1. Cayman Islands Society of Professional Accountants Insurance Subcommittee of the Public Practice Committee

2. Insurance Hot Topics Contents 1)Risk transfer 2)Deposit accounting 3)Special purpose contracts (e.g. LPT, novation, commutation, etc.) 4)Premium deficiencies 5)U.S. GAAP update

3. Risk transfer 1

4. Obtain a complete understanding of all contractual features that: Limit the amount of insurance risk to which the insurer is subject Delay the timely reimbursement of claims by the insurer Insurance Any transaction, regardless of its form, whose individual terms indemnify an insured against loss or liability relating to insurance risk Agreement must transfer SIGNIFICANT insurance risk which includes BOTH underwriting risk and timing risk.

5. Risk transfer Short-duration contracts Transfer of significant insurance risk; AND It is reasonably possible that the insurer may realize a significant loss from the transaction.

6. Risk transfer Finite Reinsurance/Insurance – Does risk transfer? Sliding scale commissions Profit sharing formulae Experience refunds Caps Loss corridors Dual triggers Retrospectively-rated premiums Reinstatement premiums Termination/commutation provisions Funds withheld accounts Thinly capitalized offshore reinsurance companies Finite Reinsurance/Insurance Reinsurance or insurance that transfers only a finite or limited amount of risk. Risk is reduced through accounting or financial methods, along with the actual transfer of economic risk. By transferring less risk to the reinsurer, the direct insurer or policyholder receives coverage on its potential claims at a lower cost than “traditional” reinsurance or insurance.

7. - premium + Min: losses and operating costs Actuary report Industry rates Use of discounts Max: Risk transfer Must be reasonably possible to incur a significant loss (i.e. 10% chance of a 10% loss) Alternative: Deposit accounting Premium funding Definition The amount an insurer charges to provide the coverage described in the policy. Parameters of funding

8. Premium funding Approaches for setting premium: Actuarial estimate for funding based on past loss experience. Industry rates, with a level of discounting to remove profit element. Industry pressures: Growing bias due to cash flow needs to keep premium low, leading to a rise in longer term liquidity and solvency problems. As a contrast, it was common in the past to set premium above maximum cap, leading to risk transfer problems.

9. Premium funding Alternative: Use “retrospective-rating” mechanism: Initial funding is set at predetermined level (this helps with cash flow needs, as initial premium can be quite low). Both retrospectively-rated and swing-rated policies may have a mechanism to assess additional funding (must be careful not to breach maximum cap, result in risk transfer issues).

10. Deposit accounting 2

11. Deposit accounting is applied when: Only timing risk is transferred Only underwriting risk is transferred No transfer of significant timing or underwriting risk The risk cannot be determined U.S. GAAP guidance for deposit accounting: ASC 944, Financial Services — Insurance ASC 340-30, Insurance contracts that do not transfer insurance risk (which includes guidance from AICPA’s Statement of Position 98-7 Deposit Accounting)

12. Deposit accounting What is recorded in the deposit liability account? Deposit premiums/funding Subsequent premium adjustments/assessments Losses paid/payable Depending on the terms of the contract, the following can also be recorded in the deposit liability: IBNR / case reserves Net investment income Administrative expenses Yield adjustment due to changes in actual and estimated timing and amounts of cash flows Example:

13. Deposit accounting Example calculation of effective yield adjustment:

14. Special purpose contracts (e.g. LPT, novation, commutation, etc.) 3

15. Loss portfolio transfers What is a loss portfolio transfer “LPT”? A transaction where a ceding entity transfers a portfolio of claim liabilities (or book of business) to an assuming company. It is a process, not a contract, but it requires underlying contractual agreements. The underlying contract specifies where the rights and obligation resides, and therefore dictates accounting treatment. Common Forms of LPT’s Mergers/acquisitions – loss portfolios transfer on consolidation Reinsurance – transfer the risk of loss portfolio Commutation – cancellation and release of loss portfolio Novation – transfer of loss portfolio to another company

16. Loss portfolio transfers Contract types: Retroactive Prospective (claims made) Prospective (occurrence) Occurrence date Report date Contract inception Settlement Occurrence date Contract inception Report date Settlement Contract inception Occurrence date Report date Settlement

17. Loss portfolio transfers Retroactive contracts Occurrence date Report date Contract Inception Settlement Transfer of reported claim Transfer risk of ALD Onshore RRG Assets: 100 Insurance reserves: 80 Equity: 20 Offshore RRG Assets: 100 Insurance reserves: 80 Deferred gain: 20 Funding Funding for risk of adverse loss development Excess funding ???? Funding for reported claim

18. Loss portfolio transfers Accounting treatment Liability fundingIdentificationAccounting Treatment Loss reservesCase reserves plus IBNR  Funding at expected level is credited to loss reserves in the balance sheet.  Subsequent movements flow through the income statement. Excess fundingAmount of funding in excess of value of loss reserves  Technically, between third parties, the excess funding is considered to be a gain on transfer and should be amortized over the expected life of the underlying contract. Any loss is recognized immediately in the statement of income on Day 1.

19. Loss portfolio transfers LPT type 1 – Retroactive insurance/reinsurance Ceding company transfers book of business by simply entering into a reinsurance agreement with a third party reinsurer. Two parties involved – ceding company and reinsurer. Under FAS 113 the ceding company must still disclose the liabilities gross of reinsurance as well as the reinsurance recoverable. The ceding company is still responsible for these liabilities regardless of whether they recover reinsurance or not. Transaction scope is limited to liabilities (ie: IBNR and/or case reserves) as of the valuation date. Preferable to make transfer at expected level (net of gains).

20. Loss portfolio transfers LPT type 2 – Commutation The ceding company passes the right and obligation of the underlying liabilities to another party in return for consideration (two party transaction). The ceding company therefore extinguishes their obligations and therefore does not need to record any liability subsequent to the transaction date. Assuming company must record liabilities under GAAP. Captives are encouraged to use net-based pricing (ie: transfer liabilities at their value at transaction date without any gains). Any gains are deferred and amortized over the payout period.

21. Loss portfolio transfers LPT type 3 – Novation A legal agreement where one insurer is being replaced by another insurer. Underlying insured must also be involved in agreement, therefore involves three parties, insured, original insurer and replacement insurer. Replacement insurer agrees to “stand in place” of the original insurer and assumes rights and obligations under the initial contract. The new contract maintains the same terms and conditions with the insured. Original insured’s liabilities are extinguished. Replacement insurer recognizes a premium. Replacement insurer must assume all contractual responsibilities (example – claims handling).

22. Loss portfolio transfers Summary It is important to understand the purpose of the LPT and the intended outcome. The type of LPT and the supporting contract structure help dictate the appropriate accounting treatment. There is no magic bullet approach with respect to accounting treatment for LPTs. The case specifics must be considered. Encourage the client to engage us in dialogue early on in the process.

23. Special purpose contracts – Tail coverage Accounting guidance for tail liabilities on a claims made basis Type and scope of coverage impacts type of accounting treatment as follows: 1. Commercial coverage – unlimited extended reporting period This is effectively an occurrence based policy. Premium recognized as 100% earned at inception of contract over the occurrence period. IBNR reserve is based on actuarial estimates. 2. Commercial coverage – limited extended reporting period Premium is deferred as UEP and earned pro-rata over risk period. Reserves established as claims are incurred.

24. Special purpose contracts – Tail coverage Accounting guidance for tail liabilities, continued Type and scope of coverage impacts type of accounting treatment as follows: 3. Retroactive insurance – unlimited reporting period Consideration received is credited to reserves, and movement flows through income statement. 4. Deferred tail coverage triggered by physician withdrawal Premium is deferred as UEP until event is triggered (i.e. withdrawal) Premium is then earned over risk period. Reserves established as claims are incurred.

25. Special purpose contracts – Tail coverage Accounting guidance for tail liabilities, continued Insurance companies may offer separate policies providing only extended reporting period coverage to insureds whose claims-made policies are expiring. The coverage afforded by these policies is commonly referred to as “tail coverages”. Adding tail coverage to a claims-made policy may, in substance, create an occurrence based insurance policy. The tail coverage may be for a definite or an indefinite period of time. If the policy gives the insured a unilateral option to purchase tail coverage at a premium not to exceed a specified fixed maximum, we believe the Company should record liabilities as if it was an occurrence based policy.

26. Premium deficiencies 4

27. Recognize a premium deficiency if: Expected claims costs Claim adjustment expenses Expected dividends to policyholders Unamortized acquisition costs Maintenance costs > is greater than Related unearned premiums

28. Premium deficiencies Testing: Insurance contracts should be grouped consistent with the enterprise’s manner of acquiring, servicing and measuring the profitability of its insurance contracts. Anticipated investment income may be considered when determining if premium deficiency exists. Recognized by: Charge unamortized acquisition costs to expense up to amount to eliminate deficiency. If still not enough, accrue liability for excess deficiency.

29. U.S. GAAP update 5

30. 2014 Update on the Insurance Project During February 2014, FASB limited the scope to insurance entities only. Short-duration contracts (focus on improvements to disclosures only). Long-duration contracts (focus on improvements to measurement and comparison with IASB). Likely to lead to further non-convergence between FASB and IASB. Other new standards issued by FASB during 2014 Going Concern (effective for periods ending after Dec 31, 2016)

31. 2014 Update on the Insurance Project February 19, 2014 FASB meeting The FASB changed direction on its insurance contracts project, moving away from its joint project with the IASB that would have resulted in a comprehensive change to the insurance contract accounting model. The FASB decided instead to focus on making targeted improvements to US GAAP accounting for long duration contracts (which principally consist of certain life and annuity contracts), and enhancing disclosures for short duration insurance contracts (which consist principally of property/casualty insurance contracts).

32. 2014 Update on the Insurance Project April 16, 2014 FASB meeting The FASB developed the list of potential targeted improvements to long duration contract accounting and short duration contract disclosures that it expects to deliberate at future meetings. For short duration contracts, the FASB expects to consider potential enhanced disclosures in the following areas: incurred and paid loss development tables; claim reserve duration in time bands; information about the frequency and severity of claims; qualitative and quantitative information about claims estimates; information about premium deficiency testing; and for those liabilities for which discounting is elected, the amount of the discount. The FASB decided not to pursue potential changes to the existing “premiums due” revenue recognition model.

33. 2014 Update on the Insurance Project August 13, 2014 FASB meeting The FASB continued its discussions of disclosures about short-duration contracts and made the following decisions: Incurred and paid claims development tables: The Board affirmed its previous decision that incurred and paid claims development tables should be disclosed in the financial statement footnotes and that those disclosures need not go back more than 10 years, but that they should present information for the number of years for which claims incurred typically remain outstanding. Health Insurance Claims: The Board decided that insurance entities that issue short- duration insurance contracts should disclose in their interim and annual financial statements the incurred but not reported liabilities included in the liability for unpaid claims and claim adjustment expenses for health insurance claims, either as a separate disclosure or as a component of the rollforward of the liability for unpaid claims and claim adjustment expenses. The rollforward should be disaggregated so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have different characteristics.

34. 2014 Update on the Insurance Project August 13, 2014 FASB meeting, continued The FASB continued its discussions of disclosures about short-duration contracts and made the following decisions: Effective Date: The Board decided that for public business entities, the final guidance should be effective for annual reporting periods beginning after December 15, 2014, and interim reporting periods within annual reporting periods beginning after December 15, 2015. The Board decided on a one-year delay for all other entities. The Board also decided to allow early adoption for all entities. Next Step - The Board directed the staff to draft an Accounting Standards Update for vote by written ballot with an extended time frame for external review by a broad range of stakeholders.

35. Contact information Carrie Brown cabrown@deloitte.com David Watt davidwatt@kpmg.ky Melanie Snyman melanie.snyman@ky.pwc.com