LDTI, much more than an accounting rule change. It is a start of “marking liability to market,” and the beginning of the end of book accounting for life, annuity and LTC insurers, in my opinion. It requires a more rigorous ALM analysis and asset allocation framework.
Long duration target improvement (LDTI), aka, ASU 2018-12, is a new GAAP accounting requirement. Large insurers are already required to implement it in 2023. Other insurers are required to implement it in 2025. Like IFRS 17, LDTI requires insurers of long duration policies (life, annuity, long term care) to
- Update cash flows and discount rates at each reporting period (annually).
- Discount rates should be consistent with prevailing market yield of high-quality fixed income instruments (AA-A corporate bond yield, for example.)
- Policies (contracts) issued in different policy years should not be grouped together for reporting purposes.
So far, most large consulting firms have been focusing on the accounting implications and the necessary changes in actuarial assumptions and financial reporting systems. There is very limited discussion on the impact of LDTI on strategic asset allocation and (the fate of) book accounting.
Why does LDTI require more rigorous ALM analysis and asset allocation framework?
- The discount rate update at each reporting period would impact the present value of liability and hence the surplus.
- To reduce surplus volatility, insurers would need to re-align the asset allocation and to mark assets to market so that the changes in asset value would be consistent with the changes in their liability present value.
- Assets backing policies issued in different years should be managed separately from each other to facilitate better ALM and asset allocation profitability analyses.
Because the liability discount rates change at each reporting period, the acquisition yield (and hence the book yield of assets) becomes irrelevant after the initial reporting period. The new (market consistent) discount rate and the market yield of assets become the drivers of income.
The implication on ALM, book yield and strategic asset allocation may not be on the front burner of insurers and their asset managers for the time being. However, once the changes in actuarial assumptions and reporting systems are in place, this will immediately become the focus, I suspect. My suggestion is that, while insurers are re-assessing actuarial assumptions and re-designing new systems for LDTI reporting, they should take into consideration the implications on ALM, strategic asset allocation and book yield.
