There's a new philosophy in the marketplace about life insurance, and we believe it warrants a change in the accounting method used for this popular investment product. Traditionally, life insurance has been viewed as a legacy paid to designated beneficiaries after the insured's death. But in recent years policyholders have begun to view it as an underused asset, a source of significant financial resources they can tap while they are still living by selling their insurance to third parties. With the emergence of the multi-billion-dollar viatical and life settlement markets to facilitate these purchases, some accountants have begun to question the appropriateness of FASB Technical Bulletin no. 85-4, Accounting for Purchases of Life Insurance, that adopted the cash surrender method as the only generally accepted method of accounting for these assets. Many CPAs feel it fails to properly reflect the investment nature of life insurance purchases in these markets, resulting in financial reporting that lacks adequate transparency.
FASB argued in the technical bulletin that there is no justification to support recording insurance contracts at amounts other than agreed amounts (such as cash surrender value). However, we believe that because viatical and life settlement contracts are sold for amounts that exceed the cash surrender value, and because recent litigation has sought to classify the trading of interests in life insurance contracts as securities, there is compelling justification for recording such contracts at amounts greater than the cash surrender value.
We believe it's time to change the method of accounting for life insurance, and in this article we'll describe an alternative method we think FASB should consider.
CURRENT GAAP: THE CASH SURRENDER VALUE METHOD
Under the cash surrender value method, when a policy is purchased by a third party, the difference between the acquisition cost and cash surrender value is recognized as a loss. Initially, the amount of the reported asset is limited to the policy's cash surrender value. When additional premiums on the policy are paid, the reported asset amount increases only as the cash surrender value increases; any remaining amount is charged to expense. When the insured dies, the difference between the current cash surrender value and the policy's face amount is recognized as a gain.
Though the cash surrender value method is easy to apply, its economic soundness is subject to criticism for two...