Difference between revisions of "FASB.944"

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==Study Tips==
 
==Study Tips==
  
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==In Plain English!==
 
==In Plain English!==
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=== Definition of Financial Guarantee ===
  
 
A <u>financial guarantee</u> is a non-cancellable indemnity bond backed by an insurer to guarantee investors that principal and interest payments will be made. Or in simpler terms:
 
A <u>financial guarantee</u> is a non-cancellable indemnity bond backed by an insurer to guarantee investors that principal and interest payments will be made. Or in simpler terms:
  
−
* it covers a lender from the liability resulting from the borrower defaulting on a loan
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* It protects the lender if the borrower defaults.
  
 
The reading draws a distinction between short and long-duration contracts. A <u>short-duration</u> contract is characterized by:
 
The reading draws a distinction between short and long-duration contracts. A <u>short-duration</u> contract is characterized by:
  
 
* providing insurance protection for a <u>fixed period</u> of <u>short</u> duration ''(pretty darn obvious!)''
 
* providing insurance protection for a <u>fixed period</u> of <u>short</u> duration ''(pretty darn obvious!)''
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* enabling insurer to <u>cancel</u> the contract or <u>adjust</u> the provision at the end of the contract period
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* enabling the insurer to <u>cancel</u> the contract or <u>adjust</u> the provision at the end of the contract period
  
 
<u>Financial reporting</u> of a reinsurance contract depends on whether the contract is:
 
<u>Financial reporting</u> of a reinsurance contract depends on whether the contract is:
  
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* short or long-duration
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* short or long-duration <span style="color: red;">&larr; ''recall that you are <u>not</u> responsible for the material on long-duration contracts''</span>
 
* prospective or retrospective
 
* prospective or retrospective
  
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= FASB 944 – The Tiny Sliver That Matters =
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=== Review of Reinsurance Accounting Concepts ===
  
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== 1. Two Conditions for Reinsurance Accounting ==
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{| class="wikitable"
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From ASC 944, reinsurance accounting applies only if:
 
  
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* '''Significant insurance risk is transferred'''
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! style="width:50px; text-align:center;" | '''#'''
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* '''A significant loss to the reinsurer is reasonably possible'''
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! '''Topic'''
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! '''What Matters for Exam 6-US'''
  
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(See paragraphs 15-41 in the source.)
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|-
 +
| style="width:50px; text-align:center;" | '''1'''
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| '''Two Conditions for Reinsurance Accounting'''
 +
|
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* '''Significant insurance risk''' must be transferred 
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* '''Significant loss''' to reinsurer must be reasonably possible 
  
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== 2. Definition of "Significant Insurance Risk" ==
+
|-
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ASC 944 clarifies that insurance risk must include:
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| style="width:50px; text-align:center;" | '''2'''
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| '''Definition of Significant Insurance Risk'''
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| Insurance risk must include:
 +
* '''Uncertainty in amount''' of losses 
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* '''Uncertainty in timing''' of losses 
  
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* '''Uncertainty in the amount''' of losses
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|-
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* '''Uncertainty in the timing''' of losses
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| style="width:50px; text-align:center;" | '''3'''
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| '''Mechanics of the Significant-Loss Test'''
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| GAAP rules underlying ERD/10-10 logic: 
 +
* PV of '''all''' cash flows 
 +
* '''One consistent''' discount rate 
 +
* Include all cash flows between parties 
 +
* Use '''gross premiums''' (no expense netting) 
  
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(This aligns with Freihaut's definition of underwriting risk + timing risk.)
+
|-
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| style="width:50px; text-align:center;" | '''4'''
 +
| '''Reasonably Possible Scenario Requirement'''
 +
| A scenario is considered valid only if: 
 +
* '''The entire set of assumptions''' can reasonably occur together 
 +
(Prevents cherry-picking assumptions.)
  
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== 3. Mechanics of the Significant-Loss Test ==
+
|-
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ASC 944 establishes the GAAP framework that underlies ERD logic:
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| style="width:50px; text-align:center;" | '''5'''
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| '''"Substantially All" Exception'''
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| Risk transfer may still exist if significant loss is not possible, provided:
 +
* Reinsurer assumes '''substantially all''' risk 
 +
* Cedant retains '''no more than trivial''' risk 
 +
* Reinsurer's economics ≈ '''direct writer''' 
  
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* Use the '''present value of all cash flows'''
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|-
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* Use '''one consistent discount rate'''
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| style="width:50px; text-align:center;" | '''6'''
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* Include '''all''' cash flows between insurer and reinsurer (regardless of labeling)
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| '''Deposit Accounting Trigger'''
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* Use '''gross premiums''' (no expense netting)
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| If no indemnification of insurance risk exists: 
−
 
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* Ceded premium treated as a '''deposit'''
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(See paragraphs 15-49 through 15-51.)
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* No reserve credit / no reinsurance accounting 
−
 
 
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== 4. "Reasonably Possible Scenario" Requirement ==
 
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A scenario is considered reasonably possible only if:
 
−
 
 
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* '''The entire set of assumptions''' could reasonably occur together
 
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(This prevents cherry-picking favorable assumptions.)
 
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== 5. The Narrow "Substantially All" Exception ==
 
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Risk transfer may still exist even without a significant-loss possibility if:
 
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* The reinsurer assumes '''substantially all''' of the insurance risk
 
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* The cedant retains '''no more than trivial''' risk
 
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* The reinsurer’s economics are '''virtually equivalent''' to directly writing the business
 
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(See paragraphs 15-53 and 15-54. This corresponds to Freihaut’s Method 2.)
 
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== 6. If No Risk Transfer → Deposit Accounting ==
 
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ASC 944 reiterates:
 
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* Without indemnification of insurance risk, ceded premium is treated as a '''deposit'''
 
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(This is the accounting consequence of failing risk transfer.)
 
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== 7. Prospective vs. Retroactive Reinsurance ==
 
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Conceptual distinctions relevant to interpreting contract structure:
 
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* '''Prospective''' reinsurance covers future insured events
 
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* '''Retroactive''' reinsurance covers past insured events
 
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* Contracts may include '''both''' elements
 
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(Useful context, but lightly tested.)
 
  
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|-
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| style="width:50px; text-align:center;" | '''7'''
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| '''Prospective vs. Retroactive Reinsurance'''
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| Conceptual distinctions: 
 +
* '''Prospective''' reinsures future events 
 +
* '''Retroactive''' reinsures past events 
 +
* Some treaties contain '''both''' types 
  
 +
|}
  
 
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Latest revision as of 16:04, 30 November 2025

Reading: Accounting Standards Codification 944, “Financial Guarantee Insurance Contracts,” 2011, Section 15, Scope and Scope Exceptions, paragraphs:

  • 1-2
  • 5-7
  • 34-35
  • 41-44
  • 49-54

Candidates are not responsible for material relating to long-duration contracts and/or life insurance.

Author: Financial Accounting Standards Board

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BA Quick-Summary: FASB 944 - Financial Guarantee Contracts

This paper provides guidance from FASB regarding Financial Guarantee insurance contracts.

Study Tips

Virtually all of the content in this reading is covered in other reinsurance readings. The only thing you might want to learn is the definition of financial guarantee insurance.

BattleTable

  • this reading has not been tested on any exam from the year 2012 to Fall 2019 when the exams stopped being published.
reference part (a) part (b) part (c) part (d)
no prior questions

Full BattleQuiz You must be logged in or this will not work.

In Plain English!

Definition of Financial Guarantee

A financial guarantee is a non-cancellable indemnity bond backed by an insurer to guarantee investors that principal and interest payments will be made. Or in simpler terms:

  • It protects the lender if the borrower defaults.

The reading draws a distinction between short and long-duration contracts. A short-duration contract is characterized by:

  • providing insurance protection for a fixed period of short duration (pretty darn obvious!)
  • enabling the insurer to cancel the contract or adjust the provision at the end of the contract period

Financial reporting of a reinsurance contract depends on whether the contract is:

  • short or long-duration ← recall that you are not responsible for the material on long-duration contracts
  • prospective or retrospective

Review of Reinsurance Accounting Concepts

# Topic What Matters for Exam 6-US
1 Two Conditions for Reinsurance Accounting
  • Significant insurance risk must be transferred
  • Significant loss to reinsurer must be reasonably possible
2 Definition of Significant Insurance Risk Insurance risk must include:
  • Uncertainty in amount of losses
  • Uncertainty in timing of losses
3 Mechanics of the Significant-Loss Test GAAP rules underlying ERD/10-10 logic:
  • PV of all cash flows
  • One consistent discount rate
  • Include all cash flows between parties
  • Use gross premiums (no expense netting)
4 Reasonably Possible Scenario Requirement A scenario is considered valid only if:
  • The entire set of assumptions can reasonably occur together

(Prevents cherry-picking assumptions.)

5 "Substantially All" Exception Risk transfer may still exist if significant loss is not possible, provided:
  • Reinsurer assumes substantially all risk
  • Cedant retains no more than trivial risk
  • Reinsurer's economics ≈ direct writer
6 Deposit Accounting Trigger If no indemnification of insurance risk exists:
  • Ceded premium treated as a deposit
  • No reserve credit / no reinsurance accounting
7 Prospective vs. Retroactive Reinsurance Conceptual distinctions:
  • Prospective reinsures future events
  • Retroactive reinsures past events
  • Some treaties contain both types

Full BattleQuiz You must be logged in or this will not work.

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