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Article | Executive Pay Memo North America

Preparing for GAAP accounting changes: Insurance industry incentive plan design

Executive Compensation|Insurance Consulting and Technology
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By Dom Lebel , Steve Hinden , Max Fogle and Shannon Williams | November 9, 2021

U.S. life and annuity insurers will need to review incentive compensation in light of new standards.

U.S. insurance companies are preparing for the impact of Accounting Standards Update No. 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts (LDTI). The new standards are set to go into effect for public companies for fiscal years beginning after December 15, 2022, and will result in significant changes to financial measures for insurance companies issuing long-duration contracts (e.g., life insurance, disability income, long-term care policies and annuities).

Compensation professionals will need to take action to understand and prepare for the impact of LDTI. Among other changes, LDTI requires that assumptions used for calculating accounting values be updated annually (or more frequently) for all products, whereas current generally accepted accounting principles (GAAP) standards use “locked-in” assumptions throughout the life of a policy for many types of products. This change could drive increased volatility and complexity in financial measures commonly used in incentive plans (including income-based and return measures). Of particular importance for incentive planning, financial reporting for fiscal year 2023 and beyond will not be directly comparable to pre-2023 reporting, and any financial goals set prior to 2023 might not be relevant.

In the near term, companies might want to consider possible approaches to 2022 long-term incentive plan (LTIP) awards that address the challenges caused by the accounting changes. In-progress LTIP grants with performance periods carrying into fiscal year 2023 will also need to be cared for. More generally, companies will want to revalidate whether current incentive designs remain appropriate and whether measures, performance periods, goal setting, and use of adjustments or discretion need to be reconsidered.

A high-level action plan is outlined below. Key stakeholders (i.e., executive leadership and the board of directors) should be kept informed of the rule and potential approaches before soliciting their feedback and approval. A close partnership with finance and other areas of the organization (i.e., legal, human resources, investor relations) will be critical. Finally, a successful implementation will require developing and executing on a change management and communication strategy.

Near term (Q4 2021 and Q1 2022) – 2022 LTIP awards

  • Meet with your company’s finance team to discuss the company’s project plan to comply with new standards.
  • Evaluate the impact of standards changes to measures used in LTIP awards to be granted in 2022.
  • Develop an approach to LTIP awards expected to be granted in 2022, including measures, goal setting (threshold/target/maximum), and potential for adjustments or use of discretion.

Medium term (2022) – In-cycle LTIP awards

  • Evaluate the impact of standards changes to measures used in LTIP awards with performance periods that carry into fiscal year 2023.
  • For affected awards, develop approaches to manage the transition to new standards. The approach will need to balance both “fairness” (to both participants and shareholders) with administrative complexity, among other considerations.

Longer term (2022+) – Go-forward AIP and LTIP

  • Review current measures in both annual and long-term incentive plans. Consider the impact of standards changes on volatility and goal setting, and how adjustments/discretion could be appropriately applied.
  • Consider new measures that could align more closely with business strategy and talent objectives. Embedded value measures (including value of new business) could now be relatively more appealing given LDTI required changes to GAAP.

If you have any questions on the accounting changes or on implications for incentive plan design, please do not hesitate to reach out to the authors or another trusted Willis Towers Watson partner.

Authors

Managing Director and Leader, Americas Life Insurance Consulting and Technology

Senior Director, Executive Compensation (Stamford)

Associate Director, Executive Compensation (New York)

Associate, Executive Compensation (New York)

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