Statutory Accounting Principles Working Group



Statutory Accounting Principles (E) Working GroupMaintenance Agenda Submission FormForm AIssue: SSAP No. 72 DistributionsCheck (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 clarify statutory accounting guidance for distributions captured within the scope of SSAP No. 72—Surplus and Quasi-Reorganization. Specifically, this agenda item intends to clarify the difference between a dividend and other distribution to a parent or shareholders and incorporate appropriate statutory accounting and reporting guidance. Current statutory accounting guidance does not address non-dividend capital distributions. This issue has been identified as questions have been received on “dividends” (distributions) when the reporting entity has negative unassigned funds. In response to these past inquiries, there have been different state responses on how these distributions should be reported: Some have noted a preference to follow the guidance in accordance with SSAP No. 72 for dividends, with a charge to unassigned funds. With this accounting, the gross paid-in and contributed surplus line is not impacted, but unassigned funds go further negative. Some have noted a preference to deduct the distribution from gross paid in and contributed surplus, but have noted that this guidance is contrary to the dividend guidance in SSAP No. 72, which indicates that dividends should be charged directly to unassigned funds. A key element in this agenda item is to distinguish between dividends and distributions. Under tax rules, if a distribution is made that does not come from the company’s profits, then the distribution is not a dividend, but is considered a return of capital. If a shareholder was to receive nondividend distributions after their stock basis had been reduced to zero, the distribution would be a taxable capital gain. Excerpt from IRS Topic 404 – Dividends: Return of CapitalDistributions that qualify as a return of capital aren't dividends. A return of capital is a return of some or all of your investment in the stock of the company. A return of capital reduces the adjusted cost basis of your stock. For information on basis of assets, refer to?Topic No. 703. A distribution generally qualifies as a return of capital if the corporation making the distribution doesn't have any accumulated or current year earnings and profits. Once the adjusted cost basis of your stock has been reduced to zero, any further nondividend distribution is a taxable capital gain that you report on?Form 8949,?Sales and Other Dispositions of Capital Assets, and?Form 1040, Schedule D,?Capital Gains and Losses.Similar terminology is also captured in Model 440, Insurance Holding Company System Regulatory Act, as the Model often references “dividends and other distributions to shareholders.” (Excepts Below)Section 4 – Registration of InsurersE.Reporting of Dividends to Shareholders. Subject to Section 5B, each registered insurer shall report to the commissioner all dividends and other distributions to shareholders within fifteen (15) business days following the declaration thereof.Section 5 – Standards and Management of an Insurer Within an Insurance Holding Company SystemA.Transactions Within an Insurance Holding Company System(f) The insurer’s surplus as regards policyholders following any dividends or distributions to shareholder affiliates shall be reasonable in relation to the insurer’s outstanding liabilities and adequate to meet its financial needs.B.Dividends and other DistributionsNo domestic insurer shall pay any extraordinary dividend or make any other extraordinary distribution to its shareholders until thirty (30) days after the commissioner has received notice of the declaration thereof and has not within that period disapproved the payment, or until the commissioner has approved the payment within the thirty-day period.For purposes of this section, an extraordinary dividend or distribution includes any dividend or distribution of cash or other property, whose fair market value together with that of other dividends or distributions made within the preceding twelve (12) months exceeds the lesser of:(1)Ten percent (10%) of the insurer’s surplus as regards policyholders as of the 31st day of December next preceding; or (2)The net gain from operations of the insurer, if the insurer is a life insurer, or the net income, if the insurer is not a life insurer, not including realized capital gains, for the twelve-month period ending the 31st day of December next preceding, but shall not include pro rata distributions of any class of the insurer’s own securities. In determining whether a dividend or distribution is extraordinary, an insurer other than a life insurer may carry forward net income from the previous two (2) calendar years that has not already been paid out as dividends. This carry-forward shall be computed by taking the net income from the second and third preceding calendar years, not including realized capital gains, less dividends paid in the second and immediate preceding calendar years. Notwithstanding any other provision of law, an insurer may declare an extraordinary dividend or distribution which is conditional upon the commissioner’s approval, and the declaration shall confer no rights upon shareholders until (1) the commissioner has approved the payment of the dividend or distribution or (2) the commissioner has not disapproved payment within the thirty-day period referred to above.In review of the U.S. GAAP provisions, there is limited guidance on reporting distributions as return of capital. The guidance that was available under U.S. GAAP was from APB 18, The Equity Method of Accounting for Investments in Common Stock, but that guidance was superseded with the issuance of ASU 2016-01, Financial Instruments – Overall. 325-20-35-1???Under the cost method of accounting for investments in common stock, dividends are the basis for recognition by an investor of earnings from an investment. An investor recognizes as income dividends received that are distributed from net accumulated earnings of the investee since the date of acquisition by the investor. The net accumulated earnings of an investee subsequent to the date of investment are recognized by the investor only to the extent distributed by the investee as dividends. Dividends received in excess of earnings subsequent to the date of investment are considered a return of investment and are recorded as reductions of cost of the investment.325-20-35-3???As discussed in paragraph?323-10-35-36, an investment in voting stock of an investee entity may fall below the level of ownership described in paragraph?323-10-15-3?from sale of a portion of an investment by the investor, sale of additional stock by an investee, or other transactions, and the investor may thereby lose the ability to influence policy (see paragraphs?323-10-15-6 through 15-11?for guidance in determining significant influence). That paragraph requires that an investor discontinue accruing its share of the earnings or losses of the investee for an investment that no longer qualifies for the equity method. That paragraph also requires that the earnings or losses that relate to the stock retained by the investor and that were previously accrued shall remain as a part of the carrying amount of the investment. However, dividends received by the investor in subsequent periods that exceed the investor's share of earnings for such periods shall be applied in reduction of the carrying amount of the investment (see paragraph?325-20-35-1).Existing Authoritative Literature: SSAP No. 72—Surplus and Quasi-ReorganizationsGross Paid-in and Contributed Surplus7.Gross paid-in and contributed surplus is the amount of capital received in excess of the par value of the stock issued. Changes in the par value of a reporting entity’s capital stock shall be reflected as a reclassification between the capital stock account and gross paid-in and contributed surplus. Forgiveness of a reporting entity’s obligations to its parent or other stockholders shall be accounted for as contributed surplus.8.Notes or other receivables received as additional capital contributions satisfied by receipt of cash or readily marketable securities prior to the filing of the statutory financial statement shall be treated as a Type I subsequent event in accordance with SSAP No.?9 and as such shall be considered an admitted asset based on the evidence of collection and approval of the domiciliary commissioner. To the extent that the notes or other receivables are not satisfied, they shall be nonadmitted.9.Real estate or other assets received as additional capital contributions are nonreciprocal transfers as defined in SSAP No. 95—Nonmonetary Transactions (SSAP No. 95).10.Stock purchase warrants issued in return for cash shall be credited to gross paid-in and contributed surplus. When debt instruments are issued with conversion features, no value shall be assigned to the conversion features unless the conversion feature is clearly separable from the debt obligation in the form of a detachable stock purchase warrant. In such instances the relative fair value of the detachable stock purchase warrant at time of issue shall be credited to gross paid-in and contributed surplus. For instances in which a reporting entity has issued puttable warrants or mandatorily redeemable warrants, such items shall be reflected as liabilities as the warrants obligate the reporting entity to ultimately transfer cash or other assets to the holder in order to repurchase the shares. Unassigned Funds (Surplus)12.Unassigned funds (surplus) represents the undistributed and unappropriated amount of surplus at the balance sheet date. Certain components of unassigned funds (surplus) are addressed in more detail in other issue papers. Unassigned funds (surplus) is comprised of the cumulative effect of:i.Dividends to StockholdersDividends declared are charged directly to unassigned funds (surplus) on the declaration date and are carried as a liability until paid. The amount of the dividend is the cash paid if it is a cash dividend, the fair value of the assets distributed if it is property dividend, or the par value of the company’s stock if it is a stock dividend. A stock dividend is recorded as a transfer from unassigned funds (surplus) to capital stock. Stock dividends have no effect on total capital and surplus while other forms of dividends reduce surplus. Forgiveness by a reporting entity of any debt, surplus note or other obligation of its parent or other stockholders shall be accounted for as a dividend. Dividends paid to related parties are subject to the requirements of SSAP No.?25—Affiliates and Other Related Parties;SSAP No. 97—Investments in Subsidiary, Controlled Affiliated Entities is for holders of investments, but the adjustments for equity method accounting (quoted below) make a distinction in the equity method accounting treatment for amounts in excess of the undistributed earnings of the investee. (bolding added) 11.For investments in entities recorded on an equity method (paragraph 8.b.i. through 8.b.iv.) after the date of acquisition, the investment amount shall be 1) adjusted for the amortization of statutory goodwill as defined in SSAP No. 68, and 2) adjusted, with a corresponding unrealized gain or loss, for the reporting entity's share of undistributed earnings and losses of the investee (net of dividends declared). (This results in a reduction of the investment amount when dividends declared are in excess of the undistributed accumulated earnings attributable to the investee.) The following additional adjustment, based on the equity method applied for the investment, shall also be made: (subparagraphs excluded to save space.)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): NoneInformation 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 revisions to SSAP No. 72 to provide guidance for when a reporting entity provides a distribution that is a return of capital. Proposed revisions to SSAP No. 72:Gross Paid-in and Contributed SurplusGross paid-in and contributed surplus is the amount of capital received in excess of the par value of the stock issued. Changes in the par value of a reporting entity’s capital stock shall be reflected as a reclassification between the capital stock account and gross paid-in and contributed surplus. Forgiveness of a reporting entity’s obligations to its parent or other stockholders shall be accounted for as contributed surplus.Notes or other receivables received as additional capital contributions satisfied by receipt of cash or readily marketable securities prior to the filing of the statutory financial statement shall be treated as a Type I subsequent event in accordance with SSAP No.?9 and as such shall be considered an admitted asset based on the evidence of collection and approval of the domiciliary commissioner. To the extent that the notes or other receivables are not satisfied, they shall be nonadmitted.Real estate or other assets received as additional capital contributions are nonreciprocal transfers as defined in SSAP No. 95—Nonmonetary Transactions (SSAP No. 95).Stock purchase warrants issued in return for cash shall be credited to gross paid-in and contributed surplus. When debt instruments are issued with conversion features, no value shall be assigned to the conversion features unless the conversion feature is clearly separable from the debt obligation in the form of a detachable stock purchase warrant. In such instances the relative fair value of the detachable stock purchase warrant at time of issue shall be credited to gross paid-in and contributed surplus. For instances in which a reporting entity has issued puttable warrants or mandatorily redeemable warrants, such items shall be reflected as liabilities as the warrants obligate the reporting entity to ultimately transfer cash or other assets to the holder in order to repurchase the shares. Reporting entities shall receive domiciliary state approval before providing a return of capital to a parent or other stockholder. Distributions that reflect a return of capital shall be charged directly to the gross paid in and contributed surplus. (A return of capital will reduce the adjusted cost basis of the parent/stockholder in the reporting entity.) (Remaining paragraphs renumbered accordingly.) Unassigned Funds (Surplus)1213.Unassigned funds (surplus) represents the undistributed and unappropriated amount of surplus at the balance sheet date. Certain components of unassigned funds (surplus) are addressed in more detail in other issue papers. Unassigned funds (surplus) is comprised of the cumulative effect of:Dividends to StockholdersDividendsFN declared are charged directly to unassigned funds (surplus) on the declaration date and are carried as a liability until paid. The amount of the dividend is the cash paid if it is a cash dividend, the fair value of the assets distributed if it is property dividend, or the par value of the company’s stock if it is a stock dividend. A stock dividend is recorded as a transfer from unassigned funds (surplus) to capital stock. Stock dividends have no effect on total capital and surplus while other forms of dividends reduce surplus. Forgiveness by a reporting entity of any debt, surplus note or other obligation of its parent or other stockholders shall be accounted for as a dividend. Dividends paid to related parties are subject to the requirements of SSAP No.?25—Affiliates and Other Related Parties;New Footnote: As a dividend represents the distribution of earnings, in any event in which unassigned funds is negative, or goes below zero as a result of a distribution to a parent or stockholder, the distribution (or portion thereof that does not reflect undistributed accumulated earnings in unassigned funds) shall be considered a return of capital and captured in paragraph 11. Determining whether a distribution is a dividend or a return of capital does not impact consideration of whether the distribution is “extraordinary” as both dividends and other distributions (e.g., return of capital) are subject to that assessment. (Reporting entities with positive unassigned funds may choose to make return of capital distributions. Those distributions are also captured in paragraph 11.) Staff Review Completed by:Julie Gann, NAIC Staff – May 2018Status:On August 4, 2018, the Statutory Accounting Principles (E) Working Group moved this item to the active listing, categorized as nonsubstantive, and exposed proposed revisions to SSAP No. 72—Surplus and Quasi-Reorganizations, as shown above, to incorporate accounting guidance for when a reporting entity provides a distribution that represents a return of capital. FILENAME \p G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2018\Summer\NM Exposures\18-21 - SSAP No. 72 Distributions.docx ................
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