Insurance companies that issue long-duration contracts can expect volatility, increased data and disclosure requirements, and the potential for a new market for reinsurers thanks to recent accounting changes, according to Milliman’s William Hines and Francois Dauphin. In the latest episode of Critical Point, Milliman’s life insurance actuaries discuss key takeaways from the Financial Accounting Standards Board (FASB) Targeted Improvements to the Accounting for Long-Duration Contracts (LDTI), which will require significant risk management and has a go-live date of January 2021.
To listen to the entire podcast, click here. Also, to hear past Critical Point episodes, click here.
On July 17, 2019, the Financial Accounting Standards Board (FASB) announced it will extend the timeline to implement the Targeted Improvements for Long Duration Contracts (LDTI), moving the go-live date to January 1, 2022. The original timeline was aggressive, forcing companies to address several hard realities to meet the deadline. With an extra year, how should companies respond? Below we list five strategies to capitalize on the extension, ranging from conservative to aggressive.
- Reduce risk. With the original timeline, a misstep or an unknown delay could have potentially put compliance at risk. This risk still exists even with the extension. Companies may want to stick with the current implementation plan and be operational and compliant as soon as possible. Then they can work incrementally to improve upon a compliant foundation.
- Reduce cost. For many companies, the original timeline required costly approaches to meet the deadline. Project plans were highly parallelized, often with throwaway work required. Further, additional external resources were brought in to staff the multiple work streams. With extra time, companies can hire, redeploy, or pursue other options to reduce the need for external resources. More efficient project plans with less redundancy can also be pursued. Companies can adjust their plans to reduce cost with the same target objectives.
- Evaluate wider range of options. Limited time meant that companies could not fully evaluate all options on transition approaches, cohort definitions, and other methodology choices. With extra time, companies can now choose to do more analyses to understand the financial impact of various methodology levers and optimize the approach.
- Focus on strategic value. The original LDTI timeline put pressure on companies to take shortcuts and other ”triage” approaches that were necessary for compliance but were not consistent with a long-term, strategic implementation. With the extension, companies can now choose to pursue implementation approaches that will deliver a compliant solution, but with more strategic value.
- Paradigm shift. Taking the prior strategy a step further, some companies may choose to change some or all of their approach to LDTI, create a new trajectory for their implementation, and dramatically reshape the target end-state. With the prior timeline, some implementation options (e.g., migrate to a new valuation, data platform, etc.) could not even be considered. With the extension a company could choose a paradigm shift in its approach. Clearly this is still a bold move, but that option is back on the table for consideration.
The timeline dictated by the Financial Accounting Standards Board (FASB) Targeted Improvements to the Accounting for Long-Duration Contracts (LDTI) has a go-live date of January 2021, a fast-approaching deadline. With this in mind, insurers need to address these six hard realities to make sure they are ready to meet the new requirements:
- Methodology. Many companies are initially focusing on accounting policy, but too often in isolation. A desired approach may not be possible due to auditor concerns, data limitations, or LDTI vendor capabilities, among other constraints. Policy decision-makers cannot make decisions in isolation. Also, there is not enough time to fully evaluate all of the issues. Do the work to pick the right battles as to where you spend the time.
- Data. New data requirements mean that information technology (IT) needs to help. Get them involved early and often. Transition methodology options (e.g., full retrospective, historical transition date for modified retrospective, etc.) likely will be dictated in part by data availability. Ongoing valuation requires new data feeds as well. Start early with IT, get what you can ASAP, set the plan to get the rest, and develop a crisp view of how it will come together
- Calculations. With most companies using vendor systems, a huge dependency has been created. If your vendor has not already delivered LDTI functionality, contingency plans need to be developed. Using a vendor solution to provide only the LDTI calculations, process, and reporting, and then relying on existing systems for cash flow projections, may be an option. Waiting and hoping is not.
- Operations. Operational aspects of LDTI can’t wait for accounting policy to be finalized. Also remember there are multiple workflows that need to be addressed—transition processes, point-in-time valuations, roll-forwards and disclosures, unlocking processes, etc. Then you need to control it all. This work can’t wait for every decision to be made. Get an end-to-end project going now to hopefully find the operational issues early. Accept that the project won’t deliver the final answer. But it is much better than no answer.
- Governance. Factors are gone. Models and assumptions are in. If you haven’t established model governance before—it’s needed now. Assumption development processes also are required. If you use a closed system, don’t be complacent and think vendor-maintained code removes this burden—it doesn’t. It will look different, but the requirement is still there. In a big way. Establish the governance processes ASAP and start living with and using them even as LDTI models are still being developed.
- Resources. Even for the companies best prepared for LDTI, this is a big job. Few have the staff and the expertise to tackle LDTI and keep business-as-usual processes going as well. Remember there are limited resources among the consulting community and they are getting stretched across LDTI and International Financial Reporting Standard (IFRS) 17 projects, all of which are competing for many of the same skills. So again, choose your partner(s), start early, and secure the support you will need to be successful. Don’t assume the support you want will be there at some point in the future—secure it now.
What does it mean?
Limited time means that compromises are a given.
Implementation will too often be strictly compliance-focused rather than
strategic. Companies will need to be selective in where they spend their time
evaluating methodology options. Multiple work streams will all need to move
forward without perfect vision into the final state. Companies will need to
make decisions without full information. High costs for controls and compliance,
and suboptimal financial outcomes, are very real concerns.
Avoiding these pitfalls will require early action on multiple fronts and high levels of collaboration across internal and external partners. Insurers will need to be comfortable moving forward without perfect vision into the end state. Expert project management along with significant diligence and coordination amongst all parties will be required to deliver the LDTI final answer. A deferral of the implementation date by the FASB would offer an opportunity for clients to mitigate or address many of the negative impacts noted above—and there are many in the industry hoping for that opportunity—but until then, insurers need to live with the hard realities of the current LDTI timeline.
2018, the Financial Accounting Standards Board (FASB) released Accounting
Standards Update 2018-12 (ASU 2018-12), Targeted Improvements for Long-Duration
Contracts. It represents a fundamental change in the measurement and reporting
of long-duration insurance contracts that will alter the incidence and
volatility of reported income and equity.
In this paper, Milliman’s François Dauphin and William Hines illustrate the potential impacts of ASU 2018-12 relative to current US GAAP accounting with respect to four blocks of business: level term insurance, single premium immediate annuities, long-term care insurance, and universal life insurance. They followed the income emergence over a five-year period under both accounting standards using a valuation process a company might follow, including the random termination of individual policies, issuance of new policies, cash flow assumption updates and movements in market yield rates. The results show the importance of having accurate information on which to base the key decisions that need to be made well in advance of the January 1, 2021, implementation date, and that required calculations from actuarial systems will increase in order to meet the new requirements and explain the emergence of income.
The Financial Accounting Standards Board issued accounting standard update 2018-12 on August 15. It contained targeted changes to the accounting for long-duration insurance contracts. This paper by Milliman actuaries William Hines, Zi Xiang Low, and Karthik Yadatore summarizes the main resulting changes to the accounting of life insurance and annuity products.
The Financial Accounting Standards Board recently approved changes to the accounting for long-duration insurance contracts. This included the creation of a new category of benefits called market risk benefits. This paper by Milliman consultant William Hines discusses market risk benefits and contract features that might be within their scope.