In the current low interest rate environment, the LDTI discount rate may be lower than the current GAAP discount rate, which is based on an insurer’s investment portfolio on the contract issue date. The lower discount rate would result in higher insurance liabilities for many insurers. The impact of the LDTI discount rate on the LFPB is captured through accumulated other comprehensive income (OCI) on the balance sheet upon transition; changes to the LFPB in subsequent calculations due to changes in the discount rate are recognized in OCI in subsequent periods.
The anticipated higher insurance liabilities with the LDTI discount rate will offset unrealized investment gains in OCI. The reduction in OCI will decrease the retained earnings when realized in the future.
Additionally, the LDTI discount rate will drive asset-liability mismatching because it creates a disconnect between investment yield on assets held and insurance liabilities. Insurers will need to stress-test balance sheets and income statements and assess the impact of potential mismatching. Insurers should revisit their hedging strategy to mitigate the market risk exposures that do not exist under the current GAAP, which uses insurers’ investment portfolio rate.
B-1.3. Updating of assumptions
Current GAAP for traditional long-duration insurance contracts allows insurers to determine the assumptions used to measure the LFPB at policy inception and update them only if a premium deficiency is recognized. The historical mode results in recognition of income over the life of the policy based on a level percentage of net premiums, with differences between the cash flows expected at contract inception and actual cash flows reflected in income over time. The assumptions for measuring the LFPB include mortality, morbidity, expense, lapse and investment return (ASC 944-40-30-11 through 944-40-30-15). However, using these “locked-in” assumptions may provide inaccurate information regarding contractual cash flows, financial position and risk exposure.
In contrast, LDTI requires that the cash flow assumptions used in measuring LFPB be current—which means insurers must review and update cash flow assumptions on an annual basis, or more frequently if indicated (ASC 944-40-35-5). Frequent updates of assumptions may affect the LFPB, and introduce additional volatility in net income (profit and loss). However, LDTI eliminates the need for premium deficiency or loss recognition testing, as the assumptions are revisited at least annually, in the same period each year.