Jane Dotson
Insurance entities may allow policyholders to replace their existing policies or modify certain provisions in existing policies to improve the marketability of their insurance products. These modifications can be made to the product benefits, features, rights, or coverages and can occur through a contract exchange, amendment, endorsement, or rider to a contract. Modifications that substantially change the replaced contracts are considered new contracts, while internal replacements that do not substantially change the replaced contracts are considered continuations of the original contract.
| Characteristics | Values |
|---|---|
| Definition | A modification of an insurance contract is considered a new contract if it substantially changes the replaced contract. |
| Internal replacement | A modification in product benefits, features, rights, or coverage that occurs by any of the following: Legal extinguishment of one contract and issuance of another contract (referred to as a contract exchange); Amendment of, endorsement or rider to, an existing contract; Election of a benefit, feature, right, or coverage within a contract. |
| Not considered internal replacements | Changing cost of insurance charges, interest crediting rates, or similar provisions within ranges outlined in the contract, without any other changes in benefits or coverages. |
| Accounting | ASC 944-30-35-24 through ASC 944-30-35-63 provides guidance on accounting for modifications or exchanges of insurance contracts. |
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What You'll Learn
Contractual changes vs. internal replacements
An insurance contract is a legal agreement between the insurance company (the insurer) and the person(s), business, or entity being insured (the insured). Insurance contracts can be modified or exchanged, and these modifications take a variety of legal forms. The substance of the modification, rather than its legal form, dictates the accounting for changes to existing contracts.
Modifications of insurance contracts that substantially change the replaced contracts should be considered new contracts, and the related DAC written off. Internal replacements of insurance contracts that do not substantially change the replaced contracts are considered continuations of the replaced contracts, and the related DAC is maintained. The definition of an internal replacement is very broad and includes a modification in product benefits, features, rights, or coverage. This can occur through a contract exchange, amendment, endorsement, or rider to a contract, or by the election of a benefit, feature, right, or coverage within the contract.
Certain actions, such as changing the cost of insurance charges, interest crediting rates, or similar provisions within ranges outlined in the contract, without any other changes in benefits or coverages, are generally not considered modifications to the contract or internal replacements. Changes in premiums, fees, or assessments not within the ranges outlined in the original contract, whether increases or decreases, would be considered internal replacements.
Replacing an insurance policy is not a simple task and should be done with caution. It may be in the insured's best interest to replace their policy with a new one due to changing levels of coverage, reducing premiums, or finding a policy better suited to their needs. However, there are factors involved that can negatively affect a policyholder's coverage and future costs. For example, life insurance contracts typically include a contestability period, usually lasting two years, during which the insurer may contest a claim based on misrepresentations made on the application. When a policy is replaced, this period starts over, as does the suicide exclusion, which allows the insurer to deny a claim if the insured's death is caused by suicide within the first two years.
To protect the insured, strict rules, laws, and regulations are in place regarding policy replacement. The National Association of Insurance Commissioners (NAIC) lays out model regulations for replacement policies, such as specific questions to be asked on an insurance application and a system for monitoring replacement activities. Insurance companies and agents must follow certain requirements when replacing a policy, and it is important for the insured to understand these procedures and their state's specific rules and regulations.
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![Fire Insurance : Book of Forms Containing Forms of Policies Endorsements, Certificates, and Other Valuable Matter, for the Use of Agents and Others 1866 [Leather Bound]](https://m.media-amazon.com/images/I/617DLHXyzlL._AC_UY218_.jpg)
Accounting for modifications
An insurance contract is a legal contract between the insurance company (the insurer) and the person(s), business, or entity being insured (the insured). A document modifying an insurance contract is referred to as a modification or exchange of an insurance contract.
Modifications to insurance contracts can take various legal forms, and the substance of the modification, rather than its legal form, dictates the accounting for changes to existing contracts. Most modifications to insurance contracts are considered internal replacements and are subject to analysis under ASC 944-30-35-24 through ASC 944-30-35-56.
Internal replacements refer to modifications in product benefits, features, rights, or coverage that occur through legal extinguishment of one contract and the issuance of another (contract exchange), amendment of an existing contract, endorsement or rider to an existing contract, or election of a benefit, feature, right, or coverage within the contract. Changes in premiums, fees, or assessments that fall outside the ranges outlined in the original contract are also considered internal replacements.
Modifications that substantially change the replaced contracts should be treated as new contracts, and the related DAC should be written off. On the other hand, internal replacements that do not substantially change the replaced contracts are considered continuations of the original contracts, and the related DAC is maintained.
In the context of reinsurance contracts, direct participating contracts, and investment contracts with discretionary participating features, the IFRS 17 requirements are modified. An insurance contract is derecognized when it is extinguished, meaning the obligation specified in the contract expires, is discharged, or is cancelled. When an insurance contract is derecognized, the entity is no longer at risk and is not required to transfer economic resources to satisfy the contract.
Additionally, any remaining amounts for the group or contract recognized in other comprehensive income (OCI) should be reclassified to profit or loss. When an entity derecognizes an insurance contract and recognizes a new one due to modifications, it must adjust the fulfilment cash flows accordingly.
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Changes to product features
Insurance companies may modify certain provisions in existing policies to improve their products' marketability or reduce the operational burden of accounting for and servicing a wide range of policy types. These changes can be considered new contracts or internal replacements of the original contract. An internal replacement is a modification in product benefits, features, rights, or coverage. This can be achieved through a contract exchange, an amendment, endorsement, or rider to a contract, or by the election of a benefit, feature, right, or coverage within the contract.
While "product feature" is not a defined term, it is believed to include premiums, fees, or other assessments. Changes to these features are considered internal replacements and are subject to analysis under the internal replacements accounting model. Changes to product features can also be made to address evolving exposures, such as cyber risk and the emergence of new industries, like the cannabis industry.
To develop and modify insurance products, product managers must consider multiple stakeholders, data silos, and legacy systems. They must also conduct thorough market research, define product features and pricing, and ensure alignment with regulatory requirements. Involving underwriting, claims, and legal teams early in the process can help avoid costly delays and revisions. Understanding the needs of target customers, including internal users such as underwriters and claims handlers, can lead to more effective product design.
Modern technology, such as low-code product builders, is playing an increasingly important role in insurance product development and modification. These tools enable product managers to create and modify products without extensive coding knowledge, reducing the time and resources required. They also allow for rapid prototyping, testing, and launching of new products or variations to respond quickly to market changes and customer needs.
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Modifying existing policies
An insurance policy is a legal contract between the insurance company (the insurer) and the person(s), business, or entity being insured (the insured). When applying for insurance, the first step is to obtain a proposal form from the insurance company. After filling in the requested information, the proposal is sent to the company (sometimes with a premium check). This is referred to as an offer. If the insurance company agrees to insure you, this is called acceptance. In some cases, the insurer may accept your offer after making changes to your proposed terms.
Modifications to insurance contracts can take a variety of legal forms, and the substance of the modification, rather than its legal form, dictates the accounting for changes to existing contracts. Most modifications to insurance contracts may be considered internal replacements and are subject to analysis under ASC 944-30-35-24 through ASC 944-30-35-56. An internal replacement is a modification in product benefits, features, rights, or coverage that occurs through a contract exchange, amendment, endorsement, or rider to a contract, or by the election of a benefit, feature, right, or coverage within the contract.
Modifications that substantially change the replaced contracts should be considered new contracts, and the related DAC should be written off. On the other hand, internal replacements of insurance contracts that do not substantially change the replaced contracts are considered continuations of the replaced contracts, and the related DAC is maintained. Changes in premiums, fees, or assessments that are not within the ranges outlined in the original contract, whether increases or decreases, would typically be considered internal replacements.
It is important to carefully review the contract to check for any errors that may impact coverage or costs. Understanding the entire policy can help avoid problems and disagreements with the insurance company in the event of a loss. Many insured individuals purchase a policy without fully comprehending what is covered, the exclusions, and the conditions that must be met for coverage to apply. Exclusions take coverage away from the Insuring Agreement, and common examples include flood, earthquake, and wear and tear damage in homeowners and automobile policies, respectively.
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New contracts vs. continuations
An insurance contract is a legal contract between the insurance company (the insurer) and the person(s), business, or entity being insured (the insured). A modification in an insurance contract may be executed by an insurance entity for a variety of reasons, such as improving the marketability of their insurance products or reducing the operational or administrative burden of accounting and servicing a wide variety of policy types.
Modifications to insurance contracts can take a variety of legal forms, and the substance of the modification, rather than its legal form, dictates the accounting for changes to existing contracts. Most modifications to insurance contracts may be considered internal replacements and are subject to analysis under ASC 944-30-35-24 through ASC 944-30-35-56.
Internal replacements are modifications in product benefits, features, rights, or coverage that occur by:
- Legal extinguishment of one contract and issuance of another contract (referred to as a contract exchange)
- Amendment of, endorsement or rider to, an existing contract
- Election of a benefit, feature, right, or coverage within a contract
Modifications of insurance contracts that substantially change the replaced contracts should be considered new contracts, and the related DAC should be written off. Internal replacements of insurance contracts that do not substantially change the replaced contracts are considered continuations of the replaced contracts, and the related DAC is maintained.
Certain actions executed by an insurance entity, such as changing the cost of insurance charges, interest crediting rates, or similar provisions within ranges outlined in the contract, without any other changes in benefits or coverages, are generally not considered modifications to the contract or internal replacements.
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Frequently asked questions
A document that modifies an insurance contract is called an internal replacement.
An internal replacement is a modification in product benefits, features, rights, or coverage. This can be done by amending, endorsing, or adding a rider to an existing contract.
Changes to the cost of insurance charges, interest crediting rates, or similar provisions within the outlined ranges in the contract are generally not considered modifications. Changes to premiums, fees, or assessments within the ranges outlined in the original contract are considered internal replacements.
When a contract is substantially changed by a modification, it is considered a new contract.
