Statutory Accounting Principles Working Group



Statutory Accounting Principles (E) Working GroupMaintenance Agenda Submission FormForm AIssue: SSAP No. 26R – Prepayment PenaltiesCheck (applicable entity):P/CLifeHealthModification of existing SSAP FORMCHECKBOX FORMCHECKBOX FORMCHECKBOX New Issue or SSAP FORMCHECKBOX FORMCHECKBOX FORMCHECKBOX Interpretation FORMCHECKBOX FORMCHECKBOX FORMCHECKBOX Description of Issue: In 2016, guidance was adopted to SSAP No. 26R to clarify the calculation of investment income for prepayment penalty and/or acceleration fees for bonds liquidated prior to scheduled termination. Since the adoption of that guidance, comments have been received on how the calculations should be applied when the call price is below par. Adopted calculation: Realized Gain / Loss = Difference between Par and BACVInvestment Income = Consideration Received Less ParComparing the calculation for when the call price is above par, and for when the call price is less than par: Call Price Above ParPremiumCall Price Above ParDiscountCall Price Less Than ParPar100Par100Par100BACV102BACV98BACV25Consideration103Consideration103Consideration26Loss (100-102)(2)Gain (100-98)2Gain (100-25)75Income (103-100)3Income (103-100)3Income (26-100)(74)In the first two examples, when the consideration received is greater than par, the allocation accurately reflects the realized gain and the investment income for the prepayment penalty. The examples adopted in 2017 were focused on situations where amounts received were greater than par. In the third example, in which the consideration is less than par, the allocation to investment income for the prepayment penalty misrepresents that there has been a large realized gain and a large realized loss. Although the net impact in the financial statements correctly reflects $1 in net gain, the calculation in SSAP No. 26 would require the reporting entity to show a $75 realized gain (which could impact AVR and IMR) and a $74 net investment income loss (which impacts the income statement and dividend calculation). Although NAIC staff agrees that prepayment penalties reported as investment income shall be separately reported from realized gains / losses, NAIC staff notes that the resulting impact of the gross calculation, when the call price is less than par, may result with unintended consequences to AVR / IMR and net income. The intent of this agenda item is to propose clarifications to the guidance to clarify that the calculation to determine realized gains / loss and investment income shall be followed in situations in which the consideration receives exceeds par. In situations in which consideration received is less than par, the reporting entity shall separately allocate the consideration received between investment income and realized gain / loss in accordance with the terms of the callable bond. The portion of consideration received that represents prepayment penalties and/or acceleration fees shall be reported as investment income. Existing Authoritative Literature: SSAP No. 26R—Bonds:16.A bond may provide for a prepayment penalty or acceleration fee in the event the bond is liquidated prior to its scheduled termination date. Such fees shall be reported as investment income when received.17.The amount of prepayment penalty and/or acceleration fees to be reported as investment income shall be calculated as follows:The amount of investment income reported is equal to the total proceeds (consideration) received less the par value of the investment; andAny difference between the book adjusted carrying value (BACV) and the par value at the time of disposal shall be reported as realized capital gains and losses, subject to the authoritative literature in SSAP No. 7.Activity to Date (issues previously addressed by the Working Group, Emerging Accounting Issues (E) Working Group, SEC, FASB, other State Departments of Insurance or other NAIC groups): Agenda Item 2015-23: Prepayment Penalties and Presentation of Callable Bonds – Bifurcation of Agenda Item 2015-04 amended existing paragraph 16 in SSAP No. 26R regarding prepayment penalties. It specifically noted make whole call provisions when the guidance was developed. Information or issues (included in Description of Issue) not previously contemplated by the Working Group: NoneConvergence with International Financial Reporting Standards (IFRS): Not applicable.Staff Recommendation:NAIC staff recommends that the Working Group move this item to the active listing, categorized as nonsubstantive, and expose proposed revisions to SSAP No. 26R to provide guidance for situations in which the consideration received from a callable bond is less than par. In these situations, the reporting entity shall separately allocate the consideration received between investment income and realized gain / loss in accordance with the terms of the callable bond. The portion of consideration received that represents prepayment penalties and/or acceleration fees shall be reported as investment income. As part of the exposure, comments are requested on whether the following illustration should be added to the appendix and/or if all of the appendix for prepayment penalties should be eliminated / condensedProposed Edits to SSAP No. 26R: 16.A bond may provide for a prepayment penalty or acceleration fee in the event the bond is liquidated prior to its scheduled termination date. Such fees shall be reported as investment income when received.17.The amount of prepayment penalty and/or acceleration fees to be reported as investment income or loss shall be calculated as follows: For called bonds in which the consideration received exceeds par:The amount of investment income reported is equal to the total proceeds (consideration) received less the par value of the investment; andAny difference between the book adjusted carrying value (BACV) and the par value at the time of disposal shall be reported as realized capital gains and losses, subject to the authoritative literature in SSAP No. 7.Called bonds in which the consideration received is less than par: Each bond shall be reviewed individually, in accordance with the terms of the bond and call provisions, to determine the extent a prepayment penalty or acceleration fee, which should be reported as investment income, was received. After determining any prepayment penalty or acceleration fee, the reporting entity shall calculate the resulting realized gain or loss. The following are examples to determine the acceleration fee / prepayment penalty when call price is less than par: If the call price is less than par, and the call terms specify prepayment amounts in excess of current fair value, the amount in excess of fair value shall be considered the prepayment penalty / acceleration fee. Prepayments specifically identified in the contract terms as prepayment penalties or acceleration fees shall also be reported in investment income. Regulator and industry comments are requested on whether the following illustration should be added to the appendix and/or if all of the appendix for prepayment penalties should be eliminated / condensed. Call Price Less than ParEntity 1Entity 2Entity 3Par100Par100Par100BACV24BACV28BACV25Consideration26Consideration26Consideration26Fair Value25Fair Value25Fair Value25Gain (Loss)1Gain (Loss)(3)Gain (Loss)0Income 1Income 1Income 1Staff Review Completed by:Julie Gann, NAIC Staff – October 2018Status:On November 15, 2018, the Statutory Accounting Principles (E) Working Group moved this item to the active listing, categorized as nonsubstantive, and exposed revisions to SSAP No. 26R—Bonds, as shown above, to provide guidance for determining the prepayment penalty for called bonds when consideration received is less than par. Comments are requested on whether additional illustrations should be added to the SSAP, or if the existing illustrations should be eliminated or condensed.On April 6, 2019, the Statutory Accounting Principles (E) Working Group exposed revisions to SSAP No. 26R—Bonds, as shown below, to provide guidance when bonds are called with consideration received less than par. These revisions have been changed from the prior exposure with revised guidance on when a prepayment penalty should be identified and reported as investment income. The revisions also clarify that in instances where consideration received is less than BACV, the entire difference should be reported through investment income. This treatment is consistent with how the reporting would have occurred if the bond had been amortized under the yield-to-worst concept. This item was exposed with a shortened May 10, 2019 comment deadline. Spring 2019 National Meeting Exposure:SSAP No. 26R—Bonds16.A bond may provide for a prepayment penalty or acceleration fee in the event the bond is liquidated prior to its scheduled termination date. Such fees shall be reported as investment income when received.17.The amount of prepayment penalty and/or acceleration fees to be reported as investment income or loss shall be calculated as follows:For called bonds in which the total proceeds (consideration) received exceeds par:The amount of investment income reported is equal to the total proceeds (consideration) received less the par value of the investment; andAny difference between the book adjusted carrying value (BACV) and the par value at the time of disposal shall be reported as realized capital gains and losses, subject to the authoritative literature in SSAP No. 7.For cCalled bonds in which the consideration received is less than parFN: To the extent an entity has in place a process to identify explicit Each bond shall be reviewed individually, in accordance with the terms of the bond and call provisions, to determine the extent a prepayment penalty or acceleration fees, thesewhich should be reported as investment income, was received. (An entity shall consistently apply their process. Once a process is in place, an entity is required to maintain a process to identify prepayment penalties for called bonds in which consideration received is less than par.)After determining any explicit prepayment penalty or acceleration fees, the reporting entity shall calculate the resulting realized gain or loss. The following are examples to determine the acceleration fee / prepayment penalty when call price is less than par:as the difference between the remaining consideration and the BACV which shall be reported as realized capital gains and losses, subject to the authoritative literature in SSAP No. 7. If the call price is less than par, and the call terms specify prepayment amounts in excess of current fair value, the amount in excess of fair value shall be considered the prepayment penalty / acceleration fee. Prepayments specifically identified in the contract terms as prepayment penalties or acceleration fees shall also be reported in investment income. New FN: This guidance applies to situations in which consideration received is less than par, but greater than the book adjusted carrying value (BACV). Pursuant to the yield-to-worst concept, bonds shall be amortized to the call or maturity date that produces the lowest asset value. In the event a bond has not been amortized to the lowest value prior to the call (BACV is greater than the consideration received), the entire difference between consideration received and the BACV shall be reported to investment income. Staff Note: Based on prior comments received, industry supports retention of the existing examples in Exhibit C – Amoritization Treatment for Callable Bonds and the inclusion of an additional illustration for showing application of the prepayment penalty guidance when consideration received is less than par. The following Exhibit is proposed to be added to Exhibit C, as a new Example 5. Exhibit C: Amortization Treatment for Callable BondsExample 5: Determination of Prepayment Penalty When Call Price is Less Than ParCall Price Less than ParEntity 1Entity 2Entity 23Par100Par100Par100BACV24BACV28BACV25Consideration26Consideration26Consideration26Fair ValueExplicit fee215Fair Value215Fair ValueExplicit fee125Remaining consideration25Remaining consideration25Remaining consideration25Gain (Loss)1Gain (Loss)(3)Gain (Loss)0Income 1Income 1Income* 1*Entity has in place a process to identify explicit prepayment penalty or acceleration fees. FILENAME \p G:\FRS\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2019\Spring\NM Exposures\18-32 - SSAP No. 26R - Prepayment Penalties.docx ................
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