Statutory Accounting Principles Working Group s12

Ref #2015-43

Statutory Accounting Principles Working Group Maintenance Agenda Submission Form Form A

Issue: EITF 99-02: Accounting for Weather Derivatives

Check (applicable entity): P/C Life Health Modification of existing SSAP New Issue or SSAP

Description of Issue: In reviewing SSAP No. 86—Derivatives, it was identified that several Emerging Issues Task Force opinions (EITF) noted as adopted with modification in Appendix D of the Accounting Practices and Procedures Manual were not referenced within the “Relevant Literature” section of SSAP No. 86. In review, these EITFs were likely intended to be included in the “framework” adoption of FAS 133 detail in SSAP No. 86. However, staff is unable to find specific reference in historical documents regarding this intent. These EITFs have been identified as adopted in Appendix D since 2003, which is the same year as the effective date of SSAP No. 86. At the 2015 Summer National Meeting, based on comments received, the Working Group directed NAIC staff to mark these EITF’s as “pending” in Appendix D and prepare subsequent agenda items for the Working Group to review and discuss these GAAP pronouncements.

For purposes of this agenda item, staff is separately addressing EITF 99-02: Accounting for Weather Derivatives. This EITF was superseded by Accounting Standards Codification (ASC) Topic 105, Generally Accepted Accounting Principles and the information was incorporated into ASC Topic 815-45, Weather Derivatives. (The other noted EITFs will be addressed in subsequent Form A’s.)

Included below are excerpts of ASC 815-45, which outline the definition and accounting treatment of weather derivatives:

 The guidance in this subtopic applies to all weather derivatives that are not exchange-traded (and therefore not subject to the requirements of subtopic 815-10). The guidance in this Subtopic does not apply to contracts written by insurance entities that entitle the holder to be compensated only if, as a result of an insurable event, the holder incurs a liability or there is an adverse change in the value of a specific asset or liability for which the holder is at risk. (ASC 815-45-15-2)

 Glossary – Weather Derivatives: A forward-based or option-based contract for which settlement is based on a climatic or geological variable. One example of such a variable is the occurrence or nonoccurrence of a specified amount of snow at a specified location within a specified period of time. (ASC 815-45-20)

 An entity that enters into a non-exchange-traded forward-based weather derivative in connection with nontrading activities shall account for the contract by applying an intrinsic value method. The intrinsic value method requires that the reporting entity allocate the cumulative strike amount to individual periods within the contract term. That allocation shall reflect reasonable expectations at the beginning of the contract term of normal or expected experience under the contract. That allocation shall be based on data from external statistical sources, such as the National Weather Service. (ASC 815-45-25-1 and ASC 815-45-30-3)

 All weather derivative contracts entered into under trading or speculative activities shall be measured initially at their fair value. All subsequent changes in fair value of weather derivative

contracts entered into under trading or speculative activities shall be reported currently in earnings. (ASC 815-45-30-4 and ASC 815-45-35-7)

Existing Authoritative Literature:  SSAP No. 86—Derivatives

4. “Derivative instrument” means an agreement, option, instrument or a series or combination thereof:

a. To make or take delivery of, or assume or relinquish, a specified amount of one or more underlying interests, or to make a cash settlement in lieu thereof; or

b. That has a price, performance, value or cash flow based primarily upon the actual or expected price, level, performance, value or cash flow of one or more underlying interests.

56. This statement adopts the framework established by FAS 133, FASB Statement No. 137, Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133, An amendment of FASB Statement No. 133 (FAS 137) and FASB Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, An amendment of FASB Statement No. 133 (FAS 138), for fair value and cash flow hedges, including its technical guidance to the extent such guidance is consistent with the statutory accounting approach to derivatives utilized in this statement. This statement adopts the provisions of FAS 133 and 138 related to foreign currency hedges. With the exception of guidance specific to foreign currency hedges and amendments specific to refining the hedging of interest rate risk (under FAS 138, the risk of changes in the benchmark interest rate would be a hedged risk), this statement rejects FAS No. 137 and 138 as well as the various related Emerging Issues Task Force interpretations. This statement adopts paragraphs 4 and 25 of FASB Statement No. 149: Amendment of Statement 133 on Derivative Instruments and Hedging Activities (FAS 149) regarding the definition of an underlying and guidance for assessing hedge effectiveness. All other paragraphs in FAS 149 are rejected as not applicable for statutory accounting. This statement adopts FSP FAS 133-1 and FIN 45-5: Disclosures about Credit Derivatives and Certain Guarantees, An Amendment of FASB Statement No. 133 and FASB Interpretation No.45 and Clarification of the Effective Date of FASB Statement No. 161 (FSP FAS 133-1 and FIN 45-4) and requires disclosures by sellers of credit derivatives. This statement rejects FSP FIN 39-1, Amendments of FASB Interpretation No. 39, and ASU 2014-03, Derivatives and Hedging – Accounting for Certain Receive- Variable, Pay-Fixed Interest Rate Swaps – Simplified Hedge Accounting Approach.

Activity to Date (issues previously addressed by SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): Further discussion of this topic and SSAP No. 86 Relevant Literature is detailed in agenda item 2015-22. Additional EITFs are addressed in agenda item 2015-48.

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

Staff Recommendation: Staff recommends that the Working Group move this agenda item to the nonsubstantive active listing and expose nonsubstantive revisions to SSAP No. 86 as detailed below. These revisions incorporate the GAAP definition of weather derivatives into SSAP No. 86 and adopt with modification EITF 99-02 to require weather derivatives to be reported and valued consistent with other derivatives under the SSAP No. 86. (Staff expects weather derivatives will likely not meet the

© 2015 National Association of Insurance Commissioners 2 Ref #2015-43 criteria to be effective hedges, therefore will mostly be accounted for at fair value, but the provisions allow them to be reported under the hedge accounting method if meeting the effective hedge criteria.)

Proposed Revisions:

SSAP No. 86—Derivatives

Definitions (for purposes of this statement) (New paragraph 13, paragraph references will be updated accordingly)

13. Weather derivatives are defined as a forward-based or option-based contract for which settlement is based on a climatic or geological variable. One example of such a variable is the occurrence or nonoccurrence of a specified amount of snow at a specified location within a specified period of time.

Relevant Literature (New paragraph 60, paragraph references will be updated accordingly)

60. This statement adopts with modification ASC Topic 815-45: Weather Derivatives. Weather derivatives are within scope of SSAP No. 86 and shall be accounted and reported as other derivatives.

Appendix D

Acctg. GAAP Stds. Prono Dispositi Stat. Name Status Codificati uncem o Ref. on Topic- ent n Subt. PendingC omplete

Supersed ed by ASC 99-2 Accounting for Weather Derivatives 86 815-45 Topic 105 Adopt/M and incorporat ed into ASC 815- 45

Staff Review Completed by: Josh Arpin – September 2015

Status: On November 19, 2015, the Statutory Accounting Principles (E) Working Group moved this item to the nonsubstantive active listing and exposed nonsubstantive revisions to SSAP No. 86 and Appendix D, as illustrated above, to incorporate the definition of a weather derivative, and to adopt with modification EITF 99-02 to require weather derivatives to be reported and valued consistently with other derivatives in SSAP No. 86.

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