Posts Tagged ‘other-than-temporary impairment’

When SFAS Statement 157, Fair Value Measurements was issued in September 2006, the Statement’s underlying concepts of fair value (an exit price) and the fair value hierarchy (more emphasis is to be placed on market transactions when determining a security’s fair value) seemed reasonable. It was understood at the time that a level 3 price, which is a fair value calculated based on unobservable market inputs, would carry less weight by market analysts. However, in that benign market environment it was not a challenging task to obtain reasonable and observable market data to support fair value measurements. Today, with liquidity and trading volumes near all time lows, it can be difficult to obtain observable market data to support a fair value. Further, even when there is observable market data, it can be challenging to ascertain if the market data is related to orderly transactions between two willing parties, which should only be used to support a true exit price, or if the transactions are a result of distressed sales or forced liquidations.

This past September the FASB and the SEC released a document that answered questions surrounding fair value accounting. Below are several excerpts from the memo:

• “The determination of fair value often requires significant judgment”
• “Determining whether a particular transaction is forced or disorderly requires judgment”
• “The determination of whether a market is active or not requires judgment”
• “Determining whether impairment is other-than-temporary is a matter that often requires the exercise of reasonable judgment based upon the specific facts and circumstances of each investment”

The individuals who are deeply involved with establishing the fair values of investments or making impairment decisions should completely agree with the bullet points above. There are several characteristics that are indicative of an impaired security (length of time and severity of unrealized loss position) or transactions resulting from an inactive market (significant spread between bid and ask prices). However. making these ultimate decisions requires the input and judgment of those most familiar with the underlying facts and circumstances of the particular situation. Therefore, I would first like to encourage insurance companies to review their internal policies surrounding the determination of impaired securities and consider using the wording “reasonable judgment” as a component of your impairment policy. Secondly, I encourage these insurance companies to schedule some time with their asset manager to discuss the specific details surrounding any securities that, on the surface, appear to be other-than-temporarily impaired.

We recently met with a well respected Chicago based accounting firm to discuss FASB 157 and OTTI related issues. The members of this firm were impressed to see the level of security-specific information available to AAM’s clients and believed that their firm’s audit procedures could be completed much more efficiently if this information was available to them. It is apparent that auditors will be requiring more investment related information in discussions regarding impairments. AAM acknowledges this, believes the audit community should agree with this concept of reasonable judgment and is prepared to provide you with the necessary information to be prepared for your upcoming audit.

Joseph A. Borgmann, CPA
Vice President
Investment Accounting

SSAP No. 98 — Treatment of Cash Flows When Quantifying Changes in Valuation and Impairments, an Amendment of SSAP No. 43 — Loan-backed and Structured Securities

Issued: November 5, 2008
Effective: January 1, 2009, with early adoption permitted

This pronouncement requires that when recording an other-than-temporary impairment related to a loan backed security, the security’s cost basis should be reduced to its fair value. Prior to the adoption of SSAP No. 98 and 99, the cost basis of an other-than-temporarily impaired loan backed security was written down to its undiscounted estimate of future cash flows.

Loan backed securities that have been previously impaired should be reviewed to determine if an additional write-down is warranted.

SSAP No. 99 — Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment

Issued: September 23, 2008
Effective: January 1, 2009, with early adoption permitted

This pronouncement requires that after writing down a bond or redeemable preferred stock, whereby the cost basis of the security is reduced to its fair value, the difference between the new cost basis and the estimated recovery value (the new premium or discount) should be amortized or accreted over the remaining life of the security.

SSAP No. 99 also clarifies that any bond premium that is written-off upon recognition of an impairment shall be recorded as a realized loss versus a reduction to investment income.

Other Relevant Statutory Guidance:
INT 06-07: Definition of “Other Than Temporary”

One of the key concepts of this OTTI guidance is that there are two types of impairments – interest related impairments and credit related impairments. An interest related impairment is obviously caused by changes in the risk free interest rate, but also includes general credit spread widening due to “supply/demand imbalances” or “perceived higher/lower risk of an entire sector”. From a recognition standpoint, an interest related OTTI adjustment should be recorded when the holder has the intent to sell the position.

In contrast, a credit related impairment should be recognized when it is deemed other-than-temporary. Since we are currently experiencing a market where many securities have been trading at severely depressed levels, it is important to assess the issuers’ ability to make principal and interest payments when they are due. If the issuer is showing signs that indicate the inability to make these payments, the impairment should be considered credit related. If the issuer remains financially sound, the impairment is most likely interest related.

Annual Statement Changes
2008-22BWG

Effective: 2008 Annual Statement

With the adoption of 2008-22BWG comes a new (electronic) column to the Schedule D Parts 1 and 2, which indentifies the source of the fair value/market value used in the statement. Below are the codes that are to be noted in this column:

a — price is from a pricing service

b — price is from a stock exchange

c — price is from a broker or the insurer’s custodian **

d — price is determined by the insurer

e — price is from the SVO

** Broker must be approved by the insurer as a counterparty for buying and selling securities or be an underwriter of the security being valued and the broker’s or custodian’s pricing policy must be retained by the insurer.

Similar to AAM’s SFAS 157 level one, two, or three reporting, AAM will provide a year-end report to our client’s that specify our valuation sources in the format outlined above.

Joseph A. Borgmann, CPA
Vice President
Investment Accounting