Updates from the SAPWG May 20 meeting and other NAIC developments

This report summarizes key activities of the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAPWG) and the NAIC/AICPA (E) Working Group during May 2021. SAPWG met virtually on May 20, 2021 to discuss revisions to statutory accounting guidance. Our insurance Value Architects™ attended this virtual meeting to monitor regulatory updates. The NAIC/AICPA (E) Working Group held an E-Vote on May 17, 2021 to approve changes to the Model Audit Rule Implementation Guide.

SAPWG updates

SAPWG discussed a variety of topics including cryptocurrencies, state Affordable Care Act (ACA) reinsurance programs, a new proposed bond definition, and more.

Insurance organizations should take note of these changes as they may significantly affect their accounting in 2021 and beyond.

Adopted revisions to statutory guidance

All adopted revisions to statutory guidance noted below are considered effective immediately after adoption by SAPWG unless specifically noted otherwise.

Ref #2020-37: Separate Account – Product Identifiers

SSAP No. 56 – Separate Accounts

Again, this agenda item does not result in statutory accounting revisions but adoption by the SAPWG on May 20 indicated support for the adoption of 2021-03BWG at the Blanks Working Group (BWG). The agenda item increases granularity within the separate account general interrogatories in response to the recent growth of pension risk transfer (PRT) transactions and registered indexed linked annuity (RILA) products that are generally held in insulated separate accounts. The BWG proposal would modify the current General Interrogatory instructions and require that a distinct disaggregated product identifier be used for each product represented. The disaggregation will require that each separate account product filing or policy form be separately identified.

Ref #2020-38: Pension Risk Transfer – Separate Account Disclosure

SSAP No. 56 – Separate Accounts

This agenda item does not result in statutory accounting revisions but adoption by the SAPWG on May 20 indicated support for the adoption of 2021-03BWG at the BWG. This agenda item increases product identification and disclosure of PRT transactions in the separate account financial statements. Regulators have requested improved reporting, in response to the recent growth of PRT, so regulators can more readily identify and analyze such transactions. Regulators requested several enhancements, including separated PRT reporting and improved PRT disclosure regarding reserves, associated assets, and general account exposure. The BWG proposal clarifies reporting by each separate product filing or policy form and adds product identifiers, specifically for PRT and RILA transactions in the Separate Account General Interrogatories.

Ref #2021-01: ASU 2021-01, Reference Rate Reform

INT 20-01: ASU 2020-04 – Reference Rate Reform

SAPWG previously issued INT 20-01 to adopt ASU 2020-04 Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting. Subsequent to that interpretation FASB issued ASU 2021-01, Reference Rate Reform, which expands the scope of ASU 2020-04 by allowing an entity to apply the optional expedients, by stating that a change to the interest rate used for margining, discounting or contract price alignment for a derivative is not considered to be a change to the critical terms of the hedging relationship that requires dedesignation. This agenda item adopts nonsubstantive revisions to INT 20-01 to provide temporary (optional) expedient and exception interpretative guidance, with an expiration date of Dec. 31, 2022. Derivative instruments affected by changes to the interest rates used for discounting, margining or contract price alignment (regardless of whether they reference LIBOR or another rate that is expected to be discontinued as a result of reference rate reform) would be in scope of INT 20-01. This exception would allow for continuation of the existing hedge relationship and thus not require hedge dedesignation. Adopted revisions also clarify that the intent of INT 20-01 is to capture all hedging transaction types, regardless of if the transaction occurred bilaterally or through a central clearing party.

Ref #2021-02: ASU 2020-08 – Premium Amortization on Callable Debt Securities

SSAP No. 26R – Bonds

Adopted revisions to SSAP No. 26R reject ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs for statutory accounting.

Ref #2021-03: SSAP No. 103R – Disclosures

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

This agenda item adopts nonsubstantive revisions for additional disclosures and to data-capture certain existing disclosure elements in SSAP No. 103R as a result of SAPWG’s continued work on the substantive project in agenda item 2019-21: SSAP No. 43R - Equity Instruments. With inclusion of the data templates, narrative reporting will still occur to provide additional information regarding transfers accounted for as a sale when the transferor maintains continuing involvement in the transferred financial assets. A BWG proposal is anticipated to be in place for 2021 year-end reporting.

Ref #2021-05: Cryptocurrencies

INT 21-01T: Statutory Accounting Treatment for Cryptocurrencies

SAPWG adopted INT 21-01T: Statutory Accounting Treatment for Cryptocurrencies which clarifies that cryptocurrencies do not meet the definition of cash in SSAP No. 2R - Cash, Cash Equivalents, Drafts, and Short-Term Investments, and when directly held by the reporting entity are nonadmitted assets for statutory accounting. Cryptocurrencies do not meet the definition within SSAP No. 2R because they are not able to be deposited or exchanged with most U.S. banks and financial institutions. This interpretation does not impact the guidance for investments in funds that may hold cryptocurrencies in SSAP No. 30R - Unaffiliated Common Stock, SSAP No. 48 - Joint Ventures, Partnerships and Limited Liability Companies or SSAP No. 97 - Investments in Subsidiary, Controlled and Affiliated Entities.

Ref #2021-06EP: Editorial Updates

SSAP No. 53 – Property and Casualty Contracts - Premiums, SSAP No. 97 – Investments in Subsidiary, Controlled and Affiliated Entities, and SSAP Glossary

Adopted nonsubstantive changes for editorial corrections and reference changes to the above referenced SSAPs for ease of readability.

Ref #2021-08: ASU 2021-02 – Franchisors Revenue from Contracts with Customers

SSAP No. 47 – Uninsured Plans

Adopted revisions to SSAP No. 47 – Uninsured Plans reject ASU 2021-02.

Exposed revisions to statutory guidance

Ref #2019-21: SSAP No. 43R

At its October 13, 2020 conference call, SAPWG exposed a proposal to define what should be captured in scope of Schedule D-1: Long-Term Bonds. Since that time, a small group of industry reps, Iowa and NAIC staff have been working to develop that definition. During the May 20th virtual meeting SAPWG exposed the proposed Schedule D-1 definition to allow for broader comments and discussion, with a comment period ending July 15, 2021. The focus of this exposure is specific to the proposed bond definition, but comments on future developments (such as reporting changes on Schedule D-1, development of accounting and reporting guidance for items that do not qualify for bond reporting, transition guidance, etc.) may also be submitted. It is important to note that the exposure provides principle concepts for the bond definition, and that discussions and developments are still required on the following aspects:

• Proposal to improve transparency and reporting for Schedule D-1 items. This is planned to revise the existing reporting lines / categories and include more granular / descriptive reporting lines as well as a potential sub-schedule to identify items that have underlying equity risk or that do not self-liquidate. (Discussions on this item by the small group is expected to begin during the definition’s exposure period.)
• Inclusion of actual revisions to the SSAPs to incorporate the bond definition as well as the development and adoption of an issue paper to document the discussions and revisions in developing the bond definition. (This work is not anticipated until after the proposed bond definition has been exposed and comments have been considered.)
• Development of accounting and reporting guidance for investments that do not fit the scope of SSAP No. 48 - Joint Ventures, Partnerships and Limited Liability Companies and that do not qualify under the bond definition. The current reporting guidance on Schedule BA only permits SSAP No. 48 items and private equity items to have NAIC designations for risk-based capital (RBC) impact. Additionally, the guidance in SSAP No. 48 requires audited financial statements for admittance and this provision may not be applicable for investments that may be captured on BA as they do not meet the principles for bond reporting.
• Consideration of transition guidance. It should be clearly noted that wide-spread grandfather provisions are not expected. As such, investments that have previously been reported as bonds may be required to move to BA (or another schedule) in accordance with the bond definition. However, consideration is expected on how to assess existing investments in determining whether they qualify for bond reporting at transition. It is recognized that assessing investments per historical origination date information may not be feasible.

Below is a summary of the key aspects of the proposed definition:

A bond represents a credit relationship in substance, not just legal form.

• Investments with equity-like characteristics or that represent ownership interests in substance, are not bonds.
• Includes a rebuttable presumption that investments which rely on equity return cash flows are not bonds. The presumption may only be overcome through documented analysis supporting the recharacterization of the underlying equity risks into bond risk through structuring and diversification of collateral. This allows certain investments (such as collateralized fund obligations) that have appropriate structuring and collateral to be reported as bonds, only if properly supported by analysis.

Bonds are either issuer obligations or asset-backed securities (ABS).

• Issuer obligations are supported primarily by the general creditworthiness of an operating entity or entities. Examples of issuer obligations have been expanded to include project finance bonds issued by operating entities, bonds issued by REITs or similar property trusts, bonds issued by closed-end funds and other operating entities registered under the 1940 Act, and equipment trust certificates (ETCs), enhanced equipment trust certificates (EETCs) and credit tenant loans (CTLs) when payment is fully supported by a lease to an operating entity.
• ABS are issued by entities that have a primary purpose of raising debt capital backed by collateral that provides the cash flows to service the debt. Although typically issued by special purpose entities (SPVs), an SPV is not a necessary component in classifying as an ABS. ABS shall be backed by either financial assets or cash-generating non-financial assets. SSAP 103R defines a financial asset as cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right (a) to receive cash or another financial instrument from a second entity or (b) to exchange other financial instruments on potentially favorable terms with the second entity. Per the bond definition, financial assets do not include assets for which the realization of the benefits depends on the completion of a performance obligation (e.g., leases, mortgage servicing rights, royalty rights, etc.). These assets represent non-financial assets, or a means through which nonfinancial assets produce cash flows, until the performance obligation has been satisfied.
• To qualify as a bond, an ABS must put the investment holder in a different economic position than owning the collateral directly. This is a requirement for all ABS regardless of the collateral backing the investment. This is accomplished through sufficient credit enhancement (process to absorb losses), overcollateralization, or other forms of guarantees or recourse.
• To qualify as a bond, cash-generating non-financial assets backing ABS shall be expected to generate a meaningful source of cash flows for repayment of the bond, other than through the sale or refinancing of the assets. (The nature of the non-financial assets must lend itself to the production of fixed-income-like cash flows.)
• Determination of sufficient credit enhancement and meaningful cash flows are determined at origination and are the responsibility of the insurer reporting entity. Documentation of the analysis shall be maintained and provided to regulators / auditors to support bond determination. Examples to assess sufficiency and meaningful are included in the proposed definition.

The principle concepts included in the proposed definition are intended to apply to all investments subject for inclusion on D-1. As such, specific consideration for certain investments (such as CTLs) may no longer be applicable. As detailed in the proposed definition, CTLs fully supported by a current lease would be considered an issuer obligation. CTLs that have residual risk (not fully supported) would be subject to the ABS provisions of sufficiency and meaningful.

Ref #2021-04: SSAP No. 97 – Valuation of Foreign Insurance SCAs

SSAP No. 97 – Investments in Subsidiary, Controlled and Affiliated Entities and SSAP No. 48 - Joint Ventures, Partnerships and Limited Liability Companies

This agenda item was added to consider whether revisions should be made to SSAP No. 97 which currently requires specific adjustments to 8.b.ii (insurance-related SCA) and 8.b.iv (foreign insurance SCA) entities as these adjustments can result in a negative equity valuation of the investment. The exposed revisions add a limit on these adjustments for foreign insurance SCAs to stop their equity valuation at zero if the entity is not engaged in providing services to, or holding assets on behalf of the U.S. insurers. If such services, including reinsurance transactions, are occurring, the adjustments required can result in a negative equity valuation. In addition, the exposed revisions add language to SSAP No. 48 to clearly indicate that the equity method valuation referenced in SSAP No. 97 can result in a negative equity valuation. NAIC staff noted that the situations that would cause a foreign insurance SCA equity value to be negative are theoretical at this time as no such situations were noted in a review of filings. However, SAPWG felt it prudent to address this issue proactively as a period of rising interest rates could cause these circumstances to occur. The comment period for this exposure ends July 15, 2021.

INT 20-10: Reporting Nonconforming Credit Tenant Loans

SAPWG exposed revisions to INT 20-10 in response to the Valuation of Securities Task Force (VOSTF) agenda item to consider edits to filing exempt requirements. These revisions intend to prevent a situation in which the interpretation may require use of Securities Valuation Office (SVO)-assigned designations beyond what is required in the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual). The comment period for this exposure ends June 28, 2021.

Other actions directed

Ref #2020-36: Derivatives for Hedging Fixed Indexed Products

SSAP No. 86 – Derivatives and SSAP No. 108 – Derivatives Hedging Variable Annuity Guarantees

This agenda item proposes the development of new guidance for the accounting and reporting of derivatives that effectively hedge the growth in interest credited for fixed indexed products (e.g., fixed indexed annuity and indexed universal, reported in the general account). This agenda item is proposed to be substantive, with potential development of a new SSAP. NAIC staff identified two potential approaches to consider in their initial assessment:

• Approach 1: Establish guidance that permits effective hedge treatment that is in line with SSAP No. 86.
• Approach 2: Establish guidance that permits effective hedge treatment that is in line with SSAP No. 108.

SAPWG re-exposed this agenda item during its March 15 virtual meeting to provide additional time for interested parties to develop a proposal. At its May 20 virtual meeting, SAPWG approved sending a formal referral to the Life Actuarial (E) Task Force to seek input regarding whether the Life Actuarial (E) Task Force would consider changes to the reserve framework of fixed indexed annuity products as their response will likely directly influence the accounting options for derivatives hedging these products.

Ref #2021-09: State ACA Reinsurance Program

SSAP No. 107 – Risk-Sharing Provisions of the Affordable Care Act

While the transitional reinsurance program under the ACA has ended, several states have received approval from the Department of Health and Human Services to run similar state ACA reinsurance programs under what are known as Section 1332 waivers. This agenda item proposes nonsubstantive revisions to SSAP No. 107 to include state ACA reinsurance programs which are using Section 1332 waivers in its scope. The intent of the proposed accounting revisions is to continue to follow the SSAP No. 107 hybrid accounting approach for the state ACA programs as they operate in a similar manner. Interested parties noted that the principles underlying the exposure draft are appropriate. However, there are important variances among the state ACA reinsurance programs as to how they are funded and operate, the significance of which requires additional context and guidance to assure that health plans report activity related to any particular state’s ACA reinsurance program in a consistent manner. At its May 20th virtual meeting, SAPWG directed NAIC staff to develop additional revisions for consideration that expand the principles-based guidance to address the diversity in state programs identified in the industry comments.

Other updates provided

Life Risk-Based Capital (E) Working Group Referral

On April 26, 2021, the Life Risk-Based Capital (E) Working Group sent a referral to SAPWG requesting consideration on the accounting and reporting aspects of a proposal to modify the treatment of real estate in the life RBC formula. Per the referral, one aspect included is the incorporation of an adjustment to the factor applied based, in part, on the fair value of real estate reported in the annual statement.

A draft response has been prepared to note comments and concerns with this proposal based on accounting and reporting provisions and highlights that using reported fair value to reduce RBC creates a situation that is susceptible for RBC optimization.

Credit Tenant Loans – Valuation of Securities (E) Task Force Referral Response

On January 22, 2021, SAPWG provided a referral to the VOSTF pursuant to the discussion and direction that occurred in 2020 regarding CTLs. For a recap on these discussions, see our article here. The VOSTF provided a detailed response to this referral on May 1, 2021 which NAIC staff will be reviewing and discussing next steps regarding CTLs with SAPWG. Further discussion is expected during the interim or the Summer National Meeting.

NAIC/AICPA (E) Working Group updates

The NAIC/AICPA (E) Working Group E-Vote on May 17, 2021 approved changes to the Model Audit Rule Implementation Guide.

Insurance organizations should take note of these changes as they will affect their “Communication of Internal Control Related Matters Noted in an Audit” (commonly referred to as the “internal control letter”) filing provided to state insurance regulators and the NAIC in 2021 and beyond.

The changes are effective for audits as of December 31, 2021 and thereafter and require the external audit firm to provide both the name of the current lead audit partner and the year at which he or she began serving in that capacity, within the internal control letter.

For more information on these topics, or to learn how Baker Tilly’s insurance industry Value Architects™ can help, contact our team.