OLDWICK, N.J.–(BUSINESS WIRE)–Changes to the Financial Accounting Standards Board (FASB) requirements for insurance companies to report GAAP financials for long-duration contracts could become costly for companies transitioning to the new accounting standards and could create earnings and reserving volatility, according to a new AM Best commentary.

The Best’s Commentary, titled, “Life/Health Insurers Daunted by FASB Long Duration Contract Changes,” states that the FASB’s new accounting standards, which become effective in 2021, include detailed disclosure requirements to increase transparency to investors and other users of GAAP financial statements. Since assumptions must be updated annually at least, insurers will be challenged to represent sources of changes effectively. While greater transparency undoubtedly will increase understanding of results by investors, the complexity of the calculations makes comparison difficult. In addition, companies will be challenged from an information technology perspective, as so-called disaggregated roll-forwards will be based each year on annual cohorts, with potentially varying assumptions, and must be shown reconciling beginning and ending period balances. As a result, insurers will need to change processes and system controls to track actual experience going back to original issue dates. Insurers that have a variety of products that were written several years ago also may be challenged when attempting to gather historical information in order to establish transition methods to the new regime, especially if blocks of business have been moved to newer systems.

The FASB changes not only affect long-duration life and annuity contracts, but also health insurance contracts, particularly long-term care and long-term disability. Variable annuities will be affected more so due to market value valuations of liabilities and hedging instruments, increasing the potential for more volatile earnings. Reserves also will become more volatile as the assumptions used to measure present values of cash flows will be updated annually, or more frequently, if experience warrants material changes. Additionally, amortization schedules on deferred acquisition costs (DAC) will become much more consistent, reflecting the actual length of the coverages, as well as be more transparent and easier to understand. DAC asset balances also will no longer accrue interest, another key change in the treatment of DAC balances. Lack of interest accruals on the DAC balance may push earnings patterns to later years as there could be more DAC amortization in earlier years. As a result, for most products, earnings patterns may be more sensitive to product designs than before.

Companies transitioning to the new accounting standards can choose how prior years’ results get adjusted. Companies electing retrospective transitioning will begin restating financials as early as 2019 if they are reporting three years of results in their filings. While this may give time for smoother transitions to the ultimate adoption date of 2021, it may be offset by the myriad disclosures required. Key aspects of AM Best’s holding company analysis include the ability to service debt through earnings, the level of leverage within the holding company debt structure and the ability to service debt either through earnings or dividends from subsidiaries. AM Best does not believe accounting changes in and of themselves change the economic health of the companies it rates, although the proposed long-duration accounting standards may create short-term swings in the consolidated equity and leverage ratios. Additionally, the extensive changes being proposed could lead to significant costs incurred as companies need to go back in time and establish assumptions used for reserves from annual cohorts.

To access the full copy of this commentary, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=285770.

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