Official releases: SOP 03-1 ... ethics interpretations and rulings.

Space considerations prevent publishing here the appendices to SOP 03-1. Since the appendices often are important to understanding SOPs, readers are advised to obtain complete copies. To obtain a copy of SOP 03-1 (product no. 014936), contact the AICP4 order department at 888-777-7077.

SOP 03-1--Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts

NOTE

Statements of Position on accounting issues present the conclusions of at least two-thirds of the Accounting Standards Executive Committee, which is the senior technical body of the Institute authorized to speak for the Institute in the areas of financial accounting and reporting. Statement on Auditing Standards No. 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, identities AICPA Statements of Position that have been cleared by the Financial Accounting Standards Board as sources of established accounting principles in category b of the hierarchy of generally accepted accounting principles that it establishes. AICPA members should consider the accounting principles in this Statement of Position if a different accounting treatment of a transaction or event is not specified by a pronouncement covered by Rule 203 of the AICPA Code of Professional Conduct. In such circumstances, the accounting treatment specified by the Statement of Position should be used, or the member should be prepared to justify a conclusion that another treatment better presents the substance of the transaction in the circumstances.

TABLE OF CONTENTS

Summary

Foreword

Introduction and Background

Nontraditional Annuity and Life Insurance Contracts

Applicability and Scope

Conclusions

Separate Account Presentation

Accounting for an Insurance Enterprise's Interest in a Separate Account

Transfers to Separate Accounts

Valuation of Liabilities

Contracts With Death or Other Insurance Benefit Features

Accounting for Contracts That Provide Annuitization Benefits

Sales Inducements to Contract Holders

Disclosures

Effective Date and Transition

APPENDIX A--Basis for Conclusions

Separate Account Presentation

Accounting for an Insurance Enterprise's Interest in a Separate Account

Transfers to Separate Accounts

Valuation of Liabilities

Contracts with Death or Other Insurance Benefit Features

Accounting for Contracts that Provide Annuitization Benefits

Sales Inducements to Contract Holders

Disclosures

Effective Date and Transition

APPENDIX B--Illustration for Presentation of an Insurance Enterprises Interest in a Separate Account

APPENDIX C--Sample Disclosures

APPENDIX D--Application of Statement of Position--Product and Product Feature Examples

APPENDIX E--Illustrations of the Calculation of Minimum Guaranteed Death Benefit Liability

GLOSSARY

SUMMARY

This Statement of Position (SOP) provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. This SOP requires, among other things, the following:

* Separate account presentation. The portion of separate account assets representing contract holder funds should be measured at fair value and reported in the insurance enterprise's financial statements as a summary total, with all equivalent summary total for related liabilities, if the separate account arrangement meets all the criteria specified in paragraph 11 of tiffs SOP. If a separate account arrangement does nor meet the criteria, assets representing contract holder funds under the arrangement should be accounted for and recognized as general account assets. Any related liability should be accounted for as a general account liability.

* Interest in separate accounts. Assets underlying an insurance enterprise's proportionate interest in a separate account do not represent contract holder funds, and thus do not qualify for separate account reporting and valuation. If a separate account arrangement meets the criteria of paragraph 11 of this SOP and (a) the terms of the contract allow the contract bolder to invest in additional units in the separate account or (h) the insurance enterprise is marketing contracts that permit timers to be invested in the separate account, the assets underlying the insurance enterprise's proportionate interest in the separate account should be accounted for in a manner consistent with similar assets held by the general account that the insurance enterprise may be required to sell.

If the insurance enterprise's proportionate interest in the separate account is less than 20 percent of the separate account and all of the underlying investments of the separate account meet the definition of securities under Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, or paragraph 46 of FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, as amended by FASB Statement No. 115, or cash and cash equivalents, the insurance enterprise may report its portion of the separate account value as an investment in equity securities classified as trading under FASB Statement No. 115.

* Gains and losses on the transfer of assets from the general account to a separate account. Assets transferred from the general account to a separate account should be recognized at fair value to the extent of third-party contract holders' proportionate interest in the separate account if the separate account arrangement meets the criteria in paragraph 11 of this SOP Any resulting gain related to the third-party contract holder's proportionate interest should be recognized immediately in earnings of the general account of the insurance enterprise, provided that the risks and rewards of ownership have been transferred to contract holders using the fair value of the asset at the date of the contract homers assumption of risks and rewards. A guarantee of the asset's value or minimum rate of return or a commitment to repurchase the asset would not transfer the risks of ownership, and no gain should be recognized. If the separate account arrangement does not meet the criteria in paragraph 11 of this SOP, the transfer generally should have no financial reporting effect (that is, general account classification and carrying amounts should be retained). However, in certain situations, loss recognition may be appropriate.

* Liability valuation. The basis for determining the balance that accrues to the contract holder for a long-duration insurance or investment contract that is subject to FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments (paragraphs 15 and 17(a)), is the accrued account balance. The accrued account balance equals:

1. Deposit(s) net of withdrawals;

2. Plus amounts credited pursuant to the contract;

3. Less fees and charges assessed;

4. Plus additional interest (for example, persistency bonus); and

5. Other adjustments (for example, appreciation or depreciation recognized in accordance with paragraph 21 of this SOP to the extent not already credited and included in item 2).

For contracts that have features that may result in more than one potential account balance, the accrued account balance should be based on the highest contractually determinable balance that will be available in cash or its equivalent at contractual maturity or the reset date, without reduction for future fees and charges. The accrued account balance should not reflect any surrender adjustments (for example, market value annuity adjustments, surrender charges, or credits). For contracts in which amounts credited as interest to the contract holder ale reset periodically, the accrued balance should be based on the highest crediting rate guaranteed or declared through the reset date.

* Return based on a contractually referenced pool of assets or index. For a contract not accounted for under the provisions of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, that provides a return based on the total return of a contractually referenced pool of assets either through crediting rates or termination adjustments, the accrued account balance should be based on the fair value of the referenced pool of assets (or applicable index value) at the balance sheet date even if the related assets are not recognized at fair value.

* Determining the significance of mortality and morbidity risk and classification of contracts that contain death or other insurance benefit features. To determine the accounting under FASB Statement No. 97 for a contract that contains death or other insurance benefit features, the insurance enterprise should first determine whether the contract is an investment or universal life type contract. If the mortality or morbidity risks are other than nominal and the fees assessed or insurance benefits are not fixed and guaranteed, the contract should be classified as a FASB Statement No. 97 universal-life type contract. There is a rebuttable presumption that a contract has significant mortality risk where the additional insurance benefit would vary significantly in response to capital markets volatility. The determination of significance should be made at contract inception, other than at transition, and should be based on a comparison of the present value of expected excess payments (that is, insurance benefit amounts and related incremental claim adjustment expenses in excess of the account balance) to be made under insurance benefit features with the present value of all amounts expected to be assessed against the contract holder (revenue).

* Accounting for contracts that contain death or other insurance benefit features. For contracts classified as insurance contracts that have amounts assessed against contract holders each period for the insurance benefit feature that are assessed in a manner that is expected to result in profits in earlier years and subsequent losses from that insurance benefit function, a liability should be established in addition to the account balance to recognize the portion of such assessments that compensates the insurance enterprise for benefits to be provided in future periods in accordance with the guidance in paragraphs 26 through 28 of this SOP

* Accounting for reinsurance and other similar contracts. If a reinsurer assumes the insurance benefit feature, the reinsurer should assess the significance of mortality and morbidity risk within the reinsurance contract according to the guidance in paragraphs 24 and 25 of this SOP, regardless of whether there is an account balance. The reinsurer should determine the classification of the reinsurance contract as an investment contract or as an insurance contract at the inception of the reinsurance contract. For reinsurance contracts, the mortality or morbidity risk could be deemed other than nominal even if the original issuer did not determine mortality or morbidity to be other than nominal. Similarly, the issuer of a contract that provides only an insurance benefit feature that wraps a noninsurance contract, for example, a guaranteed minimum death benefit related to a mutual fund balance, should evaluate its contract in the same manner. A reinsurer or issuer of the insurance benefit features of a contract should calculate a liability for the portion of premiums collected each period that represents compensation to the insurance enterprise for benefits that are assessed in a manner that is expected to result in current profits and future losses from the insurance benefit function. That liability should be calculated using the methodology described in paragraphs 26 through 28 of this SOP

* Accounting for annuitization benefits. Contracts may provide for potential benefits in addition to the account balance that are payable only upon annuitization, such as annuity purchase guarantees, guaranteed minimum income benefit (GMIBs), and two-tier annuities. Insurance enterprises should determine whether such contract features should be accounted for under the provisions of FASB Statement No. 133. If the contract feature is not accounted for under the provisions of FASB Statement No. 133, an additional liability for the contract feature should be established if the present value of expected annuitization payments at the expected annuitization date exceeds the expected account balance at the expected annuitization date in accordance with the guidance in paragraphs 31 through 35 of this SOP.

* Sales inducements to contract holders. Sales inducements provided to the contract holder, whether for investment or universal life-type contracts, should be recognized as part of the liability for policy benefits over the period for which the contract must remain in torte for the contract holder to qualify for the inducement or at the crediting date, if earlier, in accordance with paragraph 20 of this SOR No adjustments should be made to reduce the liability related to the sales inducements for anticipated surrender charges, persistency; or early withdrawal contractual features.

Sales inducements that are recognized as part of the liability under paragraph 36 of this SOP, that are explicitly identified in the contract at inception, and that meet the criteria specified in paragraph 37 of this SOP should be deferred and amortized using the same methodology and assumptions used to amortize capitalized acquisition costs,

* Disclosures. The financial statements of an insurance enterprise should disclose information related to the following:

1. Separate account assets and liabilities; the nature, extent, and tinting of minimum guarantees related to variable contracts; and the amount of gains and losses recognized on assets transferred to separate accounts.

2. An insurance enterprise's accounting policy tot sales inducements, including the nature of the costs capitalized and the method of amortizing those costs; the amount of costs capitalized and amortized for each of the periods presented; and the unamortized balance as of each balance sheet date presented.

3. The nature of the liabilities and methods and assumptions used in estimating any contract benefits recognized in excess of the account balance pursuant to paragraphs 20 and 36 of this SOP.

This SOP is effective for financial statements for fiscal years beginning after December 15, 2003, with earlier adoption encouraged. This SOP should not be applied retroactively to prior years' financial statements, Initial application of this SOP should be as of the beginning of an entity's fiscal year.

At the date of initial application of this SOP, an insurance enterprise will have to make various determinations, such as qualification for separate account treatment, FASB Statement No. 115 classification of securities in separate account arrangements not meeting the criteria in paragraph 11 of this SOP, significance of mortality and morbidity risk, adjustments to contract holder liabilities, and adjustments to estimated gross profits or margins, (1) to deter mine the cumulative effect of a change in accounting principle from adopting this SOR Refer to paragraphs 41 through 43 of this SOP for specific transition guidance.

FOREWORD

The accounting guidance contained in this document has been cleared by the Financial Accounting Standards Board (FASB). The procedure for clearing accounting guidance in documents issued by the Accounting Standards Executive Committee (AcSEC) involves the FASB reviewing and discussing in public board meetings (1) a prospectus for a project to develop a document, (2) a proposed exposure draft that has been approved by at least 10 of AcSEC's 15 members, and (3) a proposed final document that has been approved by at least 10 of AcSEC's 15 members. The document is cleared it at least four of the seven FASB members do not object to AcSEC undertaking the project, (1) issuing the proposed exposure draft or, after considering the input received by AcSEC as a result of the issuance of the exposure draft, issuing the final document.

The criteria applied by the FASB in its re view of proposed projects and proposed documents include the following:

1. The proposal does not conflict with current or proposed accounting requirements, unless it is a limited circumstance, usually in specialized industry accounting, and the proposal adequately justifies the departure.

2. The proposal will result in an improvement in practice.

3. The AICPA demonstrates the need for the proposal.

4. The benefits of the proposal are expected to exceed the costs of applying it.

In many situations, prior to clearance, the FASB will propose suggestions, many of which are included in the documents.

INTRODUCTION AND BACKGROUND

Nontraditional Annuity and Life insurance Contracts

1. At the time that Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards No. 60, Accounting and Reporting by Insurance Enterprises, as amended, and No. 97, Accounting and Reporting b), Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, were issued, annuity and 1Re insurance contracts were generally one of two basic designs: fixed or variable. Traditional fixed annuity and life insurance contracts, typically offered through an insurance enterprise's general account, (1) provide for a fixed rate of interest over some specified period, with the insurance enterprise bearing the investment risk associated with the invested assets. Traditional variable annuity and variable life insurance contracts, by contrast, offered through an insurance enterprise's separate account, provide that all investment risks associated with the separate account assets are passed through to the contract holder, with no guarantees of return of principal, minimum crediting rates or, for annuity contracts, minimum death benefits.

2. More recently, annuity and life products with nontraditional terms have been developed. Some of those products may combine fixed and variable features and are sold as general account or separate account products. The features of nontraditional contracts are many and complex, and may be offered in different combinations, such that there are numerous variations of the same basic products being sold in the marketplace. See examples of products in Appendix D of this Statement of Position (SOP).

3. A common feature in variable annuities is a minimum guaranteed death benefit (MGDB), such as a death benefit equal to the total deposits made by the contract holder less any withdrawals, referred to as "return of premium" or "basic" MGDB. Although the return of premium MGDB has become increasingly common in variable annuities, the trend has been for insurers to offer MGDBs with more extensive benefit guarantees, such as:

a. A death benefit equal to the total of deposits made to the contract less an adjustment for partial withdrawals, accumulated at a specified interest rate, often referred to as "roll up"

b. A death benefit equal to the account balance on a specified anniversary date adjusted for deposits less partial withdrawals since the specified anniversary date, often referred to as "reset."

c. A death benefit equal to the highest account balance among prior specified anniversary dares adjusted for deposits less partial withdrawals since the specified anniversary date, often referred to as "ratchet."

Another example of an insurance benefit feature is a no-lapse guarantee, in which the company agrees to keep the insurance policy in force even when the account balance is not sufficient to pay the cost of insurance.

4. Some annuities may provide for potential benefits in addition to the account balance, payable only if annuitization is elected. For ex ample, some deferred variable annuities now provide that, regardless of separate account performance, a guaranteed minimum amount is available to annuitize after a specified period, thereby providing a guaranteed minimum income benefit (GMIB) if the contract holder elects to annuitize. This benefit is in addition to the guaranteed minimum annuity interest rate traditionally offered. Another type of deferred annuity may provide multiple crediting rates throughout the life of the contract depending on whether the contract holder elects to terminate or annuitize the contract. An example is a contract that applies a lower rate to funds de posited if the contract holder elects to surrender the contract for cash, and a higher rate if the contract holder elects to annuitize, often referred to as a "two-tier" annuity.

5. Contracts also exist that potentially may be viewed as providing multiple account balances, for example, a contract that provides a return based on a contractually referenced pool of real estate assets owned by the insurance enterprise but also provides for minimum investment return guarantees. Other contracts may exist that provide for the return of principal and interest if held until maturity or a specified "market adjusted value" if surrendered at an earlier dare.

6. Sales inducements to contract holders may be offered with fixed and variable life insurance and annuity contracts. Those inducements may be offered in many forms, including an immediate bonus, a persistency bonus credited to the contract holder's account after a specified period, or an enhanced crediting rate, or "bonus interest" rate, in the initial period(s) of the contract.

7. FASB Statement No. 97 provides no explicit accounting guidance for the above examples of nontraditional contract features. This SOP ad dresses the insurance enterprise's accounting for certain contract features not covered by other authoritative accounting literature, including asset, liability, revenue, and expense recognition. Embedded derivatives contained in nontraditional contracts should be accounted for in accordance with FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and its related guidance. (2)

8. In addition, this SOP addresses the insurance enterprise's accounting for separate account assets and liabilities related to contracts for which all or a portion of the investment risk is borne by the insurer.

APPLICABILITY AND SCOPE

9. This SOP is applicable to all entities to which FASB Statement No. 60, as amended, applies, hereinafter referred to as insurance enterprises. (3)

CONCLUSIONS

Separate Account Presentation

10. Separate account assets and liabilities should be included in the financial statements of the insurance enterprise that owns the assets and is contractually obligated to pay the liabilities.

11. The portion of separate account assets representing contract holder funds should be measured at fair value and reported in the insurance enterprise's financial statements as a summary total, with an equivalent summary total reported for related liabilities, if the separate account arrangement meets ,all of the following conditions:

a. The separate account is legally recognized. That is, the separate account is established, approved, and regulated under special rules such as state insurance laws, federal securities laws, or similar foreign laws.

b. The separate account assets supporting the contract liabilities are legally insulated from the general account liabilities of the insurance enterprise (that is, the contract holder is not subject to insurer default risk to the extent of the assets held in the separate account).

c. The insurer must, as a result of contractual, statutory, or regulatory requirements, invest the contract holder's funds within the separate account as directed by the contract holder in designated investment alternatives or in accordance with specific investment objectives or policies.

d. All investment performance, net of contract fees and assessments, must as a result of contractual, statutory, or regulatory requirements be passed through to the individual contract holder. Contracts may specify conditions under which there may be a minimum guarantee, but not a ceiling, as a ceiling would prohibit all in vestment performance from being passed through to the contract holder.

For the portion of separate account arrangements meeting these criteria, the related investment performance (including interest, dividends, realized gains and losses, and changes in unrealized gains and losses) and the corresponding amounts credited to the contract holder should be offset within the same statement of operations line item netting to zero. Contract fees and assessments should be reported in accordance with FASB Statement No. 97, paragraph 19. Any liabilities related to minimum guarantees and insurance benefit liabilities under the contracts in excess of the fair value of separate account assets representing contract holder fun& should be recognized as general account liabilities.

12. If a separate account arrangement does not meet the criteria in paragraph 11 of tiffs SOP, assets representing contract holder funds under the arrangement should be accounted for (measured and presented) the same as other general account assets as prescribed in paragraphs 45 through 51 of FASB Statement No. 60, as amended. Any related liability should be accounted for as a goner al account liability; Revenue and expenses related to such arrangements should he recognized within the respective revenue and expense lines in the statement of operations. Arrangements in which contract holders' funds are maintained in separate accounts to fund fixed account options of variable contracts, market value adjusted con tracts, guaranteed investment contracts, and indexed contracts are examples of separate account arrangements that would not meet the criteria in paragraph 11 because all of the investment performance on these investments is not passed through to the connect holder.

Accounting for an Insurance Enterprise's Interest in a Separate Account

13. Assets underlying an insurance enterprise's proportionate interest in a separate account (seed money or other investment as described in paragraph A12 of this SOP) do not represent contract holder funds, and thus do not qualify for separate account accounting and reporting. The insurance enterprise should "look through" the separate account (4) for purposes of accounting for its interest therein, and account for and classify the assets of the separate account underlying that interest based on their nature as if the assets of the separate account underlying the insurance enterprise's proportionate interest were held directly by the general account rather than through the separate account structure. (5)

14. If a separate account arrangement meets the criteria in paragraph 11 of this SOP, and (a) the terms of the contract allow the contract holder to invest in additional units in the separate account or (b) the insurance enterprise is marketing contracts that permit funds to be invested in the separate account, the assets of the separate account underlying the insurance enterprise's proportionate interest in the separate account should be accounted for in a manner consistent with the accounting for similar assets held by the general account that the insurance enterprise may be required to sell. For example:

a. For a debt or equity security with an unrealized loss, the loss should be accounted fur as an other than temporary impairment consistent with the guidance of FASB Statement No, 115, Accounting for Certain Investments in Debt and Equity Securities, and recognized immediately in the statement of operations as a realized loss.

b. The guidance in FASB Statement No. 144, Accounting for the Investment or Disposal of Long-Lived Assets, should be followed for both real estate that is held for sale and real estate that is not held for sale. For real estate that does not meet the FASB Statement No. 144 held for sale criteria, the impairment test should be performed solely using undiscounted cash flows assuming immediate disposition.

Transfers to Separate Accounts

15. Assets transferred from the general account to a separate account should be recognized at fair value to the extent of the third-party contract holders' proportionate interests in the separate account if the separate account arrangement meets the criteria in paragraph it of this SOP. Any resulting gain related to the third-party contract holders' proportionate interest should be recognized immediately in earnings of the general account of the insurance enterprise provided that the risks and rewards of ownership have been transferred to contract holders using the fair value of the asset at the date of the contract holders' assumption of risks and rewards. (6) A guarantee of the asset's value or minimum rate of return or a commitment to repurchase the asset would not transfer the risks of ownership, and no gain should be recognized. If the separate account arrangement does not meet the criteria in paragraph 11 of this SOP, the transfer generally should have no financial reporting effect (that is, general account classification and carrying amounts should be retained). Consistent with the guidance in footnote 9 of this SOP, the insurance enterprise should recognize an impairment loss on an asset transferred from the general account to a separate account not meeting the criteria in paragraph 11 of this SOP if the terms of the arrangement with the contract holder are such that the insurance enterprise will not be able to recover the asset's carrying value. The insurance enterprise should recognize an impairment loss on its proportionate interest in a separate account arrangement meeting the criteria in paragraph 11, in a situation where the current fair value of the insurance enterprise's proportionate interest in the separate account assets is less than its carrying amount.

16. If the transferred asset is subsequently sold by the separate account, any remaining unrecognized gain related to the insurance enterprise's proportionate interest should be recognized immediately in the earnings of the general account of the insurance enterprise. If third-party contract holders' proportionate interests in the separate account are subsequently increased, or the insurance enterprise otherwise reduces its proportionate interest in the separate account arrangement that meets the criteria in paragraph 11 of this SOP, the reduction in the insurance enterprise's proportionate interest may result in additional gain. If an insurance enterprise's proportionate interest subsequently increases as a result of transactions executed at fair value (for example, at net asset value), the increase is considered a purchase from the contract holder and should be recognized at fair value.

17. For example, the general account transfers to the separate account arrangement, as seed money, a debt security with a book value of $60 and a fair value of $100. No gain is recognized on the initial transfer to the separate account arrangement. Contract holders subsequently direct $100 to the separate account arrangement, reducing the general account's proportionate interest to 50 percent. Assuming the fair value of the debt security is still $100, the general account recognizes a gain of $20, as a result of the contract holder investment into the separate account arrangement. In subsequent years, if the insurance enterprise reduces its interest in the separate account arrangement through withdrawal of cash or additional investment by contract holders, additional gains would be recognized if the fair value of the security continues to exceed the genera account's basis hi the security.

18. If the insurance enterprise's proportionate interest in the separate account is less than 20 percent of the separate account and all of the underlying investments of the separate account meet the definition of securities under FASB Statement No. 115 or paragraph 46 of FASB Statement No. 60, as amended by FASB Statement No. 115, or cash and cash equivalents, the insurance enterprise may report its portion of the separate account value as an investment in equity securities under FASB Statement No. 115. This investment should be classified as trading and accounted for under the guidance in FASB Statement No. 115. The guidance in paragraphs 13 through 17 of this SOP should he applied when an insurance enterprise's proportionate interest in the separate account represents 20 percent or greater of the separate account interest, or when the underlying investments are other than those that meet the definition of securities under FASB Statement No. 115 or paragraph 46 of FASB Statement No. 60, as amended by Statement No. 115, or cash and cash equivalents.

Valuation of Liabilities

19. Paragraphs 20 through 23 of this SOP provide guidance for determining the balance that accrues in the benefit of contract holders under paragraphs i5 and 17(a) of FASB Statement No. 97. Paragraphs 24 through 30 of this SOP provide guidance for determining any addition al liability for death or other insurance benefit features under paragraph 17(b) of FASB Statement No. 97. Paragraphs 31 through 35 of this SOP provide guidance for determining any additional liability for potential benefits available only upon annuitization. Paragraph 36 of this SOP provides guidance for determining any additional liability for sales inducements.

20. The balance that accrues to the benefit of the contract holder for a long-duration insurance or investment contract that is subject to FASB Statement No. 97 (paragraphs 15 and 17(a)) is the accrued account balance. The accrued account balance (7) equals:

a. Deposit(s) net of withdrawals;

b. Plus amounts credited pursuant to the con tract:

c. Less fees and charges assessed;

d. Plus additional interest (for example, persistency bonus); and

e. Other adjustments (for example, appreciation or depreciation recognized in accordance with paragraph 21 of this SOP to the extent not already credited and included in b above).

For purposes of item d above, additional interest is an amount that is required to be accrued under the liability, valuation model that has not yet been credited to the contract holder's account. Additional interest, if any, should be accrued through the balance sheet date at the rate that would accrue to the balance available in cash, or its equivalent,8 before reduction for future fees and charges, at the earlier of the date that the interest rate credited to the contract is reset or contractual maturity. The reset date is the date at which the existing contractually declared investment return expires.

21. Some contracts, such as variable life and annuity and certain group pension participating and other experience-rated contracts, provide for a return through periodic crediting rates, surrender adjustments, or termination adjustments based on the total return of a contractually referenced pool of assets owned by the insurance enterprise. Insurance enterprises should determine whether such contracts will be accounted for under the provisions of FASB Statement No. 133Y To the extent the contract is not accounted lot under the provisions of FASB Statement No. 133, the amount of other adjustments described in paragraph 20 of this SOP should be based on the fair value of the referenced pool of assets at the balance sheet date, even if the related assets are not recognized at fair value, to the extent not already credited to the accrued account balance and included in paragraph 20(b) of this SUE Amounts determined for other adjustments are not reduced for future fees and charges. (10)

22. For contracts that have features that may result in more than one potential account balance (for example, a contract that provides a return based on a contractually referenced pool of real estate assets owned by the insurance enterprise but also provides for minimum investment return guarantees), the accrued account balance should be based on the highest contractually determinable balance that will be available in cash or its equivalent at contractual maturity or the reset date, before reduction for future fees and charges. For contracts in which amounts credited as interest to the contract holder are reset periodically, the accrued balance should be based on the highest crediting rate guaranteed or declared through the reset date.

23. The accrued account balance should not reflect surrender adjustments (for example, market value annuity adjustments, (11) surrender charges, or credits). Any changes in the accrued account balance resulting thorn the application of the guidance in paragraphs 20 through 22 of this SOP should be reflected in net income in the period of the changes.

Contracts With Death or Other Insurance Benefit Features

Determining the Significance of Mortality and Morbidity Risk and Classification of Contracts That Contain Death or Other Insurance Benefit Features

24. To determine the accounting under FASB Statement No. 60 or No. 97 for a contract that contains death or other insurance benefit features, the insurance enterprise should first determine whether the contract is an investment or insurance contract. Classification of a con tract as an investment contract or as an insurance contract should be made at contract inception, and the classification should not be reassessed during the accumulation phase of the contract. If the mortality and morbidity risk associated with insurance benefit features offered in a contract is deemed to be nominal, that is, a risk of insignificant (12) amount or remote (13) probability, the contract should be classified as an investment contract; otherwise, it should he considered an insurance contract, There is a rebuttable presumption that a con tract has significant mortality risk where the additional insurance benefit would vary significantly in response to capital markets volatility. If rite mortality or morbidity risk is other than nominal and the fees assessed or insurance benefits are not fixed and guaranteed, the contract should be classified as an FASB Statement No. 97 universal life-type contract by the insurance enterprise. If the fees assessed on a contract and insurance benefits provided by the contract are fixed and guaranteed or if the contract is short duration, the contract should be classified under FASB Statement No. 60, as amended.

25. The determination of significance of mortality or morbidity risk should be based on a comparison of the present value of expected excess payments to be made under insurance benefit features (that is, insurance benefit amounts and related incremental claim adjustment expenses in excess of the account balance, herein referred to as the "excess payments") with the present value of all amounts expected to be assessed against the contract bolder (revenue). For contracts that include investment Margin (14) in their estimated gross profits, (15) the investment margin should be included with any other assessments for purposes of determining significance. In performing the analysis, an insurance enterprise should consider both frequency and severity under a full range of scenarios that considers the volatility inherent in the assumptions, rather than making a best estimate using one set of assumptions. For example, it-the annuity contract is a variable annuity contract, the insurance enterprise should consider a range of fund return scenarios. When considering a range of scenarios, the insurance enterprise should consider historical investment returns, the volatility" of those returns, and expected future returns, as applicable.

Accounting for a FASB Statement No. 97 Universal Life-Type Contract With Death or Other Insurance Benefit Features

26. For a contract determined to meet the definition of an insurance contract as described in paragraphs 24 and 25, if the amounts assessed against the contract holder each period for the insurance benefit feature ;Ire assessed in a manner that is expected to result in profits in earlier years and losses in subsequent years from the insurance benefit function, a liability should be established in addition to the account balance to recognize the portion of such assessments that compensates the insurance enterprise for benefits to be provided in future periods. Insurance coverage encompasses the concepts of amounts at risk and the relative probability of mortality and morbidity events. The amount of the additional liability should be determined based on the ratio (benefit ratio) of(a) the present value of total expected excess payments over the life of the contract, divided by (b) the present value of total expected assessments over the life of the contract. The benefit ratio may exceed 100 percent, resulting in a liability that exceeds cumulative assessments. Total expected assessments are the aggregate of all charges, including those for administration, mortality, expense, and surrender, regardless of how characterized. For contracts in which the assets are reported in the general account and that include investment margin in their estimated gross profits, the investment margin should be included with any other assessments for purposes of determining total expected assessments. The insurance enterprise should calculate the present value of total expected excess payments and total assessments and investment margins, as applicable, based on expected experience. Expected experience should be based on a range of scenarios rather than a single set of best estimate assumptions. In calculating the additional liability for the insurance benefit feature, assumptions used, such as the interest rate, discount rate, lapse rate, and mortality, should be consistent with assumptions used in estimating gross profits for purposes of amortizing capitalized acquisition costs. For contracts in which assessments are collected over a period significantly shorter than the period for which the contract is subject to mortality and morbidity risks, the assessment would be considered a front-end fee under FASB Statement No. 97 and accounted for under paragraph 20 of that Statement. The amounts recognized in income should be considered assessments for purposes of this paragraph.

27. The insurance enterprise should regularly evaluate estimates used and adjust the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. In making such revised estimates, both the present value of total excess payments and the present value of total expected assessments and investment margins, should be calculated as of the balance sheet date using historical experience from the issue date to the balance sheet date and estimated experience thereafter.

28. The additional liability at the balance sheet date should he equal to:

a. The current benefit ratio multiplied by the cumulative assessments (16)

b. Less the cumulative excess payments (including amounts reflected in claims payable liabilities)

c. Plus accreted interest

However, in no event should the additional liability balance be less than zero. The change in the additional liability should be recognized as a component of benefit expense in the statement of operations.

29. The estimated gross profits used for the amortization of deferred acquisition costs should be adjusted to reflect the recognition of the liability in accordance with paragraph 28 of this SOP.

Accounting for Reinsurance and Other Similar Contracts

If a reinsurer assumes the insurance benefit feature, the reinsurer should assess the significance of mortality and morbidity risk within the reinsurance contract according to the guidance in paragraphs 24 and 25 of this SOP, regardless of whether there is an account balance. The reinsurer should determine the classification of the reinsurance contract as an investment contract or as an insurance contract at the inception of the reinsurance contract. For reinsurance cola tracts, the mortality or morbidity risk could be deemed other than nominal even if" the original issuer did not determine mortality or morbidity to be other than nominal. There is a rebuttable presumption that a contract has significant mortality risk where the additional insurance benefit would vary significantly in response to capital markets volatility Similarly, the issuer of a contract that provides only an insurance benefit feature that wraps (17) a noninsurance con tract, for example, a guaranteed minimum death benefit related to a mutual fund balance, should evaluate its contract in the same manner. A reinsurer or issuer of the insurance benefit features oft contract should calculate a liability for the portion of premiums collected each period that represents compensation to the insurance enterprise for benefits that are assessed in a manner that is expected to result in current profits and future losses from the insurance benefit function. That liability should be calculated using the methodology described in paragraphs 26 through 28 of this SOP. For example, a reinsurance contract that assumes only the risk related to the MGDB feature for a fee that varies with the account balance rather than with the insurance coverage provided would be a FASB Statement No. 97 universal life-type contract and the contract should be accounted for in accordance with paragraphs 26 through 28 of this SOP.

Accounting for Contracts That Provide Annuitization Benefits

31. Contracts may provide for potential benefits in addition to the account balance that are payable only upon annuitization, such as annuity purchase guarantees, GMIBs and two-tier annuities. Insurance enterprises should determine whether such contract features should be accounted for under the provisions of FASB Statement No. 133. (18) If the contract feature is not accounted for under the provisions of FASB Statement No. 133, an additional liability for the contract feature should be established if the present value of expected annuitization payments at the expected annuitization date exceeds the expected account balance at the expected annuitization date. The amount of the additional liability should be determined based on the ratio (benefit ratio) of(a) the present value of expected annuitization payments to be made and related incremental claim adjustment expenses, discounted at estimated in vestment yields expected to be earned during the annuitization phase of the contract, minus the expected accrued account balance at the expected annuitization date (the "excess payments"), divided by (b) the present value of total expected assessments during the accumulation phase of the contract. Total expected assessments are the aggregate of all charges, including those for administration, mortality, expense, and surrender, regardless of how characterized. For contracts whose assets are reported in the general account and that include investment margin in their estimated gross profits, the investment margin should be included with any other assessments for purposes of determining total expected assessments. The insurance enterprise should calculate the present value of total expected excess payments and total assessments and investment margins, as applicable, based on expected experience. Expected experience should he based on a range of scenarios that considers the volatility inherent in the assumptions rather than a single set of best estimate assumptions. In calculating the additional liability for the additional benefit feature, assumptions used, such as the interest rate, discount rate, lapse rate, and mortality, should be consistent with assumptions used in estimating gross profits for purposes of amortizing capitalized acquisition costs. When determining expected excess payments, the expected annuitization rate is one of the assumptions that needs to be estimated.

32. The insurance enterprise should regularly evaluate estimates used and adjust the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. In making such revised estimates, both the present value of total excess payments and the present value of total expected assessments or investment margins should be calculated as of the balance sheet date using historical experience from the issue date to the balance sheet date and estimated experience thereafter.

33. The additional liability at the balance sheet date should be equal to:

a. The current benefit ratio multiplied by the cumulative assessments

b. Plus accreted interest

c. Less, at time of annuitization, the cumulative excess payments determined at annuitization

However, in no event should the additional liability balance be less than zero. The change in the additional liability should he recognized as a component of benefit expense in the statement of operations. "Cumulative excess payments determined at annuitization" represent the amount that should be deducted at the actual date of annuitization. That amount should be calculated as the present value of expected annuity payments and related claim adjustment expenses discounted at expected investment yields minus the accrued account balance at the actual annuitization date. On the date of annuitization, the additional liability related to the cumulative excess benefits will be zero and the amount deducted will be used in the calculation of the liability for the payout annuity.

34. The estimated gross profits used for the annuitization of deferred acquisition costs should be adjusted to reflect the recognition of the liability determined in accordance with paragraph 32 of this SUE Capitalized acquisition costs should continue to be amortized over the present value of estimated gross profits (as adjusted above) over the expected life of the book of contracts. For purposes of amortization of deferred acquisition costs, the life of the book of contracts excludes the annuitization phase.

35. A reinsurer may agree to reinsure all or a portion of the additional benefits described in paragraph 31 of this SOP. Both the ceding company and the reinsurer should determine whether such a reinsurance contract should be accounted for under the provisions of FASB Statement No. 133. For example, unlike many of the direct contracts that contain GMIB benefits, contracts to reinsure GM1B benefits often meet the definition of a derivative under FASB Statement No. 133. If the reinsurance contract should not be accounted for under the provisions of FASB Statement No. 133, the guidance in paragraphs 31 through 34 of this SOP should be followed.

Sales Inducements to Contract Holders

36. Sales inducements provided to the contract holder, whether for investment or universal life-type contracts, should be recognized as pal t of the liability for policy benefits over the period in which the contract must remain in force for the contract holder to qualify for the inducement or at the crediting date, if earlier, in accordance with paragraph 20 of this SOP. No adjustments should be made to reduce the liability related to the sales inducements for anticipated surrender charges, persistency, or early withdrawal contractual features.

37. Sales inducements that (a) are recognized as part of the liability under paragraph 36 of this SOP, (b) are explicitly identified in the contract at inception, and (c meet the criteria in the following sentence should be deferred and amortized using the same methodology and assumptions used to amortize capitalized acquisition costs. The insurance enterprise should demonstrate that such amounts are (a) incremental to amounts the enterprise credits on similar contracts without sales inducements and (b) higher than the contract's expected ongoing crediting rates for periods after the inducement, as applicable; that is, the crediting rate excluding the inducement should be consistent with assumptions used in estimated gross profits, contract illustrations, and interest-crediting strategies. Due to the nature of day-one and persistency bonuses, the criteria in the preceding sentence are generally met. The deferred amount should be recognized on the statement of financial position as an asset, and amortization should be recognized as a component of benefit expense. The annuitization phase is viewed as a separate contract under FASB Statement No. 97, and should not he combined with the accumulation phase for amortization of deferred sales inducements.

Disclosures

38. The following information should be disclosed in the financial statements of the insurance enterprise:

a. The general nature of the contracts reported in separate accounts, including the extent and terms of minimum guarantees.

b. The basis of presentation for separate account assets and liabilities and related separate account activity

c. A description of the liability valuation methods and assumptions used in estimating the liabilities for additional insurance benefits and minimum guarantees.

d. Disclosures should include the following amounts related to minimum guarantees:

(1) The separate account liability balances subject to various types of benefits (for example, guaranteed minimum death benefit, guaranteed minimum income benefit, guaranteed minimum accumulation benefit). Disclosures within these categories of benefits for the types of guarantees provided may also be appropriate (for example, return of net deposits, return of net deposits accrued at a stated rate, return of highest anniversary value).

(2) The amount of liability reported for additional insurance benefits, annuitization benefits and other minimum guarantees, by type of benefit, for the most recent balance sheet date and the incurred and paid amounts for all periods presented.

(3) For contracts for which an additional liability is disclosed in paragraph 38(d)(2), net amount at risk and weighted average attained ,age of contract holders.

e. The aggregate fair value of assets, by major investment asset category, supporting separate accounts with additional insurance benefits and minimum investment return guarantees as of each date for which a statement of financial position is presented.

f. The amount of gains and losses recognized on assets transferred to separate accounts lot the periods presented.

39. An insurance enterprise should disclose its accounting policy for sales inducements, including the nature of the costs deferred and the method of amortizing those costs. The amount of costs deferred and amortized for each of the periods presented and the unamortized balance as of each balance sheet date also should be disclosed.

EFFECTIVE DATE AND TRANSITION

40. The provisions of this SOP are effective for financial statements for fiscal years beginning after December 15, 2003, with earlier adoption encouraged. Restatement of previously issued annual financial statements or reclassification between separate account and general account balances is not permitted. Initial application of this SOP should be as of the beginning of an entity's fiscal year (that is, if the SOP is adopted prior to the effective date and during an interim period, all prior interim periods should be restated). Disclosure of the pro forma effects of retroactive application (discussed in paragraph 21 of Accounting Principles Board (APB) Opinion No. 20, Accounting Changes) or the pro forma effect on the year of adoption is not require&

41. At the date of initial application: a, For assets that no longer qualify for separate account treatment:

(1) Debt or equity securities previously classified as separate account assets but valued in accordance with FASB Statement No. 115 should maintain their designations as held-to-maturity, available-for sale, or trading upon reclassification to the genera[ account.

(2) The provisions of PASB Statement No. 115 should be adopted for any debt or equity securities previously recognized at fair value in accordance with paragraph 54 of FASB Statement No. 60, as amended. Any adjustment for FASB Statement No. 115 designation resulting from initial adoption should be reported in a manner similar to the cumulative effect of a change in accounting principle in accordance with the provisions of APB Opinion No. 20 and paragraph 25 of FASB Statement No. 115:

(a) If designated as held-to-maturity, the adjustment should be reported through income.

(b) If designated as available-for-sale, the adjustment should be reported in income, with a corresponding cumulative effect adjustment for the unrealized holding gains and losses reported in other comprehensive income.

(c) If designated as trading, there should be no adjustment.

(3) Any revaluation adjustments related to assets that are not subject to FASB Statement No. 115 should be reported in a manner similar to the cumulative effect of a change in accounting principle in accordance with the provisions of APB Opinion No. 20.

b. The guidance in paragraph 41(a) of this SOP should be applied in accounting for an insurance enterprise's proportionate interest in the separate account assets regardless of whether the interest was previously reported in the separate account or the general account. If the insurance enterprise considered its portion of separate account units to be equity securities under FASB Statement No. 115, the guidance in paragraph 41 (a)0) or (3) should be applied as appropriate.

c. To the extent a debt or equity security subject to FASB Statement No. 115 and previously classified as available-for-sale is part of a contractually referenced pool of assets in which total return will be accrued to the account balance (in accordance with paragraph 21 of this SOP), and a transition adjustment for the liability valuation is reported hi accordance with 41 (e), that security may be reclassified to trading with the revaluation adjustment recognized as a cumulative effect similar to the liability transition adjustment.

d. For contracts that are in force on the date of initial application of this SOP, the determination of significance of mortality and morbidity risk resulting from insurance benefit features, in accordance with paragraphs 24 through 25 of this SOP, should be performed as of the date of initial application of this SOP using both actual results from inception of the contract through the date of initial application and expected future results thereafter.

e. Any adjustment in contract holder liabilities h-ore adopting this SOP should be reported in a manner similar to the cumulative effect of a change in accounting principle in accordance with the provisions of APB Opinion No. 20, through income or, for amounts previously accrued under Emerging Issues Task Force (EITF) Topic No. D 41, Adjustments in Assets and Liabilities for Holding Gains and Losses as Related to the Implementation of FASB Statement No. 115, accumulated other comprehensive income.

f. If the adoption of this SOP results in changes in estimated gross profits, any adjustments to unamortized deferred acquisition costs or pro sent value of future profits (19) should be reported in a manner similar to the cumulative effect oft change in accounting principle in accordance with the provisions of APB Opinion No. 20, through income or. for amounts previously accrued under EITF Topic No. D-41, accumulated other comprehensive income.

42. This SOP should he applied prospectively with respect to the deferral of sales inducements meeting the criteria in paragraph 37 of this SOR Sales inducements deferred subsequent to the initial application of this SOP on policies in force at that date should be accounted for in accordance with paragraph 37 of this SOR Costs recognized for sales inducements prior to initial application of this SOP other than for those referred to in paragraph 43 of this SOP, whether capitalized or not, should not he adjusted to the amounts that would have been deferred had this SOP been in effect when those costs were incurred. Costs capitalized for sales inducements prior to initial application of this SOP that were previously reported with unamortized deferred acquisition costs should be reported separately. 43. Insurance enterprises that were previously amortizing sales inducements using the same methodology and assumptions used for amortizing deferred acquisition costs (the approach required by the guidance in this SOP) should continue using that approach and should consider the entire life of the contracts. Any cumulative adjustment to unamortized sales inducements resulting from changes in estimated gross profits, made as a result of the initial adoption of this SOP, should be reported in a manner similar to the cumulative effect oft change in accounting principle in accordance with the provisions of APB Opinion No. 20, through net income or, for amounts previously accrued under EITF Topic No. D-41, accumulated other comprehensive income. However, if an insurance enterprise had been amortizing sales inducements using a methodology or assumptions other than those used for amortizing deferred acquisition costs, the amortization of deferred sales inducements after implementation of this SOP should consider only estimated gross profits or interest, as applicable, depending on the amortization methodology, from the date of initial application forward.

The provisions of this Statement need not be applied to immaterial items.

GLOSSARY

accumulation phase. The period during an annuity contract prior to annnuitization. An insurance enterprise may refer to this type of annuity as a deferred annuity.

annuitization phase. The period during which the contract holder is receiving periodic payments from an annuity, also referred to as the payout phase.

general account. All operations of an insurance enterprise that are not reported in the separate account(s).

guaranteed investment option. Component oft variable contract that guarantees a specific rate of performance.

guaranteed minimum income benefit (GMIB). Benefit normally offered with deferred variable annuities to provide a guaranteed minimum amount available for annuitization after a specified period in addition to a guaranteed minimum annuity rate. That is, the fixed periodic annuity payments would be determined using the higher of the current accumulated account value that exists at the date of annuitization or the guaranteed amount.

long-term care (LTC) benefit. Benefit offered in an annuity product with a rider providing amounts in excess of the account balance to provide for LTC benefits if contract holder meets the criteria for restrictions on activities of daily riving.

minimum guaranteed death benefit (MGDB). A feature in an annuity, life insurance, or similar contract that provides that in the event of an insured's death, the beneficiary (or insurer in the case of a reinsurance contract) will receive the higher of the current account balance of the contract or another amount defined in the contract.

morbidity. The relative incidence of disability due to disease or physical impairment.

mortality. The relative incidence of" death in a given time or place.

net amount at risk. The guaranteed benefit in excess of the current account balance. For guarantees in the event of death, the net amount at risk is the minimum guaranteed amount available to the contract holder upon death in excess of the contract holder's account balance at the balance sheet date. For guarantees of amounts at annuitization, the net amount at risk is defined as the present value of the minimum guaranteed annuity payments available to the contract holder determined in accordance with the terms of the contract in excess of the current account balance.

sales inducements. Sales inducements are product features that enhance the investment yield to the contract holder on the contract. The three main types of sales inducements are (1) day-one bonus, which increases the account value at inception, also called immediate bonus; (2) persistency bonus, which increases the account value at the end of a specified period; and (3) enhanced yield, which credits interest for a specified period in excess of rates currently being offered for other similar contracts.

seed money. An investment of non contract holder finds by an insurer in a separate account when it is established, to support the initial or ongoing operations of the separate account.

separate account. A separate investment ac count established and maintained by an insurance enterprise under relevant state insurance law to which funds have been allocated for certain contracts of the insurance enterprise or similar accounts used for foreign originated products. Often for administrative purposes, separate account subaccounts with differing in vestment objectives are created within a single separate account.

separate account arrangement. An arrangement under which all or a portion of a contract holder's funds is allocated to a specific separate account maintained by the insurance enterprise, Examples include a variable life insurance contract offered through all insurance enterprise's high return separate account and a contract holder's allocation of a portion of his or her deposit in a deferred variable annuity to a growth equity fund.

traditional variable annuity. An insurance product in which all the contract holder's payments are used to purchase units of a separate account. The contract holder directs the allocation of the account value among various investment alternatives and bears the investment risk. The units may be surrendered for their current value in cash (usually less a surrender change) or applied to purchase annuity income. The insurance enterprise periodically deducts mortality and expense charges from the account.

Accounting Standards Executive Committee (2002-2003)

Mark V. Sever, Chair

Mark M. Bielstein

Val R. Bitton

Lawrence N. Dodyk

Karin A. French

James A. Koepke

Robert J. Laux

Francis T. McGettigan

Andrew M. Mintzel

Richard H. Moseley

Benjamin S. Neuhausen

Coleman D. Ross

Ashwinpaul C. Sondhi

Mary S. Stone

Brent A. Woodford

Nontraditional Long-Duration Contracts Task Force

Thomas W. Walsh, Chair

Thomas A. Campbell

Thomas M. Daugherty

Donald A. Doran

David L. Holman

David A. Jacoby

Deborah Koltenuk

L. James Kortan

Paula C. Panik

Kevin Spataro

AICPA Staff

Kim Kushmerick Hekker

Technical Manager

Accounting Standards

Daniel J. Noll

Director

Accounting Standards

AcSEC gratefully acknowledges the contributions of Mary Jane Fortin, Ellen M. Hancock, Ken Height, Elaine Lehnert, John Pintozzi, Susan J. Stature, Dave Sandberg, Mary S. Saslow, Chris C. Stroup, and Deborah H. Whitmore.

Ethics Interpretations and Rulings

Ethics interpretations and rulings are promulgated by the executive committee of the professional ethics division to provide guidelines as to the scope and application of the rules but are not intended to limit such scope or application. Publication of an interpretation or ethics ruling in the journal of Accountancy constitutes notice to members. A member who departs from interpretations or rulings shall have the burden of justifying such departure in arty disciplinary heating.

(The Professional Ethics Executive Committee has revised the following interpretations and rulings under Rule 101 of the Code of Professional Conduct [AICPA, Professional Standards, ET sections 92.08, 101.05, 101.07, 101.15, 191.208-09 and 191.210-11]. Revisions to interpretations 101-3 and 101-13, as well as ethics rulings 104 and 105, are effective as of December 31, 2003, but earlier application is permitted. The other revisions are effective immediately. Added text is in boldface italics; deleted text is struck through.)

DEFINITIONS

.08 Financial institution. A financial institution is considered to be an entity that, as part of its normal business operations, makes loans or extends credit to the general public. In addition, for automobile leases addressed under Interpretation 101-5, "Loans From Financial Institution Clients," [ET section 101.07] an entity would be considered a financial institution if it leases automobiles to the general public.

INTERPRETATION 101-3 UNDER RULE OF CONDUCT 101

.05 101-3 Performance of [begin strikethrough]other[end strikethrough] nonattest services. [begin strikethrough]a member or his or her firm ("member") who performs an attest engagement for a client may also perform other nonattest services ("other services") for that client.[end strikethrough] Before a member or his or her firm ("member") performs [begin strikethrough]other[end strikethrough] nonattest services for an attest client, (4) the member [begin strikethrough]he or she[end strikethrough] should [begin strikethrough]must evaluate the effect of such services on his or her independence[end strikethrough] determine that the requirements described in this Interpretation have been met. [begin strikethrough]in particular, care should be taken not to perform management functions or make management decisions for the attest clients, the responsibility for which remains with the client's board of directors and management.[end strikethrough] In cases were the requirements have not been met during the period of the professional engagement or the period covered by the financial statements, the member's independence would be impaired.

Engagements Subject to Independence Rules of Certain Regulatory Bodies

This interpretation requires compliance with independence regulations of authoritative regulatory bodies (such as the Securities and Exchange Commission [SEC], the General Accounting Office [GAO], the Department of Labor [DOL], and state boards of accountancy) where a member performs nonattest services for a client and is required to be independent of the client under the regulations of the applicable regulatory body. Accordingly, failure to comply with the nonattest services provisions contained in the independence rules of the applicable regulatory body that are more restrictive than the provisions of this interpretation would constitute a violation of this interpretation.

[begin strikethrough]Before performing other services, the member should establish an understanding with the clients regarding the objectives of the engagement, the services to performed, management's responsibilities, the member's responsibilities, and the limitations of the engagement. It is preferable that this understanding be documented in an engagement letter. In addition, the member should be satisfied that the client is in a position to have an informed judgment on the results of the other services and that the client understands its responsibility to[end strikethrough]

[begin strikethrough]1. Designate a management level individual or individuals to be responsible for overseeing the services being provided.[end strikethrough]

[begin strikethrough]2. Evaluate the adequacy of the services performed and any findings that result.[end strikethrough]

[begin strikethrough]3. Make management decisions, including accepting responsibility for the results of the other services.[end strikethrough]

[begin strikethrough]4. Establish and maintain internal controls, including monitoring ongoing activities.[end strikethrough]

General Requirements for Performing Nonattest Services

1. The member should not perform management functions or make management decisions for the attest client. However, the member may provide advice, research materials, and recommendations to assist the client's management in performing its functions and making decisions.

2. The client must agree to perform the following functions in connection with the engagement to perform nonattest services:

a. Make all management decisions and perform all management functions;

b. Designate a competent employee, preferably within senior management, to oversee the services;

c. Evaluate the adequacy and results of the services performed;

d. Accept responsibility for the results of the services; and

e. Establish and maintain internal controls, including monitoring ongoing activities.

The member should be satisfied that the client will be able to meet all of these criteria and make an informed judgment on the results of the member's nonattest services. In assessing the competency of the client's designated employee, the member should be satisfied that such individual understands the services to be performed sufficiently to oversee them. In cases where the client is unable or unwilling to assume these responsibilities (for example, the client does not have an individual with the necessary competence to oversee the nonattest services provided, or is unwilling to perform such functions due to lack of time or desire), the member's provision of these services would impair independence.

3. Before performing nonattest services, the member should establish and document in writings his or her understanding with the client (board of directors, audit committee, or management, as appropriate in the circumstances) regarding the following:

a. Objectives of the engagement

b. Services to be performed

e. Client's acceptance of its responsibilities

d. Member's responsibilities

e. Any limitations of the engagement

The documentation requirement does not apply to certain routine activities performed by the member such as providing advice and responding to the client's technical questions as part of the normal client-member relationship.

General Activities

The following are some general activities that would [begin strikethrough]be considered to[end strikethrough] impair a member's independence:

* Authorizing, executing, or consummating a transaction, [begin strikethrough]or[end strikethrough] otherwise exercising authority on behalf of a client, or having the authority to do so

* Preparing source documents ([begin strikethrough]4[end strikethrough]6) [begin strikethrough]or originating data[end strikethrough], in electronic or other form, evidencing the occurrence of a transaction [begin strikethrough](for example, purchase orders, payroll time records, and customer orders)[end strikethrough]

* Having custody of client assets

* Supervising client employees in the performance of their normal recurring activities

* Determining which recommendations of the member should be implemented

* Reporting to the hoard of directors on behalf of management

* Serving as a client's stock transfer or escrow agent, registrar, general counsel, or its equivalent

Specific Examples of Nonattest Services The examples in the table on pages 104 105 identify the effect that performance of [begin strikethrough]other[end strikethrough] certain nonattest services for all attest client call have on a member's independence. These examples presume that the general requirements in the previous section "General Requirements for Performing Nonattest Services" have been met and are not intended to be all inclusive of the types of [begin strikethrough]other[end strikethrough] nonattest services performed by members.

Appraisal, Valuation, and Actuarial Services

Independence would be impaired if a member performs an appraisal, valuation, or actuarial service for an attest client where the results of the service, individually or in the aggregate, would be material to the financial statements and the appraisal, valuation, or actuarial service involves a significant degree of subjectivity.

Valuations performed in connection with, for example, employee stock ownership plans, business combinations, or appraisals of assets or liabilities generally involve a significant degree of subjectivity. Accordingly, if these services produce results that are material to the financial statements, independence would be impaired.

An actuarial valuation of a client's pension or postemployment benefit liabilities generally produces reasonably consistent results because the valuation does not require a significant degree of subjectivity. Therefore, such services would not impair independence. In addition, appraisal, valuation, and actuarial services performed for nonfinancial statement purposes would not impair independence. (9) However, in performing such services, all other requirements of this Interpretation should be met, including that all significant assumptions and matters of judgment are determined or approved by the client and the client is in a position to have an informed judgment on, and accepts responsibility for, the results of the service.

Internal Audit Assistance Services

Internal audit services involve assisting the client in the performance of its internal audit activities, sometimes referred to as "internal audit outsourcing." In evaluating whether independence would be impaired with respect to an attest client, the nature of the service needs to be considered.

Assisting the client in performing financial and operational (10) internal audit activities would impair independence unless the member takes appropriate steps to ensure that the client understands its responsibility for establishing and maintaining the internal control system" and directing the internal audit function, including the management thereof. Accordingly, any outsourcing of the internal audit function to the member whereby the member in effect manages the internal audit activities of the client would impair independence.

In addition to the general requirements of this Interpretation, the member should ensure that client management:

* Designates a competent (12) individual or individuals, preferably within senior management, to be responsible for the internal audit function;

* Determines the scope, risk, and frequency of internal audit activities, including those to be performed by the member providing internal audit assistance services;

* Evaluates the findings and results arising from the internal audit activities, including those performed by the member providing internal audit assistance services; and

* Evaluates the adequacy of the audit procedures performed and the findings resulting from the performance of those procedures by, among other things, obtaining reports from the member.

The member should also be satisfied that the client's board of directors, audit committee, or other governing body is informed about the member's and management's respective roles and responsibilities in connection with the engagement. Such information should provide the client's governing body a basis for developing guidelines for management and the member to follow in carrying out these responsibilities and monitoring how well the respective responsibilities have been met.

The member is responsible for performing the internal audit procedures in accordance with the terms of the engagement and reporting thereon. The performance of such procedures should be directed, reviewed, and supervised by the member. The report should include information that allows the individual responsible for the internal audit function to evaluate the adequacy of the audit procedures performed and the findings resulting from the performance of those procedures. This report may include recommendations for improvements in systems, processes, and procedures. The member may assist the individual responsible for the internal audit function in performing preliminary audit risk assessments, preparing audit plans, and recommending audit priorities. However, the member should not undertake any responsibilities that are required, as described above, to be performed by the individual responsible for the internal audit function.

The following are examples of activities (in addition to those listed in the "General Activities" section of this interpretation) that, if performed as part of an internal audit assistance engagement, would impair independence:

* Performing ongoing monitoring activities or control activities (for example, reviewing loan originations as part of the client's approval process or reviewing customer credit information as part of the customer's sales authorization process) that affect the execution of transactions or ensure that transactions are properly executed, accounted for, or both, and performing routine activities in connection with the client's operating or production processes that are equivalent to those of an ongoing compliance or quality control function

* Determining which, if any, recommendations for improving the internal control system should be implemented

* Reporting to the board of directors or audit committee on behalf of management or the individual responsible for the internal audit function

* Approving or being responsible for the overall internal audit work plan including the determination of the internal audit risk and scope, project priorities, and frequency of performance of audit procedures

* Being connected with the client as an employee or in any capacity equivalent to a member of client management (for example, being listed as an employee in client directories or other client publications, permitting himself or herself to be referred to by title or description as supervising or being in charge of the client's internal audit function, or using the client's letterhead or internal correspondence forms in communications)

The foregoing list is not intended to be all-inclusive.

Services involving an extension of the procedures that are generally of the type considered to be extensions of the member's audit scope applied in the audit of the client's financial statements, such as confirming of accounts receivable and analyzing fluctuations in account balances, are not considered internal audit assistance services and would not impair independence even if the extent of such testing exceeds that required by generally accepted auditing standards. In addition, engagements performed under the attestation standards would not be considered internal audit assistance services and therefore would not impair independence.

Transition

Independence would not be impaired as a result of the more restrictive requirements of Interpretation 101-3, provided the provision of any such nonattest services are pursuant to arrangements in existence on December 31, 2003, and are completed by December 31, 2004, and the member was in compliance with the preexisting requirements of this interpretation.

INTERPRETATION 101-5 UNDER RULE OF CONDUCT 101

Other Permitted Loans

This [begin strikethrough]i[end strikethrough]Interpretation permits only the following new loans and leases to be obtained from a financial institution client for which independence is required. These loans and leases must be obtained under the institution's normal lending procedures, terms, and requirements and must, at all times, be kept current as to all terms.

1. Automobile loans and leases collateralized by the automobile.

2. Loans fully collateralized by the cash surrender value of an insurance policy.

3. Loans fully collateralized by cash deposits at the same financial institution (e.g., "passbook loans").

4. Aggregate outstanding [begin strikethrough]Credit cards and cash advances where the aggregate outstanding[end strikethrough] balances from credit cards and overdraft reserve accounts [begin strikethrough]on the current statement is[end strikethrough] that are reduced to $10[begin strikethrough]5[end strikethrough],000 or less on a current basis taking into consideration [begin strikethrough]by[end strikethrough] the payment due date and any available grace period.

INTERPRETATION 101-13 UNDER RULE OF CONDUCT 101

[begin strikethrough].15 101 13 Extended audit services. A member or his or her firm ("member") may be asked by a clients, for which the member performs an attest engagement, to perform extended audit services. These services may include assistance in performance of the client's internal audit activities and/or an extension of the member's audit service beyond the requirements of generally accepted auditing standards (hereinafter referred to as "extended audit services").[end strikethrough]

[begin strikethrough]A member's performance of extended audit services would not be considered to impair independence with respect to a client for which the member also performs an attest engagement, provided that the member or his or her firm is not an employee of the client or does not act or appear to act in a capacity equivalents to a member of client management.[end strikethrough]

[begin strikethrough]The responsibilities of the clients, including its board of directors, audit committee, and management, and the responsibilities of the member, as described below, should be understood by both the member and clients. It is preferable that this understanding be documented in an engagement letter that indicates that the member may not perform management functions or make management decisions.[end strikethrough]

[begin strikethrough]A member should be satisfied that the client understands its responsibility for establishing and maintaining internal control and directing the internal audit functions, if any. As part of its responsibility to establish and maintain internal control, management monitors internal control to assess the quality of its performance over time. Monitoring can be accomplished through ongoing activities, separate evaluations or a combination of both.[end strikethrough]

[begin strikethrough]The member should understand that, with respect to the internal audit function, the client is responsible for[end strikethrough]

[begin strikethrough]* Designating a competent individual or individuals, preferably within senior management, to be responsible for the internal function[end strikethrough]

[begin strikethrough]* Determining the scope, risk and frequency of internal audit activities, including those to be performed by the member providing extended audit services[end strikethrough]

[begin strikethrough]* Evaluating the findings and results arising from the internal audit activities, including those performed by the member providing extended audit services.[end strikethrough]

[begin strikethrough]* Evaluating the adequacy of the audit procedures performed and the findings resulting from the performance of those procedures by, among the other things, obtaining reports from the member[end strikethrough]

[begin strikethrough]The member should be satisfied that the board of directors and/or audit committee is informed of roles and responsibilities of both client management and the member with respect to the engagement to provide extended audit services as a basis for the board of directors and/or audit committee to establish guidelines for both management and the member to follow in carrying out these responsibilities and monitoring how well the respective responsibilities have been met.[end strikethrough]

[begin strikethrough]The member should be responsible for performing the audit procedures in accordance with the terms of the engagement and reporting thereon. The day to day performance of the audit procedures should be directed, reviewed, and supervised by the member. The report should include information that allows the individual responsible for the internal audit function to evaluate the adequacy of the audit procedures performed and the findings resulting from the performance of those procedures. This report may include recommendations for improvements in systems, process, and procedures. The member may assist the individual responsible for the internal audit function in performing preliminary audit risk assessments, preparing audit plans, and recommending audit priorities. However, the member should not undertake any responsibilities that are required, as described above, to be performed by the individual responsible for the internal audit function.[end strikethrough]

[begin strikethrough]Performing procedures that are generally of the type considered to be extensions of the member's audit scope applied in the audit of the client's financial statements, such as confirming of accounts receivable and analyzing fluctuations in account balances, would not impair the independence even if the extent of such testing exceeds that required by generally accepted auditing standards.[end strikethrough]

[begin strikethrough]The following are examples of activities that, if performed as part of an extended audit service, would be considered to impair independence:[end strikethrough]

[begin strikethrough]* Performing ongoing monitoring activities or control activities (for example, reviewing loan originations as part of the client's approval process or reviewing customer credit information as part of the customer's sales authorization process) that affect the execution of transactions or ensure that transactions are properly executed, accounted for, or both, and performing routine activities in connection with the client's operating or production processes that are equivalent to those of an ongoing compliance or quality control function[end strikethrough]

[begin strikethrough]* Determining which, if any, recommendations for improving the internal control system should be implemented[end strikethrough]

[begin strikethrough]* Reporting to the board of directors or audit committee on behalf of management or the individual responsible for the internal audit function[end strikethrough]

[begin strikethrough]* Authorizing, executing, or consummating transactions or otherwise exercising authority on behalf of the client[end strikethrough]

[begin strikethrough]* Preparing source documents on transaction[end strikethrough]

[begin strikethrough]* Having custody of assets[end strikethrough]

[begin strikethrough]* Approving or being responsible for the overall internal audit work plan including the determination of the internal audit risk and scope, project priorities and frequency of performance of audit procedures[end strikethrough]

[begin strikethrough]* Being connected with the client as an employee or in any capacity equivalent to a member of client management (for example, being listed as an employee in client directories or other client publications, permitting himself or herself to be referred to by title or description as supervising or being in charge of the client's internal audit functions, or using the client's letterhead or internal correspondence forms in communications)[end strikethrough]

[begin strikethrough]The foregoing list in not intended to be all inclusive.[end strikethrough]

ETHICS RULING 104 UNDER RULE 101: Operational Auditing Services

[begin strikethrough].208 Question As part of an extended audit engagement, a member or his or her firm reviews, certain of the client's business processes, as selected by client, for how well they function, their efficiency, or their effectiveness. For example, a member (or the firm) may assess whether performance is in compliance with management's policies and procedures, to identify opportunities for improvement, and to develop recommendations for improvement or further actions for management consideration and decision making. Would independence be considered to be impaired in performing such services?[end strikethrough]

[begin strikethrough].209 Answer Independence would not be considered to be impaired provided that during the course of the review the member of client management. The decision as to whether any of the member's (or the firm's) recommendations will be implemented must rest entirely with management.[end strikethrough]

ETHICS RULING 105 UNDER RULE 101: Frequency of Extended Audit Procedures

[begin strikethrough]105. Frequency of Performance of Extended Audit Procedures[end strikethrough]

[begin strikethrough].210 Question In providing extended audit services, would the frequency with which a member or his or her firm performs an audit procedure impair independence?[end strikethrough]

[begin strikethrough].211 Answer Independence would not be considered to be impaired provided that the limited in a manner consistent with interpretation 101 13 [ET section 101.15] and the procedures performed constituted separate evaluations of the effectiveness of the ongoing control and monitoring activities/procedures that are built into the client's normal recurring activities.[end strikethrough]

All rights reserved. For information about the procedure for requesting permission to make copies of any part of this work, please call the AICPA Copyright Permissions Hotline at [phone]. A Permissions Request Form for e-mailing requests is available at www.aicpa.org by clicking on the copyright notice on any page. Otherwise, requests should be written and mailed to the Permissions Department, AICPA, Harborside Financial Center, 20I Plaza Three, Jersey City, NJ 07311-3881.

Impact on Independence of Performance of [begin strikethrough] Other
[end strikethrough] nonattest Services

Type of [begin
strikethrough] Other
[end strikethrough]
Nonattest Service            Independence Would Not Be Impaired

Bookkeeping                  * Record transactions for which management
                             has determined or approved the appropriate
                             account classification, or post coded
                             transactions to a client's general ledger.
                             * Prepare financial statements based on
                             information in the trial balance.
                             * Post client-approved entries to a
                             client's trial balance.
                             * Propose standard, adjusting, or
                             correcting journal entries or other
                             changes affecting the financial statements
                             to the client provided the client reviews
                             the entries and the member is satisfied
                             that management understands the nature of
                             the proposed entries and the impact the
                             entries have on the financial statements.
                             [begin strikethrough] * Provide data
                             processing services. [end strikethrough]
Payroll and other            * Using payroll time records provided and
disbursement                 approved by the client, generate unsigned
                             checks, or process client's payroll.
                             * Transmit client-approved payroll or
                             other disbursement information to a
                             financial institution provided the client
                             has authorized the member to make the
                             transmission and has made arrangements
                             for the financial institution to limit the
                             corresponding individual payments as to
                             amount and payee. In addition, once
                             transmitted, the client must authorize
                             the financial institution to process the
                             information.
                             * Make electronic payroll tax payments in
                             accordance with U.S. Treasury Department
                             or comparable guidelines provided the
                             client has made arrangements for its
                             financial institution to limit such
                             payments to a named payee. (9 7)
Benefit plan                 * Communicate summary plan data to plan
administration (6 8)         trustee.
                             * Advise client management regarding the
                             application or impact of provisions of the
                             plan document.
                             * Process transactions (e.g., investment/
                             benefit elections or increase/decrease
                             contributions to the plan; data entry;
                             participant confirmations; and processing
                             of distributions and loans) initiated by
                             plan participants through the member's
                             electronic median, such as an interactive
                             voice response system or Internet
                             connection or other media.
                             * Prepare account valuations for plan
                             participants using data collected through
                             the member's electronic or other media.
                             * Prepare and transmit participant
                             statements to plan participants based on
                             data collected through the member's
                             electronic or other medium.
Investment--advisory or      * Recommend the allocation of funds that
management                   a client should invest in various asset
                             classes, depending upon the client's
                             desired rate of return, risk tolerance,
                             etc.
                             * Perform recordkeeping and reporting of
                             client's portfolio balances including
                             providing a comparative analysis of the
                             client's investments to third-party
                             benchmarks.
                             * Review the manner in which a client's
                             portfolio is being managed by investment
                             account managers, including determining
                             whether the managers are (1) following the
                             guidelines of the client's invesment
                             policy statement; (2) meeting the client's
                             investment objectives; and (3) conforming
                             to the client's stated investment styles.
                             * Transmit a client's investment selection
                             to a broker-dealer or equivalent provided
                             the client has authorized the broker-
                             dealer or equivalent to execute the
                             transaction.
Corporate finance--          * Assist in developing corporate
consulting or advisory       strategies.
                             * Assist in identifying or introducing the
                             client to possible sources of capital that
                             meet the client's specifications or
                             criteria.
                             * Assist in analyzing the effects of
                             proposed transactions including providing
                             advice to a client during negotiations
                             with potential buyers, sellers, or capital
                             sources.
                             * Assist in drafting an offering document
                             or memorandum.
                             * Participate in transaction negotiations
                             in an advisory capacity.
                             * Be named as a financial adviser in a
                             client's private placement memoranda or
                             offering documents.
[begin strikethrough]
Appraisal, valuation         [begin strikethrough] * Test the
or actuarial [end            reasonableness of the value placed on an
strikethrough]               asset or liability included in a client's
                             financial statements by preparing a
                             separate valuation of that asset or
                             liability.
                             * Perform a valuation of a client's
                             business when all significant matters of
                             judgement are determined or approved by
                             the client and the client is in a position
                             to have an informed judgement on the
                             results of the valuation. [end
                             strikethrough]
Executive or employee        * Recommend a position description or
search                       candidate specifications.
                             * Solicit and perform screening of
                             candidates and recommend qualified
                             candidates to a client based on the
                             client-approved criteria (e.g., required
                             skills and experience).
                             * Participate in employee hiring or
                             compensation discussions in an advisory
                             capacity.
Business risk consulting     * Provide assistance in assessing the
                             clients business risks and control
                             processes.
                             * Recommend a plan for making improvements
                             to a client's control processes and assist
                             in implementing these improvements.
Information systems--        * [begin strikethrough] Design, i
design, installation,        [end strikethrough] Install or integrate a
or integration               client's information system [begin
                             strikethrough] provided the clients
                             makes all management decisions [end
                             strikethrough] that was  not designed or
                             developed by the member  (e.g., art off-
                             the-shelf accounting package).
                             * Assist in setting up the client's chart
                             of accounts and financial statement format
                             with respect to the client's financial
                             information system.
                             * Design, develop, install, or integrate a
                             client's it formation systern that is
                             unrelated to the client's financial
                             statements or accounting records.
                             * [begin strikethrough] Customize a
                             prepackaged accounting or information
                             system, provided the client makes all
                             management decision. [end strikethrough]
                             * Provide [begin strikethrough] the
                             initial [end strikethrough] training and
                             instruction to client employees on a
                             [begin strikethrough] newly implemented
                             [end strikethrough] information and
                             control system.

Type of [begin
strikethrough] Other
[end strikethrough]
Nonattest Service

Bookkeeping                   Independence Would Be Impaired

                              * Determine or change journal entries,
                              account codings or classification for
                              accounting records without obtaining
                              client transactions, or other approval.
                              * Authorize or approve transactions.
                              * Prepare source documents [begin
                              strikethrough] or originate data. [end
                              strikethrough]
                              * Make changes to source documents
                              without client approval.
Payroll and other             * Accept responsibility to authorize
disbursement                  payment of client funds, electronically
                              or otherwise, except as specifically
                              provided for with respect to electronic
                              payroll tax payments.
                              * Accept responsibility to sign or cosign
                              client checks, even if only in emergency
                              situations.
                              * Maintain a client's bank account or
                              otherwise have custody of a client's
                              funds or make credit or banking
                              decisions for the client.
                              * Sign payroll tax return on behalf of
                              client management.
                              * Approve vendor invoices for payment.
Benefit plan                  * Make policy decisions on behalf of
administration (6 8)          client management.
                              * When dealing with plan participants,
                              interpret the plan document on behalf of
                              management without first obtaining
                              management's concurrence.
                              * Make disbursements on behalf of the
                              plan.
                              * Have custody of assets of a plan.
                              * Serve a plan as a fiduciary as defined
                              by ERISA.
Investment--advisory or       * Make investment decisions on behalf of
management                    client management or otherwise have
                              discretionary authority over a client's
                              investments.
                              * Execute a transaction to buy or sell a
                              client's investment.
                              * Have custody of client assets, such as
                              taking temporary possession of securities
                              purchased by a client.
Corporate finance--           * Commit the client to the terms of a
consulting or advisory        transaction or consummate a transaction
                              on behalf of the client.
                              * Act as a promoter, underwriter, broker-
                              dealer, or guarantor of client
                              securities, or distributor of private
                              placement memoranda or offering
                              documents.
                              * Maintain custody of client securities.
                              [begin strikethrough] * Prepare a
                              valuation of an employer's securities
                              contained in an employee stock ownership
                              plan (ESOP) to support transactions with
                              participants, plan contributions, and
                              allocation within the ESOP, when the
                              client is not in a position to have an
                              informed judgment on the results of his
                              valuation
Appraisal, valuation          * Prepare an appraisal, valuation, or
or actuarial                  actuarial report using assumptions
                              determined by the member and not approved
                              by the client. [END STRIKETHROUGH]
Executive or employee         * Commit the client to employee
search                        compensation or benefit arrangements.
                              * Hire or terminate client employees.
Business risk consulting      * Make or approve business risk
                              decisions.
                              * Present business risk considerations
                              to the board of others on behalf of
                              management.
Information systems--         * Design or develop a client's financial
design, installation,         information system.
or integration                * Make other than insignificant
                              modifications to source code underlying
                              a client's existing financial information
                              system.
                              * Supervise client personnel in the
                              daily operation of a client's
                              information system.
                              * Operate a client's local area network
                              (LAN) system [begin strikethrough] when
                              the client has not designated a competent
                              individual, preferably within senior
                              management, to be responsible for the
                              LAN. [end strikethrough]

(5 7) Although this type of transaction may be considered by some to be
similar to signing checks or disbursing funds, the Professional Ethics
Executive Committee concluded that making electronic payroll tax
payments under the specified criteria would not impair a member's
independence.

(6 8) When auditing plans subject to the Employee Retirement Income
Security Act (ERISA), Department of Labor (DOL) regulations, which may
be more restrictive, must be followed.

(1) The term estimated gross profits or margins relates to estimated gross profits as defined in Financial Accounting Standards Board Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, and estimated gross margins as defined in AICPA Statement of Position 95-1, Accounting for Certain Insurance Activities of Mutual Life Insurance Enterprises, and will hereinafter be referred to as estimated gross profits.

(1) At the time the Accounting Standards Executive Committee (AcSEC) undertook this project, at least five of the seven Financial Accounting Standards Board members were required to not object to AcSEC undertaking tiffs project.

(1) Terms defined in the glossary are set in boldface type the first tune they appear in this Statement of Position (SOP).

(2) Refer to the Financial Accounting Standards Board's (FASB's) publication Accounting for Derivative Instruments and Hedging Activities. As of the date of publication of this SOP, the following insurance-specific FASB Derivative Implementation Issues were available: B7--Variable Annuity Products and Policyholder Ownership of the As sets, B8--Identification of the Host Contract in a Nontraditional Variable Annuity Contract, B9--Clearly and Closely Related Criteria for Market Adjusted Value Prepayment Options, B10--Equity-Indexed Life Insurance Contracts, B25--Deferred Variable Annuity Contracts with Payment Alternatives at the End of the Accumulation Period, B29 Equity--Indexed Annuity Contracts with Embedded Derivatives, B30--Application of Statement 97 and Statement 133 to Equity--Indexed Annuity Contracts, B34--Period Certain Plus Life-Contingent Variable Payout Annuity Contracts with a Guaranteed Minimum Level of Periodic Payments, and B36--Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments.

(3) FASB Statement of Financial Accounting Standards No. 60, Accounting and Reporting b), insurance Enterprises, as amended, applies to life insurance enterprises, property and liability insurance enterprises, title insurance enterprises, mortgage guaranty insurance enterprises, assess merit enterprises, and fraternal benefit societies.

(4) For purposes of this SOP, the term separate account, includes separate accounts and subaccounts or investment divisions of separate accounts.

(5) See the example in Appendix B.

(6) If the asset transferred is real estate, no gain may be recognized if recognition is inconsistent with FASB Statement No. 66, Accounting for Sales of Real Estate.

(7) The liability for the contract is the combination of amounts recorded in separate account liabilities and general account policyholder liabilities.

(8) For this purpose, an asset or contract is the equivalent of cash if it has a readily determinable fair value and can be converted to cash without incurring significant transaction costs.

(9) Contracts that have been grandfathered under the provisions of paragraph 50 of FASB Statement No. 133 would need to follow the accounting guidance that is specified paragraph 21 of this SOP.

(10) A loss should be recognized in the statement o operations to the extent an asset reported in the general account is designated as part of a contractually referenced pool of assets and on that designation date has an unrealized loss.

(11) For a description of a market value annuity and market value annuity adjustments refer to Appendix D, paragraph D1.

(12) The terms nominal and insignificant are as used in FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale Investments, paragraph 40.

(13) The term remote is as defined in FASB Statement No. 5, Accounting for Contingencies.

(14) The term investment margin is as defined in FASB Statement No. 97, paragraph 23. (c)

(15) The term estimated gross profit is as defined in FASB Statement No. 97, paragraph 23.

(16) The term accumulative assessments refers to actual cumulative assessments, including investment margins, if applicable, recorded from contract inception through the balance sheet date.

(17) The term wrap refers to the practice of adding an insurance benefit feature to a separate noninsurance contract generally from a different issuer.

(18) Refer to FASB Derivative Implementation Issue: B25--Deferred Variable Annuity Contracts with Payment Alternatives at the End of the Accumulative Period, Questions 1 and 2, for discussion of these products

(19) Adjustments are as discussed in Emerging Issues Task Force (EITF) Issue No. 92-9. Accounting for the Present Value of Future Profits Resulting, from the Acquisition of a Life Insurance Company.

(4) A member who performs a compilation engagement for a client should modify the compilation report to indicate a lack of Independence if the member does not meet a of the conditions set out in this Interpretation when providing a nonattest service to that client (see Statement on Standards for Accounting and Review Services No. 1, Compilation and Review of Financial Statements [AR settle, 100.91]).

(5) An isolated and inadvertent failure to prepare the required documentation would not impair independence, provided that the member did establish the understanding with the client, the member documents the understanding promptly upon discovery of the failure to do so, and all other provisions of the Interpretation are met.

([begin strikethrough]4[end strikethrough]6) [begin strikethrough]The[end strikethrough] Source documents are the documents upon which evidence of an accounting transaction are initially recorded. Source documents are often followed by the creation of many additional records and reports, which do not, however, quality as initial recordings. Examples of source documents are purchase orders, payroll time cards, and customer orders.

(9) Examples of such services may include appraisal, valuation, and actuarial services performed for tax planning or tax compliance estate and gift taxation, and divorce proceedings.

(10) For example, a member map assess whether performance is in compliance with management's policies and procedures, to identify opportunities for improvement, and to develop recommendations for improvement or further action for management consideration and derision making.

(11) As part of its responsibility to establish and maintain internal control, management monitors internal control to assess the quality of its performance over time. Monitoring can be accomplished through ongoing activities, separate evaluation & or a combination of both. Ongoing monitoring activities are the procedures designed to assess the quality of internal control performance over time and built into the normal recurring activities of an entity; they include regular management and supervisory activities, comparisons, reconciliations, and other routine actions. Separate evaluations focus on the continued effectiveness of a client's internal control. A member's independence would not be impaired by the performance of separate evaluations of the effectiveness of a client's internal control, including separate evaluations of the client's ongoing monitoring activities.

(12) A competent individual would have an understanding of internal audit activities sufficient to oversee the services performed by the member.