At the Fall 2022 US National Meeting of the National Association of Insurance Commissioners (“NAIC”), the Statutory Accounting Principles (E) Working Group (the “SAP WG”) met on December 13. While the SAP WG considered several topics at its meeting, it adopted three non-contested positions and exposed (or re-exposed) approximately 13 other items with a comment deadline for these items of February 10, 2023. The three adopted positions are discussed below as well as certain key items that were exposed for comment.
Proposed Bond Definition
Since 2020, the SAP WG has been working on a multi-year project to substantially revise the definition of what kinds of investments qualify for “bond” treatment for statutory accounting purposes. Bond treatment is important to insurers because it results in lower risk-based capital (“RBC”) charges and, for life insurers, generally means that the investment can be carried at amortized cost, rather than being marked to market. Since October 2020, the project has followed a principles-based approach, with an emphasis on substance over form, in such a manner that the framework and principles established will work for an increasingly innovative market and will provide regulators and other financial statement users with transparency for understanding the risks present in an insurer’s investment portfolio.
Current exposure drafts include updated versions of SSAP No. 26R—Bonds, SSAP No. 43R—Asset-Backed Securities and sundry other SSAPs and INTs (interpretations of statutory accounting principles) to dovetail with the changes to SSAPs No. 26R and 43R. Also included among the exposure drafts are (i) a revised issue paper explaining the Principles-Based Bond Definition in depth and (ii) revisions to the Schedule D reporting blank and instructions to provide more detailed types of information about asset-backed securities. The current comment period ends on February 13, 2023, and the proposed effective date for all of these changes is January 1, 2025.
Other Key Items Exposed or Re-exposed for Comment
The SAP WG exposed or re-exposed additional items at its meeting, with comments due on all items by February 10, 2023.1 Below are several key items that were exposed for comment.
- Revisions to the Definition of a Liability
The SAP WG re-exposed revisions to SSAP No. 5R—Liabilities, Contingencies and Impairments of Assets to revise the definition of a liability to be consistent with the newly issued definition in FASB Statement of Financial Accounting Concepts No. 8 and directed NAIC staff to collaborate with interested parties on proposed clarifying language. The exposure also included a new Issue Paper No. 16X—Updates to the Definition of a Liability.
- Consideration of Negative IMR
The concept of an interest maintenance reserve (“IMR”) was added to statutory accounting for life insurers in 1992 and requires a realized fixed income gain or loss that is attributable to changes in interest rates (as distinct from gains or losses that are credit related) to be amortized into income over the remaining term to maturity of the fixed-income investments sold, rather than being reflected in income immediately. Currently, a life insurer’s net IMR balance (a liability) is not permitted to go negative.
On October 31, 2022, the American Council of Life Insurers (“ACLI”) sent a letter to the SAP WG, proposing that, in light of the rising interest rate environment, net IMR balances be allowed to go negative. At the December 13, 2022 SAP WG meeting, NAIC staff highlighted the need for guidance for state regulators in deciding whether and how to grant permitted practices to allow insurers to admit negative IMR as an admitted asset. The SAP WG voted to expose this agenda item for comment and requested industry to provide potential guardrails and details on unique considerations. It also directed NAIC staff to coordinate a joint regulator discussion with the NAIC’s Life Actuarial (A) Task Force and to develop a memorandum regarding considerations for state insurance regulators.
- Collateral for Loans
Revisions to SSAP No. 21R—Other Admitted Assets were previously exposed to clarify that invested assets pledged as collateral for admitted collateral loans must themselves qualify as admitted investment assets. This item was drafted to address an inconsistency regarding the collateral loan guidance in SSAP No. 20—Nonadmitted Assets and SSAP No. 21R. Both of these SSAPs identify the need for adequate collateral that qualifies as an “invested asset”; however, SSAP No. 20 is explicit that the investment asset collateral must qualify as an admitted asset.
The SAP WG also considered a proposal from interested parties relating to one particular collateral type: an equity investment in a joint venture, partnership or LLC, which would be accounted for under SSAP No. 48—Joint Ventures, Partnerships and Limited Liability Companies if it were owned directly. The interested parties sought to clarify that a fair value assessment of such investments could be used to determine collateral sufficiency for SSAP No. 21R purposes when an equity investment in a joint venture, partnership or LLC is pledged as collateral for a loan, but that if the loan is foreclosed and the insurer takes direct ownership of the SSAP No. 48 investment, a GAAP audit must ultimately be obtained on a consistent annual basis to continue to support valuation and admittance of the SSAP No. 48 investment.
Both the revisions to SSAP No. 21R and the footnote proposed by interested parties were exposed for further comment.
- Affiliate Reporting Clarification
At its May 24, 2022, meeting, the SAP WG adopted agenda item 2021-21: Related Party Reporting, which included revisions to clarify application of the existing affiliate definition as well as to incorporate new disclosure requirements for investments acquired through, or in, related parties, regardless of whether they meet the affiliate definition. During the discussion at that meeting, it was suggested that there needs to be a clarification of when an investment is considered to be an affiliated investment and reported on the affiliated line in an insurer’s investment schedules. The SAP WG chair made clear in that discussion that if the issuer of an investment is an affiliate, then under SSAP No. 25—Affiliates and Other Related Parties the investment is an affiliated investment, but it was unclear how an investment would be treated if the issuer of an asset-backed security was unaffiliated with the insurer but the investments underlying the asset-backed security involved exposure to affiliates of the insurer.
At the December 13, 2022 meeting, the SAP WG proposed that the foregoing question be answered in the affirmative by exposing for comment a revision to SSAP No. 25 that would add the following sentence at the end of paragraph 5: “Any invested asset held by a reporting entity which is issued by an affiliated entity, or which includes the obligations of an affiliated entity is an affiliated investment.”
- Enhanced Interest Income Disclosure
A number of comments received in the course of the bond project related to the reporting of interest income in an insurer’s financial statements. Accordingly, at the December 13, 2022 meeting, the SAP WG exposed for comments revisions to SSAP No. 34—Investment Income Due and Accrued to disclose (i) the gross, nonadmitted and admitted amounts for interest income due and accrued and (ii) aggregate deferred interest and cumulative amounts of paid-in-kind (“PIK”) interest included in the current principal balance.
- Review of Interpretation 03-02: Modification to an Existing Intercompany Pooling Arrangement
The SAP WG had previously exposed an intent to nullify Interpretation 03-02: Modification to an Existing Intercompany Pooling Arrangement (“INT 03-02”), as the SAP WG believed it to be inconsistent with SSAP No. 25, which provides guidance regarding economic and non-economic transactions between related parties. Specifically, the SAP WG was concerned that the guidance in INT 03-02 can result in unrecognized gains (dividends) or losses through the using of statutory book valuation when using assets (bonds) to make payments to affiliates for modifications to existing intercompany reinsurance pooling agreements. The NAIC staff had expressed a view that treatment of transfers of assets between affiliates should be consistent for all intercompany transactions and that there is not a compelling need to be different when valuing assets for intercompany reinsurance transactions.
The exposure of this intent was met with a strong response from the industry, with many parties recommending that INT 03-02 be retained. Accordingly, the SAP WG has re-exposed the intent to nullify INT 03-02 to allow for further discussion and, with this re-exposure, has included the following NAIC staff comments on the eight points raised by industry parties:
- In the current interest rate environment, the fair value of many bonds is below book value—for example, a bond with an amortized cost of 100 with a fair value of 85. The way INT 03-02 is written, a bond with a fair value of 85 could be used to settle an intercompany reinsurance pooling obligation of 100. If the insurer paid with cash, it would be required to pay $100. The actual cash value of obligations when they are extinguished is a relevant measure of the transaction.
- Using book value for measurement of payments between affiliates can result in either unrecognized of in effect dividend or losses. SSAP No. 25 requires such transfers of assets between affiliates to use fair value. If a subsidiary can pay the parent with assets that have a lower fair value than book value (e.g., owes $100 but pays with a bond of 85), this has a similar effect as an unrecognized capital contribution to the subsidiary. SSAP No. 72 requires a capital contribution to be valued using fair value.
- NAIC staff agrees with the interested parties that, at the ultimate parent level, such a transfer of assets (in accordance with SSAP No. 25 guidance) may be noneconomic in that the parent continues to hold an interest in the same assets. Therefore, at the parent level, such a transfer of assets may result in the deferral of gains. NAIC staff believes that losses would not be deferred at the ultimate parent level.
- NAIC staff notes that, while it may be more expedient to pay for intercompany reinsurance pooling transactions with assets, the valuation used should be similar to that used if the obligation was extinguished with cash. Therefore, an entity can still choose to pay with assets, but they just need to be valued consistently with SSAP No. 25 guidance.
- SSAP No. 62R, paragraph 36d provides an exception to retroactive reinsurance accounting guidance, an exception allowing for prospective accounting treatment for intercompany reinsurance among 100% owned affiliates, provided there is no gain to the ceding entity. If there is a gain to the ceding entity, there is guidance in SSAP No. 62R, paragraph 37 that requires a more punitive method of accounting than either prospective or retroactive reinsurance accounting. Therefore, NAIC staff’s comment is that the statutory accounting objective is to provide different treatment for retroactive reinsurance contracts if there is a gain to the ceding entity. This is another reason that the guidance in INT 03-02 is problematic. The object is to correctly measure the effects of the contract, which drives the accounting. The objective is not to obscure whether there is a gain to the ceding entity, which can happen in the event that the assets used in payment are not measured correctly.
- Interested parties noted that modifications to intercompany pooling arrangements are typically effective retroactive to the beginning of the year. NAIC staff notes that the payment value when the transaction is settled should be equivalent to the cash value of what is owed on the date of extinguishment of the liability.
- Many of the interested parties’ comments regarding GAAP use of book value are more relevant to consolidated basis accounting, which is not consistent with the legal entity basis of statutory accounting.
- Interested parties’ comments noted that there is a difference in treatment for intercompany pooling participants that are not 100% owned by a common parent. NAIC staff notes that changes to retroactive pooling agreements among participants that are not 100% under common control do not meet the exception to retroactive accounting provided in SSAP No. 62R, paragraph 36d. NAIC staff notes that SSAP No. 62R, paragraph 37 provides guidance for retroactive reinsurance agreements among affiliates where there is a gain to the ceding entity.
Adopted Accounting Positions
The SAP WG adopted the following three non-contested positions:
- ASU 2022-01: Fair Value Hedging – Portfolio Layer Method
The SAP WG voted to adopt edits to SSAP No. 86—Derivatives to incorporate key aspects of the US GAAP guidance for portfolio layer method hedges and partial-term hedges. These edits specifically included, among other revisions: (i) detailed criteria for portfolio and partial-term hedges; (ii) guidance for reporting when the hedge is discontinued; and (iii) language to identify the adoption of ASU 2022-01, Fair Value Hedging – Portfolio Layer Method and to adopt with modification the guidance for partial-term hedges from ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The SAP WG noted that, for the current proposal, the partial-term hedge guidance is limited to hedged assets (not liabilities). This differs from US GAAP, but the SAP WG further noted that additional statutory discussion is needed on basis adjustments when hedging liabilities, especially under partial term hedges. Portfolio layer method hedges are limited to recognized assets under US GAAP so that proposed guidance for statutory accounting principles for those hedges will be consistent.
In connection with the foregoing, an issue paper was prepared, discussed and exposed by the SAP WG to detail statutory accounting revisions related to derivatives for historical purposes.
This position was adopted with an effective date of January 1, 2023, with early adoption permitted.
- ASU 2022-02: Troubled Debt Restructuring and Vintage Disclosures
The SAP WG voted to retain existing guidance in SSAP No. 36—Troubled Debt Restructuring but to revise the relevant literature section to identify the rejection of ASU 2022-02 and to detail how US GAAP and statutory accounting principles differ for the accounting of troubled debt restructurings for creditors.
- Related Parties—Footnote Updates
The SAP WG adopted revisions to SSAP No. 25—Affiliates and Other Related Parties and SSAP No. 97—Investments in Subsidiary, Controlled and Affiliated Entities to incorporate language to exempt foreign open-end investment funds governed and authorized in accordance with regulations established by the applicable foreign jurisdiction from the look-through provisions included in SSAP No. 25.
Following the February 10, 2023 deadline, the SAP WG will be able to take action on a number of the items that were exposed or re-exposed for comment. As interested parties offer their perspective, it will likely become more clear which course of action the industry would like the SAP WG to take. We will continue to track and report on these developments.
To view additional updates from the US NAIC Fall 2022 National Meeting, visit our meeting highlights page.