Derivatives Implementation Group

Statement 133 Implementation Issue No. B10

QUESTION

Is an equity-indexed life insurance contract that combines term life insurance coverage with an investment feature, similar to universal life contracts, outside the scope of Statement 133 because it contains a death benefit provision?

BACKGROUND

Equity-indexed life insurance contracts combine term life insurance coverage with an investment feature, similar to universal life contracts. Death benefit amounts are based upon the amount selected by the policyholder plus the account value. Charges for the cost of insurance and administrative costs are assessed periodically against the account. The policyholder's account value, maintained in the insurance company's general account (not a separate account) is based on the cumulative deposits credited with positive returns based on the S&P 500 index or some other equity index. An essential component of the contract is that the cash surrender value is also linked to the index. Accordingly, the policy's cash surrender value is also linked to an equity index. The death benefit amount may also be dependent upon the cumulative return on the index.

Equity-indexed life insurance contracts are accounted for as universal life (UL) insurance contracts under FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. For those contracts, the customer's account value (the investment component of a UL contract) is credited with a return indexed to an equity index (for example, the S&P 500) rather than an interest rate established by the insurer, as is done with typical UL contracts.

RESPONSE

No. The existence of the death benefit provision does not exclude the entire equity-indexed life insurance contract from being subject to Statement 133 for either the issuer or the policyholder because the policyholder can obtain an equity-linked return by exercising the surrender option prior to death.

Paragraph 10(c) provides the following guidance:

...insurance enterprises enter into other types of contracts that may be subject to the provisions of this Statement. In addition, some contracts with insurance or other enterprises combine derivative instruments, as defined in this Statement, with other insurance products or nonderivative contracts, for example, indexed annuity contracts, variable life insurance contracts.... [Emphasis added.]

Paragraph 12 of Statement 133 states, in part, "Contracts that do not in their entirety meet the definition of a derivative instrument, . . . such as bonds, insurance policies, and leases, may contain "embedded" derivative instruments....." (Emphasis added.)

The investment component of the equity-indexed life insurance contract would contain an embedded derivative (the equity index-based derivative) that meets all the requirements of paragraph 12 of Statement 133 for separate accounting. (Note that Statement 155 was issued in February 2006 and allows for a fair value election for hybrid financial instruments that otherwise would require bifurcation. However, Statement 155 does not apply to hybrid instruments that are described in paragraph 8 of FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, which include insurance contracts as discussed in FASB Statements No. 60, Accounting and Reporting by Insurance Enterprises, and No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, other than financial guarantees and investment contracts. Hybrid financial instruments that are elected to be accounted for in their entirety at fair value cannot be used as a hedging instrument in a Statement 133 hedging relationship.) The economic characteristics and risks of the embedded derivative are not clearly and closely related to the economic characteristics and risks of the host contract (that is, the host UL contract is a debt instrument and the embedded option is equity-indexed), the hybrid instrument is not remeasured at fair value with changes in fair value reported in earnings as they occur under GAAP, and a separate instrument with the same terms as the embedded derivative instrument would be a derivative instrument pursuant to paragraphs 6–11 of Statement 133.

In contrast, if the contract contained an equity-indexed death benefit component that was over and above the cash surrender value that is payable to the policyholder upon surrender of the policy, that death benefit component would not meet the criterion in paragraph 12(c) for separate accounting-as a separate instrument, that death benefit component would not be a derivative subject to the requirements of Statement 133 due to the paragraph 10(c) exclusion for benefits payable only upon death, as illustrated in paragraph 200. That is, a contract component is not subject to the requirements of Statement 133 if it entitles the holder to be compensated only as a result of the death of the insured.

The above response has been authored by the FASB staff and represents the staff's views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.

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