U.S. GAAP - Chapter 9 - ANNUITIES IN PAYMENT STATUS

Background

Annuity in pay status come from many sources
- SPIA
- settlement options embedded in life/DA contracts
- structured settlement
- fund state lottery prizes
- others
if payment of benefits contingent on continued survival of annuitant(s) - F97 limited pay contracts
if investment contract (no significant life-cont payments), s/b accounted using methodologies consistent w/ those used for similar products offered by other fin services institutions

Contract Classification

Annuity w/ no mort or morb risk - investment contracts
Life w/ certain - ins contract unless
- prob life portion every being paid is remort
- PV life portion is insignificant
Option to annuitize on a DA not a mort risk, a pricing risk
- once exercises, a mort risk, but accounted for as a separate policy
rule of thumb - life contingent payments > 5-10% of PV of all payments -> not nominal mort risk
- a matter of judgement

Investment Contracts

F97 - little guidance
- amt rec'd as payments NOT reported as revenue, but liab and accounted for in manner consistent w/ acctg for int bearing or other fin instruments
F91 - some insight via loans
- loan orig fees, purch prem, discounts recognized as an adjustment to yield
- generally by interest method based on contractual terms of loan
Constant Yield Method (aka Prospective Deposit Method)
- project anticipated cash flows - best estimate assumptions w/o PADs
- solve for int rate where PV flows = net proceeds @ issue
- PV CF @ solved for rate on valn date is GAAP reserve
- net proceeds - consideration rec'd less comm or acq costs
- GAAP liab can be split into asset piece and liab piece for B/S presentation
  - calc PV maint exp (maint Vx) adn PO benefit payments (benefit Vx) only
    - where i is rate that gives PV @ issue = Prem Paid
  - DAC balance = benefit reserve + maint reserve - net GAAP reserve
- Prems booked as deposits (consistent w/ other fin institutions)
- PO benefits not ded to income, merely return of deposit
- Appropriate I/S presentation
  - + Inv Income
  - - Maint Exp
  - - Req'd/Credited Int
  - - Incr Maint Exp Reserve
  - + Increase in DAC
  - = Pre-tax GAAP profit
- if actual main expense = expected, profit emerges as inv income earned on assets supporting net reserve @ BOP - req'd int of benefit and maint exp reserves + change in DAC
- if benefit paid and maint exp emerge as expected, profits emerge as difference between inv income earned and req'd int on net GAAP reserve
- appears that loss recognition is N/A to inv contracts
- AICPA Practice Bulletin 8 - write off DAC, if determined that not recoverable from future profits (written down to recoverable level)
- realized g/l not an issue since not being amortized over EGP
- Also no shadow DAC
- assumptions not locked-in

Limited-Pay Contracts

once determined that enough mortality risk exists, contract s/b accounted for as F97 limited-pay contract
premiums as revenue
liab for policy benefits same basis as for other long dur contracts
amt of gross prem in excess of net premium s/b deferred and recognized over period that services are provided
- initial prem is revenue
- acq expenses capitalized adn amortized over prem period (instantaneous in most cases)
- benefit and maint exp reserves established using assumptoins reflecting co's expectations, incl PADs
- any excess of gross prem over acq exp and initial benefit reserve and initial maint reserve is capitalized as a deferred profit liab (DPL)
- DPL amortized in proportion to expected annuity payments to be made
since essentially treated as F60, assumptions locked at issue
critical assumptions - mortality and inv earnings assumptions
ok to grade inv earnings rate down over time as a PAD
to include PAD in mortality, decrease (not increase) future mortality (usually projecting mortality improvement)
loss recognition: PV pre-tax GAAP profits using pre-tax inv earnings rate
- if < 0, liab s/b increased by amt of deficiency
- DPL set to zero
- benefit adn maint reserves recalced using best-estimate assumptions

Conversion of Policy-Year Factors To Calendar-Year Factors

reserve factors on dates other than policy-year ends typically done through interpolation
alt: exact calc of PV of projected payments made on each valn date
if benefit payments not uniform, exact calc s/b made

Copyright © 2004 Steve Welander.
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