Statutory Accounting Updates

Adopted Items

Debt securities issued by funds (Ref #2024-01)

Regulators have adopted guidance amendments to clarify the treatment of bonds issued by funds. Under the recently adopted PBBD, bonds issued by business development corporations, closed-end funds, or similar operating entities are considered issuer credit obligations, provided they were registered under the ’40 Act. This gave preferential treatment to registered funds, even if a non-registered fund was structured in a similar manner. This guidance revision removes the emphasis on registration status and will instead focus on how the fund functions as an operating entity, and whether the fund’s primary purpose is to raise equity capital (as an operating entity) or debt capital (as an ABS issuer).

The distinction regarding a fund’s primary purpose is an important one, as it will determine whether the debt issued should be classified as an ABS issuer (or securitization vehicle), which will subject the security to the credit enhancement and cash flow requirements contained in the new bond definition (this determines whether a security meets the qualifications for Schedule D inclusion).

Regulators have also provided additional examples that will further assist in distinguishing whether a fund represents an operating entity or an ABS issuer to lessen any ambiguity by focusing on the purpose of the capital being raised (e.g., fund debt being raised for ancillary or return enhancing purposes versus debt being raised for ABS issuance, which commonly consists of instruments like collateralized fund obligations or feeder funds). This should help insurers with the classification of their fund-related debt and ensure the proper regulatory treatment.

Principles-Based Bond Definition – Implementation guide provides guidance clarifications and raises additional questions (Ref #2019-21; INT 24-01)

The Statutory Accounting Principles Working Group (SAPWG) has adopted updates to its PBBD implementation guide, which provides assistance on how the new bond accounting rules should be applied to specific investment structures or investment characteristics. The updated guide now includes guidance on commercial mortgage-backed securities (CMBS), interest-only strips (IOs), commercial mortgage loans (CMLs), single asset single borrower investments (SASBs), and hybrids.

Additionally, another issue has been raised regarding capital notes and more generally, the RBC treatment of Schedule BA debt instruments held by P&C and health entities. Because capital notes¹ are reported as surplus notes in accordance with SSAP No. 41, they are subject to the default Schedule BA capital charge (20% for P&C/Health), while life insurers are subject to a significantly lower capital charge driven by its NAIC Designation.

Therefore, SAPWG will send a referral to the health and P&C RBC working groups, with a request that they assess the feasibility of having non-bond debt securities, including surplus notes, be eligible for RBC based on SVO-assigned NAIC Designations.

Rejected Items

Repack transactions – regulators decline to change the statutory accounting for structured debt instruments with embedded derivatives (Ref #2024-16)

Due to a lack of industry support, regulators will not pursue an accounting change on repack transactions² (or repacks) that would separate embedded derivatives from its combined debt instrument.

This agenda item was originally flagged in response to a couple of concerns:

1. Because of the new PBBD, some in the industry wondered whether these securities could meet the requirement for Schedule D inclusion.
2. Would insurers have the ability to report a separated derivative on Schedule DB?

Regarding the Schedule DB, it was noted that it would be improper for an insurer to report a separated derivative on its Schedule DB, as the insurer doesn’t hold the derivative directly (it is held by the SPV).

Additionally, because repacks are SPV-issued securities, the expectation is that these will need to be analyzed as ABS under the PBBD, and would need to have substantive credit enhancement (SCE) to meet the PBBD requirement. If there is no SCE, the repack would be considered a non-bond debt security and reported on Schedule BA.

From a reporting standpoint, SAPWG will sponsor a Blanks proposal to clarify the guidance on the bond disposal and acquisition schedules to ensure that the sale of a bond to an SPV, for which a debt security is acquired back from the SPV with derivative wrappers is shown as a separate disposal and acquisition.

Exposed for comment

Investment subsidiaries – regulators propose accounting revisions to prevent capital arbitrage (Ref #2024-21)

Regulators are looking to revamp the accounting rules around investment subsidiaries, as they’ve identified situations where insurers are using subsidiaries to circumvent statutory guidance and improve their capital position.

The current accounting guidance on Subsidiary, Controlled or Affiliated Companies (SSAP No. 97) doesn’t specifically touch on investment subsidiaries. Unless the subsidiary is an insurance subsidiary or engages in specific transactions on behalf of the insurer, the subsidiary is reported based on its audited US GAAP equity value.

As part of a regulatory review, regulators have noticed a few issues regarding the reporting of subsidiaries:

• Companies have reported Schedule BA items as “investment subsidiaries” to gain RBC look through.
• Questions have been raised on whether companies can utilize the concept of an investment subsidiary to avoid punitive statutory accounting provisions for the underlying assets. For example, attempting to use a sub to get bond RBC for debt securities held by the sub without verifying that the securities would qualify as a bond under the PBBD. Or attempting the use the SVO filing exemption on subsidiary-held bonds when it isn’t allowed.
• The Life RBC instructions for affiliates under the “Type 4 – investment subsidiaries” state that “The risk-based capital charge for the ownership of an investment subsidiary is based on the risk-based capital of the underlying assets, pro-rated for the degree of ownership. The basis for this calculation is the assumption that the charge should be the same as it would be if the life insurer held the assets directly.” But the accounting for a subsidiary (U.S. GAAP equity) is not consistent with the measurement of the assets if the assets were held directly (statutory basis). Questions have been asked on whether the underlying assets within the investment subsidiary should be converted to statutory basis of accounting prior to calculation of its RBC charge. Additionally, there were questions as to how the RBC after covariance should be calculated for investment subsidiaries.
• According to Annual Statement instructions, investment subsidiaries also need to apply a “look-through” approach to calculating Asset Valuation Reserve (AVR), but there has been diversity in practice.
• The guidance in the Annual Statement instructions for Schedule D-6-1 regarding “imputed statutory value” has inconsistencies with the accounting guidance in SSAP No. 97 and is causing some confusion.
• Per a review of the statutory financial statements, the amounts reported for investment subsidiaries vary between Schedule D-6-1, AVR and RBC. From the 2023 filings, the amount reported in the RBC formula is significantly greater than the amount reported on Schedule D-6-1 and what is reported through the equity component of AVR.

In response to its concerns, regulators are looking for industry comments on a number of possible solutions, including:

• Revising SSAP No. 97 to incorporate statutory accounting guidance for subsidiaries that hold assets on behalf of the insurer. This would clarify the measurement method and address nonadmittance thresholds if the assets within the investment subsidiary would be nonadmitted if held directly.
• Creating new investment schedules or expanding existing ones, to detail the underlying assets held within an investment subsidiary.
• Submitting referrals to the Capital Adequacy Task Force (CATF) and its related RBC Working Groups to incorporate new details that would allow regulators to verify the RBC calculation for the underlying assets in an investment subsidiary.

The proposal will be exposed for public comment until January 31, 2025.

Modco and funds withheld agreements: Restricted asset disclosures and RBC reporting (Ref #2024-20)

Due to a lack of consistency in how insurers have reported restricted assets, SAPWG is proposing guidance revisions to clarify how assets held under modified coinsurance (Modco) or funds withheld (FWH) agreements shall be reported within the restricted asset disclosure (SSAP No. 1—Accounting Policies, Risks & Uncertainties, and Other Disclosures), in the Note 5L disclosure, and in the general interrogatories. This will help to identify differences in the disclosures, while also providing regulators a complete view of restricted assets and the reason they are restricted.

The need for the revision is also in part due to general interrogatories amounts, which is pulled directly into the RBC formulas. Because of the RBC framework design, this unintentionally causes an additional “noncontrolled asset” RBC charge if it isn’t manually adjusted.

Additionally, SAPWG will submit a referral to Life RBC Working Group (LRBCWG) that proposes revisions to the life RBC instructions to clarify that if an insurer uses any assets held under a Modco or FWH agreement as collateral or as a pledged asset for a purpose unrelated to the reinsurance agreement (e.g. securities lending transactions, FHLB agreements/borrowings), then the insurer should not take any Modco/FWH reduction in RBC charges for those assets in the life RBC formula.

Derivative premium costs and IMR (Ref #2024-23)

To lessen the confusion on the accounting treatment of derivative premium costs, SAPWG has exposed revisions to SSAP No. 86—Derivatives and the annual statement instructions that clarifies the terminology for derivative financing premium and further clarify that derivative premium costs are not to be included in realized losses capitalized to IMR (they are amortized into net investment income over the life of the derivative contract).

¹ Capital notes are securities issued by insurers in an effort to raise capital. Like surplus notes, they are unsecured debt subordinated to all claims by policyholders and creditors. Unlike surplus notes, payment of interest and principal generally do not require regulatory approval, but could be deferred if the issuer becomes undercapitalized.

² Not to be confused with structured notes, which are considered derivatives for statutory purposes, repacks are defined as structured debt instruments with derivative components that typically consists of an SPV acquiring a debt security and “repackaging” it, adding or removing features through the use of accompanying derivatives, then issuing a new debt security.