Please note that the information contained in this post is based on my own research and understanding of the topic. While I have made every effort to ensure its accuracy, I cannot guarantee that it is completely error-free. If you notice any errors or omissions, please let me know so that I can correct them.
Applicability
| FAS 60 | FAS 97 | |
| Contracts |
|
{US-FAS97-6} |
Assumption
- Best-Estimate + Provision for adverse deviation (PAD)
- Assumptions are locked in at the time of sale.
- Assumptions can only be unlocked in a loss recognition event.
Calculation Methodology
Statement of Financial Accounting Standard No. 60 (FAS 60)
- Projects Premiums, investment income, benefits, expenses
- Benefits = guaranteed & non-guaranteed
- Expenses = commission, acquisition expenses and direct maintenance expense (excluding overhead)
- Calculate Valuation Net Premium
- Calculate Terminal Reserve
Impact on Balance Sheet
Statement of Financial Accounting Standard No. 60 (FAS 60)
- Benefit Reserve Set up as the liability
- DAC Set up as the asset
| FAS 60 | FAS 97 | |
| Amortization of DAC | Deferred Amortization Costs amortized in proportion to premiums with interest (based on expected premium revenues). |
Deferred Amortization Costs amortized in proportion to premiums with interest (based on the present value of estimated gross profits). {US-FAS97-24} |
GAAP Reserve Items
- Benefit Reserve
- Maintenance Expense Reserve
- DPL (Deferred Profit Liability or Unearned Revenue Liability or Unearned Profit Reserve) (for FAS 97 LP only)
- DAC
- Premium Deficiency
| Premium Deficiency | FAS 60 | FAS 97 |
| Application |
|
{US-FAS97-27} |
| Calculation |
Short-Term Insurance Contract: A premium deficiency shall be recognized if [a] > [b]: [a] the sum of expected claim costs and claim adjustment expenses, expected dividends to policyholders, unamortized acquisition costs, and maintenance costs [b]related unearned premiums. {US-FAS60-33} Reserve for Premium deficiency = – ([a] – [b])+ + DAC {US-FAS60-34} Long-Term Insurance Contract: [a] Present value of future payments for benefits and related settlement and maintenance costs, determined using revised assumptions based on actual and anticipated experience. [b] the present value of future gross premiums, determined using revised assumptions based on actual and anticipated experience. {US-FAS60-35} |
|
Benefit Reserve
- Death Benefit
- Surrender Benefit
- Endowments
Premium is recognized as a revenue when due from policyholders.
Calculations of GAAP Benefit Reserve:
- – PVFB(0) = Present Value of Future Benefit at issue using lock-in assumptions plus PAD (e.g. mortality, lapse, discount rate)
- – PVGP(0) = Present Value of Gross Premium at issue using lock-in assumptions
- – Benefit K Factor: K = PVFB(0) / PVGP(0)
- – Reserve (t) = PVFB(t) – K * PVGP (t)
Maintenance Expense Reserve
- – PVFE(0) = Present Value of Future Maintenance Expense at issue using lock-in assumptions
- – PVGP(0) = Present Value of Gross Premium at issue using lock-in assumptions
- – Expense K Factor: K = PVFE(0) / PVFP(0)
- – Reserve (t) = PV Expense(t) – K * PVGP(t)
Deferred Profit Liability (DPL)
- DPL is established for limited-pay products.
- It ensures a profit emergence in a constant relationship to the amount of insurance in force (instead of fluctuating with premium payment).
Deferrable Acquisition Cost
Definition
- Primarily related to the acquisition or renewal of insurance contracts.
- Costs that are allowed for capitalization or deferral.
Example of DAC
- Commission rate, medical Examination fee, underwriting cost.
Example of non-DAC
- Executive salaries, legal and accounting fees.
Function
- Ensure the expenses match the revenue.
- Income statement and balance sheet better reflect company performances.
DAC on Internal replacement – SOP 05-1？
True-Up Process
-
- To check if the amounts capitalized in the DAC are either equal or significantly close to the deferrable costs actually incurred.
- True-up are timely processes to standardize and adjust the differences, in order to avoid under- or over-capitalization.
Recoverability Test
Purpose
-
- To determine the ability for the business to repay DAC.
- OR: Test if acquisition cost can be deferrable from economic perspective, Test if PV(GP) > PV (DAC) + PV (Benefits) + PV (Expenses).
Methodology
-
- Performed once on policies issued during the year under GAAP assumptions.
- Passed if PV (Gross Premium) >= PV (Benefit Premium) + PV (DAC Premium).
- Failing recoverability test means DAC is not recoverable from future earnings.
Loss Recognition Test
Purpose
-
- Prospective recoverability testing on an entire block of in-force business (Performed on the whole portfolio?).
Methodology
-
- Passed if Net Liability Position (VB-DAC) meets minimum liability requirement (PV Future Benefit – PV Gross Premium).
Recoverability Test & Loss Recognition Test
- To ensure PV of deferrable expenses does not exceed PV of future profits.
- Recoverability Test is done at the initial sale/pricing of product.
- Loss Recognition Test is done throughout the life of the policy whenever a loss is probable and can be reasonably estimated.
- Order of adjustment if failed:
- Remove Provision for Adverse Deviation (PAD).
- If still failed, decrease DAC.
- If still failed, set up Premium Deficiency Reserve.
GAAP Profit Characteristics
GAAP Profit is proportional to profit carrier when experience follows GAAP assumption.
- For FAS 60, GAAP Profit is proportional to gross premium income.
- For FAS 97 LP, GAAP Profit is proportional to sum assured.
IFRS V.S. GAAP
- Generally more focused on objectives and principles and less reliant on detailed rules and interpretations than US GAAP
- Greater use of fair value as a measurement basis