Understanding Insurance Products Offered to Employee Benefit ...

Understanding Insurance Products Offered to Employee Benefit ...

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Employee Benefit Plan Audit Quality Center 1 Understanding Insurance Products Offered to Employee Benefit Plans Live Forum July 25, 2012 CPE Credit For Todays Webinar Must have registered for CPE credit prior to this webinar event. A total of 8 participation markers will appear on your screen (one approximately every fifteen minutes). Click the "OK" button on the pop up marker to evidence your participation in the event. You are required to participate in a

minimum of 75% of these markers. Upon completion of the webinar, a CPE Certificate will be placed in your account at the AICPA Store at www.cpa2biz.com under the My Online Learning tab. You will have access to your CPE Certificate for up to six years. If you have any questions regarding CPE, please contact the AICPA Service Center at [email protected] Employee Benefit Plan Audit Quality Center 3 How Do I Get My CPE Certificate? Just follow these steps: 1. Log on to CPA2Biz.com 2. Click on My Account at the top of the page and enter your

CPA2Biz/AICPA username and password 3. Click on My Web Events tab 4. Click on AICPA Learning Center Transcripts and Certificates link (a new window or tab will open) 5. On the AICPA Learning Center, click on My Transcript in the lefthand menu 6. Locate your completed course and click on Go to retrieve your certificate. If you need assistance with locating your certificate, please contact the AICPA Service Center at 888.777.7077 or [email protected] Employee Benefit Plan Audit Quality Center 4 Questions and Handouts

Panelists will answer questions throughout the event and in the Q&A session. You may submit questions at any time. Use the Q&A tab at the bottom of the screen. Handouts Employee Benefit Plan Audit Quality Center 5 Presenters Bob Lavenberg, Chair, EBPAQC Executive Committee; Partner, BDO USA LLP Debbie Smith, Partner, Grant Thornton LLP Diane Walker, Partner, Johnson Lambert LLP

Michele Weldon, Partner, PricewaterhouseCoopers LLC Employee Benefit Plan Audit Quality Center 6 Introduction Bob Lavenberg, CPA Chair Executive Committee AICPA Employee Benefit Plan Audit Quality Center BDO USA LLP Employee Benefit Plan Audit Quality Center

7 Objectives Describe the most common insurance company products held by plans Provide an understanding of the nature of these insurance company products Discuss valuation challenges related to these products Provide an opportunity to ask the experts (please do not identify any specific service providers in your questions) Employee Benefit Plan Audit Quality Center

8 Challenges Insurance products represent an ongoing challenge for plan sponsors and auditors Lack of understanding regarding nature of individual plan investments Variations in reporting/practices from insurance companies Employee Benefit Plan Audit Quality Center 9

Diane Walker Partner Johnson Lambert LLP Employee Benefit Plan Audit Quality Center 10 Overview Insurance companies offer products to plans to provide: Funding Insurance Services

Funding products typically established pursuant to a contract Employee Benefit Plan Audit Quality Center 11 Insurance vs. Investment Contracts The contract and supporting documentation provide information for determining the appropriate GAAP accounting classification and financial reporting Insurance contracts subject the insurer to significant insurance risks, including mortality or morbidity Investment contracts dont have substantial mortality or

morbidity (or similar) risks Insurance companies often refer to all types of contracts they issue as insurance contracts Funding Agreements Annuity Contracts Employee Benefit Plan Audit Quality Center 12 Insurance Product Options An insurance company may offer a wide variety of product options to plans Contracts that appear to be similar can have very different terms

May include provisions designed to mitigate risks (e.g., large-scale withdrawal risks detrimental to the insurance company and remaining contractholders): Restrictions on the transfer of the funds among various parts of the contract Delay the participant or the plan from withdrawing or transferring all or part of the contract value immediately Withdrawal charge Other similar provisions Restrictions on the ability to terminate or renew the contract Employee Benefit Plan Audit Quality Center 13 Insurance Companys Contractual Liabilities

The assets that support the insurance companys contractual liabilities can be held in The insurance companys general account A separate account of the insurance company Employee Benefit Plan Audit Quality Center 14 Allocated vs. Unallocated Contracts Plans enter into allocated contracts to legally remove obligation FASB definition (FASB Codification Master Glossary) of an allocated contract* A contract in which an insurance entity unconditionally undertakes a legal obligation to provide specified pension benefits to specific

individuals in return for a fixed consideration or premium. An annuity contract is irrevocable and involves the transfer of significant risk from the employer to the insurance entity. Allocated=not recognized as a plan asset Unallocated=recognized as a plan asset *The Form 5500 definition of an allocated contract differs from the FASB definition Employee Benefit Plan Audit Quality Center 15 Funding Agreements Provide guaranteed principal repayment and interest payments for a predetermined

period of time Provide a certain return (guaranteed or variable) Offer no ability for an insurer to guarantee the payment of income based on life of participant No annuity purchase option Employee Benefit Plan Audit Quality Center 16 Annuity Contracts Allow plans or participants to purchase guaranteed income to be paid over

the life of a participant a fixed period of time a combination thereof Group Annuity Contracts vs. Individual Annuity Contracts Single Premium vs. Flexible Premium Contracts Accumulation vs. Annuitization Phase Employee Benefit Plan Audit Quality Center 17 Annuity Contracts Defined Contribution Plans Many DC plans dont purchase payout annuities

unless a participant specifically requests 403(b) plans individual annuity contracts Most other plans group annuity contracts Typically have Guaranteed component Variable component Allow plan participant to select among different investment options Employee Benefit Plan Audit Quality Center 18 Debbie Smith Partner Grant Thornton LLP

Employee Benefit Plan Audit Quality Center 19 Annuity Contracts Defined Benefit Plans Commonly purchase payout annuities Deposit Administration (DA) Immediate Participation Guarantee (IPG) Employee Benefit Plan Audit Quality Center 20 Insurance Company General Accounts

Used to fund liabilities associated with various (and sometimes disparate) insurance products (e.g., annuities, life insurance, disability insurance, etc.) Contractual guarantees for general account contracts backed by full faith and credit of the contract issuer Specific securities within the general account are not carved out and attributed to any specific contract holder Ability to satisfy contractual guarantees is dependent on the issuer's claimspaying ability financial strength rating is important Employee Benefit Plan Audit Quality Center

21 Deposit Administration Contracts Contributions applied to future benefits of participants Looks like a money market account with a bank Insurance company promises to pay a rate of interest but not a specified benefit No guarantee that funds will be sufficient to pay for future annuities Insurance company may or may not pay experience rated dividends Employee Benefit Plan Audit Quality Center 22

Immediate Participation Guarantee Contracts A variation of a Deposit Administration Contract Typically two forms of contracts Contract provides that annuities are purchased when a participant retires Experience credit/debits adjust the account balance Contract provides that pension payments are made under the contract without the purchase of an annuity Sufficient account balance must be maintained to fund remaining benefits of all current retirees (retired life fund) Employee Benefit Plan Audit Quality Center

23 Newer Generation IPG or Hybrid DB Variations on the IPG Contract give contract holder more control over investment of supporting assets, often in variable separate accounts Also more risk and benefit Employee Benefit Plan Audit Quality Center 24

Traditional GICs Also known as standard GIC Issuer agrees to a guaranteed return on principal invested over a specified period of time Various contract forms Permitted deposits or withdrawals during certain windows during the contract life Multiple maturities (and rates) Guaranteed minimum rate with potential for contract holder to be credited with additional interest Floating rate contracts Employee Benefit Plan Audit Quality Center

25 Evergreen Guaranteed Rate Products Plan owns series of promises or guarantees that are embedded in the insurance contract Similar conceptually to a bank savings account Common general account evergreen contract characteristics Promise to credit interest at crediting rates that are declared in advance and reset from time to time Guarantee that crediting rates will not be less than the contractual minimum rate, which is never less than zero regardless of the performance of the general account assets A means for the contract holder to initiate discontinuance of the contract (the payout methodology upon discontinuance is detailed (and guaranteed) in the contract)

Employee Benefit Plan Audit Quality Center 26 Synthetic GICs Intended to simulate the performance of a traditional GIC Plan owns the underlying investments (e.g., high quality government securities, mortgage and other asset-backed securities, investment grade corporate obligations) Plan purchases a wrapper contract that stabilizes investment return guarantees full payment of principal and interest Value of the wrapper is the difference between the assets underlying the GIC and the value of the

principal plus the guaranteed interest Employee Benefit Plan Audit Quality Center 27 Key Concept Benefit Responsiveness A defined contribution plan concept meaning participants transact at book value (principal plus accrued interest) Benefit responsiveness helps the stable value fund achieve the following objectives Principal preservation with capital appreciation Consistent, conservative returns Returns similar to bond funds with the liquidity of money market funds

Benefit responsiveness is provided through one or more different types of investments (GICs, Guaranteed Rate Funds, Commingled Funds, Separately Managed Funds, etc.) Employee Benefit Plan Audit Quality Center 28 Separate Accounts Not a distinct legal entity (an accounting entity created by and under the control of the insurance company) Arrangement generally legally isolates the assets backing the contracts from the general account assets can be not insulated

Insurance company owns 100% of the assets held in the separate account Arent publicly traded funds, but may be registered funds Employee Benefit Plan Audit Quality Center 29 Separate Accounts (continued) May be owned by one plan (separate separate account) or pooled (PSA) Provide for fixed or variable returns Provide guarantees, such as a guaranteed rate of return or guaranteed life income Employee Benefit Plan Audit Quality Center

30 Separate Accounts Pools of assets can be stocks, bonds, real estate, collective investment funds, shares in a mutual fund Operate similar to a mutual fund Interest in a separate account is evidenced by "units" May be fixed or variable return Employee Benefit Plan Audit Quality Center 31 Pooled Separate Account vs. Mutual Fund

Separate Account Mutual Fund Unit value Share price/NAV Portfolio holdings Portfolio holdings No public price Public price

Part of investment contract Held in separate custodial account An asset /liability of the insurance co. May be traded at omnibus or plan level May be audited Audited Employee Benefit Plan Audit Quality Center 32

Separate Account GICs Provide guarantees supported by insurance company separate accounts Generally provides for guaranteed crediting rates announced in advance and with a minimum floor crediting rate of 0% Contract (book) value is sum of deposits withdrawals + interest at net crediting rates If the separate accounts assets are insufficient to fund benefit payment obligations, general account may be required to fund the deficit; some credit risk Employee Benefit Plan Audit Quality Center 33

Michele Weldon Partner PricewaterhouseCoopers LLP Employee Benefit Plan Audit Quality Center 34 Identification of Contracts Obtain full contract, all amendments & related/referenced documents Often challenging to obtain all the pieces Look for stated contract type (IPG, DA)

Scan Table of Contents for key sections/provisions Contributions/Funding How will money be held separate or general account Investment selections Investment return guaranteed or variable Withdrawals/Benefit Payments Expenses For participant directed DC plans, materials given to plan participants can be useful in understanding the structure Employee Benefit Plan Audit Quality Center 35 Fair Value Measurement

Responsibility of plan sponsor May be delegated (with oversight/ownership) not outsourced to insurance company Insurance company may not always provide fair value measured in accordance with GAAP Need to understand valuation techniques and plan sponsor monitoring procedures Plan sponsor may need to engage a valuation specialist Auditor may consider corroboration using a valuation specialist Employee Benefit Plan Audit Quality Center 36 Possible Valuation Approaches

Using FASB ASC 820 framework, three possible valuation techniques can be considered: Income approach Uses valuation techniques to convert future amounts (i.e., cash flows) to a single present amount Option pricing models Market approach Uses observable market prices Comparable assets or liabilities

Cost approach Uses a replacement cost Employee Benefit Plan Audit Quality Center 37 Common Valuation Practices General account GICs Income approach: Present value future cash flows Other Synthetic GICs

Market approach using rebids at year-end for wrapper Quoted market for underlying investments Other Separate accounts Net asset value (FASB ASC 946) NAVs for a specific PSA may vary from plan to plan Cash components and expense structure will generally impact plans unit value Not exchange traded (little publicly available information) Other Employee Benefit Plan Audit Quality Center 38

Other Valuation Considerations Insurance companies commonly make various assertions Fair value equals contract value Fair value equals discontinuance value Management needs to look to fair valuation methodologies and assess valuation method Employee Benefit Plan Audit Quality Center 39 Questions & Answers Session Reminder: Please do not identify any specific service providers in your questions

Employee Benefit Plan Audit Quality Center 40 Upcoming AICPA Events AICPA Annual Employee Benefit Plans Accounting, Auditing and Regulatory Update Conference, Washington, DC, December 6 7, 2012 Employee Benefit Plan Audit Quality Center 41 Thanks for Participating! Please take a moment to complete our evaluation

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