Statutory Accounting Principles Working Group s10

Ref #2013-07 Statutory Accounting Principles Working Group Maintenance Agenda Submission Form Form A

Issue: ASU 2013-01: Clarifying the Scope of Disclosures About Offsetting Assets and Liabilities

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

Description of Issue: ASU 2013-01 was issued January 2013 to clarify that the scope of ASU 2011-11 applies to derivatives (including embedded derivatives), repurchase and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either netted as they meet the right of setoff under ASC 210-20- 45 or ASC 815-10-45, or are subject to a master netting agreement or similar agreement.

As a reminder, ASU 2011-11 was issued December 2011 to require entities to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position, including those offset in accordance with master netting agreements. ASU 2011-11 was reviewed by the Statutory Accounting Principles (E) Working Group, with revisions adopted in November 2012 to clarify that offsetting is not permitted under statutory accounting in accordance with master netting agreements. When reviewing ASU 2011-11, the Working Group deferred consideration of disclosures for transactions reported net under a valid right to offset in order to consider the clarifying revisions to the scope of GAAP disclosures expected with the issuance of ASU 2013-01.

The amendments in ASU 2013-01 are effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The required disclosures should be applied retrospectively for all comparative periods presented. This effective date mirrors the effective date previously included in ASU 2011-11.

More information regarding the consideration of ASU 2011-11 is reflected below in “Activity to Date”.

Existing Authoritative Literature:

Summary: Statutory accounting principles include guidance that allows netting when there is a valid right to offset. The statutory guidance for netting in accordance with a valid right to offset is consistent with GAAP - including the criteria for when a legal right to offset exists. However, statutory accounting principles have rejected GAAP guidance that allows offsetting in accordance with master netting agreements. There are specific instances within statutory accounting principles in which netting of assets and liabilities is allowed for reporting purposes when there is no valid right to offset, but this is allowed only when provided for by specific statutory accounting statements. One such example is the reporting of real estate investments shown net of encumbrances in SSAP No. 40. In addition, even with the valid right of offset, netting is prohibited in some instances by specific statements of statutory accounting principles. An example of such is in the case of reinsurance recoverables on paid losses and ceded premiums payable as provided for in SSAP No. 62R—Property and Casualty Reinsurance.

SSAP No. 64—Offsetting and Netting of Liabilities Provides the Following Statutory Guidance:

2. Assets and liabilities shall be offset and reported net only when a valid right of setoff exists except as provided for in paragraphs 3 and 4. A right of setoff is a reporting entity's legal right, by contract or otherwise, to discharge all or a portion of the debt owed to another party by applying an amount that the other party owes to the reporting entity against the debt. A valid right of setoff exists only when all the following conditions are met:

a. Each of the two parties owes the other determinable amounts. An amount shall be considered determinable for purposes of this provision when it is reliably estimable by both parties to the agreement;

c. The reporting party intends to setoff; and

d. The right of setoff is enforceable at law.

3. Assets and liabilities that meet the criteria for offset shall not be netted when prohibited by specific statements of statutory accounting principles. An example of such is in the case of reinsurance recoverables on paid losses and ceded premiums payable as provided for in SSAP No. 62R—Property and Casualty Reinsurance.

4. Netting of assets and liabilities for reporting purposes when no valid right of setoff exists shall be allowed only when provided for by specific statements of statutory accounting principles. An example of such is in the case of real estate investments required to be shown net of encumbrances as provided for in SSAP No. 40—Real Estate Investments.

SSAP No. 64 Reflects the Following GAAP Considerations:

 Adopts with modification paragraphs 1, 7 and 13 of APB Opinion No. 10, Omnibus Opinion—1966 and FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts. Modifications: (1) to prohibit offsetting as provided in specific statements and require netting when provided in specific statements, and (2) to reject guidance in paragraphs 10, 10A, and 10B of FIN 39, as amended by FSP FIN 39-1, that permits a reporting entity election to offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from the derivative instruments with the same counterparty under a master netting agreement.

 Adopts FASB Emerging Issues Task Force No. 86-25, Offsetting Foreign Currency Swaps.

 Rejects FSP FIN 39-1, Amendment of FASB Interpretation 39.

 Rejects FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. FIN 41 has an offsetting exception for repurchase and reverse repurchase agreements and permits offsetting when the reporting parties do not intend to set off. This guidance is rejected for statutory accounting, and payables under repurchase agreements may only be offset against amounts recognized as receivables under reverse repurchase agreements if there is a valid right to offset meeting all the conditions, including the intent to offset.

 Rejects ASU 2011-11, Disclosures about Offsetting Assets and Liabilities.

SSAP No. 86—Accounting for Derivative Instruments and Hedging Activities:

 Rejects FSP FIN 39-1, Amendments of FASB Interpretation No. 39. Revisions to reject FSP FIN 39-1 were effective Jan. 1, 2013 for companies that have previously reported a position in the balance sheet that was net of counterparty agreements. (Companies that have previously reported derivative instruments and/or related collateral gross shall not be impacted by these revisions.)

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

 Rejects FIN 41, Offsetting Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. This guidance has been rejected as it permits optionality as to whether offsetting and net reporting occurs for repurchase and reverse purchase agreements under master netting agreements. The provisions of SSAP No. 64 shall be used in determining whether assets and liabilities shall be offset and reported net.

 Assets: Derivatives (line 7) – Includes derivative asset amounts shown as debit balances on Schedule DB, Parts A & B, if any.

 Liabilities, Surplus & Other Funds: Derivatives (line 20) – Include derivative amounts shown as credit balances on Schedule DB, Parts A & B, if any.

 Schedule DB: All derivatives, regardless of maturity date are to be shown on Schedule DB.

Each Derivative Instrument should be reported in Parts A, B or C according to the nature of the instrument as follows:

o Part A – Positions in Options, Caps, Floors, Collars, Swaps and Forwards o Part B – Positions in Futures Contracts o Part C – Positions in Replication (Synthetic Asset) Transaction

Activity to Date (issues previously addressed by SAPWG, Emerging Accounting Issues WG, SEC, FASB, other State Departments of Insurance or other NAIC groups): Consideration of ASU 2011-11: The SAPWG considered ASU 2011-11 in agenda item #2012-17. As a result of those discussions:

On November 29, 2012, the Statutory Accounting Principles (E) Working Group adopted as final revisions, as modified during the meeting, to SSAP Nos. 64, 86 and 103. The adopted revisions, effective Jan. 1, 2013, 1) revise and clarify that offsetting is only allowed in accordance with SSAP No. 64, paragraphs 2-4; 2) modify the adoption of FIN 39 rejecting the ability to offset in accordance with master netting agreements and rejecting FSP FIN 39-1 and FIN 41; and 3) rejecting ASU 2011-11 for statutory accounting. The Working Group deferred adoption of the disclosures proposed to paragraphs 6-8 of SSAP No. 64 in the exposure as the FASB has recently exposed guidance to narrow the scope GAAP disclosures.

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

Staff Recommendation:

In accordance with existing statutory guidance offsetting is generally1 restricted unless a valid right to offset exists. As illustrated with the authoritative literature, this restriction is specifically highlighted for derivatives, and repurchase / reverse repurchase agreements that may be captured within a master netting agreement. Under GAAP, offsetting is permitted in accordance with master netting agreements, but this guidance was rejected for statutory accounting as master netting agreements alone may not provide a valid right to offset, and the recording of transactions captured within a master netting agreement as gross or net is subject to optionality by the reporting entity. As statutory accounting prohibits offsetting in accordance with master netting agreements, but allows netting in other instances when a valid right to offset exists, the Working Group is provided the following options.

Option 1 - Continue to Allow Offsetting with Valid Right of Offset and Incorporate Disclosures

Option 1 proposes to include disclosures within SSAP No. 64 to capture information related to derivatives, repurchase and reverse repurchase agreements, and securities borrowing and securities lending when those items are reported net within the financial statements (page 2 or page 3 of the annual statement filing) when a valid right of offset exists. Pursuant to the differences for when offsetting can occur between statutory and GAAP financial statements, this option proposes to reject ASU 2013-01, but incorporate statutory disclosures when offsetting occurs as reflected in the revisions proposed.

1 There are a few exceptions for when offsetting is allowed without a va lid right to offset. One example is the reporting of real estate investments shown net of encumbrances. These exceptions are specifically noted in the SSAPs and do not include transactions with derivatives, repurchase and reverse repurchase agreements, or securities borrowing and securities lending transactions. © 2013 National Association of Insurance Commissioners 3 Ref #2013-07 In order to eliminate confusion with the gross reporting on Schedule DB (all derivatives are to be reported gross – regardless if a valid right to offset exists), option 1 would also propose the inclusion of revisions within the annual statement instructions to clarify the reporting of derivatives, repurchase and reverse repurchase agreements, and securities borrowing and securities lending transactions. The Working Group may want to consider whether revisions to the annual statement schedules (or additional supplements) would be beneficial to identify the net result - in addition to the current gross reporting - of derivatives, repurchase / reverse repurchase agreements, and securities borrowing and securities lending. If so, upon finalization of statutory revisions, a referral could be sent to the Blanks (E) Working Group.

Option 1 Proposed Revisions:

1. SSAP No. 64: (New paragraphs, subsequent paragraphs will be renumbered)

Disclosures

6. The following quantitative information shall be disclosed (separately for assets and liabilities) at the end of each reporting period (interim and annual) when derivative, repurchase and reverse repurchase, and securities borrowing and securities lending assets and liabilities are offset and reported net in accordance with paragraph 2 (valid right to offset):

a. The gross amounts of recognized assets and recognized liabilities

b. The amounts offset in accordance with paragraph 2 (valid right to offset)

c. The net amounts presented in the statement of financial positions.

7. Assets and liabilities that have a valid right to offset under paragraph 2, but are not netted as they are prohibited under paragraph 3, are not required to be captured in the SSAP No. 64 disclosures.

8. This statement adopts paragraphs 1, 7 and 13 of APB Opinion No. 10, Omnibus Opinion—1966 and FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts with modifications (1) to prohibit offsetting as provided in specific statements and require netting when provided in specific statements, and (2) to reject guidance in paragraphs 10, 10A, and 10B of FIN 39, as amended by FSP FIN 39-1, that permits a reporting entity election to offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from the derivative instruments with the same counterparty under a master netting agreement. Offsetting for statutory accounting purposes is limited to situations meeting the conditions in paragraph 2 and 4 of this SSAP. This statement adopts FASB Emerging Issues Task Force No. 86-25, Offsetting Foreign Currency Swaps.

9. This statement rejects FSP FIN 39-1, Amendment of FASB Interpretation 39. This statement rejects FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. FIN 41 has an offsetting exception for repurchase and reverse repurchase agreements and permits offsetting when the reporting parties do not intend to set off. This guidance is rejected for statutory accounting, and payables under repurchase agreements may only be offset against amounts recognized as receivables under reverse repurchase agreements if there is a valid right to offset meeting all the conditions, including the intent to offset, detailed in paragraph 2. This statement rejects ASU 2011-11, Disclosures about Offsetting Assets and Liabilities and ASU 2013- 01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. Statutory disclosure requirements for assets and liabilities reported net under a valid right to offset are detailed in paragraph 6.

2. SSAP No. 86: (New disclosure paragraph, remaining paragraphs renumbered)

53h. All derivatives are required to be shown gross on Schedule DB. However, derivatives may be reported net in the financial statements (pages 2 & 3 of the statutory financial statements) in

© 2013 National Association of Insurance Commissioners 4 Ref #2013-07 accordance with SSAP No. 64 when a valid right to offset exists. Derivatives offset in accordance with SSAP No. 64 and reported net in the financial statements shall follow the disclosure requirements in SSAP No. 64, paragraph 6.

3. SSAP No. 103: (New disclosure paragraph)

28m. All repurchase and reverse repurchase transactions and securities borrowing and securities lending transactions shall be shown gross when detailed on the respective investment schedules. However, repurchase and reverse repurchase transactions and securities borrowing and securities lending transactions may be reported net in the financial statements (pages 2 & 3 of the statutory financial statements) in accordance with SSAP No. 64 when a valid right to offset exists. When these transactions are offset in accordance with SSAP No. 64 and reported net in the financial statements the disclosure requirements in SSAP No. 64, paragraph 6 shall be followed.

4. Revisions to Annual Statement Investment Schedules Instructions (BA – Short-Term Investments, DB – Derivative Investments, DL – Securities Lending Collateral Assets and BA – Other Long-Term Invested Assets):

Derivatives, repurchase and reverse repurchase agreements, and securities borrowing and securities lending transactions shall be shown gross when reported in the investment schedules. If these transactions are permitted to be reported net in accordance with SSAP No. 64, the investment schedule shall continue to provide detail of all transactions (gross), with the net amount from the valid right to offset reflected in the financial statements (pages 2 & 3 of the statutory financial statements). Disclosures for items reported net when a valid right to offset exists, including the gross amount, the amount offset, and the net amount reported in the financial statements are required per SSAP No. 64.

5. Revisions to Annual Statement Instructions - Assets:

Line 7 – Derivatives:

Include: Derivative asset amounts shown as debit balances on Schedule DB, Parts A and B, if any. The amounts from Schedule DB shall be adjusted to reflect netting from the valid right to offset in accordance with SSAP No. 64.

6. Revisions to Annual Statement Instructions – Liabilities, Surplus & Other Funds:

Include derivative amounts shown as credit balances on Schedule DB, Parts A & B, if any. The amounts from Schedule DB shall be adjusted to reflect netting from the valid right to offset in accordance with SSAP No. 64.

Option 2 - Prohibit Offsetting for the ASU 2013-03 Items in SSAP No. 64

SSAP No. 64 incorporates the ability prohibit net reporting even if there is a valid right of offset. As such, if preferred, the Working Group can require gross information for derivatives, repurchase and reverse repurchase agreements, and securities borrowing and securities lending and not allow offsetting for these items even if a valid right to offset exists.

In considering this option, it should be highlighted that Schedule DB already requires reporting derivatives gross. From discussions with some interested parties, although Schedule DB is being reported gross, there is netting reflected (netting with specific counterparties under a valid right to offset) in the Balance Sheet reporting. This process results in both derivative assets and liabilities being reported (depending on whether it is a net asset or liability with each specific counterparty), but does not result with reporting on the balance sheet that reflects the gross derivatives as reported on Schedule DB. Staff identifies that there is not an existing annual statement cross-check

© 2013 National Association of Insurance Commissioners 5 Ref #2013-07 between Schedule DB and the balance sheet. As noted above, the current balance sheet instructions provide the following guidance for balance sheet reporting:

 Assets: Derivatives (line 7) – Includes derivative asset amounts shown as debit balances on Schedule DB, Parts A & B, if any.

 Liabilities, Surplus & Other Funds: Derivatives (line 20) – Include derivative amounts shown as credit balances on Schedule DB, Parts A & B, if any.

If the Working Group is interested in pursuing option 2, Staff will prepare additional changes to the annual statement blank and SSAP No. 86 for review.

1. SSAP No. 64: (New paragraphs, subsequent paragraphs will be renumbered)

7. This statement rejects FSP FIN 39-1, Amendment of FASB Interpretation 39. This statement rejects FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. FIN 41 has an offsetting exception for repurchase and reverse repurchase agreements and permits offsetting when the reporting parties do not intend to set off. This guidance is rejected for statutory accounting, and payables under repurchase agreements may only be offset against amounts recognized as receivables under reverse repurchase agreements if there is a valid right to offset meeting all the conditions, including the intent to offset, detailed in paragraph 2. This statement rejects ASU 2011-11, Disclosures about Offsetting Assets and Liabilities and ASU 2013- 01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.

1. SSAP No. 86:

15. Derivative instruments used in hedging transactions that meet the criteria of a highly effective hedge shall be considered an effective hedge and valued and reported in a manner that is consistent with the hedged asset or liability (referred to as hedge accounting). For instance, assume an entity has a financial instrument on which it is currently receiving income at a variable rate but wishes to receive income at a fixed rate and thus enters into a swap agreement to exchange the cash flows. If the transaction qualifies as an effective hedge and a financial instrument on a statutory basis is valued and reported at amortized cost, then the swap would also be valued and reported at amortized cost. Derivative instruments used in hedging transactions that do not meet or no longer meet the criteria of an effective hedge shall be accounted for at fair value and the changes in the fair value shall be recorded as unrealized gains or unrealized losses (referred to as fair value accounting). Derivative asset and derivative liabilities are required to be reported gross in schedule DB and in the financial statements without offsetting regardless if there is a valid right to offset.

2. SSAP No. 103:

83. The transferor of securities being “loaned” accounts for collateral received in the same way whether the transfer is accounted for as a sale or a secured borrowing. The collateral received shall be

© 2013 National Association of Insurance Commissioners 6 Ref #2013-07 recognized as the transferor’s asset – as shall investments made with that collateral, even if made by agents or in pools with other securities lenders – along with the obligation to return the collateral. If securities that may be sold or repledged are received by the transferor or its agent, the transferor of the securities being “loaned” accounts for those securities in the same way as it would account for collateral received. Collateral which may be sold or repledged by the transferor or its agent is reflected on balance sheet, along with the obligation to return the asset10. Collateral received which may not be sold or repledged by the transferor or its agent is off balance sheet11. For collateral on the balance sheet, the reporting is determined by the administration of the program. Reporting entities shall not offset securities lending and securities borrowing transactions in the financial statements even if a valid right to offset exists as defined in SSAP No. 64, paragraph 2

Offsetting 111. Reporting entities may operate on both sides of the repurchase agreement market resulting in recording of liabilities and assets representing repurchase and reverse repurchase agreements, respectively.

112. Reporting entities shall not offset such liabilities and assets in the financial statements, even if only to the extent that a legal valid right to offset exists as defined in SSAP No. 64, paragraph 2. Otherwise, sSeparate assets and liabilities shall be recognized gross.

Annual Statement Instructions: No revisions are proposed, but a cross-check would be recommended to Schedule DB and the respective Balance Sheet reporting rows.

Staff Review Completed by: Julie Gann – February 2013

Status: On April 6, 2013, the Statutory Accounting Principles (E) Working Group moved this item to the nonsubstantive active listing and exposed the nonsubstantive revisions included in Option 1 that allow companies to continue offsetting derivatives, repurchase and reverse repurchase agreements, and securities borrowing and securities lending transactions with a valid right of offset, but incorporate disclosures to illustrate the netting impact. The exposed revisions are as follows:

SSAP No. 64: (New paragraphs, subsequent paragraphs will be renumbered)

Disclosures

6. The following quantitative information shall be disclosed (separately for assets and liabilities) at the end of each reporting period (interim and annual) when derivative, repurchase and reverse repurchase, and securities borrowing and securities lending assets and liabilities are offset and reported net in accordance with paragraph 2 (valid right to offset):

a. The gross amounts of recognized assets and recognized liabilities

b. The amounts offset in accordance with paragraph 2 (valid right to offset)

1010 If cash is received by the transferor or its agent and reinvested or repledged it is reported on balance sheet. It is explicitly intended that when the lender bears reinvestment risk, that collateral is on balance sheet. 1111 An example of collateral which is off balance sheet is when securities are received by the transferor or its agent in which the collateral must be held and returned, without the ability to transfer or repledge the collateral. This would involve limited situations in which the transferor or agent is prohibited from reinvesting the collateral.

7. Assets and liabilities that have a valid right to offset under paragraph 2, but are not netted as they are prohibited under paragraph 3, are not required to be captured in the SSAP No. 64 disclosures.

9. This statement rejects FSP FIN 39-1, Amendment of FASB Interpretation 39. This statement rejects FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. FIN 41 has an offsetting exception for repurchase and reverse repurchase agreements and permits offsetting when the reporting parties do not intend to set off. This guidance is rejected for statutory accounting, and payables under repurchase agreements may only be offset against amounts recognized as receivables under reverse repurchase agreements if there is a valid right to offset meeting all the conditions, including the intent to offset, detailed in paragraph 2. This statement rejects ASU 2011-11, Disclosures about Offsetting Assets and Liabilities and ASU 2013- 01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. Statutory disclosure requirements for assets and liabilities reported net under a valid right to offset are detailed in paragraph 6.

SSAP No. 86: (New disclosure paragraph, remaining paragraphs renumbered)

53h. All derivatives are required to be shown gross on Schedule DB. However, derivatives may be reported net in the financial statements (pages 2 & 3 of the statutory financial statements) in accordance with SSAP No. 64 when a valid right to offset exists. Derivatives offset in accordance with SSAP No. 64 and reported net in the financial statements shall follow the disclosure requirements in SSAP No. 64, paragraph 6.

SSAP No. 103: (New disclosure paragraph)

28m. All repurchase and reverse repurchase transactions and securities borrowing and securities lending transactions shall be shown gross when detailed on the respective investment schedules. However, repurchase and reverse repurchase transactions and securities borrowing and securities lending transactions may be reported net in the financial statements (pages 2 & 3 of the statutory financial statements) in accordance with SSAP No. 64 when a valid right to offset exists. When these transactions are offset in accordance with SSAP No. 64 and reported net in the financial statements the disclosure requirements in SSAP No. 64, paragraph 6 shall be followed.

Revisions to Annual Statement Investment Schedules Instructions (BA – Short-Term Investments, DB – Derivative Investments, DL – Securities Lending Collateral Assets and BA – Other Long-Term Invested Assets):

Derivatives, repurchase and reverse repurchase agreements, and securities borrowing and securities lending transactions shall be shown gross when reported in the investment schedules. If these transactions are permitted to be reported net in accordance with SSAP No. 64, the investment schedule shall continue to provide detail of all transactions (gross), with the net amount from the valid right to offset reflected in the financial statements (pages 2 & 3 of the statutory financial statements). Disclosures for items reported net when a valid right to offset exists, including the gross amount, the amount offset, and the net amount reported in the financial statements are required per SSAP No. 64.

Revisions to Annual Statement Instructions - Assets:

Include: Derivative asset amounts shown as debit balances on Schedule DB, Parts A and B, if any. The amounts from Schedule DB shall be adjusted to reflect netting from the valid right to offset in accordance with SSAP No. 64.

Revisions to Annual Statement Instructions – Liabilities, Surplus & Other Funds:

Include derivative amounts shown as credit balances on Schedule DB, Parts A & B, if any. The amounts from Schedule DB shall be adjusted to reflect netting from the valid right to offset in accordance with SSAP No. 64.

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