Basics of US GAAP for Life Insurers FS 11 - aktuariat …

1 aktuariat -witzelBasics of US gaap for life InsurersETH / Universit tZ richFr hjahrssemester2011Dr. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1121. Introduction2. Product Classification3. Expense Classification4. BS and P&L Structure5. Asset Classification6. Technical Reserves7. Deferred Acquisition Costs8. Recoverability Test and Loss Recognition Test9. Shadow Adjustments10. Legal Quote 11. Purchase GAAPC ontentFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 113 US gaap (General Accepted Accounting Principals) financial reporting is characterized by the following two principles: true and fair time wise matching (synchronization) of proceeds (income) and expenditures (outgo)1. IntroductionFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 114 The US gaap financial reporting should be true and fair because the main addressees are investors and analysts True and fairimplies for example that a reserve can only be set up if there is really a corresponding claim against the insurance company contingency reserves(provisions for unlikely or undefined purposes) are not allowed the assets and liabilities should be neither overstated nor understated relative to their real value1.

2 IntroductionFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 115 Thetime wise matching (synchronization) of proceeds and expenditures is realized byaccrual accounting and deferring. Accrual accounting and deferringmeans that adjustments in the financial statements are made to allocate revenue and expenses more appropriately to the measurement period Examplesare the deferred acquisition costs (DAC)or the way the bonus reserve is build up 1. IntroductionFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 116 US gaap distinguishes between H-GAAPand P- gaap H- gaap is the accounting standard for a historical grown company P- gaap is the accounting standard for a purchased company In the following, first the H- gaap methodology is presented and called just US gaap In the last chapter, the characteristics of P- gaap are presented1. IntroductionFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 117 US gaap or more general Anglo-American Accounting Systems are based on case law This is very well verified by a look at the different FASes(Financial Accounting Standards) in US gaap Example: FAS 97 as an amendment to FAS 60, if premium paying period is shorter than insurance period are focused on the capital markets The main purpose is to provide useful and reliable information for the investors and the analysts1.

3 IntroductionFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 118 Continental-European Accounting Systemsin contrast are based on code law are focused on creditors This allows for example to understate the financial situation you are allowed to present the company poorer as it really is A typical example are the hidden reserves1. IntroductionFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1191. Introduction2. Product Classification3. Expense Classification4. BA and P&L Structure5. Asset Classification6. Technical Reserves7. Deferred Acquisition Costs8. Recoverability Test and Loss Recognition Test9. Shadow Adjustments10. Legal Quote 11. Purchase GAAPC ontentFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS FAS FAS Classification Deposit versus Separate Account versus General Summary2. Product ClassificationFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1111 US gaap accounting rules for insurance companies are formulated in different Statements of Financial Accounting Standards (SFAS or short FAS) FAS 60, FAS 97 and FAS 120are relevant for insurance product classification FAS 60(issued in 1982) contains the general principles of accounting for insurance products; there you find: definition of premium income, calculation method to determine provisions for future policyholders benefits (technical reserves) including assumptions setting, definition of investment income, expense classification and expense allocation OverviewFinanz.

4 F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1112 But not all types of products are covered by FAS 60 FAS 60 is the basis FAS 97 and FAS 120 are amendments for special life products FAS 97(issued in 1987) addresses Universal life Type Contracts (Unit Linked Products) Limited Payment Contracts Investment Contracts FAS 120(issued in 1995) addresses participating life products with policyholders dividends according to the contribution OverviewFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS FAS FAS FAS Classification Deposit versus Separate Account versus General Summary2. Product ClassificationFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1114 According to FAS 60insurance contracts are classified as short-duration or long-duration contracts: Short-duration contractsprovide insurance protection for a fixed period of short duration Typical examplesare non-lifeinsurance contractssuch as motor or household insurance.

5 The contract enables the insurer to cancel the contract or to adjust the provisions of the contract at the end of any contract period, such as adjusting the amount of premiumscharged for coverage FAS 60 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1115 FAS 60short(cont.) The premiums written ( gezeichnetePr mien ) are the premiums belonging to a written contract If the contract lasts for five years and is financed by annual premiums, the premiums written equal five annual premiums The premiums booked ( gebuchtePr mien ) would be in this example of a five years contract five times the premium for one year The premiums booked are the premiums receivedin the reporting FAS 60 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1116 FAS 60short(cont.) The premiums earned( verdientePr mien ) are that part of the premiums booked which belongs to the accounting period They are determined using the unearned premium reserve (UPR) The premiums earned are part of the income in the P&L to finance the losses of that accounting period That is why a change in the UPR is not going through the P&L The UPR is part of a prologue to the P&L Short-duration contracts do not need an actuarial premium reserve There is no savings FAS 60 Finanz.

6 F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1117 FAS 60 long-duration contractsare expected to remain in force for an extended period Typical examples are life insurance contractsas non participating endowments, annuities, whole life etc. The contract generally is not subject to unilateral changes by the insurer Typically there is a tariff guarantee The performance of various functions and services (including insurance protection) is guaranteed for an extended FAS 60 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1118 FAS 60 long (cont.) The premiums due ( f lligePr mien ) are part of the income in the P&L The part which is not earned, is going into the unearned premium reserve (UPR) Because premiums due are part of the income in the P&L, a change in UPR has an impact to the P&L for long-duration contracts The UPR is part of the provisions of policyholders benefits (Technical Reserves) FAS 60 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1119 FAS 60 Long Duration Contract Provisions The provisions for future policyholders benefits (technical reserves) for FAS 60 long-duration productsare calculated using the prospective method they are determined as the difference of the present value of the expected future insurance benefits and of the present value of the expected future premiums payments using locked-in best estimate assumptions including lapse rates and PADs(Provisions of Adverse Deviations) FAS 60 Finanz.

7 F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS FAS FAS FAS Classification Deposit versus Separate Account versus General Summary2. Product ClassificationFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1121 FAS 97 establishes accounting standards for Universal life type contracts (Unit Linked Products) Investment contracts Limited payment FAS 60 long FAS 97 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1122 FAS 97 Universal life Type Contract The provisions for future policyholders benefits (technical reserves) equal the account value;in general (exception SOP 03-1; SOP = Standard of Position), they can only be determined using the recursive deposit method According to the SOP 03-1,special additional reserves belonging to such products may be calculated in a different way ( minimum guaranteed death benefit) Amounts that accrue to the benefits of the policyholders (including interestaccrued to policyholders balances) are not fixed or guaranteed by the terms of the FAS 97 Finanz.

8 F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1123 FAS 97 Universal life Type Contract Premiums may be changed by the policyholder within contract limits without consent of the insurer Savings premiums and interest accrued on investments are not recorded as revenues, but as deposits Only fees for risk and expenses, surrender charges and interest charges are recognized as income There is no technical interest rate It is usual to classify all Unit Linked Products whenever possible as FAS 97 Universal life Type FAS 97 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1124 FAS 97 Investment Contract In these contracts there is no or no significant insurance risk For example there is no or no significant mortality or morbidity risk Premiums and interest accrued on investments are not recorded as revenues but as deposits Two types are to distinguish: Unit linked type Traditional FAS 97 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1125 FAS 97 Investment Contract For the unit linked type The provisions for future policyholders benefits (technical reserves) equal the account value they can only be determined using the recursive deposit method There is no technical interest rate The difference to the universal life type is the missing insurance risk FAS 97 Finanz.

9 F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1126 FAS 97 Investment Contract For the traditional type there is a technical interest rate premiums cannot be increased by the policyholder without consent of the FAS 97 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1127 FAS 97 Limited Payment FAS 60 Long Contract These are traditional insurance products where the insurance period is longer than the period of paying premiums, single premium business For these products both FAS 60 long and FAS 97 are relevant Any amounts of gross premiums in excess of net premiums should be deferred and recognized over the period that services are provided The corresponding reserve is called Deferred Profit Liability (DPL) FAS 97 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1128 FAS 97 Limited Payment FAS 60 Long Contract (cont.) The provisions for future policyholders benefits (technical reserves) for these products are calculated using the prospective method they are determined as the difference of the present value of the expected future insurance benefits and of the present value of the expected future premiums payments using locked-in best estimate assumptions including lapse rates and PADsas typical for FAS 60 long FAS 97 Finanz.

10 F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1129 FAS 97 Limited Payment FAS 60 Long Contract (cont.) These products are often classified as: Traditional limited payment insurance FAS 60 long with FAS 97 DPL FAS 97 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS FAS FAS FAS Classification Deposit versus Separate Account versus General Summary2. Product ClassificationFinanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1131 For certain participating life insurance contractsthere were some special rules firstly stated in a Statement Of Position (SOP 95-1)relevant only for mutual life insurance enterprisesand then secondly in FAS 120also applicable for stock life insurance enterprises(in force since 1995) FAS 120 Finanz. F hrungsinfo. Teil3; US GAAPDr. RuprechtWitzel; FS 1132 The rules of FAS 120 (SOP 95-1)should be applied if the life insurance contract meets both of the following conditions: The contract is a long duration participating contractthat is expected to pay dividends to policyholders based on actual experience of the insurer Annual policyholder dividends are paid in a manner that identifies divisible surplus and distributes that surplus in approximately the same proportion as the contracts are considered to have contributed to divisible surplus (contribution principle) FAS 120 Finanz.