Highlights:

• Schedule D bonds: Regulators release significant changes to proposed bond accounting rules
  
  
• Regulators begin new projects to further reform investment-related RBC
  
  
• Proposed reporting requirements would provide additional insight into insurers’ related party relationships 
  
  
• The SVO looks to require additional market data from insurers, in an effort to better analyze risk in bond portfolios
  

Statutory Accounting Updates

Schedule D bonds: Regulators propose significant changes to previously released principles-based bond definition (Ref# 2019-21)

In continuation of the project to overhaul guidance for what will be considered a Schedule D bond, regulators have released some significant changes that introduced some notable deviations from previous proposals. Those changes include:

• Removal of the stapling restriction – After further consideration, regulators have removed the restriction on stapled structures¹ and their ability to receive bond treatment. These would be allowed even if the structure requires ownership of a vertical slice of the entire capital stack. The guidance amendment would allow the debt portion(s) to be a Schedule D bond, while the equity tranche would be a Schedule BA asset.
  
  
• ABS collateralized with equity interests – The guidance would soften the restriction on these bonds (examples would include SPV-issued debt backed by private equity, hedge fund and/or limited partnership interests). The general assumption still leans toward exclusion from Schedule D, but regulators are allowing these to be further analyzed for inclusion onto Schedule D, provided certain conditions exist regarding the sources of cash flows that would service the debt (e.g. dividend distributions versus the selling of the underlying collateral). The need to sell or refinance the underlying collateral to service the debt doesn’t automatically remove the ABS’ ability to be treated as a Schedule D bond, but relying on equity interests (and thereby equity appreciation or unpredictable cash flows) is fundamentally distinct from ABS with cash-generating financial or non-financial assets (i.e. collateral with contractual cash flows). Therefore, the guidance is more partial to structures with predictable cash flows and diversified collateral pools when considering whether Schedule D bond treatment is appropriate.
  
  
• Clarification of the “return” component as it relates to interest – A guidance update was provided that clarifies that an investment with the potential for “additional returns” must be assessed as if the “additional returns” are a component of the investment’s interest. In other words, it is not permissible to have a “stated interest” and then the potential for “additional returns” and conclude that the investment does not have a variable interest based on equity interests. Structures with these features have the potential for variable principal or interest/returns, due to the underlying equity appreciation or depreciation or an equity-based derivative, and would not be permitted to be treated as a Schedule D bond. Examples of affected securities include principal protected notes and structured notes.
  
  
• Hybrid securities – Guidance revisions clarify that since these have characteristics of both debt and equity, hybrids can only be reported as bonds if they been reviewed and meet the definition of bonds under the issuer obligation guidance or the new principles-based ABS guidance.

Additional edits were proposed to reaffirm asset classes currently included in statutory guidance as Schedule D bonds, including:

• U.S. Treasury Inflation-Protected Securities (TIPS) – The new guidance will explicitly include TIPS, as a continuation of current guidance, to avoid any confusion.
  
  
• Equipment Trust Certificates (ETCs), Enhanced Equipment Trust Certificates (EETCs) and Credit-Tenant Loans (CTLs) – These will continue to be Schedule D eligible (as SSAP 26R issuer obligation bonds), provided that their cash flows will cover at least 95% of their principal and interest obligations.

Regulators have also outlined plans to revise portions of Schedule D-1’s design to add additional granularity and transparency to the annual statement. A summary of these proposed schedule revisions are expected to be released in time for SAPWG’s² May conference call.

Adopted Items

RMBS/CMBS – Minor guidance edits adopted pertaining to NAIC Designations on mortgage-backed securities subject to financial modeling (Ref #2021-23)

This guidance amendment updates SSAP 43R, retaining a summarized version of the SVO’s NAIC designation guidance for modeled legacy and non-legacy³ RMBS/CMBS securities. Continuing to include the SVO’s language for financially modeled securities within the NAIC’s accounting guidance will ensure financial statement preparers have a single reference point for the new revisions.

Cryptocurrencies – General interrogatory reporting (Ref #2021-24)

A revision to the general interrogatory was adopted that will require insurers to disclose 1) if cryptocurrencies are held by the reporting insurer (and if so, on which reporting schedules) and 2) if cryptocurrencies are accepted for the payment of premiums. The change was requested by regulators after previously adopted guidance confirmed that directly held cryptocurrencies do not meet the definition of an admitted asset for statutory accounting.

Exposed Items, to be further considered

Related party reporting (Ref #2021-21)

This agenda item proposes additional revisions to SSAP 25 and 43R to clarify application of the related party affiliate guidance. Previous revisions to SSAP 25 highlighted scenarios where investment vehicles, such as limited partnerships, trusts and other special purpose entities, would need to be disclosed as being an affiliate/related party due to direct or indirect control, which could include common management. Specific to loan-backed and structured securities (LBaSS), the guidance in SSAP 43R is designed to clarify that LBaSS issued by a related party or acquired through a related party transaction or arrangement is subject to the affiliate guidance and disclosure requirements of SSAP 25.

New quarterly and annual statement electronic-only disclosures would also be implemented that identify the role a related party plays in an investment. The disclosures will highlight various relationship scenarios including:

• A direct relationship between the insurer and the related party via a loan or investment where there is direct credit exposure to the related party
  
  
• Securitizations or similar investment vehicles (such as mutual funds, limited partnerships and limited liability companies) involving a relationship with a related party as sponsor, originator, manager, servicer or other similar influential role. Also included will be vehicles in which the structure reflects an in-substancerelated party transaction even if it doesn’t involve a relationship with the related party

Once the guidance is fully adopted, the above disclosures will provide added transparency into insurers’ use of related party relationships to access certain investment exposures. This has been a regulatory focus in recent years, primarily due to increased exposures to limited partnerships, collateralized loan obligations (CLOs) and other structured securities in certain corners of the insurance industry.

Derivatives and hedging – Regulators continue work in making targeted improvements to the accounting for hedging activities (Ref #2021-20)

Because of recent changes⁴ to U.S. GAAP on derivatives and hedging, regulators have been working to develop statutory revisions to minimize guidance differences and retain consistency between statutory accounting and U.S. GAAP.

Recently, the focus has centered on updating some of the supporting documentation and applicable language in SSAP 86, which includes:

• The assessment of hedging effectiveness – The goal for regulators is to ensure that transactions identified to be highly effective hedges under U.S. GAAP would also be identified as highly effective hedges under statutory accounting. SSAP 86 has reference guidance that has not been meaningfully updated since its original issuance (and as a result, it includes outdated U.S. GAAP guidance⁵). U.S. GAAP for derivatives has gone through a number of changes over the years, which includes the adoption of FASB ASC 815: Derivatives and Hedging and Accounting Standard Update 2017-12: Derivatives and Hedging, both of which have elements that need to be included in the revised SSAP 86.
  
  
• Measurement of excluded components in hedging instruments – Supporting documentation within SSAP 86 addresses components permitted to be excluded when determining hedge effectiveness. The proposed documentation addresses the treatment for:  
  • Foreign currency forward contracts that have a premium/discount – the premium would need to be amortized into income over the life of the contract or hedge program.
  • Foreign currency swaps with a cross-currency basis spread – fair value changes shall be reflected as a component of the foreign currency swap’s periodic interest accrual.
  • All other excluded components – the excluded component shall be measured and reported at fair value, with changes in fair value recognized as unrealized gains or losses. Any unrealized gain/loss shall be realized as the derivative transaction is closed out.

Regulators have exposed these new edits for industry comment, while also continuing to work on other revisions for topics such as partial term hedging and the last-of-layer (portfolio) method, which will be further discussed at future meetings.

Freddie Mac “When-Issued K-Deal” (WI Trust) Certificates (Ref #2022-08)

SAPWG is proposing statutory revisions that would clarify that investments in the Freddie Mac WI Program are to be reported as bonds from initial acquisition, in scope of SSAP 43R. WI Trust certificates are bonds where the cash proceeds from the bond purchase are used to secure newly issued K-Deal Certificates (which are Freddie Mac fully guaranteed structured pass-through certificates). Questions were raised as to what the appropriate accounting treatment should be for WI certificates prior to the delivery of the K-Deal Certificates, which typically occurs within 90 days of settlement.

Investment RBC Updates

Regulators begin new projects to further reform investment-related RBC

The NAIC’s new RBC working group, the Risk-Based Capital Investment Risk and Evaluation Working Group (RBCIREWG), has begun its work on developing a plan to further reform certain parts of the investment RBC framework. The need to address certain RBC elements can be traced to evolving investment portfolios and regulators’ attempts to address those changes (see Schedule D Bonds section above). As separate regulator working groups work to tackle issues on the appropriate accounting treatment and the use of credit ratings for bond holdings, the RBCIREWG will be reevaluating RBC for various asset types.

The asset types where new and/or expanded capital charges will be evaluated for further development include:

• Asset-backed securities (ABS), including, but not limited to:
  • CLOs, collateralized fund obligations (CFOs) or other similar securities carrying similar types of tail risk
  • Residual interest securities (i.e. equity tranches within ABS)
• Fixed income and preferred stock funds, which include:
  • SVO-identified bond mutual funds (reported on Schedule D-2-2)
  • SVO-identified bond ETFs (reported on Schedule D-1)
  • Private fixed income funds with SVO-assigned NAIC Designations (reported on Schedule BA)
  • SVO-identified preferred stock ETFs (reported on Schedule D-2-1)
• Structured notes – Structured to resemble debt instruments, but treated as derivatives under statutory guidance due to their performance being linked to a reference asset or index

Regulators will also look to assess whether consistencies can be created between the concentration risk provisions within the RBC instructions and the requirements in the Supplemental Investment Risk Interrogatory (e.g. top 10 largest exposures, exclusions for diversified funds, etc.).

Next steps regarding timeline and priority will be defined at future committee meetings, beginning in April.

Exposed Items, to be further considered

Asset Valuation Reserve (AVR) factors to be expanded due to the recent bond RBC adoptions

To account for the expanded bond RBC factors, life insurance regulators are proposing corresponding changes to AVR that expands the basic contribution, reserve objective and maximum reserve factors. This change was necessary due to AVR’s direct relationship to the post-tax bond capital charges. If adopted, the changes would be effective for year-end 2022.

VOSTF/SVO Updates

Adopted Items

Working capital finance investments (WCFI) – NAIC Designations for unrated subsidiaries of rated parent companies

A guidance amendment was adopted that will allow the SVO to assign NAIC Designations to issues of non-guaranteed, unrated subsidiaries of rated parent companies. This is relevant for WCFI with unrated obligors that are wholly owned, but not guaranteed by their parent entities. Under the proposal, the unrated subsidiary would rely on the NAIC Designation equivalent of its parent, with the SVO having the ability to notch down or decline that designation based on its analytical judgement. If the SVO’s analysis results in an NAIC Designation below NAIC 2, any investments related to the below-investment-grade WCFI program would become non-admitted.

Exposed Items, to be further considered

SVO looks to add additional market data fields for bonds on Schedule D-1

To assist regulators by providing additional or alternative ways to measure risk, particularly for private securities, the SVO is proposing to have insurers report various analytical measures on securities reported on Schedule D-1. The additional data points⁶ would be reported as electronic-only columns within the annual statement. To allow insurers time to update their systems, if adopted, the proposed changes wouldn’t be effective until year-end 2023.

Principal protected securities (PPS) – Potential guidance revisions to capture alternative structures

The SVO will continue working on edits to its PPS guidance. The objective is to include alternative structures that didn’t fit cleanly into the current definition but pose similar risks. These alternative structures are separate from the typical SPV issued notes, and can include issuer obligations that depend on other non-Schedule D-1 assets to satisfy contractual payment obligations. (Also of note, see above: Clarification of the “return” component as it relates to interest – the NAIC’s proposed accounting guidance would disallow PPS for Schedule D treatment).

Securities with “Other Non-Payment Risks” – Filing exemption clarification

Discussions continue on a proposed guidance amendment that would update the SVO’s guidance for securities that possess “Other Non-Payment Risks” (which are assigned a subscript of “S” with its NAIC Designation). This revision would add these investments to the list for securities that are not eligible for the filing exemption.

Other non-payment risks are typically associated with contractual agreements between an insurer and the issuer in which the issuer is given some measure of financial flexibility not to make payments that otherwise would be assumed to be scheduled, given how the instrument has been denominated, or where the insurer agrees to be exposed to a participatory risk.

Schedule BA assets with bond or fixed income characteristics – Revisions to clarify rules on NAIC Designations

SVO discussions continue on proposed guidance revisions that would better clarify that Schedule BA assets are not eligible for a filing exemption (i.e. they must be filed with the SVO to receive an NAIC Designation). The revisions would also clarify that the SVO has the ability to assign NAIC Designations to assets that are not expressly covered by other sections of the SVO’s guidance. This is beneficial for life insurers, as the RBC rules allow Schedule BA assets with NAIC Designations more favorable capital treatment.

¹ Some ABS have clauses where residual interests (i.e. equity tranches) are required to be held when holding debt tranches. Within this structure, an investor would be restricted from selling, assigning or transferring the unsecured debt investment without also selling, assigning or transferring the equity interest to the same party.
² Statutory Accounting Principles Working Group.
³ Non-legacy is defined under SVO guidance as financially modeled (FM) RMBS/CMBS securities issued on or after Jan. 1, 2013. All FM securities issued before that date are considered to be legacy securities. The distinction is relevant when determining NAIC Designations. The NAIC Designation for non-legacy securities is determined solely by the NAIC’s modeling output. NAIC Designations for legacy securities are determined using price breakpoints that, in addition to the modeling output, also factor in the security’s amortized cost when determining its final NAIC Designation.
⁴ In 2017, the FASB issued Accounting Standard Update 2017-12: Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities to reduce complexity and align hedge accounting with risk management activities.
⁵ Back in 2009, to simplify its guidance structure, FASB began to transition to the current Accounting Standards Codification (ASC) and away from its previous structure, which referenced older derivative guidance such as FAS 133, Accounting for Derivative Instruments and Hedging Activities.
⁶ The proposed data points include market yield, market price, purchase yield, weighted average life, spread to average life UST, option-adjusted spread, effective duration and convexity.