AICPA insurance companies committee projects.

This month we summarize two American Institute of CPAs insurance companies committee projects: (1) a proposed statement of position (SOP), Insurance Entities' Disclosures Concerning Risks and Uncertainties (a supplement to the proposed SOP, "Disclosure of Risks and Uncertainties and Financial Flexibility"), and (2) a proposed industry accounting guide, Insurance Agents and Brokers.

Members may obtain copies of these proposals by calling AICPA library services at [phone] [[phone] in New York State]. Photocopy and other fees may apply. (The library is relocating this fall and will be closed for part of October 1992.)

INSURANCE ENTITIES' DISCLOSURES CONCERNING RISKS AND UNCERTAINTIES

Today's volatile business and economic environment underscores the need for improved disclosures concerning risks and uncertainties facing reporting entities. In response, the AICPA is drafting an SOP, Disclosure of Risks and Uncertainties and Financial Flexibility, which would apply to all reporting entities that prepare financial statements in accordance with generally accepted accounting principles.

Concurrently, the AICPA insurance companies committee task force on insurance companies' disclosures is drafting another SOP, Insurance Entities' Disclosures Concerning Risks and Uncertainties, which would provide timely guidance on applying the general risks and uncertainties SOP to insurance companies, insurance holding companies, and companies that have significant insurance operations. Both proposed SOPs will be exposed for public comment simultaneously.

The proposal would require insurance entities to provide note disclosure as of the balance sheet date on the following risks and uncertainties:

Nature of operations. The insurance entity's major lines of business, products or services, distribution systems and principal markets, including geographic locations or concentration of those markets, would be described.

Volatility of property-casualty insurance entities' loss reserves. The effects on current year's net income of prior-accident years' development of insurance loss reserves and loss adjustment expenses would be provided. The causes of prior-accident years' development would have to be explained in sufficient detail. Other planned disclosures include

1. Management's policies and methodologies for establishing loss reserves, particularly for environmental and other emerging or difficult-to-estimate exposures.

2. A description of significant adjustments to historical claims experience that management considers to be unusual or nonrecurring, the potential effects of these adjustments on loss reserves and how such claims experience could indicate a change in trend requiring a reevaluation of reserves for incurred-but-not-reported claims.

Effects of regulation and statutory accounting practices (SAP). This note would identify and describe the differences between the basis of presentation (GAAP) and SAP. Other planned disclosures would include

1. A discussion of the impact on aggregate statutory capital surplus of material transactions arising from transactions permitted by state insurance departments (for statutory reporting) that depart from prescribed SAP. (SAP may be prescribed in numerous ways; state law and regulation are foremost. Other sources include the National Association of Insurance Commissioners accounting practices and procedures manuals, Annual Statement Instructions and Examiners' Handbook. )

In addition to requiring insurance entities to follow prescribed or permitted statutory accounting practices, state insurance departments regulate the operations and solvency of insurers. Disclosures about the risks and uncertainties of complying with or not meeting these existing regulations would be made in insurance entities' financial statements. Examples include capital adequacy and risk-based capital requirements, rate regulation, preapproval of

material reinsurance contracts, limitations on fronting activities, guaranty fund assessments and dividend restrictions.

Life insurance entities' asset-liability matching. Life insurance entities try to plan a reasonable spread between what they will earn on their assets and what they must pay on their liabilities. Because many of these contracts are subject to early withdrawal, information on investment spread, changes in prevailing market interest rates and liquidity would be useful to financial statement users. Proposed note disclosure therefore would include

1. The extent to which investment returns and investment liquidity are matched against the interest rate on liabilities and the estimated duration of liabilities.

2. The impact of possible changes in prevailing market interest rates on the entity's liquidity, financial position and results of operations.

3. Withdrawal characteristics of liabilities for limited-payment contracts, investment contracts and universal life-type contracts, as indicated by the percentage of contractholders'-policyholders' reserves.

INSURANCE AGENTS AND BROKERS

In 1991 the AICPA exposed for comment an industry accounting guide that would provide guidance on applying GAAP in financial statements of insurance agents and brokers. ("Brokers" Will be used to refer to both agents and brokers. ) The insurance agents and brokers task force of the insurance companies committee currently is revising the guide based on comment letters received and on a task force meeting with industry organizations. Briefly, the proposed guide, Insurance Agents and Brokers, recommends the following:

Revenues arising from the place-ment of service. For services involving the placement of insurance cover-age, brokers would recognize revenue for regular commissions, negotiated commissions and shared or split commissions on the revenue recognition date, which is the date when all the following are met:

1. Protection is afforded under the insurance policy (that is, coverage is effective).

2. The premium due under the policy is known or can be reasonably estimated.

3. Substantially all required services related to placing the insurance have been performed. (This generally is the date the premium is billable to the client. )

4. No significant obligation exists to perform services after the insurance has become effective.

Revenues arising from the placement of service when the broker specifically obligates itself to perform services. If a broker specifically obligates itself by agreement with a client or an underwriter to provide services after placing the coverage and subsequent costs can be associated directly with the policy placed by the broker, a portion of the broker's related revenue would be deferred and recognized as the services are performed. A loss would be recognized if it is probable the future costs to provide contractual services will exceed the deferred revenues. A broker that is not obligated, either by contract or by industry practice, to provide services after placing the insurance, but does so either to retain or increase business with the clients, would expense these costs as incurred as period costs.

Costs associated with placing insurance coverage. A broker's costs associated with placing insurance coverage would be expensed as incurred, which is current practice. This practice would continue except for probable losses on subsequent servicing activities, as discussed above.

Reporting certain items as assets and liabilities. Fiduciary funds and premiums receivable would be included as assets, and premiums payable to underwriters would be included as liabilities in brokers' balance sheets. Fiduciary funds, premiums due from clients, advances to underwriters and clients and premiums payable to underwriters would be disclosed in brokers' financial statements.

After the task force and committee meet with industry organizations to discuss the revisions, the AICPA accounting standards executive committee will discuss the proposed revisions and vote on whether to issue the guide at its November meeting.

EXECUTIVE SUMMARY

AcSEC SPOTLIGHTS two important proposals on the insurance industry:

* Insurance Entities' Disclosures Concerning Risks and Uncertainties--a proposed SOP that would require certain note disclosures on risks and uncertainties for insurance companies, insurance holding companies and companies that have significant insurance operations.

* Insurance Agents and Brokers --a proposed industry accounting guide that would codify GAAP for insurance agents and brokers and eliminate existing diversity in their accounting practices.

By ELLISE G. KONIGSBERG, CPA, technical manager of the AICPA accounting standards division. Edited by LINDA A. VOLKERT, CPA, technical manager of the AICPA technical information division.