Ref #2015-17
Statutory Accounting Principles Working Group
Maintenance Agenda Submission Form
Form A
Issue: Measurement Method for NAIC 5 Designations
Check (applicable entity):
P/C
Life
Health
Modification of existing SSAP
New Issue or SSAP
Description of Issue:
In response to comments on the measurement method allowed for certain insurers (AVR filers) that hold
investments considered to be the lowest-credit quality (NAIC 5 designation), this agenda item proposes to
revise the measurement method for fixed-income investments with these designations to require a lower
of amortized cost or fair value approach.
In reviewing the NAIC definitions for NAIC designations, the NAIC 5 is defined as follows:
NAIC 5 is assigned to obligations of the lowest credit quality, which are not in or near
default. Credit risk is at its highest and the issuer’s credit profile is highly volatile, but
currently the issuer has the capacity to meet its obligations. This means that the likelihood that
interest, principal or both will be paid in accordance with the contract agreement is
significantly impaired given any adverse business, financial or economic condition. An
NAIC 5 designation suggests a very high probability of default. An NAIC 5 obligation should
incur more stringent treatment under the NAIC Financial Condition Framework.
Pursuant to existing Statutory Accounting Principles in SSAP No. 26—Bonds and SSAP No. 43R—Loanbacked and Structured Securities, investments held by AVR filers with an NAIC designation of 1 through
5 are to be reported at amortized cost, and investments with an NAIC designation of 6 are reported at the
lower of amortized cost or fair value. (Under SSAP No. 32—Preferred Stock, investments held by AVR
filers with NAIC designations of 4-6 are already required to be held at the lower of amortized cost or fair
value.)
The provisions to allow more investments to be reported at amortized cost for AVR filers (generally life
companies) is based on the concept that these insurers intend to hold the investments for a longer period
of time to mirror durations of their expected insurance liabilities. However, for investments with an NAIC
5 designation, which represent highly volatile investments with a high probability of default that are of
the lowest credit quality and investments that cannot be assessed for credit quality, permitting these
investments to be reported at amortized cost is inconsistent with policyholder protection pursuant to the
NAIC Statutory Accounting Concept of conservatism. As noted in the Statutory Accounting Preamble:
29.
Financial reporting by insurance enterprises requires the use of substantial judgments
and estimates by management. Such estimates may vary from the actual amounts for numerous
reasons. To the extent that factors or events result in adverse variation from management’s
accounting estimates, the ability to meet policyholder obligations may be lessened. In order to
provide a margin of protection for policyholders, the concept of conservatism should be followed
when developing estimates as well as establishing accounting principles for statutory reporting.
30.
Conservative valuation procedures provide protection to policyholders against adverse
fluctuations in financial condition or operating results. Statutory accounting should be reasonably
conservative over the span of economic cycles and in recognition of the primary responsibility to
© 2015 National Association of Insurance Commissioners 1
Ref #2015-17
regulate for financial solvency. Valuation procedures should, to the extent possible, prevent sharp
fluctuations in surplus.
This agenda item proposes to revise the existing guidance in SSAP No. 26 and SSAP No. 43R to require
investments with an NAIC designation of 5 to be reported at the lower of amortized cost or fair value. If
reported at fair value, fluctuations would be reported as unrealized gains and losses. By requiring a lower
of cost or fair value measurement method, the value would be adequately and timely updated for
decreases based on market assessment – preventing situations in which assets that reflect the lowest credit
quality and for which any adverse impact may trigger default – would be reported over time at a value
that does not reflect appropriate consideration of those characteristics.
It is noted that the proposed revisions would not completely mirror the guidance in SSAP No. 32, as that
statement only allows an amortized cost/cost method for the highest-quality, high-quality or medium
quality redeemable preferred stocks (NAIC designations 1-3). SSAP No. 32 requires a lower of amortized
cost or fair value measurement method for AVR investments that are consider low quality with an NAIC
designation of 4-6. Comments are requested on whether the guidance in SSAP No. 26 and SSAP No.
43R should be further revised to require a lower of amortized cost or fair value measurement
method for investments with an NAIC 4 designation. To assist with this consideration, the definition of
an NAIC 4 is as follows:
NAIC 4 is assigned to obligations of low quality. Credit risk is high and the issuer’s credit profile is
volatile. These obligations are highly speculative, but currently the issuer has the capacity to meet
its obligations. This means that the likelihood that interest, principal or both will be paid in
accordance with the contractual agreement is low and that an adverse change in circumstances
or business, financial or economic conditions would accelerate credit risk, leading to a significant
impairment in the issuer’s capacity to make timely payments. As NAIC 4 obligations should
accorded stringent treatment under the NAIC Financial Condition Framework.
Impact of Proposal to Investments Reported as 5*
The NAIC 5* certification process is a special reporting process included within the Purposes and
Procedures Manual of the NAIC Investment Analysis Office (P&P Manual). This process allows insurers
to obtain a special, non-analytical symbol from the SVO to use in reporting based on a certification. This
process is under review by the Valuation of Securities (E) Task Force and may be subsequently revised.
Per the current guidance in the P&P Manual, the NAIC 5* is deemed to possess the credit
characteristics of a security assigned an NAIC 5 designation, and should receive the same
regulatory treatment. The use of the asterisk (*) distinguishes the security as one that is not able to have
credit assessment. As the items that receive an NAIC 5* would be impacted by this agenda item (as the
measurement method for such items currently follows items with an NAIC 5 designation) detail on the
current guidance for this special reporting process is provided below.
Under current guidance in the P&P Manual, in order to receive an NAIC 5*, an insurer submits a filing
with the NAIC certifying that the documentation necessary to permit a full credit analysis does not
exist. Although the filing insurer identifies that the issuer is current on all required interest and principal
payments and the insurer has an actual expectation of ultimate payment of all required interest and
principal. Although the filing is submitted to the SVO, without providing documentation to allow a credit
analysis, the SVO is unable to assess the issuer’s credit risk. In addition to the insurer’s certification
that credit analysis is not possible, the following are noted as other permitted uses of the principal and
interest certification form and the NAIC 5* and 6* designations per the Purposes and Procedures Manual
of the Investment Analysis Office:
1. Corporate bonds and preferred stocks with unaudited financial statements.
© 2015 National Association of Insurance Commissioners 2
Ref #2015-17
2.
3.
4.
5.
Residential mortgage backed securities that have never been rated by an NAIC CRP.
Commercial mortgage backed securities that have never been rated by an NAIC CRP.
Foreign securities of issuers domiciled with no NAIC CRP Sovereign rating.
Corporate bonds representing specific parent-subsidiary situations where the parent holding
company has audited financials and the issuing subsidiary does note.
6. Military housing bonds or securities issued on/after Dec. 31, 2009 and not rated by an NAIC CRP.
7. Catastrophe-linked bonds that have not been assigned a credit rating by an NAIC CRP and those
that have been assigned a credit rating by an NAIC CRP on other than the approved
methodology.
It is expected that the Valuation of Securities (E) Task Force will request that the Statutory Accounting
Principles (E) Working Group to evaluate whether different accounting parameters, particularly
measurement and admittance allowances, or reporting requirements should be established for 5* and 6*
securities. The Task Force has identified that the population of 5*/6* securities reported in the statutory
financial statements has grown exponentially, and without specific guidance there is concern that the
statutory accounting guidance may not fully reflect the potential risks of these securities. As there is no
credit assessment, and no specific accounting provisions, there are concerns on the ability to rely on these
investments to satisfy future policyholder obligations, as well as concerns that there is insufficient
information for regulators to assess the aggregate impact of these securities within a reporting entity.
Existing Authoritative Literature:
SSAP No. 26—Bonds
7.
Bonds, except mandatory convertible securities addressed in paragraph 9, shall be
valued and reported in accordance with this statement, the Purposes and Procedures
Manual of the NAIC Investment Analysis Office, and the designation assigned in the
NAIC Valuations of Securities product prepared by the NAIC Securities Valuation Office.
For reporting entities that maintain an Asset Valuation Reserve (AVR), the bonds
shall be reported at amortized cost, except for those with an NAIC designation of 6,
which shall be reported at the lower of amortized cost or fair value. For reporting
entities that do not maintain an AVR, bonds that are designated highest-quality and highquality (NAIC designations 1 and 2, respectively) shall be reported at amortized cost; with
all other bonds (NAIC designations 3 to 6) reported at the lower of amortized cost or fair
value.
Note – In reviewing Issue Paper No. 26—Bonds, Excluding Loan-Backed and Structured
Securities, there have been no changes to the NAIC designation assignments for
amortized cost and lower of amortized cost or fair value since original adoption in 1998.
Also, there is no discussion in Issue Paper No. 26 regarding how these breakdowns were
determined. From a reference that the adopted issue paper is consistent with the thencurrent accounting guidance for bonds, it is assumed that these breakdowns were in place
prior to codification and not discussed as part of the SSAP development.
SSAP No. 32—Preferred Stock
21.
Highest-quality, high-quality or medium quality redeemable preferred stocks (NAIC
designations 1 to 3), which have characteristics of debt securities, shall be valued at cost
or amortized cost. All other redeemable preferred stocks (NAIC designations 4 to 6)
shall be reported at the lower of cost, amortized cost, or fair value.
22.
Highest-quality, high-quality or medium quality perpetual preferred stocks (NAIC
designations 1 to 3), which have characteristics of equity securities, shall be valued at
© 2015 National Association of Insurance Commissioners 3
Ref #2015-17
cost. All other perpetual preferred stocks (NAIC designations 4 to 6) shall be
reported at the lower of cost or fair value.
Note – In reviewing Issue Paper No. 32—Investments in Preferred Stock (excluding investments
in preferred stock of subsidiary, controlled or affiliated entities), there have been no
changes to the NAIC designation assignments since original adoption in 1998. Also, there
is no discussion in Issue Paper No. 32 regarding how these breakdowns were determined.
From a reference that the adopted issue paper is consistent with the then-current
accounting guidance for preferred stock, it is assumed that these breakdowns were in
place prior to codification and not discussed as part of the SSAP development.
SSAP No. 43R – Loan-backed and Structured Securities
24.
Loan-backed and structured securities shall be valued and reported in accordance with
this statement, the Purposes and Procedures Manual of the NAIC Investment Analysis
Office, and the designation assigned in the NAIC Valuations of Securities product
prepared by the NAIC Securities Valuation Office or equivalent specified procedure. The
carrying value method shall be determined as follows:
a.
For reporting entities that maintain an Asset Valuation Reserve (AVR), loanbacked and structured securities shall be reported at amortized cost, except for
those with an NAIC designation of 6, which shall be reported at the lower of
amortized cost or fair value.
b.
For reporting entities that do not maintain an AVR, loan-backed and structured
securities designated highest-quality and high-quality (NAIC designations 1 and
2, respectively) shall be reported at amortized cost; loan-backed and structured
securities that are designated medium quality, low quality, lowest quality and in
or near default (NAIC designations 3 to 6, respectively) shall be reported at the
lower of amortized cost or fair value.
Note – In reviewing Issue Paper No. 43—Loan-Backed and Structured Securities, there have
been no changes to the NAIC designation assignments for amortized cost and lower of
amortized cost or fair value since original adoption in 1998. Also, there is no discussion
in Issue Paper No. 43 regarding how these breakdowns were determined. From a
reference that the adopted issue paper is consistent with the then-current accounting
guidance for bonds, it is assumed that these breakdowns were in place prior to
codification and not discussed as part of the SSAP development.
Activity to Date (issues previously addressed by SAPWG, Emerging Accounting Issues WG, SEC,
FASB, other State Departments of Insurance or other NAIC groups): The SAPWG currently has the
Investment Classification Project (agenda item 2013-36) that is reviewing a variety of investment-related
accounting and reporting issues. The valuation and measurement method of investments in certain SSAPs
may be subject to further discussion under that project.
Information or issues (included in Description of Issue) not previously contemplated by the
SAPWG: As noted in this agenda item, investment with a 5* receive the same accounting treatment as an
NAIC 5. The consideration of 5* and 6* securities – and whether such securities should have specialized
accounting treatment – is subject to current discussion by the Valuation of Securities (E) Task Force, and
a referral to the Statutory Accounting Principles (E) Working Group requests the Working Group to
evaluate whether different accounting parameters, particularly measurement and admittance allowances,
or reporting requirements should be established for 5* and 6* securities
© 2015 National Association of Insurance Commissioners 4
Ref #2015-17
Staff Recommendation:
Staff recommends that the Working Group move this item to the nonsubstantive active listing and
expose nonsubstantive revisions to require investments in SSAP No. 26 and SSAP No. 43R held by
an AVR filer that have an NAIC 5 designation to be reported at the lower of amortized cost or fair
value. As this proposal would not mirror the guidance in SSAP No. 32, which only permits amortized
cost for investments held by AVR filers that are the highest-quality, high-quality and medium-quality
(NAIC 1-3), it is recommended that comments be requested on whether SSAP No. 26 and SSAP No.
43R should be further revised to require a lower of amortized cost or fair value measurement
method for investments held by an AVR filer with an NAIC 4 designation (low quality).
Additionally, as this proposal would impact investments reported as 5* (as they are currently reported
similar to investments with explicit NAIC 5 designations), it is also recommended that comments be
requested on the impact to 5* securities and if explicit accounting and reporting guidance should be
established for those securities. (A VOSTF referral is requests the SAPWG to evaluate the accounting
and reporting impact of removing the SVO from the application of the 5*/6* Rule and allowing insurers
to provide certification in the general interrogatories. This referral is proposed to be considered in a
separate agenda item.)
Investments in SSAP No. 26 and SSAP No. 43R held by a non-AVR filers with an NAIC 5 designation
are already required to be reported at the lower of amortized cost or fair value. Additionally, SSAP No. 32
already requires NAIC 5 designated investments held by both AVR and non-AVR filers to be reported at
the lower of amortized cost or fair value.
Per the 2014 financial statements, requiring SSAP No. 26 and SSAP No. 43R securities with an NAIC 5
designation to be held at the lower of amortized cost or fair value would impact 1,574 reported
securities, including 208 securities designated as NAIC 5*. If this proposal was extended to NAIC 4
securities (to mirror SSAP No. 32 thresholds), an additional 4,371 securities would be impacted.
Proposed Revisions to SSAP No. 26—Bonds
7.
Bonds, except mandatory convertible securities addressed in paragraph 9, shall be
valued and reported in accordance with this statement, the Purposes and Procedures
Manual of the NAIC Investment Analysis Office, and the designation assigned in the
NAIC Valuations of Securities product prepared by the NAIC Securities Valuation Office.
For reporting entities that maintain an Asset Valuation Reserve (AVR), the bonds shall be
reported at amortized cost, except for those with an NAIC designation of 5 or 6, which
shall be reported at the lower of amortized cost or fair value. For reporting entities that do
not maintain an AVR, bonds that are designated highest-quality and high-quality (NAIC
designations 1 and 2, respectively) shall be reported at amortized cost; with all other
bonds (NAIC designations 3 to 6) reported at the lower of amortized cost or fair value.
Proposed Revisions to SSAP No. 43R – Loan-backed and Structured Securities
24.
Loan-backed and structured securities shall be valued and reported in accordance with
this statement, the Purposes and Procedures Manual of the NAIC Investment Analysis
Office, and the designation assigned in the NAIC Valuations of Securities product
prepared by the NAIC Securities Valuation Office or equivalent specified procedure. The
carrying value method shall be determined as follows:
a.
For reporting entities that maintain an Asset Valuation Reserve (AVR), loanbacked and structured securities shall be reported at amortized cost, except for
those with an NAIC designation of 5 or 6, which shall be reported at the lower of
amortized cost or fair value.
© 2015 National Association of Insurance Commissioners 5
Ref #2015-17
b.
For reporting entities that do not maintain an AVR, loan-backed and structured
securities designated highest-quality and high-quality (NAIC designations 1 and
2, respectively) shall be reported at amortized cost; loan-backed and structured
securities that are designated medium quality, low quality, lowest quality and in
or near default (NAIC designations 3 to 6, respectively) shall be reported at the
lower of amortized cost or fair value.
Staff Review Completed by:
Julie Gann – May 5, 2015
Status:
On August 15, 2015, the Statutory Accounting Principles (E) Working Group moved this item to the
nonsubstantive active listing and exposed revisions to SSAP No. 26 and SSAP No. 43R, as illustrated
above, to require investments with an NAIC 5 designation held by a reporting entity that maintains an
AVR to be reported at the lower of amortized cost or fair value.
G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2015\Summer\NM Exposures\15-17 NAIC 5 Designation.docx
© 2015 National Association of Insurance Commissioners 6
Ref #2015-17
Information from 2014 Year-End Financial Statements:
From a query of the 2014 financials, the following details the # of securities with NAIC 4, 5 and 6 designations:
Schedule D – Part 1 (Bonds & LBSS) with NAIC 4 Designation
NAIC
DESIGNATION
4
4AM
4F
4FE
4FM
4Fe
4S
4Z
4Z*
Total
Fraternal
16
3
160
30
Life
253
282
45
2,699
443
Property
144
79
Title
2,510
184
75
Health
180
17
1,548
32
2
7
40
389
4
249
4,122
4,371 AVR Filers
1
144
18
4
3,066
77
1,795
4,938 Non-AVR Filers
Sum of
All
593
381
45
6,992
689
2
8
591
8
9,309
Distinct
occurrences
across all blank
types
512
350
45
3,913
661
2
8
505
8
6,004
If the Working Group decided to require lower of cost or fair value for all NAIC 4 bonds, this would
impact 4,371 bonds held by life and fraternal companies (AVR filers). The non-AVR filers are already
required to use the lower of amortized cost or fair value. (Staff Note – 4Z* is not a valid designation.)
Schedule D – Part 1 (Bonds & LBSS) with NAIC 5 Designation
NAIC
DESIGNATION
5
5*
5AM
5FE
5FM
5Z
5Z*
Total
Fraternal
6
7
9
34
4
1
Life
194
208
133
587
150
239
2
61
1,513
1,574 AVR Filers
Property
Title
Health
74
2
8
76
2
88
29
745
10
254
78
21
108
2
11
8
1,177
14
325
1,516 Non-AVR Filers
Sum of
All
284
293
259
1,630
253
361
10
3,090
Distinct
occurrences
across all blank
types
246
276
239
1,099
240
341
9
2,450
If the Working Group decided to require lower of cost or fair value for all NAIC 5 bonds, this would
impact 1,574 bonds & LBSS held by life and fraternal companies (AVR filers). The non-AVR filers
are already required to use the lower of amortized cost or fair value. For items with 5* - the change
would impact 215 bonds & LBSS. (Staff Note – 5Z* is not a valid designation.)
Schedule D – Part 1 (Bonds & LBSS) with NAIC 6 Designation
NAIC
DESIGNATION
Fraternal
Life
Property
Title
© 2015 National Association of Insurance Commissioners 7
Health
Sum of
All
Distinct
occurrences
across all blank
types
Ref #2015-17
6
6*
6*S
6AM
6F
6FE
6FM
6S
6Z
6Z*
Total
36
17
159
503
1
25
2
40
551
5
197
38
14
119
30
113
1,624
1,737 AVR Filers
134
231
1
8
46
12
329
1
43
18
73
2
29
866
3
991 Non-AVR Filers
26
19
2
17
122
375
763
1
36
2
947
264
56
225
59
2,728
326
714
1
33
2
853
255
44
207
53
2,488
All bonds and LBSS with an NAIC 6 are already required to be reported at the lower of amortized cost or fair value.
Schedule D – Part 2 – Section 1 (Preferred Stocks)
With NAIC 4 Designation
NAIC
DESIGNATION
P4A
P4AZ
P4K
P4L
P4LFE
P4LZ
P4U
P4UFE
P4UZ
P4V
P4VFE
P4VZ
RP4A
RP4J
RP4L
RP4LFE
RP4LZ
RP4U
RP4UFE
RP4VFE
RP4VZ
Total
Fraternal
6
6
1
1
Life
1
4
12
32
4
8
7
6
2
1
3
5
14
1
2
4
1
1
27
28 AVR Filers
Property
2
4
3
14
44
3
Title
Health
2
10
2
2
1
2
3
2
2
2
2
12
3
2
2
25
25 Non-AVR Filers
© 2015 National Association of Insurance Commissioners 8
-
Sum of All
3
10
3
34
85
7
8
20
8
4
2
3
2
2
7
27
4
2
6
1
2
53
Distinct
occurrences
across all blank
types
3
7
3
28
52
7
8
14
8
4
2
3
2
2
6
23
3
2
4
1
2
45
Ref #2015-17
All preferred stocks with an NAIC 4 are already required to be reported at the lower of cost, amortized cost or fair value.
NAIC
DESIGNATION
P5*A
P5*U
P5*V
P5A
P5AZ
P5J
P5KZ
P5L
P5LFE
P5LZ
P5U
P5UFE
P5UZ
P5V
P5VZ
RP5*A
RP5*U
RP5A
RP5L
RP5LFE
RP5U
RP5UFE
RP5UZ
RP5V
RP5VZ
Total
Schedule D – Part 2 – Section 1 (Preferred Stocks)
With NAIC 5 Designation
Sum of
Fraternal
Life
Property
Title
Health
All
2
1
7
10
3
4
7
13
1
14
10
5
15
3
1
1
5
1
1
1
1
2
3
5
5
15
1
3
11
3
18
1
3
4
2
3
2
7
1
3
2
6
6
9
15
13
7
20
12
3
1
16
1
1
2
2
3
2
5
2
2
3
3
6
12
2
2
4
1
1
1
1
1
3
3
3
2
2
6
89
71
23
189
95 AVR Filers
94 Non-AVR Filers
Distinct
occurrences
across all blank
types
10
7
14
14
5
1
1
11
15
4
7
4
13
20
15
1
2
5
2
10
4
1
3
3
2
174
All preferred stocks with an NAIC 5 are already required to be reported at the lower of cost, amortized cost or fair value.
Schedule D – Part 2 – Section 1 (Preferred Stocks)
Distinct
With NAIC 6 Designation
occurrences
NAIC
across all blank
DESIGNATION
Fraternal
Life
Property
Title
Health
Sum of All
types
P6*A
23
8
31
34
P6*K
4
4
4
P6*L
3
1
4
4
P6*U
20
12
32
31
© 2015 National Association of Insurance Commissioners 9
Ref #2015-17
P6*V
P6A
P6AZ
P6KZ
P6L
P6LFE
P6LZ
P6LZ*
P6U
P6UF
P6UFE
P6UZ
P6UZ*
P6V
P6VFE
P6VZ
P6VZ*
RP6*A
RP6*U
RP6*V
RP6A
RP6AF
RP6L
RP6LFE
RP6LZ
RP6U
RP6UFE
RP6UZ
RP6UZ*
RP6V
RP6VZ
Total
1
7
3
2
54
7
2
1
6
16
1
1
22
12
2
4
7
3
1
2
6
5
6
3
3
1
4
5
4
1
1
21
223
244 AVR Filers
28
3
1
1
4
23
2
24
24
1
15
11
5
9
1
1
3
3
3
3
3
2
1
1
6
1
1
2
2
1
5
3
205
213 Non-AVR Filers
8
82
10
4
1
11
48
1
25
50
1
30
16
9
16
3
4
3
6
8
9
7
1
2
13
1
6
6
3
1
6
3
457
71
7
4
1
11
31
1
25
50
1
27
16
9
12
3
4
3
6
8
7
3
1
2
11
1
6
6
3
1
5
3
412
All preferred stocks with an NAIC 6 are already required to be reported at the lower of cost, amortized cost or fair value.
© 2015 National Association of Insurance Commissioners 10