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Statutory Accounting Principles (E) Working Group Materials

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Statutory Accounting Principles (E) Working Group Materials Statutory Accounting Principles Working Group Additional Handouts June 13, 2009 1. Comment letter from Interested parties 2. Separate Account Subgroup Update and Referral 3. Principles Based Reserving Update 4. Ref # 2009-11 Accounting Practices and Procedures Manual Content Changes Additional Handout 1 - IP Comment Letter D. Keith Bell, CPA Rose Albrizio, CPA Senior Vice President Vice President Accounting Policy Accounting Practices Corporate Finance AXA Financial, Inc. The Travelers Companies, Inc. 212-314-5630; FAX 212-314-5662 860-277-0537; FAX 860-954-3708 Email: [email protected] Email: [email protected] June 10, 2009 Mr. Joe Fritsch, Chairman Statutory Accounting Principles Working Group National Association of Insurance Commissioners 2301 McGee Street, Suite 800 Kansas City, MO 64108-2604 RE: Comments on Other Than Temporary Impairments of Loan-backed and Structured Securities Dear Mr. Fritsch, We offer the following comments on Other Than Temporary Impairments of Loan- backed and Structured Securities, which represent the views of the interested parties included in the attached sign on list. Many companies (primarily property/casualty companies or P&C companies) prefer to make no change to statutory accounting. These differing views result from the current differences in statutory accounting rules for life companies eligible for IMR and AVR reporting, HMO, stand-alone health and P&C companies not eligible for AVR and IMR reporting as well P&C companies’ concerns about the added complexity involved in bifurcating credit and non credit losses. Background SSAP No. 43 Prior to the adoption of SSAP No. 98, the statutory accounting rules for other than temporary impairment (OTTI) of loan-backed and structured securities were governed by SSAP No. 43. Under SSAP No. 43, an OTTI is considered to have occurred if the undiscounted estimated cash flows are less than the current book value of the investment. If an OTTI has occurred, the cost basis of the security is written down to the undiscounted estimated future cash flows and the amount of the write-down is accounted for as a realized loss. The accounting for the entire amount of the realized loss is recorded to AVR (for life companies) in accordance with SSAP No. 7, AVR and IMR and the Annual Statement Instructions. INT 06-07 During 2006, the NAIC Emerging Accounting Issues Working Group issued Interpretation 06-07 – Definition of Phrase “Other Than Temporary” (INT 06-07), in order to provide consistent guidance to all applicable SSAPs as to determining when an 1 Additional Handout 1 - IP Comment Letter SAPWG May 4, 2009 Page 2 investment is considered other than temporarily impaired. INT 06-07 incorporated much of the U.S. GAAP guidance surrounding impairment considerations, including severity/duration, financial condition/prospects of the issuer, ability/intent to hold for recovery, etc. INT 06-07 also incorporated “statutory-specific” guidance for interest related and credit related impairments in paragraph 5, summarized as follows: • An interest related impairment is considered other than temporary when an investor has the intent to sell an investment at the reporting date prior to recovery of the cost of the investment. “Interest related” includes a decline in value due to both increases in the risk free interest rate and general credit spread widening, which can occur for a variety of reasons, including supply/demand imbalances in the marketplace, or perceived risk of an entire sector. If the declining value is caused in whole or in part due to credit spreads widening, but not due to fundamental credit problems of the issuer, the change in credit spreads is deemed to be interest related. • 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. For securities in the scope of SSAP No. 43 (prior to the adoption of SSAP No. 98), fundamental credit problems were deemed to exist if the revaluation based on new currently estimated cash flows results in a negative yield (i.e., undiscounted estimated future cash flows are less than the current book value). For impairments considered other than temporary, INT 06-07 indicates that the carrying value of the asset should be written down to reflect its value in accordance with the relevant SSAP. For securities in the scope of SSAP No. 43 (prior to the adoption of SSAP No. 98), an other than temporary impaired security would be written down to the undiscounted estimated future cash flows as described above. SSAP No. 98 During 2008, the NAIC issued SSAP 98 – “Treatment of Cash Flows When Quantifying Changes in Valuation and Impairments, an Amendment of SSAP No. 43”. SSAP No. 98 changed both the trigger and measurement of impairments of loan-backed and structured securities. The revised trigger incorporated the guidance in INT 06-07 as to determining when a security is other than temporarily impaired and, more importantly, revised the measurement of the impairment to require a write down to fair value (instead of undiscounted cash flows). SSAP No. 98 also indicated that credit related OTTI losses should be recorded through the AVR while interest related OTTI losses should be recorded through the IMR. SSAP No. 98 was originally to be effective January 1, 2009, with early adoption permitted and encouraged. During April 2009, in response to newly issued U.S. GAAP 2 Additional Handout 1 - IP Comment Letter SAPWG May 4, 2009 Page 3 guidance on impairments of debt securities, the NAIC elected to defer the required implementation of SSAP No. 98 until the quarter ending September 30, 2009. GAAP OTTI Until recently, under U.S. GAAP, (specifically FAS 115 and EITF 99-20), structured securities were considered OTTI when there was an adverse change in expected cash flows (expected credit loss) or a company could not assert its ability and intent to hold the security for an anticipated recovery. If an OTTI was determined, the security was written down to its fair value with a corresponding charge recorded to earnings. In April 2009, the FASB issued FSP FAS 115-2 which included significant changes to the trigger and measurement of other than temporary impairments under U.S. GAAP. Key provisions include: • If a company intends to sell, or is more likely than not required to sell, a security that is “underwater”, then an OTTI has been triggered and the security should be written down to fair value • If the above is not the case, but a company does not expect to recover the amortized cost of the security (i.e. there is a expected credit loss), then an OTTI has been triggered; however, in this case, the impairment is bifurcated between the credit loss and the non-credit loss portion of the unrealized loss – only the credit loss is reflected in earnings, while the non-credit loss remains in unrealized losses within “other comprehensive income”. The credit loss portion is determined as the difference between amortized cost and recoverable value (NPV of expected cash flows, discounted at effective interest rate) • As noted above, in light of the recent changes to U.S. GAAP, the NAIC deferred the adoption of SSAP No. 98 from 1/1/09 to the quarter ending September 30, 2009. This deferral will allow the NAIC time to consider if, and how, it should react to this updated U.S. GAAP guidance for purposes of statutory accounting. Our Views and Recommendation We embrace the FASB’s issuance of FSP FAS 115-2 as a positive step in accounting rule-making. It portrays an economic view of losses that should be recognized in earnings, i.e., only expected credit losses, We also believe that regulatory capital for insurance companies should reflect the realized loss associated with the credit loss portion of the impairment, but should not reflect a detriment for the remaining unrealized loss (down to fair value) if it is not expected to be realized. Lastly, we believe that it is beneficial to have consistency among U.S. GAAP and Statutory Accounting regimes where it fits within the overarching principles of each regime, consistent with the initial proposed movement to SSAP No. 98 when it reflected U.S. GAAP.. 3 Additional Handout 1 - IP Comment Letter SAPWG May 4, 2009 Page 4 As such, we recommend that for determining other than temporary impairments for structured securities, the NAIC should not adopt SSAP No. 98 in its current form, but instead should incorporate GAAP’s FSP FAS 115-2 into all relevant statutory accounting for investment impairments so that a company would: • Bifurcate the credit/noncredit portions of loss; • Measure the credit loss component consistent with GAAP (FSP FAS 115-2) • Include the credit loss as realized loss in operations; • Disclose the non-credit loss portion of loss (which would not be recognized in either operations or surplus) • Carry the investment at “adjusted amortized cost” (i.e. amortized cost, less the credit loss impairment) This proposal is appropriate because it: a. Reflects the economic viewpoint, whereby only the expected credit loss is recognized in operations, and reflects an insurance company’s long-term buy and hold intentions since the non-credit loss component is expected to be recovered through the expected cash flows. This is particularly important in cases where the fair value of a structured security indicates a significant liquidity discount when only a small loss of principal is expected. b. Promotes consistency among GAAP and STAT for credit losses associated with structured securities, and also promotes operational ease with respect to the control environment. c. Promotes more consistency with respect to capital among insurers and banks, as banks exclude unrealized gains/losses from their calculation of Tier 1 capital and other key ratios.
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