Statutory Accounting Principles Working Group



Statutory Accounting Principles (E) Working GroupMaintenance Agenda Submission FormForm AIssue: Private Placement Variable AnnuitiesCheck (applicable entity):P/CLifeHealthModification of existing SSAP FORMCHECKBOX FORMCHECKBOX FORMCHECKBOX New Issue or SSAP FORMCHECKBOX FORMCHECKBOX FORMCHECKBOX Interpretation FORMCHECKBOX FORMCHECKBOX FORMCHECKBOX Description of Issue: This agenda item has been drafted to address private placement variable annuities (PPVA). Several questions / product inquiries have been received involving these specific structures, and existing statutory accounting and reporting guidance does not differentiate these products from other variable annuity products. This agenda item intends to provide information regarding these products and consider whether specific disclosures or reporting information for these products should be incorporated. Under the Securities Act of 1933, variable annuities must be registered with the SEC before they can be offered to the public. There are two exceptions to this registration requirement. The first registration exclusion is for variable annuity contracts issued in connection with certain qualified plans (such as 401k plans). The second exclusion is for private placement variable annuities, which are contracts that are offered only to sophisticated investors who meet certain requirements under the federal securities laws (and not to members of the general public). To qualify to acquire a PPVA a client must be an accredited investor. However, as most funds under these products are structured as Section 3(c)7 investment vehicles under the Investment Company Act of 1940, as a practical matter, a client must be both an accredited investor and a qualified purchaser to utilize a PPVA investment account. Although these are referred to as PPVA, these products can be designed as Private Placement Life Insurance (PPLI) or as Private Placement Variable Annuities (PPVA). These products are utilized to invest in an “insurance dedicated fund” (IDF) through insurance carriers on a tax-deferred or tax-free basis. IDFs are generally alternative investment portfolios containing hedge funds, high-yield bonds, direct lending credit vehicles and high-turnover portfolios linked to variable annuity or life insurance products. Unlike traditional life insurance, an investor buys a PPLI or PPVA principally as an income tax-free investment vehicle. In addition to insurers selling PPVA and PPLI products to high-wealth individuals, institutional uses for these products have been noted to include Corporate Owned Life Insurance (COLI), Bank Owned Life Insurance (BOLI) and Insurance Company Owned Life Insurance (ICOLI). Information received on these products have identified that they are not dependent on an individual’s health or death, however, the products can be tailored to incorporate a minimum death benefit so that it is considered a “life product” under statutory accounting. These products are not reflective of traditional annuities and without the main focus of the income guarantees or protection of principal in the event of premature death, are considered “less expensive”. Although these private placement products are not subject to SEC registration, there are specific provisions to ensure that the tax benefits are obtained: The product must be administered by an insurance company and allow for systematic distribution of principal over a period of payments. The investment offerings are structured as IDFs available only to qualified insurance companies. (These are generally insulated separate accounts not subject to the claims of an insurer’s general account.) The IDF must meet diversification requirements under the internal revenue code. If these are not met, the investment account could be subject to current period taxation on all embedded gains in the contract and cause the loss of tax deferral going forward. The IRS diversification requirements include the following:No one investment can constitute more than 55% of the total assets of the account. No two investments can constitute more than 70% of the value of the total assets of the account.No three investments can constitute more than 80% of the value of the total assets of the account.No four investments can constitute more than 90% of the value of the total assets of the account.The IDF must also satisfy the investment control rules of the internal revenue code. Under these rules the owner of the PPVA cannot influence the IDF manager, directly or indirectly, with respect to the selection of underlying funds and/or securities to which the IDF assets will be allocated. This means that the IDF investment manager must select underlying funds and/or securities on a completely discretionary basis. The IRS has provided guidance that a client may work with an investment advisor to create a clearly defined investment mandate according to which the investment advisor will manage the account with complete discretion. This agenda item intends to provide information regarding these products and propose revisions to capture information on the use of these products, and propose statutory accounting if held by an insurer. The following identifies considerations for both insurer issuers and insurer acquirers:Insurer Issuers –Separate account reporting provisions do not identify “private placement” securities. NAIC staff believes that there may be a general assessment that separate account variable annuity products are SEC registered, therefore, NAIC staff recommends it would be appropriate to highlight the issuance of products that are not registered by the SEC. Insurer Acquirers – Statutory accounting does not prescribe specific guidance for the accounting and reporting of these products. Based on inquiries received, NAIC staff believes that some insurers considering acquisition of these products refer to the guidance in SSAP No. 21, paragraph 6, which addresses situations when a reporting entity is the owner and beneficiary of a life insurance policy. Under that guidance, the amount that can be realized (generally cash surrender value) is permitted to be reported as an admitted asset. (From one inquiry, it was noted that the product would encompass a minimum death benefit so it could be considered a life product and be captured under SSAP No. 21.) Reference has also occurred to SSAP No. 21, paragraph 5, which addresses structured settlement annuities where the reporting entity is the owner and payee in the context of the insurer purchasing an annuity to settle a claim. Under that guidance the annuity is admitted to the extent of its net realizable value and is reported as an other-than-invested asset. As PPLI and PPVA products are considered “investment vehicles” and generally hold “alternative asset class investments” (hedge funds, high-yield bond funds, direct lending credit vehicles, and high turnover portfolios), NAIC staff does not believe it is appropriate to report these products under SSAP No. 21. (NAIC staff believes that the investment focus of these products goes beyond the original intent of the “owner and beneficiary” of a life insurance product captured in SSAP No. 21, paragraph 6.) NAIC staff suggests that specific guidance be established to address the accounting and reporting for these investments, particularly whether they should be admitted, the measurement method that should apply, and to identify the appropriate reporting schedule. From inquiries received, and the investment focus of these products, NAIC staff believes that the “amount realizable” by a holder under these products is not reflective of what would be available as “cash surrender value” in a traditional variable annuity product. Rather, a significant portion of the initial “premium cost” (invested asset value – e.g., the purchase price / product value) is immediately “realizable” after acquisition. As such, unless specific guidance is established, it’s likely that these “alternative investment products” structured as life insurance (if they contain a minimal death benefit) may be captured as admitted assets under SSAP No. 21. NAIC staff does not believe the guidance in SSAP No. 21 was intended to capture these investment products, where the “beneficiary” is electing the underlying investments, but rather to capture traditional life products (key man life insurance) that gradually build cash value over time. NOTE: If an insurer acquirer is reporting this product as an admitted “other than invested asset” under the existing guidance in SSAP No. 21, there is no RBC charge.Additionally, NAIC staff received a presentation from an investment company seeking approval on their structure to market these products to insurance companies (under the confines of SSAP No. 21). As part of that discussion, it was identified that liquidity, and the timely realization of the “cash value” would be an issue. Per that discussion, it was noted that although the PPVA would permit the insurer to withdraw their “realizable value” at any time, the insurer would be subject to any delays from liquidating the underlying investments. As the underlying investments are often not liquid investments (e.g., hedge funds), the insurer would not receive their net realizable value until their underlying interest was sold. As a result of this information, NAIC staff is recommending that these investment products default to nonadmitted status pursuant to the guidance under SSAP No. 4—Admitted and Nonadmitted Assets. Existing Authoritative Literature: SSAP No. 56—Separate Accounts – This SSAP provides guidance for products reported in the separate account (including variable annuities). There is no specific reporting guidance that requires issuers to separately identify variable annuities that are registered with the SEC and those that that are excluded from SEC registration requirements. SSAP No. 50—Classifications of Insurance or Managed Care Contracts – This SSAP provides the general framework for classifying insurance or managed care contracts. Pursuant to this SSAP, life insurance contracts include contracts with life contingencies, and include variable life and annuity contracts. Guidance from paragraph 20 specifically addresses annuity contracts with death benefits:20.An annuity contract is an arrangement whereby an annuitant is guaranteed to receive a series of stipulated amounts commencing either immediately or at some future date. The contract shall be issued to or for the benefit of an identifiable individual or group of individuals. Such a contract containing well-defined class-based (e.g. age, gender) annuity purchase rates used in defining either a specific or maximum purchase rate guarantee would constitute an annuity contract containing a life contingency that would require it to be classified as a life contract. Some examples of contracts issued for the benefit of a group of individuals include pension plan sponsors purchasing contracts for the benefit of their plan participants, employers or associations purchasing contracts for the benefit of their employees or members, and collective trusts purchasing contracts for the benefit of participating pension plans and their plan participants. The main types of annuity contracts with life contingencies are discussed below.a.A deferred annuity provides for the accumulation of funds to be applied at some future period designated by the policyholder. Premium payments can be made in a lump sum amount (single premium deferred annuity), or periodically (flexible or fixed premium deferred annuity) as allowed by the policy contract. At the end of the accumulation period, the policyholder may elect to receive a lump sum distribution or may elect to receive periodic payments for life, or over a specific period, or some combination thereof;b.A variable annuity is an annuity which includes a provision for benefit payments which vary in accordance with the rate of return of the underlying investment portfolio selected by the policyholder. The considerations for a variable annuity are usually invested in a separate account in which the value of the contract share varies according to the performance of the separate account before the commencement of annuity payments as well as after. Premium payments can be made in lump sum amounts or periodically as allowed by the policy contract. A minimum death benefit is often guaranteed during the annuity consideration accumulation period and these contracts are, therefore, classified as life contracts;c.A straight-life annuity provides for periodic payments to the annuitant as long as the annuitant lives. Death of the annuitant constitutes completion of the contract and no further payments are made by the insurance company;d.A life annuity with a period certain works essentially the same way as the straight-life annuity as the annuitant receives periodic payments for as long as the annuitant lives. However, if the annuitant dies before the end of the specified "certain" period, payments are continued to a beneficiary until the specified number of "certain" payments (i.e., the specified period in the contract) is completed;e.A refund annuity is similar to the life annuity with a period certain in which the annuitant receives periodic payments for as long as the annuitant lives. There are two variants of this type of annuity. Under the cash refund annuity, a lump-sum payment is made at the death of the annuitant equal to the excess, if any, of the purchase price of the annuity over the sum of the annuity payments made to date of death. The installment refund annuity provides that annuity payments are to continue to a beneficiary after the death of the annuitant until the sum of all payments made equals the purchase price;f.A joint and survivorship annuity provides for the continuation of payments after the death of one of the annuitants during the lifetime of the surviving annuitant.43.Deposit-type contracts do not incorporate insurance risk. Contracts issued by insurers that do not incorporate risk from the death or disability of policyholders (mortality or morbidity risk) are more comparable to financial or investment instruments issued by other financial institutions than to insurance contracts.SSAP No. 21—Other Admitted Assets – This SSAP provides statutory accounting principles for admitted assets not specifically addressed in other statements: Cash Value of Structured Settlements5.The reporting of the present value of structured settlement annuities where the reporting entity is the owner and payee as described in SSAP No. 65, paragraph 17.a. shall account for the annuity an admitted asset at its net present realizable value. The annuity described is reported as an other-than-invested asset. Income from the annuities shall be recorded as miscellaneous income. The present value of the annuity and the related amortization schedule shall be obtained from the issuing life insurance company at the time the annuity is purchased. When the reporting entity is the owner and payee, no reduction shall be made to loss reserves.The Amount That Could Be Realized on Life Insurance Where the Reporting Entity is Owner and Beneficiary or Has Otherwise Obtained Rights to Control the Policy6.The amount that could be realized on life insurance policies where the reporting entity is the owner and beneficiary or has otherwise obtained the rights to control the policy, is similar to a cash deposit that is realizable on demand. As such, the amount that could be realized on a life insurance policy as of the date to which premiums have been paid, shall be reported as an admitted asset. In determining the amount that could be realized, reporting entities shall consider the cash surrender value as well as other contractual terms which limit or provide for additional realizable amounts. Amounts recoverable by the reporting entity at the discretion of the issuing company shall not be included. Amounts realizable beyond one year from the surrender date shall be discounted. For group policies or a group of individual life policies, reporting entities shall assume surrender on a policy by policy or certificate by certificate basis, unless contractual terms only allow for surrender of all policies or certificates as a group, in which case the amount that could be realized shall be determined on a group rmation or issues (included in Description of Issue) not previously contemplated by the Working Group: None. Staff Recommendation: NAIC staff recommended for March 2018 discussion that the Working Group move this item to the active listing, classified as nonsubstantive, and expose revisions to SSAP No. 56—Separate Accounts to capture information regarding the issuance of private placement life insurance and private placement variable annuities. NAIC staff proposed that these revisions be required as of year-end 2018 and suggested a concurrent blanks proposal to allow the disclosures to be adopted in time to allow for data-capturing as of year-end 2018. At initial presentation of this agenda item, NAIC staff also recommended revisions to SSAP No. 21 to prescribe the accounting and reporting for insurers that hold these products. After discussion at the 2018 Spring National Meeting, the Working Group directed exposure of the proposed SSAP No. 56 disclosures, along with the concurrent blanks proposal, but directed that the revisions to SSAP No. 21 be removed. The removal of the proposed revisions was directed to allow interested parties to provide information on how to differentiate private placement products that are investment-focused and traditional life insurance products when the insurer is the owner and beneficiary before exposing revisions to SSAP No. 21. Once this information is reviewed, revisions will be considered to SSAP No. 21—Other Admitted Assets. Insurer Issuers of PPLI and PPVA - Proposed Revisions to SSAP No. 56: 35.The Separate Account Annual Statement Blank shall include detailed information on the characteristics of the separate account assets, specifically categorizing separate account assets in accordance with the following characteristics:Identification of separate account assets that are legally insulated from the general account and those which are not legally insulated.Aggregation of separate account assets from products registered with the SEC and separate account assets from products excluded from registration. In addition to the overall aggregation, this disclosure shall specifically identify separate account assets from private placement variable annuities (PPVA) and private placement life insurance (PPLI). Note – Staff recommends this disclosure to be captured in the separate account general interrogatory: 1.01Identify the product types in the separate account, quantify the assets associated with those products, indicate if there are any guarantees associated with those products, quantify seed money and quantify other fees and expenses due to the general account: Note:A distinct product identifier shall be used for each product and shall be used consistently throughout the interrogatory.1Product Identifier2Separate Account Assets3Guarantees Associated withthe ProductYes/No4Seed Money5Fees and ExpensesDue to theGeneral Account6AdditionalRequired SurplusAmountsRegistered with SECNot Registered with the SEC$$$$Totals$XXX$$$1.01AFor the products (and related assets) that are not registered with the SEC, identify whether the products are considered private placement variable annuity products or private placement life insurance: 1Product Identifier2Not Registered with the SECPrivate Placement Variable AnnuityPrivate PlacementLife Insurance Other (Not PPVA or PPLI)$Totals$Amount of separate account assets that represent seed money, other fees and expenses due to the general account, and additional required surplus amounts. This disclosure shall include the amount of seed money and other fees and expenses currently included in the separate account, as well as the amount of seed money received and repaid to the general account during the current year. This disclosure shall also include information on insulation (if applicable), the time duration for which seed money and other fees and expenses due the general account are retained in the separate account, and information on how whether seed money is invested pursuant to general account directives or in accordance with stated policies and procedures.Identification of the separate account assets in which the investment directive is not determined by a contractholder. (In most instances, having multiple investment choices at the option of a contractholder would be considered a situation in which the investment directive is determined by a contractholder. This is not true for situations in which the asset is invested in a manner that mirrors the investment directives of the general account.) Situations in which the investment directive is not determined by the contractholder (and situations in which the reporting entity is the contractholder) shall include disclosure regarding whether the investments of the respective separate account assets, if included within the general account investments, would have resulted with the reporting entity exceeding any investment limitations imposed on the general account.Identification of the separate account assets in which less than 100% of investment proceeds are attributed to a contractholder. This shall include identification of the separate account investment income attributed to the reporting entity during the reporting period and whether such income was transferred to the general account or reinvested within the separate account. Instances in which such income is reinvested within the separate account shall include disclosure on whether the subsequent investments, if categorized with investments in the general account, would have exceeded investment limitations imposed on the general account. Staff Review Completed by: Julie Gann – November 2017Status:On March 24, 2018, the Statutory Accounting Principles (E) Working Group moved this agenda item to the active listing, categorized as nonsubstantive, and exposed proposed revisions to SSAP No. 56—Separate Accounts to capture information on the insurer issuance of private placement life insurance and private placement variable annuities. A concurrent blanks proposal requests the disclosure for year-end 2018 reporting. After discussion of originally proposed revisions to SSAP No. 21, the Working Group directed that the revisions to SSAP No. 21 should be removed from the agenda item. The removal of the proposed revisions allows interested parties to provide information on how to differentiate private placement products that are investment-focused and traditional life insurance products when the insurer is the owner and beneficiary before exposing revisions. Once this information is reviewed, revisions will be considered to SSAP No. 21—Other Admitted Assets.. FILENAME \* Lower \p \* MERGEFORMAT g:\data\stat acctg\3. national meetings\a. national meeting materials\2018\spring\nm exposures\18-08 - private placement annuities.docx ................
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