There are a number of fundamentals associated with accounting for life insurance contracts. Sometimes they're referred to as long duration insurance contracts. So let's establish these first before we look at the accounting for the different contract types.

It's important to note that these fundamentals apply for both US GAAP and IFRS.

Firstly, the contracts are much longer in duration than for P&C business. Often they cover many decades.

Therefore, all the cash flows need to be discounted in life insurance accounting.

This gives rise to a new version of our insurance equation that links premiums, claims, and profits.

For life insurance, the present value of premiums is equal to the present value of future benefits, plus the present value of future profit. So if we write a life insurance contract with a premium of $100 million, and we think that the present value of the future benefits on that insurance contract, for example, the guaranteed death benefit discounted to today is $80 million, then the present value of the future profit in the contract is $20 million.

Secondly, there are many different types of life insurance contract, some with premiums paid upfront and some with premiums paid over time.

Likewise, the benefits can either be paid at a point in time, as with a death benefit, or gradually over time, as with an annuity. The accounting needs to ensure that the profit recognized over the life of the contract reflects how the insurance company is released from risk as time passes.

This therefore requires the profits to be gradually released to earnings over the contract duration, regardless of when the cash flows actually occur.

Thirdly, reserves need to be updated to reflect current estimates of future cash flows. In general, this will require the cash flow estimates in reserves to reflect current expectations of mortality, current expectations of policy lapses and surrenders, and also current discount rates.

This can mean that there are situations where a long duration contract becomes onerous, meaning that the present value of the future benefits and claims exceed the value of the premiums, and the contract will be loss-making rather than generating future profits.

The accounting needs to ensure that these contract losses are recognized appropriately in earnings.