NAIC 2015 Spring Meeting

Issues & Trends In Insurance April 2015, No. 15-3 NAIC 2015 Spring Meeting National Association of Insurance Commissioners (NAIC) groups continued to discuss initiatives related to captives and special purpose vehicles and principle-based reserving. This edition of Issues & Trends briefly describes these topics and other actions taken at the Spring meeting in Phoenix, Arizona, which was held March 26-31, 2015. Contents Captives and Special Purpose Vehicles... 2 Other Actuarial Topics... 4 Other Accounting Highlights... 6 Other Regulatory Highlights... 9 Key Actions Adopted regulatory criteria for the principle-based reserving (PBR) small company exemption based on company premium writings, risk-based capital (RBC), and other risk criteria. Recommended that the U.S. GAAP definition of security be incorporated in SSAP No. 26 and require all SSAP No. 26 investments to have a contractual amount of principal due. 1 Adopted revisions to SSAP No. 1 to incorporate recent U.S. GAAP accounting guidance on going concern disclosures to require a reporting entity to evaluate whether there is substantial doubt about the entity s ability to continue as a going concern and make disclosures when substantial doubt exists. 2 Exposed revisions to SSAP No. 41 to report surplus notes with a certified rating program rating equivalent to an NAIC 1 at amortized cost and all other surplus notes at the lower of amortized cost or fair value. 3 Exposed additional revisions to SSAP No. 93 to adopt with modification recently adopted accounting guidance for investments in qualified affordable housing projects. The revisions were made to be explicit that statutory accounting will continue to reflect proportional amortized cost balance sheet treatment, which essentially is the same as the optional U.S. GAAP proportional amortization method. Statutory accounting continues to reject the net reporting allowed by U.S. GAAP. 4 1 SSAP No. 26, Bonds, Excluding Loan-Backed and Structured Securities, and FASB ASC Topic 320: Investments Debt and Equity Securities. 2 SSAP No. 1, Disclosure of Accounting Policies, Risks and Uncertainties, and Other Disclosures, and FASB Accounting Standards Update No. 2014-15, Presentation of Financial Statements Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity s Ability to Continue as a Going Concern, available at www.fasb.org. 3 SSAP No. 41, Surplus Notes. 4 FASB Accounting Standards Update No. 2014-01, Investments Equity Method and Joint Ventures (Topic 323) Accounting for Investments in Qualified Affordable Housing Projects, available at www.fasb.org, and SSAP No. 93, Accounting for Low Income Housing Tax Credit Property Investments. network of independent member firms affiliated with KPMG International Cooperative, All

Captives and Special Purpose Vehicles Principle-Based Reserving (PBR) Implementation Task Force. The NAIC adopted Actuarial Guideline XLVIII (AG 48) on December 16, 2014. 5 AG 48 requires captive transactions to hold assets meeting the definition of a Primary Security up to the reserve amount determined using a modified Valuation Manual (VM)-20 methodology. AG 48 is effective as of January 1, 2015. XXX/AXXX policies issued before January 1, 2015, for which the reinsurance captive was in place by December 31, 2014, are exempt. Before the Spring meeting, the Task Force held calls to discuss the 2015 XXX/AXXX Reinsurance Supplement proposal and exposed it for comment on February 11, 2015. During the comment process, some concerns were raised about the scope of reporting required for special exemption and grandfathered transactions and whether the inclusion of all the information could produce misleading results by looking at information not relevant to the particular transaction. The Task Force wants an insurer who has received special exemption to disclose information about the transactions because it will help the NAIC, regulators, and the public assess how the exemption is applied to determine whether the AG 48 exemption should be revised. Additionally, the Task Force felt these exemptions are expected to be very limited so disclosure of the information should not be burdensome to insurers. The Task Force also discussed the information required for grandfathered transactions and felt it was appropriate. Grandfathered and non-grandfathered transactions are reported separately in Part 2A and 2B of the exhibit so there should not be confusion. The Task Force discussed concerns expressed about the information required in the Interrogatories. The American Council of Life Insurers (ACLI) thought the disclosure of the RBC impact and collateral/liability mismatches could lead to misunderstanding and potentially not be very useful because it is based on some hypothetical information. Some felt the information should only be disclosed to regulators in 2015 so they can assess if the information was misleading and propose changes. Others favored making the Interrogatories public information to help compare companies entering into these transactions. The Task Force decided the Interrogatories would be regulator-only in 2015. The Task Force made some recommended technical and clarifying revisions. It also voted to adopt the 2015 XXX/AXXX Reinsurance Supplement Proposal and to send to the Blanks Working Group. Life RBC Working Group. Before the Spring meeting, the Life RBC Working Group exposed proposals that address the three charges assigned to them by the PBR Implementation Task Force: Develop an appropriate RBC cushion for an insurer ceding XXX/AXXX policies when the assuming reinsurer does not file an RBC report using the RBC formula and related instructions; Develop appropriate asset charges for Other Security; and 5 Actuarial Opinion and Memorandum Requirements for the Reinsurance of Policies Required to be Valued under Sections 6 and 7 of the NAIC Valuation of Life Insurance Policies Model Regulation (Model 830). 2 network of independent member firms affiliated with KPMG International Cooperative, All

Determine if the current RBC charge adjustment within the C-3 factor for qualified actuarial opinions is adequate for the risks of XXX/AXXX reinsurance transactions that receive a qualified actuarial opinion. The Working Group believes that it has two primary tasks that need to be completed to address the charges: Identify an appropriate consequence for transactions that do not comply with the requirements of AG 48; and Develop a methodology to ensure that there are sufficient good assets backing the reserves in the covered transactions. To address the first task, the Working Group exposed a proposal that eliminates the RBC impact of a qualified actuarial opinion that is qualified solely due to requirements of AG 48 and a proposal that increases the Authorized Control Level (ACL) RBC by any aggregate shortfall in an insurer s primary security under AG 48. At the Spring meeting, the Working Group discussed comments received from interested parties. They were very supportive of eliminating the RBC impact for a qualified opinion based solely on AG 48. Concern was expressed that the increase in ACL RBC for any aggregate shortfall could have unintended results. Interested parties had previously suggested the shortfall be subtracted from Total Adjusted Capital (TAC) but the Working Group felt that an increase in ACL RBC was needed to incorporate a penalty for non-compliance with AG 48. Interested parties suggested the increase be to the Company Action Level RBC instead of to ACL RBC. The Working Group will continue discussions on a call. To address the second task, the Working Group exposed a consolidated RBC shortfall proposal. The proposal creates another RBC exhibit that calculates if there is an RBC shortfall at each captive. A shortfall at one captive cannot be offset by excess RBC at another captive. The ceding entity s RBC cushion is determined as the total of the shortfall at all captives and is recorded as an adjustment to TAC. The Working Group will discuss this proposal and any comments received on a call. Statutory Accounting Principles Working Group (SAPWG). During the Spring meeting, SAPWG exposed revisions to guidance that will be incorporated in SSAP No. 61R to develop a note to the audited financial statements about compliance with the NAIC XXX/AXXX Reinsurance Model Regulation. 6 The revisions are based on comments received on the initial exposure. The revisions clarify that disclosure is required for periods ending on or after December 31, 2015, even if a state determines the insurer or transaction will not have to comply in full with all aspects of the applicable standard. The exposed guidance requires insurers annual audited financial statements to disclose: Whether the disclosure requirement standard is the NAIC Term Life and Universal Life with Secondary Guarantees (XXX/AXXX) Credit for Reinsurance Model Regulation or AG 48; The number of reinsurance contracts in which risks under covered policies have been ceded by the reporting entity; The amount of funds consisting of Primary Securities or Other Securities held for each contract and the amount of shortfall if any; and 6 SSAP No. 61R, Life, Deposit-Type and Accident and Health Reinsurance. 3 network of independent member firms affiliated with KPMG International Cooperative, All

Additional details for all contacts with a shortfall that include the assuming insurer by name and NAIC code, name and effective date of the contract, the total amount of XXX/AXXX statutory reserves ceded under the contract, the required level of primary security, the actual amount of primary security, the actual amount of other security, and the amount of shortfall in primary and/or other security. Other Actuarial Topics Principle-Based Reserving (PBR) Implementation Task Force. At the Spring meeting, the Task Force discussed the operative date of the Valuation Manual. The Valuation Manual will become effective 6 to 18 months after 42 states with at least 75 percent of the subject premium have adopted the revised law with substantially similar terms and provisions. It was reported that currently: 22 states have adopted the law; 3 states are awaiting the governor s signature; 13 states have active legislation; and 7 states are expected to introduce the law this year. The Task Force believes that if all 45 of these states adopt the revised law, the premium requirement will be close to being achieved. A sufficient number of states must adopt the law by July 1, 2016, to achieve a January 1, 2017, effective date. The Task Force is continuing work to establish the criteria that will be used to determine substantially similar terms and provisions. The Task Force has received approximately 35 responses to the state survey about implementation plans and is reviewing them. The Task Force plans to have a call in the next couple of months to discuss the results and plans for implementation. Valuation Manual (VM)-22. On calls before the Spring meeting, the VM 22 Subgroup continued to develop a model reserve for non-variable deferred annuities. The Subgroup identified six approaches to design VM 22 and presented Life Actuarial Task Force (LATF) with the three approaches that it believes are feasible and credible as well as the pros and cons of each at the Spring meeting: Replicate VM 20 but with a stochastic exclusion test designed specifically for fixed annuities; Representative Scenario Method; and Modernize Current Formulaic / Deterministic Method. While the Subgroup feels the first option is the best, it believes it adds unnecessary complexity to the statutory reserves for non-variable annuities. The Subgroup believes that some combination of the second and third approaches appears to be the most logical option, but it is seeking feedback from LATF. 4 network of independent member firms affiliated with KPMG International Cooperative, All

Small Company Exemption for VM-20. On a call prior to the Spring meeting, the PBR Implementation Task Force adopted regulatory criteria for the PBR small company exemption based on company premium writings, risk-based capital, and other risk characteristics. The Task Force decided that it will be a companywide exemption. Those companies that meet the exemption criteria will not need to perform the PBR exclusion test but will not be exempt from the Valuation Manual entirely. The small-company exemption is limited to companies with: Ordinary life premiums less than $300 million for the legal entity and less than $600 million for the associated group; RBC is at least 450 percent of the authorized control level; and No material Universal Life Secondary Guarantee business in force. Companies that apply for exemption will be required to set their reserves in accordance with the Commissioners Reserve Valuation Methodology (CRVM). The Task Force determined that the exemption language will be included in the Valuation Manual instead of being added to the model Standard Valuation Law. Some regulators still believe the small company exemption is unwarranted and has no actuarial basis. Others felt it was appropriate to exempt companies where the cost and burden of implementation would outweigh the benefits to solvency regulation. The ACLI reiterated that the exemption provided a riskbased approach to exclude small companies from the PBR requirement (it would still be required for approximately 95 percent of the industry). Concern was raised about the use of the Net Premium Reserve (NPR) within the exemption because it would produce a lower reserve than what would be calculated using CRVM. Several regulators thought CRVM should be used by exempted small companies instead of NPR because they have historical experience with CRVM. The ACLI said it believes NPR is the appropriate reserving approach for exempted small companies because CRVM has been shown to be too high for certain products including term life insurance. In addition, a company will only be exempt if there are no material secondary guarantees written so the Task Force only needs to focus on the reserve for term life business. After discussion, the Task Force decided that a small company exemption should be included and exempted companies should continue setting reserves calculated by CRVM. The Task Force decided to include the small company exemption in the Valuation Manual instead of in the Standard Valuation Law. Inclusion in the Valuation Manual will create uniformity across states, and regulators felt it was more appropriate as states are at different adoption stages of the Standard Valuation Law. LATF adopted the small-company exemption proposal on a call prior to the Spring meeting. New Valuation Mortality Tables. At the Spring meeting, the American Academy of Actuaries presented developments on the 2014 Valuation Basic Table (VBT) and the accompanying 2017 Commissioners Standard Ordinary (CSO) table to LATF. The risk rating tables were exposed. There will still be 10 tables, which was requested by interested parties for IT system purposes, but the proposed structure is changing. The lowest risk is now the RR50 table (previously RR70). The proposed margins for the draft CSO 2017 table are about 18 percent in aggregate. This is lower than in the past because there is more data (439 percent additional exposure by face, 52 percent by number of policies), resulting in greater statistical significance of the data. No explicit margins are 5 network of independent member firms affiliated with KPMG International Cooperative, All

proposed for catastrophes, or random variations. The idea is that those events are covered by capital, not reserves. The CSO table will be exposed once the impact study (on cash values and statutory and tax reserves) is complete. A question remains about having different margins by rating class to reflect the different statistical credibility of the different classes, but several regulators questioned this approach and stated they would not accept different margins without a very good reason. Discussion will continue on future calls. Other Accounting Highlights Project to Review Investment SSAPs. At the Spring meeting, staff members presented their recommendations to address the first two SSAP No. 26 issues within the investment classification project. Based on their research, the staff did not see a regulatory reason to define security differently between U.S. GAAP and statutory accounting, and recommended that the U.S. GAAP definition of security be incorporated in SSAP No. 26. The staff also recommended that guidance be incorporated to require all SSAP No. 26 investments to have a contractual amount of principle due. Currently there are some exchange-traded funds and mutual funds within the scope of SSAP No. 26 that will not be able to follow this guidance based on the above revisions. The staff is recommending that these securities be considered concurrently with drafting potentially new guidance. The staff expects the revised accounting treatment to: Appropriately bifurcate investments by type, which will create better transparency about the investments a company holds; Eliminate inconsistencies in how amortized cost is calculated for investments with no contractual amount of principal due; and Allow the risk of an investment type and the related RBC charge to be better determined for each investment type. Moving certain investments into a new SSAP with new guidance is not expected to impact state investment law limitation requirements because they are based on investment type and not SSAP classification. The staff provided the Working Group with a financial data summary that highlights the inconsistencies in current accounting for exchange-traded funds to support its recommendation. The staff also presented its work on defining debtlike investments that are outside the bond definition in proposed revisions to SSAP No. 26. The recommendations and support are summarized in four memorandums that were exposed for comment. Cash Flow Statement. Nonsubstantive revisions to SSAP No. 69 were adopted. 7 These changes clarify that the cash flow statement should only include cash activity and expand the required disclosures to include noncash operating items. Changes are effective for the year ended December 31, 2015, reporting. 7 Defined in SSAP No. 69, Statement of Cash Flow, as cash, cash equivalents, and short-term investments. 6 network of independent member firms affiliated with KPMG International Cooperative, All

Investments in Qualified Affordable Housing. SAPWG re-exposed revisions to SSAP No. 93 to adopt with modification U.S. GAAP guidance in FASB ASU 2014-01. SAPWG revised the changes previously exposed based on comments received from interested parties. The changes are intended to explicitly state that statutory accounting will continue to reflect proportional amortized cost balance sheet treatment, which is essentially the same as the optional U.S. GAAP proportional amortization methodology within ASU 2014-01. No changes to the statutory accounting income statement treatment were made, and it will continue to be a gross presentation, which is different from the net U.S. GAAP presentation in ASU 2014-01. Additionally, some changes were made to SSAP No. 93 to reflect U.S. GAAP terminology. Single Member Limited Liability Company (LLC). Issue Paper No. 149 and revisions to SSAP No. 40 were adopted in December 2014. 8 The adoption moved wholly owned real estate owned through an LLC that meets certain criteria as assets into the scope of the real estate guidance in SSAP No. 40R. Changes were effective on January 1, 2015. Since adoption in December, questions have been raised about whether a mortgage loan on real estate held in an LLC would disqualify the real estate from being classified as wholly owned real estate under SSAP No. 40R. The Working Group discussed that a normal mortgage loan was not intended to restrict classification and exposed additional revisions to SSAP No. 40R to clarify the intention. Going Concern Disclosure. Nonsubstantive revisions to SSAP No. 1 exposed during the Fall meeting were adopted. These revisions incorporate disclosure requirements from U.S. GAAP for a reporting entity to evaluate whether there is substantial doubt about the entity s ability to continue as a going concern. Additionally, revisions to SSAP No. 48, SSAP No. 68, and SSAP No. 97 also exposed during the Fall meeting, were adopted. 9 These changes require certain investments to be nonadmitted if the audited financial statements include management s assessment that there is substantial doubt about the entity s ability to continue as a going concern. The guidance is effective December 31, 2016, to be consistent with the U.S. GAAP effective date. Early application is permitted. Sale-Leasebacks with Nonadmitted Assets. During the Spring meeting, SAPWG exposed an agenda item for feedback after receiving several questions about what property means in the section of SSAP No. 22 that addresses saleleaseback transactions. 10 Questions received have requested clarification on transactions involving nonadmitted assets with unrelated parties. The current guidance provides that these transactions may include real estate, but it is unclear on whether it was intended to include non-real estate depreciating assets such as software when the nonadmitted asset is sold and leased-back. SAPWG will review feedback to determine what clarifications to SSAP No. 22 are necessary. 8 Issues Paper No. 149, Wholly-Owned Single Real Estate Property in an LLC, and SSAP No. 40, Real Estate Investments. 9 SSAP No. 48, Joint Ventures, Partnerships and Limited Liability Companies; SSAP No. 68, Business Combinations and Goodwill; and SSAP No. 97, Investments in Subsidiary, Controlled and Affiliated Entities, A Replacement of SSAP No. 88. 10 SSAP No. 22, Leases. 7 network of independent member firms affiliated with KPMG International Cooperative, All

Prepayment Penalties and Amortization on Callable Bonds. During the Spring meeting, SAPWG exposed three nonsubstantive revisions to SSAP No. 26. Require prepayment penalties and acceleration fees to be reported as realized capital gains. Current guidance requires these penalties and fees to be classified as investment income, which conflicts with annual statement instructions and creates complexity to identify all penalties. Incorporate guidance for continuously callable bonds to clarify the yield-toworst concept, including when to expense premium. Amortization based on the call schedules should be compared to the standard amortization to determine the lowest asset value. Revise the measurement method for bonds with make-whole call provisions. Currently the yield-to-worst guidance includes an exception for bonds with make-whole call provisions, the revision would remove the exception. Extraordinary and Unusual Items. SAPWG exposed revisions to SSAP No. 24 to adopt with modification the new U.S. GAAP guidance to eliminate the concept of extraordinary items. 11 The revisions reflect the U.S. GAAP terminology, but the statutory accounting guidance is unchanged. Events considered to be unusual in nature or infrequent should be reported consistently within continuing operations. Events that are unusual in nature, or infrequently occurring, or both should be disclosed in the financial statements. Discontinued Operations. During the Spring meeting, SAPWG exposed additional revisions to SSAP No. 24 to adopt with modification U.S. GAAP guidance to improve the definition of discontinued operations and improve clarity on disposals through disclosure. 12 Several revisions were made to reflect U.S. GAAP guidance and terminology; however, the overall statutory accounting for discontinued operations will not change. Statutory accounting rejected the guidance in ASU 2014-08 for separate reporting of discontinued operations. Statutory reporting specifies that discontinued operations should continue to be reported with other operations. The additional disclosures in U.S. GAAP will be adopted to the extent they apply to statutory accounting. Disclosures related to components, group of components and equity method investments are rejected and not required. SAPWG also exposed some revisions to SSAP No. 90 to be consistent in paragraphs that refer to SSAP No. 24. 13 Holders of Surplus Notes. SAPWG exposed revisions to SSAP No. 41 after considering interested party comments and reviewing the information in schedule BA. The revisions are proposed to clarify some of the guidance in paragraph 10, which is sometimes referred to as the hanging paragraph. The changes clarify that surplus notes: 11 SSAP No. 24, Discontinued Operations and Extraordinary Items, and FASB Accounting Standards Update No. 2015-01, Income Statement Extraordinary and Unusual Items (Subtopic 225-20) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items, available at www.fasb.org. 12 FASB Accounting Standards Update No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, available at www.fasb.org. 13 SSAP No. 90, Accounting for the Impairment or Disposal of Real Estate Investments. 8 network of independent member firms affiliated with KPMG International Cooperative, All

With a Certified Rating Program (CRP) rating equivalent to an NAIC 1 rating are to be reported at amortized cost. Not rated by a CRP, or with a CRP rating that is anything other than equivalent to an NAIC 1 rating, are to be reported at the lower of amortized cost or fair value. The changes eliminate the concept of reporting surplus notes at outstanding face value or a calculated amount based on a statement factor. SAPWG believes the prior guidance was outdated and the reporting on schedule BA did not encompass these concepts. The revisions also clarify that fair value fluctuations, or moving from fair value to amortized cost, should be reported as unrealized gains or losses in surplus and that other impacts to surplus notes such as if the issuer is under regulatory action should be reported as nonadmitted assets. SAPWG plans to draft and expose an issue paper once it receives comments on the exposed revisions to SSAP No. 41. Repurchase Agreements. On a call before the Spring meeting, the Restricted Asset Subgroup continued discussions about statutory accounting for repurchase agreements. During the call the Subgroup agreed to consider revisions to SSAP No. 103 to: 14 Clarify that collateral or the purchased security must meet the requirements to be an admitted asset; Update the collateral percentages required under the repurchase agreement and reverse-repurchase agreements; and Clarify the short-term restrictions for repurchase agreements. These revisions were exposed for comment with the intention to continue discussions on future calls. Other Regulatory Highlights Operational Risk. On calls before the Spring meeting, the Operational Risk Subgroup continued discussions about the development of a new operational risk charge for the RBC formula. The Subgroup has been working to gain an understanding of the nature and amount of operational risk that is currently embedded in existing risk charges so it can determine the amount of operations risk remaining that needs to be captured in the new charge. However, the Subgroup determined that the quantification of risk embedded in charges other than the growth charge is not currently possible and decided to develop an overall operational risk change. The Subgroup used the informational-only reporting of operational risk charge in the 2014 RBC reports as it continued to work on an appropriate charge. Additionally, the Subgroup has requested the assistance of the life RBC Working Group to develop the life operational risk charge because some members believe that it needs to occur at a more granular level. 9 14 SSAP No. 103, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. network of independent member firms affiliated with KPMG International Cooperative, All

Investment Risk-Based Capital. On a call before the Spring meeting, the Investment Risk-Based Capital Working Group discussed the granularity of RBC factors. The American Academy of Actuaries reported on its work to analyze the effects of changing the current 5 factors to 13 factors. Based on preliminary results, using 13 factors might better capture outliers. Additionally, portfolio changes may be better captured by using more factors. From a risk-focused perspective, the Academy reported that using 13 factors more accurately captures the investment risks. Regulators expressed the need for a cost-benefit analysis so they can better understand the cost to change the RBC factors. During the Spring meeting, the Academy provided an update on the status of its work on the corporate bond factors. The Academy is close to recommending a set of factors to the Working Group, but believes there are still some economic adjustments that may need to be made to the preliminary results. The Academy is in the process of performing model and rate validation, which includes peer review of the model and factor reconciliation, and completing the documentation for factor changes. A final recommendation is expected to be presented at the Summer meeting. The Academy continues to recommend using the corporate bond factors for the non-modeled fixed-income assets, including municipal bonds, sovereign bonds, hybrid securities, and preferred stocks. The Working Group plans to follow the recommendation and suggested that any party that disagrees present a robust model with credible data at the Summer meeting. Mortgage Guaranty Insurance. During the Spring meeting, the Mortgage Guaranty Insurance Working Group continued discussions on revisions to the Mortgage Guaranty Insurers Model Act. The Working Group agreed to post the current draft of the Mortgage Guaranty Insurers Model Act and the current draft of the Mortgage Guaranty Insurance Standards Manual to the Web site and is requesting feedback from regulators and interested parties. Discussions will continue on future calls. Contact us: This is a publication of KPMG s Department of Professional Practice 212-909-5600 Contributing authors: Jennifer D. Austin, Alan W. Goad, Francis de Regnaucourt, and Ashley N. Rogers Earlier editions are available at: http://www.kpmg-institutes.com/financial-reporting-network Legal The descriptive and summary statements in this newsletter are based on participating in conference meetings and conference calls and are not necessarily applicable to the specific circumstances of individual companies. They are not intended to be a substitute for the final texts of the relevant documents or the official minutes of the NAIC proceedings. Companies should consult the texts of any requirements they apply, the official minutes of the NAIC meetings, and seek the advice of their accounting and legal advisors. Issues & Trends In Insurance is a registered trademark of KPMG LLP. 10 network of independent member firms affiliated with KPMG International Cooperative, All