Audit and Accounting Guide: Life and Health Insurance Entities 2018

By AICPA

This book helps simplify the complexities of insurance entity regulatory compliance. Whether performing audit engagements or management at an insurance entity, the 2018 edition of this guide is a must-have resource to keep abreast of recent regulatory changes related to the life and health insurance industry, its products and regulatory issues, and the related transaction cycles that an insurance entity is involved with.

New to the 2018 edition: This edition covers recent regulatory updates related to the Affordable Care Act and provides guidance for new standards that impact life and health insurance, including revenue recognition, financial instruments, leases, and more.

• Language: English
• Publisher: Wiley
• Release date: Oct 26, 2018
• ISBN: 9781945498510

Book preview

Preface

PREPARED BY THE INSURANCE COMPANIES COMMITTEE AND THE LIFE INSURANCE AUDIT GUIDE TASK FORCE

(Updated as of August 1, 2018)

About AICPA Audit and Accounting Guides

This AICPA Audit and Accounting Guide was developed by the former Insurance Companies Committee and the Life Insurance Audit Guide Task Force to assist practitioners in performing and reporting on their audit engagements, and to assist management in the preparation of their financial statements in conformity with U.S. generally accepted accounting principles (GAAP) and statutory accounting practices.

An AICPA Guide containing auditing guidance related to generally accepted auditing standards (GAAS) is recognized as an interpretive publication as defined in AU-C section 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards.1 Interpretive publications are recommendations on the application of GAAS in specific circumstances, including engagements for entities in specialized industries.

An interpretive publication is issued under the authority of the AICPA Auditing Standards Board (ASB) after all ASB members have been provided an opportunity to consider and comment on whether the proposed interpretive publication is consistent with GAAS. The members of the ASB have found the auditing guidance in this guide to be consistent with existing GAAS.

Although interpretive publications are not auditing standards, AU-C section 200 requires the auditor to consider applicable interpretive publications in planning and performing the audit because interpretive publications are relevant to the proper application of GAAS in specific circumstances. If the auditor does not apply the auditing guidance in an applicable interpretive publication, the auditor should document how the requirements of GAAS were complied with in the circumstances addressed by such auditing guidance.

The ASB is the designated senior committee of the AICPA authorized to speak for the AICPA on all matters related to auditing. Conforming changes made to the auditing guidance contained in this guide are approved by the ASB Chair (or his or her designee) and the Director of the AICPA Audit and Attest Standards Staff. Updates made to the auditing guidance in this guide exceeding that of conforming changes are issued after all ASB members have been provided an opportunity to consider and comment on whether the guide is consistent with the Statements on Auditing Standards (SASs).

Any auditing guidance in a guide appendix or exhibit (whether a chapter or back matter appendix or exhibit), though not authoritative, is considered an other auditing publication. In applying such guidance, the auditor should, exercising professional judgment, assess the relevance and appropriateness of such guidance to the circumstances of the audit. Although the auditor determines the relevance of other auditing guidance, auditing guidance in a guide appendix or exhibit has been reviewed by the AICPA Audit and Attest Standards staff and the auditor may presume that it is appropriate.

The Financial Reporting Executive Committee (FinREC) is the designated senior committee of the AICPA authorized to speak for the AICPA in the areas of financial accounting and reporting. Conforming changes made to the financial accounting and reporting guidance contained in this guide are approved by the FinREC Chair (or his or her designee). Updates made to the financial accounting and reporting guidance in this guide exceeding that of conforming changes are approved by the affirmative vote of at least two-thirds of the members of FinREC.

This guide does the following:

•

Identifies certain requirements set forth in the Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC).

•

Describes FinREC’s understanding of prevalent or sole industry practice concerning certain issues. In addition, this guide may indicate that FinREC expresses a preference for the prevalent or sole industry practice, or it may indicate that FinREC expresses a preference for another practice that is not the prevalent or sole industry practice; alternatively, FinREC may express no view on the matter.

•

Identifies certain other, but not necessarily all, industry practices concerning certain accounting issues without expressing FinREC’s views on them.

•

Provides guidance that has been supported by FinREC on the accounting, reporting, or disclosure treatment of transactions or events that are not set forth in FASB ASC.

Accounting guidance for nongovernmental entities included in an AICPA Guide is a source of nonauthoritative accounting guidance. As discussed later in this preface, FASB ASC is the authoritative source of U.S. GAAP accounting and reporting standards for nongovernmental entities, in addition to guidance issued by the Securities and Exchange Commission (SEC).

Statutory Accounting Principles applicable to U.S. insurance entities are codified in the National Association of Insurance Commissioners’s (NAIC) Accounting Practices and Procedures Manual (manual). The manual is subject to an ongoing maintenance process. All states have adopted the manual as the primary basis of prescribed SAP in those states. If, however, the requirements of state laws, regulations, and administrative rules differ from the guidance provided in the manual or subsequent revisions, those state laws, regulations, and administrative rules will take precedence.

AICPA Guides may include certain content presented as Supplement, Appendix, or Exhibit. A supplement is a reproduction, in whole or in part, of authoritative guidance originally issued by a standard setting body (including regulatory bodies) and applicable to entities or engagements within the purview of that standard setter, independent of the authoritative status of the applicable AICPA Guide. Both appendixes and exhibits are included for informational purposes and have no authoritative status.

Purpose and Applicability

This guide is intended to apply to all life and health insurance entities including stock, mutual, fraternal, and assessment entities. This guide is intended to be applied to all life and health entities that can issue life or accident and health insurance. This guide does not apply to governmental entities or to managed health care organizations.

Recognition

2018 Guide Edition

AICPA Senior Committees

Auditing Standards Board

Ilene Kassman, ASB Member

Mike Santay, Chair

Financial Reporting Executive Committee

Michelle Avery, FinREC Member

James Dolinar, Chair

The AICPA gratefully acknowledges the following individuals who reviewed or otherwise contributed to the development of this edition of the guide: Jennifer Austin, Barbara Bartlett, Dianne Batistoni, Dan Buttke, , Zach Gietl, Jason Jacobs, Mark Johnson, Margie Keeley, Eric Kegler, Tom Kivell, Robbie Knight, Joe Lee, Brittanie Lehman, Ben Leiser, Brigitte Lenz, Jeff Maffitt, Matt Martinez, Tricia Matson, Doreen McLaughlin, Phil Pennino, Todd Ross, Andrew Rouse, Jim Richardson, Andrew Setz, Jie Shen, Carrie Small, Margaret Spencer, John Sproull, Anne Stevens and Kyle Stewart.

AICPA Staff

Ahava Goldman

Associate Director

Audit and Attest Standards

Kim Kushmerick

Associate Director

Accounting Standards

Staff Liaison to the AICPA Insurance Expert Panel

Insurance Companies Committee

1998–1999

(members when this edition was completed)

Patrick J. Shouvlin, Chair

James J. Butler

John Greed

David L. Holman

R. Larry Johnson

Patricia L. Kubera

Edward R. Morrissey

Peter W. Presperin

Brian Reilly

Karen O'Connor Rubsam

Robert Solitro

Douglas Stolte

Chris C. Stroup

Richard Warren

Life Insurance Audit Guide Task Force

1998–1999

(members when this edition was completed)

William J. Chrnelich, Chair

Robert J. Giordano

Martha E. Marcon

Thomas G. Schneider

Bennett Troxler

Guidance Considered in This Edition

This edition of the guide has been modified by the AICPA staff to include certain changes necessary due to the issuance of authoritative guidance since the guide was originally issued and other revisions as deemed appropriate. Relevant guidance issued through August 1, 2018, has been considered in the development of this edition of the guide. However, this guide does not include all audit, accounting, reporting, and other requirements applicable to an entity or a particular engagement. This guide is intended to be used in conjunction with all applicable sources of relevant guidance.

Relevant guidance that is issued and effective for entities with fiscal years ending on or before August 1, 2018, is incorporated directly in the text of this guide. Authoritative guidance issued but not yet effective as of August 1, 2018, but becoming effective on or before December 31, 2018, is also presented directly in the text of the guide, but shaded gray and accompanied by a footnote indicating the effective date of the new guidance. The distinct presentation of this content is intended to aid the reader in differentiating content that may not be effective for the reader’s purposes (as part of the guide’s dual guidance treatment of applicable new guidance).

Relevant guidance issued but not yet effective as of the date of the guide and not becoming effective until after December 31, 2018, is referenced in a guidance update box; that is, a box that contains summary information on the guidance issued but not yet effective.

In updating this guide, all guidance issued up to and including the following was considered, but not necessarily incorporated, as determined based on applicability:

•

FASB Accounting Standards Update (ASU) No. 2018-11, Leases (Topic 842) Targeted Improvements

•

SAS No. 133, Auditor Involvement With Exempt Offering Documents (AU-C sec. 945)

•

National Association of Insurance Commissioners Statement of Statutory Accounting Principles No. 107, Accounting for the Risk-Sharing Provisions of the Affordable Care Act

•

PCAOB Staff Guidance Staff Guidance Changes to the Auditor’s Report Effective for Audits of Fiscal Years Ending on or After December 15, 2017 (PCAOB Staff Guidance, sec. 300.04)2

Users of this guide should consider guidance issued subsequent to those items listed previously to determine their effect on entities covered by this guide. In determining the applicability of recently issued guidance, its effective date should also be considered.

The changes made to this edition of the guide are identified in the Schedule of Changes appendix. The changes do not include all those that might be considered necessary if the guide were subjected to a comprehensive review and revision.

PCAOB quoted content is from PCAOB Auditing Standards and PCAOB Staff Audit Practice Alerts, ©2015, Public Company Accounting Oversight Board. All rights reserved. Used by permission.

FASB standards quoted are from the FASB Accounting Standards Codification ©2015, Financial Accounting Foundation. All rights reserved. Used by permission.

FASB ASC Pending Content

Presentation of Pending Content in the FASB ASC

Amendments to FASB ASC (issued in the form of ASUs) are initially incorporated into FASB ASC in pending content boxes below the paragraphs being amended with links to the transition information. The pending content boxes are meant to provide users with information about how the guidance in a paragraph will change as a result of the new guidance.

Pending content applies to different entities at different times due to varying fiscal year-ends, and because certain guidance may be effective on different dates for public and nonpublic entities. As such, FASB maintains amended guidance in pending content boxes within FASB ASC until the roll-off date. Generally, the roll-off date is six months following the latest fiscal year end for which the original guidance being amended could still be applied.

Presentation of FASB ASC Pending Content in AICPA Audit and Accounting Guides

Amended FASB ASC guidance that is included in pending content boxes in FASB ASC on August 1, 2018, is referenced as pending content in this guide. Readers should be aware that pending content referenced in this guide will eventually be subjected to FASB’s roll-off process and no longer be labeled as pending content in FASB ASC (as discussed in the previous paragraph).

Terms Used to Define Professional Requirements in This AICPA Audit and Accounting Guide

Any requirements described in this guide are normally referenced to the applicable standards or regulations from which they are derived. Generally the terms used in this guide describing the professional requirements of the referenced standard setter (for example, the ASB) are the same as those used in the applicable standards or regulations (for example, must or should). However, where the accounting requirements are derived from FASB ASC, this guide uses should, whereas FASB uses shall. In its resource document About the Codification that accompanies FASB ASC, FASB states that it considers the terms should and shall to be comparable terms and to represent the same concept — the requirement to apply a standard.

Readers should refer to the applicable standards and regulations for more information on the requirements imposed by the use of the various terms used to define professional requirements in the context of the standards and regulations in which they appear.

Certain exceptions apply to these general rules, particularly in those circumstances where the guide describes prevailing or preferred industry practices for the application of a standard or regulation. In these circumstances, the applicable senior committee responsible for reviewing the guide’s content believes the guidance contained herein is appropriate for the circumstances.

Applicability of Generally Accepted Auditing Standards and PCAOB Standards

Appendix A, Council Resolution Designating Bodies to Promulgate Technical Standards, of the AICPA Code of Professional Conduct recognizes both the ASB and the PCAOB as standard setting bodies designated to promulgate auditing, attestation, and quality control standards. Paragraph .01 of the Compliance With Standards Rule (ET sec. 1.310.001 and 2.310.001)3 requires an AICPA member who performs an audit to comply with the applicable standards.

Audits of the financial statements of those entities subject to the oversight authority of the PCAOB (that is, those audit reports within the PCAOB’s jurisdiction as defined by the Sarbanes-Oxley Act of 2002, as amended) are to be conducted in accordance with standards established by the PCAOB, a private sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002. The SEC has oversight authority over the PCAOB, including the approval of its rules, standards, and budget. In citing the auditing standards of the PCAOB, references generally use section numbers within the reorganized PCAOB auditing standards and not the original standard number, as appropriate.

Audits of the financial statements of those entities not subject to the oversight authority of the PCAOB (that is, those audit reports not within the PCAOB’s jurisdiction as defined by the Sarbanes-Oxley Act of 2002, as amended) — hereinafter referred to as nonissuers — are to be conducted in accordance with generally accepted auditing standards (GAAS) as issued by the ASB. The ASB develops and issues standards in the form of SASs through a due process that includes deliberation in meetings open to the public, public exposure of proposed SASs, and a formal vote. The SASs and their related interpretations are codified in the AICPA’s Professional Standards. In citing GAAS and their related interpretations, references generally use section numbers within the codification of currently effective SASs and not the original statement number, as appropriate.

The auditing content in this guide primarily discusses GAAS issued by the ASB and is applicable to audits of nonissuers. Users of this guide may find the tool developed by the PCAOB’s Office of the Chief Auditor helpful in identifying comparable PCAOB Standards. The tool is available at http://pcaobus.org/Standards/Auditing/Pages/FindAnalogousStandards.aspx.

Considerations for audits of issuers in accordance with PCAOB standards may also be discussed within this guide’s chapter text. When such discussion is provided, the related paragraphs are designated with the following title: Considerations for Audits Performed in Accordance With PCAOB Standards. PCAOB guidance included in an AICPA Guide has not been reviewed, approved, disapproved, or otherwise acted upon by the PCAOB and has no official or authoritative status.

Applicability of Quality Control Standards

QC section 10, A Firm’s System of Quality Control,4 addresses a CPA firm’s responsibilities for its system of quality control for its accounting and auditing practice. A system of quality control consists of policies that a firm establishes and maintains to provide it with reasonable assurance that the firm and its personnel comply with professional standards, as well as applicable legal and regulatory requirements. The policies also ensure reports issued by the firm are appropriate in the circumstances.

QC section 10 applies to all CPA firms with respect to engagements in their accounting and auditing practice. In paragraph .06 of QC section 10, an accounting and auditing practice is defined as a practice that performs engagements covered by this section, which are audit, attestation, compilation, review, and any other services for which standards have been promulgated by the ASB or the AICPA Accounting and Review Services Committee under the General Standards Rule (ET sec. 1.300.001) or the Compliance With Standards Rule" of the AICPA Code of Professional Conduct.

Although standards for other engagements may be promulgated by other AICPA technical committees, engagements performed in accordance with those standards are not encompassed in the definition of an accounting and auditing practice.

In addition to the provisions of QC section 10, readers should be aware of other sections within AICPA Professional Standards that address quality control considerations, including the following provisions that address engagement level quality control matters for various types of engagements that an accounting and auditing practice might perform:

•

AU-C section 220, Quality Control for an Engagement Conducted in Accordance With Generally Accepted Auditing Standards

•

AT-C section 105, Concepts Common to All Attestation Engagements5

•

AR-C section 60, General Principles for Engagements Performed in Accordance With Statements on Standards for Accounting and Review Services6

Because of the importance of engagement quality, this guide includes an appendix, "Overview of Statements on Quality Control Standards." This appendix summarizes key aspects of the quality control standard. This summarization should be read in conjunction with QC section 10, AU-C section 220, AT-C section 105, AR-C section 60, and the quality control standards issued by the PCAOB, as applicable.

Alternatives Within U.S. Generally Accepted Accounting Principles

The Private Company Council (PCC), established by the Financial Accounting Foundation’s Board of Trustees in 2012, and the FASB, working jointly, will mutually agree on a set of criteria to decide whether and when alternatives within U.S. GAAP are warranted for private companies. Based on those criteria, the PCC reviews and proposes alternatives within U.S. GAAP to address the needs of users of private company financial statements. These U.S. GAAP alternatives generally may be applied to those entities that are not public business entities, not-for-profits, or employee benefit plans, but each standard sets forth its specific scope.

The FASB ASC Master Glossary defines a public business entity as

A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity nor an employee benefit plan is a business entity.

a.     

It is required by the SEC to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).

b.     

It is required by the Securities Exchange Act of 1934 (the act), as amended, or rules or regulations promulgated under the act, to file or furnish financial statements with a regulatory agency other than the SEC.

c.     

It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.

d.     

It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.

e.     

It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.

An entity may meet the definition of a public business entity solely because its financial statements or financial information is included in another entity’s filing with the SEC. In that case, the entity is only a public business entity for purposes of financial statements that are filed or furnished with the SEC.

Readers should refer to Technical Questions and Answers (Q&A) section 7100.15, Insurance Companies and the Definition of Public Business Entity,7 for additional information related to applying the definition of a public business entity to insurance entities.

Considerations related to alternatives for private companies may be discussed within this guide’s chapter text. When such discussion is provided, the related paragraphs are designated with the following title: Considerations for Private Companies that elect to use Standards as Issued by the Private Company Council.

AICPA.org Website

The AICPA encourages you to visit its website at www.aicpa.org and the Financial Reporting Center at www.aicpa.org/frc. The Financial Reporting Center supports members in the execution of high quality financial reporting. Whether you are a financial statement preparer or a member in public practice, this center provides exclusive member-only resources for the entire financial reporting process and provides timely and relevant news, guidance, and examples supporting the financial reporting process, including accounting; preparing financial statements; and performing compilation, review, audit, attest, or assurance and advisory engagements. Certain content on the AICPA’s websites referenced in this guide may be restricted to AICPA members only.

Select Recent Developments Significant to This Guide

Insurance Contracts Project

IASB Activities

The International Accounting Standards Board (IASB) split its insurance contract project into two phases so that some components of the project were completed by 2005 without delaying the rest of the project. Phase I addressed the application of existing International Financial Reporting Standards (IFRSs) to entities that issue insurance contracts. The issuance of IFRS 4, Insurance Contracts, along with Basis for Conclusions on IFRS 4 and Implementation Guidance to IFRS 4, brought to a close phase I of the international insurance project. Phase II, initiated in September 2004, was a comprehensive project on accounting for insurance contracts.

In September 2016, IASB issued amendments to IFRS 4 to address concerns arising from implementing the new financial instruments Standard, IFRS 9, Financial Instruments, before implementing the replacement Standard that the Board was developing for IFRS 4. These concerns included temporary volatility in reported results. IFRS 9 is effective for annual periods beginning on or after January 1, 2018 with early application permitted.

The amendments introduce two approaches: an overlay approach and a deferral approach. The amended Standard will:

•

give all companies that issue insurance contracts the option to recognize in other comprehensive income, rather than profit or loss, the volatility that could arise when IFRS 9 is applied before the issuance of the new insurance contracts Standard; and

•

give companies whose activities are predominantly connected with insurance an optional temporary exemption from applying IFRS 9 until 2021. The entities that defer the application of IFRS 9 will continue to apply the existing financial instruments Standard — International Accounting Standard 39, Financial Instruments: Recognition and Measurement.

The amendments to IFRS 4 supplement existing options in the Standard that can already be used to address the temporary volatility.

In May 2017 the IASB issued IFRS 17, Insurance Contracts, replacing IFRS 4 Insurance Contracts. IFRS 17 has an effective date of January 1, 2021 but companies can apply it earlier. IFRS 17 is the first comprehensive and truly international IFRS Standard establishing the accounting for insurance contracts.

IFRS 17 requires a company that issues insurance contracts to report them on the balance sheet as the total of:

a.

the fulfilment cash flows — the current estimates of amounts that the insurer expects to collect from premiums and pay out for claims, benefits and expenses, including an adjustment for the timing and risk of those cash flows; and

b.

the contractual service margin — the expected profit for providing future insurance coverage (that is, unearned profit).

The measurement of the fulfilment cash flows reflects the current value of any interest-rate guarantees and financial options included in the insurance contracts.

To better reflect changes in insurance obligations and risks, IFRS 17 requires a company to update the fulfilment cash flows at each reporting date, using current estimates that are consistent with relevant market information. Changes in insurance obligations due to changes in the economic environment (such as changes in interest rates) will be reflected in an insurer’s financial statements in a timely way. IFRS 17 will therefore provide current updated information about the effect of insurance contracts on a company’s financial position and risk exposure, as well as transparent reporting of changes in insurance obligations.

FASB Activities

On August 2, 2007, FASB issued an invitation to comment on An FASB Agenda Proposal: Accounting for Insurance Contracts by Insurers and Policyholders, Including the IASB Discussion Paper, Preliminary Views on Insurance Contracts. That invitation to comment included a discussion paper issued by the IASB, Preliminary Views on Insurance Contracts, which set forth its preliminary views on the main components of an accounting model for an issuer’s rights and obligations (assets and liabilities) under an insurance contract. FASB issued the invitation to comment to gather information from its constituents to help decide whether there was a need for a comprehensive project on accounting for insurance contracts and whether FASB should undertake such a project jointly with the IASB.

In October 2008, FASB decided to join the IASB’s insurance contract project.

On September 17, 2010, FASB issued, for public comment, the discussion paper Preliminary Views on Insurance Contracts.

In June 2013, FASB issued the exposure draft Insurance Contracts, and the IASB issued a revised exposure draft, Insurance Contracts. The guidance in the FASB exposure draft would require an entity to measure its insurance contracts under one of two measurement models, referred to as the building block approach and the premium allocation approach.

At the February 19, 2014, meeting, FASB tentatively decided to change the scope and direction of the insurance contract project as follows:

•

Scope. Limit the scope to insurance entities as described in existing U.S. GAAP (instead of continuing to include all entities that issue insurance contracts or purchase reinsurance contracts as proposed in the June 2013 exposure draft).

•

Direction of the project. The project should focus on making targeted improvements to existing U.S. GAAP.

—    

For short-duration contracts, the targeted improvements will be limited to enhancing disclosures (not including measurement and recognition).

—    

For long-duration contracts, decisions reached by the IASB in its 2013 exposure draft, Insurance Contracts, should be considered when contemplating improvements to existing U.S. GAAP.

In August 2014, FASB began redeliberations on targeted improvements to the accounting for long-duration contracts.

In May 2015, FASB issued ASU No. 2015-09, Financial Services—Insurance (Topic 944): Disclosures about Short-Duration Contracts, that requires additional disclosures about the liability for unpaid claims and claim adjustment expenses for all insurance entities that issue short-duration contracts as defined in FASB ASC 944, Financial Services—Insurance.

FASB ASU No. 2015-09 was effective for public business entities for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. For all other entities, ASU No. 2015-09 was effective for annual periods beginning after December 15, 2016, and interim periods within annual periods beginning after December 15, 2017.

In September 2016, the FASB issued a proposed ASU, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. The proposed ASU focused on improving the following aspects of the current insurance accounting model:

1.    

Assumptions used to measure the liability for future policy benefits

2.    

Measurement of market risk benefits

3.    

Amortization of deferred acquisition costs

4.    

Disclosures

It is expected that the FASB will issue an ASU addressing accounting for long-duration contracts during the third quarter of 2018.

Readers should monitor the progress of this project. For more specific information, visit the FASB website at www.fasb.org and the IASB website at www.iasb.org.

The New Revenue Recognition Standard: FASB ASC 606

FASB ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), and subsequent amendments (FASB ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principle versus Agent Considerations (Reporting Revenue Gross versus Net), ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers) was effective for annual reporting periods of public business entities, certain not-for-profits and certain employee benefit plans, beginning after December 15, 2017, including interim periods within that reporting period. Earlier application would be permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.

All other entities, will apply the guidance in FASB ASU No. 2014-09 to annual reporting periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. Application is permitted earlier only as of an annual reporting period beginning after December 15, 2016, including interim reporting periods within that reporting period, or an annual reporting period beginning after December 15, 2016, and interim reporting periods within annual reporting periods beginning one year after the annual reporting period in which an entity first applies the guidance in ASU No. 2014-09.

Appendix C, The New Revenue Recognition Standard: FASB ASC 606, of this guide provides an overview of the guidance. The AICPA formed sixteen industry task forces to assist in developing a new accounting guide on revenue recognition that provides helpful hints and illustrative examples for how to apply the new standard. Revenue recognition implementation issues identified will be available for informal comment, after review by the AICPA Financial Reporting Executive Committee, at www.aicpa.org/revenuerecognition.

In this guide, revenue recognition implementation issues developed by the insurance revenue recognition task force are directly referenced from the insurance entities chapter in the AICPA Audit and Accounting Guide Revenue Recognition.

Notes

1 All AU-C sections can be found in AICPA Professional Standards.

2 All PCAOB Staff Guidance sections can be found in PCAOB Standards and Related Rules.

3 All ET sections can be found in AICPA Professional Standards.

4 All QC sections can be found in AICPA Professional Standards.

5 All AT-C sections can be found in AICPA Professional Standards.

6 All AR-C sections can be found in AICPA Professional Standards.

7 All Q&A sections can be found in Technical Questions and Answers.

__________________________

TABLE OF CONTENTS

Chapter

1 Overview of the Life and Health Insurance Industry

Introduction

Legal Forms of Organization

Size and Composition of the Industry

Stock Insurance Entities

Mutual Insurance Entities

Fraternal Benefit Societies

Assessment Entities

Operations and Distribution Systems

Operations

Distribution Systems

Major Lines of Business

Life Insurance Contracts

Accident and Health Insurance Contracts

Annuity Contracts

Investment Contracts

Fee-for-Service Contracts

Reinsurance

Regulation

National Association of Insurance Commissioners

Federal Regulations

Rating Agencies

Taxation

Federal Taxation

State Taxation

State Guaranty Funds

Industry Associations

International Considerations

Terrorism

2 Characteristics of Life and Health Insurance Products

Introduction

Classification of Insurance Contracts

Broad Lines of Business

Participating or Nonparticipating Classification

Group or Individual Classification

Accounting Classification

Types of Contracts

Life Insurance Contracts

Accident and Health Insurance Contracts

Annuity Contracts

Investment Contracts

Fee-for-Service Contracts

3 Sources of Accounting Principles and Reporting Requirements

Introduction

Statutory Accounting Principles

Permitted Statutory Accounting Practices

Statutory Reporting

Disclosure Issues

GAAP

Financial Statement Disclosures

Definition of Public Business Entity

Revenue Recognition

FASB ASC 820, Fair Value Measurement, and FASB ASC 825, Financial Instruments

Definition of Fair Value

Application to Nonfinancial Assets

Application to Liabilities and Instruments Classified in a Reporting Entity’s Shareholders’ Equity

The Fair Value Hierarchy

Fair Value Determination When the Volume or Level of Activity Has Significantly Decreased

Disclosures

Fair Value Option

Statutory Accounting

SEC Reporting Requirements

Tax Basis Accounting Requirements

Comparison of GAAP and Statutory Accounting Principles

4 General Audit Considerations

Introduction

Scope of the Audit Engagement

General Considerations

Integrated Audit of Financial Statements and Internal Control Over Financial Reporting

Additional PCAOB Audit Standards

Planning and Other Auditing Considerations

Audit Planning

Audit Risk

Risk Assessment Procedures

Understanding the Entity, Its Environment, and Its Internal Control

Common Industry Ratios and Performance Metrics

Risk Indicators in the Life and Health Insurance Industry

National Association of Insurance Commissioners Insurance Regulatory Information System

Identifying and Assessing the Risks of Material Misstatement

Performing Audit Procedures In Response to Assessed Risks

Analytical Procedures

Use of Assertions in Obtaining Audit Evidence

Other Risk Assessment Activities and Considerations

Planning Materiality

Consideration of Fraud in a Financial Statement Audit

Insurance Industry — Fraud Risk Factors

The Importance of Exercising Professional Skepticism

Discussion Among Engagement Personnel Regarding the Risks of Material Misstatement Due to Fraud

Obtaining the Information Needed to Identify the Risks of Material Misstatement Due to Fraud

Identifying Risks That May Result in a Material Misstatement Due to Fraud

Assessing the Identified Risks After Taking Into Account an Evaluation of the Entity’s Programs and Controls That Address the Risks

Responding to the Results of the Assessment

Evaluating Audit Evidence

Responding to Misstatements That May Be the Result of Fraud

Communicating About Possible Fraud to Management, Those Charged With Governance, and Others

Documentation and Guidance

Use of Information Technology

Use of Service Organizations

Going Concern Considerations

Evaluating Misstatements

Audit Documentation

Accounting Estimates

Insurance Entities Use of Actuarial Specialists

Auditing Actuarially Determined Accounting Estimates

Auditor Use of Actuarial Specialists

Specialists Engaged by the Auditor

Use of Management Specialists by Auditors in Evaluating Actuarially Determined Estimates

Auditor’s Response to Management’s Use or Non-Use of an Actuarial Specialist

Evaluating the Reasonableness of the Estimates

Consideration of the Work of Internal Auditors

Communication of Matters Related to Internal Control

Identification of Deficiencies in Internal Control

Communication of Deficiencies in Internal Control

Communication of Other Matters With Those Charged With Governance

Matters to Be Communicated

Communications by Successor Auditors

Auditor Independence

Auditing Fair Value Measurements and Disclosures

Considerations for Auditors to Comply With the NAIC Model Audit Rule

Awareness

Change in Auditor

Auditor’s Letter of Qualifications

Qualifications of the Auditor

Indemnification

Partner Rotation

Prohibited Services

Consideration of Internal Control in a Financial Statement Audit

Notification of Adverse Financial Condition

Report on Internal Controls

Working Papers

Communications to Audit Committees

Management’s Report on Internal Controls Over Financial Reporting

Auditor's Consideration of State Regulatory Examinations

Auditor's Consideration of Permitted Statutory Accounting Practices

SEC Requirements for Management’s Report on Internal Control Over Financial Reporting

5 Auditing Inforce Files

Introduction

Control Objectives

Auditing Procedures

Confirmation of Insurance Contracts Inforce

Audit Consideration Chart

6 Insurance Revenues

Introduction

Regulation of Premium Rates

Taxation of Premiums

Accounting Practices

Statutory Accounting Principles

Generally Accepted Accounting Principles

Auditing

Risk of Material Misstatement — Inherent Risk Factors

Obtaining an Understanding of Internal Control for Premium Transactions

Control Environment

Risk Assessment Process

Control Activities

Information and Communication

Audit Procedures Responsive to the Assessed Risks of Material Misstatement

Audit Consideration Chart

7 Liabilities for Future Policy Benefits (Statutory Policy Reserves) and Other Contract Liabilities

Introduction

Regulation

Statement of Actuarial Opinion

Calculation Methods

Reserve Definitions

Retrospective and Prospective Methods

Accounting Practices

Statutory Accounting Principles

Calculation of Reserve Liabilities by Contract Type

Participating Policies

Generally Accepted Accounting Principles

Significant Actuarial Assumptions for Traditional Life and Health Insurance Products

Calculation of Liabilities for Future Policy Benefits by Contract Type

Participating Contracts

Auditing

Risk of Material Misstatement — Inherent Risk Factors

Obtaining an Understanding of Internal Control for Auditing Liabilities for Future Policy Benefits and Other Contract Liabilities

Control Environment

The Entity’s Risk Assessment Process

Control Activities

Information and Communication

Special Considerations

Auditing Statutory Reserve Adequacy

Auditing GAAP Benefit Liabilities — Reviewing Assumptions Used

Audit Consideration Chart

8 Benefit and Claim Payments

Introduction

Kinds of Benefit and Claim Payments

Regulation

Accounting Practices

Statutory Accounting Principles — Benefit and Claim Payments

Generally Accepted Accounting Principles — Benefit and Claim Payments

Auditing

Risk of Material Misstatement — Inherent Risk Factors

Obtaining an Understanding of Internal Control for Contract Benefit and Claim Transactions

Control Environment

The Entity’s Risk Assessment Process

Control Activities

Information and Communication

Audit Consideration Chart

9 Commissions, General Expenses, and Deferred Acquisition Costs

Introduction

Regulation

Accounting Practices

Statutory Accounting Principles

Generally Accepted Accounting Principles

Accounting for DAC in Connection With Contract Modifications or Exchanges

Sales Inducements to Contract Holders

Amortization of DAC

Calculation Methodologies

Recoverability Testing and Loss Recognition

Special Considerations

Auditing

Risk of Material Misstatement — Inherent Risk Factors

Obtaining an Understanding of Internal Control for Commissions, General Expenses, and Deferred Acquisition Costs

Control Environment

The Entity’s Risk Assessment Process

Control Activities

Information and Communication

Commissions and Allowances

General Expenses

DAC

Audit Consideration Chart

10 Investments

Introduction

Regulation

Accounting Practices

Security Investments

Debt Securities

Securities Lending Transactions

Repurchase Agreements and Wash Sales

Statutory Accounting

Equity Securities

Derivative Instruments

Short Sales

Interest Maintenance Reserve and Asset Valuation Reserve

Realized and Unrealized Gains and Losses on Debt and Equity Securities

Investments Other Than Securities

Mortgage Loans

Troubled Debt Restructurings

Real Estate Investments

Joint Ventures and Partnerships

Policy Loans

Investment Income Due and Accrued

Auditing

Debt and Equity Securities

Risk of Material Misstatement — Inherent Risk

Obtaining an Understanding of Internal Control for Investment Transactions

Control Environment

The Entity’s Risk Assessment Process

Control Activities

Information and Communication

Group Audit Considerations for Investments in Alternative Investments and Subsidiary, Controlled and Affiliated Entities

Audit Consideration Chart

11 Reinsurance

Introduction

Reinsurance Transactions

Types of Reinsurance Entities

Bases of Reinsurance Agreements

Types of Reinsurance Agreements

Regulation

Accounting Practices

Statutory Accounting Principles

Generally Accepted Accounting Principles

Reporting Reinsurance Assets and Liabilities

Reporting Reinsurance Revenues and Costs

Auditing

Risk of Material Misstatement — Inherent Risk Factors

Obtaining an Understanding of Internal Control for Reinsurance Transactions

Control Environment

The Entity’s Risk Assessment Process

Control Activities

Information and Communications

Reinsurance Ceded

Planning Substantive Tests of Reinsurance Ceded

Reinsurance Assumed

Planning Substantive Tests of Reinsurance Assumed

Audit Consideration Chart: Reinsurance Transactions in General

12 Taxation of Life Insurance Entities

Introduction

Federal Income Taxes

Accounting Practices

Statutory Accounting Principles

GAAP Accounting for Income Taxes

Auditing

Risk of Material Misstatement — Inherent Risk Factors

Obtaining an Understanding of Internal Control for Auditing Income Tax Transactions

Control Environment

The Entity’s Risk Assessment Process

Control Activities

Information and Communication

Audit Consideration Chart

13 Other Assets and Liabilities, Lending and Financing, Surplus Notes, Separate Accounts, Insurance Related Assessments and Equity Contract Holders’ Surplus

Introduction

Other Assets

Nonadmitted Assets, Statutory Financial Statements Only

Other Liabilities

Lending and Financing

Surplus Notes

Separate Accounts

Variable Annuity Contracts and Variable Life Insurance Contracts

Separate Account Structures

Group Annuity Contracts

Statutory Accounting Principles — Separate Accounts

Generally Accepted Accounting Principles — Separate Accounts

SEC Registration — Separate Accounts

Additional Literature — Separate Accounts

Insurance Related Assessments

Guaranty Fund Assessments

Generally Accepted Accounting Principles

Other Insurance Related Assessments

Reporting Liabilities

Application of Guidance

Present Value

Reporting Assets for Premium Tax Offsets and Policy Surcharges

Pensions

Guarantees

Equity Contract Holders’ Surplus

Statutory Accounting Principles — Capital and Surplus

Auditing

Auditing Procedures

14 Reports on Audited Financial Statements

Reports on Financial Statements

Unmodified Opinions on GAAP Financial Statements

Modified Opinions

Qualified Opinion

Disclaimer of Opinion

Adverse Opinion

Emphasis-of-Matter Paragraphs

Evaluating Consistency of Financial Statements

Additional Guidance When Performing Integrated Audits of Financial Statements and Internal Control Over Financial Reporting

Integrated Audits Performed in Accordance With GAAS

Considerations for Audits Performed in Accordance With PCAOB Standards

Reporting on Whether a Previously Reported Material Weakness Continues to Exist

Auditors’ Reports on Statutory Financial Statements of Insurance Entities

NAIC — Codified Statutory Accounting

Regulatory Basis Financial Statements Intended for General Use

Regulatory Basis Financial Statements Intended for Limited Use

Regulatory Basis Financial Statements — Other Issues

Correction of Error

Correction of an Error — Regulatory Basis Financial Statements Intended for General Use

Correction of an Error — Regulatory Basis Financial Statements Intended for Limited Use

Opinion on Supplemental Schedules

Other Reports

Accountant’s Awareness Letter

Change in Auditor Letter

Notification of Adverse Financial Condition Letter

Auditor Reports for Communicating Unremediated Material Weaknesses in Internal Control to Insurance Regulators

Accountant's Letter of Qualifications

Appendix

A Accounting for Financial Instruments

B The New Leases Standard: FASB ASC 842

C Overview of Statements on Quality Control Standards

D The New Revenue Recognition Standard: FASB ASC 606

E Life & Health Insurance Entity Specific Disclosures

F List of Industry Trade and Professional Associations, Publications, and Information Resources

G Schedule of Changes Made to the Text From the Previous Edition

Glossary

EULA

Chapter 1

Overview of the Life and Health Insurance Industry

Introduction

1.01 The function of insurance is to pool the risks of many persons who are exposed to similar risks. For a payment known as a premium, insurance entities undertake to relieve the policyholder of all or part of a risk and to spread the total cost of similar risks among large groups of policyholders. One of the primary purposes of life insurance is to provide financial assistance to named beneficiaries at the time of the death of the insured. The long term nature of the coverage involving the risk of death — a risk that increases with age — is the distinguishing characteristic that sets life insurance apart from other forms of insurance. Traditionally, life insurance entities provided life and health products to protect against the loss of financial stability resulting from premature death or illness, and provided annuity products to protect against the risk of outliving one's financial resources. The primary emphasis was on meeting the customer's insurance needs.

1.02 Recently, however, insurers have been providing a wide range of financial service products that meet more of the customer's investment and retirement savings needs. Although the mix of products has retained the traditional features of life and health insurance, there is an increased emphasis on interest sensitive products and investment related contracts with a combination of fixed and variable features.

1.03 The Gramm-Leach-Bliley Act, enacted in 1999, removed restrictions on bank affiliations with insurers and permits mergers that combine commercial banks, insurers, and securities firms under one holding company. Until passage of the Gramm-Leach-Bliley Act, the Glass-Steagall Act of 1933 had limited the ability of banks to engage in securities related businesses, and the Bank Holding Company Act of 1956 had restricted banks from being affiliated with insurance entities.

Legal Forms of Organization

1.04 Life insurance entities may be grouped into the following four broad categories according to the legal form of their ownership:

a.

Stock entities

b.

Mutual entities

c.

Fraternal benefit societies

d.

Assessment entities

Size and Composition of the Industry

1.05 A vast majority of life insurance entities in business are owned by stockholders. The remaining are mutual entities, fraternal benefit societies, and assessment entities. Mutual companies can convert to stock companies by a process of demutualization.

1.06 In addition to the legal forms of organization, life insurance entities can be identified by the kinds of insurance products they offer and the markets they serve. For example, reinsurance entities do not serve the public directly, but assume portions of the risk underwritten by insurance entities for their contract holders. Captive insurance entities underwrite insurance exclusively for the members or customers of a group, typically the captive’s parent. An example of a captive entity is a credit life insurance corporation that writes insurance on customers of its finance entity or bank parent.

Stock Insurance Entities

1.07 A stock insurance entity is a corporation organized for profit with ownership rights and control of operations vested in the stockholders. In most states, stock insurance entities may issue both participating and nonparticipating contracts. Participating contracts are those contracts under which a portion of the associated earnings are returned to contract holders in the form of participating or contract holder dividends. Nonparticipating contracts are those contracts under which contract holders have no right to share in the associated earnings arising from their contracts. Stock insurance entities may also pay dividends to their shareholders; however, these payments are a return of profits and are reflected as a decrease in the retained earnings of the stock insurance entity. Stock insurance entities, like other stock corporations, are capitalized through the private or public sale of ownership shares or the issuance of debt.

Mutual Insurance Entities

1.08 A mutual insurance entity is an incorporated entity without private ownership interests that operates for the benefit of its contract holders and their beneficiaries. Mutual insurance entities issue participating contracts that pay participating dividends, and may also issue nonparticipating contracts. In a mutual entity, participating contract holders are contractual creditors who have the right to vote for members of the entity's board of directors and trustees, as provided by law. In some states, the insurance laws provide that upon liquidation of a mutual insurance entity, the net assets are to be distributed among the existing contract holders, and prior contract holders have no right to a share of the net assets. The net assets and net income of a mutual insurance entity belong to the entity, and on the termination of their contracts contract holders lose their rights and interests in the mutual insurance entity.

1.09 Mutual insurance entities commonly create wholly owned stock subsidiaries to issue nonparticipating contracts. The capital used to establish a mutual insurance entity is usually obtained from contributions by the original contract holders and the sale of interest bearing debt.

1.10 Many mutual insurance entities are seeking enhanced financial flexibility and better access to capital to support long term growth and other strategies to accomplish strategic initiatives.

1.11 FASB Accounting Standards Codification (ASC) 944-805 provides guidance on accounting by insurance enterprises for demutualization and the formation of mutual insurance holding companies (MIHC). This guidance also applies to stock insurance enterprises that apply FASB ASC 944, Financial Services—Insurance, to account for participating policies that meet the criteria of FASB ASC 944-20-15-3.

1.12 FASB ASC 944-805 specifies the following:

•

Financial statement presentation of the closed block (that is, the block of participating business operated for the exclusive benefit of the policies included therein for policy holder dividend purposes only)

•

Accounting for pre-demutualization participating contracts after the demutualization date or formation of an MIHC

•

Emergence of earnings

•

Accounting for participating policies sold outside the closed block after the date of demutualization or formation of an MIHC

•

Accounting for expenses related to a demutualization and the formation of an MIHC

•

Accounting for retained earnings and other comprehensive income at the date of demutualization and formation of an MIHC

•

Accounting for a distribution from an MIHC to its members

FASB ASC 944-805-05 applies to past and future demutualization or formations of an MIHC. Readers may refer to FASB ASC 944-805-05 for a complete understanding of its provisions.

Fraternal Benefit Societies

1.13 A fraternal benefit society resembles a mutual insurance entity in that, although incorporated, it does not have capital stock, and it operates for the benefit of its members and their beneficiaries. Contract holders participate in the earnings of the society, and the contracts stipulate that the society has the power to assess its members if its legal reserves become impaired. Fraternal societies use contracts that incorporate their charter, constitution, and bylaws, in addition to the insurance contract. Any subsequent amendments to the entity's charter or bylaws automatically amend the insurance contract. The management of a fraternal benefit society is elected by member delegates to national conventions, who in turn elect the officers and directors. Fraternal benefit societies operating under a lodge system are exempt from federal income taxation.

Assessment Entities

1.14 An assessment entity is a group of insureds that share similar interests or characteristics, such as a religious denomination or a professional group. Assessment entities represent only a minor segment of the industry and, in many states, the organization of a new one is not permitted. Most existing assessment entities have been reorganized on a legal reserve assessment entity basis, by which they charge fixed premiums and maintain the amount of reserves required by law, but retain the right to call for additional premiums. These entities are required by law to charge no less than the required minimum rates and have an assessment clause only until they accumulate surplus in excess of the legal minimum required. An assessment clause enables an assessment entity to collect assessments from members if funds are not sufficient to pay claims.

Operations and Distribution Systems

Operations

1.15 The operations of life insurance entities are generally complex. Depending on the products offered and market segments served, life insurance entities can be organized into several departments or specialized areas, such as accounting, actuarial, administration, sales or distribution (for example agency), claims, contract issue, contract holder services, enterprise risk management, information systems, investment, legal, marketing, product development, and underwriting. These areas can be centralized so that they assume entity wide responsibility, or they can be organized by product or line of business. Given the nature of the life insurance business, all departments may engage in activities that produce data that directly affect the financial statements.

1.16 Life insurance entities offer a variety of products and may serve unique markets, but are also apt to share a number of characteristics. Operating functions that are basic to life insurance entities include the following:

a.

Underwriting and collection of premiums. Underwriting is the process of establishing guidelines to evaluate and investigate applications for insurance, accepting or rejecting insurance risks, and classifying those risks to determine the proper premium for each. The proper selection and pricing of insurance risks are critical to a successful insurance entity. Billing and collection of premiums are significant operating activities of a life insurance entity.

b.

Investment of premium. Once premiums for insurance coverage are received, the life insurance entity invests the funds. Assumptions regarding the use of investable funds and estimated maturities and returns on those investments are inherent in the profit planning and pricing policies of life insurance entities. Funds are invested so that the income from the investments, plus the maturities and anticipated renewal premiums, meet the cash flow needs of the life insurance entity. In most jurisdictions, regulatory standards and limitations on investment activities are intended to ensure adequate stability and liquidity. Regulations may also prescribe statutory accounting methods for valuing and reporting invested assets.

c.

Payment of benefits and claims. The claim payment process in a life insurance entity begins with the receipt by the entity of a notice either to file a claim or fully or partially surrender a contract. However, before receiving requests for benefit payments, life insurance entities will have received premiums and recorded revenue, as well as recorded estimates of liabilities for future policy benefits (benefit and claim liabilities) and related expenses. Contract liabilities for future policy benefits, on an aggregate basis, are intended to be sufficient to provide for future promised benefits as they become due. These benefit and claim liabilities are estimated using generally accepted actuarial standards and methodologies based on factors that include mortality, morbidity, interest rate, withdrawal, and expense assumptions. Benefit and claim liabilities are usually the most significant liability of life insurance entities. Accurate databases, a good understanding of the industry environment, consistent application of acceptable approaches, and detailed comparisons of actual to expected results are necessary to produce appropriate benefit and claim liability estimates.

Distribution Systems

1.17 Life insurance entities sell their products through various distribution systems. The choice of distribution systems is dependent on a number of factors, such as relative cost considerations, marketing strategies, and product processing requirements. Most life insurance entities employ either a general agency or branch office distribution system, or some combination thereof; however, they are increasingly, all captive distributions or relying on other third parties, such as brokers, to sell certain life insurance products. Additionally, certain captive insurance entities maintain distribution systems associated with employees or customers of its banking, finance or association parent.

1.18 In the past, home service insurance was typically sold by life insurance entities in small amounts through door-to-door salespersons; with contracts issued on either ordinary or home service contract forms. Premiums on such insurance are generally collected by the agent on a weekly or monthly basis.

1.19 Many life insurance entities now generally obtain new business leads through other channels, such as direct mail solicitation, advertising in the news media, the internet, and telemarketing. Sales are also generated through banks, independent financial advisers, and wire houses. Still, the general agent and branch office systems remain the most common distribution systems.

1.20 Distribution systems, which are described in paragraphs 1.21–.23, are distinctive as a result of their relationship with the life insurance entity. However, distributors submit applications for insurance to the insurance entity; distributors not only accept or reject the applications, but may hold the power to issue binding agreements.

1.21 General agencies. General agents are usually independent contractors and often are granted an exclusive territory in which to produce business for a life insurance entity. However, this practice varies among entities and usually does not apply to agencies operating in large metropolitan areas. General agents agree to promote an entity's interests, pay their own expenses (although reimbursement may be provided by contract), maintain a satisfactory agency force, and secure subagents. They perform services associated with securing applications for insurance and the issuing of contracts. General agents are compensated primarily by commission, a percentage of the premiums they produce, plus certain allowances designed to cover related expenses. The allowance may be a gross percentage, out of which the general agents pay the subagents whom they appoint, or it may be a specific overriding commission, with the subagents' and brokers' commissions paid directly by the insurance entity. General agents typically represent only one life insurance entity, and they commonly have vested rights to renewal commissions, depending on their contractual agreement.

1.22 Branch offices. Branch office salespersons may be employees of a life insurance entity, independent contractors, or employees of general agents. Offices are operated by managers, who are usually salaried employees of the life insurance entity. The manager's compensation may be based partly on production; however, the manager usually does not have vested rights to renewal commissions. The branch office's expenses are usually paid directly by the life insurance entity.

1.23 Brokers. Brokers are independent agents who solicit business and place it with various life insurance entities. They represent the contract holder and may write business. They submit applications for acceptance or rejection directly to the entity or through a general agent, subagent, or other broker. They are compensated on the basis of a commission, which is usually calculated according to the amount of premium on contracts placed with the life insurance entity. Brokers usually have vested rights to renewal commissions, depending on their contractual agreement.

Major Lines of Business

1.24 Typically, the products of life insurance entities can be grouped into several broad lines of business. The majority of these insurance products are sold on either a group or individual basis and on either a participating or nonparticipating basis.

Life Insurance Contracts

1.25 Traditional life insurance contracts include whole life, term, and endowment contracts that provide a fixed amount of insurance either for a fixed term or over the life of the insured. The related death benefits are payable only upon the insured's death except for those contracts that contain living benefit clauses. For policies that include the accumulation of cash surrender value, such amounts may be payable to the policyholder if the policy is surrendered or otherwise prematurely terminated. Premiums are paid over various periods under the terms of the contract.

1.26 Universal life and similar contracts are contracts with terms that are not fixed or guaranteed relative to premium amounts, expense assessments, or benefits accruing to the contract holder.

1.27 Variable life contracts are contracts with adjustable terms that are usually dependent on the investment performance of a specific separate pool of assets, usually a separate account. Separate accounts are discussed further in paragraph 2.21 and in chapter 13, Other Assets and Liabilities, Lending and Financing, Surplus Notes, Separate Accounts, Insurance Related Assessments and Equity — Contract Holders' Surplus.

1.28 Some annuity and life contracts sold as general account or separate account products may combine fixed and variable features and embedded derivatives. The features of these nontraditional contracts may be complex, and are offered in different combinations, such that there are numerous variations of the same basic products being sold in the marketplace. FASB ASC 944-815 provides accounting guidance for and examples of some of these product features.

Accident and Health Insurance Contracts

1.29 Accident and health insurance contracts are generally classified as either medical indemnity contracts, which provide benefits for medical expenses, or disability income contracts, which provide for periodic benefit payments for a predetermined period (fixed or for life) in the event the insured is unable to work as a result of total or partial disability resulting from illness or injury. Long-term care insurance contracts provide predefined benefit levels, sometimes increasing with inflation, protecting against the costs of long-term care services provided in the insured’s home or in assisted living or nursing facilities. In contrast to health insurance, long-term care insurance provides coverage for skilled and custodial care provided outside of a hospital or health-related facility. Long-term care insurance policies generally have fixed premiums that are cancellable by the policyholders but not by the insurance entity, and are guaranteed to be renewable.

Annuity Contracts

1.30 Annuity contracts are arrangements whereby a contract holder is guaranteed to receive benefits over a fixed or variable period commencing either immediately or at some future date. As stated in paragraph 1.28, some of these products may combine fixed and variable features.

Investment Contracts

1.31 Investment and similar contracts are those that do not subject the insurer to significant insurance risks of contract holder mortality or morbidity and are comparable to financial or investment products offered by other kinds of financial institutions.

Fee-for-Service Contracts

1.32 Fee based services, such as group plan administrative services, investment advisory services, and other back office services, are contracts that provide for services only, and do not contain significant elements of insurance or investment risks to the life insurance entity.

In addition, life insurance entities commonly offer products through noninsurance subsidiaries, such as finance entities, broker-dealer operations, mutual funds, unit trusts, joint ventures, mortgage banks, and real estate trusts.

1.33 These ancillary services are beyond the scope of this guide.

Reinsurance

1.34 Frequently, life insurance entities respond to market conditions, risk management or capital limitations by writing contracts on risks for amounts that exceed either their financial capacity or willingness to be at risk of loss. Such risks are spread among other insurance entities through reinsurance, which is the indemnification by one insurer (referred to as the reinsurer or the assuming entity) of all or part of a risk originally underwritten by another insurer (referred to as the ceding entity or the direct writer).

1.35 All life insurance entities set limits on the amounts and kinds of risks they will retain. Such limits are referred to as retention, and may differ depending on the insured's age or the classification of the risk as standard or substandard. Amounts at risk in excess of the retention limit are generally reinsured for a negotiated fee arrangement. In reinsuring all or part of a risk, a ceding entity does not discharge its primary liability to its insured, but reduces its maximum exposure in the event of an unexpected loss by obtaining the right to reimbursement from the assuming entity for the reinsured portion of the loss. A ceding entity is also exposed to the possibility that the reinsurer will be unable to make the reimbursement to the ceding entity.

1.36 Indemnity reinsurance transactions are between insurance entities, not insureds. The legal rights of the insureds generally are not affected by reinsurance except as described in paragraph 1.37 for assumption reinsurance. The entity issuing the contract remains liable for the payment of the contract benefits.

1.37 Reinsurance also applies to the sale of all or part of an entity's insurance in force to another entity, commonly referred to as assumption reinsurance. If the original contract is novated, the assuming entity legally replaces the ceding entity as the primary obligor to the contract holder. Such a transaction may arise upon the insolvency or liquidation of an entity, or it may be instituted by a management decision (with regulatory approval) to sell a portion of the business. (Regulators typically require the agreement of individual policyholders before the novation is effective.)

Regulation

1.38 The insurance industry is deemed to be vested with the public interest because it acts in a fiduciary capacity and therefore requires regulation. In 1945, Congress passed the McCarran-Ferguson Act (Public Law 15), which states that although the federal