A&A Update Bill Miller, KPMG Justin Jackson, Ohio National Financial Services November 10, 2017
Agenda ASU 2016-01, Recognition and measurement of financial assets and liabilities ASU 2016-13, Financial Instruments Credit Losses Targeted Improvements to the Accounting for Long-Duration Contracts NAIC Insurance Data Security Model Law Statutory Accounting Update 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative 2
ASU 2016-01, Recognition and measurement of financial assets and financial liabilities
Main Changes Available for Sale - equity investments Cost method vs measurement alternative Financial liabilities (fair value option) Deferred taxes, presentation and other disclosures 4
Available-for-sale - Equity Investments Current GAAP ASU 2016-01 Available for sale changes in fair value recorded in OCI Fair value through Net Income More volatility in Net Income 5
Cost method vs measurement alternative Current GAAP ASU 2016-01 Cost method Measurement alternative may be elected Cost minus impairment Cost minus impairment +/- changes in observable prices Eliminates cost method, but an exception to full FV available 6
Measurement alternative - +/- Changes in observable prices Changes in observable prices must be From orderly transactions In the same or similar investment of the same issuer Potential challenges Is the transaction orderly? What to do if transaction is not orderly? Identifying observable prices Determining if an investment is similar 7
Effective date Effective Date Public Business Entities: Fiscal years beginning after December 15, 2017 (including interim periods within those fiscal years) For All Other Entities: Fiscal years beginning after December 15, 2018 and interim periods in fiscal years beginning after December 15, 2019 Early Adoption Entities that are not public business entities: may adopt for fiscal years beginning after December 15, 2017 (including interim periods within those fiscal years) All entities: may early adopt the provisions related to the recognition of changes in fair value of financial liabilities 8
ASU 2016-13, Financial Instruments Credit Losses
ASU 2016-13, Financial Instruments Credit Losses Effective date Scope Current Expected Credit Losses (CECL) Model Main areas of change Measurement and methodologies Available-for-sale credit loss model Transition Transition Resource Group 10
Effective Date SEC filers that are Public Business Entities Fiscal years beginning after December 15, 2019 and interim periods within those years Non-SEC filers that are Public Business Entities Fiscal years beginning after December 15, 2020 and interim periods within those years All of entities Fiscal years beginning after December 15, 2020 and interim periods thereafter Early adoption Fiscal years beginning after December 15, 2018 11
Scope In scope Loans Loan commitments Financial guarantees (not insurance contracts) Trade receivables Reinsurance receivables Lease receivables recognized by a lessor Receivables that result from revenue transactions Loans made by a NFP entity to meet its mission (programmatic loans) Debt securities classified as held-to-maturity Debt securities classified as available-for-sale Out of scope CECL Equity instruments Financial instruments measured at FV through NI Loans and receivables between entities under common control Policy loan receivables of an insurance entity Loans made to participants by defined contribution employee benefit plans Pledge receivables of a not-for-profit entity 12
Main areas of change - CECL No probability threshold Expected lifetime loss estimate Estimate future economic conditions Applies to HTM securities 13
CECL Measurement overview Historical loss experience adj. for asset specific attributes Adjustments for current economic conditions Reasonable and supportable forecasts Estimate of current expected credit losses?? 14
Further CECL measurement considerations Pool assets with similar risk characteristics Do not consider beyond contractual term Consider expected prepayments Not required to recognize a loss when the risk of nonpayment of the amortized cost is zero Beyond reasonable and supportable forecast period, revert to historical loss experience 15
Loss curve 16
Potential for diversity Judgment would be needed Methodology DCFA Loan loss Vintage Other If other, which one? Reasonable and supportable forecasts What is reasonable & supportable? How long? Revert back to historical losses (adjusted for asset attributes but not economic conditions) Immediate or straight line? 17
AFS credit loss model - Main areas of change Allowance Reversals Floor Cannot consider length of time fair value is below amortized cost 18
Disclosures Qualitative disclosures about how an entity estimates expected losses, including changes in credit loss expectations Rollforward of the allowance for expected credit losses for financial assets measured at amortized cost and FV-OCI Current credit quality indicators that are disclosed under current GAAP would be disaggregated by year of origination (vintage disclosures) A discussion of the type of collateral and extent to which collateral secures an entity s financial assets Reconciliation between the purchase price and the par value of PCD financial assets at the time of purchase AFS debt securities Retain current disclosure requirements, updated for the general principles regarding disclosing credit risk 19
Transition Cumulative effect adjustment to the statement of financial position as of the beginning of the first reporting period PCD financial assets Assets to which Subtopic 310-30 (including by analogy) was applied reclass as PCD at adoption Gross up the allowance at adoption date Prospective interest income will be recognized based on EIR determined after the adjustment for credit losses made on the adoption date Previously impaired debt securities Prospective Certain amounts in AOCI will continue to be accreted in interest income 20
Insurance: Targeted Improvements to the Accounting for Long- Duration Contracts
Insurance Contracts FASB Initiatives Short-Duration Contracts (Final Standard ASU 2015-09 Issued May 2015) Long-Duration Contracts (Exposure Draft Issued September 2016) Focused efforts on targeted improvements to disclosures Focused efforts on targeted improvements to both accounting and disclosures No change to current U.S. GAAP model for recognition and measurement Change to current U.S. GAAP model for recognition, measurement, presentation and disclosure 22
Long-duration Insurance Contracts Timeline Proposed ASU issued in September 2016 Feedback from comment letters discussed in February 2017 Public roundtable meeting held in April 2017 Redeliberations begin in August 2017 Legend to matters that have been redeliberated: FASB affirmed previous decisions FASB revised previous decisions as highlighted Unmarked items have not yet been redeliberated or affirmed. Marked affirmed or revised decisions apply only to nonparticipating traditional and limited payment contracts; participating contracts and market-risk benefits have not yet been redeliberated. 23
Overview - Changes to Liability for Future Policy Benefits Best Estimate Assumptions Cash flow assumptions updated at least annually on a catch-up basis* * Previously referred to as the retrospective approach Discount rate assumptions updated each reporting period on an immediate basis Reserving Model Retained the net premium reserving model Provision for adverse deviation and premium deficiency reserve removed from determination of the liability ASU Long- Duration Liability Income Statement Impact Cash flow assumption changes reflected in P&L Discount rate assumption changes reflected in OCI Market-risk benefit changes in instrument-specific credit risk reflected in OCI Disclosures Several new disclosures required 24
Assumption Changes Cash Flow Assumptions Unlocking of assumptions is meant to provide more relevant estimates of future policy benefit reserves Key Changes: Updated at least annually in the same quarter every year, but more frequently if experience warrants Unlocked and updated on a catch-up basis (previously the retrospective approach) through net income Discount Rate Unlocking of the discount rate better reflects the market environment of the liabilities Key Changes: Updated at each reporting date Unlocked and updated on an immediate basis in other comprehensive income Reflected in the Net Premium % Not Reflected in the Net Premium % 25
Net Premium Reserving Model Value t = PV (Benefits + Expenses*) PV (Net Premium % x Premiums) All Cash Flow Assumptions Unlocked Net Premium % = PV (Benefits + Expenses) PV (Premiums) * The Board decided to permit, but not require, updating expense assumptions consistently with the update methodology used for other cash flow assumptions 26
Discount Rate Current practice is that the discount rate can vary depending on the type of insurance contract. Discount rates can be currently based on: expected investment yield, policy crediting rate, or dividend interest rate. Determine discount rate using a reference portfolio of upper-medium grade, fixed income investments Insurance entities would be required to: - Use reliable information that reflects duration characteristics of the future policy benefit reserves - Maximize the use of observable inputs and minimize the use of unobservable inputs - Use the interest accretion rate as the original discount rate IMPACT: Discount rate on assets and liabilities are no longer connected; therefore, the Asset Liability Management reported discount rate could be out of sync with the financial statement discount rate 27
Long Duration Contracts with Market-risk Benefits Approach One measurement model for all types of contracts with market-risk benefits Measured at fair value and presented separately on the statement of financial position Recognize the change in fair value: in other comprehensive income (OCI) when attributable to a change in the instrument-specific credit risk remainder as a separate line item in the statement of operations Market-risk Benefits Contract feature that exposes the insurance entity to other-thannominal capital market risk that arises from either of the following 1) A contract feature that protects the account balance (or similar amount) from adverse capital market performance 2) A contract feature that causes variability in the account balance (or similar amount) in response to capital market volatility. IMPACTS: 1. No longer would evaluate whether market-risk benefits are derivatives 2. Increased volatility in the P&L due to changes in FV 28
Deferred Acquisition Costs (DAC) Concepts eliminated under the proposed standard: Accruing interest on the unamortized balance of DAC Adjusting DAC for the effect of investment performance or changes in expected future liability cash flows (shadow adjustments) Impairment analysis on DAC 29
Disclosures Additional disaggregated disclosures for the future policy benefit reserves and DAC would include rollforwards of opening and closing balances and quantitative and qualitative information about significant inputs, judgments and assumptions used in the measurement of the liabilities for future policy benefits and DAC. Provides a principle for determining how to disaggregate the new disclosures to provide meaningful information without requiring a large amount of insignificant detail or aggregation of items with significantly different characteristics. Provides examples of disaggregation characteristics (e.g., type of coverage, etc.). Consider how information about future policy benefit reserves or DAC has been disaggregated for other purposes when determining which categories would be the most relevant and useful. Clarifies that the aggregation of the disclosures would at a minimum be consistent with segment-related disclosures. IMPACT: The proposed ASU would significantly expand the disclosure requirements for longduration contracts in the annual and interim financial statements. 30
Transition Requirements Effective Date The FASB has not discussed an effective date Market-Risk Benefits Future Policy Benefit Reserves Apply to existing carrying amounts at the transition date, adjusted to remove related amounts in accumulated OCI (prospective basis) Difference between fair value and carrying value at the transition date, excluding changes in instrumentspecific credit risk, recognized in opening retained earnings Deferred Acquisition Costs Apply to existing carrying amounts at the transition date, adjusted to remove amounts in OCI (shadow DAC) Disclosures During the Year of Adoption Information required for a change in accounting principle, but on a disaggregated basis consistent with recurring disclosure disaggregation Option to apply the guidance retrospectively, with a cumulative adjustment to opening retained earnings Cumulative effect of changes in instrumentspecific credit risk recognized in accumulated OCI Apply to other balances amortized consistently with deferred acquisition costs (e.g., sales inducements) Qualitative and quantitative information about transition adjustments when net premiums exceed gross premiums and additional liability for a universal life-type or investment contract is recorded 31
NAIC Insurance Data Security Model Law
NAIC Passes Insurance Data Security Model Law On October 24, 2017, the NAIC adopted the Insurance Data Security Model Law, which creates rules for insurers, agents and other licensed entities covering data security, investigation and notification of breach. Purpose is to establish standards for data security and standards for the investigation of and notification to the Commissioner of a Cybersecurity Event applicable to Licensees. Cybersecurity Event means an event resulting in unauthorized access to, disruption or misuse of, an Information System or information stored on such Information System. Effective date will vary based on when individual states adopt, but upon that date, Licensees will have one year from the effective date to implement Section 4 (Information Security Program) and two years from the effective date to implement Section 4F (Oversight of Third-Party Service Provider Arrangements) If a Licensee is in compliance with N.Y. Comp. Codes R. & Regs. tit.23, 500, Cybersecurity Requirements for Financial Services Companies, effective March 1, 2017, such Licensee is also in compliance with this Act. 33
NAIC Passes Insurance Data Security Model Law (cont.) Section 4: Information Security Program A. Implementation of an Information Security Program B. Objectives of Information Security Program C. Risk Assessment D. Risk Management E. Oversight by Board of Directors F. Oversight of Third-Party Service Provider Arrangements G. Program Adjustments H. Incident Response Plan I. Annual Certification to Commissioner of Domiciliary State Section 5: Investigation of a Cybersecurity Event Section 6: Notification of a Cybersecurity Event Section 7: Power of Commissioner Section 8: Confidentiality Section 9: Exceptions 34
Statutory Accounting Update
Investments Money Market Mutual Funds (SSAP No. 2) Adopted Reclassified to cash equivalents Measured at fair value Effective December 31, 2017 Accounting for ETFs (SSAP No. 26) Adopted Removed from the definition of a bond Measured at fair value May elect to use the systematic value approach, if certain conditions are met AVR and IMR (SSAP No. 26) Adopted Clarify OTTI to be recorded either entirely in AVR or IMR Effective upon adoption (August 6, 2017) Bank Loans (SSAP No. 26) Exposed Revised definition to include bank loans issued directly by insurer Potential separate reporting on schedule D Mortgage Loans (SSAP No. 37) Adopted Mortgage acquired through assignment, syndication or participation In scope Real estate funds or securitization of assets Out of scope Effective upon adoption (June 8, 2017) 36
Investments (continued) Derivatives (SSAP No. 86) Impact of future settlement premiums on option value Exposed - Treatment of initial cost to acquire derivative contracts Derivative contracts related to variable annuity products Ongoing discussions - Issue Paper proposes hedge accounting treatment for certain limited derivative contracts - Discussions focused on: Dynamic hedging strategies Amortization or accretion period for unrecognized gains or losses Recognition of unrealized gains and losses Ability to apply current accounting, in certain situations Derivatives (SSAP No. 86) Variation margin Exposed - Recognize as unrealized gains or losses until maturity, termination or expiration - Report collateral separately on the balance sheet 37
Investments (continued) Repurchase and reverse repurchase agreements (SSAP No. 103R) Adopted New disclosures - General information - Detailed information for agreements accounted for as secured borrowing and sales transitions Effective December 31, 2017 NAV as a practical expedient to fair value (Exposed) Allow the use of NAV when: - Specifically permitted by an SSAP - No readily determinable fair value FV and an investment company or real estate fund that measures FV using NAV and issues financial statements following measurement principles of an investment company Mid-Year reporting of investment schedules Adopted by SAPWG and AP&P Discussions are on-going at the E Committee 38
Other Accounting Topics Guaranty Fund Credits (SSAP No. 35) Adopted Allowed discounting of guaranty fund assessments resulting from insurers that wrote long-term care contracts Allows expected renewals of short-term contracts for long term care assessments when determining: - Premium tax credit - Policy surcharge assets Effective January 1, 2017 Risk Transfer (SSAP No. 61R and 62R) Exposed SSAP No. 61R - Additional guidance to determine if a contract is proportional or non-proportional and if significant loss is transferred for non-proportional reinsurance contracts - Clarified that provisions that limit reinsurer s losses should be reflected as a reduction in claims and losses ceded - Additional disclosures SSAP No. 62R - Clarified that provisions that limit reinsurer s losses should be reflected as a reduction in claims and losses ceded - Prohibition of reserve credit for non-proportional reinsurance unless the aggregate attachment point has been penetrated 39
Other Accounting Topics (continued) U.S. GAAP disclosures for short-duration contracts (SSAP No. 55 and 65) Adopted SSAP No. 55 disclose significant changes in methodologies and assumptions SSAP No. 65 disclose amount of interest accretion recognized in statement of income Effective upon adoption (April 8, 2017) Goodwill limitations (SSAP No. 68) Exposed Proposed 5 options for admissibility of goodwill - Decrease admissibility limit from 10% to 5% - Limit admissibility based on percentage of the dollar amount of goodwill remaining after the initial 10% limitation based on amount of capital held by the parent - Limit to the asset or net asset value of the SCA - Eliminate admissibility - No change to current admissibility High Deductible Disclosures (SSAP No. 65) Adopted Gross amount of loss reserves Amounts that have been billed and are recoverable on paid claims Collateral pledged related to deductible and paid recoverables Unsecured high deductible (amount and percentages) Highest 10 unsecured high deductible amounts by counterparty Effective upon adoption (June 8, 2017) 40
Projects to Watch Leases Exposed Revisions consider new U.S. GAAP guidance for leases - Retain concept of operating leases - Revisions are significant but are not intended to result in significant changes to current statutory accounting Credit Losses (CECL) Considering adoption of new U.S. GAAP accounting Expect to have discussion later this year 41
Principles Based Reserving (PBR) Completed a pilot project - Made changes to address inconsistencies within VM-20 - Made changes to VM-31 to streamline actuarial report Life PBR Exemption - Ordinary premium of less than $300 million (or $600 million for a group) - Total Adjusted Capital of at least 450 % - Unqualified actuarial opinion on reserves - No universal life policies issued or assumed with material secondary guarantees, after January 1, 2020 Adopted changes to Life PBR exemption to - Exclude small companies from requirement to meet the 450 percent risk-based capital; - Allow certain companies that fall below the 450 percent RBC requirement, to seek an exemption from their commissioner; - Clarify that companies cannot have material Universal Life with Secondary Guarantees policies on or after January 1, 2020; and - Exclude the following from the ordinary life premium threshold of $300 million: premiums for preneed life contracts; and transfers of reserves in-force as of the effective date of a reinsurance assumed transaction. 42
Regulatory Update Investment RBC Discussed updated bond factors for Life insurers - Suggested starting point for P&C and Health insurers Real Estate - Proposal to change base factor from 15% to 10% Federal Home Loan Banks - Proposal to change 1.3% to zero for collateral held for FHLB advances NAIC Group Capital Calculation inventory method based on RBC aggregation Existing legal entity requirements, not new standards Treatment of different typed of entities: - Insurers that are not subject to RBC formula, non insurance entities, entities with no capital requirements and; - Captives that: Exclusively self-insure Do not assume XXX/AXXX business Assume XXX/AXXX business Treatment of permitted and prescribed practices Scalars for capital from non-u.s. jurisdictions 43
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