As finance leaders at US Insurers come out of year-end close efforts, they are expected to quickly turn their attention to ASU 2018-12 - FASB’s update to Topic 944 known within the industry as LDTI (‘Targeted Improvements to the Accounting for Long Duration Contracts.’) LDTI has an effective date of January 2021 and is likely to impact core systems and processes so Insurers don’t have much time to lose.
LDTI impacts Insurance entities that issue Long Duration contracts including Term Life, Universal life type contracts, Traditional Whole Life and Limited Payment contracts to name a few. It is viewed as the biggest overhaul in FASB accounting in several decades.
For many Insurers, the core requirements of LDTI will potentially highlight the lack of investment in and flexibility of finance systems that have been in place over the last few decades. In addition to specific changes around Assumptions for the Liability for Future Policyholder Benefits, Deferred Acquisition Cost Amortization (DAC), Market Risk Benefits (MRBs) and Extensive Disclosures, more wide-reaching, general challenges will include:
- Explaining increased volatility in financial statements and disclosures
- Accessing a much deeper level of data granularity at both the cohort and policy level
- Managing increased pressure on the close process and actuarial systems
- Storing an evolution of data over time
- Tracking actuarial model runs and accounting output in a controlled, timely and auditable manner
- Managing a significant increase in disclosures and assessing and accessing the detail required for the disaggregated roll forwards
Addressing these challenges will likely require more than just a change to the actuarial environment. This is likely why many Insurers are looking at LDTI as a chance to take a holistic look at finance architecture improvements to both comply with the new standard and position their organization for the future of digital finance.
A closer look at the changes:
Deferred Acquisition Costs
LDTI overhauls the current method of accounting for Deferred Acquisition Costs, requiring Insurers to move to a DAC amortization method based on a constant level basis whilst also processing any adjustments from subsequent changes in expectations. In addition to the change, insurers will need to track the movements in a way that supports the disclosure requirements.
Market Risk Benefits
This change may not impact all Insurers but for those impacted, they will need to first reassess whether benefits meet the definition of MRB. The requirement is to measure all MRBs at fair value, so this may be a change for some depending on their current measurement model. Additionally, any changes in credit risk needs to be reported in OCI so there will be a need to track these movements accordingly. For MRB’s the disaggregated roll forward disclosures will require tracking of model runs at the right level of granularity to effectively substantiate the movement in FV.
LDTI will result in a significant increase to the number of required disclosures and the attributes required to support the disaggregated roll forwards. Insurers will need to provide a complete audit trail to substantiate and explain movements at a suitable level of granularity as well as any balance volatility resulting from the changes and unlocking of assumptions. With finance professionals already spending significant amounts of time collating data for current disclosure reporting, the increase will be challenging to keep up with without implementing a more automated, reconciled environment.
Under current US GAAP, the original assumptions used to measure the insurance liability are locked in at initial measurement and held constant. For Traditional Life and Limited Payment Long-duration contracts under LDTI, insurers must now review the initial assumptions at least annually. This will require insurers to document evidence of review, update cash flows and record resulting differences as impacts to Net Income and OCI in a controlled manner. The calculations will introduce the need to store all historical data for policies at an appropriate level of granularity. Additional challenges will include calculating any catch-up adjustments to the liability for future policy benefits, tracking the impacts of assumption changes to the expected cash flows and understanding and recording the associated accounting entries.
The time to kick off LDTI Initiatives is now
A recent survey by PWC found that despite a deadline that is actually quite close, the bulk of companies (73%) will only complete impact assessments during 2019, giving a very short implementation period to design, build, implement, test and dry run systems over the latter part of 2019 and 2020 before go-live reporting in 2021 for public entities. (source)
While it may be early days, it’s time to begin thinking hard about LDTI projects, especially for Insurers who want to include a broader transformation effort as a part of the project.
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