Accounting Changes for Split-Dollar Life Insurance Arrangements
By Brian Pollice
Community Bank Advisor, 2007 Winter
In September 2006, the Emerging Issues Task Force of the Financial Accounting Standards Board (FASB) issued guidance on accounting for deferred-compensation and post-retirement aspects of endorsement split-dollar-like insurance arrangements. This guidance was provided in Issue No. 06-4, which is accessible on www.fasb.org. The guidance may potentially have an impact on the financial statements of companies and ultimately their view on split-dollar arrangements.
The FASB was asked to address inconsistencies in practice. Some accounting firms suggested that the purchase of an endorsement split-dollar insurance arrangement does not settle a post-retirement benefit obligation. Other firms did not require this accounting treatment, thus the confusion.
Does my company have an issue?
The change in accounting impacts companies with all of the following circumstances:
- The company owns life insurance covering an employee.
- The company endorses a portion of the death benefits to the employee (the employee designates a beneficiary). This is referred to as an endorsement split-dollar life insurance arrangement.
- A benefit is provided to an employee that extends to post-retirement periods.
- A liability is not currently recorded.
The key aspect of this list is the point regarding a benefit that extends to post-retirement periods. For example, if the employee’s benefit ends at termination or retirement, there is no impact.
What is the impact to my company if this does apply?
The impact from a cash-flow perspective has not changed. However, the recognition of the obligation related to the benefit provided in the split-dollar arrangement is now accounted for in the same manner as other post-retirement benefits. Therefore, an expense is incurred over the period from inception of the benefit through the life expectancy of the retiree. The timing and extent of expense is explained in FAS 106. Regardless, the timing of the recognition of expense for this benefit is significantly sooner compared to the prior practice of waiting until the death of the employee.
Most companies have historically, upon the death of an employee, recorded income for the difference between the death benefits received from the policy and the cash-surrender value recorded as an asset. Net income is reduced by the amount paid out under the split-dollar arrangement.
What should I do now?
- For some of our clients, the first piece of advice has been to make sure you understand what you have. This is a perfect time to double check the terms and conditions of previous arrangements made years ago.
- Secondly, contact your consultant to determine the financial statement impact of this accounting change. Many companies will need the use of an actuary to determine the accounting impact.
- While talking to your consultant, consider alternative benefits, or amendments to existing plans, if the accounting impact is too adverse to the company.
- As always, get your auditor involved to help determine the impact of the accounting change as well as the potential impact of various alternatives.
- Communication internally (management and the board of directors) is always important. For some entities the impact may be nominal, but for others, major benefit changes may be proposed, so an understanding of the impact is imperative.
This pronouncement is applicable for calendar-year companies in 2008, but earlier application is permitted. The change can be recognized as a cumulative-effect adjustment to retained earnings. If benefits are not fully vested at the time of adoption, further charges to earnings will be required as well. Companies will be required to discuss the impact of this recent accounting pronouncement in their upcoming annual reports. Therefore, an expense is incurred over the period from inception of the benefit through the life expectancy of the retiree.
