Loss Disclosures for Short-Duration Insurance Contracts (GAAP Filers)

In 2008, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board embarked on a joint project to explore the creation of a comprehensive accounting standard for insurance contracts. In 2014, the FASB abandoned the joint project in favor of making targeted improvements to generally accepted accounting principles (GAAP), which was divided into two projects, as follows.

• Short-duration: enhancing disclosures (ASU 2015–09)
• Long-duration: improvements to recognition, measurement, presentation, and disclosure (project in process)

Long-duration contracts include contracts, such as whole life, guaranteed renewable term life, endowment, annuity, and title insurance contracts, that are expected to remain in force for an extended period. All other insurance contracts are considered short-duration contracts and include most property and liability insurance contracts, such as those typically written by captive insurance companies (e.g., workers compensation, commercial general liability, commercial auto, and professional liability insurance).

In May 2015, the FASB issued Accounting Standards Update (ASU) 2015–09, which will be effective December 31, 2017, for nonpublic, calendar year-end filers (e.g., many captives). (It was effective for public companies on December 31, 2016.) This ASU requires additional disclosures for the purpose of providing better insight into an insurer's initial claim estimates and subsequent adjustments and to help financial statements users understand the frequency, severity, and timing of future cash flows related to the estimated claim costs (i.e., "loss disclosures").

In summary, the new disclosures include the following.

• Incurred losses and allocated loss adjustment expenses (ALAE) development triangles [Note: incurred losses are synonymous with ultimate losses, which are the sum of inception-to-date (ITD) paid losses and ALAE, case reserves, and incurred but not reported (IBNR) reserves.]
  • Disaggregated by category
  • Net of reinsurance
  • Undiscounted
  • By accident year (AY), not required to exceed 10 years
  • Exclude unallocated loss adjustment expenses (ULAE)
• Paid losses and ALAE development triangles
  • Disaggregated by category
  • Net of reinsurance
  • By AY, not required to exceed 10 years
  • Exclude ULAE
• Average annual percentage payout of incurred claims
  • By category, net of reinsurance
  • For the same number of years as the triangles
• IBNR, net, by AY, by category as of the reporting date
  • Net cumulative claim counts by AY, by category as of the reporting date
• Reconciliation of the total claims liability (unpaid losses and ALAE) to the incurred and paid claims development tables for the current reporting date presented in the financial statements showing the following.
  • Net unpaid losses and ALAE by each disaggregated category
  • Reinsurance recoverables by each disaggregated category
  • Net and ceded unpaid losses and ALAE for insignificant categories (aggregated)
  • ULAE

For insurers discounting all or a portion of the claims liability, the following additional disclosures are required by category.

• Amount of discount recorded to the claims liability for each balance sheet period presented
• Change in discounting for each income statement period presented
• Identification of the income statement line item(s) in which the change in discounting is recorded
• Range of interest rates used to discount the claims liability

Details Behind the New Disclosures

Claims Development Tables

Number of Years

In the year of implementation, the claims development tables (triangles) need not exceed 5 years if it is impractical to gather the historical information required for the disclosure beyond 5 years. For each subsequent year, the number of years disclosed will increase until the maximum requirement to present 10 years of historical information is reached.

For short-tail coverages, where claims are closed quickly, an insurer may elect to present data for fewer than 10 years. On the other hand, for long-tail coverages, where the claim settlement period exceeds 10 years, the insurer may elect to disclose additional years.

Accident Year

The claims development tables are required to be disaggregated by AY, which is defined as "the year in which a covered event (as defined by the terms of the contract) occurs."¹ For calendar year-end filers, this includes claims with dates of loss during that respective calendar year for occurrence policies and claims reported during that calendar year for claims-made policies. Insurers that only capture data by underwriting year or policy year (i.e., accumulating loss history according to when the policy was written rather than when the loss event occurs) will need to convert that data to AY.

Data—Actuarial Analysis

The majority of the data required to build the loss development tables will be derived from the actuarial analysis, which may not agree exactly to the liability recorded. Insurers will need to identify ways to resolve such differences.

Level of Disaggregation (Category)

The data included in the tables needs to be aggregated or disaggregated to provide useful information regarding claims frequency (i.e., the number of claims) and severity (amounts). The guidance does not prescribe the level of disaggregation but suggests insurers consider the following when making that determination.

• Information routinely reviewed by the chief operating decision maker to assess financial performance
• Information provided outside of the financial statements including, but not limited to, earnings releases and statutory filings to aid financial statement users in evaluating financial performance

The insurer may also consider the level of disaggregation used by the actuary in estimating claims liabilities. Examples of suitable categories include the following.

• Type of coverage (e.g., auto liability or homeowners)
• Geography (e.g., country or region)
• Market or type of customer (e.g., personal, commercial, or specialty lines of business)
• Claim duration (e.g., short-tail or long-tail)

An insurer may use multiple categories to disaggregate its insurance liabilities. For example, an insurer writing workers compensation (WC) and general liability (GL) insurance in Vermont (VT) and California (CA) may decide to present four categories, WC-VT, WC-CA, GL-VT, and GL-CA, if this is how management reviews and makes decisions based on that level of information.

Insignificant Categories

The guidance does not require loss development tables for insignificant categories, which can be aggregated into one category and included in the reconciliation disclosure only.

Merger/Acquisition/Loss Portfolio Transfer

The standard does not provide specific guidance for mergers, acquisitions, or loss portfolio transfers, except that when such situations occur, they should be communicated in a manner that allows users to understand the amount, timing, and uncertainty of cash flows² arising from its contracts in light of relevant circumstances.

An insurer could use several approaches to incorporate such information in the disclosures.

In the case of a business combination, an insurer could use the prospective approach and include the newly acquired business in the year it was purchased and highlight that fact in the narrative or include a separate column prior to the year of acquisition. The insurer could use the retrospective approach and restate the claims development tables to reflect the data as though the insurer and acquired business had always been together. An insurer may also consider including the acquired business as a separate category.

In a disposal scenario, an insurer could remove all claims information related to the disposed business from all accident years disclosed or from the AY in which the business was disposed to preserve the historical development of claims.

Staff of the Securities and Exchange Commission (SEC) indicated the retrospective approach would best achieve the intention of ASU 2015–09. For an acquired business, they believe that a prospective presentation that illustrates the year of acquisition as the accident year for all liabilities acquired in the acquisition would not be consistent with the ASU's definition of accident year. They also specified that the prospective approach where the incurred and paid accident year claim information of the acquiree is presented separately from the acquirer as of the acquisition date and in subsequent periods could be appropriate. For a disposed business, they noted that a prospective presentation that continues to present the historical claim information relating to the disposed business in the same table as the existing business would not be consistent with the ASU's requirement to present claims development data for the liability at the balance sheet date.²

Changing Your Disaggregation in the Future

Although disclosures are not presented at this level, maintaining granular level data may be helpful in the event management modifies the categories used in the future as this may lead to a revision in the triangles.

Other Disclosures

Claims Count

Claims frequency may be tracked and analyzed in various ways, such as claim events or individual claimants. Some types of coverage, such as excess of loss insurance, could result in no liability to the insurer. However, the insurer generally has records of the claims that have not yet reached the attachment point but may in the future. As such, insurers must disclose the methodology used to track claims frequency, as insurers use different definitions of claims count.

Claims count may be omitted if it is impractical to obtain such information (e.g., residual market business or reinsurance assumed contracts). In such instances, the insurer should disclose the reasons why obtaining the information is impractical.

Change in Mix of Business, Policy or Reinsurance Terms, or Others

As time passes, the average cost per claim could be impacted by changes in the mix of business, policy or reinsurance terms, or other reasons. For example, participation in a quota share agreement may shift from 30 percent to 50 percent. Since the claims development triangles are presented net of reinsurance, it may be useful to the financial statement users to include a description of such changes.

Historical Average Annual Percentage Claims Payout

To help users of the financial statements to understand the potential timing of future loss payments, the ASU requires insurers to disclose the average annual percentage payout of incurred claims (net of reinsurance, by category) for each year presented in the claims development tables. The guidance includes an example that uses an all-year average percent payout calculated for each AY. Other methods may be appropriate. The insurer is allowed to provide additional disclosures to explain large variations, which may be particularly useful in the case of large catastrophic events or other changes that make the historical payout percentage misleading or confusing for evaluating the potential timing of future loss payments.

Changes in Methods and Assumptions

GAAP has historically required insurers to disclose the reasons for changes in significant accounting estimates (i.e., favorable or unfavorable reserve development on prior year estimates) and the effects reflected in current year earnings. The new guidance requires insurers to also disclose methodologies used to calculate management's best estimate. It also requires the reasons for and effects of significant changes in methodologies and assumptions used in calculating the liability. Examples of when disclosure is required include when the actuarial analysis utilizes a new method or weighting of a particular method and it significantly changes management's best estimate.

Another would be if an actuary were to begin using company-specific historical loss data rather than industry data used in previous actuarial analyses and this change resulted in a significant impact to the claims liability.

Health Insurance—Considerations

Health insurance claims are defined as "claims related to the cost of medical treatments (other than claims related to liability insurance that covers claims against the insured for injury of or by others, such as, but not limited to, workers' compensation, disability, and general liability insurance)." With the exception of the average annual percentage payout of incurred claims, all other disclosures are applicable to health insurance entities. Since health insurance is short-tail, the claims development tables will likely be sparse. Additionally, health insurance entities are required to disaggregate health insurance claims in the loss rollforward.

Location of Disclosures

The FASB decided to require insurance companies to present the incurred and paid claims development information for years prior to the current reporting period and the average annual percentage payout disclosures as required supplementary information (RSI). This decision was in response to concerns regarding potential auditor independence issues if the historical development information were to be included within the financial statements, and therefore, requiring the auditor to be independent for each of the years presented. RSI is not subject to audit but is subject to certain limited procedures by the auditor. RSI can be included as a supplementary schedule apart from the financial statement notes or in financial statement notes but with a clear distinction made between supplementary information and other information that is disclosed. All other disclosures are required to be included in the notes and audited.

1. Insurance Entities Expert Panel, American Institute of Certified Public Accountants, Inc., New York, NY, 2016, AICPA.org
2. Ibid.