For the insurance industry, 2022 was another year of unpredictability, frustrating for some and rewarding for others. Regardless of how they fared, all insurance companies dealt with a laundry list of issues related, most particularly, to inflation, weather and cryptocurrency volatility.
On top of that, they were having to tackle a slew of new and proposed regulations that could significantly affect the industry over the next several years.
During Baker Tilly’s annual year in review of insurance hot topics, a team of our industry professionals gave updates on U.S. GAAP and statutory accounting guidance as well as on the status of the SEC’s proposed rules regarding environmental, social and corporate governance (ESG) and how the industry can benefit from ESG-related tax credits, and on how digital assets are moving into the industry. Learn more about our key takeaways and then watch our on-demand webinar below.
One of the most talked about changes is the new current expected credit loss (CECL) standard (ASU 2016-13 and related ASUs) that was required to be implemented Jan. 1, 2023. It replaces the legacy GAAP concept of the incurred loss model.
The standard will affect everyone to some extent, depending on their individual circumstances. In many cases, the ultimate accounting will not change drastically and the numbers reported in an organization’s financial statements may not differ from what it has historically reported. However, because the company may need to alter its policies, procedures and internal controls as it is implementing CECL, it should change the way it reaches its conclusion.
The National Association of Insurance Commissioners (NAIC) has not yet commented on what it plans to do from a CECL adoption perspective.
A new concept that will significantly affect statutory accounting is the NAIC’s “Bond Project.” The initiative stemmed from the increasing sophistication of investments that were showing up on insurers’ balance sheets, specifically items reported as bonds but had equity-like characteristics. To understand what was really happening from an accounting perspective, the NAIC established this bond project which has yielded two primary components: the principles-based bond definition and reporting changes to follow the implementation of accounting changes.
The NAIC has created a decision tree to help organizations determine if an investment qualifies as a bond.
The majority of insurers’ portfolios will be minimally affected. In fact, holders of only traditional issuer obligations will likely not feel any impact. The assets that will require additional analysis include those that are collateralized by underlying equity investments, those collateralized by nonfinancial assets relying heavily on cash flows not contractually secured, and those with other unique or complex structures, particularly when third-party market validation is not present to help support conclusions.
The proposed effective date is Jan. 1, 2025, but the comment period on revisions for SSAP Nos. 26R, 43R, 2R and 21R ends Feb. 10, 2023.
The Securities and Exchange Commission (SEC) proposed rules around how companies report their ESG initiatives, making them more “consistent, comparable and reliable.” The proposal isn’t expected to be finalized until 2023 based on statements from the SEC, which means adoption is likely going to be pushed to 2024.
Although the rules aren’t finalized, the SEC formed essentially an enforcement subcommittee on ESG matters and has started putting out enforcement cases. So even though it is not enforcing compliance with its proposed rules, it is enforcing that companies have to provide accurate information in their filings.
The SEC is signaling that organizations need to be preparing for this action, and most SEC registrants either already have an ESG program in place or are working on the framework. They are being proactive and requesting their suppliers, vendors and suppliers fill out ESG vendor questionnaires, and they are instituting rules similar to the SEC proposed rules.
Smaller companies are still working out how to start to develop their own ESG programs. For the most part, the journey should start with an assessment of where the organization is and where it wants to be. Every department should be involved in putting together an ESG mission statement that can then be communicated to organization stakeholders. Once that is socialized, the organization can start executing on its plan. The critical final step is reporting reliable information to its stakeholders and regulatory and compliance agencies.
ESG has taken on a larger role in tax thanks in part to the Inflation Reduction Act (IRA) that was passed in 2022. The legislation included a number of energy-related tax credits and incentives with the aim of putting the U.S. on a path to reduce greenhouse emissions from its 2005 levels by 40% by 2030. It also gives organizations a number of opportunities to accomplish some of their ESG goals via their tax position.
On the energy side, for many years, the government has offered alternative energy credits for solar and wind power. The IRA expanded those offerings to include credits for carbon oxide sequestration, clean hydrogen production, clean vehicle purchases, among many others.
Relating to the social part of ESG, organizations have had the opportunity to apply for New Markets Tax Credits and low-income housing credits for creating jobs and housing in designated areas. Those have been helpful, but they aren’t relevant for all industries and organizations.
To make ESG credits even more accessible to all industries, even those in the not-for-profit realm, the IRA monetized tax credits and made them transferable, allowing for a one-time sale for cash to taxpayers who need more credits.
As far as how to fit the governance aspect into its tax function, an organization will have to resolve which of its core tax principles and strategies that it’s willing to disclose since this part of ESG is looking at transparency and adaptability, which can be tricky depending on an organization’s tax planning objectives.
Still, if it conducts a review of its total tax footprint, an organization will be able to share that it’s not only paying federal taxes, but state, employment, property and municipal taxes, revealing how it is a good corporate citizen in how it gives back to the local communities in which it operates.
Despite volatility within the digital asset space, big players in traditional financial services markets, including BNY Mellon, U.S. Bank, Aon and Mastercard, are exploring opportunities within it.
One of the biggest reasons more mainstream investors are still avoiding crypto is the lack of regulation. The collapse of FTX followed by the massive crypto selloff brought even more attention to that point. Interestingly, those very issues may expedite actions by regulators, bringing more stability and elevating expectations for digital asset governance in terms of proof of reserves, proof of liabilities, transparency requirements, quality of reserves and internal control requirements.
Furthermore, the Financial Crimes Enforcement Network (FinCEN) has continued to push its anti-money laundering enforcement activity, which has been in place long before the emergence of digital assets. A data point from an oft quoted 2021 Chainalysis study noted that approximately .15% of crypto transactions had ties to illicit activity, which compared to the traditional. A recent CoinDesk events speaker noted that even if that volume was 10x of the .15% quoted, that number would still be short of the estimated 2.5-3% of the volume of illicit activity which occurs through the traditional financial markets.
Recent bad press may make the general public think that crypto will disappear, but two of the world’s countries with the largest populations — China and India — have had their central banks roll out pilot programs using digital currency, and the U.S. Federal Reserve announced this past fall that it is collaborating with a dozen large financial institutions to work through how a central bank digital currency might work domestically.
In light of those actions, it could be assumed we’re heading toward the use of central bank digital currencies faster than most think. So how will this affect how we do business, and in particular how do digital assets relate to insurance?
Crypto-native insurance: Already, carriers are writing policies in which they are providing wallet holders, whether retail or institutional, with coverage over their wallet if something happens at a specific exchange. The underwriting process has to engage that exchange, look at their internal controls and risk management programs, evaluate controls over access and authorization, as well as, assess the cybersecurity programs of the exchange.
Aon and Copper, a crypto custody firm, reached an agreement which provides Copper with $500 million of coverage over cold storage assets. The Gemini exchange launched its own insurance platform to provide insurance over assets that are held by a custodian. Nexus Mutual and Bridge Mutual provide smart contract cover to protect against hacks, vulnerabilities or failures.
The impact of crypto risk on the insurance industry: What is the exposure relating to existing policies that aren’t explicitly excluded? One can look at existing policies and/or exclusions around employee fraud or crime, but some of these risks are specific to crypto, like misplacing wallet keys, business interruption impact of trading halts in periods of volatility for crypto native companies, etc. Organizations have to conduct an assessment to see how much of this risk exists in its policies and the potential impact.
Use of smart contracts in insurance: An example of this is the use of smart contracts for parametric weather coverage for simple farm policies. Already carriers Arbol and the Lemonade Foundation, are able to issue policies based on GPS coordinates and historical weather patterns to execute smart contracts via blockchain oracles. The data source is a blockchain-based weather platform that independently reports weather data. Using that information, the contract is executed in according to the contract terms based on the way the smart contract was written.
While the topics that were most important in 2022 will continue to influence the industry in 2023, we know the industry will face an entirely different set of unforeseen challenges in the year ahead. To discuss how the above topics may impact your organization, please connect with our team or watch our on-demand webinar below.