Some life insurance products that are currently being marketed for businesses may expose the policyholders to significant valuation adjustments (i.e., write-downs) for balance sheet and income statement purposes. The situation arises because some product offerings seek to apply a specific citation under GAAP that is at least somewhat unclear. However, the result of applying this specific citation (out of context) can be objectively and empirically shown to be counter to the underlying principle set forth under GAAP for these assets (addressed in ASC 325-30), which typically requires businesses to carry these assets at the net realizable value of the insurance contract.
The products in question seek to settle the insurance contract obligations over extended time periods, but, instead of complying with a specific rule that such extended payments are subject (by the policyholder) to discounting, the products seek to comply with GAAP under a provision that may be construed to not require a realizable value.
We ask a reader: Does an exception from discounting really mean that the policyholder can carry the asset at a demonstrably unrealizable value?
We then analyze the underlying GAAP as it relates to these assets and provide descriptions of the product structures that we believe are inherently lacking in substance. We also provide empirical examples of the structures.
In one of the empirical examples the interest credited during the extended settlement period was floored at zero for 5.5 years. This resulted in a total decrease of ~$2.3 million in the carrying value from when the policy termination was requested to the date that the contract’s defined interest rate rose above 0%. At the settlement date, it is worth noting that the product provider had no loss exposure whatsoever. When we discount the amount received by the riskless rate, we arrive at a realizable value closer to $87 million versus the purported carrying value of $100 million.
We conclude that the adoption of approaches that set aside the premise of net realizable value as the underlying foundation for the carrying value could result in undesirable financial reporting adjustments – potentially at very inopportune moments (e.g., when the amount of the restatement could be quite material).