January 1999 Issue AcSEC Issues SOP on Insurance Deposit Accounting By Anthony J. Mancuso, CPA The Accounting Standards Executive Committee recently issued Statement of Position 98-7, Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk, which provides guidance on how to account for such contracts. The SOP does not address when deposit accounting, its term for insurance contracts that do not transfer insurance risk, should be applied. With the exception of long-duration life and health insurance contracts, the SOP applies to all entities and all insurance and reinsurance contracts that do not transfer insurance risk. Contracts for which the deposit method is appropriate should be classified as either those that transfer only significant timing risk, those that transfer only significant underwriting risk, those that transfer neither significant timing nor underwriting risk, or those with indeterminate risk. At inception, a deposit asset or liability should be recognized for insurance and reinsurance contracts accounted for under deposit accounting, and should be measured based on the consideration paid or received less any explicitly identified premiums or fees to be retained by the insurer or reinsurer. Insurance and reinsurance contracts that transfer neither significant timing nor underwriting risk and insurance, and reinsurance contracts that transfer only significant timing risk, should be accounted for using the interest method. Changes in estimates of the timing or amounts of recoveries require recalculating the effective yield. The asset or liability should then be adjusted to the amount that would have existed had the new effective yield been applied since the inception of the contract. Revenues and expenses for such contracts are included in interest income or expense. Insurance or reinsurance contracts that transfer only significant underwriting risk should be accounted for by measuring the deposit based on the unexpired portion of the coverage provided until losses are incurred that would be reimbursed under the contracts. Any reimbursed deposit losses should be measured by the present value of the expected future cash flows arising from the contract, plus the remaining unexpired portion of the coverage provided. With the exception of the unexpired portion of the coverage provided, changes in the recorded amount of the deposit should be included in the insured's income statement as an offset against the loss recorded by the insured that will be reimbursed under the contract and in an insurer's income statement as an incurred loss. The reduction in the deposit related to the coverage's unexpired portion should be recorded by the insured and the insurer who are insurance enterprises as an adjustment to incurred losses. For insured and insurer enterprises, other than insurance enterprises, the reduction in the deposit related to the coverage's unexpired portion should be recorded as an expense. For insurance and reinsurance contracts with indeterminate risk, the open-year method guidance outlined in SOP 92-5, Accounting for Foreign Property and Liability Reinsurance, should be followed. The open-year method should not, however, be used to defer losses that otherwise would be recognized pursuant to FASB Statement 5. Under the open-year method, the contracts' effects are not included in the determination of net income until sufficient information becomes available to reasonably estimate and allocate premiums. The open-year method requires that these effects be aggregated in the balance sheet. When sufficient information becomes available to estimate and allocate premiums reasonably, the insurance or reinsurance contract with indeterminate risk should be reclassified into one of the other three categories (as an insurance or reinsurance contract that transfers neither significant timing nor underwriting risk, transfers only significant timing risk, or transfers only significant underwriting risk) and accounted for accordingly. SOP 98-7 is effective for financial statements with fiscal years beginning after June 15, 1999, with earlier application encouraged. Restatement of previously issued annual financial statements is not permitted. *

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