General Electric’s $6.2 billion hit to income in January to catch up on losses on long-term care insurance contracts highlights the problem accounting standard-setters now say will be solved with some new rules, set to take full effect in 2021.
See also: GE shocks market with multibillion-dollar loss in legacy reinsurance business
The Financial Accounting Standards Board introduced a big change on Wednesday in how U.S. insurers must update for economic events that should change their assumptions on long-term insurance contracts. FASB says new rules will now require insurers, and their auditors, to annually review the assumptions made at the inception of the contract and over its life and update each year, if necessary.
The impact of applying new discount rates, for example, will be recognized immediately in earnings when the rule goes into affect in 2021.
Until now, when a long term insurance contract was signed, for example in 1980, the original assumptions such as discount rates that were used to estimate cash flow each year stayed in place, even if the contract was still in force almost forty years later.
Under existing accounting standards, the assumptions used for long-term care contracts such as GE’s GE, +0.65% North America Life & Health reinsurance portfolio, aren’t reviewed if they don’t show losses.
FASB board member Christine Botosan told an audience of accounting professors in Washington, D.C., on Aug. 6 that “current accounting for long duration insurance contracts did not provide relevant information or timely information, and it wasn’t transparent.”
Botosan explained that when insurance companies originally established the assumptions that impact how they measure cash flow for long-term insurance contracts, they were “locked in” and never updated, unless the contract went into a loss position.
“That’s why we saw things like GE taking a $6.2 billion charge related to insurance in January. They had crossed over that threshold and this set of contracts was now in a loss position.”
A GE spokeswoman did not immediately respond to a request for comment.
GE’s decision to retain this reinsurance portfolio, 60% of which is related to long-term care insurance, after mostly exiting the business between 2004 and 2006, was based on the view that a gradual runoff of existing claims would be more profitable than selling the business, GE Chief Executive John Flannery told analysts in January when the company announced the huge hit.
See also: GE says shock multibillion-dollar insurance charge is ‘a special case’
Genworth Financial GNW, +1.78% , the reinsurance business that GE spun off in 2004, disclosed in a routine SEC filing that year that periodic reviews of claim reserves are common and charges are to be expected. Genworth Financial has disclosed nine changes in estimates related to its long-term care portfolio, totaling $3.8 billion since 2004.
GE told analysts in January that it had totally reconstructed its long-term care claims cost projections. The charge in the fourth quarter of 2017 was driven by higher cost estimates combined with claims costs that now extend out over 40 years based on current life expectancies.
