Short-duration contract disclosures: An overview of ASU 2015-09
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Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2015-09, Financial Services—Insurance (Topic 944): Disclosures about Short-Duration Contracts, requires insurance entities to disclose certain information, including the following:
- Incurred and paid claims development information on a net basis, by accident year, for the number of years for which claims incurred typically remain outstanding (but need not exceed 10 years)
- A reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for unpaid claims and claim adjustment expenses
- For each accident year presented, the total incurred-but-not-reported (IBNR) liabilities plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses
- For each accident year presented, quantitative information about claim frequency
- A description of the reserving methodologies along with any significant changes to those methodologies
- A description of the methodologies used for determining claim frequency information along with any significant changes to those methodologies
- For all claims except health insurance claims, the average annual percentage payout of incurred claims by age
While the ASU came into effect for public business entities for annual periods beginning after December 15, 2015, for many middle market insurance entities, the amendments will first be effective for the December 31, 2017 financial statements.
Key implementation considerations
Level of disaggregation
The new guidance does not prescribe the level of disaggregation an insurance entity should use in presenting certain disclosures. The level of information should be useful to the users of the financial statements. The disclosures should allow users to understand the amount, timing and uncertainty of cash flows arising from contracts issued by an insurance entity.
An insurance entity should analyze how it presents information about its liability for unpaid claims and claim adjustment expenses in other documents or presentations. This may include earnings releases, annual reports, statutory filings or investor presentations. The FASB’s guidance also suggests analyzing how information is used internally by key decision makers in evaluating an insurance entity’s financial performance. Examples of categories included in ASC 944-40-55-9C that an insurance entity should consider when selecting the type of category to use to aggregate or disaggregate disclosures include:
- Type of coverage (major product lines)
- Geography (country or region)
- Reportable segment (for public entities)
- Market or type of customer (personal vs. commercial lines)
- Claim duration (short tail vs. long tail)
It is important for an insurance entity to decide early the level of disaggregation needed to meet the objectives of ASU 2015-09. It is expected that the cost of accumulating the data will be reduced if an insurance entity utilizes a disaggregation methodology that resembles how internal financial information is analyzed. This assumes senior management is disaggregating data internally that is meaningful for its business, and users of the financial statements would find similar disaggregation to be useful.
Number of claim development years
While the FASB determined the maximum number of years required to be included in the disclosure, it did not specifically prescribe the number of years to be disclosed. An insurance entity is required to analyze its own level of disaggregation and present the number of years for which claims incurred typically remain outstanding.
An insurance entity is required to disclose cumulative claim frequency information along with the methodology utilized to determine those claim counts. An insurance entity may encounter implementation issues when accumulating the information for the disclosure, including, but not limited to: (a) changes in claim count methodologies in previous years, (b) information system changes, (c) introduction of new sub-coverage types within a line of business, (d) an insured’s use of a self-reporting incident mechanism, (e) previous mergers and acquisitions, (f) claims below certain attachment points, (g) limited information available on assumed business, (h) inclusion of claim counts on business that is 100 percent ceded, and (i) changes in an insurance entity’s reinsurance program over time.
These implementation issues will require an insurance entity to analyze its methodologies and determine the usefulness of the information disclosed. An insurance entity may determine it is impracticable to disclose certain claim frequency information; however, the reason for excluding this information is required to be disclosed. Certain claim frequency information may be available to an insurer; however, the inclusion of the data may distort the disclosure (e.g., previous mergers or acquisition); therefore, an insurer may be required to separately disclose that claim frequency information.
An insurance entity is required to disclose the methodologies utilized in estimating its liability for unpaid claims and claim adjustment expenses; however, the new guidance does not offer any specific guidance on the level of detail to disclose. It is common for a property and casualty insurance entity to utilize an actuary to estimate an ultimate loss and then subtract the reported case base reserves to arrive at the IBNR amount. However, users of the financial statements may not find that disclosure to be particularly useful based upon factors specific to that insurance entity, such as unique coverage types or use of multiple methodologies.
An insurance entity should disclose the specific methodologies utilized, but should take care in not disclosing information at a level of extreme detail. The reason an insurance entity should carefully consider the extent of disclosure is that the guidance requires significant changes in methods and assumptions to be disclosed along with the reason for the changes and the related effects on the income statement. In practice, a significant change may be defined differently based on the level of detail disclosed, so it may be difficult for an insurance entity to measure the income statement impact related to a significant change in a detailed assumption.
Health insurance claims
Health and(or) life insurance entities that issue accident and health insurance, and certain life insurance contracts, may be subject to the new disclosure requirements. This may present challenges for certain insurance entities as certain coverage contracts may be classified as short-duration by one insurer and long-duration by another insurer. Coverage such as group long-term disability, group life or Medicare Supplement (issue-age-rated vs. attained-age-rated) may present challenges in effectively scoping out long-duration contracts from the disclosures. As such, it may be more useful to the users of the financial statements if such coverage types are not excluded, but rather included in the disclosures to accurately show the full picture of the insurer’s reserve development.
The new guidance requires an insurance entity to disclose cumulative claim frequency information. For certain contracts, this information may be useful and easy to calculate and accumulate. However, for other health contracts, such as medical insurance, this information would be less meaningful, more difficult to accumulate and not pertinent to the liability valuation process. As such, the omission of the cumulative claim frequency information for medical insurance contracts may require an insurance entity to consider medical insurance contracts as its own category for purposes of disaggregation.
The implementation of ASU 2015-09 will pose a challenge to most insurers, but the information disclosed should allow users to better understand the amount, timing and uncertainty of cash flows arising from contracts issued by insurance entities and the development of loss reserve estimates.
For additional information regarding the implementation of ASU 2015-09, download our full white paper, Short-duration contract disclosures: Implementing ASU 2015-09.