Posts Tagged ‘SSAP No. 99’

On September 14, 2009, the Statutory Accounting Principles Working Group adopted SSAP 43R, which provides guidance on recording other-than-temporary impairments (OTTI) on loan-backed and structured securities. The new pronouncement will supersede SSAP No. 98 – Treatment of Written downs When Quantifying Changes in Valuation and Impairments, an Amendment of SSAP No. 43 – Loan-Backed and Structured Securities, as well as, paragraph 13 of SSAP No. 99 – Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment. It will be officially adopted at the NAIC’s fall meeting next week and will become effective for September 30, 2009 reporting. This memo outlines the new guidance, with the focus being on securities held by clients of AAM. Since SSAP 43R was based on FSP FAS 115-2 and 124-2: Recognition and Presentation of Other-Than-Temporary Impairments, it may be helpful to read this memo in conjunction with our April 24, 2009 memo (attached), which covered the newly adopted FSP.

When the holder of a loan-backed or structured security (“security”) with an unrealized loss position either has the intent to sell the security or does not have the intent and ability to hold the security for a period of time sufficient to recover the amortized cost basis, the security is OTTI and must be written down to fair value. The write-down shall be recognized in earnings as a realized loss.

When the holder of a security with an unrealized loss position does not intend to sell the security and has the intent and ability to hold the security for a period of time sufficient to recover the amortized cost, the security must be classified into one of three categories:

Category One

Category One includes securities that when purchased, were not of high credit quality (rated below AA) or securities that can be contractually prepaid or otherwise settled in such a way that the reporting entity would not recover substantially all of its investment (interest only strips). For these securities, the best estimate of future cash flows shall be used along with the current yield being used to accrete the security as the discount rate to determine a present value of the expected cash flows. If this present value is less than the amortized cost of the security, the security must be written down to this present value amount. The write-down shall be recognized in earnings as a realized loss. Using the effective interest rate method, the security shall be prospectively accreted over its remaining life to the undiscounted estimate of principal recovery.

Category Two

Category Two includes securities where the collection of all contractual cash flows are not probable. Category Two excludes securities that can be included in Category One. For these securities, the best estimate of future cash flows shall be used along with the security’s effective interest rate (book yield) immediately prior to the recognition of the OTTI as the discount rate to determine a present value of the expected cash flows. If this present value is less than the amortized cost of the security, the security must be written down to this present value amount. The write-down shall be recognized in earnings as a realized loss. Using the effective interest rate method, the security shall be prospectively accreted over its remaining life to the undiscounted estimate of principal recovery.

Category Three

Category Three includes securities where the collection of all contractual cash flows are probable. Category Three excludes securities that can be included in Category One or Two. For these securities, the best estimate of future cash flows shall be used along with the security’s effective interest rate at the acquisition of the security (trade yield) as the discount rate to determine a present value of the expected cash flows. If this present value is less than the amortized cost of the security, the security must be written down to this present value amount. The write-down shall be recognized in earnings as a realized loss. Using the effective interest rate method, the security shall be prospectively accreted over its remaining life to the undiscounted estimate of principal recovery.

AVR/IMR Implications

When an OTTI is recorded because there is intent to sell or the holder does not have the intent and ability to hold the security for a period of time sufficient to recover the amortized cost basis, the security is written down to fair value. The total loss recorded shall be bifurcated between the interest related loss and the non-interest related loss.

View diagram in original PDF.

The interest related portion shall be recorded through the IMR and the non-interest related portion shall be recorded through the AVR.

Transition

A cumulative effect adjustment shall be made to the July 1, 2009 balance of unassigned surplus for impairments recorded prior to July 1, 2009 under SSAP No. 98 or SSAP No. 43. The adjustment shall be calculated by comparing the present value of the cash flows and the amortized cost basis of the security as of July 1, 2009. The discount rate used to calculate the present value of the cash flows shall be the rate in effect before recognizing any OTTI.

Disclosures

Please refer to SSAP 43R for new disclosure requirements.

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