What Are the New GAAP LDTI Requirements?

The Financial Accounting Standards Board (FASB) has introduced a significant update to U.S. Generally Accepted Accounting Principles (GAAP) for insurance entities. This update, known as Long-Duration Targeted Improvements (LDTI), alters the accounting for long-duration insurance contracts such as life insurance, annuities, and long-term disability. The primary purpose of these changes is to modernize accounting standards to deliver more transparent and useful financial information to investors and other stakeholders. Formally titled Accounting Standards Update (ASU) 2018-12, the new standard aims to provide better insight into the amount, timing, and uncertainty of cash flows associated with these contracts, addressing previous models that were often criticized for using outdated assumptions.

Core Principles of the LDTI Standard

The scope of LDTI is comprehensive, affecting all insurance companies that issue long-duration contracts and report under U.S. GAAP. The standard was developed to create a more uniform and comparable reporting framework across the insurance industry. By mandating more frequent updates to assumptions and simplifying complex calculations, the FASB aims to give stakeholders a more realistic view of an insurer’s financial health and risk exposure.

A key principle is the move away from static, locked-in assumptions that were established when a contract was first written. The previous guidance allowed insurers to use these original assumptions for decades, unless a significant loss event occurred. The new standard requires a more dynamic approach, ensuring that the values reported on the balance sheet reflect current and expected future conditions, resulting in a more accurate measure of an insurer’s obligations.

Key Changes to Measurement and Recognition

Liability for Future Policy Benefits

A fundamental change introduced by LDTI is the method for calculating the liability for future policy benefits, which represents an insurer’s obligation to its policyholders. The previous accounting model relied on assumptions set at the inception of the contract, which remained “locked-in.” The new standard requires insurers to review and update their cash flow assumptions, such as mortality, morbidity, and policyholder behavior, at least annually. This ensures the liability on the balance sheet reflects more current information.

The discount rate used to calculate the present value of these future benefits has also been revised. Insurers must now use a discount rate based on an upper-medium grade (low-credit-risk) fixed-income instrument yield, which must be updated at each reporting date. The impact of changes in future cash flow assumptions is recorded in the income statement, while the effect of discount rate changes is recognized in other comprehensive income. This separation provides users with clear visibility into the drivers of liability changes.

This updated measurement approach eliminates the previous requirement for premium deficiency testing, as the new model’s annual review of assumptions inherently incorporates loss recognition. The unit of account has also been refined; contracts issued in different years can no longer be grouped together, which simplifies the aggregation process.

Deferred Acquisition Costs (DAC)

LDTI simplifies the accounting for deferred acquisition costs (DAC), which are the incremental costs directly related to acquiring new insurance contracts. Previously, the methods for amortizing these costs were complex and varied by product, often linked to estimated gross profits or premiums, creating inconsistencies across companies.

The new standard mandates a single, simplified approach for all long-duration contracts. DAC must now be amortized on a straight-line basis over the expected term of the associated contracts. This method provides a more predictable and understandable pattern of expense recognition and removes the complexities and volatility associated with the previous profit-linked amortization models.

Furthermore, under the new guidance, interest will no longer be accrued on the unamortized DAC balance. The new standard also eliminates the separate impairment testing for DAC. Instead, the amortization of DAC is now linked to the life of the contract, and any write-offs would occur if the contract is terminated or expires.

Market Risk Benefits (MRBs)

The LDTI standard introduces a new definition and accounting treatment for Market Risk Benefits (MRBs). MRBs are features within a contract that protect the policyholder from capital market risk, such as certain types of guaranteed minimum benefits found in variable annuity products. These features expose the insurer to the risk of investment market fluctuations.

Under the new rules, all MRBs must be measured at fair value. This is a change from the previous guidance, where different types of guarantees were accounted for under various models, leading to inconsistent reporting. The requirement to use fair value provides a more current and market-consistent measure of the liability associated with these benefits.

The change in the fair value of MRBs is now required to be recognized in net income each reporting period. This will likely increase the volatility of reported earnings for insurers with significant exposure to these types of product features. By reporting these changes in the income statement, the standard provides a more transparent view of the risks these benefits pose to the insurer’s financial performance.

Enhanced Disclosure Requirements

A major component of the LDTI standard is the expansion of disclosure requirements in the financial statement footnotes. The goal is to provide users with greater transparency into the key judgments and estimates that drive an insurer’s financial results. These new disclosures are designed to complement the changes in measurement by explaining the reasoning behind the numbers.

Insurers are now required to provide detailed disaggregated roll-forwards for several key balances. This includes tabular reconciliations from the opening to the closing balance for the liability for future policy benefits, deferred acquisition costs (DAC), and market risk benefits. These roll-forwards must detail the impact of various activities during the period, such as new business, benefit payments, and assumption updates.

The standard also mandates new qualitative and quantitative disclosures about the significant inputs, judgments, and assumptions used in measurement. For example, an insurer must disclose the discount rates and mortality assumptions used to calculate its liabilities. This information must be disaggregated by contract type, allowing analysts and investors to better understand the risk profile of different business segments.

Adoption and Transition Methods

The effective date for public companies that are SEC filers was for fiscal years beginning after December 15, 2022, while all other entities have until fiscal years beginning after December 15, 2024. The standard provides two primary approaches for adoption, depending on the specific financial statement item, to ensure consistent application.

For the liability for future policy benefits and deferred acquisition costs, companies must use a modified retrospective approach. This means they apply the new accounting rules to the opening balance sheet of the earliest period presented in their financial statements. This avoids a full restatement of all prior periods but still provides a consistent basis for comparison from the transition date forward.

In contrast, the transition for market risk benefits (MRBs) requires a full retrospective approach. Companies must apply the new fair value measurement as if the standard had always been in effect for these specific contract features. The FASB did provide some practical relief, allowing an election to exclude contracts that were sold or derecognized before the LDTI effective date, provided the insurer has no significant continuing involvement. Preparing for adoption is a significant undertaking, involving updates to actuarial models, accounting systems, and internal controls.