Discounting of loss reserves

downthesundownthesun
in Odomirok.22-23-GAAP

Hi,

Fall 2014 Q19 examiner's report makes seem like for both SAP and GAAP discounting of reserves is limited to special lines like Workers' Compensation with the difference between SAP and GAAP being that GAAP accounting allows for the use of a reasonable alternate discount.

But in Spring 2019 Q17, makes it sound like, for GAAP, reserves for any line of business can be discounted, so long as the discount is reasonable.

Am I misreading the examiner's reports? Can I get some additional clarity on this?

Thanks.

Comments

  • Staff - ACStaff - AC

    I read the two answers to be within similar lines. The key is, GAAP rules for discounting are more relaxed. Tabular discounting uses life tables, so it is appropriate for lines like workers comp and long-term disability. Non-tabular discounts allow for alternative discount rates: the rules for these are more strict for SAP, and more relaxed for GAAP.

  • jasonchwjasonchw

    I am also not very clear about when to discount reserves (not only talking about balance sheet). I have listed my understanding as below, would you please help to verify or supplement?

    loss reserves being discounted in difference situations (except tabular discounting for WC):
    Undiscounted: Schedule P, 5 yr historical data, schedule F, IEE, SAO, AOS, Balance sheet (Both SAP and GAAP)
    Discounted: commutation pricing, loss calculation for taxable income

  • grahamgraham

    Your understanding that loss reserves are generally undiscounted for statutory and GAAP reporting, with exceptions like commutation pricing and taxable income calculations where discounting is applied, is correct. However, it's also crucial to recognize the context and specific requirements of different reporting frameworks, including the application of fair value measurements under U.S. GAAP for certain transactions, which involve discounting of future cash flows associated with loss reserves.

    A more complete answer based on the source text, which may be much more detail than you're looking for, is shown below:

    1. Undiscounted Loss Reserves: Your list includes several instances where loss reserves are reported on an undiscounted basis. This is consistent with the principles outlined for Statutory Accounting Principles (SAP) and U.S. Generally Accepted Accounting Principles (GAAP) regarding loss reserves. For example, the liability for unpaid claims under U.S. GAAP is based on the estimated ultimate cost of settling the claims, without discounting for the time value of money, except for certain long-duration contracts where discounting is permitted or required.

    2. Discounted Loss Reserves: Your mention of discounting in situations like commutation pricing and loss calculation for taxable income aligns with practices where discounting is applied. For U.S. GAAP, discounting is more common in situations where the timing of cash flows is relatively certain, allowing for the application of a discount rate. This is notably different from the general rule under SAP, where loss reserves are not discounted except under specific conditions, such as certain workers' compensation and long-term disability claims.

    3. Fair Value Measurement: When determining the fair value of loss and LAE (loss adjustment expenses) reserves, the process involves discounting expected future cash flows. This process takes into account the time value of money at a risk-free rate plus an adjustment for the illiquidity of the liabilities, and includes a risk adjustment to compensate an investor for the risk associated with the liabilities. This approach is used for Purchase GAAP (P-GAAP) where the acquisition of insurance entities is concerned, and it illustrates a specific scenario where discounting is applied to measure the fair value of insurance liabilities.

    4. Regulatory and Reporting Requirements: Different reporting frameworks (SAP, GAAP, P-GAAP, and tax purposes) have varying requirements for discounting reserves. It's important to consider the purpose of the valuation and the applicable regulatory or reporting framework when deciding whether to discount loss reserves. For example, the fair value under U.S. GAAP for insurance contracts may involve discounting, whereas SAP typically does not discount loss reserves except in specific circumstances such as Workers' Compensation, Long-Term Disability, Structured Settlements, and Tabular Discounting.

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