Sabrina Wilson, CPA, FLMI
Global Regulatory Policy Expert
Sabrina serves as a subject matter expert for regulatory filings at Clearwater. In this role, she works with internal teams for the ongoing enhancement of NAIC reports. Sabrina has over 20 years’ of statutory accounting and reporting experience and uses her background to communicate industry best practices and comment on regulatory guidance and procedures. She also handles complex statutory accounting and analytics questions posed by our user community.
Sabrina is a certified public accountant, has earned the designation of Fellow, Life Management Institute (FLMI), and has a master’s degree in accounting and taxation from Boise State University.
The Statutory Accounting Principles Working Group of the NAIC held a virtual meeting on March 2, 2022. The following updates pertain to investment accounting.
Exposed Items with Comment Deadline May 6, 2022
Ref #2019-24: Proposed Bond Definition
NAIC staff modified the principles-based bond definition and drafted an issue paper after incorporating feedback from the industry and regulators.
Under the proposed principles-based bond definition, any security representing a creditor relationship and that qualifies as either an issuer credit obligation or an asset backed security (ABS), is defined as a bond which is eligible for reporting on Schedule D Part 1.
NAIC staff made the following changes to the principles-based bond definition that was exposed last year:
- Added US Treasury Inflation-Indexed Securities (US TIPs) to the scope because the proposed principles-based bond definition is explicit that any security that has variable principal or interest due to underlying equity appreciation or depreciation, or an equity-based derivative, will be precluded from bond reporting. NAIC staff believes only US TIPs are an exception to the proposed guidance.
- Clarified SVO Identified Exchange Traded Funds – Bonds remain in scope of SSAP No. 26R.
- Removed hybrid securities, e.g., trust preferreds and Yankee bonds. NAIC staff said securities with both debt and equity components shall be reported as bonds only if they qualify as issuer obligations or ABS per the new principles-based bond definition.
- Clarified the pass-through investments (e.g. Credit Tenant Loans (CTLs), Equipment Trust Certificates (ETCs), other lease-backed securities, funding agreement backed notes (FABNs), etc.) in the form of securities for which repayment is fully supported by an underlying operating entity obligation, are in the scope of SSAP No. 26R if it provides cash flows that can cover all interest and at least 95% of the principal of the security. This threshold would be in line with the residual risk provisions that the SVO assesses in determining SVO-Identified CTLs which are currently in the scope of SSAP No. 43R but would be considered in the scope of SSAP No. 26R.
- All returns from an ABS in excess of principal repayment are required to be considered as interest. For example, principal-protected securities (PPS) and structured note transactions generate additional returns, and both the stated interest and additional returns shall be assessed together in determining if the investment has variable principal or interest. The proposed bond definition requires a structural assessment inclusive of all investment components and so, it is not allowed to segregate components within a structure.
- Removed the stapling restriction from the examples of securities that do not represent creditor relationships in substance. NAIC staff said some investments require the insurers to invest in both debt and equity tranches and the insurers would be restricted from disposing the debt tranches without also disposing the equity tranches to the same party. Both investments would be considered an equity instrument in substance when considering the entirety of the holdings.
After receiving comment letters from the industry and discussing with the industry and regulators, this stapling restriction example is removed because the equity tranches are unlikely liquid regardless of if there was an explicit sales restriction or not. It will require a schedule move from BA to D-1 if the sale restriction was subsequently eliminated. There may be a legitimate business purpose (e.g., compliance with conflict-of-interest provisions) for the issuer’s stapling of debt and equity investments and not intended for Risk-Based Capital (RBC) arbitrage.
There is currently a request for comment for the review of the RBC treatment of ABS including collateralized loan obligations (CLOs), collateralized fund obligations (CFOs), or other similar securities carrying similar types of tail risk for the RBC Investment Risk and Evaluation Working Group. NAIC staff agreed stapling should not prevent separate debt and equity asset recognition based on the characteristics of the specific tranche. - Revised the example for debt instrument issued from an SPV that owns underlying equity interests. It clarifies simply reliance on the sale of underlying equity interests or refinancing at maturity does not preclude the investments from being classified as bonds but it does require the mitigating factors, e.g., number and diversification of the underlying equity interests, characteristics of the underlying equity interests, liquidity facilities, overcollateralization, waiting period for distributions/paydowns to begin, capitalization of interest, covenants (e.g. loan-to-value trigger provisions), reliance on ongoing sponsor commitments, sources of expected cash flows to service the debt (i.e. dividend distributions from the underlying collateral vs sales of the underlying collateral).
NAIC staff recommended the working group expose both the revised principles-based bond definition and a draft issue paper which requests comments on the following questions. They also asked the working group to direct them to continue discussions on the bond definition, proposed SSAP revisions and reporting changes.
- Which schedule should those investments that will not qualify as bonds be reported other than Schedule BA?
- Which measurement method should be used for those investments that are moved from Schedule D-1 to BA reporting? For example, shall NAIC Designation be used to determine the measurement method, e.g., amortized cost, lower of cost or fair value?
- Which SSAPs should be considered for revisions other than SSAP No. 2R (the draft issue paper proposes that ABS are not allowed to be reported as short-term investments or cash equivalents) and 103R?
Life Risk-Based Capital Working Group
The Life Risk-Based Capital Working Group of the NAIC held a virtual meeting on March 10, 2022. The following items pertain to investment accounting.
Exposed Item with Comment Deadline March 25, 2022
Update the Asset Valuation Reserve (AVR) factors to correspond with the adopted Risk-Based Capital (RBC) factors for the expanded bond designation categories.
The AVR maximum reserve factors were updated to reflect the existing relationship to the RBC after-tax factors. The AVR basic contribution and reserve object factors were updated to reflect the existing relationships to the maximum reserve factors.
It is expected this item will get adopted in the Blanks Working Group’s May meeting.
Philip Barlow, the chair, said the Life Risk-Based Capital Working Group doesn’t need to adopt this item because this agenda item will go to the Blanks Working Group for exposure and adoption. NAIC staff said they don’t expect any changes on this agenda item after talking with the American Council of Life Insurers (ACLI) earlier.
Other Item
Bond Factors Phase II
The Financial Condition Committee had an exposure for public comment on the RBC treatment of asset backed securities (ABS) and residual interest securities with a comment deadline of February 28, 2022. The Risk-Based Capital (RBC) Investment Risk and Evaluation Working Group, the newly formed working group of the Capital Adequacy Task Force, will discuss the comment letters received in the upcoming meeting on March 22, 2022.