Accounting Standard Updates

ASU 2016-13 – Financial Instruments-Credit Losses: Accounting for Premium Receivable

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Premium receivable is measured at amortized cost and is subject to Topic 326. While the NAIC rejected ASU 2016-13, publicly traded insurance companies, holding companies, and agencies that prepare GAAP financial statements must understand the implementation of ASU 2016-13.

This article provides the accounting for credit losses for premium receivables and includes sample financial statement disclosures.

Measurement. Premium receivable is short-term in nature and is generally collected prior to providing coverage, minimizing credit risk. Nonetheless, the update requires the implementation of the Current Expected Credit Loss (CECL) model and assessing impairment of financial assets measured at amortized cost, which includes premium receivable, regardless of collectability. Therefore, estimates of expected credit losses on premium receivables over its life will be required to be recorded at inception based on historical information, current conditions, and reasonable and supportable forecasts.

Application. The guidance provides flexibility in choosing an estimation method to determine the expected credit loss on premium receivables, as long as the application is consistent year over year, represents the entity’s historical experience, and reflects an assessment of future economic conditions. Entities can leverage the same estimation methods used under previous guidance, such as applying the historical loss percentage to aging categories. However, this must be combined with current conditions and reasonable and supportable forecasts of future losses to determine estimated credit losses.

Aging Schedule Method. The aging schedule method, which considers the length of time an asset has been outstanding to determine an adjusted loss rate, is widely utilized for estimating the expected credit loss for premium receivables. Most entities have access to historical loss data used to estimate allowance for doubtful accounts under the incurred loss model.  This historical loss information is often determined to be a reasonable base to calculate the expected credit loss using the aging schedule method because the composition of the receivables is consistent with that used in developing the historical credit-loss percentages (that is, the similar risk characteristics of the customers and lending practices have not changed significantly over time). When evaluating the current trends and reasonable and supportable forecasted economic conditions, an entity might regularly review indicators such as unemployment and interest rates, regulatory developments such as restrictions on cancellation of policies for nonpayment of premiums, and insurance policy specific indicators such as trends in policy cancellations to determine adjustments in credit-loss percentages. Premium receivables are generally pooled with similar risk characteristics, such as customer credit rating, aging categories (e.g., 30-90 days past due), lines of business, geographical location, and other relevant factors that may impact the probability of the customers not being able to pay for the policy when applying the credit-loss percentages.

Below is a sample calculation of expected credit loss for premium receivable using the aging schedule method:

Consideration of Cancellation Provisions and Unearned Premium Reserves. Premium receivable is required to be evaluated for credit losses by Topic 326. When an insurance contract is incepted, a premium receivable and an equal amount of unearned premium reserve are recorded. Most insurance policies allow the insurance entity the authority to cancel policies unilaterally due to nonpayment. Any outstanding balance of premium receivable and unearned premium reserve is written off in the event of cancellation. This mitigates the insurance company’s exposure to unpaid earned premiums recognized prior to the cancellation date.

Cancellation provisions in insurance policies can mitigate the risk of credit losses since the write-off of outstanding premium balances, including the premium receivable and unearned premium reserves, do not constitute a credit loss requiring inclusion in the CECL calculation. However, if legal requirements mandate coverage regardless of policyholder delinquencies or defaults, the insurer must assess credit losses on the entire premium receivable without regard for the unearned premium.

Transition. The update should be applied using a modified retrospective transition approach that would require a cumulative effect adjustment to the opening retained earnings as of the date of adoption.

Disclosures. The following tables illustrate the disclosure of the allowance for credit losses on the balance sheet, cumulative effect adjustment in shareholder’s equity, qualitative information about the credit quality of the receivables, and a roll-forward of the allowance.

Related topics:
ASU 2016-13 – Financial Instruments-Credit Losses: An Overview
ASU 2016-13 – Financial Instruments-Credit Losses: Accounting for Reinsurance Recoverable
ASU 2016-13 – Financial Instruments-Credit Losses: Accounting for Available-for-Sale Debt Securities