There is a new accounting standard that insurance companies will be required to incorporate into their accounting and cash f low models starting in 20201, and it represents a fundamental shift in how insurers recognize credit losses for financial instruments in their reported earnings.

The Financial Accounting Standards Board (FASB) issued Accounting Standard Update 2016-13, Financial Instruments – Credit Losses on June 16, 2016. The new standard introduces the current expected credit-loss methodology (CECL) for estimating allowances for credit losses, which represents a significant change from existing U.S. Generally Accepted Accounting Principles (U.S. GAAP) guidance that currently requires an incurred-loss methodology for recognizing credit losses. The standard takes effect for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. All other organizations will have an additional year for implementation.

FASB’s motivating factor for making the change was a concern expressed by financial institutions and users of financial statements that current U.S. GAAP restricts the ability to record credit losses that are expected but do not meet the “probable” threshold. FASB concluded that the existing approach for determining the impairment of financial assets delayed the recognition of credit losses on loans, thus resulting in loan loss allowances that were “too little, too late.”

CECL requires organizations to incorporate forward-looking information into their financial statements and to estimate credit losses over the life of a financial asset not subject to fair-value accounting. The new measurement approach applies to f inancial assets measured at amortized cost, including loans, held-to-maturity debt securities, net investment in leases, and reinsurance and trade receivables, as well as certain off-balance-sheet credit exposures, such as loan commitments.

CECL introduces into reported earnings subjective forecasts of possible future events that have not yet occurred, and may not occur, resulting in increased volatility of regulatory capital and comparability issues between entities relating to core operating income items. Companies will have to change the way they approach setting allowances for credit losses and move away from a backward-looking to a forward- looking approach; therefore, it will be imperative for companies to retool their systems and controls and make significant changes to their loss-forecasting infrastructure.

There are many things property/casualty insurance companies need to be aware of in relation to the new CECL standard. This paper attempts to describe how FASB arrived at its decision to introduce an expected credit-loss concept and explain how that applies to mutual insurance companies. In doing so, the paper starts off by explaining how the financial crisis spurred FASB, together with the International Accounting Standards Board (IASB) to come up with a new converged credit-loss impairment standard. The paper then goes on to unravel many of the problems that came up during the joint convergence project that ultimately resulted in FASB going in a different direction and producing a new standard that presents many issues for property/casualty insurance companies.

Resource Details

Publish Date

April 18, 2019

Topics

  • Financial & Accounting Issues