Under LDTI, DAC amortization will no longer obscure the relationship between direct and ceded accounting. It is now possible to align ceded accounting with direct, without any noise from DAC amortization. With poor alignment, distortions within the results reported to management and financial statement users will be different, sometimes greater than before. Whether the goal is to improve reporting or to avoid making it worse, a fresh look can help.
Most of the approaches that have been used to account for UL reinsurance can still be used. One exception is the implicit approach where, in lieu of explicit accounting for reinsurance, the gross profits used to amortize DAC were adjusted to be net of reinsurance. With the elimination of gross profits as an amortization base, this approach no longer has meaning.
For surviving approaches, it is now easier to evaluate their effectiveness in presenting the economic protection provided by reinsurance.
In this article, I begin an evaluation by examining the fundamentals of accounting for the insurance element of universal life. After that, I consider the economic protection provided by reinsurance and look for an ideal—a way to effectively account for that protection.
In a second article to be published later this year, I’ll evaluate several reinsurance approaches in terms of noise from missing the ideal, then end with some thoughts on what might be done to eliminate noise.
The focus of both articles is on the insurance element. Accounting for the deposit element, embedded derivatives, and market risk benefits is beyond the scope of these articles. Also outside of scope is the requirement, in Accounting Standards Codification (ASC) Topic 326, to recognize a current estimate of credit losses from the failure of a reinsurer to reimburse reinsured benefits.
Author(s): Steve Malerich
Publication Date: Sept 2022
Publication Site: Financial Reporting newsletter, SOA