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Attachment A Ref #2016-39

© 2016 National Association of Insurance Commissioners 1

Statutory Accounting Principles (E) Working Group Maintenance Agenda Submission Form

Form A

Issue: Mortgage Loans With Multiple Lenders Check (applicable entity): P/C Life Health

Modification of existing SSAP New Issue or SSAP Interpretation

Description of Issue: The Investment Classification Project (detailed in agenda item #2013-36) supported a review of the investment SSAPs to address a variety of application questions, mostly focusing on definitions and scope limitations of each of the noted SSAPs. In response to an industry inquiry, SSAP No. 37—Mortgage Loans was included within the Investment Classification Project, with a specific focus to consider whether a partial interest in a mortgage loan (in which there is one borrower, with more than one lender identified in a single lending agreement, and all lenders are secured with the same real estate) should be in scope of SSAP No. 37, and reported in a similar manner as other mortgage loans on Schedule B. The mortgage loan structures intended to be the focus of this agenda item are investments when the reporting entity/ investor is a “participant in a mortgage loan.” This focus intends to consider standard mortgage loan agreements (with principal and interest payments) in which the mortgage loan agreement identifies more than one lender providing the funds to a sole borrower in a single loan agreement. These generally occur for larger commercial mortgage loans. The use of the term “participant” to identify these mortgage loan structures shall not be interpreted as encompassing “participating mortgages.” In a “participating mortgage” the lender is entitled to share in the rental or resale proceeds from the property by the borrower, generally as a certain percentage of the cash flows generated from the real estate acquired with the mortgage loan. Furthermore, this agenda item is not intended to encompass an interest in a “fund” with underlying real estate assets (such as a Real Estate Investment Trust—REIT). A scenario of the structure intended to be captured within this agenda item is listed below:

• Five reporting entities each provide a $400,000 commercial mortgage loan to a single borrower. • Mortgage loan is secured by a single $2,000,000 commercial real estate structure. • None of the lenders can foreclose on the borrower without all lenders agreeing to foreclose. • This is not a “securitization” in which the lenders are issued a security representing an interest in cash

flows, supported by the real estate collateral held in trust. Instead, the five lenders are all identified as lenders in the single loan agreement (“as participants in a mortgage loan”).

Pursuant to the guidance in SSAP No. 37, mortgage loans are defined as a debt obligation that is not a security, which is secured by a mortgage on real estate. Within the definition of a “security” in SSAP No. 37 (definition adopted from U.S. GAAP), a “participation” is specifically noted. As such, some have concluded that an insurer as a “participant” in a group mortgage loan agreement results with these mortgage loan structures being outside the scope of SSAP No. 37. Excerpt from SSAP No. 37:

2. A mortgage loan is defined as a debt obligation that is not a security, which is secured by a mortgage on real estate. (A security is a share, participation, or other interest in property or in an enterprise of the issuer or an obligation of the issuer that (a) either is represented by an instrument issued



in bearer or registered form, or if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer, (b) is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment, and (c) either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations).

From comments originally received, these transactions reflect “loan participation agreements” backed by real estate, in which a mortgage loan is made by multiple lenders to a single borrower. It has been communicated that the key difference between this “participant” agreement and a standard mortgage loan (one lender) is that the reporting entity is unable to unilaterally foreclose on the loan. Instead, all lenders identified as a “participant” in the group transaction must agree to foreclose on the mortgage loan. This structure appears to be similar to a bank loan acquired through a syndication, except that the loan is secured with real estate collateral. (Bank loans are captured within SSAP No. 26—Bonds; the Investment Classification Project revisions currently being considered for that SSAP would clarify that bank loans are not securities, but are fixed-income investments specifically noted for inclusion in SSAP No. 26. Definitions for bank loans acquired by assignment, participation or syndication are also proposed with the current exposures under the Investment Classification Project.) Although this “group mortgage loan” issue was requested to be considered by the Working Group as part of the Investment Classification Project, the Annual Statement Instructions already include guidance which implies that “loans subject to a participation agreement” would be captured in Schedule B – Part 1:

Column 14 – Value of Land and Buildings: Report the appraisal value of the property (for land and buildings). For loans subject to a participation agreement, include only the reporting entity’s pro rata share of the appraised value as it relates to the reporting entity’s interest in the mortgage loan.

The intent of this agenda item is to clarify the SSAP that should address these transactions, and clarify the appropriate reporting schedule for consistency purposes. Based on the substance of these items, as well as the current guidance in Schedule B-Part 1, initial proposed revisions (detailed in the staff recommendation) propose to clarify the inclusion of these agreements in SSAP No. 37—Mortgage Loans. However, the Working Group could consider other SSAPs / reporting structures. Regardless of the SSAP identified, it is anticipated that revisions would be needed to clarify the inclusion of these items within that SSAP. A summary of possible SSAPs that could be considered by the Working Group is listed below:

• SSAP No. 37—Mortgage Loan: This SSAP would reflect the investment as a mortgage loan (secured by real estate), and would allow the mortgage loan to be recorded at the principal amount of the loan made by a specific reporting entity. Revisions to the SSAP are recommended to clarify the inclusion of these structures within scope, as well as propose guidance for the assessment of impairment to ensure comparisons based on the full amount loaned by the group of lenders to the fair value of the real estate, rather than a comparison of the amount loaned by the reporting entity to the full fair value of the real estate. If included within this SSAP, the mortgage loan would be reported on Schedule B. Under current RBC factors, for health and p/c companies, the RBC would be .05, and for life companies, RBC would depend on the type of loan, status (good standing, 90-days past due, or in foreclosure) and loan-to-value and debt-service coverage.

o Staff Note: As identified above, staff recommends SSAP No. 37 for these agreements. This is also consistent with existing Annual Statement Instructions.

• SSAP No. 21—Other Admitted Assets: This SSAP would reflect that the transaction is a “collateral loan”

as an unconditional obligation for the payment of money secured by the pledge of an investment. This standard allows the loan balance to be admitted if the collateral qualifies as an investment to the extent



that the collateral equals or exceeds the outstanding loan balance. If captured within SSAP No. 21, the investment would be reported on BA and the RBC for p/c and health companies would be 20%, and the RBC companies for life companies would be 30%.

o Staff Note: If the decision is made to not include these transactions within SSAP No. 37 (perhaps as a result of the group foreclosure restrictions), staff would recommend inclusion within SSAP No. 21 as a collateral loan. This would continue to reflect that a reporting entity acting as a “participant” in a mortgage loan agreement (as defined in this agenda item) does not result with the loan being considered a “security.” Classification within SSAP No. 21 (reported on Schedule BA) would result with a much higher RBC, particularly for mortgage loans that are in good standing. As the life RBC for mortgage loans (Schedule B) considers a variety of components (loan standing, loan-to-value ratio and debt service coverage), inclusion on BA may be perceived to result with an uncorrelated RBC as it does not consider elements specific to the mortgage loan.

• SSAP No. 26—Bonds: This SSAP would reflect the reporting entity’s “participant” structure as a “security” representing a creditor relationship whereby there is a fixed schedule for one or more future payments. If captured under this SSAP, the accounting and reporting of the loan would depend on an NAIC designation (requiring a credit assessment of the borrower), with either an amortized cost or fair value measurement method. (This SSAP would not consider the real estate collateral in valuation.) Although this approach could result with a more desirable RBC (on Schedule D-1), the original comments identified that obtaining an NRSRO rating for commercial mortgages is prohibitively expensive. If these items cannot be filed with the NAIC SVO, this could result with these structures being classified as 5* or 6*, with less desirable RBC.

o Staff Notes: It is staff’s initial interpretation that the “participant” lending structure is not intended to be captured within the “security” definition. Furthermore, the mortgage loan terms and real estate collateral is perceived to be a more relevant factor in determining valuation (e.g., impairment) and RBC then a credit assessment of the borrower (particularly if credit assessments are not feasible and the item is reported as a 5*).

• SSAP No. 43R—Loan-backed and Structured Securities: This SSAP would reflect the cash-flow nature of

the transaction, as the reporting entity is entitled to a share of cash flows from the borrower’s repayment of mortgage loan. However, the security does not currently fit within the construct of SSAP No. 43R as the real asset collateral is not held in trust. If the investment was captured within this SSAP, the transactions would be reported on Schedule D-1, with RBC based on NAIC designation. (For SSAP No. 43R securities, the NAIC designation can be impacted if the security is financially modeled or not financially modeled, but with a CRP rating.)

o Staff Notes: Similar to the comments on SSAP No. 26, it is staff’s initial interpretation that the

“participant lending” structure is not intended to be captured within the “security” definition. Also consistent, the mortgage loan terms and real estate collateral is perceived to be a more relevant factor in determining valuation (e.g., impairment) and RBC then a credit assessment of the borrower. Lastly, as this investment does not place the real estate collateral in a trust, revisions to incorporate an exception to the current SSAP No. 43R provisions would be necessary for inclusion in this SSAP.

• SSAP No. 48—Joint Ventures, Partnership and LLC: This SSAP could reflect the investment as a joint

venture or partnership interest, but it does not seem that this mortgage loan structure would fit the intent of structures envisioned to be in scope, as this SSAP requires audited financial statements of the investee for admittance. If captured within this SSAP, the structure would be reported on Schedule BA as an other-than-invested asset with the underlying characteristic of a mortgage loan. If reported on BA, RBC for p/c



and health companies would be 20%, and the RBC companies for life companies would be 30% unless the reporting entity filed the investment with the NAIC to receive a lower RBC.

o Staff Notes: As noted above, staff does not believe that this mortgage loan structure reflects the intent of what was to be captured within the scope of SSAP No. 48 as a joint venture or partnership. If captured within the scope of this SSAP, the reporting entity would need audited financial statements to be admitted.

Existing Authoritative Literature (underlining added for emphasis): SSAP No. 37—Mortgage Loans

2. A mortgage loan is defined as a debt obligation that is not a security, which is secured by a mortgage on real estate. (A security is a share, participation, or other interest in property or in an enterprise of the issuer or an obligation of the issuer that (a) either is represented by an instrument issued in bearer or registered form, or if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer, (b) is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment, and (c) either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations).

Schedule B – Part 1: Mortgage Loans Owned December 31 of Current Year

Column 14 – Value of Land and Buildings: Report the appraisal value of the property (for land and buildings). For loans subject to a participation agreement, include only the reporting entity’s pro rata share of the appraised value as it relates to the reporting entity’s interest in the mortgage loan.

SSAP No. 26—Bonds: (Current Authoritative Guidance)

2. Bonds shall be defined as any securities representing a creditor relationship, whereby there is a fixed schedule for one or more future payments. This definition includes:

Note – Revisions to SSAP No. 26 are proposed under the Investment Classification Project:

3. Bonds shall be defined as any securities1 representing a creditor relationship, whereby there is a fixed schedule for one or more future payments. This definition includes:

Proposed Footnote to Define “Security”: This SSAP adopts the GAAP definition of a security as it is used in FASB Codification Topic 320 and 860: Security: A share, participation, or other interest in property or in an entity of the issuer or an obligation of the issuer that has all of the following characteristics:

a. It is either represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.

b. It is of a type commonly dealt in on securities exchanges or markets or, when represented by an

instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.

c. It either is one of a class or series or by its terms is divisible into a class or series of shares,

participations, interests, or obligations.



The following definitions are also proposed in SSAP No. 26 to define “bank loan”:

Bank Loan – Fixed-income instruments, representing indebtedness of a borrower, made by a financial institution and acquired by a reporting entity through an assignment, participation or syndication:

• Assignment – A bank loan assignment is defined as a fixed-income instrument in which there is

the sale and transfer of the rights and obligations of a lender (as assignor) under an existing loan agreement to a new lender (and as assignee) pursuant to an Assignment and Acceptance Agreement (or similar agreement) which effects a novation under contract law, so the new lender becomes the direct creditor of and is in contractual privity with the borrower having the sole right to enforce rights under the loan agreement.

• Participation – A bank loan participation is defined as a fixed-income investment in which a single

lender makes a large loan to a borrower and subsequently transfers (sells) undivided interests in the loan to other entities. Transfers by the originating lender may take the legal form of either assignments or participations. The transfers are usually on a nonrecourse basis, and the originating lender continues to service the loan. The participating entity may or may not have the right to sell or transfer its participation during the term of the loan, depending on the terms of the participation agreement. Reporting entities shall account for loan participations within the guidelines of this statement if the participation agreement provides the reporting entity with the right to sell or transfer its participation during the term of the loan. Loan Participations can be made on a parri-passu basis (where each participant shares equally) or a senior subordinated basis (senior lenders get paid first and the subordinated participant gets paid if there are sufficient funds left to make a payment).

• Syndication – A bank loan syndication is defined as a fixed-income investment in which several

lenders share in lending to a single borrower. Each lender loans a specific amount to the borrower and has the right to repayment from the borrower. Separate debt instruments exist between the debtor and the individual creditors participating in the syndication. Each lender in a syndication shall account for the amounts it is owed by the borrower. Repayments by the borrower may be made to a lead lender that then distributes the collections to the other lenders of the syndicate. In those circumstances, the lead lender is simply functioning as a servicer and shall not recognize the aggregate loan as an asset. A loan syndication arrangement may result in multiple loans to the same borrower by different lenders. Each of those loans is considered a separate instrument.

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): The Investment Classification Project is addressed in agenda item 2013-36. However, per request of the Working Group, subsequent issues addressed pursuant to that project will have new agenda item references. These items will identify that they are captured within the direction of the “Investment Classification Project” originally detailed in agenda item 2013-36. Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): Not Applicable Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, classified as nonsubstantive, and expose revisions to clarify that a reporting entity providing a mortgage loan as a “participant in a mortgage loan agreement” (as defined in this Form A - reflecting one borrower, with more-than-one lender in an agreement that does not reflect a “securitization of assets”) shall consider the mortgage loan in scope of SSAP No. 37. In addition to clarifying that these mortgage loans are not securities and in scope of SSAP No. 37, revisions are proposed to clarify the impairment assessment for these mortgage loans and incorporate disclosures for these structures.



Inquiry – As detailed in the Form A summary, this agenda item is not intended to capture “participating mortgages” or “real estate funds.” SSAP No. 40—Real Estate provides guidance if the reporting entity is the borrower in a participating mortgage (recognition of liability), but there is no guidance in SSAP No. 37 if the reporting entity is the lender entitled to cash flows (or appreciation of the real estate’s fair value) from a participating mortgage. Also, NAIC staff often receives questions on whether real estate trusts are captured in SSAP No. 37. It is staff’s interpretation that REITs are outside the scope of SSAP No. 37, but there is no specific guidance addressing these investments in that SSAP. If preferred by the Working Group, this agenda item (or a separate agenda item) could consider these issues. If desired, this agenda item could request comments on these items to see if they are topics that industry supports addressing. Upon adoption of revisions to clarify the accounting and reporting for these “participant in a mortgage loan” structures (whether in SSAP No. 37 or in a different SSAP), it will be recommended that the Working Group send a referral to the Blanks (E) Working Group to clarify the annual statement reporting instructions, with inclusion of a new characteristic code to identify whether the reporting entity is a “participant in the mortgage loan” on Schedule B, as well as a referral to the Capital Adequacy (E) Task Force to review and clarify the RBC instructions to ensure the “group” lending arrangement (e.g., inability to foreclose outside of the group) is given appropriate risk consideration. Proposed Revisions to SSAP No. 37:

2. A mortgage loan is defined as a debt obligation that is not a security, which is secured by a mortgage on real estate. Unless the definition of a security is otherwise met, (or the transaction reflects a “securitization” captured in SSAP No. 43R), a reporting entity that takes part in a mortgage loan participation agreement1 shall report the lending as a mortgage loan within scope of this standard.

a. (A security is a share, participation, or other interest in property or in an enterprise entity of the

issuer or an obligation of the issuer that has all of the following characteristics:

i. (a) either is represented by an instrument issued in bearer or registered form, or if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer, .

ii. (b) It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment, and .

i.iii. (c) It either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations).

3. Mortgage loans meet the definition of assets as specified in SSAP No. 4—Assets and Nonadmitted Assets and are admitted assets to the extent they conform to the requirements of this statement.

1 The mortgage loan participation agreement captured within scope of this standard is specific to situations in which the reporting entity is a “participant” in a single mortgage loan agreement that identifies more-then-one lender (which includes the reporting entity) providing funds to a sole borrower with the real estate collateral securing all lenders identified in the agreement. Although a “participation” is captured within the definition of a security, the components required in paragraphs 2.a.i, 2.a.ii and 2.a.iii are not met under a standard “mortgage loan participation agreement” captured within this guidance. A mortgage loan participation agreement details the lenders providing a pro-rata share of a mortgage loan to a single borrower. These agreements do not have “issuers,” rather each lender is incorporated directly into the loan documents. Furthermore, these agreements are not captured on securities exchanges or markets, nor are they represented by an instrument. The key differentiating characteristic of a mortgage loan provided under a group “mortgage loan participation agreement” rather than a solely-owned mortgage loan is that no one lender of the lending group may unilaterally foreclose on the mortgage. With these agreements, the lenders must foreclose on the mortgage loan as a group.



Impairments 26. A mortgage loan shall be considered to be impaired when, based on current information and events, it is probable that a reporting entity will be unable to collect all amounts due according to the contractual terms of the mortgage agreement. According to the contractual terms means that both the contractual principal payments and contractual interest payments of the mortgage loan will be collected as scheduled in the mortgage agreement. A reporting entity shall measure impairment based on the fair value (as determined by acceptable appraisal methodologies) of the collateral less estimated costs to obtain and sell. The difference between the net value of the collateral2 and the recorded investment in the mortgage loan shall be recognized as an impairment by creating a valuation allowance with a corresponding charge to unrealized loss or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to unrealized gain or loss. Subsequent to the initial measurement of impairment, if there is a significant change (increase or decrease) in the net value of the collateral, the reporting entity shall adjust the valuation allowance; however, the net carrying amount of the loan shall at no time exceed the recorded investment in the loan. For reporting entities required to maintain an asset valuation reserve (AVR), the unrealized gain or loss on impairments shall be included in the calculation of the AVR. If the impairment is other than temporary (INT 06-07), a direct write down shall be recognized as a realized loss, and a new cost basis is established. This new cost basis shall not be changed for subsequent recoveries in value. Mortgage loans for which foreclosure is probable shall be considered permanently impaired.

Disclosures

25. The following disclosures shall be made in the financial statements:

f. An age analysis of mortgage loans, aggregated by type, with identification of mortgage loans in which the insurer is a participant in a group mortgage loan agreement (more than one lender in a single agreement to a sole borrower), capturing: 1) recorded investment of current mortgage loans, 2) recorded investment of mortgage loans past due classified as 30-59 days past due, 60-89 days past due, 90-179 days past due, and greater than 180 days past due; 3) recorded investment of mortgage loans 90 days and 180 days past due still accruing interest; 4) interest accrued for mortgage loans 90 days and 180 days past due; and 5) recorded investment and number of mortgage loans where interest has been reduced, by percent reduced; and

26. The following additional disclosures shall be made for impaired loans:

a. The total recorded investment in impaired loans, aggregated by type, at the end of each period and with (i) the amount for which there is a related allowance for credit losses determined in accordance with this statement and the amount of that allowance, and (ii) the amount for which there is no related allowance for credit losses determined in accordance with this statement, and (iii) the total recorded investment in impaired loans subject to a participant mortgage loan agreement for which the reporting entity is restricted from unilaterally foreclosing on the mortgage loan;

b. The policy for recognizing interest income on impaired loans, including how cash receipts

are recorded; c. For each period for which results of operations are presented, the average recorded

investment, aggregated by type, in the impaired loans during each period, the related amount of interest income recognized during the time within that period that the loans

2 If the mortgage loan is subject to a mortgage loan participation agreement as defined in paragraph 2, collateral valuations conducted for impairment assessment, and the reporting of the appraisal value of land and buildings shall only reflect the reporting entity’s pro-rata share of the collateral/appraised value as it relates to the reporting entity’s interest in the mortgage loan.



were impaired, the recorded investments on nonaccrual status pursuant to SSAP No. 34, paragraph 6 and, unless not practicable, the amount of interest income recognized using a cash-basis method of accounting during the time within that period that the loans were impaired; and

d. For each period for which results of operations are presented, the activity in the

allowance for credit losses account, including the balance in the allowance for credit losses account at the beginning and end of each period, additions charged to operations, direct write-downs charged against the allowance, and recoveries of amounts previously charged off.

Staff Review Completed by: Julie Gann - NAIC Staff, October 2016 G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\A - 16-39 - Mortgage Loan Multiple Lenders.docx

Attachment B Ref# 2016-40



Form A

Issue: Definition of LBSS Check (applicable entity): P/C Life Health


Description of Issue: The Investment Classification Project (detailed in agenda item #2013-36) supported a review of the investment SSAPs to address a variety of application questions, mostly focusing on definitions and scope limitations of each of the noted SSAPs. SSAP No. 43R—Loan-backed and Structured Securities (SSAP No. 43R) was originally identified as a SSAP to review within the Investment Classification Project. Pursuant to the original project focus, the assessment of SSAP No. 43R is intended to include a review of definitions for the investments within scope, and to verify whether investments are being appropriately included (or excluded) from that standard. As the SAPWG initially focused on revisions to SSAP No. 26—Bonds under the Investment Classification Project in 2016, the Valuation of Securities (E) Task Force undertook a project to assist with reviewing the definitions for loan-backed and structured securities (LBSS) captured in SSAP No. 43R. In initiating this review, the Task Force identified that they have significant interest in SSAP No. 43R and would propose revised definitions, which may address industry concerns, pursuant to the SVO and Structured Securities Group (SSG) perspective. On June 10, 2016, the Task Force submitted a referral to the Working Group proposing definition changes for SSAP No. 43R investments. The proposed definitions focus on the collateral pool as the source of dynamic cash flow. As detailed in the referral, the Task Force recommends a change for SSAP No. 43R securities, broadly referred to as “structured finance securities,” to recognize that a dynamic cash flow pattern is the result of a specific structural construct, which includes all of the following:

• Legal isolation and pooling of a finite number of cash generating assets. • Each cash generating asset from a different obligor, • Cash generating assets are held in a trust, • Cash flows from the cash generating assets are used to pay the security holders.

In developing the recommended definition, the Task Force first exposed their proposed definition for comment in April 2016. The Task Force’s adopted definition, detailed in the June 2016 referral, reflects the exposed definition modified to incorporate comments received by the ACLI. Upon adoption of the definition, the Task Force agreed to recommend the proposed definition to the Statutory Accounting Principles (E) Working Group for consideration into SSAP No. 43R. VOSTF Proposed Definition (from May 17, 2016 memo) Modified to Reflect ACLI’s Comments: (Italics reflect changes incorporated from the ACLI comments.)

• Loan-backed securities and structured securities are more broadly characterized as structured finance securities.

• In a structured finance security, an issuer, typically an SPE): 1) sells loan-backed or structured securities

and uses the proceeds of the sale to purchase a pool of assets associated with multiple unrelated obligors, including derivatives, from one or more originators; and 2) places the such assets within a trust that serves as trustee for the benefit of the holders of the loan-backed or structured securities, with



instructions that the trustee use the cash flow generated by the assets to pay the holders of the SPE’s loan -backed or structured securities.

• The asset pool in a structured finance security contains multiple unrelated obligors, which affects the

dynamic of cash flow generation. An asset pool is a closed pool so that the default of any one of the unrelated an asset pool obligors permanently impairs the cash flow generating ability of the asset pool.

• Loan-backed securities are defined as a structured finance security in which a servicing intermediary

collects payments from the asset pool multiple unrelated obligors and remits or passes them through to holders of the securities so that payment of interest and/or principal to each SPE noteholder is directly proportional to the payments received by the issuer from the underlying assets.

• Structured securities are defined as a structured finance security that has been divided into two or more

classes and in which a servicing intermediary collects payments from the asset pool multiple unrelated obligors and distributes the amounts collected in accordance with a specified set of contractual instructions, typically referred to as a “waterfall,” that allocate the payment of interest and/or principal of any class of securities in a manner that is not proportional to payments received by the issuer from the underlying collateral assets.

In drafting this agenda item, the SAPWG staff has proposed revisions to the Task Force’s proposed definition for inclusion in SSAP No. 43R. These revisions include the following:

1. Reformat the definition to add a statement on what the reporting entity has acquired and incorporate into the paragraph structure of SSAP No. 43R;

2. Remove from the definition the reference to “unrelated” obligors. In discussing with SVO staff and representatives of the ACLI, this term was not intended to require the obligors in an asset pool to be unrelated. It was noted that if this was retained, it could potentially require extensive investment tracking of the investments to determine if the obligors of the assets in the pool are related. As there could be concerns with using these structures to avoid related party accounting (if the obligor was related to the reporting entity), separate guidance has been proposed in SSAP No. 43R for these situations.

3. Revise the term “multiple” in reference to the number of obligors required in an asset pool to instead reflect “more-than-one.” As there is no reference amount for the term “multiple” it was noted that it could cause confusion as to what would be required to meet the threshold for a SSAP No. 43R security. From correspondence with the representatives of the ACLI and NAIC staff for the VOSTF, the intent was for investments with only one obligor to be captured within scope of SSAP No. 26. As such, the reference for “more-than-one” has been proposed to replace the term “multiple” in the suggested definition.

4. Incorporate footnote definitions to clarify use of certain terms (asset, obligor and originator) and provide guidance on the general structure of these transactions.

5. Incorporate admitted asset requirements to require the underlying item to qualify as an asset, but clarifying that the underlying assets do not need to meet the criteria of an admitted asset, as well as require that all obligors must be unrelated to the reporting entity. If the structured finance security has obligors in the asset pool that are related to the reporting entity, then the entire structured finance security is a nonadmitted asset.



Excerpts from Agenda Item 2013-36: Investment Classification Project: (Identified SSAP No. 43R definitions and scope as key elements to consider.)

SSAP No. 43R—Loan-backed and Structured Securities Key Elements:

1. The cash flow assessments required within SSAP No. 43R have been misinterpreted for single-payer investments (e.g., equipment-trust certificates, credit tenant loans).

2. The definition of beneficial interests includes items that may be in the form of debt and equity. Items that resemble equity-interests do not fit in the definition of a loan-backed and structured security, but they are included in SSAP No. 43R.

3. Additional securities may be eligible to be financially modeled, but the determination of NAIC designation as a result of financial modeling is only addressed for loan-backed and structured securities.

Possible Options: A. Incorporate guidance to clarify the scope of SSAP No. 43R.

B. Consider accounting and reporting guidance in accordance with the review of other

investments conducted as part of this project.

Existing Authoritative Literature: SSAP No. 43R—Loan-backed and Structured Securities includes the following definitions:

2. Loan-backed securities are defined as securitized assets not included in structured securities, as

defined below, for which the payment of interest and/or principal is directly proportional to the payments received by the issuer from the underlying assets, including but not limited to pass-through securities, lease-backed securities, and equipment trust certificates.

3. Structured securities are defined as loan-backed securities which have been divided into two or more classes for which the payment of interest and/or principal of any class of securities has been allocated in a manner which is not proportional to payments received by the issuer from the underlying assets.

4. Loan-backed securities are issued by special-purpose corporations or trusts (issuer) established by a sponsoring organization. The assets securing the loan-backed obligation are acquired by the issuer and pledged to an independent trustee until the issuer’s obligation has been fully satisfied. The investor only has direct recourse to the issuer’s assets, but may have secondary recourse to third parties through insurance or guarantee for repayment of the obligation. As a result, the sponsor and its other affiliates may have no financial obligation under the instrument, although one of those entities may retain the responsibility for servicing the underlying assets. Some sponsors do guarantee the performance of the underlying assets.

U.S. GAAP – per the FASB Codification, Mortgage Backed Securities are defined as follows: (This definition is not adopted for SAP.)

Mortgage-Backed Securities (ASC Topic 948) – Securities issued by a governmental agency or corporation (for example, Government National Mortgage Association [GNMA] or Federal Home Loan Mortgage Corporation [FHLMC]) or by private issuers (for example, Federal National Mortgage Association [FNMA], banks, and mortgage banking entities). Mortgage-backed securities generally are referred to as mortgage participation certificates or pass-through certificates. A participation certificate represents an undivided interest in a pool of specific mortgage loans. Periodic payments on GNMA



participation certificates are backed by the U.S. government. Periodic payments on FHLMC and FNMA certificates are guaranteed by those corporations, but are not backed by the U.S. government.

(Definitions for asset-backed security, loan-backed security, or structured security were not found in the FASB Codification.)

SEC - Includes the following information for Asset-Backed Securities: (This information is not adopted in SAP.)

Asset-backed securities, or ABS, are securities that are backed by a discrete pool of self-liquidating financial assets. Asset-backed securitization is a financing technique in which financial assets, in many cases themselves less liquid, are pooled and converted into instruments that may be offered and sold more freely in the capital markets. In a basic securitization structure, an entity, often a financial institution and commonly known as a “sponsor,” originates or otherwise acquires a pool of financial assets, such as mortgage loans, directly or through an affiliate. It then sells the financial assets to a specially created investment vehicle that issues securities backed by those financial assets, which are “asset-backed securities.” Payment on the asset-backed securities depends primarily on the cash flows generated by the assets in the underlying pool and other rights designed to assure timely payment, such as guarantees or other features generally known as credit enhancements. The structure of asset-backed securities is intended, among other things, to insulate ABS investors from the corporate credit risk of the sponsor that originated or acquired the financial assets. Asset-backed securities are created by buying and bundling loans – such as residential mortgage loans, commercial mortgage loans or auto loans and leases – and creating securities backed by those assets that are then sold to investors. Often a bundle of loans is divided into separate securities with different levels of risk and returns. Payments on the loans are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities. Most public offerings of ABS are conducted through expedited SEC procedures known as “shelf offerings.”

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): The Investment Classification Project is addressed in agenda item 2013-36. However, per request of the Working Group, subsequent issues addressed pursuant to that project will have new agenda item references. These items will identify that they are captured within the direction of the “Investment Classification Project” originally detailed in agenda item 2013-36.

Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None

Convergence with International Financial Reporting Standards (IFRS): N/A

Staff Recommendation: Staff recommends that the Working Group receive the referral from the Valuation of Securities (E) Task Force, move this agenda item to the active listing, categorized as substantive, and expose revisions to SSAP No. 43R (with limited revisions to other SSAPs). As further detailed, this agenda item requests comments on the overall proposed change, and the securities that will be impacted if these revisions are adopted.

Key revisions reflected in the initial exposure include:

1. Revised definitions for investments within scope of SSAP No. 43R.

2. A title change of SSAP No. 43R as well as a broad change from LBSS to “structured finance security” throughout the SSAP.

3. Revisions to clarify admitted asset requirements.

4. Revisions to update the “effective” date guidance – removing explicit guidance on transition from the adoption of the 2009 SSAP No. 43R substantive revisions.



5. Update to the Q&A to remove outdated guidance, mostly pertaining to the 2009 transition, but also removing issues subsequently addressed or revised in the SSAP.

Under the proposed definition, it is intended that securities with a single-obligor will no longer be in scope of SSAP No. 43R, but will instead be captured within SSAP No. 26 (proposed revisions also clarify this change in SSAP No. 26.) Comments are requested on this proposed change, whether the proposed definition adds or removes other securities from the scope of SSAP No. 43R, and if there are any unintended consequences from incorporating the revised definition into SSAP No. 43R. Comments are also requested on other aspects of SSAP No. 43R that should be reviewed under the Investment Classification Project, with a specific inquiry on the continued inclusion of past effective date / transition guidance as well as the Q&A Implementation Guide.

• Commenters providing information on the impact to securities from the proposed definition are requested

to provide detailed information on the security, including where it was previously reported (if not previously in scope) or where it would subsequently be captured (if no longer in scope) if the proposed definition for SSAP No. 43R is adopted.

• Commenters are requested to provide information regarding the need to retain effective date and transition guidance from initial application of the 2009 substantive revisions, and whether there are concerns with the proposed deletion of transition-related questions from Appendix A - Question and Answer Implementation Guide in SSAP No. 43R.

With exposure of the proposed revisions to SSAP No. 43R, staff recommends a referral to the Structured Securities Group (SSG) to verify that the inclusion of the proposed definition will not impact the scope of securities captured within the financial modeling process. If the revised definition is adopted, referrals to the Blanks (E) Working Group and the Valuation of Securities (E) Task Force would be recommended so that the terminology is updated in all NAIC publications.

As the proposed revisions will result with some securities being classified to a different SSAP, staff has proposed for the revisions to be considered substantive. To facilitate initial discussion, proposed revisions are shown in the agenda item for initial exposure. However staff recommends that the Working Group proceed with directing NAIC staff to draft an issue paper for historical purposes.

Staff Note: It is anticipated that a request may be subsequently received to reconsider the “modified filing exempt” guidance currently included in SSAP No. 43R from the Structured Securities Group (SSG). Revisions to that guidance are not proposed to be included in this agenda item, and if requested, will be considered in a separate agenda item.

Staff Review Completed by: Julie Gann - NAIC Staff, September 2016

Proposed Revisions to SSAP No. 43R

SCOPE OF STATEMENT

1. This statement establishes statutory accounting principles for investments in loan-backed securities and structured securitiesstructured finance securities. In accordance with SSAP No. 103R—Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SSAP No. 103R), retained beneficial interests from the sale of loan-backed securities and structured securitiesstructured finance securities are accounted for in accordance with this statement. In this statement loan-backed securities and structured securities are collectively referred to as loan-backed securitiesstructured finance securities.

SUMMARY CONCLUSION



2. A reporting entity’s investment in a structured finance security reflects the acquisition of a loan-backed or structured security, often issued by an special purpose entity (SPE), that reflects the right for the reporting entity to receive future cash flows generated from a pool of assets1, associated with multiple more-than-one obligor2, held in trust:

a. Issuer acquires a pool of assets, including derivatives, associated with multiple more-than-one obligor from one or more originators3.

b. Issuer places the pool of assets within a trust for the benefit of the holders of the structured finance security, with instructions that the trustee use the cash flow generated by the assets to pay the holders of the structured finance security.

3. The asset pool in a structured finance security contains multiple unrelated more-than-one obligor, which affects the dynamic of cash flow generation. An asset pool is a closed pool so that the default of any one of the unrelatedasset pool obligors permanently impairs the cash flow generating ability of the asset pool.

4. Loan-backed securities are defined as a structured finance security in which a servicing intermediary collects payments from the multiple unrelated obligors (more-than-one) and remits or passes them through to holders of the securities so that payment of interest and/or principal to each SPE noteholder is directly proportional to the payments received by the issuer from the underlying assets.

5. Structured securities are defined as a structured finance security that has been divided into two or more classes and in which a servicing intermediary collects payments from the multiple unrelated obligors (more-than-one) and distributes the amounts collected in accordance with a specified set of contractual instructions, typically referred to as a “waterfall,” that allocate the payment of interest and/or principal of any class of securities in a manner that is not proportional to payments received by the issuer from the underlying collateral assets.

2. Loan-backed securities are defined as securitized assets not included in structured securities, as defined below, for which the payment of interest and/or principal is directly proportional to the payments received by the issuer from the underlying assets, including but not limited to pass-through securities, lease-backed securities, and equipment trust certificates.

3. Structured securities are defined as loan-backed securities which have been divided into two or more classes for which the payment of interest and/or principal of any class of securities has been allocated in a manner which is not proportional to payments received by the issuer from the underlying assets.

4. Loan-backed securities are issued by special-purpose corporations or trusts (issuer) established by a sponsoring organization. The assets securing the loan-backed obligation are acquired by the issuer and pledged to an independent trustee until the issuer’s obligation has been fully satisfied. The investor only has direct recourse to the issuer’s assets, but may have secondary recourse to

1 The term “assets” refers to items meeting the asset definition in SSAP No. 4, paragraph 2. It is not permissible to securitize or establish a structured finance security for underlying items that do not qualify as assets. For example, it is not permissible to securitize future cash flows from a “management service contract” for services that will be provided in the future. The management service contract does not qualify as a recognizable asset.

2 The “obligor” is the underlying borrower. For a mortgage-backed security, the obligor obtains the mortgage from the originator and is responsible for principle and interest payments under the terms of the mortgage. With a securitization of cash flows, the obligor has sold the right to collect a specific set of future cash flows (e.g., rent from commercial office building).

3 The “originator” (often a bank) provides the initial loan or funds to the obligor. For a mortgage-backed security, the originator provides the mortgage. With a securitization of cash flows, the originator has purchased the right to collect future cash flows. The originator sells these loans/rights to cash flows to the issuer (SPE). The issuer then pools the acquired assets and issues loan-backed or structured securities representing rights to the expected cash flows (repayment of loan or cash receipts) from the obligors.



third parties through insurance or guarantee for repayment of the obligation. As a result, the sponsor and its other affiliates may have no financial obligation under the instrument, although one of those entities may retain the responsibility for servicing the underlying assets. Some sponsors do guarantee the performance of the underlying assets.

6. Loan-backed and structuredStructured finance securities meet the definition of assets as defined in SSAP No. 4—Assets and Nonadmitted Assets and are admitted assets to the extent they conform to the requirements of this statement.

a. In a structured finance security, the underlying assets in the asset pool generating the cash flows must meet the definition of an asset in SSAP No. 4, but do not need to qualify as admitted assets in order for the structured finance security to be an admitted asset. For example, a structured finance security representing expected cash flows from lease payments generated from an underlying asset pool of aircraft may be an admitted asset even though aircraft held directly by the reporting entity would be considered a nonadmitted asset.

b. A reporting entity shall not admit any structured finance securities involving assets related to insurance products or premiums (such as life settlements).

b.c. It is the intent to prohibit use of structured finance securities as a means to engage in related party transactions. Transactions involving related parties shall follow the guidance in SSAP No. 25. In the event a structure finance security is identified as a mechanism to engage in related-party transactions, the structured finance security shall be nonadmitted4.

5.7. The scope of this statement encompasses all types of loan-backed and structured finance securities, including, but not limited to, the following:

a. Loan-backed and sStructured finance securities acquired at origination,

b. Loan-backed and sStructured finance securities acquired subsequent to origination for which it is probable, at acquisition, that the reporting entity will be able to collect all contractually required payments receivable, and are accounted for at acquisition under SSAP No. 103R,

c. Loan-backed and sStructured finance securities for which it is probable, either known at acquisition or identified during the holding period5, that the reporting entity will be unable to collect all contractually required payments receivable, and

d. Transferor’s beneficial interests in securitization transactions that are accounted for as sales under SSAP No. 103R and purchased beneficial interests in securitized financial assets6.

6.8. At acquisition, loan-backed and structured finance securities, except for loan-backed or structured finance securities that are beneficial interests that are not of high credit quality or can contractually be prepaid or otherwise settled in such a way that the reporting entity would not recover substantially all of its recorded amount7 (see paragraphs 19-2322-25), shall be reported at cost, including brokerage and related fees. Acquisitions and dispositions shall be recorded

4 Nonadmittance is required to prevent structured finance securities from being used as a way to circumvent statutory accounting provisions for related party transactions.

5 Securities classified within the type of paragraph 67.a. or 67.b. may be required to change classification to type 67.c. when it becomes probable that the reporting entity will be unable to collect all contractually required payments receivable. 6 The accounting requirements related to these type of securities included in paragraphs 21-2422-25 shall be determined at acquisition or initial transfer. 7 As referenced in the Relevant Literature section, this statement adopts EITF 99-20, including the scope requirements of that guidance.



on the trade date, not the settlement date, except for the acquisition of private placement loan-backed and structured finance securities which shall be recorded on the funding date. For securities where all information is not known as of the trade date (e.g., actual payment factors and specific pools), a reporting entity shall make its best estimate based on known facts.

7.9. Amortization of premium or discount shall be calculated using the scientific (constant yield) interest method and shall be recorded as an adjustment to investment income.(INT 07-01) The interest method results in a constant effective yield equal to the prevailing rate at the time of purchase or at the time of subsequent adjustments to book value. The amortization period shall reflect estimates of the period over which repayment of principal of the loan-backed and structured finance securities is expected to occur, not the stated maturity period.

8.10. Interest shall be accrued using the effective-yield method using the redemption prices and redemption dates used for amortizing premiums and discounts. Interest income consists of interest collected during the period, the change in the due and accrued interest between the beginning and end of the period as well as reductions for premium amortization and interest paid on acquisition of loan-backed and structured finance securities, and the addition of discount accrual. Contingent interest may be accrued if the applicable provisions of the underlying contract and the prerequisite conditions have been met.

9.11. For reporting entities required to maintain an IMR, the accounting for realized capital gains and

losses on sales of loan-backed and structured securities shall be in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserveparagraph 38 of this statement. For reporting entities not required to maintain an IMR, realized gains and losses on sales of loan-backed and structured securities shall be recorded on the trade date and shall be reported as net realized capital gains or losses in the Statement of Income. (Drafting Note: Revised to be consistent with paragraph 29 and 38.)

10.12. A loan-backed or structured finance security may provide for a prepayment penalty or

acceleration fee in the event the investment is liquidated prior to its scheduled termination date. These fees shall be reported as investment income when received.

11.13. The amount of prepayment penalty and/or acceleration fees to be reported as investment income shall be calculated as follows:

a. The amount of investment income reported is equal to the total proceeds (consideration) received less the Par value of the investment; and

a. Any difference between the book adjusted carrying value (BACV) and the Par Value at the time of disposal shall be reported as realized capital gains and losses subject to the authoritative literature in SSAP No. 7.

Collection of All Contractual Cashflows is Probable

12.14. The following guidance applies to loan-backed and structured finance securities for which it is probable that the investor will be able to collect all contractually required payments receivable. (Paragraphs 18-2019-21 provide guidance for structured finance securities in which collection of all contractual cash flows is not probable and paragraphs 21-2422-25 provide guidance for beneficial interests.) Prepayments are a significant variable element in the cash flow of loan-backed and structured finance securities because they affect the yield and determine the expected maturity against which the yield is evaluated. Falling interest rates generate faster prepayment of the mortgagesassets (e.g., mortgages) underlying the security, shortening its duration. This causes the reporting entity to reinvest assets sooner than expected at potentially less advantageous rates. This is called prepayment risk. Extension risk is created by rising interest rates which slow repayment and can significantly lengthen the duration of the security. Differences in cash flows can also result from other changes in the cash flows from the underlying assets. If assets are delinquent or otherwise not generating cash flow, which this should be reflected in the cash flow analysis through diminishing security cash flows, even if assets have not been liquidated and gain/losses have not been booked.



13.15. Changes in currently estimated cash flows, including the effect of prepayment assumptions, on

loan-backed and structured finance securities shall be reviewed periodically, at least quarterly. The prepayment rates of the underlying loans shall be used to determine prepayment assumptions. Prepayment assumptions shall be applied consistently across portfolios to all securities backed by similar collateral (similar with respect to coupon, issuer, and age of collateral). Reporting entities shall use consistent assumptions across portfolios for similar collateral within controlled affiliated groups. Since each reporting entity may have a unique method for determining the prepayment assumptions, it is impractical to set standard assumptions for the industry. Relevant sources and rationale used to determine each prepayment assumption shall be documented by the reporting entity.

14.16. Loan-backed and sStructured finance securities shall be revalued using the currently estimated cash flows, including new prepayment assumptions, using either the prospective or retrospective adjustment methodologies, consistently applied by type of securities. However, if at any time during the holding period, the reporting entity determines it is no longer probable that they will collect all contractual cashflows, the reporting entity shall apply the accounting requirements in paragraphs 18-2019-21.

15.17. The prospective approach recognizes, through the recalculation of the effective yield to be applied to future periods, the effects of all cash flows whose amounts differ from those estimated earlier and the effects and changes in projected cash flows. Under the prospective method, the recalculated effective yield will equate the carrying amount of the investment to the present value of the anticipated future cash flows. The recalculated yield is then used to accrue income on the investment balance for subsequent accounting periods. There are no accounting changes in the current period unless the security is determined to be other than temporarily impaired.

16.18. The retrospective methodology changes both the yield and the asset balance so that expected future cash flows produce a return on the investment equal to the return now expected over the life of the investment as measured from the date of acquisition. Under the retrospective method, the recalculated effective yield will equate the present value of the actual and anticipated cash flows with the original cost of the investment. The current balance is then increased or decreased to the amount that would have resulted had the revised yield been applied since inception, and investment income is correspondingly decreased or increased.

Collection of All Contractual Cashflows is Not Probable

17.19. The following guidance applies to loan-backed and structured finance securities with evidence of deterioration of credit quality since origination for which it is probable, either known at acquisition or identified during the holding period, that the investor will be unable to collect all contractually required payments receivable, except for those beneficial interests that are not of high credit quality or can contractually be prepaid or otherwise settled in such a way that the reporting entity would not recover substantially all of its recorded amount determined at acquisition (see paragraphs 21-2422-25).

18.20. The reporting entity shall recognize the excess of all cash flows expected at acquisition over the investor’s initial investment in the loan-backed or structured finance security as interest income on an effective-yield basis over the life of the loan-backed or structured finance security (accretable yield).8 Any excess of contractually required cash flows over the cash flows expected to be collected is the nonaccretable difference. Expected prepayments shall be

8 A loan-backed or structured finance security may be acquired at a discount because of a change in credit quality or rate or both. When a loan-backed or structured finance security is acquired at a discount that relates, at least in part, to the security’s credit quality, the effective interest rate is the discount rate that equates the present value of the investor’s estimate of the security’s future cash flows with the purchase price of the loan-backed or structured finance security.



treated consistently for determining cash flows expected to be collected and projections of contractual cash flows such that the nonaccretable difference is not affected. Similarly, the difference between actual prepayments and expected prepayments shall not affect the nonaccretable difference.

19.21. An investor shall continue to estimate cash flows expected to be collected over the life of the loan-backed or structured finance security. If, upon subsequent evaluation:

a. The fair value of the loan-backed or structured finance security has declined below its

amortized cost basis, an entity shall determine whether the decline is other than temporary (INT 06-07). For example, if, based on current information and events, there is a decrease in cash flows expected to be collected (that is, the investor is unable to collect all cash flows expected at acquisition plus any additional cash flows expected to be collected arising from changes in estimate after acquisition (in accordance with paragraph 2021.b.), an other-than-temporary impairment shall be considered to have occurred. The investor shall consider both the timing and amount of cash flows expected to be collected in making a determination about whether there has been a decrease in cash flows expected to be collected.

b. Based on current information and events, if there is a significant increase in cash flows

previously expected to be collected or if actual cash flows are significantly greater than cash flows previously expected, the investor shall recalculate the amount of accretable yield for the loan-backed or structured finance security as the excess of the revised cash flows expected to be collected over the sum of (1) the initial investment less (2) cash collected less (3) other-than-temporary impairments plus (4) amount of yield accreted to date. The investor shall adjust the amount of accretable yield by reclassification from nonaccretable difference. The adjustment shall be accounted for as a change in estimate in conformity with SSAP No. 3—Accounting Changes and Corrections of Errors (SSAP No. 3), with the amount of periodic accretion adjusted over the remaining life of the loan-backed or structured finance security (prospective method).

Beneficial Interests

20.22. Paragraphs 22-25 The following paragraphs provide statutory accounting guidance for interest income and impairment for a reporting entity that continues to hold an interest in securitized financial assets accounted for as sales under SSAP No. 103R, or that purchases a beneficial interest in securitized financial assets that are not of high credit quality or can contractually be prepaid or otherwise settled in such a way that the reporting entity would not recover substantially all of its recorded amount, determined at acquisition or the date of transfer9. Beneficial interests that are of high credit quality and cannot contractually be prepaid or otherwise settled in such a way that the reporting entity would not recover substantially all of its recorded investment, shall be accounted for in accordance with paragraphs 13-1714-18.

21.23. The reporting entity shall recognize the excess of all cash flows attributable to the beneficial

interest estimated at the acquisition/transaction date (referred to herein as the transaction date) over the initial investment (the accretable yield) as interest income over the life of the beneficial interest using the effective yield method. If the holder of the beneficial interest is the reporting entity that transferred the financial assets for securitization, the initial investment would be the fair value of the beneficial interest as of the date of transfer, as required by SSAP No. 103R. The amount of accretable yield shall not be displayed in the balance sheet.

22.24. The reporting entity that holds a beneficial interest shall continue to update the estimate of cash

flows over the life of the beneficial interest. If upon evaluation:

9 The accounting requirements related to these types of securities included in paragraphs 21-2422-25 shall be determined at acquisition or initial transfer. As referenced in the Relevant Literature section, this statement adopts EITF 99-20 (as amended by FAS 166), including the scope requirements of that guidance.



a. Based on current information and events it is probable that there is a favorable (or an

adverse) change in estimated cash flows from the cash flows previously projected, then the investor shall recalculate the amount of accretable yield for the beneficial interest on the date of evaluation as the excess of estimated cash flows over the beneficial interest’s reference amount (the reference amount is equal to (1) the initial investment less (2) cash received to date less (3) other-than-temporary impairments recognized to date [as described in paragraph 2324.b.] plus (4) the yield accreted to date. The adjustment shall be accounted for prospectively as a change in estimate in conformity with SSAP No. 3, with the amount of periodic accretion adjusted over the remaining life of the beneficial interest. Based on estimated cash flows, interest income may be recognized on a beneficial interest even if the net investment in the beneficial interest is accreted to an amount greater than the amount at which the beneficial interest could be settled if prepaid immediately in its entirety.

b. The fair value of the beneficial interest has declined below its reference amount; a

reporting entity shall determine whether the decline is other-than-temporary. If, based on current information and events it is probable that there has been an adverse change in estimated cash flows (in accordance with paragraph 2324.a.), then (1) an other-than-temporary impairment shall be considered to have occurred and (2) the beneficial interest shall be written down to the current estimate of cash flows at the financial reporting date discounted at a rate equal to the current yield used to accrete the beneficial interest with the resulting change being recognized as a realized loss. Determining whether there has been a favorable (or an adverse) change in estimated cash flows from the cash flows previously projected (taking into consideration both the timing and amount of the estimated cash flows) involves comparing the present value of the remaining cash flows as estimated at the initial transaction date (or at the last date previously revised) against the present value of the cash flows estimated at the current financial reporting date. The cash flows shall be discounted at a rate equal to the current yield used to accrete the beneficial interest. If the present value of the original cash flows estimated at the initial transaction date (or the last date previously revised) is less than the present value of the current estimate of cash flows expected to be collected, the change is considered favorable (that is, an other-than-temporary impairment shall be considered to have not occurred). If the present value of the original cash flows estimated at the initial transaction date (or the last date previously revised) is greater than the present value of the current estimated cash flows, the change is considered adverse (that is, an other-than-temporary impairment shall be considered to have occurred). However, absent any other factors that indicate an other-than-temporary impairment has occurred, changes in the interest rate of a “plain-vanilla,” variable-rate beneficial interest generally shall not result in the recognition of an other-than-temporary impairment10 (a plain-vanilla, variable-rate beneficial interest does not include those variable-rate beneficial interests with interest rate reset formulas that involve either leverage or an inverse floater).

23.25. All cash flows estimated at the transaction date are defined as the holder’s estimate of the

amount and timing of estimated future principal and interest cash flows used in determining the purchase price or the holder’s fair value determination for purposes of determining a gain or loss under SSAP No. 103R. Subsequent to the transaction date, estimated cash flows are defined as the holder’s estimate of the amount and timing of estimated principal and interest cash flows based on the holder’s best estimate of current information and events. A change in

10 Changes in the interest rate of a “plain-vanilla,” variable-rate beneficial interest (a plain-vanilla, variable-rate beneficial interest does not include those variable-rate beneficial interests with interest rate reset formulas that involve either leverage or an inverse floater) generally should not result in the recognition of an other-than-temporary impairment. For plain-vanilla, variable-rate beneficial interests, the yield is changed to reflect the revised interest rate based on the contractual interest rate reset formula. For example, if a beneficial interest pays interest quarterly at a rate equal to LIBOR plus 2 percent, the yield of that beneficial interest is changed prospectively to reflect changes in LIBOR. However, changes in the fair value of a plain-vanilla, variable-rate beneficial interest due to credit events should be considered when evaluating whether there has been an other-than-temporary impairment.



estimated cash flows is considered in the context of both timing and amount of the estimated cash flows.

Reporting Guidance for All Loan-Backed and Structured Finance Securities

24.26. Loan-backed and sStructured finance securities shall be valued and reported in accordance with this statement, the Purposes and Procedures Manual of the NAIC Investment Analysis Office, and the designation assigned in the NAIC Valuations of Securities product prepared by the NAIC Securities Valuation Office or equivalent specified procedure. The carrying value method shall be determined as follows:

a. For reporting entities that maintain an Asset Valuation Reserve (AVR), loan-backed and structured finance securities shall be reported at amortized cost, except for those with an NAIC designation of 6, which shall be reported at the lower of amortized cost or fair value.

b. For reporting entities that do not maintain an AVR, loan-backed and structured finance securities designated highest-quality and high-quality (NAIC designations 1 and 2, respectively) shall be reported at amortized cost; loan-backed and structured finance securities that are designated medium quality, low quality, lowest quality and in or near default (NAIC designations 3 to 6, respectively) shall be reported at the lower of amortized cost or fair value.

Designation Guidance

25.27. For securities within the scope of this statement, the initial NAIC designation used to determine the carrying value method and the final NAIC designation for reporting purposes is determined using a multi-step process. The Purposes and Procedures Manual of the NAIC Investment Analysis Office provides detailed guidance. A general description of the processes is as follows:

a. Financial Modeling: The NAIC identifies securities where financial modeling must be used to determine the NAIC designation. NAIC designation based on financial modeling incorporates the insurers’ carrying value for the security. For those securities that are financially modeled, the insurer must use NAIC CUSIP specific modeled breakpoints provided by the modelers in determining initial and final designation for these identified securities. Securities where modeling results in zero expected loss in all scenarios are automatically considered to have a final NAIC designation of NAIC 1, regardless of the carrying value. The three-step process for modeled securities is as follows:

i. Step 1: Determine Initial Designation – The current amortized cost (divided by

remaining par amount) of a loan-backed or structured finance security is compared to the modeled breakpoint values assigned to the six (6) NAIC designations for each CUSIP to establish the initial NAIC designation.

ii. Step 2: Determine Carrying Value Method – The carrying value method, either

the amortized cost method or the lower of amortized cost or fair value method, is then determined as described in paragraph 25 26 based upon the initial NAIC designation from Step 1.

iii. Step 3: Determine Final Designation – The final NAIC designation that shall be

used for investment schedule reporting is determined by comparing the carrying value (divided by remaining par amount) of a security (based on paragraph 2627.a.ii.) to the NAIC CUSIP specific modeled breakpoint values assigned to the six (6) NAIC designations for each CUSIP. This final NAIC designation shall be applicable for statutory accounting and reporting purposes (including establishing the AVR charges). The final designation is not used for establishing the appropriate carrying value method in Step 2 (paragraph 276.a.ii.).



b. Modified Filing Exempt Securities: The modified filing exempt method is for securities that are not subject to modeling under paragraph 2627.a., and is further defined in the Purposes and Procedures Manual of the NAIC Investment Analysis Office and have a NAIC Credit Rating Provider (CRP) rating. The four-step process for these securities is similar to the three-step process described in paragraphs 2627.a.i. through 2627.a.iii.

i. Step 1: Translate ARO Rating – Translate CRP Rating to the NAIC Designation Equivalent in accordance with the Purposes and Procedures Manual of the NAIC Investment Analysis Office. If the result is NAIC 1 or NAIC 6, the remaining steps do not need to be performed; use the NAIC 1 or NAIC 6 to establish the appropriate carrying value methodology per paragraph 25 26 and report the NAIC 1 or NAIC 6 as the Final Designation. For NAIC 2 through NAIC 5, proceed to Step 2.

ii. Step 2: Determine Initial Designation – Use the NAIC 2 through NAIC 5 from Step 1 to identify the appropriate breakpoints from the pricing matrix (see table, “NAIC Designations Breakpoints for Loan-Backed and Structured Finance Securities” provided in Part Three Section 3 (c) (iv) (A) of the Purposes and Procedures Manual of the NAIC Investment Analysis Office) and compare to the amortized cost (divided by outstanding par) to determine the initial NAIC designation. (Drafting Note – Send referral to update this title.)

iii. Step 3: Determine Carrying Value Method – The carrying value method, either the amortized cost method or the lower of amortized cost or fair value method, is then determined as described in paragraph 25 26 based upon the initial NAIC designation determined in Step 2.

iv. Step 4: Determine Final Designation – If the appropriate carrying value methodology established in Step 3 results in the security being carried at amortized cost (including securities where the carrying value method is lower of amortized cost or fair value where the amortized cost is the lower value), then the final NAIC designation is the same as the initial NAIC designation. If the appropriate carrying value methodology established in Step 3 results in the security being carried at fair value (thus the carrying value method is lower of amortized cost and fair value, and the fair value is the lower value), use the converted ARO rating NAIC designation from Step 2 to identify the appropriate breakpoints from the pricing matrix and compare to the fair value (divided by outstanding par) to determine the final NAIC designation. This final NAIC designation shall be applicable for statutory accounting and reporting purposes (including establishing the AVR charges). The final NAIC designation is not used for establishing the appropriate carrying value method in Step 3 (paragraph 2627.b.ii.).

c. All Other Loan-Backed and Structured Finance Securities: For loan-backed and structured finance securities not subject to paragraphs 2627.a. (financial modeling) or 2627.b. (modified filing exempt), follow the established designation procedures according to the appropriate section of the Purposes and Procedures Manual of the NAIC Investment Analysis Office. The NAIC designation shall be applicable for statutory accounting and reporting purposes (including determining the carrying value method and establishing the AVR charges). The carrying value method is established as described in paragraph 2526. Examples of these securities include, but are not limited to, equipment trust certificates, credit tenant loans (CTL), 5*/6* securities, interest only (IO) securities, and loan-backed and structured finance securities with SVO assigned NAIC designations. Staff Note – Reference to equipment trust certificates and credit tenant loans are proposed to be deleted as they reflect single-obligor structures, which under the proposed definition, will be outside the scope of SSAP No. 43R.

Specific Interim Reporting Guidance for RMBS/CMBS Securities



26.28. The guidance in this paragraph shall be applied in determining the reporting method for residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS) acquired in the current year for quarterly financial statements. Securities reported as of the prior-year end shall continue to be reported under the prior-year end methodology for the current-year quarterly financial statements. For year-end reporting, securities shall be reported in accordance with paragraph 2627, regardless of the quarterly methodology used.

a. Reporting entities that acquired the entire financial modeling database for the prior-year end are required to follow the financial modeling methodology (paragraph 2627.a.) for all securities acquired in the subsequent year that were included in the financial modeling data acquired for the prior year-end.

b. Reporting entities that acquired identical securities (identical CUSIP) to those held and financially modeled for the prior year-end are required to follow the prior year-end financial modeling methodology (paragraph 2627.a.) for these securities acquired subsequent to year-end.

c. Reporting entities that do not acquire the prior-year financial modeling information for current-year acquired individual CUSIPS, and are not captured within paragraphs 2728.a. or 2728.b., are required to follow the analytical procedures for non-financially modeled securities (paragraph 2627.b. or paragraph 2627.c. as appropriate). Reporting entities that do acquire the individual CUSIP information from the prior-year financial modeling database shall use that information for interim reporting.

d. Reporting entities that acquire securities not previously modeled at the prior year-end are required to follow the analytical procedures for non-financially modeled securities (paragraph 2627.b. or paragraph 2627.c. as appropriate).

Unrealized Gains and Losses and Impairment Guidance

27.29. For reporting entities required to maintain an AVR, the accounting for unrealized gains and losses shall be in accordance with paragraph 37 38 of this statement. For reporting entities not required to maintain an AVR, unrealized gains and losses shall be recorded as a direct credit or charge to unassigned funds (surplus).

28.30. The application of this reporting requirement resulting from NAIC designation (i.e., lower of cost or fair value) is not a substitute for other-than-temporary impairment recognition (paragraphs 34-3835-39). For securities reported at fair value where an other-than-temporary impairment has been determined to have occurred, the realized loss recognized from the other-than-temporary impairment shall first be applied towards the realization of any unrealized losses previously recorded as a result of fluctuations in the security’s fair value due to the reporting requirements. After the recognition of the other-than-temporary impairment, the security shall continue to report unrealized gains and losses as a result of fluctuations in fair value.

29.31. If the fair value of a loan-backed or structured finance security is less than its amortized cost

basis at the balance sheet date, an entity shall assess whether the impairment is other than temporary. Amortized cost basis includes adjustments made to the cost of an investment for accretion, amortization, collection of cash, and previous other-than-temporary impairments recognized as a realized loss (including any cumulative-effect adjustments recognized in accordance with paragraphs 57-59 of this statement).

30.32. If an entity intends to sell the loan-backed or structured finance security (that is, it has decided

to sell the security), an other-than-temporary impairment shall be considered to have occurred.

31.33. If an entity does not intend to sell the loan-backed or structured finance security, the entity shall assess whether it has the intent and ability11 to retain the investment in the security for a period

11 This assessment shall be considered a high standard due to the accounting measurement method established for the securities within the scope of this statement (amortized cost).



of time sufficient to recover the amortized cost basis. If the entity does not have the intent and ability to retain the investment for the time sufficient to recover the amortized cost basis, an other-than-temporary impairment shall be considered to have occurred.

32.34. If the entity does not expect to recover the entire amortized cost basis of the security, the entity

would be unable to assert that it will recover its amortized cost basis even if it does not intend to sell the security and the entity has the intent and ability to hold. Therefore, in those situations, an other-than temporary impairment shall be considered to have occurred. In assessing whether the entire amortized cost basis of the security will be recovered, an entity shall compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If present value of cash flows expected to be collected is less than the amortized cost basis of the security, the entire amortized cost basis of the security will not be recovered (that is, a non-interest related decline12 exists), and an other-than-temporary impairment shall be considered to have occurred. A decrease in cashflows expected to be collected on a loaned-backed or structured security that results from an increase in prepayments on the underlying assets shall be considered in the estimate of the present value of cashflows expected to be collected.

33.35. In determining whether a non-interest related decline exists, an entity shall calculate the

present value of cash flows expected to be collected based on an estimate of the expected future cash flows of the impaired loan-backed or structured finance security, discounted at the security’s effective interest rate.

a. For securities accounted for under paragraphs 13-1714-18 – the effective interest rate of

the loan-backed or structured finance security is the rate of return implicit in the security (that is, the contractual interest rate adjusted for any net deferred fees or costs, premium, or discount existing at the origination or acquisition of the security).13

b. For securities accounted for under paragraphs 18-2019-21 – the effective interest rate is

the rate implicit immediately prior to the recognition of the other-than-temporary impairment.

c. For securities accounted for under paragraphs 21-2422-25 – the reporting entity shall

apply the guidance in paragraph 2324.b.

34.36. When an other-than-temporary impairment has occurred because the entity intends to sell the security or has assessed that that they do not have the intent and ability to retain the investments in the security for a period of time sufficient to recover the amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings as a realized loss shall equal the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. (This guidance includes loan-backed and structured finance securities previously held at lower of cost or market. For these securities, upon recognition of an other-than-temporary impairment, unrealized losses would be considered realized.)

35.37. When an other-than-temporary impairment has occurred because the entity does not expect to

recover the entire amortized cost basis of the security even if the entity has no intent to sell and the entity has the intent and ability to hold, the amount of the other-than-temporary impairment recognized as a realized loss shall equal the difference between the investment’s amortized cost basis and the present value of cash flows expected to be collected, discounted at the loan-

12 A non-interest related decline is a decline in value due to fundamental credit problems of the issuer. Fundamental credit problems exist with the issuer when there is evidence of financial difficulty that may result in the issuer being unable to pay principal or interest when due. An interest related decline in value may be due to both increases in the risk-free interest rate and general credit spread widening.

13 See Footnote 1.



backed or structured finance security’s effective interest rate in accordance with paragraph 3435. (This guidance includes loan-backed and structured finance securities previously held at lower of cost or market. For these securities, upon recognition of an other-than-temporary impairment, unrealized losses would be considered realized for the non-interest related decline. Hence, unrealized losses could continue to be reflected for these securities due to the reporting requirements.)

36.38. For reporting entities required to maintain an AVR or IMR, the accounting for unrealized gains

and losses shall be in accordance with paragraph 3738.a. For realized gains and losses, the AVR and IMR analysis required and provision to allocate gains and losses between AVR and IMR is the same regardless whether the realized loss results from an impairment write-down or whether there was a gain or loss upon sale. Guidance on specific scenarios resulting in realized gains and losses are addressed in paragraphs 3738.b. through 3738.f.:

a. Unrealized Gains and Losses – Record all unrealized gains and losses through AVR. At

the time an unrealized gain or loss is realized, the accounting shall follow the premise in paragraph 3738, as detailed in paragraphs 3738.b. through 3738.f. for specific transactions. Unrealized gains or losses that are realized shall be reversed from AVR before the recognition of the realized gain or loss within AVR and IMR. Gains and losses shall only be reflected in IMR when realized and as appropriate based on the analysis of interest and non-interest factors.

b. Other-Than-Temporary Impairment – Non-interest related other-than-temporary

impairment losses shall be recorded through the AVR. If the reporting entity wrote the security down to fair value due to the intent to sell or does not have the intent and ability to retain the investment for a period of time sufficient to recover the amortized cost basis, the non-interest related portion of the other-than-temporary impairment losses shall be recorded through the AVR; the interest related other-than-temporary impairment losses shall be recorded through the IMR. The analysis for bifurcating impairment losses between AVR and IMR shall be completed as of the date when the other-than-temporary impairment is determined.

c. Security Sold at a Loss Without Prior OTTI – An entity shall bifurcate the loss into AVR

and IMR portions depending on interest and non-interest related declines in accordance with the analysis performed as of the date of sale. As such, an entity shall report the loss in separate AVR and IMR components as appropriate.

d. Security Sold at a Loss With Prior OTTI – An entity shall bifurcate the current realized

loss into AVR and IMR portions depending on interest and non-interest related declines in accordance with the analysis performed as of the date of sale. An entity shall not adjust previous allocations to AVR and IMR that resulted from previous recognition of other-than-temporary impairments.

e. Security Sold at a Gain With Prior OTTI – An entity shall bifurcate the gain into AVR and

IMR portions depending on interest and non-interest factors in accordance with the analysis performed as of the date of sale. The bifurcation between AVR and IMR that occurs as of the date of sale may be different from the AVR and IMR allocation that occurred at the time of previous other-than-temporary impairments. An entity shall not adjust previous allocations to AVR and IMR that resulted from previous recognition of other-than-temporary impairments.

f. Security Sold at a Gain Without Prior OTTI – An entity shall bifurcate the gain into AVR

and IMR portions depending on interest and non-interest factors in accordance with the analysis performed as of the date of sale.

37.39. For situations where an other-than-temporary impairment is recognized pursuant to paragraphs

35 36 and 36 37 of this statement, the previous amortized cost basis less the other-than-temporary impairment recognized as a realized loss shall become the new amortized cost basis of the investment. That new amortized cost basis shall not be adjusted for subsequent



recoveries in fair value. Therefore, the prospective adjustment method shall be used for periods subsequent to loss recognition.

38.40. In periods subsequent to the recognition of an other than temporary impairment loss for a loan-

backed or structured finance security, the reporting entity shall account for the other-than-temporarily impaired security as if the security had been purchased on the measurement date of the other-than-temporary impairment at an amortized cost basis equal to the previous amortized cost basis less the other-than-temporary impairment recognized as a realized loss. The difference between the new amortized cost basis and the cash flows expected to be collected shall be accreted as interest income. A reporting entity shall continue to estimate the present value of cash flows expected to be collected over the life of the loan-backed or structured finance security.

d. For securities accounted for under paragraphs 13-2014-21, if upon subsequent

evaluation, there is a significant increase in the cash flows expected to be collected or if actual cash flows are significantly greater than cash flows previously expected, such changes shall be accounted for as a prospective adjustment to the accretable yield in accordance with paragraphs 18-2019-21. The security shall continue to be subject to impairment analysis for each subsequent reporting period. The new amortized cost basis shall not be changed for subsequent recoveries in fair value. Future declines in fair value which are determined to be other-than-temporary shall be recorded as realized losses.

e. For beneficial interests accounted for under paragraphs 21-2422-25, a reporting entity

shall apply the guidance in paragraphs 22-2323-24 to account for changes in cash flows expected to be collected.

39.41. It is inappropriate to automatically conclude that a security is not other-than-temporarily

impaired because all of the scheduled payments to date have been received. However, it also is inappropriate to automatically conclude that every decline in fair value represents an other-than-temporary impairment. Further analysis and judgment are required to assess whether a decline in fair value indicates that it is probable that the holder will not collect all of the contractual or estimated cash flows from the security. In addition, the length of time and extent to which the fair value has been less than cost can indicate a decline is other than temporary. The longer and/or the more severe the decline in fair value, the more persuasive the evidence that is needed to overcome the premise that it is probable that the holder will not collect all of the contractual or estimated cash flows from the issuer of the security.

40.42. In making its other-than-temporary impairment assessment, the holder shall consider all

available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of future cash flows. Such information generally shall include the remaining payment terms of the security, prepayment speeds, the financial condition of the issuer(s), expected defaults, and the value of any underlying collateral. To achieve that objective, the holder shall consider, for example, industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security. The holder also shall consider how other credit enhancements affect the expected performance of the security, including consideration of the current financial condition of the guarantor of a security (if the guarantee is not a separate contract) and/or whether any subordinated interests are capable of absorbing estimated losses on the loans underlying the security. The remaining payment terms of the security could be significantly different from the payment terms in prior periods (such as



for some securities backed by “nontraditional loans”14). Thus, the holder shall consider whether a security backed by currently performing loans will continue to perform when required payments increase in the future (including “balloon” payments). The holder also shall consider how the value of any collateral would affect the expected performance of the security. If the fair value of the collateral has declined, the holder needs to assess the effect of that decline on the ability of the holder to collect the balloon payment.

Origination Fees

41.43. Origination fees represent fees charged to the borrower in connection with the process of originating or restructuring a transaction. The fees include, but are not limited to, points, management, arrangement, placement, application, underwriting, and other fees pursuant to such a transaction. Origination fees shall not be recorded until received in cash. Origination fees intended to compensate the reporting entity for interest rate risks (e.g., points), shall be amortized into income over the term of the loan-backed or structured finance security consistent with paragraph 8 9 of this statement. Other origination fees shall be recorded as income upon receipt.

Origination, Acquisition, and Commitment Costs

42.44. Costs related to origination when paid in the form of brokerage and other related fees shall be capitalized as part of the cost of the loan-backed or structured finance security, consistent with paragraph 7 8 of this statement. All other costs, including internal costs or costs paid to an affiliated entity related to origination, purchase, or commitment to purchase loan-backed and structured finance securities, shall be charged to expense when incurred.

Commitment Fees

43.45. Commitment fees are fees paid to the reporting entity that obligate the reporting entity to make available funds for future borrowing under a specified condition. A fee paid to the reporting entity to obtain a commitment to make funds available at some time in the future, generally, is refundable only if the loan-backed or structured finance security is issued. If the loan-backed or structured finance security is not issued, then the fees shall be recorded as investment income by the reporting entity when the commitment expires.

44.46. A fee paid to the reporting entity to obtain a commitment to borrow funds at a specified rate and

with specified terms quoted in the commitment agreement, generally, is not refundable unless the commitment is refused by the reporting entity. This type of fee shall be deferred, and amortization shall depend on whether or not the commitment is exercised. If the commitment is exercised, then the fee shall be amortized in accordance with paragraph 8 9 of this statement over the life of the loan-backed or structured finance security as an adjustment to the investment income on the loan-backed or structured finance security. If the commitment expires unexercised, the commitment fee shall be recognized in income on the commitment expiration date.

Giantization/Megatization of FHLMC or FNMA Mortgage Backed Securities

14 A nontraditional loan may have features such as (a) terms that permit principal payment deferral or payments smaller than interest accruals (negative amortization), (b) a high loan-to-value ratio, (c) multiple loans on the same collateral that when combined result in a high loan-to value ratio, (d) option adjustable-rate mortgages (option ARMs) or similar products that may expose the borrower to future increases in repayments in excess of increases that result solely from increases in the market interest rate (for example, once negative amortization results in the loan reaching a maximum principal accrual limit), (e) an initial interest rate that is below the market interest rate for the initial period of the loan term and that may increase significantly when that period ends, and (f) interest-only loans that should be considered in developing an estimate of future cash flows.



45.47. Giantization/megatization of mortgage backed securities is defined as existing pools of FHLMC or FNMA mortgage-backed securities (MBS) with like coupon and prefix which are repooled together by the issuing agency creating a new larger security. The new Fannie Mae “Mega” or Freddie Mac “Giant” is a guaranteed MBS pass-through representing an undivided interest in the underlying pools of loans.

46.48. Repooled FHLMC and FNMA securities meet the definition of substantially the same as defined

in SSAP No. 103R—Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The transaction shall not be considered a sale/purchase and no gain or loss shall be recognized. To properly document the repooling, the transaction shall be reported through Schedule D of the Annual Statement as a disposition and an acquisition.

47.49. Transaction fees charged by the issuing agencies shall be capitalized and amortized over the

life of the repooled security.

Structured Finance Securities Acquired for a Specified Investment Strategy

50. To achieve certain strategic investment results, structured finance securities may be issued in combination with other structured finance securities as a unit or a pair. One strategy involves the purchase of two structured finance securities with opposite interest rate reset provisions. Under that strategy, the fixed coupon rate or maturity date for each structured finance security would be determined shortly after issuance depending on movements in market interest rates. Following that reset date, the resulting yields on each of the structured finance securities will move in opposite directions; however, the average yield of the two securities will generally reflect the market yield of the combined instruments in effect on the issuance date. In situations when structured finance securities are issued in combination with other structured finance securities as a unit or a pair, each structured finance security shall be accounted for separately in accordance with the appropriate SSAP. The guidance in paragraph 8 of SSAP No. 103R on the accounting for transfers of entire financial assets or group of entire financial assets that qualify as sales shall be applied to each structured security upon transfer.

Staff Note: Is the above paragraph specific to structured securities, or would it apply to structured finance securities (both loan-backed and structured securities).

Disclosures

48.51. In addition to the disclosures required for invested assets in general, the following disclosures regarding loan-backed and structured finance securities shall be made in the financial statements. Regardless of the allowances within paragraph 62 of the Preamble, the disclosures in paragraphs 5051.f., 5051.g. and 5051.h. are required in separate, distinct notes to the financial statements:

a. Fair values in accordance with SSAP No. 100—Fair Value (SSAP No. 100).

b. Concentrations of credit risk in accordance with SSAP No. 27;

c. Basis at which the loan-backed and structured finance securities are stated;

d. The adjustment methodology used for each type of security (prospective or retrospective);

e. Descriptions of sources used to determine prepayment assumptions.

f. All securities within the scope of this statement with a recognized other-than-temporary impairment, disclosed in the aggregate, classified on the basis for the other-than-temporary impairment: (1) intent to sell, (2) inability or lack of intent to retain the investment in the security for a period of time sufficient to recover the amortized cost



basis, or (3) present value of cash flows expected to be collected is less than the amortized cost basis of the security.

g. For each security with an other-than-temporary impairment, recognized in the current reporting period by the reporting entity, as the present value of cash flows expected to be collected is less than the amortized cost basis of the securities:

i. The amortized cost basis, prior to any current-period other-than-temporary impairment.

ii. The other-than-temporary impairment recognized in earnings as a realized loss.

iii. The fair value of the security.

iv. The amortized cost basis after the current-period other-than-temporary impairment.

h. All impaired securities (fair value is less than cost or amortized cost) for which an other-than-temporary impairment has not been recognized in earnings as a realized loss (including securities with a recognized other-than-temporary impairment for non-interest related declines when a non-recognized interest related impairment remains):

i. The aggregate amount of unrealized losses (that is, the amount by which cost or amortized cost exceeds fair value) and

ii. The aggregate related fair value of securities with unrealized losses.

i. The disclosures in (i) and (ii) above should be segregated by those securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer using fair values determined in accordance with SSAP No. 100.

j. Additional information should be included describing the general categories of information that the investor considered in reaching the conclusion that the impairments are not other-than-temporary.

k. When it is not practicable to estimate fair value, the investor should disclose the following additional information, if applicable:

i. The aggregate carrying value of the investments not evaluated for impairment, and

ii. The circumstances that may have a significant adverse effect on the fair value.

l. For securities sold, redeemed or otherwise disposed as a result of a callable feature (including make whole call provisions), disclose the number of CUSIPs sold, disposed or otherwise redeemed and the aggregate amount of investment income generated as a result of a prepayment penalty and/or acceleration fee.

49.52. Refer to the Preamble for further discussion regarding disclosure requirements. All disclosures within this statement, except disclosures included in paragraphs 5051.b. and 5051.k., shall be included within the interim and annual statutory financial statements. Disclosure requirements in paragraphs, 5051.b. and 5051.k. are required in the annual audited statutory financial statements only.

Relevant Literature

50.53. This statement adopts FASB Emerging Issues Task Force No. 99-20, Exchange of Interest-Only and Principal-Only Securities for a Mortgage-Backed Security, as amended by FAS 166,



Accounting for Transfers of Financial Assets, An Amendment of FAS 140, and FASB Staff Position EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20. This statement adopts paragraphs 5, 7 and 9 of AICPA Statement of Position 03-03, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-03) for loan-backed and structured securities only. With the exception of this specific adoption, consideration of SOP 03-03 is still pending consideration for statutory accounting.

51.54. This statement rejects ASU 2016-01, Financial Instruments – Overall, FASB Statement

No. 115, Accounting for Certain Investments in Debt and Equity Securities and FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.

52.55. This statement also rejects FASB Emerging Issues Task Force No. 89-4, Accounting for a

Purchased Investment in a Collateralized Mortgage Obligation Instrument or in a Mortgage-Backed Interest-Only Certificate, FASB Emerging Issues Task Force No. 90-2, Exchange of Interest-Only and Principal-Only Securities for a Mortgage-Backed Security, FASB Emerging Issues Task Force No. 93-18, Recognition of Impairment for an Investment in a Collateralized Mortgage Obligation Instrument or in a Mortgage-Backed Interest-Only Certificate, FASB Emerging Issues Task Force No. 96-12, Recognition of Interest Income and Balance Sheet Classification of Structured Notes, and FASB Emerging Issues Task Force No. 98-15, Structured Notes Acquired for a Specified Investment Strategy.

Effective Date and Transition

56. This statement is effective for years beginning January 1, 2001. A change resulting from the adoption of this statement shall be accounted for as a change in accounting principle in accordance with SSAP No. 3—Accounting Changes and Corrections of Errors. Subsequent revisions to this SSAP include: a. Substantive revisions pertaining to valuation and impairment based on expected cash

flows, as detailed in Issue Paper No. 140, were effective September. 30, 2009. (Transition guidance is retained for historical purposes in the issue paper.)

b. Substantive revisions to incorporate a new method to determine the final NAIC designation were effective, on a prospective basis, for reporting periods ending on or after December. 31, 2009. (Drafting Note: The paragraph above is referring to the initial “RMBS” process. The modified filing exempt process was not adopted until 2011. There is no reference to it currently in the SSAP No. 43R effective date guidance, but could be added.)

c. Nonsubstantive revisions to clarify the accounting for gains and losses between AVR and IMR securities were adopted in June 2010, with a January 1, 2011 effective date, with early application allowed. Reporting entities that had previously bifurcated gains and losses between AVR and IMR for sale transactions were restricted from reversing prior bifurcations and were prohibited from reverting to a process that did not bifurcate gains and losses in the period between adoption and the effective date.

d. Nonsubstantive revisions to incorporate guidance from INT 00-11: EITF 98-15: Structured Notes Acquired for a Specified Investment Strategy were effective September 11, 2000.

e. Nonsubstantive revisions pertaining to the calculation of investment income for

prepayment penalty and/or acceleration fees, reflected in paragraph 13, were effective January 1, 2017, on a prospective basis with early application permitted.

53.57. For securities purchased prior to January 1, 1994, where historical cash flows are not readily available for applying the retrospective method, the reporting entity may use January 1, 1994



as the acquisition date and the then book value as the cost for purposes of determining yield adjustments in future periods.

54. This revised statement (except for the guidance in paragraph 26 inserted in December 2009)

supersedes SSAP No. 98 and paragraph 13 of SSAP No. 99 effective September 30, 2009. For reporting entities that either early adopted the requirements of SSAP No. 98 or previously adopted a statutory accounting policy that was in accordance with the prescriptions of SSAP No. 98, and if such reporting entities do not intend to sell the security, and have the intent and ability to retain the investment in the security for a period of time sufficient to recover the amortized cost basis, those reporting entities shall recognize the cumulative effect of reversing the impact of the adoption of SSAP No. 98, or an equivalent statutory accounting policy, and paragraph 13 of SSAP No. 99 as an adjustment to the opening balance of unassigned funds (surplus) as of July 1, 2009, with a corresponding adjustment to applicable financial statement elements.

55. The accounting and reporting requirements of this revised statement (except for the guidance

in paragraph 26 inserted in December 2009) shall be applied to existing and new investments held by a reporting entity on or after September 30, 2009. For loan-backed and structured securities held at the beginning of the interim period of adoption (July 1, 2009) and continue to be held as of September 30, 2009, if a reporting entity does not intend to sell the security, and has the intent and ability to retain the investment in the security for a period of time sufficient to recover the amortized cost basis, the reporting entity shall recognize the cumulative effect of initially applying this revised statement as an adjustment to the opening balance of unassigned funds (surplus) as of July 1, 2009, with a corresponding adjustment to applicable financial statement elements. The cumulative effect on unassigned funds (surplus) shall be calculated by comparing the present value of the cash flows expected to be collected determined in accordance with the methodology in paragraph 34, as applicable, with the amortized cost basis of the loan-backed and structured security as of the beginning of the interim period in which this revised statement is adopted (July 1, 2009). The cumulative-effect adjustment shall include related tax effects. The discount rate used to calculate the present value of the cash flows expected to be collected shall be the rate in effect before recognizing any other-than-temporary impairments and not a rate that has been adjusted to reflect those impairments.

56. The amortized cost basis of a security for which an other-than-temporary impairment was

previously recognized shall be adjusted by the amount of the cumulative-effect adjustment before taxes. The difference between the new amortized cost basis and the cash flows expected to be collected shall be accreted as interest income (see paragraph 39).

57. In the period of adoption, an entity shall provide the disclosures required by SSAP No. 3 for

changes in accounting principles.

58. In December 2009, guidance in paragraph 26 was inserted and subsequent paragraphs were renumbered. These changes were related to a new method of determining the final NAIC designation. Substantive revisions related to determining the final NAIC designation, are effective for reporting periods ending on or after December 31, 2009. Changes related to determining the final NAIC designation will be accounted for on a prospective basis. No cumulative effect adjustments or application of the NAIC designation guidance to prior events or periods are permitted, similar to a change in accounting estimate.

59. In June 2010, nonsubstantive revisions were adopted to paragraphs 28 and 37 to clarify the

accounting for gains and losses between AVR and IMR for SSAP No. 43R securities. As illustrated within paragraph 37, the AVR and IMR analysis required and provision to allocate gains and losses between AVR and IMR is the same regardless whether the security is written down as a result of an impairment analysis or whether the security was sold. Although the revisions to paragraphs 28 and 37 are considered nonsubstantive and are in accordance with the communicated intent provided in the Question and Answer Implementation Guide, it was identified that some entities had not correctly interpreted the Question and Answer Implementation Guide and such entities would need to make significant system changes to comply with the AVR and IMR bifurcation requirements for sale transactions. As a result, the



revisions to paragraphs 28 and 37 adopted in June 2010 have an effective date of January 1, 2011 with early application allowed. Entities that have previously bifurcated gains and losses between AVR and IMR for sale transactions shall not reverse previous bifurcations, and shall not revert to a process that does not bifurcate gains and losses between AVR and IMR when conducting future sales transactions before the January 1, 2011 effective date. Thus, if an entity bifurcated gains and losses from sale transactions between AVR and IMR any time after the adoption of SSAP No. 43R (September 2009), that entity must continue to bifurcate gains and losses resulting from sale transactions for SSAP No. 43R securities in accordance with the nonsubstantive revisions to paragraphs 28 and 37 adopted in June 2010.

60.58. The guidance in paragraph 49 was originally contained within INT 00-11: EITF 98-15:

Structured Notes Acquired for a Specified Investment Strategy and was effective September 11, 2000. Revisions adopted in October 2010 to paragraphs 2, 3 and 4 are effective January 1, 2011. The nonsubstantive revisions clarify the definitions of loan-backed and structured securities. (Drafting Note – These definitions are proposed to be deleted with the revisions proposed in this agenda item. As such, this old effective date guidance is not proposed to be retained in the SSAP.)

61. The guidance in paragraph 12, with respect to the calculation of investment income for

prepayment penalty and/or acceleration fees, is effective January 1, 2017, on a prospective basis and is required for interim and annual reporting periods thereafter. Early application is permitted.

REFERENCES

Other • Purposes and Procedures Manual of the NAIC Investment Analysis Office

• NAIC Valuation of Securities product prepared by the Securities Valuation Office

Relevant Issue Papers • Issue Paper No. 43—Loan-Backed and Structured Securities

• Issue Paper No. 140—Loan-Backed and Structured Securities, Revised September, 2009

Attachment B Ref #2016-40


Appendix A – Question and Answer Implementation Guide SSAP No. 43R—Loan-Backed and Structured Securities – Revised (SSAP No. 43R), with an effective date of September 30, 2009, was issued to provide revised guidance on the accounting and impairment treatment for loan-backed and structured securities. SSAP No. 43R superseded SSAP No. 43—Loan-backed and Structured Securities (SSAP No. 43), SSAP No. 98—Treatment of Cash Flows When Quantifying Changes in Valuations and Impairments, an Amendment of SSAP No. 43 (SSAP No. 98) and paragraph 13 of SSAP No. 99—Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment (SSAP No. 99). Questions regarding implementation of SSAP No. 43R were raised by reporting entities, regulators and auditors. It was determined that this Question & Answer Implementation Guide should be issued as an aid in understanding and implementing SSAP No. 43R due to the relatively high number of inquiries received. This Q&A is effective for reporting periods ending on or after December 31, 2009. The Statutory Accounting Principles (E) Working Group assumes that industry made their best efforts to adopt the guidance set forth under SSAP No. 43R in the third quarter of 2009. The Statutory Accounting Principles (E) Working Group also acknowledges that at year-end 2009 there were many outstanding questions which resulted in this Q&A. It is recommended that any adjustment to the other-than-temporary impairment cumulative effect as a result of this Q&A be reflected in the 2009 Annual Statement with no restatement of the prior quarterly statement.This appendix addresses common questions regarding the valuation and impairment guidance detailed in SSAP No. 43R:

Index to Questions: No. Question 1 Are reporting entities permitted to establish an accounting policy to write down a SSAP No.

43R other-than-temporarily impaired security, for which a “non-interest” related decline exists, to fair-value regardless of whether the reporting entity intends to sell, or has the intent and ability to hold?

2 Can a reporting entity avoid completing a cash-flow assessment or testing for a specific other-than-temporarily impaired security when the entity believes there is a clear cash-flow shortage (i.e., non-interest related impairment) and elect to recognize a full impairment for the SSAP No. 43R security (no impairment bifurcation), with fair value becoming the new amortized cost basis, and recognition of the full other-than-temporary impairment as a realized loss?

3 Can reporting entities change their “intend to sell” or “unable to hold” assertions and recover previously recognized other-than-temporary impairments?

4 Under SSAP No. 43R, in accordance with the cumulative adjustment provisions, is it possible for a previously other-then-temporarily impaired security to be completely “unimpaired” (not recognized as OTTI)? Drafting Note: Delete – Related to Initial Application.

5 How do the regulators intend the phrase “intent and ability to hold” as used within SSAP No. 43R to be interpreted?

6 How do contractual prepayments affect the determination of credit losses?



No. Question 7 Paragraph 37 states that AVR and IMR should be accounted for in accordance with SSAP

No. 7, however paragraph 37 also states that AVR and IMR should be separated into two components if the entity has the intent to sell or does not have the intent and ability to retain the investment for a time sufficient to recover the amortized cost basis. This guidance is different from the treatment when the gain or loss is due to an actual sale and also different from the treatment for SSAP No. 26 investments. When an impairment is recognized, should an entity follow SSAP No. 7 when an investment changes by two or more NAIC categories (i.e., reported entirely in AVR) or stay within the guidance of SSAP No. 43R? Drafting Note: Delete – Follow guidance in paragraph 38. Updated in 2010.

8 If a security is sold and no previous other-than-temporary impairment was recognized, how should the entity record the loss within AVR and IMR? Drafting Note: Delete – Follow guidance in paragraph 38. Updated in 2010.

9 If a security with a recognized other-than-temporary impairment is subsequently sold for a gain, how should the gain be recognized within AVR and IMR? Drafting Note: Delete – Follow guidance in paragraph 38. Updated in 2010.

10 Shall a cumulative effect adjustment be recorded to reflect other-than-temporary impairments for securities for which an other-than-temporary impairment was not previously recorded under SSAP No. 43 or for securities for which an other-than-temporary impairment was previously recorded under SSAP No. 43, but not to the extent required under SSAP No. 43R? Drafting Note: Delete – Related to Initial Application.

11 If a reporting entity had previously adopted SSAP No. 98, or had a company policy in accordance with SSAP No. 98, and had previously recognized an other-than-temporary impairment to fair value, if at September 30, 2009, the entity has the intent and ability to retain the security for a period of time to recover the amortized cost, is the entity permitted to make a cumulative effect adjustment to reflect a reversal of the previously recognized loss? Drafting Note: Delete – Related to Initial Application.

12 If a reporting entity had previously adopted SSAP No. 98, or had a company policy in accordance with SSAP No. 98, and had previously recognized an other-than-temporary impairment in accordance with SSAP No. 98, if an additional other-than-temporary impairment is necessary under SSAP No. 43R, should the additional other-than-temporary impairment be recognized as part of the cumulative effect adjustment permitted under SSAP No. 43R? Drafting Note: Delete – Related to Initial Application.

13 With respect to the calculation of the cumulative effect adjustment, paragraph 58 states the following: “The cumulative effect adjustment shall include related tax effects.” Because of the interrelated nature of realized gains and losses, AVR and IMR and taxes to AVR and IMR, should the cumulative effect adjustment also be net of AVR and IMR effects? Drafting Note: Delete – Related to Initial Application.

14 Are the disclosure requirements within paragraphs 5051.f. and 5051.g. of SSAP No. 43R required to be completed for the current reporting quarter only, or as a year-to-date cumulative disclosures?

15 If an impairment loss is recognized based on the "present value of projected cash flows" in one period is the entity required to get new cash flows every reporting period subsequent or just in the periods where there has been a significant change in the actual cash flows from projected cash flows?



No. Question 16 What disclosure information is required for securities recognized as OTTI on the basis of

"present value of projected cash flows," in years subsequent to the OTTI? Drafting Note: Delete – The guidance to require disclosure for as long as the security is held was removed in 2014. The language in paragraph 51g only requires disclosure for impairments recognized in the current reporting period.

17 Do RMBS structured finance securities purchased in different lots result in a different NAIC designation for the same CUSIP? Can reporting entities use a weighted average method determined on a legal entity basis? Drafting Note: The designation guidance added in 2009 was originally focused on RMBS only. With the changes added in 2011, which expanded the designation guidance to all securities within scope of SSAP No. 43R, reference to only RMBS is no longer accurate.

18 The NAIC Designation process for RMBS structured finance securities may incorporate loss expectations that differ from the reporting entity’s expectations related to OTTI conclusions. Should the reporting entities be required to incorporate recovery values obtained from data provided by the service provider used for the NAIC Designation process for impairment analysis as required by SSAP No. 43R? Drafting Note: The designation guidance added in 2009 was originally focused on RMBS only. With the changes added in 2011, which expanded the designation guidance to all securities within scope of SSAP No. 43R, reference to only RMBS is no longer accurate.

19 For companies that have separate accounts, can the NAIC designation be assigned based upon the total legal entity or whether it needs to be calculated separately for the general account and the total separate account?

20 Should the initial or final rating be used to determine the AVR/IMR classification on sold securities?

21 Why is the final designation used for the AVR/IMR classification of realized gains and losses on sales? If the initial rating results in a NAIC 6 designation, and the final designation is higher, how does this impact reporting for AVR/IMR?

1. Question - Are reporting entities permitted to establish an accounting policy to write down a SSAP No. 43R other-than-temporarily impaired security, for which a “non-interest” related decline exists, to fair-value regardless of whether the reporting entity intends to sell, or has the intent and ability to hold? 1.1 Pursuant to the guidance in SSAP No. 43R, optionality is not permitted. As such, an accounting policy that differs from SSAP No. 43R would be considered a departure from statutory accounting principles as prescribed by the NAIC Accounting Practices and Procedures Manual. 2. Question – Can a reporting entity avoid completing a cash-flow assessment or testing for a specific other-than-temporarily impaired security when the entity believes there is a clear cash-flow shortage (i.e., non-interest related impairment) and elect to recognize a full impairment for the SSAP No. 43R security (no impairment bifurcation), with fair value becoming the new amortized cost basis, and recognition of the full other-than-temporary impairment as a realized loss? 2.1 Under the basis of SSAP No. 43R, an entity is not permitted to elect a write-down to fair value in lieu of assessing cash flows and bifurcating “interest” and “non-interest” impairment components. As noted in paragraph 3334, if the entity does not have the intent to sell, and has the intent and ability to hold, but does not expect to recover the entire amortized cost basis of the security, the entity shall compare the present value of cash flows expected to be collected with the amortized cost basis of the security. If present value of cash flows expected to be collected is less than the amortized cost basis of the security, the entire amortized cost basis of the security will not be recovered (a non-interest decline exists) and an other-than-temporary impairment shall be considered to have occurred. Pursuant to



paragraph 3637, when an other-than-temporary impairment has occurred because the entity does not expect to recover the entire amortized cost basis of the security even if the entity has no intent to sell and the entity has the intent and ability to hold, the amount of the other-than-temporary impairment recognized as a realized loss shall equal the difference between the investment’s amortized cost basis and the present value of cash flows expected to be collected, discounted at the loan-backed or structured finance security’s effective interest rate. 2.2 If the entity does not want to assess cash flows of an impaired security (fair value is less than amortized cost), the entity can designate the security as one the entity intends to sell, or one that the entity does not have the intent and ability to hold, providing it is reflective of the true intent and assessment of the ability of the entity. Once an impaired security has this designation, pursuant to paragraphs 31 32 or 3233, an other-than-temporary impairment shall be considered to have occurred. As detailed in paragraph 3536, the amount of the other-than-temporary impairment recognized in earnings as a realized loss shall equal the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. 2.3 As addressed in question 3 of this Question and Answer Guide, reporting entities are not permitted to change assertions regarding their intent to sell or their lack of intent and ability to hold. Once the security has been identified as one the entity intends to sell, or as a security that the entity does not have the intent and ability to hold, that assertion shall not change as long as the entity continues to hold the security. 3. Question - Can reporting entities change their “intend to sell” or “unable to hold” assertions and recover previously recognized other-than-temporary impairments? 3.1 No, a reporting entity is not permitted to change assertions and reverse previously recognized SSAP No. 43R other-than-temporary impairments. Although an entity may elect to hold a security due to a favorable change in the security’s fair value, once the security has been identified as one the entity intends to sell, or as a security that the entity does not have the intent and ability to hold for purposes of initially recognizing an other-than-temporary impairment, that assertion shall not change as long as the entity continues to hold the security. 3.2 Reporting entities that have recognized an other-than-temporary impairment on a SSAP No. 43R security in a manner corresponding with an assertion on the intent to sell or the lack of the intent and ability to hold, for which a subsequent other-than-temporary impairment has been identified, shall recognize a realized loss for the difference between the current amortized cost (reflecting the previously recognized SSAP No. 43R other-than-temporary impairment) and the fair value at the balance sheet date of the subsequent impairment. Thus, bifurcation of impairment between interest and non-interest related declines is not permitted for securities in which an other-than-temporary impairment was previously recognized on the basis that the reporting entity had the intent to sell, or lacked the intent and ability to hold, regardless if the entity has subsequently decided to hold the security. 3.3 Reporting entities shall reclassify a security as one for which there is an intent to sell, or for which there is not an intent or ability to hold, regardless if a bifurcated other-than-temporary impairment had previously been recognized, as soon as the entity realizes that they can no longer support a previous assertion to hold the security. In making such reclassifications, if the security is impaired, the difference between the amortized cost (reflecting the initial non-interest other-than-temporary impairment recognized) and fair value at the balance sheet date of the reclassification shall be recognized as a realized loss, with fair value reflecting the new amortized cost basis. Once such a reclassification occurs, and the security is classified as one for which there is an intent to sell, or for which there is not an intent and ability to hold, the security must continue to carry that assertion until it is no longer held by the reporting entity. 4. Question – Under SSAP No. 43R, in accordance with the cumulative adjustment provisions, is it possible for a previously other-then-temporarily impaired security to be completely “unimpaired” (not recognized as OTTI)?



4.1 Yes, a security that was previously determined to be other-than-temporarily impaired may be completely “unimpaired” under SSAP No. 43R if the other-than-temporary impairment is determined to be 100% interest related upon adoption. If there is any aspect of non-interest impairment (present value of cash flows expected to be collected is less than amortized cost) then the security would continue to be considered other-than-temporarily impaired under SSAP No. 43R. The amount recognized as a realized loss, if applicable, has changed. (Please refer to the cumulative effect adjustment guidance.) 4.2 Although INT 06-07: Definition of Phrase “Other Than Temporary” (INT 06-07) did not require a security to be considered other-than-temporarily impaired if the impairment was 100% caused by interest related declines, it has been identified that reporting entities may have been compelled to write-down such securities as other-than-temporarily impaired due to the time and/or extent to which the security had been impaired. Thus, in these instances, if there is no “non-interest” related decline, and the reporting entity does not have the intent to sell and has the intent and ability to hold until recovery of the amortized cost basis, then under the SSAP No. 43R cumulative effect transition provisions, such securities will be completely “unimpaired” (not recognized as OTTI). 5. Question – How do the regulators intend the phrase “intent and ability to hold” as used within SSAP No. 43R to be interpreted? 5.1 SSAP No. 43R paragraph 32 33 states in part “…the entity shall assess whether it has the intent and ability to retain the investment in the security for a period of time sufficient to recover the amortized cost basis. If the entity does not have the intent and ability to retain the investment for the time sufficient to recover the amortized cost basis, an other-than-temporary impairment shall be considered to have occurred.” 5.2 The intent of this language within SSAP No. 43R is focused on ensuring that, as of the balance sheet date, after considering the entity’s own cash or working capital requirements and contractual or regulatory obligations and all known facts and circumstances related to the impaired security, the entity does not have the intention of selling the impaired security and has the current intent and ability to hold the security to recovery. Due to impairment bifurcation provisions provided within SSAP No. 43R, and the amortized cost measurement method generally permitted for loan-backed and structured finance securities, the assessment of “intent and ability” is intended to be a high standard. Despite the intent of paragraph 3233, it is identified that information not known to the entity may become known in subsequent periods and/or facts and circumstances related to an individual holding or group of holdings may change thereby influencing the entity’s subsequent determination of intent and ability with respect to a security or securities. 5.3 If a reporting entity asserts that it has the intent and ability to hold a security, or group of securities, until recovery of the amortized cost, but sells or otherwise disposes the security or securities prior to such recovery, the reporting entity shall be prepared to justify this departure from their original assertion to examiners and auditors. SSAP No. 43R purposely does not identify specific circumstances in which a change in assertion would be justifiable, but requires judgment from management, examiners and auditors on whether future assertions warrant closer review. 5.4 Delaying recognition of other-than-temporary impairments is a cause of serious concern by the regulators, and entities that habitually delay such recognition through false assertions on the “intent and ability to hold” may face increased scrutiny and regulatory action by their domiciliary state. It is imperative that a reporting entity recognize the full other-than-temporary impairment as soon as the entity realizes that they will no longer be able to hold the security until recovery of the amortized cost basis. Greater scrutiny shall be placed on securities sold or otherwise disposed shortly after a financial statement reporting date if such securities had been excluded from the full other-than-temporary impairment recognition on the basis of the reporting entity’s intent and ability to hold. 5.5 As noted in paragraph 3.3 of this question and answer guide, once a security is classified as one for which there is an intent to sell, or for which there is not an intent and ability to hold, the security must continue to carry that assertion until the security is no longer held by the reporting entity.



6. Question – How do contractual prepayments affect the determination of credit losses? 6.1 Paragraph 33 34 of SSAP No. 43R states that "A decrease in cash flows expected to be collected on a loan-backed or structured finance security that results from an increase in prepayments on the underlying assets shall be considered in the estimate of present value of cash flows expected to be collected.” Paragraph 15 16 states that "Loan-backed and sStructured finance securities shall be revalued using the currently estimated cash flows, including new prepayment assumptions, using either the prospective or retrospective adjustment methodologies consistently applied by type of securities." 6.2 The language in paragraph 33 34 is consistent with GAAP, and the GAAP guidance related to the treatment of prepayments in the consideration of credit losses was intended to provide clarification for determining the "cash flows expected to be collected" on interest-only securities and other similar securities that can be contractually prepaid or otherwise settled in such a way that the holder would not recover substantially all of the investment. These securities are generally accounted for in accordance with paragraphs 18-2419-25 of SSAP No. 43R, which requires that an entity estimate cash flows expected to be collected including both amount and timing. Therefore, for securities under SSAP No. 43R, excluding those accounted for under paragraphs 18-2419-25, decreases in cash flows resulting in contractual prepayments should be considered yield adjustments rather than potential credit losses. 7. Question – Paragraph 37 states that AVR and IMR should be accounted for in accordance with SSAP No. 7, however paragraph 37 also states that AVR and IMR should be separated into two components if the entity has the intent to sell or does not have the intent and ability to retain the investment for a time sufficient to recover the amortized cost basis. This guidance is different from the treatment when the gain or loss is due to an actual sale and also different from the treatment for SSAP No. 26 investments. When an impairment is recognized, should an entity follow SSAP No. 7 when an investment changes by two or more NAIC categories (i.e., reported entirely in AVR) or stay within the guidance of SSAP No. 43R? 7.1 SSAP No. 43R includes specific guidance on the treatment for AVR and IMR of other-than-temporary impairment losses which indicates that an entity should bifurcate the loss into AVR and IMR portions depending on whether it is an interest or a non-interest related decline. It was the Statutory Accounting Principles (E) Working Group’s intention that for those securities subject to SSAP No. 43R, an entity should report the gain or loss in separate AVR and IMR components regardless of whether the NAIC designation of the security has changed by two or more NAIC designations. The Statutory Accounting Principles (E) Working Group acknowledges that the actual language of SSAP No. 43R is inconsistent and not explicit on this point. In addition, the Statutory Accounting Principles (E) Working Group also notes that due to the rapid adoption of SSAP No. 43R, the annual statement instructions were not fully updated. As a result, a Form A and updates to the annual statement instructions are being prepared for 2010 review. The Form A and updates will address the issue of bifurcation of gains or losses on sales between AVR and IMR for those securities subject to SSAP No. 43R. Appropriate disclosures will also be included in the Form A. In June 2010, nonsubstantive revisions were adopted to paragraphs 28 and 37 to clarify the bifurcation of gains and losses between AVR and IMR. Guidance on the effective date for these nonsubstantive revisions is included within paragraph 62. 8. Question – If a security is sold and no previous other-than-temporary impairment was recognized, how should the entity record the loss within AVR and IMR? 8.1 As noted in paragraph 7.1, it was intended that reporting entities shall follow the guidance in SSAP No. 43R that indicates an entity shall bifurcate the loss into AVR and IMR portions depending on interest and non-interest related declines. As such, an entity should report the loss in separate AVR and IMR components as appropriate. The AVR/IMR analysis performed, and resulting AVR/IMR allocation, for SSAP No. 43R securities should be same regardless whether the security is written down as a result of an impairment analysis or whether the security was sold without any impairment. A Form A is being prepared to more directly address this issue in SSAP No. 43R. In June 2010, nonsubstantive revisions were adopted to paragraphs 28 and 37 to clarify the bifurcation of gains and losses between AVR and IMR. Guidance on the effective date for these nonsubstantive revisions is included within paragraph 62.



9. Question – If a security with a recognized other-than-temporary impairment is subsequently sold for a gain, how should the gain be recognized within AVR and IMR? 9.1 As noted in paragraph 7.1, it was intended that reporting entities that recognize an other-than-temporary impairment for securities within SSAP No. 43R that subsequently sell such securities for a gain, shall recognize the gain proportionately through AVR and IMR relative to analysis performed of the gain at the date of the sale. A Form A is being prepared to more directly address this issue in SSAP No. 43R. In June 2010, nonsubstantive revisions were adopted to paragraphs 28 and 37 to clarify the bifurcation of gains and losses between AVR and IMR. Guidance on the effective date for these nonsubstantive revisions is included within paragraph 62. 10. Question – Shall a cumulative effect adjustment be recorded to reflect other-than-temporary impairments for securities for which an other-than-temporary impairment was not previously recorded under SSAP No. 43 or for securities for which an other-than-temporary impairment was previously recorded under SSAP No. 43, but not to the extent required under SSAP No. 43R? 10.1 Paragraph 58 of SSAP No. 43R states that the cumulative effect applies to securities “for which an other-than-temporary impairment was previously recognized under SSAP No. 43.” Does this imply that no cumulative effect should be recorded for securities for which an impairment was not previously recorded, and therefore any credit related impairment prior to July 1, 2009 is recorded in 3Q 2009 earnings? The following facts are provided to illustrate this scenario:

• At 6/30 the insurer owns a security whose fair value is less than cost and has undiscounted cash flows of $97. A $3 impairment is recorded. At 7/1 discounted cash flows (under SSAP No. 43R) are calculated as $90. The difference of $7 ($97-90) is recorded as a cumulative adjustment as required by SSAP No. 43R.

• At 6/30 the insurer owns a security whose fair value is less than cost but has undiscounted

expected cash flows of $101. Therefore, no impairment is recorded. At 7/1 discounted cash flows (under SSAP No. 43R) are calculated as $90. Is the difference of $10 ($100-$90) recorded as a cumulative adjustment or does it get recorded as an impairment through earnings for the quarter ended 9/30/09?

10.2 The Statutory Accounting Principles (E) Working Group has concluded that in both cases a cumulative adjustment shall be recorded. If not, in the first example, a company that recognized a small impairment under SSAP No. 43 would not have to recognize any additional pre-7/1/09 credit-related impairment in their income statement, while in the second case, a company that did not happen to trigger an impairment under SSAP No. 43 would be required to recognize the entire pre-7/1/09 credit-related impairment in their 2009 income statement. 10.3 Recording cumulative adjustments for both scenarios is consistent with SSAP No. 3—Accounting Changes and Corrections of Errors (SSAP No. 3). SSAP No. 3 states that “a change in accounting principle results from an adoption of an accepted accounting principle, or method of applying the principle…The cumulative effect of changes in accounting principles shall be reported as adjustments to unassigned funds (surplus) in the period of the change in accounting principle. The cumulative effect is the difference between the amount of capital and surplus at the beginning of the year and the amount of capital and surplus that would have been reported at that date if the new accounting principle had been applied retroactively for all prior periods.” As a result of this Q&A item, the following nonsubstantive revisions have been made to paragraphs 57 and 58 of SSAP No. 43R as follows:

56. This revised statement supersedes SSAP No. 98 and paragraph 13 of SSAP No. 99 effective September 30, 2009. For reporting entities that either early adopted the requirements of SSAP No. 98 or previously adopted a statutory accounting policy that was in accordance with the prescriptions of SSAP No. 98, and if such reporting entities do not intend to sell the security, and have the intent and ability to retain the investment in the security for a period of time sufficient to



recover the amortized cost basis, those reporting entities shall recognize the cumulative effect of reversing the impact of the adoption of SSAP No. 98, or an equivalent statutory accounting policy, and paragraph 13 of SSAP No. 99 as an adjustment to the opening balance of unassigned funds (surplus) as of July 1, 2009, with a corresponding adjustment to applicable financial statement elements. 57. The accounting and reporting requirements of this revised statement shall be applied to existing and new investments held by a reporting entity on or after September 30, 2009. For loan-backed and structured securities held at the beginning of the interim period of adoption (July 1, 2009) and continue to be held as of September 30, 2009, if a reporting entity does not intend to sell the security, and has the intent and ability to retain the investment in the security for a period of time sufficient to recover the amortized cost basis, the reporting entity shall recognize the cumulative effect of initially applying this revised statement as an adjustment to the opening balance of unassigned funds (surplus) as of July 1, 2009, with a corresponding adjustment to applicable financial statement elements. The cumulative effect on unassigned funds (surplus) shall be calculated by comparing the present value of the cash flows expected to be collected determined in accordance with the methodology in paragraph 34, as applicable, with the amortized cost basis of the loan-backed and structured security as of the beginning of the interim period in which this revised statement is adopted (July 1, 2009). The cumulative-effect adjustment shall include related tax effects. The discount rate used to calculate the present value of the cash flows expected to be collected shall be the rate in effect before recognizing any other-than-temporary impairments and not a rate that has been adjusted to reflect those impairments.

11. Question – If a reporting entity had previously adopted SSAP No. 98, or had a company policy in accordance with SSAP No. 98, and had previously recognized an other-than-temporary impairment to fair value, if at September 30, 2009, the entity has the intent and ability to retain the security for a period of time to recover the amortized cost, is the entity permitted to make a cumulative effect adjustment to reflect a reversal of the previously recognized loss? 11.1 Yes, under the cumulative effect guidance within SSAP No. 43R the entity shall reflect a reversal of the previously recognized loss so that only any non-interest other-than-temporary impairment, determined by comparing the present value of cash flows expected to be collected with the amortized cost of the security, is reflected within the financial statements. (See question 4 regarding whether a previously recognized other-than-temporary impairment can be completely “unimpaired”.) 12. Question – If a reporting entity had previously adopted SSAP No. 98, or had a company policy in accordance with SSAP No. 98, and had previously recognized an other-than-temporary impairment in accordance with SSAP No. 98, if an additional other-than-temporary impairment is necessary under SSAP No. 43R, should the additional other-than-temporary impairment be recognized as part of the cumulative effect adjustment permitted under SSAP No. 43R? 12.1 To further elaborate on this question, assume that an entity early adopted SSAP No. 98 or had an accounting policy similar to SSAP No. 98, and, for a particular security, the entity had previously recognized an other-than-temporary impairment. Assume, at September 30, 2009, the entity has the intent and ability to retain the security for a period of time sufficient to recover the amortized cost. Under SSAP No. 43R, should the cumulative catch-up adjustment recorded to unassigned funds (surplus) as of July 1, 2009 be only the amount required to reverse the previously recognized loss, or does the entity make the adjustment for the amount necessary to recognize the impairment in accordance with the requirements of SSAP No. 43R? The following facts are provided to illustrate this scenario:

o Fair Value at 7/1/09 $75 o PV of Expected Cash Flows at 7/1/09 $90 o Amortized Cost at 7/1/09 $100 o Impairment Under SSAP No. 98 Previously Recognized $25 o Cumulative Catch Adjustment if Apply Only Paragraph 57 $25 o Cumulative Catch Adjustment if Apply Paragraphs 57 and 58 $15



12.2 The cumulative effect recorded by the entity relative to this previously impaired security would be the amount necessary to adjust surplus as of July 1 to what it would have been had the requirements of SSAP No. 43R been applied as of that date. Therefore, in this example the cumulative effect adjustment (prior to the impact of related taxes and AVR and IMR, if any) is $15. Please note the emphasis as of July 1. If an additional other-than-temporary impairment is recognized during the third-quarter, this additional other-than-temporary impairment would not be included in the cumulative effect, but would be reflected as a recognized loss within the third-quarter financials. 13. Question – With respect to the calculation of the cumulative effect adjustment, paragraph 58 states the following: “The cumulative effect adjustment shall include related tax effects.” Because of the interrelated nature of realized gains and losses, AVR and IMR and taxes to AVR and IMR, should the cumulative effect adjustment also be net of AVR and IMR effects? 13.1 Yes. The impact of a cumulative effect adjustment of a new accounting standard typically reflects the net impact of adoption. Accordingly, the cumulative effect adjustment from adopting SSAP No. 43R should be presented net of taxes, AVR and IMR. Alternatively, the cumulative effect may exclude AVR and IMR impact if the AVR and IMR impact is reflected in applicable financial statement elements and the impact is reflected in capital and surplus. 14. Question – Are the disclosure requirements within paragraphs 5051.f. and 5051.g. of SSAP No. 43R required to be completed for the current reporting quarter only, or as a year-to-date cumulative disclosures? 14.1 The disclosures should reflect the year-to-date other-than-temporary impairments. The “fair value” reported within the disclosure is intended to reflect the fair value at the date of the other-than-temporary impairment, and shall not be updated due to the fluctuations identified at subsequent reporting dates. If a security has more than one other-than-temporary impairment identified during a fiscal reporting year, the security shall be included on the disclosure listing separately for each identified other-than-temporary impairment. Notation shall be included on the disclosure identifying the other-than-temporary impairments that were recognized for each respective reporting period. (Please note that question 16 addresses subsequent year disclosure for OTTI securities that continue to be held.) 15. Question – If an impairment loss is recognized based on the "present value of projected cash flows" in one period is the entity required to get new cash flows every reporting period subsequent or just in the periods where there has been a significant change in the actual cash flows from projected cash flows? 15.1 The guidance in paragraph 39 40 of SSAP No. 43R indicates that a reporting entity shall continue to estimate the present value of cash flows expected to be collected over the life of the loan-backed or structured finance security. This guidance is explicit that the reporting entity shall continue to estimate the present value of cash flows expected to be collected over the life of the loan-backed or structured finance security. 15.2 As provided in paragraph 2.2 of this Q&A, if the entity does not want to assess cash flows of an impaired security (fair value is less than amortized cost), the entity can designate the security as one the entity intends to sell, or one that the entity does not have the intent and ability to hold, providing it is reflective of the true intent and assessment of the ability of the entity. Reporting entities subject to the requirements of AVR and IMR should allocate the impairment loss between AVR and IMR accordingly. 16. Question – What disclosure information is required for securities recognized as OTTI on the basis of "present value of projected cash flows," in years subsequent to the OTTI? 16.1 Paragraph 50.g. is explicit that disclosure shall continue to occur for securities with other-than-temporary impairments that continue to be held by the reporting entity. As such, disclosure must continue in all future reporting periods, even over subsequent years, for which the security continues to be held.



17. Question – Do RMBS structured finance securities purchased in different lots result in a different NAIC designation for the same CUSIP? Can reporting entities use a weighted average method determined on a legal entity basis? 17.1 SSAP No. 43R and several other statements of statutory accounting principle require use of the scientific (constant yield) method of amortization. In addition to purchase price, the purchase date is an inherent part of this method and will typically result in different amortization values for different lots. Therefore, structured finance securitiesRMBS in different lots can result in a different NAIC designation for the same CUSIP. In accordance with the current instructions for calculating AVR and IMR, reporting entities are required to keep track of the different lots separately, which means reporting the different designations. Specific to the RMBS proposal only, for year-end 2009 and until an alternative long-term solution is developed, if companies' accounting and reporting systems do not accommodate this approach, a weighted-average method on a legal entity basis can be used. To the extent that a different accounting method applies to a legal entity's general and separate account, then the weighted average for each account should be calculated separately for the general account and separate account. 18. Question – The NAIC Designation process for RMBS structured finance securities may incorporate loss expectations that differ from the reporting entity’s expectations related to OTTI conclusions. Should the reporting entities be required to incorporate recovery values obtained from data provided by the service provider used for the NAIC Designation process for impairment analysis as required by SSAP No. 43R? 18.1 In accordance with INT 06-07: Definition of Phrase “Other Than Temporary,” reporting entities are expected to “consider all available evidence” at their disposal, including the information that can be derived from the NAIC designation. 19. Question - For companies that have separate accounts, can the NAIC designation be assigned based upon the total legal entity or whether it needs to be calculated separately for the general account and the total separate account? 19.1 The answer to this question is identical to the answer for question 17. SSAP No. 43R and several other statements of statutory accounting principle require use of the scientific (constant yield) method of amortization. In addition to purchase price, the purchase date is an inherent part of this method and will typically result in different amortization values for different lots. Therefore, RMBS structured finance securities in different lots can result in a different NAIC designation for the same CUSIP. In accordance with the current instructions for calculating AVR and IMR, reporting entities are required to keep track of the different lots separately, which means reporting the different designations. Specific to the RMBS proposal only, for year-end 2009 and until an alternative long-term solution is developed, if companies' accounting and reporting systems do not accommodate this approach, a weighted-average method on a legal entity basis can be used. To the extent that a different accounting method applies to a legal entity's general and separate account, then the weighted average for each account should be calculated separately for the general account and separate account. 20. Question - Should the initial or final designation be used to determine the AVR/IMR classification on sold securities? 20.1 The final designation should be utilized to determine the AVR/IMR classification on sold securities. 21. Question - Why is the final designation used for the AVR/IMR classification of realized gains and losses on sales? If the initial designation results in a NAIC 6 designation and the final designation is higher, how does this impact reporting for AVR/IMR? 21.1 With regards for AVR/IMR determination and other reporting purposes, the FINAL designation, after application of the multi-step method described in paragraph 2627, shall be used. The initial designation, which is not used for any reporting purposes except for determining the carrying value method as described in paragraph 25, is only an interim step in determining the (final) NAIC designation.



However, as noted in paragraph 2627, securities assigned an NAIC 6 designation are not modified by the carrying value; therefore the final designation is also an NAIC 6. The same is true for securities assigned an NAIC 1 designation by the SVO. As NAIC 1 securities are assumed to have zero expected loss, the initial designation is not modified by the carrying value; therefore the final designation is also an NAIC 1. (Please see paragraph 26 27 and related subparagraphs for additional information related to the multi-step method.)

Proposed Revisions to Other Impacted SSAPs:

(All References to SSAP No. 43R would be updated to reflect the revised title. These are not noted.) SSAP No. 7—Asset Maintenance Reserve and Interest Maintenance Reserve

3. The IMR and AVR shall be calculated and reported as determined per guidance in the SSAP for the specific type of investment (e.g. SSAP No. 43R for— loan-backed and sStructured Finance sSecurities), or if not specifically stated in the respective SSAP, in accordance with the NAIC Annual Statement Instructions for Life, Accident and Health Insurance Companies.

SSAP No. 26—

2. This statement excludes:

a. Loan-backed and sStructured finance securities addressed captured in SSAP No. 43R—Loan-Backed and Structured Finance Securities. (Bond securities with a single obligor are outside the scope of structured finance securities, as defined in SSAP No. 43, and are captured within the scope of SSAP No. 26.)

SSAP No. 103—Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

2. This statement focuses on the issues of accounting for transfers1 and servicing of financial assets and extinguishments of liabilities. This statement establishes statutory accounting principles for transfers and servicing of financial assets, including asset securitizations and securitizations of policy acquisition costs, extinguishments of liabilities, repurchase agreements, repurchase financing and reverse repurchase agreements, including dollar repurchase and dollar reverse repurchase agreements that are consistent with the Statutory Accounting Principles Statement of Concepts and Statutory Hierarchy (Statement of Concepts). This statement discusses generalized situations. Facts and circumstances and specific contracts need to be considered carefully in applying this statement. Securitizations of nonfinancial assets are outside the scope of this statement. Transfers of financial assets that are in substance real estate shall be accounted for in accordance with SSAP No. 40R—Real Estate Investments. Additionally, retained beneficial interests from the sale of loan-backed or structured finance securities are to be accounted for in accordance with SSAP No. 43R—Loan-Backed and Structured Finance Securities, Revised.

11. Upon completion of a transfer of an entire financial asset or a group of entire financial assets that

satisfies the conditions to be accounted for as a sale (see paragraph 8), the transferor (seller) shall:

a. Derecognize the transferred financial assets;

b. Recognize and initially measure at fair value servicing assets, servicing liabilities, and

any other assets obtained (including a transferor’s beneficial interest in the transferred financial assets) and liabilities incurred in the sale (paragraphs 60 and 62-66).



c. For reporting entities required to maintain an Interest Maintenance Reserve (IMR), the accounting for realized and unrealized capital gains and losses shall be determined per the guidance in the SSAP for the specific type of investment (e.g., SSAP No. 43R—Structured Finance Securities for loan-backed and structured securities), or if not specifically stated in the related SSAP, in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve. For reporting entities not required to maintain an IMR, realized capital gains and losses shall be reported as net realized capital gains or losses in the statement of income, and unrealized capital gains and losses shall be reported as net unrealized gains and losses in unassigned funds (surplus).

18. Financial assets, except for instruments that are within the scope of SSAP No. 86, that

can contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its recorded investment shall be subsequently measured like investments in debt securities and loan-backed and structured finance securities in accordance with SSAP No. 43R. Examples of such financial assets include, but are not limited to, interest-only strips, other beneficial interests, loans, or other receivables.

SSAP No. 105—Working Capital Finance Investments

15. In the case of a certificate, note, or other manifestation, capable of verification, representing a right to payment from a trust, other special purpose entity, or special purpose pool holding confirmed supplier receivables, the investor must certify that it has a commercially reasonable belief that the documents establishing and governing the working capital finance program create and preserve interests in the confirmed supplier receivables capable of being enforced by the trustee or other entity holding confirmed supplier receivables as first priority perfected security interests under the Uniform Commercial Code. The investor must be able to demonstrate the basis for such belief to a regulator or to the SVO upon either’s request. Commercially reasonable belief shall mean the SVO deems the investor’s belief reasonable in light of the systems, policies, and practices commonly recognized in the field of investing in securitizations, loan-backed, structured finance securities, or trust-issued securities.

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© 2016 National Association of Insurance Commissioners

MEMORANDUM

TO: Dale Bruggeman, Chair, Statutory Accounting Principles (E) Working Group

FROM: Kevin Fry, Chair, Valuation of Securities (E) Task Force

Cc: Julie Gann, Senior Manager, NAIC Financial Regulatory Services

Bob Carcano, Senior Counsel, NAIC Investment Analysis Office

DATE: June 10, 2016

RE: Referral to the Statutory Accounting Principles (E) Working Group Pertaining to SSAP No. 43R–Loan Backed and

Structured Securities

1. Background – The Statutory Accounting Principles (E) Working Group indicated it would review modifications to

the definition of loan-backed and structured securities made in 2010 as part of its investment SSAP project. SVO agreed with

the FRS to evaluate the issues and make analytical recommendations to the Task Force as a way to advance the objectives of

both regulatory groups. The SVO proposes a change in the definition that would focus on the collateral pool as the source of

dynamic cash flow associated with most structured finance securities. The recommendation reflects that each asset in a

structured finance collateral pool is an obligation of a different and unrelated obligor. The dynamic cash flow pattern with

which SSAP No. 43R is concerned is the result of the potential that each unrelated obligor in the collateral pool makes a

different payment decision (i.e., to prepay, to extend payment, to pay late or not to pay) on any payment date specified in the

contract. The 2010 amendments focus on the existence of a trust and associate the existence of a trust with a dynamic cash

flow pattern whether or not a collateral pool with multiple unrelated obligors exists, whereas trusts are very frequently used

(for a number of legal and structural reasons) in structures involving only a single obligor. The SVO analysis and

recommendations were released for comment with the ACLI suggesting a friendly modification but otherwise expressing

support.

2. Referral – The Valuation of Securities (E) Task Force refers to the Statutory Accounting Principles (E) Working

Group the SVO report and analysis (Attachment One) and the proposed definition as modified by the ACLI’s friendly

modification (Attachment Two) and recommends that the Working Group consider adopting the proposed definition. Do not

hesitate to call upon the staff of the SVO and of the SSG if any issue in its analysis should require further discussion. Please

contact me if you have any questions. Technical issues should be referred to Bob Carcano of the IAO.

G:\DATA\Vos-tf\Referrals & Responses\Task Force 2016 Refer LBaSS Def for 43R to SAPWG.docx

Attachment C

Attachment Six

Valuation of Securities (E) Task Force

6/8/16


MEMORANDUM

TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force

Members of the Valuation of Securities (E) Task Force

FROM: Bob Carcano, Senior Counsel, NAIC Investment Analysis Office

CC: Charles Therriault, Director, NAIC Securities Valuation Office

DATE: May 17, 2016

RE: Definition of Loan-Backed and Structured Securities in SSAP No. 43R – An Issue in the Investment SSAP

Revisions Project of the Statutory Accounting Principles (E) Working Group

1. Background – The SVO presented a proposal pertaining to the captioned project dated March 7, which was discussed

with the Task Force April 4 during the Spring National Meeting and then received and released for a 30-day comment period.

During the April 4 discussion, Michael Monahan (American Council of Life Insurers—ACLI) proposed a friendly

amendment to the text, which he agreed to provide in a comment letter. The ACLI’s comment letter is attached. It proposes

an insert to the SVO’s March 7 memorandum to clarify the meaning of a “single obligor” and the addition of a phrase of text

in several parts of the proposed amendment. SVO has no objection to the inclusion of the ACLI-proposed phrase in the SVO-

proposed definition.

The purpose of the March 7 memorandum was to express a view on a definition in SSAP No. 43R—Loan-Backed and

Structured Securities. In that context, “single obligor” was used as a contrast and not as a definitional element to

SSAP No. 43R. Although the proposed ACLI text is not objectionable to the SVO, references to “assignments” may require

further discussion and illustrates that further efforts to define the phrase “single obligor” may benefit from a more specific

context related to SSAP No. 26—Bonds, Excluding Loan-Backed and Structured Securities. The SVO stands ready to assist

the Statutory Accounting Principles (E) Working Group in any such effort.

The SVO recommends that the proposed definition, shown below with the ACLI-requested modification, be adopted by the

Task Force and referred to the Statutory Accounting Principles (E) Working Group, with a recommendation that the Working

Group consider adopting the proposed definition.

2. Proposed Definition (Modified to Reflect ACLI Comment)

Loan-backed securities and structured securities are more broadly characterized as structured finance securities.

In a structured finance security, an issuer, typically an SPE): 1) sells loan-backed or structured securities and uses the

proceeds of the sale to purchase a pool of assets associated with multiple unrelated obligors, including derivatives, from

one or more originators; and 2) places the such assets within a trust that serves as trustee for the benefit of the holders of

the loan-backed or structured securities, with instructions that the trustee use the cash flow generated by the assets to pay

the holders of the SPE’s loan -backed or structured securities.

Attachment C

Attachment Six


6/8/16


The asset pool in a structured finance security contains multiple unrelated obligors, which affects the dynamic of cash

flow generation. An asset pool is a closed pool so that the default of any one of the unrelated an asset pool obligors

permanently impairs the cash flow generating ability of the asset pool.

Loan-backed securities are defined as a structured finance security in which a servicing intermediary collects payments

from the asset pool multiple unrelated obligors and remits or passes them through to holders of the securities so that

payment of interest and/or principal to each SPE noteholder is directly proportional to the payments received by the

issuer from the underlying assets.

Structured securities are defined as a structured finance security that has been divided into two or more classes and in

which a servicing intermediary collects payments from the asset pool multiple unrelated obligors and distributes the

amounts collected in accordance with a specified set of contractual instructions, typically referred to as a “waterfall,” that

allocate the payment of interest and/or principal of any class of securities in a manner that is not proportional to

payments received by the issuer from the underlying collateral assets.

Attachment

G:\DATA\Vos-tf\Meetings\2016\June\06-B Task Force 2016 SSAP No. 43R Project Two.docx

Attachment C

Attachment Ten


4/4/16

© 2016 National Association of Insurance Commissioners

MEMORANDUM

TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force

Members of the Valuation of Securities (E) Task Force

FROM: Bob Carcano, Senior Counsel, NAIC Investment Analysis Office

CC: Charles Therriault, Director, NAIC Securities Valuation Office

DATE: March 7, 2016

RE: Definition of Loan-Backed and Structured Securities in SSAP No. 43R – An Issue in the Investment SSAP

Revisions Project of the Statutory Accounting Principles (E) Working Group

1. Background – In 2012, the Statutory Accounting Principles (E) Working Group formed the SSAP No. 43R (E)

Subgroup1 and asked that it consider industry comments and concerns with modifications made to the definition of loan-

backed and structured securities (LBaSS) in 2010.2 The 2010 amendments caused many bonds previously regarded to be in

scope of SSAP No. 26—Bonds to be in scope of SSAP No. 43R—Loan-backed and Structured Securities. This affected capital

market pricing and risk assessment and required the Task Force to clarify that the credit assessment methodology and criteria

for bonds that existed prior to the 2010 amendment would continue to apply.3 Given the Task Force’s significant interest in

SSAP No. 43R, and that the issue is part of the Working Group’s Investment SSAP project, I agreed to work with NAIC

statutory accounting staff to provide an SVO and Structured Securities Group (SSG) perspective and propose a definition for

LBaSS that may address the concerns expressed by industry.

2. Analysis4 – Bonds are subjected to one of two accounting standards based on their cash flow pattern. This suggests a

need to identify the factors that account for the cash flow pattern associated with one or the other accounting standard. SSAP

No. 26 has historically been concerned with traditional corporate and municipal bonds. Such bonds are issued by a single

obligor, and the amount borrowed is expected to be repaid by cash flow from an ongoing business operation (whether private

or governmental in nature) whose long-term viability can be assessed by analyzing financial performance as presented in an

audited financial statement. In this framework, the expectation that the obligor will pay a specified payment amount on a

given payment date is supported by a written contract that requires the single obligor to make scheduled payments in

specified amounts. SSAP No. 43R was created in response to structured finance securities, specifically mortgage-backed

securities, where despite the presence of a specific special-purpose entities (SPE) issuer, each asset in the collateral pool

represents a different obligor, and each obligor may make a different payment decision on any payment date—the most

relevant of which are to prepay, to extend the life of the payment obligation, to make a late payment and or to default. SSAP

No. 43R recognizes that collateral pools with multiple obligors have a dynamic cash-generating pattern. The 2010

amendment automatically equates the existence of a trust with the existence of a dynamic cash flow pattern that would be

generated by an asset pool with multiple obligors. This would make in scope determinations less reliable because structural

elements are used for a number of different reasons, among them: 1) to comply with different legal and regulatory regimes; 2)

to improve the economics of a transaction such as by lowering taxes; and 3) to provide the investor collateral to lessen the

severity of a default by giving the insurer assets to foreclose on.

Attachment C

Attachment Ten


4/4/16


3. Proposed LBaSS Definition – The following definition recognizes that the dynamic cash flow pattern that SSAP

No. 43R was originally concerned with is the result of a specific structural construct: i.e., 1) the legal isolation and pooling

of; 2) a finite number of cash generating assets; 3) each from a different obligor; 4) in a trust; and 5) the use of the cash flow

from the collateral assets to pay the holders of the securities.

Loan-backed securities and structured securities are more broadly characterized as structured finance securities.

In a structured finance security, an issuer, typically an SPE: 1) sells loan-backed or structured securities and uses the

proceeds of the sale to purchase a pool of assets, including derivatives, from one or more originators; and 2) places the

assets within a trust that serves as trustee for the benefit of the holders of the loan-backed or structured securities with

instructions that the trustee use the cash flow generated by the assets to pay the holders of the SPE’s loan backed or

structured securities.

The asset pool in a structured finance security contains multiple unrelated obligors, which affects the dynamic of cash

flow generation. An asset pool is a closed pool so that the default of an asset pool obligor permanently impairs the cash

flow generating ability of the asset pool.

Loan-backed securities are defined as a structured finance security in which a servicing intermediary collects payments

from the asset pool obligors and remits or passes them through to holders of the securities so that payment of interest

and/or principal to each SPE noteholder is directly proportional to the payments received by the issuer from the

underlying assets.

Structured securities are defined as a structured finance security that has been divided into two or more classes and in

which a servicing intermediary collects payments from the asset pool obligors and distributes the amounts collected in

accordance with a specified set of contractual instructions, typically referred to as a waterfall, that allocate the payment

of interest and/or principal of any class of securities in a manner that is not proportional to payments received by the

issuer from the underlying collateral assets.

1. NAIC Proceedings – Fall 2012 at page 10-172: “ … the SSAP No. 43R (E) Subgroup had an organization meeting Sept. 6, with a subsequent call held Oct. 18 … (the) discussion focused on attributes of various securities … Discussion also occurred on variability of cash flows, as well as various rights of

priority in a bankruptcy ... ” 2. NAIC Proceedings – Summer 2014 at page 10-352: “The Working Group disbanded the SSAP No. 43R (E) Subgroup, noting that SSAP No. 43R will be

included as part of the investment classification project and discussed by the full Working Group …”

3. Purposes and Procedures Manual of the NAIC Investment Analysis Office, Part Seven, Section 6 (a) (iv) (C) – Exclusion of Certain Securities from Application of Carrying Value Methodology for Non Modeled Securities

(1) Exclusion and Excluded Securities – The carrying value methodology described in subsection (iv) A, above, shall not apply (the Exclusion) to

Credit Tenant Loans, Equipment Trust Certificates (whether rated by an NAIC CRP or designated for quality by the SVO) or to every other individual security to which the SVO has assigned an NAIC Designation (collectively, “Excluded Securities”), effective with the 2011 year-end reporting cycle. Please

refer to SSAP No. 43R, paragraph 26c.

(2) Deriving NAIC Designations for Excluded Securities – The NAIC Designation for Excluded Securities that are Credit Tenant Loans or Equipment Trust Certificates shall be the credit rating assigned by CRPs after application of the filing exemption procedure described in Part Two, Section 4

(d) (i) of this Manual or the NAIC Designation assigned by the SVO. The NAIC Designation for Excluded Securities that are individual securities to which

the SVO has assigned an NAIC Designation, shall be the NAIC Designation assigned by the SVO. Please refer to SSAP No. 43R, paragraph 26c.

For a record of the deliberations of the Task Force on the impact of the 2010 amendments on credit assessment and valuation of securities, see NAIC

Proceedings – Fall 2011 at page 10-518 and page 10-523; Attachments One – A2 to the Nov. 4, 2011, minutes of the Valuation of Securities (E) Task Force

contains the letters of capital market participants testifying to the turmoil caused by the 2010 amendments. See footnote 4 below for a synopsis so the

comments.

4. The record shows that industry made this or much the same points to regulators.

NAIC Proceedings – Fall 2010 at pages 10-85, 90–92 “…the intent … is to change the accounting for some insurer fixed income assets which had

generally been accounted for as bonds under SSAP No. 26, to loan backed and structured securities under SSAP 43R. Two examples … are equipment trust certificates and credit tenant loans. In each case there is generally an entity which passes cash flows from the operation of an

underlying asset or lease agreement (controlled by single party) to the insurer in the form of scheduled bond interest and principle payments.

However, the makeup of these arrangements vary as to the characteristics of the security held, recourse the insurer might have to make a claim against the underlying assets and the operator or lessee, the type of assets or leases involved and other factors which in some cases make them more bond-like

and in other cases more like loan-backed and structured securities … SSAP No. 26 includes credit tenant loans as one of its disclosure categories. …

The accounting and analysis required (in … SSAP No. 43R … is designed to capture the characteristics and risk posed by a pool of assets where the cash flow derives from more than one source (and frequently where the knowledge of the underlying credit risk and residual assets is limited) … This

type of approach is not suited to analyzing and accounting for a credit tenant loan or equipment trust certificate, where the focus should be on the

ability of the single party (i.e., lessee or operator) to continue the payments representing the cash flow. The appropriate analysis is almost identical to

Attachment C

Attachment Ten


4/4/16


that applied to a corporate bond. The difference is in default, where the holder of the security in most cases first looks to the value of the underlying

assets, as opposed to the bankruptcy court for satisfaction of the debt …”

NAIC Proceedings – Fall 2010 at page 10-243; Minutes of the Statutory Accounting Principles (E)Working Group, Oct. 18, 2010, at page 10-79: “ e. Agenda Item 2010-12 “ (The Sponsor said) .. there is one category for issuer obligations that are issued by a corporation and anything that is

securitized is subject to SSAP No. 43R … originally, SSAP No. 43R listed several securities as an example and was not intended to be an exhaustive listing … (In response a speaker) … stated that there is a continuum of security types for fixed-income securities from simple (cash flows obtained

from a single source) to complex (cash flows obtained from multiple sources). Valuation is based on the differences between these security types …

requiring fixed-income securities with single source cash flows to be subject to the guidance in SSAP No. 43R would require accounting based on cash flows that is not consistent with these securities … (The sponsor of the amendment said) … issuer obligations are subject to SSAP No. 26 and all

other single or multiple source fixed income securities are subject to SSAP No. 43R … Mr. … stated that he respectfully disagrees … SSAP No. 43R

provides guidance for securities with multiple sources of cash inflows, where the default of one of those sources of cash inflows does not result in the default of the entire security … SSAP No. 26 is aligned with a security with a single obligor and the assessment of the cash flows of that security is

based on the ability of that single obligor to continue payments … he disagreed … that SSAP No. 26 is to be applied to the simplest form of fixed-

income securities and that SSAP No. 43R is applicable to all others … (The sponsor said) … he failed to see the difference between the direct and indirect obligations from single or multiple sources of cash flows … When a trust is involved in issuing a fixed-income security, the credit of the

corporation cannot be considered. It is the assets of the trust and other trust cash flows. Upon default, recourse is subject only to the assets of the trust

and not the source of cash flows … ”

NAIC Proceedings – Fall 2010 at page 10 – 94 -95. “… When the NAIC originally drafted the definitions for SSAP 26 and SSAP 43R … almost all

securities falling under the guise of loan-backed and structured securities consisted of pools of mortgage assets, tranched or nontranched, and there

was clear delineation between corporate bonds and structured assets. … trust structures were primarily utilized for mortgage-backed securities; however, in today’s market … (i)nstruments with radically different sources of cash flows and risk characteristics utilize trust structures … A single

debtor equipment trust certificate (ETC) is more akin to a corporate bond than an ABS backed by a pool of disparate equipment leases. The mere fact

that all may be issued via a trust structure should not imply they are similar instruments, … From a credit risk and solvency perspective, it makes sense to focus on the source of cash flows to the insurer rather than a feature such as the legal form of the asset. The accounting and analysis required

for SSAP 43R securities is designed to capture the risk posed by a pool of assets where the cash flows are derived from more than one debtor …

Hence, the guidance in SSAP 43R focuses on cash flow analysis of the underlying pool … this would be the incorrect analysis for a CTL or an ETC, where the focus should be on the ability of the single debtor (i.e. lessee) to continue the payments that underlie the cash flows. That analysis,

obviously, is almost identical to that of a corporate bond. …”

o 2011 letter entitled Definition of Loan-backed and Structured Securities Included in Statement of Statutory Accounting Principles No. 43 –

Revised, Loan-backed and Structured Securities (Attachment One-A to the Accounting Practices and Procedures Task Force 9/8/11 and the letter

dated Aug. 28, 2012, of the same title in … o For the impact of the 2010 amendments on the pricing and credit assessment of securities presented to the Valuation of Securities (E) Task Force,

see NAIC Proceedings – Summer 2011 at page 10-191; 10-531.

o Paul Severn, Managing Director, SunTrust Robinson Humphrey o Jonathan Olick, Duane Morris, LLP

o Patrick Durkin, Managing Director, Barclays Capital

o Jones Lang LaSalle, William J. Cavagnaro and G. Brion Haist, Executive Directors o CTL Securities LLC, John Inglesby, Managing Director

o CGA Capital, W. Kyle Gore, Managing Director

o G2 Investment Group, B. Scott Best, Managing Director o Mesirow Financial, Stephen D. Jacobson, Senior Managing Director

o Federal Funding Group, LLC , Thomas P. Zarrilli, Managing Director

o Dechert LLP, Lewis A. Burleigh o Parkland Financial Advisors, Nicolas J. Muzychak

o Chapman & Cutler, LLP, James R. Nelosn and David J. LaSota, Esq.

Also 10-565; 10-1287; 10-1296; 10-1315.

Attachment C

Attachment D Ref #2016-41



Form A

Issue: AVR and IMR in SSSAP No. 26 Check (applicable entity): P/C Life Health


Description of Issue: In reviewing the asset valuation reserve (AVR) and the interest maintenance reserve (IMR) guidance included within SSAP No. 26—Bonds, as part of the Investment Classification Project, NAIC staff identified potential inconsistencies with the existing AVR/IMR guidance in the SSAP and the AVR/IMR guidance in the annual statement instructions. Furthermore, NAIC staff has also identified possible interpretation differences on how the other-than-temporary impairment (OTTI) guidance is being applied. Although these questions were identified when developing the issue paper proposing revisions to SSAP No. 26 under the Investment Classification Project, this AVR/IMR discussion is proposed to be addressed as a separate agenda item, with subsequent updating of the SSAP No. 26 issue paper, if needed, based on whether revisions are proposed to SSAP No. 26. Overview: From preliminary information obtained, guidance in the annual statement instructions may be given higher priority than the SSAP No. 26 guidance for the allocation of gains and losses between AVR and IMR when an OTTI has been recognized. This has been particularly noted in situations in which there was a more-than-one designation change and/or the investment had an NAIC 6 designation. In these situations, reporting entities may be taking the entire realized loss to AVR (or IMR), rather than dividing between credit-related OTTI (AVR) and interest-related OTTI (IMR) as required in SSAP No. 26, paragraph 12.

Prior SAPWG Discussion - An agenda item was presented in 2010 (Ref # 2010-16), in response to a referral from the Rating Agency (E) Working Group, which proposed to incorporate guidance for AVR/IMR allocation directly into the SSAPs (instead of the A/S instructions). This referral requested the Statutory Accounting Principles (E) Working Group (SAPWG) to analyze whether it is appropriate to continue to use changes in NAIC designations to determine if realized capital gains and losses are to be classified as interest rate gains or losses. Although the agenda item recommended revisions to incorporate AVR/IMR guidance within the SSAPs, this agenda item was disposed without revisions; with a SAPWG referral response indicating that the bifurcation between the asset valuation reserve (AVR) and the interest maintenance reserve (IMR) did not present a solvency concern. In the referral response, it was noted that research regarding the existing approach to bifurcate between the two reserves, as well as research into possible different bifurcation methods was not proposed by the SAPWG unless a specific issue was identified. This SAPWG referral response also identified that SSAP No. 43R—Loan-Backed and Structured Securities had guidance requiring bifurcation between AVR and IMR based on interest and non-interest factors, but noted that this guidance was specific to SSAP No. 43R, as a cash flow analysis for determining interest and non-interest declines is a key component of that SSAP for recognizing impairment. Although this statement regarding SSAP No. 43R was accurate at the time of the referral response, bifurcation of OTTI losses between AVR/IMR is no longer specific to SSAP No. 43R, and is included in SSAP No. 26, paragraph 12. Inclusion of the AVR/IMR OTTI bifurcation in SSAP No. 26 occurred with the adoption of agenda item 2010-18, on November 29, 2010. Agenda item 2010-18 superseded SSAP No. 99—Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment, and incorporated guidance from that SSAP into SSAP No. 26, SSAP No. 32 and SSAP No. 34. The explicit AVR/IMR guidance from SSAP No. 26 and the annual statement instructions is included below under “authoritative literature.” However, for ease of reference, key excerpts are duplicated below:



SSAP No. 26:

• Realized capital gains and losses from the sale of bonds - follow SSAP No. 7 (Annual Statement instructions).

• Unrealized capital gains and losses - follow SSAP No. 7 (Annual Statement instructions).

• Credit related other-than-temporary impairment (OTTI) shall be recorded as AVR and Interest-related OTTI shall be recorded as IMR (SSAP No. 26, paragraph 12).

o In addition to recognizing OTTI when it is probable a reporting entity will be unable to collect all contractual amounts due, SSAP No. 26 requires OTTI recognition when a reporting entity has made a decision to sell a security prior to its maturity at an amount below its carrying value.

AVR / IMR Annual Statement Instructions – Debt Securities:

• IMR – Include realized capital gains/losses for debt securities whose designation at the end of the holding period is not different from the NAIC designation at the beginning of the period by more than one designation. Realized gains or losses for any debt security with an NAIC 6 designation at any time is excluded from IMR.

• AVR - Include all realized capital gains/losses for debt securities whose designation at the end of the holding period is different from the NAIC designation at the beginning of the period by more than one designation. Realized gains or losses for any debt security with an NAIC 6 designation at any time is included in AVR.

• Although guidance is also included in the AVR instructions to require divisions between AVR and IMR for OTTI based on credit and interest related factors, this is contradictory to the guidance in the IMR instructions. The IMR instructions indicate that realized capital gains/losses must be classified as either interest (IMR) or credit (AVR) related, and not a combination except as specified in SSAP No. 43R. (This guidance is also inconsistent with SSAP No. 26, paragraph 12, as that guidance requires bifurcation with an OTTI.)

Existing Authoritative Literature: SSAP No. 26—Bonds

12. An other-than-temporary(INT 06-07) impairment shall be considered to have occurred if it is probable that the reporting entity will be unable to collect all amounts due according to the contractual terms of a debt security in effect at the date of acquisition. A decline in fair value which is other-than-temporary includes situations where a reporting entity has made a decision to sell a security prior to its maturity at an amount below its carrying value. If it is determined that a decline in the fair value of a bond is other-than-temporary, an impairment loss shall be recognized as a realized loss equal to the entire difference between the bond’s carrying value and its fair value at the balance sheet date of the reporting period for which the assessment is made. The measurement of the impairment loss shall not include partial recoveries of fair value subsequent to the balance sheet date. For reporting entities required to maintain an AVR/IMR, the accounting for the entire amount of the realized capital loss shall be in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve. Credit related other-than-temporary impairment losses shall be recorded through the AVR; interest related other-than-temporary impairment losses shall be recorded through the IMR.



SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve 2. Life and accident and health insurance companies shall recognize liabilities for an AVR and an IMR. The AVR is intended to establish a reserve to offset potential credit-related investment losses on all invested asset categories excluding cash, policy loans, premium notes, collateral notes and income receivable. The IMR defers recognition of the realized capital gains and losses resulting from changes in the general level of interest rates. These gains and losses shall be amortized into investment income over the expected remaining life of the investments sold. The IMR also applies to certain liability gains/losses related to changes in interest rates. These gains and losses shall be amortized into investment income over the expected remaining life of the liability released.

3. The IMR and AVR shall be calculated and reported as determined per guidance in the SSAP for the specific type of investment (e.g. SSAP No. 43R for loan-backed and structured securities), or if not specifically stated in the respective SSAP, in accordance with the NAIC Annual Statement Instructions for Life and Accident and Health Insurance Companies.

IMR Annual Statement Instructions

Line 2 – Current Year’s Realized Pre-tax Capital Gains/(Losses) of $______ Transferred into the Reserve Net of Taxes of $______

Include interest-rate related realized capital gains/(losses), net of capital gains tax thereon. All realized capital gains/(losses) transferred to the IMR are net of capital gains taxes thereon. Exclude credit related (default) realized capital gains and losses, realized capital gains/(losses) on equity investments, and unrealized capital gains/(losses).

All realized capital gains/(losses), due to interest rate changes on fixed income investments, net of related capital gains tax, should be captured in the IMR and amortized into income (Column 2, Lines 1 through 31) according to Table 1 or the seriatim method. Realized capital gains/(losses) must be classified as either interest (IMR) or credit (AVR) related, not a combination except as specified in SSAP No. 43R—Loan-Backed and Structured Securities. Purchase lots with the same CUSIP are treated as individual assets for IMR and AVR purposes.

Exclude those capital gains and losses that, in accordance with contract terms have been used to directly increase or decrease contract benefit payments or reserves during the reporting period. The purpose of this exclusion is to avoid the duplicate utilization of such gains and losses.

Capital gains tax should be determined using the method developed by the company to allocate taxes used for statutory financial reporting purposes. By capturing the realized capital gains/(losses) net of tax, the capital gains tax associated with those capital gains/(losses) due to an interest rate change is charged or credited to the IMR and amortized in proportion to the before-tax amortization.

Include realized capital gains/(losses) on:

Debt securities (excluding loan-backed and structured securities) and preferred stocks whose National Association of Insurance Commissioners (NAIC)/Securities Valuation Office (SVO) designation at the end of the holding period is NOT different from its NAIC designation at the beginning of the holding period by more than one NAIC designation. Exclude any such gains/(losses) exempt from the IMR.

Bond Mutual Funds – as Identified by the SVO. Include any capital gains/(losses) realized by the Company, whether from sale of the Fund or capital gains distributions by the Fund. If, during the course of the year, the SVO removes the designation of “NAIC 1” from a Bond Mutual Fund – as Identified by the SVO, the company shall not report capital gains/(losses) in



this schedule. Any such removal of the “NAIC 1” designation will cause the Fund to be reported as common stock on the applicable schedules.

Called bonds, tendered bonds, and sinking fund payments.

Mortgage loans where:

• Interest is NOT more than 90 days past due, or

• The loan is NOT in process of foreclosure, or

• The loan is NOT in course of voluntary conveyance, or

• The terms of the loan have NOT been restructured during the prior two years.

Mortgage loan prepayment penalties are not included in IMR. Treat them as regular investment income.

Interest-related gains/(losses) realized on directly held capital and surplus notes reported on Schedule BA should be transferred to the IMR in the same manner as similar gains and losses on fixed income assets held on Schedule D. A capital gain/(loss) on such a note is classified as an interest rate gain if the note is eligible for amortized-value accounting at both the time of acquisition and the time of disposition.

Determination of IMR gain/(loss) on multiple lots of the same securities should follow the underlying accounting treatment in determining the gain/(loss). Thus, the designation, on a purchase lot basis, should be compared to the designation at the end of the holding period to determine IMR or AVR gain or loss.

Realized capital gains/(losses) on any debt security (excluding loan-backed and structured securities) that has had an NAIC/SVO designation of 6 at any time during the holding period should be excluded from the IMR and included as a credit related gain/(loss) in the Asset Valuation Reserve (AVR).

Realized capital gains/(losses) on any preferred stock that had an NAIC/SVO designation of RP4, RP5 or RP6 or P4, P5 or P6 at any time during the holding period should be reported as credit related gains/(losses) in the AVR.

The holding period for debt securities (excluding loan-backed and structured securities) and preferred stocks is defined as the period from the date of purchase to the date of sale. For the end of period classification, the most recent available designation should be used. For bonds acquired before January 1, 1991, the holding period is presumed to have begun on December 31, 1990. For preferred stocks acquired before January 1, 1993, the holding period is presumed to have begun on December 31, 1992. For Bond Mutual Fund – as Identified by the SVO, the holding period is defined as one calendar year to expected maturity.

Where the gain on a convertible bond or preferred stock sold while “in the money” is included in the IMR; the expected maturity date is defined as the next conversion date. “In the money” is defined to mean that the number of shares available currently or at next conversion date, multiplied by their current market price, is greater than the book/adjusted carrying value of the convertible asset. However, for a convertible bond or convertible preferred stock purchased while its conversion value exceeds its par value, any gain or loss realized from its sale before conversion must be excluded from the IMR and included in the AVR. Conversion value is defined to mean the number of shares available currently or at next conversion date, multiplied by the stock’s current market price.



Other-than-temporary impairments taken on “interest-related” declines in value that are only required to be impaired in accordance with INT 06-07: Definition of Phrase “Other-Than-Temporary” because management no longer has the intent and ability to retain the investment in the issuer for a period of time sufficient to allow for recovery in value. Credit-related other-than-temporary impairment losses shall be recorded through the Asset Valuation Reserve. In accordance with SSAP No. 43R—Loan-Backed and Structured Securities, for loan-backed and structured securities only, if the reporting entity wrote the loan backed or structured security down to fair value due to the intent to sell or does not have the intent and ability to retain the investment in the security for a period of time sufficient to recover the amortized cost basis, the non-interest-related portion of the other-than-temporary impairment losses shall be recorded through the AVR; the interest-related other-than-temporary impairment losses shall be recorded through the IMR.

For derivative instruments used in hedging transactions, the determination of whether the capital gains/(losses) are allocable to the IMR or the AVR is based on how the underlying asset is treated. Realized gains/(losses) on portfolio or general hedging instruments should be included with the hedged asset. Gains/(losses) on hedges used, as specific hedges should be included only if the specific hedged asset is sold or disposed of.

For income generation derivative transactions, the determination of whether the capital gains/(losses) are allocable to the IMR or the AVR is based on how the underlying interest (for a put) or covering asset (for a call, cap or floor) is treated. Realized gains/(losses) should be included in the same sub-component where the realized gains/(losses) of the underlying interest (for a put) or covering asset (for a call, cap or floor) is reported. For a more complete and detailed explanation, refer to SSAP No. 86—Derivatives for accounting guidance.

Realized gains/(losses), on derivative transactions entered into solely for the purpose of altering the interest rate characteristics of the company’s assets and/or liabilities (hedging transactions) should be allocated to the IMR and amortized over the life of the hedged assets. Realized gains/(losses), on income generation derivative transactions where the underlying interest (put) or covering asset (call, cap or floor) is subject to IMR, should be allocated to the IMR and amortized over the remaining life of the:

a. underlying interest for a put

b. covering asset for a call

c. derivative contract for a cap or floor

Capital gains/(losses) associated with the cash components of a replication (synthetic asset) transaction should be categorized as interest-rate related or credit related and as to sub-component within the Asset Valuation Reserve as they would be in the absence of the replication (synthetic asset) transaction.

Capital gains/(losses), other than those arising at the time of counterparty default, on the derivative component of a replication (synthetic asset) transaction that is not a swap of prospectively-determined interest rates should be categorized as interest-rate related or credit related and as to sub-component within the Asset Valuation Reserve as if they were gains and losses on the replicated (synthetic) asset(s).

Capital gains/(losses) arising from counterparty default or the curing of a previous counterparty default should be separately identified and credited or charged to the bond and preferred stock component of the Asset Valuation Reserve.

Interest-rate related gains/(losses) associated with the cash component of a replication (synthetic asset) transaction should be amortized in the same manner as they would be in the absence of the replication (synthetic asset) transaction.



Interest-rate related gains/(losses) associated with the derivative component of a replication (synthetic asset) transaction that is not a swap of prospectively determined interest rates should be amortized as if they arose from the replicated asset.

Realized capital gains/(losses) arising from a swap of prospectively-determined interest rates constituting a component of a replication (synthetic asset) transaction should be credited or charged to the Interest Maintenance Reserve using the maturity bucket corresponding to the side of the transaction with the longest interest rate guarantee period.

Gains/(losses) on dollar repurchase agreements that are traded for the fee have no IMR (or AVR) impact because they are treated as financing.

The total dollar value of these IMR realized capital gains and (losses), net of capital gains tax will be excluded from the realized gains/(losses) reported on Page 4, Line 34 in the general account.

In the Separate Accounts Statement, the total dollar value of these IMR realized capital gains/(losses), net of capital gains tax will be excluded from the realized gains/(losses) reported on Page 4, Line 3.

By capturing the realized capital gains/(losses), net of tax, the capital gains tax associated with those capital gains/(losses) due to an interest rate change is charged or credited to the IMR and amortized in proportion to the before-tax amortization.

AVR Annual Statement Instructions

Line 2 – Realized Capital Gains/(Losses) Net of Taxes – General Account

Report all realized credit-related (default) and equity capital gains/(losses), net of capital gains tax, applicable to the assets in each component and sub-component. All realized capital gains/(losses) transferred to the AVR are net of capital gains taxes thereon. Exclude all interest rate-related capital gains/(losses) from the AVR.

Capital gains tax should be determined using the method developed by the company to allocate taxes used for statutory financial reporting purposes.

Report all realized capital gains/(losses), net of capital gains tax, on each debt security (excluding loan-backed and structured securities) whose NAIC/SVO designation at the end of the holding period is different from its NAIC/SVO designation at the beginning of the holding period by more than one NAIC/SVO designation. The holding period is defined as the period from the date of purchase to the date of sale. For end of period classification, the most recent available designation should be used. For bonds acquired before January 1, 1991, the holding period is presumed to have begun on December 31, 1990.

Determination of AVR gain/(loss) on multiple lots of the same fixed income securities should follow the underlying accounting treatment in determining gain/(loss). Thus, the designation, on a purchase lot basis, should be compared to the designation at the end of the holding period to determine IMR or AVR gain or loss. Other-than-temporary impairment write-downs are treated as credit-related (losses) and recorded through the AVR, except for other-than-temporary impairments taken on interest-related declines in value, as described in INT 06-07, Definition of Phrase “Other-Than-Temporary.” Interest-related other-than-temporary impairments are treated as interest-related losses and recorded through the IMR.

In accordance with SSAP No. 43R—Loan-Backed and Structured Securities, for loan-backed and structured securities only, if the reporting entity wrote the security down to fair value due to the intent to sell or does not have the intent and ability to retain the investment in the



security for a period of time sufficient to recover the amortized cost basis, the non-interest-related portion of the other-than-temporary impairment losses shall be recorded through the AVR; the interest-related other-than-temporary impairment losses shall be recorded through the IMR.

In addition, all gains/(losses), net of capital gains tax, on mortgage loans where:

• Interest is more than 90 days past due, or

• The loan is in the process of foreclosure, or

• The loan is in course of voluntary conveyance, or

• The terms of the loan have been restructured during the prior two years

Would be classified as credit-related gains/(losses).

The gain/(loss), net of capital gains tax, on any debt security (excluding loan-backed and structured securities) that has had an NAIC/SVO designation of “6” at any time during the holding period should be reported as a credit related gain/(loss).

All capital gains/(losses), net of capital gains tax, from preferred stock that had an NAIC/SVO designation of RP4, RP5 or RP6 or P4, P5 or P6 at any time during the holding period should be reported as credit related gains/(losses) in the AVR.

However, for a convertible bond or preferred stock purchased while its conversion value exceeds its par value, any gain/(loss) realized from its sale before conversion must be included in the Equity Component of the AVR. Conversion Value is defined to mean the number of shares available currently or at next conversion date multiplied by the stock’s current market price.

Report all realized equity capital gains/(losses), net of capital gains tax, in the appropriate sub-components.

For derivative instruments used in hedging transactions, the determination of whether the capital gains/(losses) are allocable to the IMR or the AVR is based on how the underlying asset is treated. Realized gains/(losses), net of capital gains tax, on portfolio or general hedging instruments should be included with the hedged asset. Gains/(losses), net of capital gains tax, on hedges used, as specific hedges should be included only if the specific hedged asset is sold or disposed of.

For income generation derivative transactions, the determination of whether the capital gains/(losses) are allocable to the IMR or the AVR is based on how the underlying interest (for a put) or covering asset (for a call, cap or floor) is treated. Realized gains/(losses), net of capital gains tax should be included in the same sub-component where the realized gains/(losses) of the underlying interest (for a put) or covering asset (for a call, cap or floor) is reported. Refer to SSAP No. 86—Derivatives for accounting guidance.

Realized gains/(losses), net of capital gains tax, resulting from the sale of U.S. government securities and the direct or guaranteed securities of agencies which are backed by the full faith and credit of the U.S. government are exempt from the AVR. This category is described in the Investment Schedules General Instructions.

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): If revisions are proposed to SSAP No. 26 to clarify the accounting/reporting of AVR/IMR, staff would recommend that these revisions be incorporated into the issue paper detailing substantive revisions to SSAP No. 26 as part of the Investment Classification Project (Agenda Item 2013-36).



Previous agenda items addressing this topic:

1. Agenda Item 2010-18: Agenda item 2010-18 superseded SSAP No. 99—Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment, and incorporated guidance from that SSAP into SSAP No. 26, SSAP No. 32 and SSAP No. 34. These revisions resulted with SSAP No. 26 guidance instructing the AVR/IMR bifurcation as a result of OTTI, so that credit losses from OTTI shall be recorded through AVR, and interest-related OTTI losses shall be recorded in IMR.

2. Agenda Item 2010-06: Agenda item 2010-16 was drafted in response to an April 2010 referral received from the Rating Agency (E) Working Group and the Financial Condition (E) Committee. This referral requested the Statutory Accounting Principles Working Group to analyze whether it is appropriate to continue using changes in NAIC designations to determine if realized capital gains or losses are to be classified as interest rate gains or losses. The referral requested that the NAIC examine whether the proxy of using NAIC designations has worked well and whether other analytical benchmarks can be identified that have a more natural connection to changes in the general level of interest rates. On November 3, 2011, the Working Group adopted a referral response to the Rating Agency Working Group and the Financial Condition (E) Committee to advise that research to further assess the allocation of realized gains and losses to the asset valuation reserve (AVR) and the interest maintenance reserve (IMR) will not have a material solvency or accounting issue impact. The Working Group also agreed to move this item to the disposed listing.

Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): N/A Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, initially classified as substantive, and expose this agenda item requesting regulators and industry to provide information on the current practices of allocating gains and losses between AVR/IMR, as well as information on the recognition of OTTI (and division between AVR/IMR) if the security is sold in the same reporting period in which the OTTI is first identified. In order to move forward with understanding current practice / regulator interpretations, prior to drafting proposed revisions, staff requests comments on the following scenarios and identified situations:

1) Recognized OTTI for Security with NAIC 6 Designation – SSAP No. 26 requires OTTI bifurcation between AVR and IMR, whereas A/S instructions indicate AVR allocation.

2) Impaired Security Sold for Realized Loss (In the Same Reporting Timeframe as the Decision to Sell) with No NAIC Designation Change – SSAP No. 26 requires OTTI recognition when a decision to sell has occurred prior to maturity at an amount below its carrying value. As such, is this security recognized as OTTI, with the realized loss bifurcated between AVR and IMR per SSAP No. 26, or is this security sold at realized loss, without recognition of OTTI, with the loss recognized directly to IMR?

3) Impaired Security Sold (In the Same Reporting Timeframe as the Decision to Sell) with a Two NAIC Designation Change – SSAP No. 26 requires OTTI recognition when a decision to sell has occurred prior to maturity prior to maturity at an amount below its carrying value. As such, is this security recognized an OTTI, with realized loss bifurcated between AVR and IMR, or is this security sold at realized loss, without OTTI, with the loss recognized directly to AVR?

4) Sold OTTI Securities before Maturity for less than Carrying Value – From preliminary review, there are situations in which a “Current Year OTTI” is shown on Schedule D – Part 4; however, there are many



more instances in which the security is sold prior to maturity, at an amount below the carrying value, when there is no recognition of OTTI. As such, it appears that reporting entities may not be recognizing OTTI if the security is sold in the same reporting timeframe in which the OTTI would initially be required. Comments are requested regarding industry practice in recognizing OTTI in these situations, and whether regulators believe that identifying these situations on Schedule D-4 (under “Current Year OTTI”) would be beneficial for regulator purposes.

• Under current guidance in SSAP No. 26, paragraph 12, if there is an OTTI, bifurcation

between AVR and IMR based on credit and interest factors is required. If securities are sold, without the reflection of OTTI, this bifurcation may not be occurring.

• With the exception of bifurcating the OTTI loss between AVR/IMR, the recognition of the realized loss (either as a sale or as OTTI) is reported on the same line in the financial statements - Net Realized Capital Gains/Losses.

(Staff requests comments from regulators as to whether a review of sold investments to identify whether they were recognized as OTTI is something that is considered beneficial as part of a regulatory review, perhaps to assess the quality of investments / investment decisions overtime.)

5) Negative OTTI on Schedule D – Part 4 – There have been identified instances in which the “Current Year OTTI” is reported as a negative number (rather than a positive number), and has increased the disposal date BACV. Comments are requested on the situations in which this reporting would occur. (Staff notes that it has been observed in schedules where other OTTIs are reported correctly.)

Staff Review Completed by: Julie Gann - NAIC Staff, October 2016 G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\D - 16-41 - AVR IMR - SSAP No. 26.docx

Attachment E Ref #2016-42



Form A

Issue: Appendix C Introduction Check (applicable entity): P/C Life Health


Description of Issue: This agenda item recommends updates to the introduction page of Appendix C - Actuarial Guidelines in the Accounting Practices and Procedures Manual to promote consistent application of the Actuarial Guidelines. The proposed revisions add language noting that various Statements of Statutory Accounting Principles (SSAPs) incorporate the Actuarial Guidelines by reference into the accounting standard. Additionally, the updates provide information regarding the applicability of actuarial guidelines after the operative date of the Valuation Manual (1/1/2017). Existing Authoritative Literature: The title page of Appendix C currently includes:

Introduction The NAIC Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force, formerly known as the Life and Health Actuarial Task Force, have been asked on many occasions to assist a particular state insurance department in interpreting a statute dealing with an actuarial topic relative to an unusual policy form or situation not contemplated at the time of original drafting of a particular statute. The Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force, in developing an interpretation or guideline, must often consider the intent of the statute, the reasons for initially adopting the statute and the current situation. The Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force feel that for those situations which are sufficiently common to all states, that the publishing of actuarial guidelines on these topics would be beneficial to the regulatory officials in each state and would promote uniformity in regulation, which is beneficial to everyone. To this end, the Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force have developed certain actuarial guidelines and will continue to do so as the need arises. The guidelines are not intended to be viewed as statutory revisions but merely a guide to be used in applying a statute to a specific circumstance.

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): Agenda item 2014-22: Health Actuarial Guideline XLVII previously updated the Appendix C introduction to be consistent with the separation of the Life and Health Actuarial (A&B) Task Force into the Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force. Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): Not applicable Staff Review Completed by: Robin Marcotte, NAIC Staff October 2016

Attachment E Ref #2016-42


Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, categorized as nonsubstantive and expose revisions to the introduction section of Appendix C – Actuarial Guidelines of the Accounting Practices and Procedures Manual.

Introduction The NAIC Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force, formerly known as the Life and Health Actuarial Task Force, have been asked on many occasions to assist a particular state insurance department in interpreting a statute dealing with an actuarial topic relative to an unusual policy form or situation not contemplated at the time of original drafting of a particular statute. The Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force, in developing an interpretation or guideline, must often consider the intent of the statute, the reasons for initially adopting the statute and the current situation. The Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force feel that for those situations which are sufficiently common to all states, that the publishing of actuarial guidelines on these topics would be beneficial to the regulatory officials in each state and would promote uniformity in regulation, which is beneficial to everyone. To this end, the Life Actuarial (A) Task Force and the Health Actuarial (B) Task Force have developed certain actuarial guidelines and will continue to do so as the need arises. The guidelines are not intended to be viewed as legislative statutory revisions but merely a guideance to be used in applying a statute to a specific circumstance. Various statements of statutory accounting principles (SSAPs) reference applicable actuarial guidelines in this appendix, which thereby incorporates the actuarial guidelines into the accounting standard. To the extent a reporting entity departs from the actuarial guideline, the difference should be disclosed as a prescribed or permitted practice in in accordance with SSAP No. 1—Accounting Policies, Risks & Uncertainties, and Other Disclosures While the Valuation Manual is expected to reduce the need for future actuarial guidelines, it should be noted that actuarial guidelines will continue to be required for interpretations of statues governing valuation of policies issued prior to the January 1, 2017 operative date of the Valuation Manual, for interpretations of statues governing valuation of policies issued after the operative date of the Valuation Manual that are not subject to a principle-based valuation and for non-valuation related interpretive guidance.

G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\E - 16-42 - appendix C intro .docx

Attachment F Ref #2016-43



Form A

Issue: Inflation Indexed Securities Check (applicable entity): P/C Life Health


Description of Issue: In addition to being in-scope of SSAP No. 26—Bonds, inflation-indexed securities backed by the full faith and credit of the United States government are provided additional accounting guidance, as detailed in INT 01-25: Accounting for U.S. Treasury Inflation-Indexed Securities. As detailed in INT 01-25, Treasury inflation-indexed securities are direct obligations of the United States government, and are backed by the full faith and credit of the government. The principal is protected against inflation as the security is indexed to the Consumer Price Index and grows with inflation. Therefore, the investor is guaranteed that the real purchasing power of the principal will keep pace with the rate of inflation. Although deflation could cause the principal to decline, Treasury will pay at maturity an amount that is no less than the par amount as of the date the security was first issued. Per INT 01-25, inflation-indexed securities are accounted for as follows:

• Premiums paid for the security should be amortized over the remaining life of the security.

• The reporting entity should record the unrealized gain/loss based on the difference in the inflation factor times the par amount, and amortize the premium over the remaining life of the security.

• Inflation adjustment should be recognized as an unrealized gain until such time as it is paid, at which time it should be recognized as a realized gain. If there is a deflation adjustment, such amounts should only be recognized to the extent the inflation factor is not reduced to an amount less than 1.0000 as the investor is guaranteed at maturity to receive at least the par amount of the security.

NAIC staff has received questions regarding whether foreign inflation-indexed securities, such as the United Kingdom’s Index-Linked Gilt, should be allowed to follow the guidance in INT 01-25, since these securities are also backed by the full faith and credit of their respective foreign government. Existing Authoritative Literature: INT 01-25: Accounting for U.S. Treasury Inflation-Indexed Securities (See Exhibit A) SSAP No. 26—Bonds:

2. Bonds shall be defined as any securities representing a creditor relationship, whereby there is a fixed schedule for one or more future payments. This definition includes:

a. U.S. Treasury securities,(INT 01-25) Purposes and Procedures Manual of the NAIC Investment Analysis Office: Part Two, Section 10. Reporting Conventions and Required Documents

(vi) Foreign Sovereign Government and Supranational Entities A reporting insurance company that owns a security issued by a foreign sovereign government, an agency or political subdivision of a foreign sovereign government or a supranational entity (entities with



more than one sovereign government as a member), or that is guaranteed directly or indirectly by such an entity, must file such security with the SVO accompanied by a prospectus, investment committee memorandum and proof of rating from an NAIC CRP unless it is filing exempt as defined in Section 4 (d) of this Part above. Insurance companies shall not file issues with the SVO if the issuer does not have a sovereign rating from an NAIC CRP. If the issuer is not rated by an NAIC CRP, proof of a guarantee from an NAIC CRP-rated foreign sovereign government may be submitted. See Part Three, Section 1(a)(ii)(B) of this Manual for instructions for issuers with unaudited financial statements.

Purposes and Procedures Manual of the NAIC Investment Analysis Office: Part Three, Section 1 (a) (D) (1) – (4)

(D) Foreign Securities (1) Where a reporting insurance company has filed a foreign security accompanied by an Audited Financial Statement, in English, the SVO will assess the security in accordance with the applicable corporate methodology, but the NAIC Designation it may assign shall be limited by the sovereign rating of the issuer's country of origin. This section should not be read as prohibiting the presentation of transactions structured to eliminate foreign sovereign risk.

(2) For a security issued by a company domiciled in a country with no NAIC CRP sovereign rating, the SVO shall be limited to assigning the security an NAIC 5* Designation and such Designation shall only be assigned if the following conditions are met:

(a) the SVO has received a signed statement by a qualified officer of the reporting insurance company certifying that the issuer is current on its contracted principal and interest payments and

(b) for securities neither issued by nor guaranteed by a foreign sovereign government, the SVO has received:

(i) a copy of the most recent covenant compliance certificate detailing the issuer's compliance with various financial coverage ratios and other terms of the transaction,

(ii) a signed statement from a qualified officer of the reporting insurance company with regard to the insurer's expectation as to the issuer's ability to meet the established financial covenants during the next twelve months and

(iii) a statement of the insurer or other acceptable evidence, that the governmental entity charged with monetary policy has not and is unlikely to adopt, legislation, rules, regulations or foreign exchange controls that would prohibit the issuer from remitting funds to the insurer to meet the obligations represented by the reported security.

If the insurance company is unable to provide the SVO with the information set forth above, the security should be reported with an NAIC 6* Designation.

(3) The insurance company must file all foreign securities for which the information required by this Manual is available. For those foreign securities held by a “Sub-paragraph D Company” as defined below, where the required information is not available for the SVO to value the security, the NAIC Designation may be determined by the reporting insurance company. This determination shall carry an F suffix. In no case shall the NAIC Designation exceed the sovereign rating of the issuer's country of origin. The company shall provide its domestic regulator with a description of the procedure it used to evaluate and assign ratings to these foreign securities. In addition, the company shall retain the documentation supporting each designation assigned by it until the next domestic insurance department examination.



(4) “Sub-paragraph D Company” is defined as a domestic insurer which is holding foreign securities in support of its foreign liabilities and where the U.S. gross premiums of the company are no more than 20 % of its gross worldwide premiums or the amount of the company's gross reserves and other liabilities under contracts of insurance (for life insurers gross reserves and other liabilities shall be actuarial reserves and policyholder liabilities currently reported on page 3, lines 1 - 11 of the NAIC Financial Statement Blank, grossed up for reinsurance ceded; for property and casualty insurers gross reserves and other liabilities shall be loss reserves, loss adjustment expense reserves and unearned premium reserves reported on page 3, lines 1, 2 and 9 of the NAIC Financial Statement Blank, grossed up for reinsurance ceded) on lives or risks resident or located in the U.S. are no more than 20 % of its total gross reserves and other liabilities under contracts of insurance as reported on the company's last NAIC Financial Statement Blank.

The insurer must also maintain a trust fund in a qualified U.S. financial institution for the payment of the valid claims of its U.S. policyholders, their assigns and successors in interest. The trust shall consist of a trusteed account representing 103% of the company's gross reserves and other liabilities under contracts of insurance on lives or risks resident or located in the U.S. The assets of the trust shall maintain an NAIC Designation as assigned by the SVO and be valued at admitted values carried in the insurer's NAIC Financial Statement Blank. Such trust shall be established in a form approved by the insurer's domestic commissioner of insurance. The trust instrument shall provide that contested claims shall be valid and enforceable upon the final order of any court of competent jurisdiction in the U.S. and shall allow the right of substitution without diminution. The trust shall be subject to examination as determined by the insurer's domestic commissioner and the assets of the trust shall be reported in the insurer's NAIC Financial Statement Blank special deposit schedule. The trust shall remain in effect for as long as the insurer shall qualify as a “Sub-paragraph D Company” and have outstanding obligations under contracts of insurance on lives or risks resident or located in the U.S.

If a Company which previously qualified as a “Sub-paragraph D Company” no longer qualifies, any foreign securities held by such company which are not assigned an NAIC Designation by the SVO shall be assigned an NAIC Designation in accordance with the procedure set forth in sub-paragraph (B) above, Unaudited Financial Statements. These securities shall be reported by the company with a “Z” suffix for the reporting year and shall comply with the provisions of sub-paragraph (B) for subsequent reporting years.

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): The accounting for U.S. Treasury Inflation-Indexed Securities is addressed in INT 01-25. Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): N/A Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, categorized an nonsubstantive and expose revisions to INT 01-25: Accounting for U.S. Treasury Inflation-Indexed Securities as detailed below, which restricts foreign inflation-indexed securities from using the guidance in INT 01-25 and requires the security to follow the applicable SSAP without recognition of unrealized gains or losses based on the inflation factor. As part of this exposure, Staff is requesting specific input from industry on the volume of foreign inflation-indexed securities held by insurance reporting entities and whether they believe specific statutory accounting guidance should be developed for these securities. Further information on the filing and designation process for foreign securities is detailed with the P&P Manual, with the applicable sections included above under Existing Authoritative Literature. Staff Review Completed by: Josh Arpin, NAIC Staff - October 2016



2016 Fall National Meeting – Proposed Revisions to INT 01-25 Interpretation of the Emerging Accounting Issues (E) Working Group: INT 01-25: Accounting for U.S. Treasury Inflation-Indexed Securities 1. Treasury inflation-indexed securities are direct obligations of the United States government, and are backed by the full faith and credit of the government1. The principal is protected against inflation. Since the principal is indexed to the Consumer Price Index and grows with inflation, the investor is guaranteed that the real purchasing power of the principal will keep pace with the rate of inflation (Based on the Reference CPI-U, which has a three-month lag). Although deflation could cause the principal to decline, Treasury will pay at maturity an amount that is no less than the par amount as of the date the security was first issued.

New Footnote: The guidance prescribed within this interpretation is limited to treasury inflation-indexed securities backed by the full faith and credit of the United States Government. Inflation-indexed securities of foreign governments shall not follow the guidance within this interpretation and shall be accounted for and reported according to the applicable SSAP without adjustments for the inflation factor.

2. Interest is also protected from inflation. The investor will receive semiannual interest payments, based on a fixed semiannual interest rate applied to the inflation-adjusted principal, so that the investor is guaranteed a real rate of return above inflation.

Summary of the Structure and Index: Principal amount. The principal amount of Treasury inflation-indexed securities will be adjusted for changes in the level of inflation. The inflation-adjusted principal amount of the securities can be calculated daily. However, the inflation adjustment will not be payable by Treasury until maturity, when the securities will be redeemed at the greater of their inflation-adjusted principal amount or the principal amount of the securities on the date of original issuance (i.e., par).

Index. The index for measuring the inflation rate will be the nonseasonally adjusted CPI-U (U.S. City Average All Items Consumer Price Index for All Urban Consumers). CPI-U was selected by Treasury because it is the best known and most widely accepted measure of inflation.

Interest payments. Every six months Treasury will pay interest based on a fixed rate of interest determined at auction. Semiannual interest payments are determined by multiplying the inflation-adjusted principal amount by one-half the stated rate of interest on each interest payment date.

Payment at maturity. If at maturity the inflation-adjusted principal is less than the par amount of the security (due to deflation), the final payment of principal of the security by Treasury will not be less than the par amount of the security at issuance. In such a circumstance, Treasury will pay an additional amount at maturity so that the additional amount plus the inflation-adjusted principal amount will equal the par amount of the securities on the date of original issuance. Initially, the securities will be issued with a 10-year maturity; however, Treasury expects to issue other maturities over time.

Stripping. The securities will be eligible for the STRIPS program (Separate Trading of Registered Interest and Principal of Securities) as of the first issue date. Unlike the conventional STRIPS program, however, interest components stripped from different inflation-indexed securities, at least initially, will not be interchangeable or fungible with interest components from other securities, even if they have the same payment or maturity date.

3. The accounting issue is how should changes to inflation-adjusted principal be recorded? 4. At the September 10, 2002 and December 8, 2002 the Working Group expanded this interpretation to address specific questions regarding U.S. Treasury Inflation-Indexed Securities purchased at either a premium or discount and how the inflation adjustment interacts with any such premium or discount, as well as the calculation of each of these amounts.



5. The following example will be used to highlight issues concerning the amortization of premium and inflation adjustment for a typical security:

Assume: Par value of TIP security $500,000 Inflation factor at date of purchase 1.12075 Price at date of purchase 102.96875 Original issue date 6/30/X0 Purchase date 06/30/X6 Maturity date 06/30/X10 Amount of inflation adjustment at date of purchase ($500,000 * .12075) $60,375 Total purchase price ($500,000*1.12075*1.0296875) $577,011 Premium at date of purchase ($577,011 - $500,000 - $60,375) $16,636 6. The issues are:

Issue a. – If accretion or amortization should be recognized over the period of time the security is owned. Issue b. – Assuming that at the end of the accounting period, 12/31/X6, the inflation factor is 1.13000, what the correct book value of the security would be. Issue c. – Assuming that at the end of the accounting period, 12/31/X6, the inflation factor is 1.12000, what the correct value of the security would be. Issue d. – How changes in accounting treatment would be handled.

INT 01-25 Discussion 7. At its October 16, 2001 meeting, the Working Group reached a consensus that the inflation adjustment be recognized as an unrealized gain until such time as it is paid, at which time it should be recognized as a realized gain. If there is a deflation adjustment, such amounts should only be recognized to the extent of any previously recognized inflation adjustment for that particular security, (reduce any unrealized gain on that security to zero) as the investor is guaranteed at maturity to receive at least the par amount of the security. (See paragraph 8.c. below for amendments to this paragraph adopted at the December 8, 2002 meeting.) 8. At its December 8, 2002 meeting, the Working Group reached a consensus on the following issues related to the purchase of a treasury inflation-indexed security at either a premium or a discount, how the inflation adjustment interacts with any such premium or discount, as well as the calculation of each of these amounts.

Issue a. – The $16,636 premium paid for the security should be amortized over the remaining life of the security. Therefore, if the inflation adjustment factor never changed from the 1.12075 at date of purchase, the security would have a book value at maturity of $560,375, the amount the reporting entity would receive at maturity date ($500,000*1.12075). Issue b. – The reporting entity should record the unrealized gain/loss based on the difference in the inflation factor times the par amount, and amortize the premium over the remaining life of the security. Issue c. – In the case where the inflation factor is reduced to a factor not less than 1.0000, the reporting entity should reflect the change in the inflation adjustment as well as amortization of premium. Paragraph 7 of this interpretation is amended as follows:

7. The Working Group reached a consensus that the inflation adjustment be recognized as an unrealized gain until such time as it is paid, at which time it should be recognized as a realized gain. If there is a deflation adjustment, such amounts should only be recognized to the extent the inflation factor is not reduced to an amount less than 1.0000 as the investor is guaranteed at maturity to receive at least the par amount of the security.

Issue d. - A change in accounting principle should be recorded per the requirements of SSAP No. 3—Accounting Changes and Corrections of Errors, paragraph 5:



5. The cumulative effect of changes in accounting principles shall be reported as adjustments to unassigned funds (surplus) in the period of the change in accounting principle. The cumulative effect is the difference between the amount of capital and surplus at the beginning of the year and the amount of capital and surplus that would have been reported at that date if the new accounting principle had been applied retroactively for all prior periods.

In the specific question noted, if the reporting entity is currently recognizing both amortization of premium as well as the change in the inflation adjustment factor as amortization of premium, there should not be a cumulative effect on surplus to record.

INT 01-25 Status 9. No further discussion is planned.

10. On __________, the Working Group modified this interpretation, adding footnote 1 to clarify that the guidance within this interpretation is only applicable to Treasury inflation-indexed securities backed by the full faith and credit of the United States Government. G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\F - 16-43 - Inflation Indexed Securities.docx

Attachment G Ref #2016-44



Form A

Issue: Revisions to Appendix A-791 Check (applicable entity): P/C Life Health


Description of Issue: During a review of jurisdictions for accreditation, it was identified that the 1992 revisions to add Section 5(C) of the Life and Health Reinsurance Agreements Model Regulation (#791), which is a required element for accreditation, was not incorporated into Appendix A-791, Life and Health Reinsurance Agreements. Upon review of A-791, the guidance within paragraphs 4-5 is interpreted from the language in Section 5(A) and 5(B) of Model #791. As the context of paragraphs 4-5 (Written Agreements) is consistent with the language in Section 5 of Model #791, including the guidance in Section 5(C) of Model #791 to A-791 is appropriate. Existing Authoritative Literature: SSAP No. 62R—Property and Casualty Reinsurance contains similar language to Section 5(C) of Model #791:

8. In addition to credit for reinsurance requirements applicable to reinsurance transactions generally, no credit or deduction from liabilities shall be allowed by the ceding entity for reinsurance recoverable where the agreement was entered into after the effective date of these requirements (see paragraphs 108 and 109) unless each of the following conditions is satisfied:

c. The agreement shall constitute the entire contract between the parties and must provide no guarantee of profit, directly or indirectly, from the reinsurer to the ceding entity or from the ceding entity to the reinsurer;

Appendix A-791, Life and Health Reinsurance Agreements

Written Agreements 4. No reinsurance agreement or amendment to any agreement may be used to reduce any liability or to establish any asset in any financial statement, unless the agreement, amendment or a binding letter of intent has been duly executed by both parties no later than the “as of date” of the financial statement. 5. In the case of a letter of intent, a reinsurance agreement or an amendment to a reinsurance agreement must be executed within a reasonable period of time, not exceeding ninety (90) days from the execution date of the letter of intent, in order for credit to be granted for the reinsurance ceded. Life and Health Reinsurance Agreements Model Regulation (#791) Section 5. Written Agreements A. No reinsurance agreement or amendment to any agreement may be used to reduce any liability

or to establish any asset in any financial statement filed with the Department, unless the agreement, amendment or a binding letter of intent has been duly executed by both parties no later than the "as of date" of the financial statement.

B. In the case of a letter of intent, a reinsurance agreement or an amendment to a reinsurance

agreement must be executed within a reasonable period of time, not exceeding ninety (90) days

Attachment G Ref #2016-44


from the execution date of the letter of intent, in order for credit to be granted for the reinsurance ceded.

C. The reinsurance agreement shall contain provisions which provide that:

(1) The agreement shall constitute the entire agreement between the parties with respect to

the business being reinsured thereunder and that there are no understandings between the parties other than as expressed in the agreement; and

(2) Any change or modification to the agreement shall be null and void unless made by

amendment to the agreement and signed by both parties. Activity to Date (issues previously addressed by the Working Group, Emerging Accounting Issues (E) Working Group, SEC, FASB, other State Departments of Insurance or other NAIC groups): Agenda item 1999-12 adopted the Q&A section of A-791 in accordance with a recommendation from the Life Insurance and Annuities (A) Committee. Information or issues (included in Description of Issue) not previously contemplated by the Working Group: None Convergence with International Financial Reporting Standards (IFRS): N/A Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, categorized as nonsubstantive and expose revisions to A-791, as detailed below. Staff Review Completed by: Josh Arpin, NAIC Staff – October 2016 Proposed Revisions to Appendix A-791, Life and Health Reinsurance Agreements

Written Agreements

4. No reinsurance agreement or amendment to any agreement may be used to reduce any liability or to establish any asset in any financial statement, unless the agreement, amendment or a binding letter of intent has been duly executed by both parties no later than the “as of date” of the financial statement. 5. In the case of a letter of intent, a reinsurance agreement or an amendment to a reinsurance agreement must be executed within a reasonable period of time, not exceeding ninety (90) days from the execution date of the letter of intent, in order for credit to be granted for the reinsurance ceded. 6. The reinsurance agreement shall contain provisions which provide that:

a. The agreement shall constitute the entire agreement between the parties with respect to the business being reinsured thereunder and that there are no understandings between the parties other than as expressed in the agreement; and

b. Any change or modification to the agreement shall be null and void unless made by

amendment to the agreement and signed by both parties.

G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\G - 16-44 - Revisions to A-791.docx

Attachment H Ref #2016-45



Form A

Issue: ASU 2016-16 – Intra-Entity Transfers of Assets Other than Inventory Check (applicable entity): P/C Life Health


Description of Issue: During October 2016, the FASB issued ASU 2016 - Intra-Entity Transfers of Assets Other than Inventory to improve the accounting for income tax consequences of intra-entity transfers of assets other than inventory. As detailed in the ASU, Current U.S. GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in U.S. GAAP. Through discussions with stakeholders it was identified that the limited amount of authoritative guidance about this exception has led to diversity in practice and is a source of complexity in financial reporting, particularly for an intra-entity transfer of intellectual property. Stakeholders also expressed that this exception results in an unfaithful representation of the economics of an intra-entity asset transfer because the exception requires deferral of the income tax consequences of the transfer, including income taxes payable or paid. After consideration, FASB has determined that an entity should recognize the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. Therefore, this ASU eliminates the exception for an intra-entity transfer of an asset other than inventory. Two common examples of assets included in the scope of this ASU are intellectual property and property, plant, and equipment. On the basis of stakeholders’ feedback, this ASU does not change U.S. GAAP for an intra-entity transfer of inventory. This ASU does not include new disclosure requirements; however, existing disclosure requirements might be applicable when accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory. Existing Authoritative Literature: SSAP No. 101—Income Taxes Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): None Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): The amendments in this ASU align the recognition of income tax consequences for intra-entity transfers of assets, other than inventory, with International Financial Reporting Standards (IFRS). Specifically, IAS 12, Income Taxes, requires recognition of current and deferred income taxes resulting from an intra-entity transfer of any asset (including inventory) when the transfer occurs. Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, categorized as nonsubstantive and expose revisions to SSAP No. 101 to adopt with modification, ASU 2016-16, as detailed below. Staff Review Completed by: Josh Arpin, NAIC Staff October 2016

Attachment H Ref #2016-45


Proposed revisions to SSAP No. 101

Intercompany Income Tax Transactions 16. In the case of a reporting entity that files a consolidated income tax return with one or more

affiliates, income tax transactions (including payment of tax contingencies to its parent) between the affiliated parties shall be recognized if:

a. Such transactions are economic transactions as defined in SSAP No. 25—Affiliates and

Other Related Parties (SSAP No. 25);

b. Are pursuant to a written income tax allocation agreement; and c. Income taxes incurred are accounted for in a manner consistent with the principles of

FAS 109, as modified in paragraph 31. 17. A reporting entity shall recognize the income tax consequences of an economic intra-entity transfer of an asset, other than inventory, at the time of the transfer. Guidance in SSAP No. 25 shall be followed in determining whether any gains or increases in surplus from related party transactions shall be deferred.

3031. This statement adopts the provisions of FAS 109 except as modified in paragraph 2 of this

statement which results in paragraphs 29-30, 36-37, 39, 41-42, 46, and 49-59 of FAS 109 being rejected, inasmuch as they are not applicable to reporting entities subject to this statement or are inconsistent with other statutory accounting principles. Paragraph 47 of FAS 109 is adopted with modification to provide for the disclosures required for non public reporting entities. This statement adopts ASU 2016-16, Intra-Entity Transfers of Assets Other than Inventory, as modified by paragraph 17 of this statement.

G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\H - 16-45 ASU 2016-16.docx

Attachment I Ref #2016-46



Form A

Issue: ASU 2016-15 – Classification of Certain Cash Receipts and Cash Payments Check (applicable entity): P/C Life Health


Description of Issue: FASB issued ASU 2016-15 – Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments in August 2016. This ASU was developed to reduce the existing diversity of how certain cash receipts and cash payments are presented and classified in the statement of cash flows, and it is applicable to all entities that are required to present a statement of cash flows. Statutory accounting principles require that the statement of cash flows be prepared using the direct method. Specific instructions for the classification of items are provided in the Annual Statement Instructions. The ASU amendments target specific cash flow activities for which there is no GAAP guidance or the guidance is unclear and are summarized below. ASU 2016-15 Summary of Amendments:

1. Debt Prepayment or Debt Extinguishment Costs – Cash payments for debt prepayment or debt extinguishment costs should be classified as cash outflows for financing activities.

2. Settlement of Zero-Coupon Debt Instruments or Other Debt Instruments with Coupon Interest

Rates that Are Insignificant in Relation to the Effective Interest Rate of the Borrowing – At the settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, the issuer should classify the portion of the cash payment attributable to the accreted interest related to the debt discount as cash outflows for operating activities, and the portion of the cash payment attributable to the principal as cash outflows for financing activities.

3. Contingent Consideration Payments Made after a Business Combination – Cash payments not made

soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability should be separated and classified as cash outflows for financing activities and operating activities. Cash payments up to the amount of the contingent consideration liability recognized at the acquisition date (including measurement-period adjustments) should be classified as financing activities; any excess should be classified as operating activities. Cash payments made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability should be classified as cash outflows for investing activities.

4. Proceeds from the Settlement of Insurance Claims – Cash proceeds received from the settlement of

insurance claims should be classified on the basis of the related insurance coverage (that is, the nature of the loss). For insurance proceeds that are received in a lump-sum settlement, an entity should determine the classification on the basis of the nature of each loss included in the settlement.

5. Proceeds from the Settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned

Life Insurance Policies - Cash proceeds received from the settlement of corporate-owned life insurance policies should be classified as cash inflows from investing activities. The cash payments for premiums



on corporate-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities.

6. Distributions Received from Equity Method Investees – When a reporting entity applies the equity method, it should make an accounting policy election to classify distributions received from equity method investees using either of the following approaches: 1. Cumulative earnings approach: Distributions received are considered returns on investment and classified as cash inflows from operating activities, unless the investor’s cumulative distributions received less distributions received in prior periods that were determined to be returns of investment exceed cumulative equity in earnings recognized by the investor. When such an excess occurs, the current-period distribution up to this excess should be considered a return of investment and classified as cash inflows from investing activities. 2. Nature of the distribution approach: Distributions received should be classified on the basis of the nature of the activity or activities of the investee that generated the distribution as either a return on investment (classified as cash inflows from operating activities) or a return of investment (classified as cash inflows from investing activities) when such information is available to the investor. If an entity elects to apply the nature of the distribution approach and the information to apply that approach to distributions received from an individual equity method investee is not available to the investor, the entity should report a change in accounting principle on a retrospective basis by applying the cumulative earnings approach in (1) for that investee. In such situations, an entity should disclose that a change in accounting principle has occurred with respect to the affected investee(s) due to the lack of available information and should provide the disclosures required in paragraphs 250-10-50-1(b) and 250-10-50-2, as applicable. This amendment does not address equity method investments measured using the fair value option.

7. Beneficial Interests in Securitization Transactions – A transferor’s beneficial interest obtained in a securitization of financial assets should be disclosed as a noncash activity, and cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables should be classified as cash inflows from investing activities.

8. Separately Identifiable Cash Flows and Application of the Predominance Principle - The classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance in generally accepted accounting principles (GAAP). In the absence of specific guidance, an entity should determine each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows. An entity should then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item.

Existing Authoritative Literature: SSAP No. 69—Statement of Cash Flow 2. For purposes of the Statement of Cash Flow, cash shall include cash, cash equivalents and short-term investments. The Statement of Cash Flow shall be prepared using the direct method and shall only include transactions involving cash. Cash from operations shall be reported consistent with the Statement of Income, excluding the effect of current and prior year accruals. Worksheets to facilitate completion of the cash flow statement, which necessitate adjustments for reporting entity-specific insurance operations and for non-cash transactions, are provided in the Annual Statement Instructions.

Relevant Literature 5. This statement adopts FASB Emerging Issues Task Force Issue No. 95-13, Classification of Debt Issue Costs in the Statement of Cash Flows which requires that cash payments for debt issue costs shall be classified as a financing activity in the Statement of Cash Flow. This statement adopts with modification ASU 2012-05, Not-



For-Profit Entities: Classification of the Sale Proceeds of Donated Financial Assets in the Statement of Cash Flows for all reporting entities. Donated assets with donor-restrictions as to the sale or use of the contributed financial assets, or cash receipts from the sale of donated assets that are restricted as to use are not considered available to meet policyholder obligations and are nonadmitted in accordance with SSAP No. 4—Assets and Nonadmitted Assets.

6. FASB Statement No. 95, Statement of Cash Flows, FASB Statement No. 102, Statement of Cash Flows—Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale, an amendment of FASB Statement No. 95, and FASB Statement No. 104, Statement of Cash Flows—Net Reporting of Certain Cash Receipts and Cash Payments and Classification of Cash Flows from Hedging Transactions, an amendment of FASB Statement No. 95, are rejected in this statement.

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): None Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): IFRS does not provide specific guidance regarding the cash flow classification of cash payments for debt prepayment or extinguishment costs, proceeds received from the settlement of insurance claims, proceeds received from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, beneficial interests in securitization transactions, cash payments for the settlement of a zero-coupon debt instrument, contingent consideration payments made after a business combination, and distributions received from an equity method investee. As such, the amendments in this ASU differ from IFRS. IFRS provides guidance indicating that a single transaction may include cash flows that are classified differently, which is consistent with a portion of the amendments in this ASU that clarify when an entity should separate cash receipts and payments and classify them into more than one class of cash flows Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, categorized as nonsubstantive and expose revisions to SSAP No. 69—Statement of Cash Flow to adopt ASU 2016-15. Staff recommends this ASU should be adopted for statutory accounting to improve consistency in SAP reporting, as well as to minimize differences between SAP and U.S. GAAP with cash flow classifications. Although staff notes a few of the items in the ASU may be more applicable to the insurance industry, Staff has proposed for ASU 2016-15 to be adopted in its entirety. Comments are requested from industry and regulators on whether there are concerns with adopting the entire ASU by reference in SSAP No. 69, or if specific details (for select amendments) should be detailed in SSAP No. 69. Proposed Revisions to SSAP No. 69—Statement of Cash Flow

Relevant Literature 5. This statement adopts ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. This statement adopts FASB Emerging Issues Task Force Issue No. 95-13, Classification of Debt Issue Costs in the Statement of Cash Flows which requires that cash payments for debt issue costs shall be classified as a financing activity in the Statement of Cash Flow. This statement adopts with modification ASU 2012-05, Not-For-Profit Entities: Classification of the Sale Proceeds of Donated Financial Assets in the Statement of Cash Flows for all reporting entities. Donated assets with donor-restrictions as to the sale or use of the contributed financial assets, or cash receipts from the sale of donated assets that are restricted as to use are not considered available to meet policyholder obligations and are nonadmitted in accordance with SSAP No. 4—Assets and Nonadmitted Assets.

Staff Review Completed by: Fatima Sediqzad, NAIC Staff - November 2016 G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\I - 16-46 - ASU 2016-15.docx

Attachment J Ref #2016-47



Form A

Issue: ASU 2016-07 - Simplifying the Transition to the Equity Method of Accounting Check (applicable entity): P/C Life Health


Description of Issue: In March 2016, the FASB issued ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting (Update) to eliminate the requirement to adjust the investment, results of operations and retained earnings retroactively when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence. An entity that has an available-for-sale equity security that subsequently qualifies for the equity method of accounting will recognize the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment qualifies for the equity method accounting treatment. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Detailed below is applicable GAAP guidance from the Accounting Standards Codification. Current Investment (Less than Control Amount) Gains Interest and Moves to the Equity Method

• 325-20-30: An investment in the stock of an investee recognized under paragraph 325-20-25-1 shall be measured initially at cost.

• 325-20-35-4: Paragraph 323-10-15-12 explains that an investment in common stock of an investee that

was previously accounted for on other than the equity method (for example, under this Subtopic) may become qualified for use of the equity method by an increase in the level of ownership described in paragraphs 323-10-15-6 through 15-11 (that is, acquisition of additional voting stock by the investor, acquisition or retirement of voting stock by the investee, or other transactions).

Control of Investment is Eliminated, Disallowing Equity Method

• 321-10-30-1: If an equity security no longer qualifies to be accounted for under the equity method (for example, due to a decrease in the level of ownership), the security’s initial basis shall be the previous carrying amount of the investment. Paragraph 323-10-35-36 states that the earnings or losses that relate to the stock retained by the investor and that were previously accrued shall remain as a part of the carrying amount of the investment and that the investment account shall not be adjusted retroactively. Subsequently, the security shall be accounted for pursuant to paragraph 321-10-35-1.

• 325-20-35-3: As discussed in paragraph 323-10-35-36, an investment in voting stock of an investee may fall below the level of ownership described in paragraph 323-10-15-3 from sale of a portion of an investment by the investor, sale of additional stock by an investee, or other transactions, and the investor may thereby lose the ability to influence policy (see paragraphs 323-10-15-6 through 15-11 for guidance in determining significant influence). That paragraph requires that an investor discontinue accruing its share of the earnings or losses of the investee for an investment that no longer qualifies for the equity method. That paragraph also requires that the earnings or losses that relate to the stock retained by the



investors and that were previously accrued shall remain as a part of the carrying amount of the investment. However, dividends received by the investor in subsequent periods that exceed the investor’s share of earnings for such periods shall be applied in reduction of the carrying amount of the investment (see paragraph 325-20-35-1).

Existing Authoritative Literature: SSAP No. 30—Unaffiliated Common Stock

5. At acquisition, common stocks shall be reported at their cost, including brokerage and other related fees. Common stock acquisitions and dispositions shall be recorded on the trade date. Private placement stock transactions shall be recorded on the funding date.

SSAP No. 48—Joint Ventures, Partnerships and Limited Liability Companies

2. Investments in joint ventures shall include investments in corporate joint ventures and unincorporated joint ventures (also referred to as undivided interests in ventures). A corporate joint venture is defined as a corporation owned and operated by a small group (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A corporate joint venture usually provides an arrangement under which each joint venture may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An unincorporated joint venture is similar in its purpose but is not incorporated.

SSAP No. 97—Investments in Subsidiaries, Controlled and Affiliated Entities

5. Control is defined as the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of the investee, whether through the (a) ownership of voting securities, (b) by contract other than a commercial contract for goods or nonmanagement services, (c) by common management, or (d) otherwise. Control shall be presumed to exist if a reporting entity and its affiliates directly or indirectly, own, control, hold with the power to vote, or hold proxies representing 10% or more of the voting interests of the entity.

6. Control as defined in paragraph 5 shall be measured at the holding company level. For example,

if one member of an affiliated group has a 5% interest in an entity and a second member of the group has an 8% interest in the same entity, the total interest is 13% and therefore each member of the affiliated group shall be presumed to have control. This presumption will stand until rebutted by an evaluation of all the facts and circumstances relating to the investment based on the criteria in FASB Interpretation No. 35, Criteria for Applying the Equity Method of Accounting for Investments in Common Stock, an Interpretation of APB Opinion No. 18. The corollary is required to demonstrate control when a reporting entity owns less than 10% of the voting securities of an investee. The insurer shall maintain documents substantiating its determination for review by the domiciliary commissioner

11. For investments in entities recorded on an equity method (paragraph 8.b.i. through 8.b.iv.) after

the date of acquisition, the investment amount shall be 1) adjusted for the amortization of statutory goodwill as defined in SSAP No. 68, and 2) adjusted, with a corresponding unrealized gain or loss, for the reporting entity’s share of undistributed earnings and losses of the investee (net of dividends declared4). (This results in a reduction of the investment amount when dividends declared are in excess of the undistributed accumulated earnings attributable to the investee.) The following additional adjustment, based on the equity method applied for the investment, shall also be made:

a. For investments in scope of paragraph 8.b.i. (based on audited statutory equity) the

investment amount shall be adjusted for the reporting entity’s share of the change in special surplus funds, other than special surplus funds and unassigned funds (surplus), as defined in SSAP No. 72—Surplus and Quasi-Reorganizations. Additionally, the investment amount shall



be adjusted, with a corresponding unrealized gain or loss, for the reporting entity’s share of other changes in the investee’s surplus (e.g., the change in the investee’s nonadmitted assets);

b. For investments in scope of paragraphs 8.b.ii., 8.b.iii. and 8.b.iv. (underlying audited GAAP equity), the investment amount shall be adjusted for the reporting entity’s share of adjustments recorded directly to the investee’s stockholder’s equity under GAAP, with a corresponding entry to unrealized gain or loss. For investments in scope of paragraphs 8.b.ii. and 8.b.iv. (underlying audited GAAP with limited statutory adjustments), the investment amount shall also be adjusted in accordance with paragraph 9.

13 g. An investment in a SCA entity may fall below the level of ownership described in paragraph 5

from the sale of a portion of an investment by the reporting entity, the sale of additional interests by an investee, or other transactions. The reporting entity shall discontinue accruing its share of the earnings or losses of the investee for an investment that no longer qualifies for an equity method. The earnings or losses that relate to the investment interests retained by the reporting entity and that were previously accrued shall remain as a part of the carrying amount of the investment. The investment account shall not be adjusted retroactively under the conditions described in this subparagraph. However, dividends received by the investor in subsequent periods which exceed the reporting entity’s share of earnings for such periods shall be applied as a reduction of the carrying amount of the investment.

Activity to Date (issues previously addressed by the SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): Several agenda items have recently updated guidance in SSAP No. 97 for the accounting and reporting of SCAs. These revisions have primarily focused on the equity method detailed in paragraph 8.b. Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None Convergence with International Financial Reporting Standards (IFRS): None Staff Recommendation: Staff recommends that the Working Group move this item to the active listing, categorized as nonsubstantive and expose revisions to SSAP Nos. 30, 48 and 97 to adopt ASU 2016-07 with modification to reflect statutory terms and concepts (e.g., statutory accounting does not utilize “other-comprehensive-income”). Additional proposed revisions to incorporate guidance for when an insurance reporting entity gains an interest or loses control by eliminating its investment are shown below. SSAP No. 30—Unaffiliated Common Stocks 5. At acquisition, common stocks shall be reported at their cost, including brokerage and other related fees.

Common stock acquisitions and dispositions shall be recorded on the trade date. Private placement stock transactions shall be recorded on the funding date. A reporting entity may become qualified for use of equity method accounting by an increase in the level of ownership. In this situation, the reporting entity shall add the cost of acquiring additional interest in the investee to the current basis of the previously held interest and shall apply the equity method, as prescribed in SSAP No. 97—Investments in Subsidiaries, Controlled and Affiliated Entities, prospectively, as of the date the investment becomes qualified for equity method accounting.

18. This statement adopts ASU 2016-07 – Investments - Equity Method and Joint Ventures, modified to

reflect statutory terms including the definition of control and statutory reporting concepts. This statement rejects FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities.



SSAP No. 48— Joint Ventures, Partnerships and Limited Liability Companies 26. This statement adopts ASU 2016-07 - Investments-Equity Method and Joint Ventures, providing guidance

for the prospective application of equity method accounting, modified to reflect statutory terms including the definition of control and statutory reporting concepts.

SSAP No. 97—Investments in Subsidiaries, Controlled and Affiliated Entities 6. Control as defined in paragraph 5 shall be measured at the holding company level. For example, if one

member of an affiliated group has a 5% interest in an entity and a second member of the group has an 8% interest in the same entity, the total interest is 13% and therefore each member of the affiliated group shall be presumed to have control. This presumption will stand until rebutted by an evaluation of all the facts and circumstances relating to the investment based on the criteria in FASB Interpretation No. 35, Criteria for Applying the Equity Method of Accounting for Investments in Common Stock, an Interpretation of APB Opinion No. 18. The corollary is required to demonstrate control when a reporting entity owns less than 10% of the voting securities of an investee. The insurer shall maintain documents substantiating its determination for review by the domiciliary commissioner. An investment in an SCA entity may fall below the level of ownership described in paragraph 5, in which case, the reporting entity would discontinue the use of the equity method, as prescribed in paragraph 13.g. of this statement. Additionally, through an increase in the level of ownership, a reporting entity may become qualified to use the equity method of accounting (paragraph 8.b.), in which case, the reporting entity shall add the cost of acquiring additional interest to the current basis of the previously held interest and shall apply the equity method prospectively, as of the date the investment becomes qualified for equity method accounting. Examples of situations where the presumption of control may be in doubt include the following:

a. Any limited partner investment in a limited partnership, unless the limited partner is affiliated with the general partner.

b. An entity where the insurer owns less than 50% of an entity and there is an unaffiliated individual or group of investors who own a controlling interest.

c. An entity where the insurer has given up participating rights1 as a shareholder to the investee.

45. This statement adopts ASU 2016-07 - Investments-Equity Method and Joint Ventures, modified to reflect statutory terms including the definition of control and statutory reporting concepts. This statement adopts FASB Interpretation No. 35, Criteria for Applying the Equity Method of Accounting for Investments in Common Stock, an Interpretation of APB Opinion No. 18 as guidance to be considered in determining the existence of control.

Staff Review Completed by: Fatima Sediqzad, NAIC Staff November 2016 G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\J - 16-47 - ASU 2016-07.docx

1 The term "participating rights" refers to the type of rights that allows an investor to effectively participate in significant decisions related to an investee's ordinary course of business and is distinguished from the more limited type of rights referred to as “protective rights”. Refer to the sections entitled: “Protective Rights” and “Substantive Participating Rights” in EITF 96-16, Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights. The term “participating rights” shall be used consistent with the discussion of substantive participating rights in this EITF.

Attachment K Ref #2010-08


Statutory Accounting Principles Working Group Maintenance Agenda Submission Form

Form A Issue: Policy Statement on Coordination with Valuation Manual Check (applicable entity): P/C Life ` Health

Modification of existing SSAP New Issue or SSAP

Description of Issue: The Principles Based Reserving project has adopted a Standard Valuation Law and is nearing completion of a Valuation Manual. Once adopted, the Valuation Manual will become effective when enough states and jurisdictions have adopted the Standard Valuation Law. Currently, the Valuation Manual has a policy statement on updating the Valuation Manual that clearly indicates that coordination with the Statutory Accounting Principles Working Group is required. Because it is a new publication, there is not a specific policy statement in the NAIC Accounting Practices and Procedures Manual on the Valuation Manual. Although Statements of Statutory Accounting Principles are at the top of the statutory accounting hierarchy, it is also important that statutory guidance be coordinated. The Valuation Manual has the potential to create inadvertent conflicts with statutory accounting guidance, it is important that these two publications be consistent. Existing Authoritative Literature: While there is an existing NAIC Policy Statement on the Impact of Statements of Statutory Accounting Principles on NAIC Publications, it is not specific to the Valuation Manual. In June 2014 the Life Actuarial (A) Task Force adopted the following in the Introductions section of the Valuation Manual:

COORDINATION WITH SAPWG Proposed changes to the Valuation Manual must be consistent with existing model laws, including the Standard Valuation Law, and, to the extent determinable, with models in development. To the extent that proposed changes to the Valuation Manual could have an impact on accounting and reporting guidance and other requirements as referenced by the Accounting Practices and Procedures Manual, proposed changes must be reviewed by SAPWG for consistency with the Accounting Practices and Procedures Manual, including as to implementation dates. LATF or its staff support will prepare a summary recommendation that will include as appropriate an analysis of the impact of proposed changes. If SAPWG reaches the conclusion that the proposed changes to the Valuation Manual are inconsistent with the authoritative guidance in the Accounting Practices and Procedures Manual, LATF will work with SAPWG to resolve such inconsistencies.

Activity to Date (issues previously addressed by SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None.



Recommended Conclusion or Future Action on Issue: Staff recommends that the attached Policy Statement, which is currently in the Valuation Manual be exposed for comment, for inclusion in the Accounting Practices and Procedures Manual, Appendix F, Policy Statements. Recommending Party: Robin Marcotte, NAIC Staff March 2010 Staff Recommendation: Staff recommends that the Statutory Accounting Principles Working Group move this item to the nonsubstantive active listing and expose the attached policy statement for public comment. Staff Review Completed by: Robin Marcotte, NAIC Staff Status: On March 26, 2010, the Statutory Accounting Principles Working Group moved this item to the nonsubstantive active listing and exposed a policy statement on coordination with the Valuation Manual for inclusion within Appendix F of the Accounting Practices and Procedures Manual. The exposed policy statement is currently included within the Valuation Manual. Exposed Policy Statement:

PROCESS FOR UPDATING VALUATION MANUAL

The NAIC is responsible for the ongoing maintenance of the Valuation Manual. The Life and Health Actuarial Task Force (LHATF) is charged with developing changes to the Valuation Manual for NAIC adoption. Any changes must conform to guidelines, which may be provided in a policy statement(s), developed by the NAIC to support joint use of reserve and other requirements as referenced by the Accounting Practices and Procedures Manual, the Valuation Manual and the Standard Valuation Law, etc. Changes must be consistent with existing model laws or with projects which have received Executive Committee approval to develop new model laws and to the extent the actuarial requirements could have an impact on accounting and reporting guidance in the Accounting Practices and Procedures Manual proposed changes must be reviewed by the Statutory Accounting Principles Working Group (SAPWG) for consistency with the Accounting Practices and Procedures Manual. The Life and Health Actuarial Task Force is charged with the maintenance of the Valuation Manual. The Task Force or its staff support will prepare a summary recommendation that will include an analysis of the impact of proposed changes on reserves, the consumer and the industry, including any other impact, based on size of company. LHATF staff support will work with SAPWG staff support to provide a summary and (or that) will also include an agenda submission form which will recommend changes to the Accounting Practices and Procedures Manual, if needed, to be consistent with the proposed change. If the proposed changes are inconsistent with the authoritative guidance in the Accounting Practices and Procedures Manual, the Life and Health Actuarial Task Force shall not adopt such changes until the Statutory Accounting Principles Working Group:

1. Indicates support for such change, and



2. Adopts corresponding changes to the Accounting Practices and Procedures Manual, with a concurrent effective date.

In the event that the Statutory Accounting Principles Working Group and the Life and Health Actuarial Task Force are in dispute regarding a change and are unable to come to a consensus, a joint subgroup will be formed to resolve the particular issue. Both groups shall send an equal number of knowledgeable representatives to the joint subgroup (suggest 3-5 representatives each) and report back on a recommended resolution. The representatives shall be appointed by the Chair of the Life and Health Actuarial Task Force and the Chair of the Statutory Accounting Principles Working Group. The Subgroup(s) shall provide regular updates on the progress of the specified issue. Neither group should take action, until the subgroup has a recommended resolution. Both the Statutory Accounting Principles Working Group and the Life and Health Actuarial Task Force will review proposed Valuation Manual changes for conformance with these guidelines and provide written conclusions and approvals. When both the Statutory Accounting Principles Working Group and the Life and Health Actuarial Task Force conclude the proposed Valuation Manual changes are in conformance with these guidelines and provide approval, the Valuation Manual changes must then be adopted by the A, or B (as applicable), and E Committees prior to NAIC adoption by Executive and Plenary. SAPWG input is not required for changes which are non-substantive or which provide purely actuarial guidance and do not have an accounting impact. These changes should be included in the quarterly summaries, along with a description of the actuarial guidance. Actuarial guidance is expected to be of a nature similar to what has been termed actuarial guidelines. Guidelines or a policy statement may be developed to expedite the adoption process of LHATF and SAPWG for those Valuation Manual changes where an emergency situation is present as defined by such guidelines. Valuation Manual changes must be adopted by the NAIC Executive and Plenary at least six months before becoming effective. The following January 1 will generally be the effective date unless otherwise specified in the changes adopted.

On August 14, 2010, the Statutory Accounting Principles Working Group exposed revisions to the proposed policy statement on coordination with the Valuation Manual planned for inclusion within Appendix F of the Accounting Practices and Procedures Manual. A referral was sent to the Life and Health Actuarial Task Force to incorporate corresponding revisions in the Valuation Manual.



August 14, 2010 Exposed Policy Statement:

PROCESS FOR UPDATING VALUATION MANUAL

The NAIC is responsible for the ongoing maintenance of the Valuation Manual. The Life and Health Actuarial Task Force (LHATF) is charged with developing changes to the Valuation Manual for NAIC adoption. Any changes must conform to guidelines, which may be provided in a policy statement(s), developed by the NAIC to support joint use of reserve and other requirements as referenced by the Accounting Practices and Procedures Manual, the Valuation Manual and the Standard Valuation Law, etc. Changes must be consistent with existing model laws or with projects which have received Executive Committee approval to develop new model laws and to the extent the actuarial requirements could have an impact on accounting and reporting guidance in the Accounting Practices and Procedures Manual proposed changes must be reviewed by the Statutory Accounting Principles Working Group (SAPWG) for consistency with the Accounting Practices and Procedures Manual. The Life and Health Actuarial Task Force is charged with the maintenance of the Valuation Manual. The Task Force or its staff support will prepare a summary recommendation that will include an analysis of the impact of proposed changes on reserves, the consumer and the industry, including any other impact, based on size of company. LHATF staff support will work with SAPWG staff support to provide a summary and (or that) will also include an agenda submission form which will recommend changes to the Accounting Practices and Procedures Manual, if needed, to be consistent with the proposed change. If the proposed changes are inconsistent with the authoritative guidance in the Accounting Practices and Procedures Manual, the Life and Health Actuarial Task Force shall not adopt such changes until the Statutory Accounting Principles Working Group:

1. Indicates support for such change, and 2. Adopts corresponding changes to the Accounting Practices and Procedures Manual, with

a concurrent effective date. In the event that the Statutory Accounting Principles Working Group and the Life and Health Actuarial Task Force are in dispute regarding a change and are unable to come to a consensus, a joint subgroup will be formed to resolve the particular issue. Both groups shall send an equal number of knowledgeable representatives to the joint subgroup (suggest 3-5 representatives each) and report back on a recommended resolution. The representatives shall be appointed by the Chair of the Life and Health Actuarial Task Force and the Chair of the Statutory Accounting Principles Working Group. The Subgroup(s) shall provide regular updates on the progress of the specified issue. Neither group should take action, until the subgroup has a recommended resolution. Both the Statutory Accounting Principles Working Group and the Life and Health Actuarial Task Force will review proposed Valuation Manual changes for conformance with these guidelines and provide written conclusions and approvals. When both the Statutory Accounting Principles Working Group and the Life and Health Actuarial Task Force conclude the proposed Valuation Manual changes are in conformance with these guidelines and provide approval, the Valuation Manual changes must then be adopted by the A, or B (as applicable), and E Committees prior to NAIC adoption by Executive and Plenary.



SAPWG input is not required for changes which are non-substantive or which provide purely actuarial guidance and do not have an accounting impact. These changes should be included in the quarterly summaries, along with a description of the actuarial guidance. Actuarial guidance is expected to be of a nature similar to what has been termed actuarial guidelines. Guidelines or a policy statement may be developed to expedite the adoption process of LHATF and SAPWG for those Valuation Manual changes where an emergency situation is present as defined by such guidelines. Valuation Manual changes must be adopted by the NAIC Executive and Plenary at least six months before becoming effective. The following January 1 will generally be the effective date unless otherwise specified in the changes adopted.

In October 2010, the Statutory Accounting Principles (E) Working Group deferred action on the proposed policy statement on coordination with the Valuation Manual planned for inclusion within Appendix F of the Accounting Practices and Procedures Manual to allow the Life and Health Actuarial (A&B) Task Force to work on the referral to incorporate corresponding revisions in the Valuation Manual.

Update for Fall 2016 National Meeting discussion

Staff recommends that the Statutory Accounting Principles (E) Working Group expose the Policy Statement on Coordination with the Valuation Manual for inclusion within Appendix F of the Accounting Practices and Procedures Manual reflected below for public comment. The recommended language is consistent with the language previously adopted by the Life Actuarial (A) Task Force in June 2014, which is reflected in the Authoritative Literature section of this agenda item. In addition, the Life Actuarial (A) Task Force should be notified of the exposure.

POLICY STATEMENT ON COORDINATION WITH THE VALUATION MANUAL Proposed changes to the Valuation Manual must be consistent with the existing referenced model laws, including the Standard Valuation Law, and, to the extent determinable, with models in development. To the extent that proposed changes to the Valuation Manual could have an impact on accounting and reporting guidance and other requirements as referenced by the Accounting Practices and Procedures Manual, proposed changes must be reviewed by the Statutory Accounting Principles (E) Working Group for consistency with the Accounting Practices and Procedures Manual, including as to implementation dates. The Life Actuarial (A) Task Force or its staff support will prepare a summary recommendation that will include as appropriate an analysis of the impact of proposed changes. If Statutory Accounting Principles (E) Working Group reaches the conclusion that the proposed changes to the Valuation Manual are inconsistent with the authoritative guidance in the Accounting Practices and Procedures Manual, The Life Actuarial (A) Task Force will work with Statutory Accounting Principles (E) Working Group to resolve such inconsistencies prior to implementation.

G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\K - 10-08 Valuation Manual coordination.doc

Attachment L Bonds IP No. XXX

IP XX–1

Issue Paper No. XXX

Bonds

STATUS Exposure Draft – October 24, 2016 Type of Issue: Common Area SUMMARY OF ISSUE

1. The guidance within this issue paper introduces substantive revisions to SSAP No. 26—Bonds pursuant to the Statutory Accounting Principles (E) Working Group’s (Working Group) Investment Classification Project (introduced as agenda item 2013-36). The Investment Classification Project reflects a comprehensive review to address a variety of issues pertaining to definitions, measurement and overall scope of the investment SSAPs.

2. The proposed revisions to SSAP No. 26 under the Investment Classification Project, detailed within this issue paper, reflect the following key elements:

a. Removes SVO-Identified instruments (as defined in the SSAP) from the definition of a bond, and provides guidance for these instruments separately from bonds. Within this explicit section, specific guidance for SVO-identified instruments is provided, which includes a requirement for these instruments to be reported at fair value (using net asset value (NAV) as a practical expedient), unless the investment qualifies for, and the reporting entity elects, use of a documented systematic value approach.

b. Incorporates the definition of “security” within the definition of a bond, as well as definitions for non-bond, fixed-income instruments captured in the scope of SSAP No. 26. These changes include removal of the term “bank participations” with inclusion of guidance to reflect bank loans acquired through a participation, assignment or syndication.

DISCUSSION

3. This issue paper intends to provide information on discussions that occurred when considering revisions to SSAP No. 26 under the Investment Classification Project, as well as the adopted revisions.

SVO-Identified Investments

4. Statutory accounting principles (SAP) have historically allowed certain fund investments noted by the Securities Valuation Office (SVO) (SVO-Identified investments) to be reported as bonds within SSAP No. 26. The process to include these investments within the scope of SSAP No. 26 is supported by SVO assessments that the underlying elements of the specific SVO-Identified investments are comparable to bonds; therefore these investments should be treated in a similar manner as bonds, with comparable risk-based capital (RBC) charges.

5. Discussion of these specific SVO-Identified investments was specifically noted as part of the Investment Classification Project as the accounting and reporting concepts applicable to bonds cannot be directly applied to these fund (equity) investments. The prior application of SSAP No. 26 to these

NOTE – All “Staff Notes” and the two “Regulator Questions” are not anticipated to be in the final Issue Paper and are only included to solicit comments on particular issues. As additional information is received, the Issue Paper will be updated accordingly.

Attachment L IP No. XX Issue Paper

IP XX–2

investments has resulted with various interpretations or adjustments in applying the accounting and reporting requirements, with inconsistencies in application across different reporting entities.

6. With the discussions involving these investments, the Working Group has considered:

a. Continued inclusion of SVO-Identified investments within the scope of SSAP No. 26.

b. Accounting and reporting revisions for SVO-Identified investments.

c. Limitations restricting optional accounting treatment for SVO-Identified ETFs.

Inclusion of SVO-Identified Investments in SSAP No. 26

7. As part of the Investment Classification Project, the Working Group was originally presented with an option to require a “contractual amount of principle due” in order for an investment to be captured within SSAP No. 26. After discussing this proposal, the Working Group agreed to continue including specifically noted SVO-Identified investments within the scope of SSAP No. 26. This continued inclusion was supported as the SVO-Identified investments are required to have underlying debt characteristics, and/or limited potential for significant fluctuation or risk. Furthermore, the Working Group identified that small and medium-size insurers may rely on these investment structures to supplement their bond portfolio. It was noted by interested parties that by requiring these investments to be captured in a separate SSAP, the accounting, reporting and RBC impact may be punitive to small and medium-size insurers.

8. The SVO-Identified investments captured within the scope of SSAP No. 26, as defined in the December 31, 2015 Purposes and Procedures Manual of the NAIC Investment Analysis Office, are limited to:

a. U.S. Direct Obligations / Full Faith and Credit List: This listing only includes money market mutual funds that maintain specific parameters, which include, maintaining a stable net asset value (NAV) of $1.00 per share, with 100% of all fund investments in direct obligations of the United States Government and/or in securities that are backed by the full faith and credit of the U.S. government or collateralized repurchase agreements. These investments are considered short-term, therefore they are reported on Schedule DA; however, since they are classified as within the scope of SSAP No. 26, the reporting entity is permitted to utilize an amortized cost (rather than fair value / NAV) measurement approach for these funds. With the investment restrictions of these funds, there is a 0% RBC charge for these investments. (Staff Note: Agenda item 2016-18 proposes to reclassify these investments as cash equivalents. If this proposal is adopted, the reference to these money market mutual funds would be deleted from SSAP No. 26. Staff also notes that these funds do not “amortize” and companies generally report original cost.)

b. Bond Fund List: This listing only includes bond mutual funds that maintain specific parameters, which includes a requirement to invest 100% of its total assets in U.S. government securities, class 1 bonds that are issued or guaranteed as to payment of principal and interested by agencies and instrumentalities of the U.S. government, and collateralized repurchase agreements. This fund is restricted from investing in specific investments (e.g., derivatives, specific bonds, and certain securities) and is required to maintain the highest market risk rating given by an NAIC credit rating provider (CRP) to a fund that invests in class 1 bonds.


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c. Exchange-Traded Funds – Bonds: The P&P Manual identifies a presumption that shares of an ETF are to be reported as common stock, consistent with SSAP No. 30. However, that common stock presumption can be overcome if the ETF has been issued under a U.S. SEC Exemptive Order and the SVO determines that the assets held in the ETF portfolio are predominately bonds (in the case of a bond ETF) or predominately preferred stock (in the case of a preferred stock ETF) and the ETF permits a daily “look-through” to its portfolio assets. The analysis also includes a review of the use of any other instruments to achieve the ETF’s stated investment strategy, investment constraints and any other relevant information. The overall NAIC designation is based on a risk-weighted methodology of the assets held by the ETF. The classification by the SVO as “debt-like” or “preferred-stock-like” reflects the fact that the fund does not, nor does it intend to, invest in common stock or any material holdings incompatible with debt-like or preferred-stock-like treatment. Any investment in common stock would result with the ETF no longer being eligible for treatment under SSAP No. 26 or on Schedule D – Part 1.

Reporting Revisions for SVO-Identified Investments

9. In reviewing the reporting guidelines for SVO-Identified investments, the Working Group noted that ETFs and bond mutual funds have previously been reported with other bond investments classified as “industrial and miscellaneous” on Schedule D – Part 1 (Long-Term Bonds Owned December 31). This reporting structure has hindered the ability to quickly identify these items on the investment schedule, and has prevented implementation of verification procedures to ensure specific reporting provisions for these investments are applied. For example, SVO-Identified bond ETFs are not permitted to be reported as “FE” (filing-exempt), but a significant portion of these ETFs were identified (in the 2013, 2014 and 2015 year-end financial statements) as being incorrectly reported as FE. After considering whether SVO-Identified investments shall be reported on a new sub-schedule, or on a separate reporting line1, the Working Group agreed to continue including SVO-Identified investments on Schedule D – Part 1, but to request the Blanks (E) Working Group to incorporate new subcategories (reporting lines) to distinguish SVO-Identified investments from other investments on Schedule D – Part 1. The Blanks (E) Working Group adopted revisions consistent with this request, and new reporting lines are effective year-end 2016.

10. With the decision to continue reporting the SVO-Identified investments directly on Schedule D – Part 1, rather than a sub-schedule, the Working Group noted that specific reporting columns would continue to not be applicable for these investments. The Working Group noted that these columns include those pertaining to par value, stated interest rates and contractual maturity dates, as these concepts do not exist in the SVO-Identified funds. The Working Group requested additional guidance to be included within the Annual Statement instructions to assist with the reporting of these investments.

Accounting Revisions for SVO-Identified Investments

11. After deciding to retain the SVO-Identified investments within the scope of SSAP No. 26, a key element discussed was the measurement method for these investments. SSAP No. 26 requires an amortized cost or fair value measurement method depending on the NAIC designation for the investment (and whether the reporting entity is an AVR/IMR filer). As the SVO-Identified investments are fund (equity) investments, without a stated par value, interest rate or maturity date, the SVO-Identified investments do not “amortize” in a manner similar to bonds or other fixed-income instruments. In reviewing the annual statement instructions, historical guidance directed use of original cost for the SVO-Identified investments. The Working Group identified that original cost for these equity investments is an unacceptable measurement method and agreed that revisions to the measurement method was necessary for these SVO-Identified investments.

1 This decision occurred in a separate agenda item (Ref #2015-45: ETF Reporting in Investment Schedules).


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12. In the discussion identifying prior use of original / historic cost for these investments, the Working Group noted concerns that original / historic cost does not provide a proper presentation of assets available for policyholders, with at least one state identifying that such investments are required to be presented at fair value (or NAV) under their state investment laws. The Working Group also identified that original / historic cost is inconsistent with the concept of an “economic valuation” per Insurance Core Principle (ICP) 14, Valuation:

14.5.3 The historic cost of an asset or liability may not reflect a current prospective valuation of the future cash flows and may therefore not be consistent with the current economic valuation of other assets or liabilities. Historic cost generally does not reflect changes in value over time. However, amortised cost, which adjusts the historic cost of an asset or liability over time, may reliably reflect the value of future cash flows, when used in conjunction with an adequacy or impairment test.

13. With the Working Group determination that original / historic cost is not an acceptable measurement method for these investments under statutory accounting, the Working Group considered requiring fair value (or NAV as a practical expedient) for all SVO-Identified Investments, noting that fair value was the most appropriate measurement method for these fund investments. Although a fair value (NAV) method was identified as being consistent with U.S. GAAP, readily available, and the best representation of assets available for policyholders as of a reporting date, the Working Group received comments from small and medium-size insurers that requiring fair value, with fair value fluctuations recognized as unrealized gains and losses, could be punitive to those insurers.

14. Comments from small and medium-size insurers highlighted that they utilize SVO-Identified bond ETFs to access the bond market at a lower cost than directly holding bonds. These commenters noted that with a requirement to hold ETFs at fair value (or NAV), and the recognition of unrealized gains and losses, the financial statements could reflect volatility from the fair value fluctuations. The potential for this volatility (particularly when conducting risk / investment projections) may cause small and medium-size insurers to liquidate these investments, based on their investment policy requirements, and incur greater investments costs in order to directly acquire bonds. The commenters also noted that it is more difficult for small and medium-size insurers to acquire high-quality bonds, particularly with the market changes after 2008 and the investment restraints placed on banks and mortgage firms. These commenters communicated that small and medium-size insurers have access to a lower inventory of available bonds, and these holdings are often opaque, illiquid and frequently reflect private placements and small-debt issuances.

15. After assessing the small and medium-size insurer perspective, the Working Group agreed to consider, as a special reporting-entity election, a different measurement method for the SVO-Identified investments. In making this decision, the Working Group directed that the measurement method should not be referred to as an “amortized cost” measurement, nor should it be included with the general measurement guidance for bonds. The Working Group noted that the accounting provisions for these investments should not be construed as providing any exceptions to state investment laws, particularly state laws that require fair value (or NAV) for these investments, and state laws involving investment concentration limits.

16. In response to the direction from the Working Group, NAIC staff proposed that the optional measurement method for these investments be referred to as the “systematic value” to reflect the systematic recognition of cash flows from the underlying bond holdings. The guidance reflected within this issue paper incorporates the concept of this “systematic value” measurement method as well as revisions to capture guidance for the SVO-Identified investments within a new section in SSAP No. 26. After further discussion of the systematic value approach, the Working Group anticipates sending a referral to the Blanks (E) Working Group to remove the instruction allowing original cost for these investments.


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Application of Fair Value and Systematic Value

17. With the identification that fair value was the most appropriate measurement method for SVO-Identified investments, and that several reporting entities (including some small and medium-size insurers) would prefer to use a fair value measurement method, the Working Group agreed that the statutory accounting guidance would require use of fair value (allowing NAV as a practical expedient) as the measurement method for SVO-Identified investments after initial recognition unless the reporting entity elects to use a documented systematic approach to amortize or accrete the investment in a manner that represents expected cash flows from the underlying bond holdings (systematic value). The issue paper provides this election for all SVO-Identified investments; however, it is anticipated that the systematic value measurement method may only be applied for SVO-Identified bond ETFs.

18. In addition to specifically electing its use, the Working Group agreed that certain criteria must be met in order for the investment to be reflected using a systematic value measurement method:

a. NAIC Designation: SVO-Identified investment must have a qualifying NAIC designation of NAIC 1 to 5 for AVR filers, and NAIC 1 or 2 for non-AVR filers. These NAIC designations correspond with the ability to use amortized cost for bonds in SSAP No. 26. Reporting entities holding SVO-Identified investments that do not qualify based on NAIC designation would not be permitted to elect use of the systematic value method and would be required to report these investments at fair value (or NAV). i. Pursuant to this project, it was identified that some reporting entities have

previously concluded that SVO-Identified bond ETF investments are always high-quality investments with an NAIC 1 or NAIC 2 designation. This is not an accurate conclusion. Inclusion on the SVO-Identified bond ETF listing indicates that the investment meets the overall requirements in the P&P Manual. A separate process to review the credit-quality of the underlying ETF holdings determines the NAIC designation. The SVO-Identified bond ETF investments, as of December 31, 2015, included several ETFs with NAIC designations below an NAIC 2, including investments with NAIC 4 designations. With the SVO designation process, these investments could be classified at any NAIC designation level, including an NAIC 6. With the guidance proposed in this issue paper, non-AVR filers holding an SVO-Identified bond ETF investment with an NAIC 3 (or lower) designation would be required to report the investment at fair value (or NAV) and would not be permitted to utilize the systematic value method.

b. Irrevocable Election: Reporting entities must make an irrevocable election (by CUSIP) to

use systematic value at the time the investment is originally acquired. This election shall remain as long as the investment (by CUSIP) is held (subject to other requirements). Subsequent acquisitions of the same ETF (by CUSIP), if the ETF is already held, are required to follow the same measurement method originally elected.

i. The Working Group considered requiring reporting entities to designate either “fair value” or “systematic value” for all SVO-Identified investments they owned that were included on an SVO listing (e.g., same measurement method for all investments included on the SVO-Identified ETF-bond listing). However, as the information (e.g., cash flows) to calculate systematic value may not be readily available for all investments on an SVO listing, the Working Group noted that by requiring a measurement method election for all such investments held, the guidance would inadvertently restrict the SVO-Identified investments a reporting


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entity could utilize. (If a reporting entity had designated use of the systematic value method for investments on the SVO-Identified bond ETF listing, then the reporting entity would be restricted in only acquiring SVO-Identified bond ETFs from issuers that provide data necessary to calculate a systematic value method.) In order to prevent these inadvertent restrictions, the Working Group agreed that the measurement method could be determined on a CUSIP-by-CUSIP basis.

ii. With the requirement to designate the measurement method at the time of acquisition, the issue paper includes guidance allowing investments held by the reporting entity, which were originally acquired before inclusion on the SVO listing, to be measured using systematic value if the investment is subsequently added to the SVO list. This guidance specifies that the subsequent systematic value designation would be a change in accounting principle (as defined in SSAP No. 3—Accounting Changes and Corrections of Errors), and requires a cumulative effect adjustment to capital and surplus as if the accounting method had been applied for all prior periods in which the investment was held. As items may be added to the SVO listing, without notification to all reporting entities that hold those investments, provisions were included to allow a reporting entity to designate use of the systematic value before the year-end reporting of the investment in the year in which the SVO first includes the investment on their listing. With this approach, an ETF investment already held by the reporting entity that was designated as qualifying as an SVO-Identified ETF in February could be captured within SSAP No. 30—Unaffiliated Common Stock (reported on Schedule D – Part 2, Section 2) in the first three quarters and captured at systematic value as an SVO-Identified bond ETF, within SSAP No. 26 (reported on Schedule D – Part 1), at year-end. If the reporting entity continued to report the ETF as common stock, or reported the investment at fair value on Schedule D – Part 1 in the year-end financial statements, then the reporting entity would not be permitted to subsequently designate use of systematic value for that ETF investment. (Paragraph 18.b.iii addresses situations in which the investment is no longer captured on the SVO-Identified listing.)

iii. The guidance for an irrevocable election requires that the reporting entity utilize the systematic method as long as the investment (CUSIP) is held by the reporting entity and the investment continues to be on the SVO listing with a qualifying NAIC designation. With this guidance, a reporting entity could sell an entire investment (all of a particular CUSIP), reacquire the same investment, and make an election to apply a different measurement method. (For example, if previously held at fair value, a reporting entity could sell a bond ETF, reacquire and designate use of systematic value; or if previously held at systematic value, could sell the ETF, reacquire and use fair value.) If the investment is no longer included on the SVO listing, then the investment would no longer be captured within SSAP No. 26 and the investment would be reported per the measurement method stipulated within the applicable SSAP. If the investment was to decline in NAIC designation (to an NAIC designation that does not qualify for systematic value), but was retained on the SVO-Identified listing (still within the scope of SSAP No. 26), systematic value would not be permitted and the investment would be required to be reported at the lower of fair value or systematic value. In these situations, if systematic value is lower than fair value, a reporting entity is prevented from increasing the value of the investment to fair value.


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Staff Note: Staff requests continued discussion on the ability to sell investments, reacquire and utilize a new measurement method. Comments are requested on whether restrictions should be in place to prevent subsequent application of systematic value for all SVO-Identified investments once a reporting entity elects to terminate use of systematic value and recognize a gain (if fair value is higher). Comments are requested on a disclosure citing evidence of intent to dissolve the investment position, with a later decision to reacquire, as well as whether a specific timeframe between selling and reacquiring should be added. The guidance for systematic value is not intended to allow companies the ability to change measurement methods in response to market conditions.

Additionally, as a different viewpoint on this issue, see the Regulator Question 1 on page 15 regarding whether a sale should be required to change the measurement method.

c. Systematic Value Determination: The guidance requires reporting entities to follow a documented approach in determining systematic value. Although the domiciliary state is not required to approve the calculation prior to application, the calculation must be reviewable, with the domiciliary state having the ability to disallow or require modifications to the approach being utilized.

i. The guidance restricts reporting entities to one documented approach in determining systematic value for all SVO-Identified investments a company elects to measure under that approach. For example, if a reporting entity was to hold several bond ETFs, and elected to use systematic value, the same approach to calculate systematic value must be applied to all of the designated bond ETFs.

ii. Although comments have been received supporting a standard approach for determining systematic value, the Working Group has not provided a standard approach for this calculation. Similar to the rationale provided in paragraph 18.b.i, if a specific calculation was required, reporting entities that hold SVO-Identified investments from issuers that did not have the ability to provide all underlying data (e.g., cash flows) for the specified calculation would be restricted from utilizing the systematic value measurement method. This would also inadvertently promote (or discourage) specific investments on the SVO-listings. The Working Group does not agree with establishing accounting guidance that limits use of investments referenced by the SVO on the SVO-Identified listings.

iii. The Working Group agrees that different approaches to calculate systematic value could be utilized, but the Working Group should not assume ownership in reviewing and assessing proposed calculations, nor assume ownership to ensure subsequent updates or changes are properly reflected in calculations over time. The Working Group identified that other NAIC groups or representatives (such as the Valuation of Securities (E) Task Force, or representatives from the NAIC Capital Markets Bureau) would be more appropriate in opining on proposed systematic value calculations. If requested to review a systematic value calculation, the Working Group would refer it to the appropriate groups with a request for their assessment.

iv. Although concerns have been noted that the guidance would require regulators to review calculations, which may differ by reporting entity, the guidance does restrict each reporting entity to only one systematic value calculation for its SVO-Identified investments. It is anticipated that most reporting entities electing to use the systematic value method will use the same general approach,


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particularly as BlackRock – the issuer with the most bond ETFs on the SVO listing – has been working with other bond ETF issuers in developing a proposed systematic value calculation.

19. With the provisions to continue including SVO-Identified investments within the scope of SSAP No. 26, and to permit a “systematic value” measurement method, guidance has also been included to clarify that determination of IMR and AVR is based on the inclusion of these investments within scope of SSAP No. 26, and not the equity-nature of these investments. Pursuant to this guidance, if there is a recognized other-than-temporary impairment, the credit-loss impairment is recognized through AVR and the interest-related impairment is recognized through IMR.

Staff Note: The allocation to AVR and IMR was a particular element raised for these SVO-Identified investments. It was identified that if a bond was sold for a gain or loss, there would be an AVR/IMR impact, whereas, an ETF can change investments without impacting AVR/IMR. As noted in paragraph 19, the proposed guidance continues to only include these items within SSAP No. 26 for AVR/IMR assessment. Comments are requested on whether this is a concern that should be further considered in developing guidance.

20. With the provisions allowing use of systematic value for SVO-Identified investments, guidance has been included to clarify the requirements to assess and recognize impairment. This guidance for the SVO-Identified investments is generally consistent with impairment guidance for “equity items” (as there is no contractual amount of principle due for the SVO-Identified items), in which recognized losses are required when a decline in fair value is considered to be other-than-temporary, with guidance that a decision to sell an impaired security results with an other-then-temporary impairment that shall be recognized. Specific guidance is also included for investments reported at systematic value, noting that after recognition of an other-then-temporary impairment the investment is required to be subsequently reported at the lower of systematic value or fair value.

Systematic Value Disclosures

21. The guidance to allow a “systematic value” measurement method incorporates additional disclosures for reporting entities electing this measurement method. These disclosures include information on the approach for determining systematic value, whether the reporting entity consistently uses fair value or systematic value for all SVO-Identified investments, whether any investments are being reported differently from the prior reporting period (such as if the investment was sold and re-acquired), and identification of the securities that no longer qualify for systematic value measurement method.

SSAP No. 26 Definitions

Security Definition 22. One of the initial elements discussed as part of the Investment Classification Project was the definition of a “bond” captured within SSAP No. 26, and the use of that definition to distinguish between unsecured loans or collateral loans captured within SSAP No. 20—Nonadmitted Assets or SSAP No. 21—Other Admitted Assets: Per existing guidance in SSAP No. 26, paragraph 2:

2. Bonds shall be defined as any securities representing a creditor relationship, whereby there is a fixed schedule for one or more future payments.

23. With this definition, the main distinction in separating a bond, from another structure reflecting a creditor relationship with a fixed schedule for payments (such as an unsecured or collateral loan), was the requirement for the structure to be a “security.” Although the term “security” was defined in SSAP No. 37—Mortgage Loans, using the U.S. GAAP definition, the term was not defined in SSAP No. 26. After


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reviewing the U.S. GAAP definition, the Working Group agreed to include the U.S. GAAP definition for “security” within SSAP No. 26 to better clarify the overall bond definition:

This SSAP adopts the GAAP definition of a security as it is used in FASB Codification Topic 320 and 860: Security: A share, participation, or other interest in property or in an entity of the issuer or an obligation of the issuer that has all of the following characteristics:


b. It is of a type commonly dealt in on securities exchanges or markets or, when

represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.

c. It either is one of a class or series or by its terms is divisible into a class or series of

shares, participations, interests, or obligations. 24. With the discussion of the bond definition, the Working Group was informed of prior situations in which unsecured or collateral loans, within scope of SSAP No. 20 or SSAP No. 21, were reported as bonds on Schedule D – Part 1 (rather than on Schedule BA – Other Long-Term Invested Assets) based on an assessment that the loan had been rated by a credit rating provider (CRP) or had received an NAIC designation. The Working Group received information that the reporting of investments is intended to be based on the nature of the investment, and the guidance within the applicable SSAP, and there are no instances under statutory accounting in which obtaining a CRP rating or an NAIC designation would change an investment’s applicable SSAP, reporting schedule, or override other SSAP guidance that required the investment to be nonadmitted. For example, collateral loans are captured within SSAP No. 21, reported on Schedule BA, and are only admitted to the extent qualifying collateral is held to offset the loan balance. If the loan balance exceeds the amount of qualifying collateral held, the loan balance not covered by collateral is nonadmitted. A CRP rating or NAIC designation alone does not change the SSAP, reporting schedule, and potential nonadmittance of the investment. (With the SVO-Identified listings, an investment is included on the SVO-listing if it meets specific parameters. The NAIC designation, which is a secondary process after the investment qualifies for inclusion on an SVO-listing, does not change the inclusion of the security on the SVO-listing.)

25. With the structure, and provisions of the SVO, reporting entities can submit a variety of investment structures for credit-assessments and NAIC designations. The ability to obtain a credit assessment on an investment is not intended to be utilized as support for reclassification of the investment within scope of another SSAP or to report the investment on a different reporting schedule. NAIC designations are often utilized to determine the measurement method of investments within a particular SSAP (such as amortized cost, or lower of amortized cost or fair value), but as noted above, do not change the nature of the investment or the applicable SSAP the investment should be captured within.

Staff Note: Staff suggests that the Working Group consider directing NAIC staff to propose nonsubstantive revisions to SSAP No. 20 and SSAP No. 21, in a separate agenda item, to clarify the impact of a CRP rating / NAIC designation, as well as clarify the types of investments that qualify as collateral to determine whether a collateral loan is an admitted asset.

26. In addition to incorporating the definition of a “security” within the bond definition, the Working Group also considered definitions for certain investments previously identified to be within scope of SSAP No. 26, or referenced in the annual statement instructions as general classifications for bonds.

27. After reviewing proposed definitions, revisions have been proposed to incorporate changes and definitions of specific terms in SSAP No. 26. These terms are proposed to be included in a SSAP No. 26


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glossary, shown as Exhibit A in the issue paper. (The existing SSAP No. 26 Exhibit detailing Amortization Treatment for Callable Bonds would move to Exhibit B.)

28. Bank Loans Acquired through a Participation, Syndication or Assignment: Prior guidance in SSAP No. 26 included reference to the term “bank participations” as being within the bond definition. As a result of questions received on investments, the term “bank participations” has been deleted from SSAP No. 26, and instead specific guidance for bank loans has been proposed for inclusion:


a. Assignment – A bank loan assignment is defined as a fixed-income instrument in which there is the sale and transfer of the rights and obligations of a lender (as assignor) under an existing loan agreement to a new lender (and as assignee) pursuant to an Assignment and Acceptance Agreement (or similar agreement) which effects a novation under contract law, so the new lender becomes the direct creditor of and is in contractual privity with the borrower having the sole right to enforce rights under the loan agreement.

b. Participation – A bank loan participation is defined as a fixed-income investment in which a single lender makes a large loan to a borrower and subsequently transfers (sells) undivided interests in the loan to other entities. Transfers by the originating lender may take the legal form of either assignments or participations. The transfers are usually on a nonrecourse basis, and the originating lender continues to service the loan. The participating entity may or may not have the right to sell or transfer its participation during the term of the loan, depending on the terms of the participation agreement. Reporting entities shall account for loan participations within the guidelines of this statement if the participation agreement provides the reporting entity with the right to sell or transfer its participation during the term of the loan. Loan Participations can be made on a parri-passu basis (where each participant shares equally) or a senior subordinated basis (senior lenders get paid first and the subordinated participant gets paid if there are sufficient funds left to make a payment).

c. Syndication – A bank loan syndication is defined as a fixed-income investment in which several lenders share in lending to a single borrower. Each lender loans a specific amount to the borrower and has the right to repayment from the borrower. Separate debt instruments exist between the debtor and the individual creditors participating in the syndication. Each lender in a syndication shall account for the amounts it is owed by the borrower. Repayments by the borrower may be made to a lead lender that then distributes the collections to the other lenders of the syndicate. In those circumstances, the lead lender is simply functioning as a servicer and shall not recognize the aggregate loan as an asset. A loan syndication arrangement may result in multiple loans to the same borrower by different lenders. Each of those loans is considered a separate instrument.

29. The inclusion of a bank loan acquired by an assignment was an additional element incorporated within the issue paper after the August 15, 2015 direction by the Working Group. This inclusion was requested by the Valuation of Securities (E) Task Force in a referral dated June 10, 2016.

Staff Note: The VOSTF June 10, 2016 referral requests the Working Group to consider inclusion of bank loans acquired through assignment within the SSAP No. 26 revisions, and requests the Working Group to review proposed amendments to the P&P Manual to incorporate definitions, documentation standards, methodology and criteria for bank loans in the P&P Manual.


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Although referenced in the June 10, 2016 referral, NAIC SAPWG staff anticipates a separate referral to consider including Debtor-In-Possession (DIP) financing arrangements as within the scope of SSAP No. 26. This issue will be considered in a separate agenda item.

30. As identified above in the “participation” definition (paragraph 28.a.ii), bank loans acquired through a participation are only permitted if the participation agreement provides the reporting entity with the right to sell or transfer its participation during the term of the loan. Guidance has been proposed to clarify that participation loans that do not provide the reporting entity with the ability to sell or transfer are captured as unsecured loans in SSAP No. 20.

Staff Note: The participation definition was exposed with the restriction requiring that the reporting entity have the ability to sell or transfer the participation. Staff is under the impression that these restrictions are not supported, therefore requests comments from the Working Group (and the VOSTF) on whether bank loans acquired through participations should be permitted regardless of the ability to sell or transfer.

Staff Note: Staff requests comments on whether the proposed definition for “bank loans” is sufficient to reduce confusion on what is allowed within scope of SSAP No. 26 and “loans unsecured or secured by assets that do not qualify as investments” within scope of SSAP No. 20 or SSAP No. 21. Staff highlights comments received from AIG on July 30, 2014 to the Investment Reporting (E) Subgroup regarding collateral loans, and requests whether further clarification is necessary:

Collateral loans are not the same as bank loans. Both types have a requirement to pay principal and interest that is unconditional on the part of the issuer/obligor. However, bank loans are like corporate debt whereby the borrower’s credit paying ability is derived from their financial operating results. There are varied types of collateral loans but they are all backed by specific investments. Those collateral assets must each be an admissible investment and must be periodically evaluated for fair value. These loan obligations, collateralized by investments, cannot be evaluated by the SVO or SSG. The SVO’s internal structure is set up to analyze the credit quality of the obligor and not necessarily the value of specific assets.

31. Hybrid Securities: Prior guidance in SSAP No. 26 did not specifically identify hybrid securities. Rather, guidance for hybrid securities were included in the annual statement instructions as guidance for “General Classifications Bond Only” as follows:

Securities whose proceeds are accorded some degree of equity treatment by one or more of the nationally recognized statistical rating organizations and/or which are recognized as regulatory capital by the issuer’s primary regulatory authority. Hybrid securities are designed with characteristics of debt and equity and are intended to provide protection to the issuer’s senior note holders. Hybrid securities products are sometimes referred to as coupon securities. Examples of hybrid securities include Trust Preferreds, Yankee Tier 1s (with and without coupon step-ups) and debt-equity hybrids (with and without mandatory triggers). This specifically excludes surplus notes, which are reported in Schedule BA, subordinated debt issues, which have no coupon deferral features; and “traditional” preferred stocks, which are reported in Schedule D Part 2, Section 1. With respect to preferred stock, traditional preferred stocks include, but are not limited to a) U.S. issuers that do not allow tax deductibility for dividends; and b) those issued as preferred stock of the entity or an operating subsidiary, not through a trust or a special purpose vehicle.

32. After considering the definition from the annual statement instructions, revisions were proposed to incorporate a definition for “hybrids” in SSAP No. 26, comparable to the definition included within the instructions, removing all examples except for the reference to a “trust-preferred” security, which was noted as being commonly treated as a hybrid security for annual statement reporting. A definition for a “trust-preferred” based on the SEC definition, has also been included within SSAP No. 26. Consistent with the prior guidance in the annual statement instructions for hybrids, the guidance in SSAP No. 26


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specifically excludes surplus notes, subordinated debt issues which have no coupon deferrals, and “traditional” preferred stocks. The following definition for hybrids is proposed for inclusion in the SSAP:

Hybrids – Securities whose proceeds are accorded some degree of equity treatment by one or more of the nationally recognized statistical rating organizations (NRSRO) and/or which are recognized as regulatory capital by the issuer’s primary regulatory authority. Hybrid securities are designed with characteristics of debt and equity and are intended to provide protection to the issuer’s senior note holders. Hybrid securities are sometimes referred to as capital securities. An example of a hybrid is a trust-preferred security. Excluded from bond classification are surplus notes, which are reported on Schedule BA; subordinated debt issues, which have no coupon deferral features; and “traditional” preferred stocks, which should be captured under SSAP No. 32—Preferred Stocks. Traditional preferred stocks include, but are not limited to: a) U.S. issuers that do not allow tax deductibility for dividends; and b) those issued as preferred stock of the entity of an operating subsidiary, not through a trust or a special purpose trust.

Staff Note: Upon adoption, the Working Group may consider a referral to the Blanks (E) Working Group to either make corresponding revisions and/or remove the hybrid definition from the annual statement instructions with reference to SSAP No. 26.

33. With the inclusion of the hybrid definition, and the example of trust-preferred securities, a definition for trust-preferred securities has also been proposed for inclusion within the SSAP:

Trust Preferred Securities – Security possessing characteristics of both equity and debt. A company creates trust-preferred securities by creating a trust, issuing debt to it, and then having it issue preferred stock to investors. Trust-preferred securities are generally issued by bank holding companies. The preferred stock securities issued by the trust are what are referred to as trust-preferred securities. The security is a hybrid security with characteristics of both subordinated debt and preferred stock in that it is generally very long term (30 years or more), allows early redemption by the issuer, makes periodic fixed or variable interest payments, and matures at face value. In addition, trust preferred securities issued by bank holding companies will usually allow the deferral of interest payments for up to 5 years.

Staff Note: This definition has been revised from the previous exposure to be more succinct and provide less information on the use of these securities. (For example the prior definition included reference that these securities have been issued by banks for a number of years due to regulatory capital treatment. In review, staff does not propose to include that detail within the SSAP.)

34. Definitions were also proposed for inclusion in the SSAP No. 26 glossary to define convertible bonds, mandatory convertible bonds, Yankee bonds, and zero-coupon bonds, all of which are noted to be within scope of SSAP No. 26:

Convertible Bond – A bond that can be converted into a different security, typically shares of common stock. Mandatory Convertible Bonds - A type of convertible bond that has a required conversion or redemption feature. Either on or before a contractual conversion date, the holder must convert the mandatory convertible bond into the underlying common stock. Yankee Bonds – A bond denominated in U.S. dollars that is publicly issued in the U.S. by foreign banks and corporations. According to the Securities Act of 1933, these bonds must first be registered with the Securities and Exchange Commission (SEC) before they can be sold. Yankee bonds are often issued in tranches. Yankee bonds, or bonds issued by foreign entities denominated in U.S. dollars are not considered hybrid securities unless they have equity-like features.


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Zero Coupon Bond – A bond that does not pay interest during the life of the bond. Instead, investors buy zero coupon bonds at a deep discount from their face value, which is the amount a bond will be worth when it "matures" or comes due. When a zero coupon bond matures, the investor will receive one lump sum equal to the initial investment plus the imputed interest, which is discussed below. The maturity dates on zero coupon bonds are usually long-term. Because zero coupon bonds pay no interest until maturity, their prices fluctuate more than other types of bonds in the secondary market. In addition, although no payments are made on zero coupon bonds until they mature, investors may still have to pay federal, state, and local income tax on the imputed or "phantom" interest that accrues each year.

35. With the inclusion of the definitions identified in paragraph 34, the following elements are particularly noted:

a. Mandatory Convertible Bonds – The proposed definition replaces “mandatory convertible securities” with “mandatory convertible bonds” to clarify that only mandatory convertible bonds are within scope of SSAP No. 26. Revisions to SSAP No. 32 will be subsequently considered to provide guidance for mandatory convertible preferred stock securities.

b. Yankee Bonds – In the guidance within the annual statement instructions for hybrids, a reference to “Yankee Tier 1s” was included as an example hybrid security. In accordance with information received, Yankee bonds meet the definition of a bond within SSAP No. 26 and are not considered hybrids unless they have equity-like features.

c. Zero Coupon Bonds – Definition was incorporated to clarify the inclusion of these bonds within scope of SSAP No. 26. This definition was based on the SEC definition.

Staff Note: As part of the Working Group’s discussion on definitions, a definition for American Depository Receipts, based on the SEC, was also included. This definition is planned to be included within the statutory guidance, however, it is planned for inclusion in SSAP No. 30—Unaffiliated Common Stocks when amendments to that SSAP are proposed under the Investment Classification Project.

American Depository Receipt: The stocks of most foreign companies that trade in the U.S. markets are traded as American Depositary Receipts (ADRs) issued by U.S. depositary banks. Sometimes the terms “ADR” and “ADS” (American Depositary Share) are used interchangeably. An ADR is actually the negotiable physical certificate that evidences ADSs (in much the same way a stock certificate evidences shares of stock), and an ADS is the security that represents an ownership interest in deposited securities (in much the same way a share of stock represents an ownership interest in the corporation). ADRs are the instruments actually traded in the market. Each ADR represents one or more shares of a foreign stock or a fraction of a share. If you own an ADR you have the right to obtain the foreign stock it represents, but U.S. investors usually find it more convenient to own the ADR. The price of an ADR corresponds to the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares.

Transition

36. Transition guidance has been included within the SSAP to specify initial application of the guidance within this issue paper. Different transition guidance is provided depending on the change that will be reflected:

a. For SVO-Identified Investments Not Designated for Systematic Value: As the revisions move the prior measurement method (amortized cost / original cost) to fair value (NAV), at transition, the reporting entity only needs to record the investment at the new measurement method with recognition of the unrealized gain or loss (change from prior reporting value to current fair value). As fair value fluctuations occur, the measurement of the SVO-Identified investments will continue to reflect an updated measurement,


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based on current fair value with unrealized gains or losses recognized. For these investments, there is no need to reflect a cumulative-effect adjustment. (Reporting entities that have previously reported these investments at fair value will have no change at transition.)

b. For SVO-Identified Investments Designated for Systematic Value: As the revisions move the prior measurement method (amortized cost / original cost) to systematic value, which is a new measurement concept, the reporting entity shall recognize a change in accounting principle pursuant to SSAP No. 3. With this approach, the reporting entity shall recognize a cumulative effect to adjust capital and surplus as if the systematic value measurement method had been applied retroactively for all prior periods in which the SVO-Identified investment was reported within the scope of SSAP No. 26.

c. For SSAP No. 26 Scope Revisions: If the revisions to SSAP No. 26 (e.g., definitions) results with an investment no longer qualifying (or qualifying) within the scope of SSAP No. 26, this change shall be reflected prospectively from the effective date. As such, investments previously included within SSAP No. 26, that will move into the scope of another SSAP and reporting schedule shall be shown as dispositions on Schedule D – Part 4, and shown as an acquisition on the schedule for which it should be reported. (If the revisions move the investment into the scope of SSAP No. 26, the investment would be reported as a disposition on the prior investment schedule and as an acquisition on the Schedule D – Part 3.) The fair value of the investment as of the effective date shall be reflected as the new cost basis, with realized gains or losses recognized based on the prior carrying value.

Effective Date

37. Upon adoption of this issue paper, the NAIC will release a substantively revised Statement of Statutory Accounting Principles (SSAP) for comment. The SSAP will contain the adopted Summary Conclusion of this issue paper. Users of the Accounting Practices and Procedures Manual should note that issue papers are not represented in the Statutory Hierarchy (see Section IV of the Preamble) and therefore the conclusions reached in this issue paper should not be applied until the corresponding SSAP has been adopted by the Plenary of the NAIC.

RELEVANT STATUTORY ACCOUNTING AND GAAP GUIDANCE

Statutory Accounting


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Regulator Question 1 – Although not reflected in the issue paper, one comment received was whether reporting entities had to actually sell an SVO-Identified bond ETF in order to change the measurement method. The commenter inquired whether it would be permissible to change measurement methods if the reporting entity recognized a realized gain or loss as if they sold the SVO-Identified bond ETF, but did not actually sell and reacquire the ETF. In terms of financial statement impact, the main difference in mandating the sale would be the inflow and outflow of cash. This would impact the cash inflow amounts reported for bonds sold, and bonds acquired, but would not impact the “net cash from investments” reflected on the Cash Flow statement. As a concern, if there are no additional restrictions, permitting this action would allow entities to utilize “systematic value” to minimize recognition of unrealized fair value losses, but allow reporting entities to effectively recognize fair value gains when it was beneficial for financial statement presentation without incurring the cost of actually selling the investment.

Example 1 - ETF Reflected at Systematic Value of $100, with Fair Value of $90:

If Sold and Reacquired: This action would require the ETF to be shown on Schedule D – Part 4 and Schedule D – Part 3. The cash received would be reflected as “proceeds from investments sold” and the cash paid would be reflected as “cost of investments acquired” on the Cash Flow Statement.

Cash $90 Realized Loss $10

ETF $100 ETF $90 Cash $90

If Reclassified Without Sale: This action would not require the ETF to be shown on Schedule D – Part 4 and Schedule D – Part 3, and would not be shown on the Cash Flow statement. If this approach is supported, staff would propose disclosures to assist in identifying any of these situations.

Realized Loss $10 ETF $10

Example 2 - ETF Reflected at Systematic Value of $90, with Fair Value of $100:

If Sold and Reacquired: This action would require the ETF to be shown on Schedule D – Part 4 and Schedule D – Part 3. The cash received would be reflected as “proceeds from investments sold” and the cash paid would be reflected as “cost of investments acquired” on the Cash Flow Statement. If supported, staff would suggest restrictions preventing future use of the systematic value method.

Cash $100 ETF $90 Realized Gain $10

ETF $100 Cash $100

If Reclassified Without Sale: This action would not require the ETF to be shown on Schedule D – Part 4 and Schedule D – Part 3, and would not be shown on the Cash Flow statement. If supported, staff would suggest restrictions preventing future use of the systematic value method.

ETF $10 Realized Gain $10


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Substantive Revisions to SSAP No. 26—Bonds: SCOPE OF STATEMENT

1. This statement establishes statutory accounting principles for bonds, excluding loan-backed and structured securities.specific fixed-income investments, and particular funds identified by the Securities Valuation Office (SVO) as qualifying for bond treatment as identified in this statement.

2. This statement excludes:

a. Loan-backed and structured securities addressed in SSAP No. 43R—Loan-Backed and Structured Securities.

b. Securities that meet the definition in paragraph 3 with a maturity date of one year or less from date of acquisition, which qualify as cash equivalents or short-term investments, are addressed in SSAP No. 2—Cash, Drafts and Short-Term Investments.

c. Mortgage loans and other real estate lending activities made in the ordinary course of business. These investments are addressed in SSAP No. 37—Mortgage Loans and SSAP No. 39—Reverse Mortgages.

SUMMARY CONCLUSION

1.3. Bonds shall be defined as any securities2 representing a creditor relationship, whereby there is a fixed schedule for one or more future payments. This definition includes:

a. U.S. Treasury securities;(INT 01-25)

b. U.S. government agency securities;

c. Municipal securities;

d. Corporate bonds, including Yankee bonds and zero-coupon bonds;

e. Bank participations;

e. Convertible debtbonds, including mandatory convertible debt bonds as defined in paragraph 1011.b;

f. Fixed-income instruments specifically identified:

i.

2 This SSAP adopts the GAAP definition of a security as it is used in FASB Codification Topic 320 and 860: Security: A share, participation, or other interest in property or in an entity of the issuer or an obligation of the issuer that has all of the following characteristics:


b. It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is

commonly recognized in any area in which it is issued or dealt in as a medium for investment. c. It either is one of a class or series or by its terms is divisible into a class or series of shares, participations,

interests, or obligations.


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Certificates of deposit that have a fixed schedule of payments and a maturity date in excess of one year from the date of acquisition;

Commercial paper;

Exchange Traded Funds, which qualify for bond treatment, as identified in Part Six, Section 2, of the Purposes and Procedures Manual of the NAIC Investment Analysis Office;

Bond Mutual Funds, which qualify for bond treatment, as identified in Part Six, Section 2, of the Purposes and Procedures Manual of the NAIC Investment Analysis Office; and

Money Market Mutual Funds on the U.S. Direct Obligations/Full Faith and Credit Exempt List as identified in Part Six, Section 2, of the Purposes and Procedures Manual of the NAIC Investment Analysis Office.

Loan-backed and structured securities meet this definition, but are excluded from the scope of this statement, and are addressed in SSAP No. 43R—Loan-Backed and Structured Securities. Securities which meet the definition above, but have a maturity date of one year or less from the date of acquisition are addressed in SSAP No. 2—Cash, Drafts, and Short-term Investments. Mortgage loans and other real estate lending activities made in the ordinary course of business meet the definition above, but are not addressed in this statement. These types of transactions are addressed in SSAP No. 37—Mortgage Loans and SSAP No. 39—Reverse Mortgages. Investments in a debt instrument of a certified capital company (CAPCO) shall be reported as a bond in accordance with INT 06-02: Accounting and Reporting for Investments in a Certified Capital Company (CAPCO).Certifications of deposit that have a fixed schedule of payments and a maturity date in excess of one year from the date of acquisition;

ii. Bank loans acquired through a participation3, syndication or assignment;

iii. Hybrid securities, excluding surplus notes, subordinated debt issues which have no coupon deferral features, and traditional preferred stocks.

iv. Debt instruments in a certified capital company (CAPCO) (INT 06-02)

4. The definition of a bond, per paragraph 3, does not include equity investments, such as mutual funds or exchange-traded funds. However, the following types of SVO-identified investments are provided special statutory accounting treatment and are included within the scope of this statement. These investments shall follow the guidance within this statement, as if they were bonds, unless different treatment is specifically identified in paragraphs 23-29.

a. Exchange Traded Funds, which qualify for bond treatment, as identified in Part Six, Section 2 of the Purposes and Procedures Manual of the NAIC Investment Analysis Office. (SVO-identified ETFs are reported on Schedule D – Part 1.)

b. Bond Mutual Funds which qualify for the Bond List, as identified in Part Six, Section 2 of the Purposes and Procedures Manual of the NAIC Investment Analysis Office. (SVO-identified Bond Mutual Funds are reported on Schedule D – Part 1.)

f.c. Money Market Mutual Funds which qualify for the U.S. Direct Obligations / Full Faith and Credit Exempt List, as identified in Part Six, Section 2 of the Purposes and

3 Bank loans acquired through participations are only within scope of this statement if the participation agreement provides the reporting entity with the right to sell or transfer its participation during the term of the bank loan. Bank loans that cannot be sold or transferred shall be considered either collateral loans or unsecured loans and follow guidance in SSAP No. 20 or SSAP No. 21.


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Procedures Manual of the NAIC Investment Analysis Office. (SVO-identified exempt Money Market Mutual Funds are reported on Schedule DA as short-term investments.)

2.5. Bonds Investments within scope of this statement meet the definition of assets as defined in SSAP No. 4—Assets and Nonadmitted Assets and are admitted assets to the extent they conform to the requirements of this statement.

Acquisitions, Disposals and SalesChanges in Unrealized Gains and Losses

3.6. A bond acquisition or disposal shall be recorded on the trade date, (not the settlement date), except for the acquisition of private placement bonds which shall be recorded on the funding date. At acquisition, bonds shall be reported at their cost, including brokerage and other related fees.

7. For reporting entities required to maintain an Interest Maintenance Reserve (IMR), the accounting for realized capital gains and losses on sales of bonds shall be in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve. For reporting entities required to maintain an Asset Valuation Reserve (AVR), the accounting for unrealized gains and losses shall be in accordance with SSAP No. 7.

4.8. For reporting entities not required to maintain an IMR, realized gains and losses on sales of bonds shall be reported as net realized capital gains or losses in the statement of income. For reporting entities not required to maintain an AVR, unrealized gains and losses shall be recorded as a direct credit or charge to unassigned funds (surplus).

Amortized Cost

5.9. Amortization of bond premium or discount shall be calculated using the scientific (constant yield) interest method taking into consideration specified interest and principal provisions over the life of the bond (INT 07-01). Bonds containing call provisions (where the issue can be called away from the reporting entity at the issuer’s discretion), except “make-whole” call provisions, shall be amortized to the call or maturity value/date which produces the lowest asset value (yield-to-worst). Although the concept for yield-to-worst shall be followed for all callable bonds, make-whole call provisions, which allow the bond to be callable at any time, shall not be considered in determining the timeframe for amortizing bond premium or discount unless information is known by the reporting entity indicating that the issuer is expected to invoke the make-whole call provision.

Application of Yield-to-Worst

6.10. For callable bonds4, the first call date after the lockout period, (or the date of acquisition if no lockout period exists), shall be used as the “effective date of maturity” for reporting in Schedule D, Part 1. Depending on the characteristics of the callable bonds, the yield-to-worst concept in paragraph 6 9 shall be applied as follows:

a. For callable bonds with a lockout period, premium in excess of the next call price5 (subsequent to acquisition6 and lockout period) shall be amortized proportionally over the

4 Callable bonds within the scope of this paragraph 10 excludes bonds with make-whole call provisions unless information is known by the reporting entity indicating that the issuer is expected to invoke the make-whole call provision. 5 Reference to the “next call price” indicates that the reporting entity shall continuously review the call dates/prices to ensure that the amortization (and resulting BACV) follows the yield-to-worst concept throughout the time the reporting entity holds the bond. 6 The reporting entity shall only consider call dates/prices that occur after the reporting entity acquires the bond. If all of the call dates had expired prior to the reporting entity acquiring the bond, the reporting entity would consider the bond continuously callable without a lockout period.


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length of the lockout period. After each lockout period (if more than one), remaining premium shall be amortized to the call or maturity value/date which produces the lowest asset value.

b. For callable bonds without a lockout period, the book adjusted carrying value (at the time of acquisition) of the callable bonds shall equal the lesser of the next call price (subsequent to acquisition) or cost. Remaining premium shall then be amortized to the call or maturity value/date which produces the lowest asset value.

c. For callable bonds that do not have a stated call price, all premiums over par shall be immediately expensed. For callable bonds with a call price at par in advance of the maturity date, all premiums shall be amortized to the call date.

Balance Sheet Amount

11. Bonds, as defined in paragraph 3, except mandatory convertible securities addressed in paragraph 10, shall be valued and reported in accordance with this statement, the Purposes and Procedures Manual of the NAIC Investment Analysis Office, and the designation assigned in the NAIC Valuations of Securities product prepared by the NAIC Securities Valuation Office.

a. Bonds, except for mandatory convertible bonds: For reporting entities that maintain an Asset Valuation Reserve (AVR), the bonds shall be reported at amortized cost, except for those with an NAIC designation of 6, which shall be reported at the lower of amortized cost or fair value. For reporting entities that do not maintain an AVR, bonds that are designated highest-quality and high-quality (NAIC designations 1 and 2, respectively) shall be reported at amortized cost; with all other bonds (NAIC designations 3 to 6) shall be reported at the lower of amortized cost or fair value.

a.b. Mandatory convertible bonds: Mandatory convertible bonds are subject to special reporting instructions and are not assigned NAIC designations or unit prices by the SVO. The balance sheet amount for mandatory convertible bonds shall be reported at the lower of amortized cost or fair value during the period prior to conversion. This reporting method is not impacted by NAIC designation or information received from credit rating providers (CRPs). Upon conversion, these securities will be subject to the accounting guidance of the statement that reflects their revised characteristics. (For example, if converted to common stock, the security will be in scope of SSAP No. 30, if converted to preferred stock, the security will be in scope of SSAP No. 32.)

7.12. The premium paid on a zero coupon convertible bond that produces a negative yield as a result of the value of a warrant exceeding the bond discount shall be written off immediately so that a negative yield is not produced. The full amount of the premium should be recorded as amortization within investment income on the date of purchase.

8. Mandatory convertible securities are defined as a type of convertible bond that has a required conversion or redemption feature. Either on or before a contractual conversion date, the holder must convert the mandatory convertible security into the underlying common stock. Mandatory convertible securities are subject to special reporting instructions and are therefore not assigned NAIC designations or unit prices by the SVO. The balance sheet amount for mandatory convertible securities shall be reported at the lower of amortized cost or fair value during the period prior to conversion. This reporting method is not impacted by NAIC designation or information received from credit rating providers (CRPs). Upon conversion, these securities will be subject to the accounting guidance of the statement that reflects their revised characteristics.


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9. For reporting entities required to maintain an AVR, the accounting for unrealized gains and losses shall be in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve (SSAP No. 7). For reporting entities not required to maintain an AVR, unrealized gains and losses shall be recorded as a direct credit or charge to unassigned funds (surplus).

Impairment

10.13. An other-than-temporary (INT 06-07) impairment shall be considered to have occurred if it is probable that the reporting entity will be unable to collect all amounts due according to the contractual terms of a debt security in effect at the date of acquisition. A decline in fair value which is other-than-temporary includes situations where a reporting entity has made a decision to sell a security prior to its maturity at an amount below its carrying value. If it is determined that a decline in the fair value of a bond is other-than-temporary, an impairment loss shall be recognized as a realized loss equal to the entire difference between the bond’s carrying value and its fair value at the balance sheet date of the reporting period for which the assessment is made. The measurement of the impairment loss shall not include partial recoveries of fair value subsequent to the balance sheet date. For reporting entities required to maintain an AVR/IMR, the accounting for the entire amount of the realized capital loss shall be in accordance with SSAP No. 7—Asset Valuation Reserve and Interest Maintenance Reserve. Credit related other-than-temporary impairment losses shall be recorded through the AVR; interest related other-than-temporary impairment losses shall be recorded through the IMR.

11.14. In periods subsequent to the recognition of an other-than-temporary impairment loss for a bond, the reporting entity shall account for the other-than-temporarily impaired security as if the security had been purchased on the measurement date of the other-than-temporary impairment. The fair value of the bond on the measurement date shall become the new cost basis of the bond and the new cost basis shall not be adjusted for subsequent recoveries in fair value. The discount or reduced premium recorded for the security, based on the new cost basis, shall be amortized over the remaining life of the security in the prospective manner based on the amount and timing of future estimated cash flows. The security shall continue to be subject to impairment analysis for each subsequent reporting period. Future declines in fair value which are determined to be other-than temporary shall be recorded as realized losses.

Income

12.15. Interest income for any period consists of interest collected during the period, the change in the due and accrued interest between the beginning and end of the period as well as reductions for premium amortization and interest paid on acquisition of bonds, and the addition of discount accrual. In accordance with SSAP No. 34—Investment Income Due and Accrued, investment income shall be reduced for amounts which have been determined to be uncollectible. Contingent interest may be accrued if the applicable provisions of the underlying contract and the prerequisite conditions have been met.

13.16. A bond may provide for a prepayment penalty or acceleration fee in the event the bond is liquidated prior to its scheduled termination date. Such fees shall be reported as investment income when received.

14.17. The amount of prepayment penalty and/or acceleration fees to be reported as investment income shall be calculated as follows:

a. The amount of investment income reported is equal to the total proceeds (consideration) received less the Par value of the investment; and

b. Any difference between the book adjusted carrying value (BACV) and the Par Value at the time of disposal shall be reported as realized capital gains and losses, subject to the authoritative literature in SSAP No. 7.


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Origination Fees

15.18. Origination fees represent fees charged to the borrower in connection with the process of originating or restructuring a transaction such as the private placement of bonds. The fees include, but are not limited to, points, management, arrangement, placement, application, underwriting, and other fees pursuant to such a transaction. Origination fees shall not be recorded until received in cash. Origination fees intended to compensate the reporting entity for interest rate risks (e.g., points), shall be amortized into income over the term of the bond consistent with paragraph 6 9 of this statement. Other origination fees shall be recorded as income upon receipt.

Origination, Acquisition, and Commitment Costs

16.19. Costs related to origination when paid in the form of brokerage and other related fees shall be capitalized as part of the cost of the bond, consistent with paragraph 4 6 of this statement. All other costs, including internal costs or costs paid to an affiliated entity related to origination, purchase or commitment to purchase bonds shall be charged to expense when incurred.

Commitment Fees

17.20. Commitment fees are fees paid to the reporting entity that obligate the reporting entity to make available funds for future borrowing under a specified condition. A fee paid to the reporting entity to obtain a commitment to make funds available at some time in the future, generally, is refundable only if the bond is issued. If the bond is not issued, then the fees shall be recorded as investment income by the reporting entity when the commitment expires.

18.21. A fee paid to the reporting entity to obtain a commitment to be able to borrow funds at a specified rate and with specified terms quoted in the commitment agreement, generally, is not refundable unless the commitment is refused by the reporting entity. This type of fee shall be deferred, and amortization shall depend on whether or not the commitment is exercised. If the commitment is exercised, then the fee shall be amortized in accordance with paragraph 6 9 of this statement over the life of the bond as an adjustment to the investment income on the bond. If the commitment expires unexercised, the commitment fee shall be recognized in income on the commitment expiration date.

Exchanges and Conversions

19.22. If a bond is exchanged or converted into other securities (including conversions of mandatory convertible securities addressed in paragraph 1011.b), the fair value of the bond surrendered at the date of the exchange or conversion shall become the cost basis for the new securities with any gain or loss realized at the time of the exchange or conversion. However, if the fair value of the securities received in an exchange or conversion is more clearly evident than the fair value of the bond surrendered, then it shall become the cost basis for the new securities.

SVO-Identified Investments

23. SVO-identified investments, as discussed in paragraph 4, are captured within the scope of this statement for accounting and reporting7 purposes only. The inclusion of these investments within this statement is not intended to contradict state law regarding the classification of these investments and does not intend to provide exceptions to state investment limitations involving types of financial instruments (e.g., equity interests), or with regards to concentration risk (e.g., issuer).

7 With the inclusion of these SVO-identified investments in Schedule D-Part 1 or Schedule DA, specific guidelines are detailed in the Annual Statement Instructions for reporting purposes.


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24. SVO-identified investments shall be initially reported at cost, including brokerage and other related fees. Subsequently, SVO-identified investments shall be reported at fair value8 unless the reporting entity has elected use of a documented systematic approach to amortize or accrete the investment in a manner that represents the expected cash flows from the underlying bond holdings. This special measurement approach is referred to as the “systematic value” measurement method and shall only be used for the SVO-identified investments within scope of this statement.

25. Use of the systematic value for SVO-identified investments is limited as follows:

a. Systematic value is only permitted to be designated as the measurement method for AVR filers acquiring qualifying investments that have an NAIC designation of 1 to 5, and for non-AVR filers acquiring qualifying investments with an NAIC designation of 1 or 2.

b. Designated use of a systematic value is an irrevocable election per qualifying investment (by CUSIP) at the time investment is originally acquired9. Investments owned prior to being identified by the SVO as a qualifying SSAP No. 26 investment are permitted to be subsequently designated to the systematic value measurement method. This designation shall be applied as a change in accounting principle pursuant to SSAP No. 3, which requires the reporting entity to recognize a cumulative effect to adjust capital and surplus as if the systematic value measurement method had been applied retroactively for all prior periods in which the investment was held. The election to use systematic value for investments shall be made before the year-end reporting of the investment in the year in which the SVO first identifies the investment as a qualifying SSAP No. 26 investment.

c. Once designated for a particular investment, the systematic value measurement method must be retained as long as the qualifying investment is held by the reporting entity and the investment remains within scope of this statement with an allowable NAIC designation per paragraph 25a. Subsequent purchases of an SVO-identified investment must follow the election previously made by the reporting entity. If an investment no longer qualifies because the NAIC designation has declined, then the security must be subsequently reported at the lower of “systematic value” or fair value10. If the security has been removed from the SVO-identified listings, and is no longer in scope of this statement, then the security shall be measured and reported in accordance with the applicable SSAP.

d. Determination of the designated systematic value must follow a documented approach, which is consistently applied for all equity SVO-identified investments designated for a systematic value. Unless domiciliary state rules/regulations requires otherwise, the documented approach is not required to be approved by the domiciliary state before initial application, but must be reviewable with the domiciliary state having the ability to disallow, or require modifications to the approach. In all situations, an approach that continuously reflects “original” or “historical cost” is not an acceptable measurement method. The designated approach shall result with systematic amortization or accretion of the equity investment in a manner that represents the expected cash flows from the underlying bond holdings.

8 For these investments, net asset value (NAV) is allowed as a practical expedient to fair value. 9 This guidance requires investments purchased in lots to follow the measurement method established at the time the investment was first acquired. 10 Recognition of unrealized gains from fair value fluctuations is prohibited for investments designated as following a “systematic value.”


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26. Income distributions received from SVO-identified investments (cash or shares) shall be reported as interest income in the period in which it is received. (Staff notes that the phrase “received” matches prior info from BlackRock. Staff would prefer for this to be “earned,” however, comments are requested on whether “earned” is something that can be determined for ETFs.)

27. For reporting entities required to hold an IMR and AVR reserve, realized and unrealized gains and losses for the SVO-identified investments shall be reported in accordance SSAP No. 7.

28. Regardless if reporting at fair value or systematic value, the SVO-identified investments shall be assessed for impairment on the basis of fair value. For any decline in fair value of the SVO-identified investment that is determined to be other than temporary (INT 06-07) the SVO-identified investment shall be written down to fair value as the new cost basis and the amount of the write-down shall be accounted for as a realized loss. For reporting entities required to maintain an IMR/AVR, the realized losses shall be accounted for in accordance with SSAP No. 7. Credit related other-than-temporary impairment losses shall be recorded through the AVR; interest related other-than-temporary impairment losses shall be recorded through the IMR. A decline in fair value which is other than temporary includes situations where a reporting entity has made a decision to sell a security at an amount below its carrying value.

29. Upon recognition of an other-than-temporary impairment of a SVO-identified investment, the reporting entity shall subsequently report the investment at the lower of systematic value or fair value. Future declines in fair value which are determined to be other-than-temporary shall be recorded as realized losses.

Disclosures

20.30. The financial statements shall include the following disclosures:

a. Fair value in accordance with SSAP No. 100—Fair Value;

b. Concentrations of credit risk in accordance with SSAP No. 27—Off-Balance-Sheet and Credit Risk Disclosures (SSAP No. 27);

c. The basis at which the bonds, mandatory convertible securities, and SVO-identified investments identified in paragraph 4, are stated;

d. Amortization method for bonds and mandatory convertible securities, and if elected by the reporting entity, the approach for determining the systematic value for SVO-identified securities per paragraph 24. If utilizing systematic value measurement method approach for SVO-identified investments, the reporting entity must include the following information:

i. Whether the reporting entity consistently utilizes the same measurement method for all SVO-identified investments11 (e.g., fair value or systematic value). If different measurement methods are used12, information on why the reporting entity has elected to use fair value for some SVO-identified investments and systematic value for others.

11 As identified in paragraph 25d, a consistent approach must be followed for all investments designated to use the systematic value method. As such, this disclosure is limited to situations in which a reporting entity uses both fair value and systematic value for reported SVO-identified investments. 12 The guidance in this statement allows different measurement methods by qualifying investment (CUSIP), but it is anticipated that companies will generally utilize a consistent approach for all qualifying investments.


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ii. Whether SVO-identified investments are being reporting at a different measurement method from what was used in the prior reporting period. (For example, if reported at systematic value prior to the sale, and then reacquired and reported at fair value.)

STAFF NOTE: The above disclosure is included as an example if a change in measurement method was allowed. Whether a change is permitted will depend on the Working Group’s decision of guidance in paragraph 25c. If the intent is to not allow a change in measurement method, the above disclosure would not be needed.

Regulator comments have noted concern with a “wash sale” approach that allows a change in measurement methods. Comments are specifically requested on requiring disclosures citing evidence that the company intended to exit the investment, with a later decision to re-enter the investment. Comments are also specifically requested on the timeframe needed between selling the investment before reacquiring the investment.

i.iii. Identification of securities still held that no longer qualify for the systematic value method. This should separately identify those securities that are still within scope of SSAP No. 26 and those that are being reported under a different SSAP. ;

d.e. For each balance sheet presented, the book/adjusted carrying values, fair values, excess of book/carrying value over fair value or fair value over book/adjusted carrying values for each pertinent bond category issued by:

i. U.S. Governments;

ii. All Other Governments;

iii. States, Territories and Possessions (Direct and Guaranteed);

iv. Political Subdivisions of States, Territories and Possessions (Direct and Guaranteed);

v. Special Revenue & Special Assessment Obligations and all Non-Guaranteed Obligations of Agencies and Authorities of Governments and Their Political Subdivisions;

vi. Industrial & Miscellaneous (Unaffiliated);

vii. Hybrid Securities;

viii. Parent, Subsidiaries and Affiliates;

e.f. For the most recent balance sheet, the book/adjusted carrying values and the fair values of bonds due:

i. In one year or less;

ii. After one year through five years;

iii. After five years through ten years;

iv. After ten years; and


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f.g. For each period for which results of operations are presented, the proceeds from sales of such bonds and gross realized gains and gross realized losses on such sales.

g.h. For each balance sheet presented, all bonds in an unrealized loss position for which other-than-temporary declines in value have not been recognized:

i. The aggregate amount of unrealized losses (that is, the amount by which cost or amortized cost exceeds fair value) and

ii. The aggregate related fair value of bonds with unrealized losses.

h.i. The disclosures in paragraphs 2230.h.i. and 2230.h.ii. should be segregated by those bonds that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer using fair values determined in accordance with SSAP No. 100.

i.j. As of the most recent balance sheet date presented, additional information should be included describing the general categories of information that the investor considered in reaching the conclusion that the impairments are not other-than-temporary.

j.k. When it is not practicable to estimate fair value in accordance with SSAP No. 100, the investor should disclose the following additional information, if applicable, as of each date for which a statement of financial position is presented in its annual financial statements:

i. The aggregate carrying value of the investments not evaluated for impairment, and

ii. The circumstances that may have a significant adverse effect on the fair value.

k.l. Separately identify structured notes, on a CUSIP basis, with information by CUSIP for actual cost, fair value, book/adjusted carrying value, and whether the structured note is a mortgage-referenced security.13

l.m. For securities sold, redeemed or otherwise disposed as a result of a callable feature (including make whole call provisions), disclose the number of CUSIPs sold, disposed or otherwise redeemed and the aggregate amount of investment income generated as a result of a prepayment penalty and/or acceleration fee.

21.31. Refer to the Preamble for further discussion regarding disclosure requirements. The disclosures in paragraphs 2230.b., 2230.e., 2230.f., 2230.g., 2230.h., 2230.i., 2230.j. and 2230.k. shall be included in the annual audited statutory financial reports only.

Relevant Literature

22.32. This statement adopts AICPA Statement of Position 90-11, Disclosure of Certain Information by Financial Institutions About Debt Securities Held as Assets, and AICPA Practice Bulletin No. 4, Accounting for Foreign Debt/Equity Swaps. This statement also adopts FASB Staff Position 115-1/124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, paragraph 16, with modification to be consistent with statutory language in the respective statutory

13 Determination of a “structured note” and “mortgage-referenced security” for this disclosure shall follow the definitions adopted within the Purposes and Procedures Manual of the NAIC Investment Analysis Office.


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accounting statements. This statement adopts the GAAP definition of “security” as it is used in FASB Codification Topic 320 and 860.

23.33. This statement rejects the GAAP guidance for debt securities, which is contained in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, FASB Emerging Issues Task Force No. 89-18, Divestitures of Certain Investment Securities to an Unregulated Commonly Controlled Entity under FIRREA, and FASB Emerging Issues Task Force No. 96-10, Impact of Certain Transactions on Held-to-Maturity Classifications Under FASB Statement No. 115.

Effective Date and Transition

24.34. This statement is effective for years beginning January 1, 2001. A change resulting from the adoption of this statement shall be accounted for as a change in accounting principle in accordance with SSAP No. 3—Accounting Changes and Corrections of Errors. The guidance in paragraphs 12 13 and 13 14 was previously included within SSAP No. 99—Accounting for Securities Subsequent to an Other-Than-Temporary Impairment and was effective for reporting periods beginning on January 1 2009, and thereafter, with early adoption permitted. In 2010, the guidance from SSAP No. 99 was incorporated within the impacted standards, with SSAP No. 99 superseded. The original impairment guidance included in this standard, and the substantive revisions reflected in SSAP No. 99 are retained for historical purposes in Issue Paper No. 131. Guidance reflected in paragraph 912, incorporated from INT 02-05: Accounting for Zero Coupon Convertible Bonds, was originally effective December 8, 2002. Guidance adopted in December 2013 clarifying the ‘yield-to-worst’ concept for bonds with make-whole call provisions is a nonsubstantive change initially effective January 1, 2014, unless the company has previously been following the guidance. (Companies that have previously been following the original intent, as clarified in the revisions, should not be impacted by these changes.) The guidance in paragraph 16 17 with respect to the calculation of investment income for prepayment penalty and/or acceleration fees is effective January 1, 2017, on a prospective basis and is required for interim and annual reporting periods thereafter. Early application is permitted.

35. In _________, substantive revisions, as detailed in Issue Paper No. ____, were adopted. These revisions, effective December 31, 2017, clarify the definition of a bond and what is in scope of the bond definition, as well as incorporate new guidance for SVO-Identified investments identified as in scope of SSAP No. 26, but that are not considered bonds. As of the effective date, reporting entities shall modify the measurement method for SVO-Identified investments to reflect the guidance in the substantive revisions as follows:

STAFF NOTE: Regulator comments have specifically requested a Dec. 31, 2017 effective date. Comments are requested on this proposed effective date, however, comments are also requested on a Jan. 1, 2018 effective date, with early adoption permitted.

a. For SVO-Identified investments captured within SSAP No. 26 and held by the reporting entity at the time of transition that will be reported at fair value (or NAV), the reporting entity shall reflect an unrealized gain or unrealized loss for the difference between the prior book/adjusted carrying value and fair value (NAV). Subsequently the investment shall continue to be reported at fair value (or NAV) with fair value fluctuations recorded as unrealized gains or losses, until the time of sale or recognition of an other-then-temporary impairment.

b. For SVO-Identified investments captured within SSAP No. 26 and held by the reporting entity at the time of transition for which the reporting entity elects use of the systematic value measurement method, the change in measurement method shall be recognized as a change in accounting principle pursuant to SSAP No. 3. With this approach, the reporting entity shall


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recognize a cumulative effect to adjust capital and surplus as if the systematic value measurement method had been applied retroactively for all prior periods in which the investment was reported within scope of SSAP No. 26.

c. For SSAP No. 26 Scope Revisions: If the revisions to SSAP No. 26 (e.g., definitions) results with an investment no longer qualifying (or qualifying) within scope of SSAP No. 26, this change shall be reflected prospectively from the effective date. As such, investments previously included within SSAP No. 26, that will move within scope of another SSAP and reporting schedule shall be shown as dispositions on Schedule D – Part 4, and shown as an acquisition on the schedule for which it will be subsequently reported. (If the revisions move the investment into the scope of SSAP No. 26, the investment shall be reported as a disposition on the prior investment schedule and as an acquisition on the Schedule D – Part 3.) The fair value as of the investment date shall be reflected as the new cost basis, with realized gains or losses recognized based on the prior carrying value.

REFERENCES

Other

• Purposes and Procedures Manual of the NAIC Investment Analysis Office

• NAIC Valuation of Securities product prepared by the Securities Valuation Office

Relevant Issue Papers

• Issue Paper No. 26—Bonds, Excluding Loan-Backed and Structured Securities

• Issue Paper No. 131—Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment

(Note: Exhibit – Amortization Treatment for Callable Bonds is not included in the issue paper. This Exhibit will be renamed to Exhibit B.)


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EXHIBIT A – SSAP NO. 26 GLOSSARY


• Assignment – A bank loan assignment is defined as a fixed-income instrument in which there is

the sale and transfer of the rights and obligations of a lender (as assignor) under an existing loan agreement to a new lender (and as assignee) pursuant to an Assignment and Acceptance Agreement (or similar agreement) which effects a novation under contract law, so the new lender becomes the direct creditor of and is in contractual privity with the borrower having the sole right to enforce rights under the loan agreement.

• Participation – A bank loan participation is defined as a fixed-income investment in which a

single lender makes a large loan to a borrower and subsequently transfers (sells) undivided interests in the loan to other entities. Transfers by the originating lender may take the legal form of either assignments or participations. The transfers are usually on a nonrecourse basis, and the originating lender continues to service the loan. The participating entity may or may not have the right to sell or transfer its participation during the term of the loan, depending on the terms of the participation agreement. Reporting entities shall account for loan participations within the guidelines of this statement if the participation agreement provides the reporting entity with the right to sell or transfer its participation during the term of the loan. Loan Participations can be made on a parri-passu basis (where each participant shares equally) or a senior subordinated basis (senior lenders get paid first and the subordinated participant gets paid if there are sufficient funds left to make a payment).

• Syndication – A bank loan syndication is defined as a fixed-income investment in which several

lenders share in lending to a single borrower. Each lender loans a specific amount to the borrower and has the right to repayment from the borrower. Separate debt instruments exist between the debtor and the individual creditors participating in the syndication. Each lender in a syndication shall account for the amounts it is owed by the borrower. Repayments by the borrower may be made to a lead lender that then distributes the collections to the other lenders of the syndicate. In those circumstances, the lead lender is simply functioning as a servicer and shall not recognize the aggregate loan as an asset. A loan syndication arrangement may result in multiple loans to the same borrower by different lenders. Each of those loans is considered a separate instrument.

Bond – Securities representing a creditor relationship, whereby there is a fixed schedule for one or more future payments. Convertible Bond – A bond that can be converted into a different security, typically shares of common stock. Hybrids – Securities whose proceeds are accorded some degree of equity treatment by one or more of the nationally recognized statistical rating organizations (NRSRO) and/or which are recognized as regulatory capital by the issuer’s primary regulatory authority. Hybrid securities are designed with characteristics of debt and equity and are intended to provide protection to the issuer’s senior note holders. Hybrid securities are sometimes referred to as capital securities. An example of a hybrid is a trust-preferred security. Excluded from bond classification are surplus notes, which are reported on BA; subordinated debt issues, which have no coupon deferral features; and “Traditional” preferred stocks, which should be captured under SSAP No. 32—Preferred Stocks. Traditional preferred stocks include, but are not limited to a) U.S. issuers that do not allow tax deductibility for dividends; and b) those issued as preferred stock of the entity of an operating subsidiary, not through a trust or a special purpose trust.


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Trust Preferred Securities – Security possessing characteristics of both equity and debt. A company creates trust-preferred securities by creating a trust, issuing debt to it, and then having it issue preferred stock to investors. Trust-preferred securities are generally issued by bank holding companies. The preferred stock securities issued by the trust are what are referred to as trust-preferred securities. The security is a hybrid security with characteristics of both subordinated debt and preferred stock in that it is generally very long term (30 years or more), allows early redemption by the issuer, makes periodic fixed or variable interest payments, and matures at face value. In addition, trust preferred securities issued by bank holding companies will usually allow the deferral of interest payments for up to 5 years. Mandatory Convertible Bonds - A type of convertible bond that has a required conversion or redemption feature. Either on or before a contractual conversion date, the holder must convert the mandatory convertible bond into the underlying common stock. Security – Adopts the GAAP definition of a security as it is used in FASB Codification Topic 320 and 860: A share, participation, or other interest in property or in an entity of the issuer or an obligation of the issuer that has all of the following characteristics:

a. It is either represented by an instrument issued in bearer or registered form or, if not

represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.

b. It is of a type commonly dealt in on securities exchanges or markets or, when represented

by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.

c. It either is one of a class or series or by its terms is divisible into a class or series of

shares, participations, interests, or obligations. Yankee Bonds – A bond denominated in U.S. dollars that is publicly issued in the U.S. by foreign banks and corporations. According to the Securities Act of 1933, these bonds must first be registered with the Securities and Exchange Commission (SEC) before they can be sold. Yankee bonds are often issued in tranches. Yankee bonds, or bonds issued by foreign entities denominated in U.S. dollars are not considered hybrid securities unless they have equity-like features. Zero Coupon Bond – A bond that does not pay interest during the life of the bond. Instead, investors buy zero coupon bonds at a deep discount from their face value, which is the amount a bond will be worth when it "matures" or comes due. When a zero coupon bond matures, the investor will receive one lump sum equal to the initial investment plus the imputed interest, which is discussed below. The maturity dates on zero coupon bonds are usually long-term. Because zero coupon bonds pay no interest until maturity, their prices fluctuate more than other types of bonds in the secondary market. In addition, although no payments are made on zero coupon bonds until they mature, investors may still have to pay federal, state, and local income tax on the imputed or "phantom" interest that accrues each year. G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\L - SSAP No. 26 IP.docx

Attachment M

December XX, 2016 Technical Director Fire Reference No. 2016-330 Financial Accounting Standards Board 401 Merritt 7 Norwalk, CT 06856-5116 The Statutory Accounting Principles (E) Working Group (SAPWG) of the NAIC 1 is responsible for the development and enhancement of Statements of Statutory Accounting Principles (SSAPs) used by U.S. insurers in their statutory filings. Statutory Accounting Principles (SAP) presents an effective, comprehensive and understood approach, which has been built using the framework established by U.S. GAAP. Under the SAP process, all new GAAP issuances are considered and ultimately adopted, adopted with modification, or rejected. Although SAP may make some modifications, it is preferred to have minimal differences in accounting methodologies between SAP and GAAP, with as limited variations as possible to meet regulatory objectives. Consequently, proposals that significantly revise GAAP standards are a vital matter for U.S. regulators. The statements within this letter are predominantly from the viewpoint of the financial statement user. The NAIC’s primary goal is to protect policyholders, including regulation of insurer financial solvency, with direct interest in minimizing differences between GAAP and SAP, however, our responsibilities are not limited to this role. We have a profound interest in ensuring insurers have access to capital markets to obtain capital to expand their business, to provide new and innovative products, to increase competition in existing markets as well as to meet liquidity and capital needs in possible stress situations, all of which are benefits for policyholders. As such, we have a keen interest of revisions proposed to general purpose financial statement accounting standards. The SAPWG has historically followed the development of U.S. GAAP insurance revisions, and supported the separation of the insurance project into short-duration and long-duration projects. The SAPWG also supported the approach to consider targeted revisions to existing requirements, and agrees that this the targeted improvement approach will most likely result in meaningful improvements for financial reporting, without the extent of costs expected from incorporating new measurement models. Although considered targeted improvements, the SAPWG highlights that the proposed revisions in the ASU are significant changes from existing U.S. GAAP standards. We caution against assumptions that “targeted” is synonymous with “minimal” and encourage the FASB to take efforts to ensure an adequate timeframe for implementation, as well as, to consider industry and preparer concerns pertaining to application, transition and potential refinements to the standard during the implementation timeframe. We hope you find our input within this letter valuable. Summary Position U.S. regulators support the proposed ASU for long-duration insurance contracts as the guidance will improve decision-useful information necessary for financial statement users. As regulators use U.S. GAAP financial 1 The National Association of Insurance Commissioners (NAIC) is the U.S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best practices, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collective views of state regulators domestically and internationally. NAIC members, together with the central resources of the NAIC, form the national system of state-based insurance regulation in the U.S.

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statements to evaluate the consolidated positions of insurance company groups, the proposed revisions are also anticipated to positively impact regulators’ ability to assess insurance companies using a comprehensive, consolidated approach. Cash Flow Assumptions (Questions 2-3, and Questions 8-6 for Participating Contracts) Consistent with previous comments, U.S. regulators agree that assumptions of risks and uncertainties should be “unlocked” - with periodic reevaluations and updates - to reflect available information. We agree that recognizing changes in assumptions, to reflect actual historical experience and updated future cash flows expectations, will provide more decision useful information to users on management’s expectations of future net benefits to be paid. U.S. regulators support the proposed guidance to update cash flow assumptions on an annual basis, at the same time every year, or more frequently if actual experience or other evidence indicates that prior assumptions should be revised in the interim. Although our prior comments previously supported updates “each reporting period,” we agree that annual updates are sufficient in providing timely information unless actual experience or other evidence suggests that earlier cash flow assumptions should be revised. As U.S. regulators are focused on the use and relevance of the information presented in the financial statements, we are not commenting on the retrospective application process to update assumptions. We believe that comments on the ability to implement this process would be best addressed by the insurance company preparers. However, we do support the separate recognition processes for changes in cash flow and experience assumptions and changes from updating the discount rate. We agree that dividing information on these components will allow for users to better understand the information presented in the financial statements and the effect of the specific changes. Lastly, we agree that the timely recognition of losses is a critical component for proper presentation by insurance companies; therefore when it is identified that expected benefits and expenses exceed expected gross premiums, we support the immediate full recognition of those expected losses, eliminating the ability to defer losses into future periods.

Discount Rates (Questions 4-6, and Questions 10-12 for Participating Contracts)

Consistent with previous comments, U.S. regulators continue to agree that the discount rate, when used, should reflect the characteristics of the insurance contract liability (i.e., the economics of the insurance obligations including the nature, structure and term). Also consistent with prior comments, U.S. regulators support consistent application, across different reporting entities, in calculating discount rates. We have previously noted concern on the use of different methods as that could potentially distort financial results and hinder the ease in which financial results can be compared. In accordance with our position, we support the approach detailed in the exposure draft in which entities would maximize current observable market prices of high-quality fixed-income instruments with durations similar to the liability for future policy benefits in determining the discount rate. Comparable to our opposition on the consideration of own-creditworthiness in establishing the fair value of liabilities, we agree that similar contract liabilities across different reporting entities, which are not directly impacted by specific investment performance, should be determined similarly, and should not be impacted by the operational decisions (e.g., quality of the investment portfolio) of the separate reporting entities. We understand the Board’s simplicity rationale with the proposal to use the same discount rate approach for traditional, limited-pay and participating contracts, however, for discretionary components of participating components specifically attributable to investment performance, this approach could result with an inappropriate reflection of insurance contract obligations. As users of the financial statements, we must note that this approach could result with the financial statements not reflecting the most current view of an insurance company’s expected future cash flows. However, before deviating from the simplistic approach, we would encourage consideration of comments from preparers pertaining to the ability to bifurcate contract elements in order toon the application of apply relevantthe proposed discount rates approach to the different contract components, as well as an impact assessment to contract liabilities. If the investment performance for discretionary components would not be

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significantly different from a current high-quality, fixed-income instrument yield, then we agree there would be no need for the added complexity to bifurcate contract components. U.S. regulators identify that the timeframe to update the assumptions and the discount rate are proposed to be different in the exposure draft. (Cash flow assumptions would be updated at least annually, unless interim updates were warranted, and discount rates would be updated each reporting date.) We do not necessarily oppose this guidance, but question whether the discount rate change for a high-quality, fixed-income instrument would vary enough between reporting periods to warrant the costs to conduct these calculations and incorporate the changes in the financial statements. Although we agree that an updated discount rate would provide a more current measurement at each reporting date, we share the prior user concerns about unnecessary capital volatility between reporting periods, as well as concerns that the cost and process changes required to incorporate this change would be excessive for the limited measurement clarity this change may provide. We would encourage the Board to consider comments received from the preparers of financial statements, particularly with regards to cost and implementation efforts needed to incorporate this proposal in comparison to the added measurement value, and potentially reassess whether discount rate changes could be considered on an annual basis. If reconsidered, we would suggest discount rate changes to occur simultaneously, and/or, based on the same thresholds as changes in cash flow assumptions. Under our recommendation, the discount rate would be updated annually, unless evidence exists indicating that the discount rate should be updated for an interim reporting date, or at any time in which cash flow assumptions are revised. Market Risk Benefits (Questions 13-14) Consistent with previous comments, U.S. regulators agree that insurance entity obligations representing policyholder funds, as the contract holder bears the investment risk, and the insurance entity’s obligations under these contracts protecting against adverse capital market performance, should be reported at fair value through net income. We agree that the criteria established for these contracts and the insurance benefits are appropriate:

Contracts – Contract holder has ability to direct funds to one or more separate account investment alternatives maintained by the insurance entity; and investment performance, net of contract fees and assessments, is passed through to the contract holder. We agree that classification as a “separate account” or “legal insulation from general account liabilities” should not be required to identify these contracts. Benefits – Insurance entity provides a benefit protecting the contract holder from adverse capital market performance pertaining to equity risk, interest risk or foreign exchange risk. We agree that “insurance risks” (e.g., mortality) should not be captured in the assessment of capital market risks.

Deferred Acquisition Costs (Questions 15-17) U.S. regulators agree that the U.S. GAAP guidance for deferred acquisition costs improved significantly with the issuance of ASU 2010-26, Financial Services—Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (ASU 2010-26), and the restrictions to only capitalize incremental direct costs related to certain acquisition activities. Although acquisition costs continue to be expensed immediately under statutory accounting, we agree that the proposed exposure draft revisions will further improve accounting for these capitalized expenses by requiring amortization in proportion to the amount of insurance in-force, or on a straight-line basis. We highlight that the use of insurance in-force (or a straight-line approach) is an improvement in determining amortization timeframe, but would also recommend that the FASB consider comments from industry on additional alternatives to amortization. as premiums can increase overtime, but yet the amount of insurance in-force remains constant. We also agree with the immediate reduction of deferred acquisition costs in response to unexpected contract terminations (as the deferred acquisition cost no longer represents a future benefit from a successful contract), which would prevent the need for impairment assessment for these sunk costs. Presentation and Disclosure (Questions 18-19)

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U.S. regulators support the proposed reconciliation disclosures as the format and components will provide key information on fluctuations from beginning reserve balances to ending reserve balances, allowing for more detailed comparison of factors impacting reserves across different companies. We believe that the disaggregationenhanced of detail, as shown in the proposed illustrations, will provide significant benefit to financial statement users and the comparisons of insurance entities, and recommend consideration of preparer comments in determining the level of disaggregation feasible to be completed. Effective Date and Transition / Costs and Complexities (Questions 20-23) U.S. regulators believe that information on the key drivers affecting implementation, transition provisions and costs of adopting the proposed amendments (transition costs and cost of ongoing application) would be best addressed by insurance company preparers. Thank you for your review and consideration of this comment letter. Should you have any questions, please contact me at 614-728-1071, or NAIC staff Julie Gann (816-783-8966). Sincerely, Dale Bruggeman Chair, NAIC Statutory Accounting Principles Working Group G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\M - NAIC SAPWG Draft 11-16-2016.doc

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2016 – Summary of Exposure Draft Targeted Improvements to the Accounting for Long-Duration Contracts

Issued – Sept. 29, 2016 / Comments Due – Dec. 15, 2016 This document identifies the key revisions included in the 2016 FASB Long-Duration Contract Exposure Draft, along with information on past SAPWG positions and initial staff comments. Introduction - Convergence/Improvement of US GAAP: In 2013 the FASB and the IASB jointly considered several amendments for the accounting of both short-term and long-term insurance contracts. After considering comments received, the FASB elected to separate from the IASB on the comprehensive insurance contracts proposal, and instead consider targeted improvements for both short-term and long-term insurance contracts.

• Short-Term Contracts – For short-duration contracts, the FASB decided to focus on improving disclosures, and issued ASU 2015-09: Disclosures about Short-Duration Contracts in May 2015.

• Long-Term Contracts – For long-duration contracts, after outreach with users, preparers, auditors, as well as insurance industry trade groups and actuaries, the FASB decided to focus on making targeted improvements to existing recognition, measurement and disclosure requirements. (Although considered “targeted” improvements, these are significant changes to existing FASB guidance.)

Targeted Improvements A. Liability Assumptions: Amendments would require an insurance entity to update (1) the assumptions used to

measure future cash flows at least annually (or more frequently) and (2) the discount rate assumption at each reporting date.

B. Discount Rate: Amendments would require insurance companies to discount the liability for future policy

benefits using a high-quality fixed-income instrument yield. This change maximizes market observable inputs independent of the return that an insurance company expects to earn on its investment portfolio.

C. Market Risk Benefits: Amendments would require an insurance entity to measure all market risk benefits at fair value. Changes in fair value would be recognized in earnings, with the exception of fair value changes attributable to change in the instrument-specific credit risk, which would be recognized in other comprehensive income. Market risk benefits could be positive (assets) or negative (liabilities).

D. Amortization of Deferred Acquisition Costs: Amendments are intended to simplify the amortization of deferred acquisition costs (DAC). Under the amendments, DAC that are currently amortized in proportion to premiums, gross profits or gross margins would be amortized in proportion to the amount of insurance in force or on a straight-line basis if the amount of insurance in force over the expected term of the related contract cannot be reasonably estimated. DAC would not be subject to impairment testing.

E. Disclosures: Amendments would require an insurance entity to provide disaggregated rollforwards of the liability for future policy benefits, policyholder account balances, market risk benefits, separate account liabilities and deferred acquisition costs. The amendments would also require an insurance entity to disclose quantitative and qualitative information about significant inputs, judgements, and assumptions used in measurement, including changes in those inputs, judgements, and assumptions and the effect of those changes on the measurement.

Comment Letter Summary: As detailed within, NAIC staff is proposing a comment letter noting support for key revisions in the FASB’s targeted improvements exposure draft from the basis of a financial statement user. These comments are consistent with general positions previously communicated by the Working Group. The letter does not provide comments on certain areas pertaining to application of the proposed revisions and suggests that the FASB consider comments from preparers on the feasibility of incorporating the proposed improvements.

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A. Liability Assumptions: Amendments would require an insurance entity to update (1) the assumptions used to measure future cash flows at least annually (or more frequently) and (2) the discount rate assumption at each reporting date. Overview / FASB Discussion

1. Under current U.S. GAAP, the liability for future policy benefits for traditional, limited-payment, and

participating contracts is accrued as premium revenue is recognized. The liability, which represents the present value of future benefits to be paid to (or on behalf of) policyholders and related expenses less the present value of future net premiums is estimated using methods that include assumptions applicable at the time that the insurance contracts are originated. The liability also includes a provision for risk of adverse deviation as an allowance for possible unfavorable deviations from assumptions.

2. The FASB has identified that the liability calculated under current guidance does not represent management’s expectation of future net benefits to be paid under the contract. Original assumptions continue to be used in subsequent periods to determine changes in the liability for future policy benefits (lock-in concept) unless a premium deficiency arises.

3. Rather than change the net premium reserving model, the FASB decided to retain the existing model, but improve it by eliminating the “lock-in” concept. Specifically, the Board decided to require an insurance entity to update all model assumptions on a periodic basis rather than retain contract inception assumptions over a contract’s life. The FASB believes that a liability measured with updated assumptions provides more decision-useful information and more faithfully represents the insurance entity’s obligation, as it provides a better estimate of an insurance entity’s expected future cash flows.

Key FASB Proposed Amendments:

4. Cash flow assumptions shall be updated on an annual basis, at the same time every year, or more frequently in

interim reporting periods if actual experience or other evidence suggests that earlier cash flow assumptions should be revised. (Updated assumptions shall reflect actual historical experience and updated future cash flow assumptions.) The updated cash flow assumptions shall be used to update the net premium ratio calculated as of the contract issue date. The revised ratio is applied retrospectively to derive an updated liability for future policy benefits, discounted at the original (contract issuance) discount rate. The updated liability is then compared to the carrying amount to determine the cumulative catch-up adjustment to be recognized in current-period benefit expense. The FASB identified that this “retrospective” approach better presents in earnings the prior-period effect of updated assumptions and allows for future profits to emerge on the basis of new assumptions without being encumbered by prior periods.

5. Discount rate assumptions shall be updated for annual and interim reporting periods. Net premiums shall not

be updated for discount rate assumption changes. The difference between the carrying amount of the liability for future policy benefits measured using the updated discount rate assumption and the original discount rate assumption shall be recognized directly to other comprehensive income (that is, on an immediate basis). The interest accretion rate shall remain the original discount rate used at contract issue date.

6. Experience adjustments shall be recognized in the period in which the experience arises.

7. If the present value of future benefits and expenses exceeds the present value of future gross premiums, an

immediate charge shall be recognized to current-period benefit expense such that net premiums are set equal to gross premiums. In no event shall the liability for future policy benefits balance be less than zero. The unlocking of assumptions eliminates the premium deficiency testing.

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Impact to SAP / Prior Comments / Initial Staff Assessment 8. Although statutory reserves are calculated differently than the current U.S. GAAP guidance, previously

proposed FASB revisions to “unlock” assumptions was a position previously supported by the SAPWG:

2013 NAIC Comment Letter – FASB Insurance Contracts Exposure Draft:

Consistent with our 2010 comments, we agree that assumptions of risks and uncertainties should be evaluated and updated each reporting period to reflect all available information.

2010 NAIC Comment Letter – FASB Insurance Contracts Discussion Paper:

US insurance regulators agree that assumptions of risks and uncertainties inherent in these contracts should be reevaluated and updated at each reporting period to reflect all available information. US insurance regulators note that this desired improvement would likely not be achieved under the IASB ED as that proposed standard provides for a residual margin to be determined at inception and not adjusted subsequently. US insurance regulators agree that any change in expected future cash flows as a result of changes in future non-financial assumptions should be recognized in any residual margin. Although we fundamentally disagree with the risk and residual approach, we have several concerns regarding the IASB ED proposal to lock-in the residual margin if it is incorporated, which includes:

• By locking in the profit, the future revenue and expenses from the provision of services in the future is effectively locked in, contrary to the reality that future services are likely to be more or less profitable as future assumptions vary.

• Allowing any changes in future non-financial assumptions or risk margin to go straight to

profit and loss will produce volatility in reported profit for only a small change in assumptions, particularly for life insurance where the impact over a number of years is capitalized.

• Booking any change in future non-financial assumptions or risk margin directly into profit and

loss leaves the system open to manipulation – assumptions will be set adversely at inception and then subsequently improved, generating a capitalized profit. Even a small change in assumptions for long-term insurance can have significant effects. In contrast, the FASB DP proposal limits the risk of manipulation, since any change in non-financial assumptions will not have an immediate effect on profit.

9. Although the change in the FASB guidance will not directly impact statutory reserves, the proposal to update

assumptions is a concept supported in the approach for deterministic and stochastic reserves, which requires companies to use prudent mortality assumptions on each valuation date:

The minimum reserve under PBR is equal to: NPR + Max[0, DR-NPR, SR-NPR] where the NPR = Net Premium Reserve (all assumptions mortality, lapse, interest etc. are prescribed at issue), the DR = Deterministic Reserve and the SR = Stochastic Reserve. For the deterministic and stochastic reserves, on each valuation date for the entire PBR block being valued, a company must use prudent mortality assumptions (procedure described in Section 9.C. of VM-20). Therefore there is not mention of unlocking, because for the in-force book of PBR contracts, the company must use prudent mortality assumptions on each valuation date so nothing is ever locked in to begin with. However that is not true of the NPR where everything is prescribed at issue. Therefore in VM-20 Section 3.C.1.e.iii, there is a Guidance Note which states as follows: “The Valuation Manual can be updated by the NAIC to define a new valuation table. … It is further intended that the adoption of such tables would apply to all business issued since the adoption of this Valuation Manual. The details of how to implement any unlocking of mortality tables will need to be addressed in the future.”

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2016 NAIC Comment Letter Proposed Response

10. NAIC staff proposes a response that reiterates the prior position noting agreement that assumptions of risks and uncertainties should be reevaluated and updated to reflect all available information.

11. With regards to frequency of updates to assumptions, prior comment letters have suggested “each reporting

period,” but staff does not oppose the FASB proposal to require cash flow assumptions to be updated on an annual basis, at the same time every year, or more frequently if actual experience or other evidence indicates that earlier assumptions should be revised.

12. With regards to the FASB proposal to update assumptions on a retrospective basis, staff does not oppose (or support) the suggested approach, but identifies that it may be cumbersome to calculate and apply an updated net premium ratio on an annual basis, even if the guidance allows aggregation at the level at which reserves are calculated. For the SAPWG comment letter, unless the regulators are concerned (or support) the specific approach, staff suggests following an approach similar to prior letters and provide limited comments stating support for the general change to update assumptions.

B. Discount Rate:

Amendments would require insurance companies to discount the liability for future policy benefits using a high-quality fixed-income instrument yield. This change maximizes market observable inputs independent of the return that an insurance company expects to earn on its investment portfolio.

Overview / FASB Discussion

13. Under existing U.S. GAAP, interest assumptions used in estimating the liability for future policy benefits are

based on estimates of investment yields (net of related investment expenses) expected at the time insurance contracts are made.

14. The FASB concluded that the proper rate to discount the net liability is a liability rate rather than a rate linked to the insurance entity’s investment experience. The Board noted that an insurance entity’s economic success is influenced by its ability to invest its assets and earn a rate that exceeds the time value of money on its liabilities. If an insurance entity’s investment yield is used to discount the liability, the liability accretion expense would approximate the insurance entity’s investment returns, which would not provide information about duration risk and the spread between the return on investment and time value of the liability.

15. The Board noted that an insurance entity is obligated to perform on its guaranteed benefit obligations irrespective of its investment strategy. Also, an independent market observable rate allows for better comparability across insurance entities. Per the FASB, an insurance company with a lower-quality investment portfolio should not report a lower liability than an insurance entity with a high-quality investment portfolio simply because the lower-quality portfolio has increased risk causing a higher estimated rate of return.

16. The Board acknowledged that there is no perfect discount rate, therefore placed emphasis on ease of

operability, noting that high-quality rates are sufficiently available, which approximate a risk-free rate plus liquidity adjustment.

17. The Board considered whether a different discount rate should be used for participating contracts, particularly one that reflects the return on the insurance entity’s investment portfolio. The Board ultimately concluded that isolating the portion of discretionary cash flows attributable to investment performance and applying a discount rate to those isolated cash flows that considered the insurance entity’s investment return would be overly complex and operationally burdensome.

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FASB Proposed Amendments:

18. The liability for future policy benefits shall be discounted using a high-quality fixed-income instrument yield. An insurance entity shall consider reliable information in estimating the high-quality fixed-income instrument yield that reflects the duration characteristics of the liability for future policy benefits. An insurance entity shall maximize the use of relevant observable inputs and minimize the use of unobservable inputs in determining the discount rate assumption.

Impact to SAP / Prior Comments / Initial Staff Assessment

19. An approach to change the discount rate to reflect characteristics of an insurance contract liability was a

FASB position previously supported by the SAPWG. Previous comments noted concern if discount rates were not converged, as they could impact comparability across different companies.

2013 NAIC Comment Letter – FASB Insurance Contracts Exposure Draft:

For contracts measured under the BBA (traditional long-term contracts), U.S. regulators continue to agree that the discount rate, when used, should reflect the characteristics of the insurance contract liability – (i.e., the economics of the insurance obligations in the jurisdiction including the nature, structure and term). As noted within our prior 2010 comment letter, U.S. regulators support a converged method for calculating discount rates. With the guidance in the proposed ASU we are concerned that liabilities and supporting assets will be valued using different methods potentially distorting financial results and conditions, and hindering the ease in which financial results can be compared.


“Discount rate for traditional long-duration contracts” – US insurance regulators agree that the discount rate, when used, should reflect the characteristics of the insurance contract liability, i.e., the economics of the insurance obligations in the jurisdiction including the nature, structure and term. Discounting – Long-Term Contracts: US insurance regulators agree that the discount rate for long-term contracts should reflect the characteristics of the insurance contract liability. US insurance regulators are aware that the preferred method to calculate the discount-rate has resulted in significant world-wide debate and support a converged solution. The details of such a converged solution are unclear at present, and US insurance regulators will be supporting a call for the IASB and the FASB to create a working group on the issues surrounding discount rates in which we would wish to participate. Pending the report of such a group, US insurance regulators are prepared to consider the possibility of either the same discount rate in the balance sheet and the income statement, or a different rate in each with the difference between the two being recorded in Other Comprehensive Income. As a single rate, or for income statement presentation, at present, the majority of US insurance regulators are considering a discount rate approach that reflects the economic default adjusted rate (EDAR). Under this approach, insurance liabilities would be discounted at an average asset book yield less a prescribed provision for defaults (the risk adjustment). This provision is most impacted by real-world historical distributions of default losses, but also contains a limited recognition of the current market view of risk through two elements that rely on current market spreads. As such, the default spread will not necessarily move directly with changes in market interest rates, but will be heavily informed by them. If the balance sheet were to be valued differently, then US insurance regulators are considering the possibility that guidance be prescribed that directs companies to value liabilities in the balance sheet using the same discount rate as required in the IASB standard, IAS 19, which is a high-quality corporate bond rate – interpreted to be a AA rate in the US. Under such circumstances that difference between the high-quality corporate bond rate and EDAR would go through other comprehensive income. Pending FASB/IASB work on financial instruments, we are concerned that liabilities and supporting assets will be valued using different methods which can distort financial results and conditions. An inappropriate discount rate can aggravate such distortions.

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In addition, either risk margins or discount rates should include provision for expected default cost (e.g., fund the allowance account in the IASB’s Financial Instrument proposal).

20. Although the change in the FASB discount rate guidance will not directly impact statutory reserves, the

concept to use a standard discount rate, based on high-quality, fixed-income instruments is consistent with certain components of the Valuation Manual PBR reserve:

Similar to mortality, the discount rate varies by the PBR reserve component. For the NPR, the discount rate is prescribed using exactly the same methodology that is used today under the formula based system where the discount rate is a function of the monthly average of the composite yield on seasoned corporate bonds as published by Moody’s Investor Service, Inc. (VM-20 Section 3.C.2.) For the DR, the discount rate is equal to the path of net asset earned rates. The net asset earned rates are determined from the portfolio of assets from the net general account backing the reserve and will be a function of the projected investment earnings from the portfolio of starting assets, pattern of projected asset cash flows from the starting assets and subsequent reinvestment assets, pattern of net liability cash flows and net investment earnings from reinvestment assets. (VM-20 Section 7.H.) For the SR, the discount rates are equal to the 1-Year U.S. Treasury rates in effect at the beginning of each projection year multiplied by 1.05. (VM-20 Section 7.H.4.)

21. The FASB has identified that the approach to use a reporting entities’ own investment performance as the basis for the discount rate, could impact insurance liabilities, simply because the company has elected to take on an increased (or decreased) amount of risk. The Board identified that an insurance entity is obligated to perform on guaranteed obligations irrespective of its investment strategy. NAIC staff agrees with this concept and believes the reflection of operational performance (whether by investment performance or own-creditworthiness) should not impact the reporting of an insurance entity’s guaranteed obligations (unless the obligations were specifically tied to investment performance).

2010 NAIC Comment Letter – FASB Insurance Contracts Discussion Paper: (These comments addressed the concept of fulfillment cash flows, but highlighted the opposition of own-credit standing in reducing liabilities. As noted above, this concept is considered similar to using own-investment performance to discount liabilities for liabilities that are not based on specific investment performance. )

US insurance regulators support the premise for measuring insurance contracts based on the concept of probability-weighted cash flows to fulfill insurance contract obligations. We agree that insurers should measure liabilities using cash flows that will arise through fulfillment because this reflects how the insurer expects to extinguish the liability – by fulfilling the liability through payment of benefits and claims to policyholders as they become due. We strongly support the guidance included in paragraphs BC50a and BC51 of the IASB Exposure Draft (ED) that prohibits the reflection of non-performance risk by the insurer in the measurement of the insurance contract liabilities. Due to the nature of insurance contracts, we agree it is inappropriate to allow a reduction of liability on the basis of an insurer’s own-credit standing.

2016 NAIC Comment Letter Proposed Response

22. NAIC staff proposes a response that reiterates the prior position noting agreement that the discount rate, when

used, should reflect the characteristics of the insurance contract liability – (i.e., the economics of the insurance obligations in the jurisdiction including the nature, structure and term). The proposed letter identifies that the use of “own investment performance” as a discount rate for insurance contract liabilities that are not based on specific-investment performance, could be considered akin to the consideration of own credit-worthiness in determining the fair value of liabilities, which has historically been opposed by the NAIC. In both instances, the reported liabilities would be impacted by operational decisions of the reporting entity. NAIC staff agrees with the FASB that an insurance entity with a lower-quality investment portfolio should not report a lower liability than an insurance entity with a high-quality investment portfolio simply because the lower-quality portfolio has a higher estimated return due to increased risk.

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23. Although the SAP reserving provisions may continue to allow for investment performance-based discount rates in some scenarios, NAIC staff agrees that for U.S. GAAP reporting purposes, a comparable discount rate that reflects a current high-quality, fixed-income instrument yield for traditional contracts is appropriate. For contracts that incorporate “participating components” that are attributed to investment performance, a bifurcated discount rate approach would likely yield the most appropriate reflection of insurance contract obligations. However, it is noted that using a standard high-quality fixed-income instrument yield for the discount rate approach would be the easiest to apply, resulting with comparable financial statements, and before deviating to a bifurcated approach, consideration would have to occur on the ability to bifurcate elements and whether the liability impact supports the added complexity.

24. The comment letter also identifies that the updates between assumptions and discount rates will be required on different timeframes (assumptions – annually / discount rate – each reporting period). Staff does not necessarily oppose the different timeframes, but has included questions on whether the required quarterly assessment of the discount rate would result in changes that would warrant the cost of those calculations and the process to incorporate the changes into the financial statements.

C. Market Risk Benefits: Amendments would require an insurance entity to measure all market risk benefits at fair value. Changes in fair value would be recognized in earnings, with the exception of fair value changes attributable to changes in the instrument-specific credit risk, which would be recognized in other comprehensive income. Market risk benefits could be positive (assets) or negative (liabilities). Overview / FASB Discussion

25. Variable contracts allow the contract holder to direct all or a portion of the account balance into an investment

that passes the risks and rewards of holding that investment to the contract holder. Over time, features (market risk benefits) have been added to these products whereby an insurance entity may provide the contract holder with protection from adverse investment performance. Features include guaranteed minimum death, accumulation, income, withdrawal, and lifetime withdrawal benefits. A common attribute of these benefits is that the insurance entity is obligated to cover the shortfall between the guaranteed benefit and the account balance (net amount at risk), thus exposing the insurance entity to capital market risk.

26. Benefits considered to be embedded derivatives are already measured at fair value, and comments have previously been received on the complexity in evaluating whether a “benefit” is an embedded derivative, or whether it should be captured under the insurance accrual model. Commenters also noted concern with the existing financial reporting disincentive to economically hedge capital market risk exposures arising from benefits currently accounted for the insurance accrual model because the hedging instruments are measured at fair value, resulting in earnings volatility not reflective of the economics.

27. Given the significant effect of capital market risk on the benefit payment amounts, the Board concluded that a fair value measurement is more decision-useful than a ratable insurance accrual measurement.

Key FASB Proposed Amendments: 28. A market risk benefit shall be recognized, and measured at fair value, for contracts and benefits that meet both

of the following clauses:

a. Contract: The contract holder has the ability to direct funds to one or more separate account investment alternatives maintained by the insurance entity, and investment performance, net of contract fees and amendments is passed to the contract holder. The separate account need not be legally recognized or legally insulated from the general account liabilities of the insurance entity.

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b. Benefit: The insurance entity provides a benefit protecting the contract holder from adverse capital market performance, exposing the insurance entity to other-than-nominal capital market risk. A nominal risk is a risk of insignificant amount or a risk that has a remote probability of occurring. A benefit is presumed to have other-than-nominal capital market risk if the net amount at risk (the guaranteed benefit in excess of the account balance, cash value, or similar amount) varies more than an insignificant amount in response to capital market volatility. Capital market risk includes equity, interest rate and foreign exchange risk.

29. Changes in fair value related to market risk benefits shall be recognized in earnings, with the exception of fair value changes attributable to a change in the instrument-specific credit risk. The portion attributed to instrument-specific credit risk shall be recognized in other comprehensive income. The carrying amount of market risk benefits shall be reported separately in the statement of financial position, and the change in fair value related to market risk benefits shall be reported separately in net income.


30. Under SSAP No. 56—Separate Accounts, assets supporting contractual benefits shall be recorded at fair value

unless the contract is a guaranteed insurance contract (GIC) with a fixed interest-rate guarantee (or if specific grandfather clauses are met). Under SSAP No. 56, contractual benefits pertaining to “insurance risks” (e.g., death benefits) are reported in the general account based on “insurance reserving” methodologies.

31. Guidance for “participating” contracts was included in the 2013 exposure draft. This guidance proposed that segregated portfolios of assets, which include the policyholder funds and the entity’s proportionate interest in the segregated portfolio of assets, should be reported at fair value through net income if (a) the entity invested the policyholder funds as directed by the policyholder in designated investment alternatives or in accordance with specific investment objectives of policies and (b) all of investment performance, net of contract fees and assessments must be passed through to the policyholder. (see page 40 of the ED) The following reflects the 2013 NAIC Comment Letter submitted addressing participating contracts:

U.S. regulators do not object to the guidance for participating contracts. We agree that the process should be limited to participating features that pass performance of the underlying items to policyholders through contractual determinants and that exclude “participating” features that allow an entity to limit the performance results passed through to policyholders.

32. It is NAIC staff’s assessment that the guidance proposed in the current exposure draft appears to have been

clarified from the 2013 exposure, as the guidance is specific to “capital market risk” guarantees, with examples of what is captured with this guidance. In reviewing this guidance, staff does not oppose this guidance as the “capital market risk” is specific to equity, interest rate and foreign exchange risk and seemingly would not include death or other “insurance” benefits.

33. Pursuant to Section 7.J of the Valuation Manual, the investment guidance and objectives of separate account funds are used in determining the appropriate valuation:

Similar to the approach used for general account equity investments, the company may group the portion of the starting asset amount held in the separate account represented by the variable funds and the corresponding account values for modeling using an approach that recognizes the investment guidelines and objectives of the funds. Similar to the approach used for general account equity investments, the company shall design an appropriate proxy for each variable subaccount in order to develop the investment return paths and map each variable account to an appropriately crafted proxy fund normally expressed as a linear combination of recognized market indices (or sub-indices). The company shall include an analysis in the proxy construction process that establishes a firm relationship between the investment return on the proxy and the specific variable funds.

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D. Amortization of Deferred Acquisition Costs: The FASB Amendments are intended to simplify the amortization of deferred acquisition costs. Under the amendments, deferred acquisition costs that are currently amortized in proportion to premiums, gross profits or gross margins would be amortized in proportion to the amount of insurance in force or on a straight-line basis if the amount of insurance in force over the expected term of the related contract cannot be reasonably estimated. Deferred acquisition costs would not be subject to impairment testing. Overview / FASB Discussion 34. Under current U.S. GAAP, multiple amortization methods results in inconsistency by product type, even

though the nature of the costs (e.g., commissions and underwriting costs) are the same across product types. The Board noted that the amount of insurance in force is an existing amortization basis for certain long-duration contract balances, and if used for deferred acquisition costs, would not reflect a new method.

35. The FASB noted that existing estimated gross profit and estimated gross margin amortization models are complex and require numerous inputs and assumptions and that assumption updates can result in periodic adjustments that are challenging to calculate, understand and explain.

36. The Board identified that deferred acquisition costs represent historical cash flows (such as commissions or underwriting costs incurred when a contract is originated). As the cash flows occurred in the past, and a cost accumulation measurement approach is followed, there is no measurement uncertainty associated with the asset balance. The carrying amount of deferred acquisition costs should be reduced as a result of unexpected terminations, but not as a result of changes in contract profitability.

37. The Board observed that a long-duration contract is akin to a financing arrangement in which a contract holder provides cash to the insurance industry (premium or deposit) and the insurance entity agrees to return cash to the contract holder or beneficiary at a future date, subject to the terms of the agreement, and establishes a liability to recognize that obligation. In this regard, deferred acquisition costs are similar to debt issuance costs. Under GAAP, debt issuance costs are deferred and amortized over the borrowing term, independent of how the entity utilizes the borrowing proceeds. No impairment is performed on deferred borrowing costs; rather costs are amortized as long as borrowing is outstanding as part of the funding costs.


38. Actual acquisition costs for long-duration contracts shall be used in determining acquisition costs to be

capitalized, but shall not be amortized before incurrence of the costs, including future contract renewal costs.

39. Capitalized acquisition costs shall be charged to expense using termination or inforce assumptions consistent with those used in establishing the liability for future policy benefits. Capitalized acquisition costs shall be charged to expense on a ratable basis as follows: (a) In proportion to the undiscounted amount of insurance in force over the expected term of the related contract, (b) On a straight-line basis, if the amount of insurance in force over the expected term of the related contract cannot be reasonably estimated.

40. The balance of capitalized acquisition costs shall be reduced for actual experience in excess of expected experience (that is, as a result of unexpected contract terminations). The effect of changes in future estimates (for example, revisions of mortality or lapse assumptions) shall be recognized in those future periods on a prospective basis as a change in accounting estimate. No interest shall accrue to the unamortized balance of capitalized acquisition costs.


41. Under SAP, acquisition costs and commissions are expensed as incurred. These include costs incurred in the acquisition of new and renewal insurance contracts and include those costs that vary with and are primarily

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related to the acquisition of insurance contracts (e.g., agenda and broker commissions, certain underwriting and policy issue costs, and medical and inspection fees).

42. Although GAAP guidance for deferred acquisition costs will not impact statutory accounting, the Statutory Accounting Principles (E) Working Group has previously provided comments on changes to the GAAP treatment of deferred acquisition costs in prior comment letters.

2013 NAIC Comment Letter – FASB Insurance Contracts Exposure Draft: (As detailed in these comments, support was given for the separate recognition of deferred acquisition costs for clear presentation and identification in the GAAP financial statements.) U.S. insurance regulators agree with the consideration of incremental acquisition costs, defined in ASU 2010-26 as cash flows related to the insurance contract. We believe the application of this guidance has significantly improved the accounting for acquisition costs under insurance contracts and is superior to the guidance proposed by the IASB. We disagree with the inclusion of acquisition costs in the margin with future expected cash flows. In accordance with the definition in 834-10-55-104, acquisition costs are costs directly related to the entity’s selling efforts that result in insurance contracts in the portfolio. By this definition, these costs are known, and are not subject to future fluctuations. Under the proposed ASU to include acquisition costs within the margin, users of the financial statements will be unable to differentiate between future cash flow expectations and previously expended costs. Although such acquisition costs are expensed immediately under statutory accounting, we understand the capitalization of these expenses under U.S. GAAP as costs incurred that produce future economic benefits. With the GAAP capitalization of these assets, a better presentation would be to separately identify these items within the balance sheet. With again referring to the U.S. GAAP accounting for the Section 9010 ACA fee, we note that current guidance requires a separate “deferred cost” asset to be recognized for the ACA fee simultaneously with the liability recognition (Jan. 1) although nothing has transacted (no item received, no payment made) resulting in a future economic benefit. If the insurer ACA fee warrants asset recognition without incurring costs or noted future benefit, qualifying acquisition costs – as those costs have been incurred, resulting in insurance products that provide future cash inflows – should have separate asset recognition within the financial statements. Additionally, separate recognition allows users to identify the incurred costs from obtaining insurance contracts, and the cash flows (asset/liability) expected from covering insured risks. 2010 NAIC Comment Letter – FASB Insurance Contracts Discussion Paper: (These comments note the original proposed differences between the IFRS and U.S. GAAP.) “Deferral of acquisition costs” – US insurance regulators agree that ASU 2010-26, Financial Services—Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (ASU 2010-26) has significantly improved the accounting for acquisition costs under insurance contracts, and is superior to the guidance proposed within the IASB ED. US insurance regulators have concerns that the proposed IASB approach does not effectively consider costs incurred by direct-marketing insurers, and failing to consider the approach of these insurers could have material financial impact, resulting in competitive disadvantages. Specifically, under the current IASB ED acquisition costs from a third-party distribution channel will be included in fulfillment cash flows, but in-house distribution channels would expense costs. Furthermore, US insurance regulators support the position within the FASB DP that acquisition costs shall be identified as part of the cash flows from a portfolio of insurance contracts. US regulators strongly believe that it is important for acquisition costs, as well as other facets considered in the measurement of insurance contracts, to be determined at the portfolio level and believe this is another element of how the FASB DP is superior to the IASB ED.

43. From a review of the proposed guidance, staff does not have any opposition to the proposed amortization change for deferred acquisition costs.

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E. Disclosures:

Amendments would require an insurance entity to provide disaggregated rollforwards of the beginning to ending balances of the liability for the future policy benefits, policyholder account balances, market risk benefits, separate account liabilities, and deferred acquisition costs. The amendments would also require an insurance entity to disclose quantitative and qualitative information about significant inputs, judgments, and assumptions used in measurement, including changes in those inputs, judgments and assumptions and the effect of those changes on the measurement.

Overview / FASB Discussion

44. From comments received from the 2013 exposure, the FASB received information that current disclosures

provide limited decision-useful information, and that users rely on information received from other sources, such as supplemental schedules provided by insurance entities and U.S. statutory filings, therefore additional disclosures would improve the decision usefulness of the financial statements.

45. With regards to the proposed reconciliations, the Board noted that these provide information about changes in asset and liability balances during a reporting period that would not be discernable simply by observing the change in the asset or liability balances. Additionally, users noted that the reconciliations would be one of the most useful disclosures because of the numerous factors that cause changes in these balances, thus providing decision-useful information in assessing performance and expected performance of an insurance entity.


46. Liability for Policy Benefits and Additional Liability for Annuitization, Death or Other Insurance Benefits:

For annual and interim periods, disclose: a. Disaggregated tabular rollforward of the beginning balance to the ending balance, including: b. For each rollforward presented:

i. Undiscounted ending balance for both expected future net premiums and expected future benefits. ii. Gross premiums recognized in the statement of operations

iii. Amount of any related reinsurance recoverable iv. Weighted-average duration of the liability v. Qualitative and quantitative information about significant inputs, judgments and assumptions used

in measuring the liability, including ranges and weighted averages, actual experience during the period, changes in those significant inputs, judgments and assumptions during the period, and the effect of those changes on the measurement of the liability during the period.

c. Reconciliation of the rollforward to the aggregate ending carrying amount of the liability in the statement of financial position and the total interest and gross premiums recognized in the statement of operations.

d. Qualitative and quantitative info about adverse development at the level of aggregation at which reserves are calculated that resulting a change to current-period expense due to the following: i. Net premiums exceeding gross premiums in the current period.

ii. Establishment of an additional liability for a universal life-type contract or investment contract. e. For contracts with surrender adjustments, for which the entity did not recognize a liability because no

future losses are expected, qualitative and quantitative info about the significant inputs, judgments and assumptions used to conclude that no losses are expected.

47. Liability for Policyholder Account Balances: For annual and interim periods, disclose: a. Disaggregated tabular rollforward of the beginning balance to the ending balance, including: b. For each rollforward presented:

i. Weighted-average earned rate and the weighted-average crediting rate ii. Guaranteed benefit amounts in excess of the current account balances

iii. Cash surrender value

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iv. Weighted-average duration of the liability c. Reconciliation of the rollforward to the aggregate ending carrying amount of the liability for

policyholders’ account balances. d. Tabular presentation of policyholders’ account balances by range of guaranteed minimum crediting rates,

and the related range of the difference between rates being credited to policyholders and the respective guaranteed minimums.

e. Qualitative and quantitative information about objectives, policies, and processes for managing risks, including information about hedging activity undertaken to manage capital market risk.

48. Market Risk Benefits: For annual and interim periods, disclose: a. Disaggregated tabular rollforward of the beginning balance to the ending balance, disaggregated further

by type of market risk benefit. b. For each rollforward presented:

i. Guaranteed benefit amount in excess of the current account balances (for example, for variable annuity contracts, the net amount at risk).

ii. Qualitative and quantitative information about the methods, significant inputs, judgments, and assumptions used in measurement, including ranges and weighted averages, actual experience during the period, changes during the period, and the effect of those changes on the measurement during the period.

c. Reconciliation of the rollforward to the aggregate ending carrying amount, disaggregated between positions that are in an asset position and those that are in a liability position.

d. Qualitative and quantitative information about objectives, policies, and processes for managing risks arising from market risks benefits, including information about hedging activity undertaken to manage capital market risk.


49. Disclosures are required in SSAP No. 51—Life Contracts, SSAP No. 56—Separate Accounts, and SSAP No. 61R—Life, Deposit-Type and Accident and Health Reinsurance, for key information on reserves, practices, methods, significant reserve changes, etc. However, the proposed reconciliation format in the FASB exposure draft may provide additional information on fluctuations from beginning reserve balances to ending reserve balances, allowing for more detailed comparison of factors impacting reserves across different companies.

50. The Statutory Accounting Principles (E) Working Group has previously provided comments on proposed disclosures from the 2010 and 2013 exposures. In these situations, the comments focused mostly on the limited information proposed to be captured on the face of the financial statements, and the voluminous disclosures proposed to capture extensive detail on how the “building-block approach” reserves were determined. As the 2016 exposure does not incorporate a new accounting model, but only focuses on targeted improvements – including enhancing disclosure information, staff does not oppose the new disclosure reconciliations, and believes that the proposed revisions would be in line with the SAPWG’s 2010 comment to “consider the appropriate performance metrics for insurers and then conclude on the appropriate presentation and disclosure requirements that effectively presents performance.”

2013 NAIC Comment Letter – FASB Insurance Contracts Exposure Draft: (These comments were in response to a proposed “margin” presentation that would limit the information on the balance sheet.)

U.S. regulators support the long-standing position that disclosure should not be considered an adequate substitute for reporting on the face of the financial statements. Disclosures should supplement reported key performance information, and not be the source of such detail. We are concerned with the limited amount of information readily proposed to be available on the face of the financial statements, with the inclusion of specific, voluminous disclosures. We encourage reconsideration of the financial statement presentation, focusing on the needs of investors and other users, as we suspect this assessment will demonstrate the need for more information consistently presented in the financial statements.

Attachment N

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As previously stated, the NAIC strongly supports the inclusion of the undiscounted claims development as it is critical information allowing users to understand the insurer’s ability to properly underwrite and anticipate claims. With this new disclosure, which can be completed by insurers without cost or complexity as it is already required under statutory accounting principles, users of U.S. GAAP financials will be able to readily obtain this key performance information without the need to acquire the specialized statutory financials.


Disclosure: US insurance regulators do not disagree with the overall disclosure principle provided in paragraph 79 of the IASB ED: “To help users of financial statements understand the amount, timing and uncertainty of future cash flows arising from insurance contracts, an insurer shall disclose qualitative and quantitative information about (a) the amounts recognized in the financial statements arising from insurance contracts; and (b) the nature and extent of risks arising from insurance contracts.” Although US insurance regulators do not disagree with the overall IASB ED disclosure principle, there is significant concern with the specific, voluminous disclosures considered necessary – presented in paragraphs 85-97 (six pages) of the IASB ED – to achieve compliance with the disclosure principle. It seems that compliance with these extensive disclosure requirements will be costly, and likely provide only limited benefit to users. US insurance regulators are also particularly concerned regarding the extent of proprietary information that the IASB ED seems to require within the disclosures. For example, with regards to the risks arising from insurance contracts other than insurance risks, the guidelines in the ED specifically indicate that the disclosure of summary qualitative information regarding exposure to risk shall be based on information provided internally to key management personnel of the insurer and provide information about the risk management techniques and methodologies applied by the insurer. It is our assessment that these requirements may be crossing the line between pertinent information necessary to assess the insurer and confidential information regarding the insurer’s operating assessments. Lastly, as previously stated, US insurance regulators are concerned with the overall presentation of information in the statement of income for insurance contracts. It is likely that the determination of essential disclosures may be significantly impacted if the statement of income provides the information necessary to allow users to complete comparisons and financial assessments on insurers. US insurance regulators recommend that the IASB and FASB establish a technical advisory group to consider the appropriate performance metrics for insurers and then conclude on the appropriate presentation and disclosure requirements that effectively presents performance.

51. From a review of the proposed guidance, staff does not have any opposition to the proposed disclosures.

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Attachment O Review of GAAP Exposures


2016 Fall National Meeting - Review of GAAP Exposures for Statutory Accounting:

Pursuant to a 2014 direction from the SAPWG chair, there is a desire for the Statutory Accounting Principles (E) Working Group to be more proactive in considering FASB exposures that may be significant to statutory accounting and reporting. Historically, the SAPWG has commented on limited, key FASB exposures – mostly pertaining to insurance contracts and financial instruments. To ensure consideration of all FASB exposures, staff has prepared this memorandum to highlight the current exposures, comment deadlines, and to provide a high-level summary of the exposed item’s potential impact to statutory accounting. It is anticipated that this information would assist the Working Group in determining whether a comment letter should be submitted to the FASB on each of the issues. Regardless of the Working Group’s election to submit comments to the FASB on proposed accounting standards, under the NAIC Policy Statement on Statutory Accounting Principles Maintenance Agenda Process, issued US GAAP guidance noted in the hierarchy within Section V of the Preamble to the Accounting Practices and Procedures Manual must be considered by the Statutory Accounting Principles (E) Working Group.

FASB Exposures: http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1175805074609

Exposed FASB Guidance Comment Deadline & Initial Staff Comments

Concepts Statement 8—Conceptual Framework for Financial Reporting—Chapter 7: Presentation

November 9, 2016 Review ASU under the SAP Maintenance Process as detailed in Appendix F—Policy Statements

Technical Correction to Update No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities—Endowment Reporting


Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities


Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities


Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts

December 15, 2016 Exposed draft SAPWG Comment Letter on Nov. 3, 2016. Adoption of comment letter anticipated at Fall National Meeting, for submission by the Dec. 15 Comment Deadline.

Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services

January 06, 2017 Review ASU under the SAP Maintenance Process as

detailed in Appendix F—Policy Statements

Proposed ASU – Concepts Statement 8—Conceptual Framework for Financial Reporting—Chapter 7: Presentation — Comment Deadline: November 9, 2016 Information from FASB Exposure Draft: The proposed amendment is part of FASB’s conceptual framework project. It focuses on concepts for the presentation and measurement of financial statements. FASB requests comments specifically on these two questions: 1) Would the concepts for developing line items in this proposed chapter encompass the information appropriate for the Board to consider for developing financial statements that would assist resource providers in their decision making? Are there concepts that should be added or removed?; 2) The conceptual framework does not address whether specific characteristics of a single contract should be recognized, measured, and presented separately or grouped with other contracts. Similarly, the conceptual framework does not address whether specific characteristics of multiple contracts should be recognized, measured, or presented separately or combined with



other contracts. Some Board members believe that the factors developed in paragraph PR37 could be potentially helpful in addressing these issues when considering changes to the definitions of the elements or recognition criteria. Could the Board use any of the factors in paragraph PR37 of this Exposure Draft to help make decisions about combining contracts or separating specific aspects of a single contract when recognizing, measuring, and presenting items? Staff Review and Commentary: Comment deadline has passed. Review ASU under the SAP Maintenance Process as detail in Appendix F—Policy Statement Proposed ASU – Technical Correction to Update No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities—Endowment Reporting — Comment Deadline: November 11, 2016 Information from FASB Exposure Draft: The proposed amendments would remove the words “that contain no purpose restrictions,” which were added by the amendments in Update 2016-14, thus clarifying the minimum requirements for the reconciliation that an NFP is required to disclose if it has endowment funds. The proposed amendments would restore legacy wording that should not have been changed because of the amendments in Update 2016-14 and would clarify the correct guidance that was intended. Staff Review and Commentary: Comment deadline has passed. Review ASU under the SAP Maintenance Process as detail in Appendix F—Policy Statements

Proposed ASU – Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities — Comment Deadline: November 22, 2016 Information from FASB Exposure Draft: This amendment proposes to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. It has been proposed as stakeholders have indicated that the hedge accounting requirements in current GAAP do not always permit an entity to properly recognize the economic results of its hedging strategies in its financial statements. Staff Review and Commentary: Comment deadline is on November 22, 2016. Review ASU under the SAP Maintenance Process as detail in Appendix F—Policy Statements Proposed ASU – Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities — Comment Deadline: November 28, 2016 Information from FASB Exposure Draft: This Update proposes to shorten the amortization period for callable debt securities purchased at a premium; the premium would be amortized to the earliest call date. Staff Review and Commentary: Comment deadline is on November 28, 2016. Review ASU under the SAP Maintenance Process as detail in Appendix F—Policy Statements



Proposed ASU - Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts — Comment Deadline: December 15, 2016 Information from FASB Exposure Draft: This Update proposes four changes to the accounting guidance for insurance contracts: 1) improve the timeliness of recognizing changes in the liability for future policy benefits by requiring that updated assumptions be used to measure the liability for future policy benefits (that is, that assumptions be “unlocked”) and modify the rate used to discount future cash flows; 2) simplify and improve the accounting for certain options or guarantees embedded in variable contracts; 3) simplify the amortization of deferred acquisition costs; and 4) improve the effectiveness of the required disclosures. Staff Review and Commentary: Comment deadline is on December 15, 2016. Exposed draft SAPWG Comment Letter on Nov. 3, 2016. Adoption of comment letter anticipated at Fall National Meeting, for submission by the Dec. 15 Comment Deadline. Proposed ASU - Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services— Comment Deadline: January 1, 2017 Information from FASB Exposure Draft: This Update proposes to clarify that the grantor, rather than the third-party drivers, is the customer of the operation services in all cases for service concession arrangements within the scope of Topic 853. Staff Review and Commentary: Comment Deadline is on January 1, 2017. Review ASU under the SAP Maintenance Process as detail in Appendix F—Policy Statements G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Fall\Meeting\O - 12 2016 - Review of GAAP Exposures.docx