      Life Insurance Company Accounting
Statutory invested asset reconciliation


          Invested assets beginning of year            100


          Cash flow
          Premiums                                     100
          Investment income                             10
          Expenses                                     (20)
          Claims                                       (10)
          Total cash flow                               80


          Investment assets end of year                180




Page 31            Life Insurance Company Accounting
Statutory reserve reconciliation




             Reserve beginning of year              90

             Increase in reserve                    30

             Reserve end of year                   120




Page 32        Life Insurance Company Accounting
Statutory surplus reconciliation




              Surplus beginning of year            10


              After tax profit                     50


              Surplus end of year                  60




Page 33        Life Insurance Company Accounting
GAAP balance sheet example


                                    Beginning of year              End of year
      Assets
          Invested assets*                                   100          180
          DAC                                                 30           40
          Total assets                                       130          220
      Liabilities
          Reserves*                                           90          120
      Equity                                                  40          100


      * Assumed equal to statutory value for simplicity


Page 34                  Life Insurance Company Accounting
GAAP income statement example



          Premium                                 100

          Investment income                        10

          Maintenance expenses                     (5)

          DAC amortization                         (5)

          Claims                                  (10)

          Increase in reserve                     (30)

          Pre-tax profit                           60


Page 35       Life Insurance Company Accounting
DAC rollforward




                  DAC BOY                        30

                  Expenses                       15
                  Amortization (net of
                    interest)                    (5)

                  DAC EOY                        40




Page 36      Life Insurance Company Accounting
GAAP equity reconciliation




               Equity BOY                          40

               Pre-tax profit                      60


               Equity EOY                         100




Page 37       Life Insurance Company Accounting
Advanced topics




Page 38   Life Insurance Company Accounting
Difference between GAAP and
Statutory accounting




Page 39   Life Insurance Company Accounting
Difference between GAAP and Statutory for
traditional products

                                                   Statutory                        GAAP

                 Reserving method    CRVM                               Net level


                                     No DAC, but there is an implicit   Amortization in proportion to
                      DAC method
                                     DAC in CRVM reserves               premiums


                                 Prescribed by regulators;
                                                                        Best estimate plus provision
                     Assumptions assumptions tend to be
                                                                        for adverse deviation (PAD)
                                 conservative


 Lock in of assumptions at issue Yes                                    Yes



                                                                        Recoverability and Loss
          Reserve adequacy testing   Asset Adequacy Testing required
                                                                        Recognition Testing required




Page 40                     Life Insurance Company Accounting
CRVM for traditional products

►    CRVM - Commissioners Reserve Valuation Method

►    Formula reserve/whole life concept

►    Benefit driven reserves

►    Highlights of this reserving method:
     ►    In Year 1, the insurer sets aside only enough to cover that year’s cost,
          according to statutory assumptions
     ►    Therefore, the insurer will set aside more in each renewal year
     ►    Overall, the insurer sets aside enough to cover all benefit costs

►    Difference between the higher net level premium reserve and the
     lower CRVM reserve is called the statutory expense allowance


Page 41                   Life Insurance Company Accounting
Difference between GAAP and Statutory accounting
for universal life and deferred annuities

                                                  Statutory                       GAAP
                                     CARVM for annuities; a CRVM
                                                                       Account value; additional
                                     type method for universal life;
                 Reserving method                                      reserve for supplementary
                                     additional reserve for
                                                                       benefit features
                                     supplementary benefit features
                                                                       Deferrable costs and excess
                                                                       front-end loads amortized in
                      DAC method     No DAC
                                                                       proportion to estimated gross
                                                                       profit

                                 Prescribed by regulators;
                     Assumptions assumptions tend to be                Best estimates
                                 conservative


  Lock in of assumptions at issue Yes                                  No



                                     Asset Adequacy Testing            Recoverability and Loss
          Reserve adequacy testing
                                     required                          Recognition Testing required

Page 42                    Life Insurance Company Accounting
                        CARVM for annuities

►    CARVM - Commissioners Annuity Reserve Valuation Method

►    Reserve is equal to the present value of the projected future cash
     flows (discounted using the maximum statutory interest rate)
     computed through a number of different scenarios and the worse
     scenario is selected

►    The resulting minimum statutory reserve provides an expense
     allowance equal to the difference between the current account
     balance and the CARVM reserve

►    As the surrender charges wear off, the CARVM reserve will converge
     to the full account balance (the expense allowance is fully amortized
     over a period of time)

Page 43               Life Insurance Company Accounting
Reserves for supplementary living and death
benefits in variable annuities

►    Statutory
     ►    Moving to VACARVM (AG 43) as of year-end 2009, which is cash
          flow testing approach for entire annuity


►    GAAP
     ►    If feature has an insurance element, it is generally valued under
          SOP 03-1
     ►    Otherwise, it is generally fair valued under FAS 133




Page 44                 Life Insurance Company Accounting
Income statement presentation for universal life and
annuity-type contracts

            Statutory-type presentation


            Premium                                 900

            +Investment income                       90

            -Death benefits                         (25)

            -Surrender benefits                     (40)

            -Increase in reserves                  (800)

            =Net income (profit)                    125


                                                           (continued)


Page 45        Life Insurance Company Accounting
Income statement presentation for universal life and
annuity-type contracts

            Account value rollforward

            Account value prior year                1,000
            +Premium                                 900
            -Loads                                   (20)
            -AV withdrawn at death                    (5)
            -AV withdrawn at surrender               (45)

            +Credited interest                        50

            -Cost of insurance charges                80

            =Account value current year             1,800

                                                            (continued)


Page 46         Life Insurance Company Accounting
Income statement presentation for universal life and
annuity-type contracts

              GAAP-type presentation

              Investment income                    90

              -Loads                               20

              -Surrender charges                    5

              -Cost of insurance charges           80

              +DBs in excess of AV released       (20)

              -Credited interest                  (50)

              =Net Income                         125




Page 47       Life Insurance Company Accounting
What happens when a deposit is received in a
universal life contract?

►    Deposits (assumed equal to 100) are paid and liabilities (assumed
     equal to 100) are set up

            DR      Cash                                  100

                    CR          Liability                       100




Page 48               Life Insurance Company Accounting
What happens when someone dies in a universal
life contract?

►    Liabilities (assumed equal to 100) are released and benefit is paid
     (assumed equal to 1,000)

            DR       DB in excess of reserves released 900

            DR       Liabilities                            100

                     CR          Cash                      1,000




Page 49                Life Insurance Company Accounting
The direction of insurance accounting




Page 50    Life Insurance Company Accounting
Statutory accounting


United States
 ►    Moving towards principles-based approaches for reserves and RBC


Europe
 ►    Moving towards Solvency II, which is a market consistent, principle-
      based approach for assets, reserves and RBC


Convergence
 ►    There is a potential for worldwide convergence, but it is not clear yet
      whether this will occur.




Page 51                Life Insurance Company Accounting
GAAP and international accounting


US GAAP and International Financial Reporting Standards
(IFRS) are aligning their concepts, principles and rules
 ►    Securities and Exchange Commission (SEC) movement
 ►    Joint projects between FASB and International Accounting Standards
      Board (IASB), including insurance.


Status of IASB Insurance Project
 ►    Discussion paper issued in 2007 which contained a “current exit
      value” market consistent approach.
 ►    IASB intends to have Exposure Draft issued by December 2009
 ►    This should result in a final standard by December 2011 and
      implementation about two years later.


Page 52               Life Insurance Company Accounting
The European vision leads to a single reporting and
management model for all aspects of the business
    The insurance industry is moving to measuring value and managing
              itself on an economic, “market consistent” basis


          IFRS
                 ~       MCEV                Solvency II
                                                           ~      EC




                  Market-consistent balance sheet
                      and income statement


                                                           The cornerstone is market-
                               Single reporting            consistent financial statements
                             system for financial
                             reporting, risk, and
                                   capital




Page 53              Life Insurance Company Accounting

								
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