FAS 60: Accounting and Reporting by Insurance Enterprises

In the United States, insurers must navigate two distinct sets of rules: U.S. Generally Accepted Accounting Principles (GAAP) for public financial statements and Statutory Accounting Principles (SAP) for regulatory filings focused on solvency. Historically, the primary source of GAAP guidance was the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 60, or FAS 60.

Over time, these foundational principles were integrated into the FASB’s Accounting Standards Codification (ASC), and the guidance is now found primarily within ASC 944. These standards have undergone a significant change with the full implementation of Accounting Standards Update (ASU) 2018-12, which fundamentally altered the reporting for long-duration contracts.

Scope and Applicability of Insurance Accounting

The rules within ASC 944 apply broadly to insurance enterprises, but the specific accounting treatment hinges on a classification of the contracts they issue. The standard divides insurance contracts into two primary categories: short-duration contracts and long-duration contracts. This determination dictates the entire accounting path that follows.

Short-duration contracts are characterized by a protection period that is fixed and relatively brief. Common examples of short-duration contracts include property insurance, such as homeowners and auto policies, liability insurance, and most forms of health insurance. The policy is typically in effect for a year or less, and the insurer has the ability to decline renewal or change the terms at the end of the contract period.

In contrast, long-duration contracts provide coverage over an extended period and are typically noncancelable by the insurer. These contracts often involve not only insurance protection but also an investment or savings component. Examples include traditional whole life insurance, endowment policies, and various types of annuity contracts. The accounting for these agreements must consider long-term assumptions about factors like mortality, investment returns, and policyholder behavior, making their financial reporting distinct.

Accounting Treatment for Short-Duration Contracts

For short-duration contracts, premium revenue is recognized on a pro-rata basis over the term of the contract rather than all at once. For a one-year auto insurance policy, the insurer would earn one-twelfth of the total premium as revenue each month, reflecting that it is providing one month of coverage.

Insurers must create a liability on their balance sheet for the estimated costs of claims that have been reported by policyholders but have not yet been paid. This liability must also include an estimate for claims that have been incurred but not yet reported (IBNR). Estimating IBNR requires significant judgment and statistical analysis based on historical loss data.

Costs directly related to the successful acquisition of new or renewal policies, such as sales commissions and underwriting expenses, are known as deferred acquisition costs (DAC). These costs are capitalized as an asset on the balance sheet and are then amortized to expense over the life of the related policies in proportion to the premium revenue recognized.

Accounting Treatment for Long-Duration Contracts

The accounting for long-duration contracts has been substantially revised by recent accounting updates. For traditional long-duration products like whole life insurance, premiums are recognized as revenue when they become due from the policyholders.

Insurers must establish a liability that represents the present value of estimated future benefits to be paid out, less the present value of any estimated future net premiums they expect to collect. Previously, the actuarial assumptions used to calculate this liability—such as mortality, morbidity, and interest rates—were locked in when a policy was issued.

Under the new standard, these assumptions must be reviewed, and updated if necessary, at least annually. This change means the liability on the balance sheet is more current and reflects the latest estimates of future cash flows. The discount rate used is now a market-observable rate, making it more standardized.

Similar to short-duration contracts, the direct costs of acquiring long-duration policies are capitalized as an asset. However, these acquisition costs are now amortized into expense on a simplified basis over the expected life of the contracts, which may be longer than just the premium-paying period.

Reinsurance and Premium Deficiency

Insurers often manage their risk by transferring a portion of it to another insurance company, a practice known as reinsurance. When an insurer (the ceding company) obtains reinsurance, it does not remove its direct liability to the policyholder from its books. The ceding company remains the primary obligor and records a reinsurance asset, often called a “reinsurance recoverable,” which represents the amount it expects to be reimbursed by the reinsurer for paid claims. The cost of purchasing the reinsurance coverage is amortized over the contract period.

A premium deficiency occurs if an insurer determines that the expected future claims and related expenses for a block of business will exceed its related liabilities and unearned premiums. This situation means the insurer anticipates losing money on that group of policies. When a premium deficiency is identified, U.S. GAAP requires immediate recognition of the loss.

For long-duration contracts, the requirement to annually update liability assumptions serves as a continuous check for such deficiencies. If a deficiency exists, the first step is to accelerate the amortization of any related deferred acquisition costs, charging them to expense immediately. If writing off the entire DAC asset is not sufficient to cover the total expected loss, the company must then accrue an additional liability for the remaining amount of the deficiency.