Board Meeting Handout Financial Guarantee Insurance January 9, 2008 At the January 9, 2008 Board meeting, the staff plans to continue redeliberations of the FASB Exposure Draft, Accounting for Financial Guarantee Insurance Contracts. UNEARNED PREMIUM REVENUE Issue 1 Recognition of Asset and Liability Background Information 1. The Exposure Draft requires that an insurance enterprise recognize a liability for the unearned premium revenue at inception of a financial guarantee insurance contract. The Board observed that in current practice, premiums are received in two forms either at inception (a single premium) or in installments (installment premiums). Generally, single premium insurance contracts are issued for insured financial obligations such as municipal bonds and installment premium insurance contracts are issued for insured financial obligations such as asset-backed securities. 2. The Board decided that a liability for the unearned premium revenue should be recognized in its entirety at inception of the financial guarantee insurance contract, regardless of when the premium is received, because the obligation under a financial guarantee insurance contract is created at the contract s inception. Further, the Board concluded that the insurance enterprise is contractually entitled to the premium specified in the financial guarantee insurance contract. Therefore, in instances where the premium is received in installments, a premium receivable (asset) should be recognized. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. t the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.
Constituent Comments 3. Some respondents to the Exposure Draft disagreed with recognizing a premium receivable (asset) and unearned premium revenue (liability) at inception of a financial guarantee insurance contract where premiums are received in installments. These respondents stated that (a) this accounting is inconsistent with FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, (b) the premium receivable (asset) would not meet the definition of an asset in FASB Concepts Statement No. 6, Elements of Financial Statements, and (c) recognition of the asset and liability does not provide incremental information to users. Several respondents suggested that, rather than recognizing the balances in the balance sheet, disclosures should be used to convey this information similar to disclosures currently provided in the insurance enterprises non-gaap operating supplements. Question for Board 4. Does the Board believe that an insurance enterprise should recognize an asset for the premium receivable and a liability for the unearned premium revenue at inception of a financial guarantee insurance contract where premiums are received in installments? (Note: The remaining issues are only relevant if the Board decides that a premium receivable [asset] and unearned premium revenue [liability] should be recognized in the balance sheet for installment premium insurance contracts.) Issue 2 Contractual Term versus Expected Term Background Information 5. Paragraph 7 of the Exposure Draft requires that the initial measurement of the unearned premium revenue (liability) be the present value of the premium due over the contractual term of the financial guarantee insurance contract. Paragraph 9 of the Exposure Draft specifies that for installment premium insurance contracts, the unearned premium revenue (liability) should be initially measured based on the present value of the premium receivable (asset) over the 2
contractual term of the financial guarantee insurance contract. The Board observed that the obligation under a financial guarantee insurance contract is created at the contract s inception for the entire contractual term of the insured financial obligation and that the insurance enterprise is entitled to the premium specified by the insurance contract. Constituent Comments 6. The majority of respondents disagreed with using the contractual term to measure the premium receivable (asset) and unearned premium revenue (liability). These respondents stated that (a) the asset would be overstated because prepayments are not factored into the contractual term, (b) adjustments to the contractual term as prepayments occur would increase complexity, (c) prepayment data are available and can be reliably measured, (d) the pricing of financial guarantee insurance contracts incorporates the expected term, and (e) the usefulness of the financial statements would be reduced. Questions for Board 7. Does the Board agree that the initial measurement of the unearned premium revenue (liability) should be the present value of the premium due over the contractual term of the financial guarantee insurance contract? If not, should the term of a financial guarantee insurance contract be adjusted for prepayments that are probable and reasonably estimable? Issue 3 Discount Rate Background Information 8. The Exposure Draft links the initial measurement of the unearned premium revenue (liability) to the premium receivable (asset) for financial guarantee insurance contracts where premiums are received in installments. Paragraph 10 requires that the present value of the premium receivable (asset) should be determined using a discount rate that reflects the credit standing of the policyholder at the inception of the contract. The Board observed that installment 3
Constituent Comments 9. Many respondents disagreed with using a discount rate reflecting the credit standing of the policyholder at inception of the contract. These respondents stated that it would be impracticable and costly to determine the discount rate for each policyholder. Several respondents also stated that the policyholder is not always the party responsible for paying insurance premiums and that the discount rate should reflect the enterprise that has the payment obligation. 10. Some respondents provided alternative approaches to determining the discount rate. For example, one respondent commented that the discount rate used should be the insurance enterprise s incremental borrowing rate consistent with paragraph 13 of APB Opinion No. 21, Interest on Receivables and Payables, and updated on a quarterly basis. Another respondent suggested using a weighted-average rate based on the term and underlying ratings of the insured financial obligations. Questions for Board 11. Does the Board agree that the present value of the premium receivable (asset) should be determined using a discount rate that reflects the credit standing of the enterprise responsible for the payment obligation at the inception of the contract? If not, what discount rate should be used? 4
Issue 4 Adjustment to Cumulative Premium Revenue (Retrospective, Cumulative Catch-up, or Prospective) for Installment Premium Insurance Contracts Background Information 12. Paragraph 11 of the Exposure Draft requires that in periods after initial recognition, the insurance enterprise should adjust the premium receivable (asset) for collectibility issues with an offsetting adjustment to bad debt expense. The insurance enterprise should consider its assessment of recognition and measurement of the claim liability in determining whether the premium receivable (asset) is fully collectible. The Board observed that adjustments to the premium receivable (asset) due to collectibility issues should flow through the bad debt expense to appropriately reflect the amount of the premium receivable (asset). 13. The Exposure Draft does not provide any additional guidance regarding how estimated prepayments and changes in those estimates would be accounted for in the financial statements because the Exposure Draft requires the use of the contractual term. Constituent Comments 14. Several respondents commented that additional guidance would be needed if the use of contractual cash flows is retained in the final Statement. Specifically, respondents asked (a) how the asset and liability would be relieved, (b) whether those adjustments are retrospective, cumulative-effect, or prospective, and (c) whether there is an impact to the income statement and, if so, which accounts are impacted. These comments were provided in the context of using the contractual term to measure the premium receivable (asset). Respondents were concerned as to how the premium receivable (asset) would be measured when prepayments affect the term over which the premium is expected as well as the ultimate amount of premium expected to be received. Further, the respondents were concerned about how those adjustments to the 5
measurement of the premium receivable (asset) should be reflected in the income statement (if at all). Question for Board 15. How should adjustments for prepayments on installment premium insurance contracts be accounted for? Issue 5 Accretion of the Premium Receivable (Asset) and Display in the Income Statement Background Information 16. The Exposure Draft requires that the discount amount be accreted on the premium receivable (asset) through investment income over the period of the contract in accordance with Opinion 21. The Board observed that the contractual arrangement is in effect a premium financing arrangement between the insurance enterprise and the enterprise that has the payment obligation. The Board observed that a portion of the premium specified by the financial guarantee insurance contract is compensation to the insurance enterprise for entering into the premium financing arrangement. Constituent Comments 17. Many respondents disagreed with the characterization of financial guarantee insurance contracts in which premiums are received in installments as a form of premium financing. Specifically, these respondents stated that the revenue from a financial guarantee insurance contract should not be split between premium revenue and interest income. They stated that (a) the mode of premium payment is not a choice but, rather, determined almost entirely by market convention, (b) a financing has not occurred because cash has not been exchanged nor has a service been fully performed under the contract, (c) revenue is being recognized using two different recognition models for the same contract (premium and interest revenue), (d) separating premium into premium revenue and interest income is inconsistent with Statement 60, (e) key 6
performance measures will be distorted, and (f) the accretion of a claim liability is not considered interest expense. Questions for Board 18. Does the Board agree that the discount amount should be accreted on the premium receivable (asset) through investment income over the period of the contract in accordance with Opinion 21? If not, where should the discount amount be accreted in the income statement? Issue 6 Adjustment to Cumulative Premium Revenue (Retrospective, Cumulative Catch-up, or Prospective) for Single Premium Insurance Contracts Background Information 19. This issue arises from the use of the expected term. The Exposure Draft requires the use of the contractual term. Therefore, there were no previous discussions regarding how changes in estimated prepayments would affect premium revenue recognition that is, would changes be recognized as retrospective, cumulative catch-up, or prospective? Constituent Comments 20. As noted above under Issue 4, respondents to the Exposure Draft raised concerns regarding how the subsequent measurement of the premium receivable (asset) would affect premium revenue recognition (which specifically relates to installment premium insurance contracts). Because the expected term was not allowed in the Exposure Draft, respondents did not specifically comment as to how prepayments should be factored into premium revenue recognition for a single premium insurance contract. However, similar issues may arise for a single premium insurance contract where prepayments occur, such as (a) how these adjustments would be recognized in the income statement and (b) the comparability in how these adjustments would be applied by insurance enterprises (retrospective, cumulative catch-up, or prospective). 7
Question for Board 21. How should adjustments for prepayments on single premium insurance contracts be accounted for? 8
Board Meeting Handout Not-for-Profit Endowments and UPMIFA January 9, 2008 PURPOSE The purpose of this meeting is to discuss the following matters concerning a proposed FASB Staff Position (FSP): (a) Proposed new disclosures (b) Effective date and transition (c) Length of the public comment period. BACKGROUND At its October 31, 2007, meeting, the Board added to its agenda a short-term project to issue an FSP addressing the accounting and reporting issues raised by the model Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA). The Board also made a number of tentative decisions concerning those issues, summarized in Appendix I to this handout. Those decisions included a requirement for a not-for-profit organization to disclose how its governing board has interpreted relevant law (including the state s adopted version of UPMIFA) in determining the portion of donor-restricted endowment funds that must be retained permanently and therefore classified as permanently restricted net assets. The Board also directed the staff to proceed with vetting and refining additional disclosures that may be necessary to provide sufficient transparency in the new UPMIFA environment. Following the October 31 meeting, the staff circulated a draft set of disclosures to a diverse group of external reviewers from the not-for-profit sector. Reviewers included preparers, practitioners, and users. The reviewers included the Accounting Principles Council and staff of the National Association of College and University Business The staff prepares meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.
Officers (NACUBO), a liaison organization to the FASB on not-for-profit matters that represents a constituent group greatly affected by the new UPMIFA legislation. Other reviewers included representatives from two credit rating agencies, one state charities regulator, two CFOs from professional foundations, five members of the AICPA Not-for- Profit Expert Panel, and three other practitioners (one of whom is also an academic). RECOMMENDED DISCLOSURES Based on feedback received from those external reviewers, the staff is bringing forward the following disclosures for Board consideration, in addition to the disclosure of a governing board s interpretation of relevant law (including the state s UPMIFA). The recommended disclosures are focused on providing useful information about endowment net asset classification and spending that will be even more valuable in the new UPMIFA environment. Disclosure A: Net Asset Composition by Type of Endowment Fund Each year for which a statement of financial position (balance sheet) is presented, an organization should present the composition of its endowment by net asset class, in total and by type of endowment fund, showing donor-restricted endowment funds separately from funds designated by the organization to function as endowment (that is, be invested long-term). The organization should also indicate the cumulative amount of investment return, if any, contained in the permanently restricted net asset class because of the organization s interpretation of relevant law, as opposed to explicit donor stipulations. (The last part of the disclosure could be accomplished, for example, either by a separate line within a table or in narrative.) Example of Minimum Disclosure Requirement: 2
Net Asset Composition by Type of Endowment Fund Unrestricted Temporarily Restricted Permanently Restricted Total Donor-Restricted Funds* $ $ $ $ Funds Functioning as Endowment $ $ $ $ Total Funds $ $ $ $ * Permanently restricted net assets include $XXX of cumulative investment return on donorrestricted endowment funds that the Organization has determined must be retained permanently to maintain the purchasing power of those funds, in accordance with the State Prudent Management of Institutional Funds Act of 200X, beyond the amount required by any explicit donor stipulations. The net asset composition disclosure would provide users with a holistic picture of how the different pieces of the Organization s endowment are classified in the Organization s statement of financial position (balance sheet). Reviewers unanimously agreed that this disclosure would provide valuable information. The additional disclosure concerning cumulative investment return added to permanently restricted net assets by governing boards would provide useful information in conjunction with the qualitative disclosure on board interpretation of law, to assist users in making inter-organizational comparisons. Disclosure B: Endowment Roll-Forward Each year for which a statement of activities is presented, an organization should present a reconciliation of the beginning and ending balance of its endowment, in total and by net asset class, including, at a minimum, the following line items (as applicable): investment return, separated into investment income (interest, dividends, rents) and net appreciation or depreciation of investments; contributions; distribution of endowment return to other funds (spending); reclassifications; and other changes (specified as necessary). The organization should also indicate how much, if any, of the additions of investment return to permanently restricted net assets are the result of the organization s interpretation of relevant law, as opposed to explicit donor stipulations. (The last part of the disclosure 3
could be accomplished, for example, either by a separate line within a table or in narrative.) Example of Minimum Disclosure Requirement: Endowment Roll-Forward Unrestricted Temporarily Restricted Permanently Restricted Total Net Assets, Beginning of Year $ $ $ $ Investment Return: Investment Income $ $ $ $ Net Appreciation (Depreciation) (realized and unrealized) $ $ $ $ Total Investment Return* $ $ $ $ New Gifts $ $ $ $ Distribution of Endowment Return to Other Funds ($) ($) ($) ($) Other Changes Transfers to Create Funds Functioning as Endowments $ $ $ $ Other ($) ($) ($) ($) Total Other Changes $ $ $ $ Reclassifications $ $ $ 0 Net Assets, End of Year $ $ $ $ * Additions to permanently restricted net assets include $XXX of investment return on donorrestricted endowment funds that the Organization has determined must be retained permanently to maintain the purchasing power of those funds, in accordance with the State Prudent Management of Institutional Funds Act of 200X, beyond the amount required by any explicit donor stipulations. The endowment roll-forward disclosure would provide users with information about the nature of the changes in the balance of an organization s endowment, from new gifts and internal transfers, investment performance, spending, and other changes. Some reviewers said this was a valuable disclosure, helping to put endowment spending in the context of the overall changes in the endowment during the year. The additional disclosure concerning investment return added to permanently restricted net assets by 4
governing boards would provide useful information, in conjunction with the qualitative disclosure on board interpretation of law, to help users assess organizational consistency in adhering to that interpretation. Disclosure C: Endowment Spending Policy The organization should describe its policy concerning the appropriation of endowment assets for spending (its endowment spending policy). Disclosure of an organization s endowment spending policy would provide valuable information to users concerning how an organization is approaching its stewardship and management responsibilities in the more flexible UPMIFA environment. Reviewers agreed that such disclosure was appropriate, especially under the more flexible UPMIFA environment; however, most of them urged that the requirement be kept as general as possible and allow for flexibility of presentation. Disclosure D: Planned Endowment Distributions The organization should indicate its planned distribution of endowment return to other funds (spending) for the next year, if known. The disclosure, together with the information about spending policy (Disclosure C) and current year spending (Disclosure B), and the disclosure about deficiencies that is already required in paragraph 15(d) of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations (see Appendix II), would provide valuable information to users concerning how an organization is approaching its stewardship and management responsibilities in the more flexible UPMIFA environment. OTHER POTENTIAL DISCLOSURES VETTED WITH EXTERNAL REVIEWERS 5
The staff vetted but does not recommend new disclosure requirements for endowment investment policies and strategies or for endowment asset allocation. While one could argue that such information would provide additional useful context for endowment spending information, the staff thinks that reexamination of the need for these types of disclosures rejected by the Board in its deliberations for Statement 124 (see Appendix II) is best done for all investments, not just endowment investments, and perhaps not just investments of not-for-profit organizations. The staff thinks that such a holistic reexamination of the disclosure requirements of Statement 124, and possibly those of FASB Statement No. 115, Accounting for Investments of Certain Debt and Equity Securities, is beyond the scope of the current FSP and is best done sometime in the future, when resources permit. The staff also vetted a potential new disclosure that would have complemented the information in paragraph 15(d) of Statement 124, by disclosing the specific adjustments to spending rates made by an organization in response to existing endowment deficiencies. However, consistent with not recommending a requirement to disclose specific spending formulas and spending rates in proposed Disclosure C above, the staff is not recommending this as a required disclosure. The staff thinks that the spending information provided in proposed Disclosures B and D is adequate. Does the Board agree with the staff s recommendations concerning disclosures? EFFECTIVE DATE AND TRANSITION The genesis and chief objective of this FSP project is to provide information concerning net asset classification of donor-restricted endowment funds in the new UPMIFA environment. However, the staff (and the external reviewers) thinks that the proposed disclosures are valuable even in those jurisdictions that have not yet enacted or contemplated the enactment of UPMIFA. Disclosures about endowment size, growth and 6
spending, and underlying net asset composition, provide important information, especially in an era of increased public scrutiny on these matters. And disclosure of a governing board s interpretation of relevant law informs readers about which law is currently in place for that organization (UPMIFA, UMIFA, or other) and even prior to the enactment of UPMIFA in a jurisdiction, provides important contextual information concerning an organization s classification of appreciation on endowment investments. For these reasons, the staff recommends that the disclosure provisions of the FSP be effective at this time for all organizations and not just those in states that have adopted a version of UPMIFA. On a practical level, a nationwide approach would also reduce reporting complexity for consolidated reporting entities in which the underlying component organizations are located in multiple states adopting UPMIFA in different timeframes. Because UPMIFA is already effective in a number of states and because the staff does not view the disclosure requirements as being onerous (the staff will specifically ask about this in the Notice to Recipients), the staff recommends that the effective date of the FSP be for fiscal years ending after June 15, 2008 with early adoption encouraged. The staff thinks that such transition is straight-forward, as well as consistent with the objective of improving the transparency of information about endowment size, growth and spending, and underlying net asset composition, in a timely manner. For the FSP s UPMIFA-specific accounting provisions, the staff recommends that the cumulative effect of any reclassifications between net asset classes be made as of the beginning of the period in which UPMIFA becomes effective for the organization. The staff recommends that Disclosures A and B (endowment composition and roll-forward) be presented for each period for which financial statements are presented. Does the Board agree with the staff s recommendations concerning effective date and transition? LENGTH OF PUBLIC COMMENT PERIOD 7
The staff recommends a 60-day comment period. This should provide an adequate amount of time to respond to the proposed FSP, balanced against the need to issue timely final guidance, prior to June 30, 2008. Does the Board agree with the staff s recommendation concerning length of public comment period? Does the Board approve the staff s going forward with the drafting of the FSP? 8
APPENDIX I SUMMARY OF DECISIONS REACHED BY THE BOARD At its October 31, 2007 meeting, the Board discussed the implications of the Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA) on the net asset classification of donor-restricted endowment funds by not-for-profit organizations. Those implications include the (a) short-term spending flexibility UPMIFA affords, (b) diverse views of constituents about UPMIFA s implications, and (c) need for guidance on the application of the relevant provisions and guidance provided by: 1. FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations 2. FASB Statement No. 124, Accounting for Certain Investments Held by Not-for- Profit Organizations 3. EITF Topic No. D-49, Classifying Net Appreciation on Investments of a Donor- Restricted Endowment Fund. The Board added a short-term project to its agenda and decided to issue a FASB Staff Position (FSP) to provide further guidance. The Board agreed that guidance should: 1. Affirm that, consistent with the principle for classifying endowment appreciation in paragraph 22 of Statement 117, in the absence of explicit donor stipulations, a not-for-profit organization should continue to classify a portion of a donorrestricted endowment fund as permanently restricted net assets, which continues to be based on the amount of the donor restriction that, in the long run, remains in force permanently. As noted in Statement 117, that determination ultimately rests with the organization s governing board and its interpretation of the entity s accountability to its donor for a restriction of permanent duration based on the donor s stipulations and relevant law (including the state s adopted version of UPMIFA). 2. Affirm that an organization should disclose its interpretation of relevant law in the notes to the financial statements. 3. Include additional disclosures that may be necessary to provide sufficient transparency to users in the new UPMIFA environment. The Board directed the staff to develop those disclosures for further consideration by the Board. 4. Affirm the continued applicability of the guidance in paragraphs 12 and 13 of Statement 124 to so-called under water situations and observe that the short-term spending flexibility afforded under UPMIFA does not change an organization s long-term accountability for a fund of perpetual duration. 5. Affirm the continued applicability of the guidance in Topic D-49. The Board observed that (a) contractual or other legally imposed restrictions on particular assets do not necessarily constitute donor-imposed restrictions for accounting 9
purposes and (b) a temporary restriction should not be implied from the donor restricted assets language in Section 4(a) of UPMIFA. 6. Clarify that, similar to the guidance in Topic D-49, a temporary restriction should not be implied from the rebuttable presumption of imprudence provision under some versions of UPMIFA. 10
APPENDIX II CURRENT DISCLOSURES REQUIRED IN STATEMENT 124 (paragraphs 14-16, footnotes omitted) 14. For each period for which a statement of activities is presented, a not-for-profit organization shall disclose: a. The composition of investment return including, at a minimum, investment income, net realized gains or losses on investments reported at other than fair value, and net gains or losses on investments reported at fair value b. A reconciliation of investment return to amounts reported in the statement of activities if investment return is separated into operating and nonoperating amounts, together with a description of the policy used to determine the amount that is included in the measure of operations and a discussion of circumstances leading to a change, if any, in that policy. 15. For each period for which a statement of financial position is presented, a not-forprofit organization shall disclose: a. The aggregate carrying amount of investments by major types, for example, equity securities, U.S. Treasury securities, corporate debt securities, mortgagebacked securities, oil and gas properties, and real estate b. The basis for determining the carrying amount for investments other than equity securities with readily determinable fair values and all debt securities c. The method(s) and significant assumptions used to estimate the fair values of investments other than financial instruments if those other investments are reported at fair value d. The aggregate amount of the deficiencies for all donor-restricted endowment funds for which the fair value of the assets at the reporting date is less than the level required by donor stipulations or law. 16. For the most recent period for which a statement of financial position is presented, a not-for-profit organization shall disclose the nature of and carrying amount for each individual investment or group of investments that represents a significant concentration of market risk. From the Basis for Conclusions (paragraph 90): The Exposure Draft would have required that organizations disclose information about their investment objectives and about the contractual maturities of debt securities. Many respondents, including users of financial statements, asked the Board not to require those disclosures. Some said that information about investment objectives should not be required of not-for-profit organizations because Statement 115 does not require business enterprises to make that disclosure. Others said that organizations may have different objectives for different investment portfolios and that, as an organization's policies become more complex, investment objectives become more difficult to summarize. Still 11
others said that the resulting disclosures might be "boilerplate" or would be meaningless without an accompanying disclosure of investment performance. A number of respondents said that information about contractual maturities was unnecessary when debt securities are reported at fair value. The Board decided that the information need not be disclosed. 12