Ref# 2015-31
Statutory Accounting Principles Working Group
Maintenance Agenda Submission Form
Form A
Issue: VOSTF Referral - Non-Recourse Charity Notes
Check (applicable entity):
P/C
Life
Health
Modification of existing SSAP
New Issue or SSAP
Description of Issue:
On June 16, 2015, the Valuation of Securities (E) Task Force sent a referral to the Statutory Accounting
Principles (E) Working Group with a recommendation that the Working Group consider the accounting
and reporting status of non-recourse loans issued from charitable organizations that do not have
responsibility to support the payment of principal or interest.
This agenda item intends to review the referral from the Valuation of Securities (E) Task Force with the
goal to clarify guidance under Statutory Accounting Principles.
Summary of Statutory Accounting Guidance and Issues for Discussion:

Investments are to be accounted and reported in accordance with the SSAP for which the
investment is in scope, and admitted to the extent that the investment qualifies under the
applicable SSAP and/or the provisions within SSAP No. 4, paragraphs 2-4.

The assignment of an NAIC designation (or having an investment rated by a Credit Rating
Provider (CRP)) does not change the underlying nature of the investment, the related SSAP
governing the accounting and reporting, or the investment reporting schedule. Although an NAIC
designation may determine which measurement method to apply under an SSAP (e.g., amortized
cost or fair value) or the RBC charge related to an investment, if the asset did not qualify for
admittance under the SSAP (e.g., as a non-collateralized loan), receiving an NAIC designation or
a CRP rating does not allow the asset to be admitted.

The structure of the “non-recourse charity notes” (as defined in the June 16th referral) is believed
to vary. As such, it is anticipated that some of these investments may be structured so that some
may conclude that they are within scope of SSAP No. 26—Bonds, SSAP No. 43R—Loan-backed
and Structured Securities, or SSAP No. 20—Nonadmitted Assets (as loans unsecured or secured
by assets that do not qualify for investments per paragraph 4b). In addition to measurement
guidance (and admittance provisions), once identified within scope of a specific SSAP, all
provisions within the SSAP would apply. As examples:
o
SSAP No. 20 – Paragraph 3b identifies that loans unsecured or secured by assets that do
not qualify as investments are nonadmitted. (SSAP No. 21—Other Admitted Assets allows
admittance of collateralized loans only to the extent of qualifying collateral.)
o
SSAP No. 26 – Paragraph 11 requires other-than-temporarily impairment (OTTI)
recognition if it is probable that the reporting entity will be unable to collect all amounts
due according to the contractual terms of the debt security. Within this SSAP, if an OTTI
is recognized, the realized loss is the difference between amortized cost and fair value,
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with the fair value becoming the new cost basis of the bond. This SSAP also requires
aggregate disclosures for all bonds in an unrealized loss position for which OTTI has not
been recognized, including an aggregate reporting of bonds that have been in an
unrealized loss position for less than and greater than 12 months.
o
SSAP No. 43R – Paragraphs 17-19 provides specific guidance when it is probable, either
known at acquisition, or identified during the holding period, that the investor will be
unable to collect all contractually required payments receivable. This guidance also
requires continued estimation of cash flows, with recognition of OTTI based on whether
the OTTI is based on an interest or non-interest related decline. Furthermore, pursuant to
paragraph 29, requires OTTI assessment if the fair value of the security is less than its
amortized cost basis. Similar to SSAP No. 26, aggregate disclosures are required for all
securities in an unrealized loss position for which OTTI has not been recognized,
including an aggregate reporting of securities that have been in an unrealized loss
position for less than and greater than 12 months.
Although other investments within scope of the SSAPs are structured as pass-through securities, the
investments captured within the referral are different as the fundamental purpose of the financing is to
provide funds under charity care requirements. As such, the receiving individual/organization is unable to
receive funds through conventional means.
Non-recourse here means that the issuer only promises to pass through any cash generated by a pool of
loans. In such a collateral loan structure, the loan pool is finite so a default of any single loan in the loan
pool produces a permanent reduction in the amount of possible cash flow that can be used to pay holders.
This means that when a loan in the loan pool defaults all holders will experience a permanent impairment
equal to the proportion of the defaulted loan each holder would have received when payments were next
to be passed through. In a sense, losses are passed through as well as actual cash flows. Key aspects:

The issuer of a typical bond is an entity with an on-going, cash generating activity and is legally
responsible for repaying a specified dollar amount. If such an issuer cannot pay one or more
scheduled payments because of financial difficulties (setting aside the issue of default for purpose
of this discussion) – the amount it owes is not decreased. If the same issuer is then able to reverse
its financial difficulties in subsequent periods it can then regenerate the cash flow to resume
payment on the original obligation.

There is no similar “regeneration” possible in any kind of fixed pool structure. The non-recourse
nature of the obligation therefore means full payment on the note can only occur if no loans
default. In a typical pass through security, whether or not a loan is likely to default is assessed on
the basis of lending and underwriting criteria established for the specific asset and or on the basis
of reliable data on historical performance of the loan type; for example, residential mortgages. It
is unlikely that an equivalent basis of assessment would be available to permit a reliable
assessment of the likelihood that a given loan would default. With some loans, for example, high
worth individuals, it may be possible to assess the credit risk of each individual borrower in the
pool as distinct from an assessment of performance data about the type of loan. But such an
approach would not be possible given that the individual borrowers here would have been given
loans based on charitable – not purely financial – criteria.
Despite the credit-concerns and risk of loss to insurer holders of these investments, it is noted that some
states desire their domiciliary insurers to participate in these investments as a means of community
enrichment. It is also noted that not allowing admittance of these investments is a disincentive for insurers
to participate in these investments.
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Pursuant to the SAP Statement of Concepts, “the ability to meet policyholder obligations is predicated on
the existence of readily marketable assets available when both current and future obligations are due.
Assets having economic value other than those which can be used to fulfill policyholder obligations, or
those assets which are unavailable due to encumbrances or other third party interests should not be
recognized on the balance sheet.” Based on this guidance, it seems that non-recourse, charity loans could
likely not be an investment reliable for policyholder claims and therefore not fit within the “admitted
asset” concept if the source of payment cannot be assessed. However, other investments have been
assessed over time that may not fully fit with the original concept for admittance, but for which the
Working Group has provided limited allowances in statutory accounting as admitted assets. Examples of
these assets include operating system software, deferred tax assets, and goodwill.
This agenda item requests that the Working Group consider revising statutory accounting to explicitly
provide guidance for non-recourse, charity loans (as described in the June 16th VOSTF referral) to
eliminate future questions and inconsistency in reporting.
Existing Authoritative Literature:
SSAP No. 4—Assets and Nonadmitted Assets
3.
As stated in the Statement of Concepts, "The ability to meet policyholder obligations is
predicated on the existence of readily marketable assets available when both current and
future obligations are due. Assets having economic value other than those which can be
used to fulfill policyholder obligations, or those assets which are unavailable due to
encumbrances or other third party interests should not be recognized on the balance
sheet," and are, therefore, considered nonadmitted. For purposes of statutory accounting
principles, a nonadmitted asset shall be defined as an asset meeting the criteria in
paragraph 2, which is accorded limited or no value in statutory reporting, and is one
which is:
a
Specifically identified within the Accounting Practices and Procedures Manual as
a nonadmitted asset; or
b
Not specifically identified as an admitted asset within the Accounting Practices
and Procedures Manual.
If an asset meets one of these criteria, the asset shall be reported as a nonadmitted
asset and charged against surplus unless otherwise specifically addressed within the
Accounting Practices and Procedures Manual. The asset shall be depreciated or
amortized against net income as the estimated economic benefit expires. In accordance
with the reporting entity's written capitalization policy, amounts less than a predefined
threshold of furniture, fixtures, equipment, or supplies, shall be expensed when
purchased.
4.
Transactions which do not give rise to assets as defined in paragraph 2 shall be charged
to operations in the period the transactions occur. Those transactions which result in
amounts which may meet the definition of assets, but are specifically identified within the
Accounting Practices and Procedures Manual as not giving rise to assets (e.g., policy
acquisition costs), shall also be charged to operations in the period the transactions
occur.
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SSAP No. 20—Nonadmitted Assets
3.
This statement shall not be considered an all-inclusive list of nonadmitted assets. Certain
admitted assets and nonadmitted assets are addressed in other SSAPs.
4.
Consistent with paragraph 2, the following assets shall be nonadmitted:
b.
Bills Receivable Not for Premium and Loans Unsecured or Secured by Assets
That Do Not Qualify As Investments—In accordance with SSAP No. 5R, amounts
determined to be uncollectible or otherwise impaired shall be written off. Amounts
in excess of that written off are not considered to be properly collateralized as
there are no underlying assets which would otherwise be admitted assets. Such
amounts shall be nonadmitted as they may be of questionable economic value if
needed to fulfill policyholder obligations. Receivables arising from working capital
finance programs designated by the Securities Valuation Office are subject to the
guidance in SSAP No. 105;
SSAP No. 21—Other Admitted Assets
4.
Collateral loans are unconditional obligations for the payment of money secured by the
pledge of an investment1 and meet the definition of assets as defined in SSAP No. 4, and are
admitted assets to the extent they conform to the requirements of this statement. The outstanding
principal balance on the loan and any related accrued interest shall be recorded as an admitted
asset subject to the following limitations:
a. Loan Impairment—Determination as to the impairment of a collateral loan shall be based
on current information and events. When it is considered probable that any portion of
amounts due under the contractual terms of the loan will not be collected the loan is
considered impaired. The impairment shall be measured based on the fair value of the
collateral less estimated costs to obtain and sell the collateral. The difference between
the net value of the collateral and the recorded asset shall be written off in accordance
with SSAP No. 5R—Liabilities, Contingencies and Impairments of Assets (SSAP No. 5R);
b. Nonadmitted Asset—In accordance with SSAP No. 20—Nonadmitted Assets, collateral
loans secured by assets that do not qualify as investments shall be nonadmitted. Further,
any amount of the loan outstanding which is in excess of the permitted relationship of fair
value of the pledged investment to the collateral loan shall be treated as a nonadmitted
asset.
Footnote 1 - Investment defined as those assets listed in Section 3 of Appendix A-001:
Investments of Reporting Entities.
SSAP No. 26—Bonds
2.
Bonds shall be defined as any securities representing a creditor relationship, whereby
there is a fixed schedule for one or more future payments. This definition includes:
a.
U.S. Treasury securities,(INT 01-25)
b.
U.S. government agency securities,
c.
Municipal securities,
d.
Corporate bonds,
e.
Bank participations,
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f.
Convertible debt, including mandatory convertible debt as defined in paragraph
9,
g.
Certificates of deposit that have a fixed schedule of payments and a maturity
date in excess of one year from the date of acquisition,
h.
Commercial paper,
i.
Exchange Traded Funds, which qualify for bond treatment, as identified in the
Purposes and Procedures Manual of the NAIC Investment Analysis Office, and
j.
Class 1 Bond Mutual Funds, as identified in the Purposes and Procedures
Manual of the NAIC Investment Analysis Office.
Loan-backed and structured securities meet this definition, but are excluded from the
scope of this statement, and are addressed in SSAP No. 43R—Loan-Backed and
Structured Securities. Securities which meet the definition above, but have a maturity
date of one year or less from the date of acquisition are addressed in SSAP No. 2—
Cash, Drafts, and Short-term Investments. Mortgage loans and other real estate lending
activities made in the ordinary course of business meet the definition above, but are not
addressed in this statement. These types of transactions are addressed in SSAP No.
37—Mortgage Loans and SSAP No. 39—Reverse Mortgages. Investments in a debt
instrument of a certified capital company (CAPCO) shall be reported as a bond in
accordance with INT 06-02: Accounting and Reporting for Investments in a Certified
Capital Company (CAPCO).
3.
Bonds meet the definition of assets as defined in SSAP No. 4—Assets and Nonadmitted
Assets and are admitted assets to the extent they conform to the requirements of this
statement.
SSAP No. 43R—Loan-backed and Structured Securities
2.
Loan-backed securities are defined as securitized assets not included in structured
securities, as defined below, for which the payment of interest and/or principal is
directly proportional to the payments received by the issuer from the underlying assets,
including but not limited to pass-through securities, lease-backed securities, and
equipment trust certificates.
3.
Structured securities are defined as loan-backed securities which have been divided
into two or more classes for which the payment of interest and/or principal of any class
of securities has been allocated in a manner which is not proportional to payments
received by the issuer from the underlying assets.
4.
Loan-backed securities are issued by special-purpose corporations or trusts (issuer)
established by a sponsoring organization. The assets securing the loan-backed
obligation are acquired by the issuer and pledged to an independent trustee until the
issuer’s obligation has been fully satisfied. The investor only has direct recourse to the
issuer’s assets, but may have secondary recourse to third parties through insurance or
guarantee for repayment of the obligation. As a result, the sponsor and its other
affiliates may have no financial obligation under the instrument, although one of those
entities may retain the responsibility for servicing the underlying assets. Some
sponsors do guarantee the performance of the underlying assets.
5.
Loan-backed and structured securities meet the definition of assets as defined in SSAP
No. 4—Assets and Nonadmitted Assets and are admitted assets to the extent they
conform to the requirements of this statement.
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6.
The scope of this statement encompasses all types of loan-backed and structured
securities, including, but not limited to, the following:
a.
Loan-backed and structured securities acquired at origination,
b.
Loan-backed and structured securities acquired subsequent to origination for
which it is probable, at acquisition, that the reporting entity will be able to collect
all contractually required payments receivable, and are accounted for at
acquisition under SSAP No. 103,
c.
Loan-backed and structured securities for which it is probable, either known at
acquisition or identified during the holding period, that the reporting entity will be
unable to collect all contractually required payments receivable, and
Purposes and Procedures Manual of the NAIC Investment Analysis Office
(Staff Note – Structured notes are captured within SSAP No. 26 with separate required disclosure.)
Structured Note Definition: A Structured Note’s is a direct debt issuance by a corporation,
municipality, or government entity, ranking pari-passu with the issuer’s other debt issuance of
equal seniority where either:

The coupon and/or principal payments are linked, in whole or in part, to prices of, payment
streams from, index or indices, or assets deriving their value from other than the issuer’s
credit quality, or

The coupon and/or principal payments are leveraged by a formula that is different from
either a fixed coupon, or a non-leveraged floating rate coupon linked to an interest rate
index including by not limited to LIBOR or prime rate.
Analytically, a Structured Note can be divided into the issuer’s debt issue and an embedded
derivative.
Securities with certain embedded securities are not considered Structured Notes, including but
not limited to bonds with standard call or put options.
When the issuer is a trust, the source of payments on the security is the assets in the trust, and
investors’ recourse is limited to the assets in that trust, the security is not a Structured Note.
Activity to Date (issues previously addressed by SAPWG, Emerging Accounting Issues WG, SEC,
FASB, other State Departments of Insurance or other NAIC groups): The Valuation of Securities (E)
Task Force provided a referral to the Statutory Accounting Principles (E) Working Group on June 16,
2015. This referral included a recommendation that the Statutory Accounting Principles (E) Working
Group consider the status of non-recourse charity loan obligations as described in the referral pursuant to
the AP&P Manual, as well as consider other related investments as necessary.
Information or issues (included in Description of Issue) not previously contemplated by the
SAPWG: None
Staff Recommendation:
Staff recommends that the Working Group receive the referral from the Valuation of Securities (E)
Task Force, and move this agenda item to the substantive active listing with exposure to request
comments on the structure of transactions that could be considered in-scope of this agenda item
(intended to reflect the components of the VOSTF June 16th referral) and proposals to clarify the
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accounting and reporting for these specific items. It would be helpful in the review of these
investments if information is received on how these items have been reported in the statutory
financial statements previously (e.g., which investment schedule the item was reported on,
governing SSAP, measurement method applied, and whether the item was admitted or
nonadmitted in the financial statements.) (Staff notes that this specific reporting information is
welcome either in a formal comment letter, or if preferred by commenters, can be submitted to NAIC
staff in a confidential submission.)
It is suggested that the written comments first be requested, and once information is received, that
an educational session occur to discuss the variety of structures, and key components. Due to the
nature of comments received, it is anticipated that future revisions could be either be nonsubstantive or
substantive. As detailed discussion is expected, staff recommends that the Working Group initially
classify this agenda item as substantive, with identification that the Working Group may elect to
reclassify to nonsubstantive based on the comments received.
In addition to comments on the various structures, to assist with comments, staff has identified a
variety of elements (not intended to be all-inclusive) that could be considered:

Consider specific guidance to nonadmit these investments.

Consider guidance to include / exclude these investments in specific SSAPs. (For example, due to
different structures, possible explicit exclusion from all other investment SSAPs and include in
SSAP No. 21 as an “other admitted asset”.)

Consider guidance to admit with specific SAP limitations (e.g., reporting entity not under
regulatory action, expected payments being received, limited to percentage of surplus, etc.)

Consider specific reporting instruction (e.g., Schedule BA) with a referral to Capital Adequacy
(E) Task Force for RBC assessment.

Consider specific default and/or impairment guidance (e.g., 15 day default timeframe and
impairment guidance similar to SSAP No. 105.)

Consider specific measurement guidance. (For example, often lower-credit quality securities are
reported at lower-of amortized cost or fair value. It is speculated that a fair value measurement for
these items may often be minimal (at time of acquisition) in comparison to the investment price.
As such, may want to consider whether these items should be subject to a lower-of measurement
method - and related impairment assessments/recognition - or if other measurement guidance
should be considered (e.g., concept of accretable yield.)
Staff Review Completed by:
Julie Gann – July 2015
Status:
On August 15, 2015, the Statutory Accounting Principles (E) Working Group moved this item to the
substantive active listing and exposed this agenda item with a request for comments on the structure of
transactions that could be considered in-scope and proposals to clarify the accounting and reporting.
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