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Accounting Update

Metro NY/NJ IASA ChapterMay 16, 2016

Anthony GrecoNational Professional Services Group

PwC

Course agenda

Statutory Update

− Adoption of revisions to SSAPs− Exposure of new guidance and discussions of new and on-going

projects− Solvency Modernization

GAAP Update

− Insurance contracts− Financial Instruments

• Recognition and Measurement• Impairment

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Statutory Update

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Adoption of revisions to SSAPs

NAIC Spring Update – Accounting, Investments, RBC and Solvency Modernization

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Surplus Notes

SAPWG adopted at the Spring National Meeting SSAP 41R and Issue Paper 151, Valuation for Holders of Surplus Notes. • Updated impairment guidance for surplus notes and expanded amortized

cost accounting to include NAIC 1 and 2 rated surplus notes • Unrated surplus notes or those rated other than NAIC 1 and 2 will be valued

at the lower of cost or fair value• Adopted guidance is effective January 1, 2017

◦ Early adoption is not permitted

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New Disclosures for 2016

SAPWG adopted revisions to SSAP 1 to disclose ALL permitted practices not just those that affect surplus or RBC• e.g. net reporting in the balance sheet where NAIC requires gross reporting SSAP 107 is amended to disclose risk corridors balances by program benefit year starting with Q1 2016 and data captured for YE 2016• estimated amount to be filed or final amounts filed with the federal agency; • amounts impaired or amounts not accrued for other reasons (not

withstanding collectability concerns); • amounts received from the federal agency; • asset balance gross of nonadmission;• nonadmitted amounts; and net admitted assets.

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Amendments to Statutory Investment Guidance

Quarterly Reporting of Restricted Assets• SAPWG adopted a revision to SSAP 1 clarifying that the restricted asset

disclosure shall be included in the quarterly statements only if significant changes have occurred since the annual statement disclosure.

Investments in SCAs• SAPWG adopted a clarification to SSAP 97 that ownership of an Exchange

Traded Fund or mutual fund does not represent ownership in an underlying entity within the scope of SSAP 97, unless ownership of the ETF results in “control” of an underlying company.

Both changes are effective for 2016

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Exposure of new guidance and discussions of new and on-going projects

NAIC Spring Update – Accounting, Investments, RBC and Solvency Modernization

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Proposed Amendments to Statutory Investment Guidance

Prepayment Penalties and Acceleration Fees• SAPWG proposed amendments to SSAP 26 and SSAP 43R to clarify what portion of

proceeds reflects the prepayment penalty of a callable bond with make-whole provisions, effective January 1, 2017.

• They also exposed a proposed new disclosure for callable bonds: disclose the number of CUSIPs sold, disposed or otherwise redeemed and the aggregate amount of investment income generated as a result of a prepayment penalty and/or acceleration fee from

• traditional call features;

• make-whole call provisions and

• other callable features.

NAIC 5 rated bonds• New proposed disclosure was exposed to capture current and prior period

information on the number of 5* securities and the BACV and FV for those securities by category: bonds, loan-backed and structured securities and preferred stock.

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Proposed Amendments to Statutory Investment Guidance

Quarterly Reporting of Full Investment SchedulesThe working group exposed for comment three alternatives:

1) hire a consultant to aggregate NAIC investment data,

2) in the event the working group adopts additional quarterly reporting, extend the deadline to complete the electronic-only supple-mental investment information, and

3) replace the quarterly acquisition and disposition schedules with a schedule of owned holdings.

Short Sales• NAIC re-exposed draft of Issue Paper 152, Short Sales

• Additional guidance on short sales supported by a securities borrowing transaction has been added. Revisions to clarify when the contra-asset from a short sale should be eliminated was also added.

• Revised issue paper removes language for the treatment of short sales in Schedule D, which will be included in the annual statement instructions.

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Investment classification review

• VOS TF exposed proposed LBaSS Definition that “recognizes that the dynamic cash flow pattern that SSAP 43R was originally concerned with is the result of a specific structural construct:• the legal isolation and pooling of; • a finite number of cash generating assets; • each from a different obligor;• in a trust; and • the use of the cash flow from the collateral assets to pay the holders of

the securities.”• VOS Task Force also exposed proposed P&P Manual amendments

containing definitions of different types of loans, reorganization of reference material and guidance regarding the proper documentation requirements.

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SCA Filing Requirements and Disclosures

• New appendix to SSAP 97 to include SCA Reporting/Filing process• All non-insurance SCAs that an insurer has an equity interest in are

subject to filing requirements: • SUB 1 and SUB 2 annual filings• Even if SCA is non-admitted or is immaterial

• SSAP 48 entities are not subject to the disclosure or filing requirements even if controlled by the insurer.

• Revised data capture template was also exposed for comment.

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The FASB issued ASU 2016-02 – Leases in February 2016. At the Spring National Meeting, the SAP WG exposed for comments three proposed options for accounting of operating and financing leases under SAP.• Maintain existing statutory guidance with potential new disclosure guidance

on the lease asset and lease liability required under GAAP.• Recognize the lease asset and lease liability, but require nonadmittance of the

lease asset as the right of use asset is not available for policyholder obligations.• Adopt ASU 2016-02 with some modifications to recognize lease assets and

lease liabilities for a lessee’s operating and financing leases, which would allow the lease asset to be admitted for statutory purposes.

Leases

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Cyber Security Task ForceInsurance Data Security Model Law

• First draft circulated on March 2, 2016 for comment.• Verbal comments were received during the Spring NAIC meeting.

• Purpose of the model law, “to establish the exclusive standards for data security and investigation and notification of a breach of data security applicable to licensees in this state” was supported by many but with significant revisions.

• Other industry groups stated they would oppose the law as drafted, noting “fundamental and foundational” revisions needed.

• Two day public meeting held May 25-26 in Washington DC “to allow more in depth comments without the time constraints imposed by a national meeting.”

• Goal of the task force is to complete the model law by the end of 2016.

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Investment RBC Working Group“A Way Forward”

The Way Forward document includes principles for updating bond and common stock factors to meet a goal of adoption for 2017 RBC. Significant proposed principles include the following:• Bond factors will be expanded from 6 to 20 designations, for RBC only • Factors would be based on those proposed by the AAA in 2015• Changes would not affect modeled RBMS and CMBS, but non-modeled

SSAP 43R securities would be subject to the new factors• Consider proposals for different factors for some asset classes such as

municipals and sovereign debt• The common stock factor should be the same for all statement types • AVR factors would also be updated for year-end 2017• “ No other investment types will be discussed until the final

changes for bonds and common stock are “adopted and ready for use”

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Solvency Modernization

NAIC Spring Update - Accounting, Investment and Solvency Modernization

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Principles-Based Reserving Implementation Task ForcePBR Adoption by States and “Substantially Similar” Considerations

• As of May 1, 43 states have adopted the principles-based reserving requirements, which represents 76% of direct U.S. premium

• SC adopted after the Spring National Meeting• LA is optimistic its legislature can replaced its broad PBR exemption with a

singe state exemption and maintain its “substantially similar status”• Task Force addressed process at the Spring National Meeting to “activate”

PBR once the thresholds have been met because the Standard Valuation Law does not provide a mechanism for who determines if these thresholds have been achieved.

• During its May 2 conference call, the task force exposed a recommendation for a January 1, 2017 Valuation Manual Operative Date. This will allow states time to evaluate what actions to take and allow Executive Committee and Plenary time to review before July 1 that the requirements have met.

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Principles-Based Reserving Implementation Task ForcePBR Pilot Project

• NAIC is planning for a PBR pilot in 2016 to evaluate regulatory processes and company submissions, and propose revisions to the regulatory review process and the Valuation Manual as necessary based on lessons learned.

• Twelve companies in 9 states have volunteered and will test: • PBR calculations• VM-20 reserve supplement • VM-31 Actuarial Report

• Work will occur April through August with the hopes of presenting conclusions at the Fall National Meeting.

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Group Capital Calculation Working GroupInaugural meeting

ResponsibilityConstruct a U.S. group capital calculation using an RBC aggregation methodology.

- NOT A GROUP CAPITAL STANDARD!

ObjectiveDevelop a consistent method for calculating group capital and provide a “baseline quantitative measure for group risks” as a useful tool for state financial regulators to utilize in their group assessment work.

The working group will liaise as necessary with the ComFrame Development Analysis Working Group on international capital developments and consider group capital developments by the Federal Reserve Board.

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Group Capital Calculation Working GroupInaugural meeting

The American Council of Life Insurers and the American Insurance Association provided an overview of their joint proposal of a group capital calculation:

• Approach is based on aggregation of local solvency measures and calibration across measures to ensure comparability to provide a group-wide solvency ratio.• Minimal adjustments to existing solvency regimes

• Principles-based approach to assist state regulators and supplement group solvency rules.

• The aggregation and calibration approach must be comparable and transparent across regimes.

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GAAP Update

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On the horizon

Insurance

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Insurance overview

Impacts• FASB and IASB 2013 EDs had proposed

fundamental changes to the accounting forinsurance contracts

• In February 2014, the FASB changed course,toward making targeted improvements to insureraccounting/disclosures:

- Q2 2015: ASU issued requiring additionaldisclosure for claim liabilities, effective 2016

- 2014-2016 deliberations: Potential targeted accounting changes for long durationcontracts; exposure draft possible in 2016

Enhanced disclosures for claim liabilities and targetedimprovements to the accounting for long duration insurance contracts.

Improve andsimplify the financial reporting requirements

Talking theory

Getting feedback

Coming soon

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Short duration/claim liability enhanced disclosuresShort duration contracts:

• Disaggregated claims development tables and related information, for most recentbalance sheet, including:• Tabular presentation of undiscounted, incurred and paid claims and allocated

claim adjustment expenses by accident year, on a net basis, for up to 10 years;• The sum of IBNR claims liabilities plus expected development on reported

claims included within the incurred claims development tables, and adescription of the estimation methodologies for these components;

• Cumulative claim frequency information for each accident year; and• Reconciliation of the claims development tables to the balance sheet claim

liabilities for the most recent balance sheet

• Historical average annual percentage payout of incurred claims (not required forhealth claims)

• Information regarding any loss reserves that have been discounted (carrying amount,discount amount, P/L interest accretion amount and line item classification)

• Significant changes in methodologies and assumptions

Short and long duration contracts:

• Tabular interim (year to date) claim liability rollforward (disaggregated for healthclaims) in addition to currently required annual rollforward 24

Short duration overview

Who is impacted?• Insurance entities that issue US GAAP financial statements, both public and

non-public entities.• With the exception of the claim liability rollforward guidance, the additional

disclosures pertain to short-duration insurance contracts only• Health insurance contracts:

◦ Historical average annual percentage payout is not required◦ IBNR+ is required in both interim and annual financial statements◦ Rollforward disclosure must be disaggregated

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Short duration/claim liability enhanced disclosuresImplementation Issues:• Scope questions • Disaggregated incurred and paid loss development tables as required

supplementary information (RSI), most recent year in audited footnoteso Level of disaggregation?o Acquisitions/dispositions presentation?o FX rates? o Should Guide 6 be eliminated?

• Claims count/frequency information (unless impracticable)o Diversity in claim count definitiono Impracticability exception

• Interpreting par. 4F and 4I requirements to disclose methodologies & changes• Transition

o 5 year vs 10 year?

• Data availabilityo For foreign entitieso Timing of data accumulation for GAAP F/S (vs Schedule P format)

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Required disclosures – Incurred and paid claimsdevelopment tables example

The FASB material included above is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and is reproduced with permission. 27

Required disclosures – Incurred and paid claimsdevelopment tables example (continued)

The FASB material included above is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and is reproduced with permission. 28

5,745

Total gross liability for unpaid claims and claim adjustment expense $ 62,434

Excerpt from ASC 944-40-55-9E:copyrighted by the FinancialAccounting Foundation, 401 Merritt 7, Norwalk,CT 06856, and is reproduced with permission.

Example – reconciliation of claims development tables to the claims liability

Reconciliation of the Disclosure of Incurred and Paid Claims Development to the Liability for Unpaid Claims and Claims Adjustment Expenses

Reinsurance recoverable on unpaid claims

Insurance lines other than short-duration Unallocated claims adjustment expenses Other

3,3152,420

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December 31, 2016

Net Outstanding LiabilitiesHomeowners' Insurance $ 40,550Other short-duration insurance lines 1,976

Liabilities for unpaid claims and claim adjustment expenses, net of reinsurance 42,526

Homeowners' Insurance 13,880Other short-duration insurance lines 283

Total reinsurance recoverable on unpaid claims 14,163

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When is it effective?Adoption

• Effective date for public business entities: annual reporting periods beginning after December 15, 2015 (i.e., year end 2016 for calendar yearentities), and interim reporting periods thereafter.

• Non-public business entities:year end entities).

• Early application is permitted.

one year deferral (i.e., 2017 for calendar

Transition

• Upon transition, the claims development table need not exceed five years if presenting prior years’ information is deemed impractical. An additional year should be added to the disclosure in each subsequent year of financial reporting, but need not exceed 10 years.

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Navigating the new landscape

Financial instruments (recognition and measurement)

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Recognition and measurement overviewIssued January 2016

Impacts• Equity investments:

- FV-NI- Measurement alternative available for

certain equity securities within the scope of the new standard

- Single step impairment model for equisecurities under the measurement alternative

• Financial liabilities under FVO:- Changes in fair value due to instrument

specific credit risk recognized in OCI• Loans, debt securities, and financial liabilities

(other than FVO) largely unchanged

Reduces complexity in accounting for financial instruments

Provides users decision-useful information about financial instruments

Affects public and private companies that hold financial assets or owe financial liabilities

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What is affected

Financial instrumentsexpected to be impacted

• Equity investments

• Financial liabilities under the FVO

• Presentation and certain disclosures will be impacted

Financial instruments notexpected to be impacted

• Loans

• Debt securities

• Financial liabilities not underthe FVO

• Consolidated equity investments

• Equity method investments

Mostly impacts investments in equity investmentsand financial liabilities under the fair value option

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What does it look likeEquity investment model

Fair value through net income

Measurement alternative available

Measurement alternative• Need to be in the scope of the new

standard to be applicable• If no readily determinable fair value

and doesn’t qualify for the NAVpractical expedient

• Cost less impairment adjusted forobservable price changes

Scope of equity method of accounting and consolidation model not impacted

by this guidance

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What does it look like

Financial liabilities model

• Retains bifurcation model for embedded derivatives in hybrid instruments

• If fair value option elected, changes in FV due to changes ininstrument-specific risk go to OCI

If FVO is elected (changes in instrument-specificcredit risk through OCI)

No changes to current U.S. GAAP

Amortized cost FV through netincome

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Presentation and disclosure – incrementaldisclosures

*does not apply to demand deposit liabilities or receivables/payables due in less than one year

Disclosure of financial instruments

• Requires disclosure of financial assets and financial liabilities separately, grouped by measurement category (e.g., FV, amortized cost, LOCOM) and class of financial asset (e.g., loans, securities)

Financial instruments at amortized cost

• Requires public business entities to report (parenthetically in the statement of financial position or in the notes to the financial statements) all fair values of financial instruments measured at amortized cost based on an exit price, eliminating the ability to use an entry price for certain fair value disclosures (e.g. loans)*

• Non-public business entities exempt from disclosing fair value offinancial instruments measured at amortized cost in the financialstatements (previously disclosed in accordance with ASC 825-10)

• Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value for disclosure purposes of financial instruments measured at amortized cost

• Public business entities to disclose the fair value hierarchy levelwithin which the fair value measurement is categorized for eachinterim and annual period

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Presentation and disclosure – incrementaldisclosures (continued)Equity investmentswithout readily determinableFVs

• Disclose:• The carrying value of investments without readily

determinable fair values measured using the measurementalternative

• The total amount of adjustments resulting from impairment• Total amount of adjustments for observable prices

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What are the next stepsLooking forward• Effective dates:

• Public business entities - annual periods (and interim periods within those annualperiods) beginning after December 15, 2017.

• All other entities – annual periods beginning after December 15, 2018, and forinterim periods within annual periods beginning after December 15, 2019.

• Early adoption:

• All entities can early adopt the provision to record fair value changes for financial liabilities under the fair value option resulting from changes in instrument-specificcredit risk in other comprehensive income.

• Non-PBEs can early adopt the provision permitting the omission of fair valuedisclosures for financial instruments reported at amortized cost.

• Early adoption of these provisions can be elected for all financial statements offiscal years and interim periods that have not yet been issued or that have not yetbeen made available for issuance.

Where to find additional informationIn depth US2016-01, New guidance on recognition and measurement to impact financial instruments 38

Navigating the new landscape

Financial instruments -Impairment

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Recognize losseson a more timelybasis

Model based onan expected lossapproach

Impairment overview

Impacts• Changes determination of losses from

incurred loss approach to expected loss approach and replaces multiple impairment models

• Could impact regulatory capital requirements, key financial metrics

• Convergence will not be achieved– FASB - Single measurement lifetime

losses at inception except for availablefor sale debt securities

– IASB - Dual measurement lifetime losses upon trigger

Talkingtheory

Gettingfeedback

Comingsoon

Current “incurred lossmodel” – criticized fordelaying timely lossrecognition

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Who is affected

Scope of the standard

Financial assets, including:• Loans• Held to maturity debt

securities• Loan commitments• Trade receivables• Lease receivables• Reinsurance receivables• Financial guarantees

The scope is designed to replace all of the differentimpairment models we have today

Specifically excluded

• Loan receivables held for sale• Financial assets where fair

value option is elected• Equity instruments and

equity method investments

• Derivatives• Related party loans

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How does it work

Overview of the FASB model

The Current Expected Credit Loss model (CECL)• Single measurement objective for assets held at amortized cost – no

“trigger”• "Balance sheet approach"• Exposure draft states that CECL reserves are measured as the

contractual cash flows not expected to be collected

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How does it work

Measuring Current Expected Credit LossesExpected credit loss principles

• Financial assets within scope must be pooled when similar riskcharacteristics exist; otherwise assessed individually

• All relevant internal and external information must be considered,including:o Historical experienceo Current conditionso Reasonable and supportable forecasts

• Future periods beyond which the entity is able to make a reasonable and supportable forecast – use of reversion to the historical loss mean

• Use of a model explicitly using time value of money concepts not required• For all impairment models (including those that consider time value of

money or do not) the allowance should be calculated based on the amortized cost basis of the financial asset.

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How does it work

Measuring Current Expected Credit LossesTime horizon for measurement of CECL

• Estimate of expected credit losses represents contractual amountsthat an entity does not expect to collect over the contractual life ofthe asset

• Consideration of expected pre-payments but not renewals, modifications or extensions unless a Troubled Debt Restructuring is anticipated

• For unfunded commitments:o Consider the period over which the commitment is legally bindingo Shorter horizon may be appropriate if the commitment is irrevocably

and unilaterally cancellable at the lender’s discretion

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Key Differences from “Incurred Losses” for LoansToday Major Changes Expected

ASC 450 (FAS 5) for incurred losses in the loan portfolio (collectively evaluated for impairment)

• Removal of the recognition threshold by replacing the current incurred loss with a Current Expected Credit Loss (CECL) model

• Replace loss emergence period with full lifetime of the loan (single measurement approach)

• Inclusion of forward looking information and macroeconomic factors either through the model or through the qualitative framework

ASC 310 (FAS 114) specific valuation allowances

• No threshold for identification of individually impaired loans• Continue to maintain practical expedient for collateral

dependent loans.• Measurement approach is similar to today when using

discounted cash flow modelling approach

ASC 310-40 TDR’s • Measurement of the allowance will be based on principles of CECL

ASC 310-30 Purchase CreditImpaired

• Basis “grossed up” to reflect expected loss estimate

• Initial credit loss will not be recognized in income

• Changes (+ / -) going forward recognized immediately in income

Under the proposed standard, assets with similar risk characteristics shall be collectively assessed for expected credit losses. 45

How does it work – (FASB continued)

Available for sale (“AFS”) Debt Securities*• FASB re-deliberations: moved from a CECL model to a modified

impairment model for AFS debt securities• Approach is similar to the impairment accounting model under ASC 320

with the following changes:– Modified approach will require impairment losses to be accounted for

as an allowance subject to future reversal upon credit improvements– Duration of loss is no longer a consideration in determining whether a

security is impaired– No forecasts of future recoveries post balance sheet date– No explicit requirement to evaluate the historical volatility of

the fair value of a security– Measurement and recognition of credit losses are “capped” at

the excess of amortized cost over fair value• Measurement of credit loss based on the present value of expected

cash flows* The FASB recognition and measurement standard retains measurementof changes in fair value through OCI for available for sale debt securities 46

How does it work – (FASB continued)

Purchased Credit Deteriorated assets (PCD)(Assets with more than insignificant deterioration in credit quality sinceorigination)

Upon acquisition

• Basis “grossed up” to reflect expected loss estimate on Day 1• PCD scope will apply to financial assets in scope of CECL and AFS debt securities

(including beneficial interests)• If a discounted cash flow (DCF) model is used:

• Step 1: Calculate the effective interest rate (EIR) by solving for the discountrate such that discounted expected cash flows equal the purchase price.

• Step 2: Calculate the initial allowance by discounting the cashflows notexpected to be collected (i.e. difference between contractual and expected cashflows) by the EIR.

• If a non-DCF model is used, the Day 1 allowance is based on par amount of thePCD asset.

• Initial credit loss not recognized in income• Changes (+ / -) going forward recognized immediately in income

Establish Day 1 allowance

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Results of FASB re-deliberations – incremental disclosures

Allowance for credit loss roll forward schedule

• The current disclosure requirements in ASC 310 – Receivables, to disclose the rollforward of the allowance for credit loss accounts for receivables will be extended to all financial assets in scope of the proposed standard, including AFS debt securities

Credit quality indicators (CQI)

• The current disclosure requirements related to credit quality indicators for receivables will now be extended to other in scope financial instruments, including held to maturity securities

• This requirement will not be applicable to AFS debt securities or short term trade receivables

• The disclosure is incremental to the current required disclosure for receivables; it will require the current disclosure of CQI’s by class of financial asset, but will also require expansion of the disclosure to be by “vintage”, or year of financial asset origination

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Results of FASB re-deliberations – transition

Transition

• Generally, a cumulative transition adjustment will be required on the date of adoption (with the exception of PCD assets).

• Financial assets currently accounted for under the purchased credit deteriorated (“PCD”) model will continue to be classified as PCI at transition. At date of adoption an allowance for credit loss “gross up” to the balance sheet will be recorded.

• Debt instruments that experienced other than temporary impairmentwrite downs prior to adoption will adopt the new requirements of theproposed standard prospectively.

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What are the next steps

Looking forward• Results of current deliberations are still tentative• Final standard expected to be issued in Q2 2016• The effective date for the impairment standard is:

• Public business entities (PBEs) that meet the definition of an SECfiler in fiscal years beginning after December 15, 2019 includinginterim periods within those fiscal years;

• PBEs that do not meet the definition of an SEC filer in fiscal yearsbeginning after December 15, 2020 including interim periods withinthose fiscal years; and

• Early application of the guidance will be permitted for fiscal yearsbeginning after December 15, 2018, including interim periods withinthose fiscal years.

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Questions?

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