ASU 2022-05: Transition Relief for Sold Contracts

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2022-05 to provide targeted relief for insurance companies. This update amends the transition rules for a major accounting standard, ASU 2018-12, also known as Long-Duration Targeted Improvements (LDTI). The purpose of ASU 2022-05 is to ease the implementation burden for insurance contracts sold before a company adopted the new LDTI guidance, addressing costly challenges from the original transition requirements.

Scope and Applicability of the Update

The guidance within ASU 2022-05 is narrow, applying only to insurance entities under the LDTI standard. Its provisions are for long-duration insurance contracts, such as life insurance or annuities, that an insurer derecognized prior to its LDTI adoption date. Derecognition occurs through events like a sale of a block of business or a reinsurance transaction that transfers the risks and rewards of the contracts to another party.

A condition for applying the relief is that the insurance entity must not have any significant continuing involvement with the derecognized contracts. Examples of such involvement could include retaining significant influence over the contracts or having other arrangements that allow for significant participation in their results.

The Original Transition Challenge Under LDTI

The original LDTI standard, ASU 2018-12, mandated a retrospective application upon adoption. This meant insurance companies were required to restate their financial results for prior periods as if the new accounting rules had been in place. This process involves recalculating liabilities for future policy benefits using updated assumptions and discount rates, a significant undertaking for active contracts.

This retrospective requirement created a substantial burden for contracts that had already been sold. To restate past financial statements, a company would need detailed historical data and models for contracts it no longer owned or managed. Insurers often no longer possessed this information, making the recalculation difficult, and stakeholders argued the high costs outweighed any informational benefit to investors.

The Accounting Relief Provided by ASU 2022-05

In response to these challenges, ASU 2022-05 provides an optional accounting policy election. This allows an insurance entity to choose not to apply the LDTI transition guidance to qualifying contracts that were derecognized before the LDTI effective date. This is a choice that companies can make on a transaction-by-transaction basis for each sale or disposal.

By making this election, an insurer is permitted to exclude the sold contracts from its LDTI transition calculations. The direct accounting consequence is that there would be no adjustment to the opening balance of retained earnings related to these derecognized contracts when the company adopts LDTI. This avoids the need to track down historical data for contracts the company no longer holds, saving time and expense.

This relief is targeted only at contracts where the selling entity has truly transferred control and economic interest. As noted in ASC 944, this means the sold business has no effect on the insurer’s future cash flows.

Disclosure Requirements and Effective Date

Entities that choose to use the accounting policy election must provide specific disclosures in their financial statements. The company is required to disclose the nature of the accounting change and the reason for making it. This includes providing a qualitative description of each sale or disposal transaction to which the election was applied.

The effective dates for ASU 2022-05 are aligned with the adoption dates for the LDTI standard. For public companies that are SEC filers, excluding smaller reporting companies, the guidance is effective for fiscal years beginning after December 15, 2022. For all other entities, the rules become effective for fiscal years beginning after December 15, 2024. Early adoption is permitted.