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SSAP 43R-Revised Loan-Backed and Structured Securities

On September 14, 2009, the Statutory Accounting Principles Working Group adopted SSAP 43R, which provides guidance on recording other-than temporary impairments (OTTIs) on loan-backed and structured securities. The new pronouncementwill supersede SSAP 98, “Treatment of Cash Flows When Quantifying Changes in Valuation and Impairments,” An Amendment of SSAP 43, “Loan-Backed and Structured Securities,” as well as paragraph 13 of SSAP 99, “Accounting for Certain Securities Subsequent to an Other-Than-Temporary Impairment.” SSAP 43R was officially adopted at the NAIC’s fall meeting and became effective for September 30, 2009 reporting.

When the holder of a loan-backed or structured security (security) with an unrealized loss position has either 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 considered an OTTI and must be written down to fair value. The writedown 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 the following 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 (e.g., 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 at the discount rate to determine the 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 estimated remaining life to the undiscounted estimate of principal recovery.

Category Two

Category two includes securities upon which the collection of all contractual cash flows is 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 at 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 estimated remaining life to the undiscounted estimate of principal recovery.

Category Three

Category three includes securities upon which the collection of all contractual cash flows is 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) at the discount rate to determine the 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. Prior to making this comparison, we believe that the amortized cost shall be updated to reflect the security’s current estimate of prepayment assumptions. If a write-down is necessary, it 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 a security is recorded as an OTTI 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 noninterest- related loss.

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 98, or an equivalent statutory accounting policy, and paragraph 13 of SSAP 99. 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 OTTIs.

Disclosures

Under SSAP 43R, a number of disclosures are required. First, you will need to disclose the basis of the loan-backed securities, as well as the adjustment methodology used for each type of security. Management will also need to include a description of the sources used to determine prepayment assumptions.

Recognized Impairment Losses

For all securities in which an OTTI has occurred, disclosure in the aggregate must be broken down into the following three categories, depending on the reason for impairment:

Category 1—Intent to sell
Category 2—Inability or lack of intent to hold the security for a period of time sufficient to recover the amortized cost basis
Category 3—Present value of cash flows expected to be collected is less than the amortized cost basis of the security

For those items in category three that are still being held at the end of a reporting period the following additional disclosures are required:

• The amortized cost basis prior to the current period impairment
• The amount of impairment loss recognized in earnings as a realized loss
• The fair value of the security, and
• The amortized cost basis after the current period impairment

Nonrecognized Impairment Losses

All impaired securities, for which other-than-temporary impairments have not been recognized in earnings as a realized loss, should disclose the following:

• The aggregate amount of unrealized losses, and
• The fair value of the securities with unrealized losses

The above disclosures should be broken down into two categories:

(1) those in a continuous loss position for less than 12 months and
(2) those in a continuous loss position for 12 months or longer.

Management should also include the information it used to determine that the impairments are not other-than-temporary.

Questions about SSAP 43R? Contact Jeff Dertz at 312-980-3224 or your Blackman Kallick representative.

Co-authored with Joseph A. Borgmann, Vice President, AAM
312-845-2372, joe.borgmann@aamcompany.com

AAM is a registered independent investment advisor, specializing in the management of insurance company assets. The firm was founded in 1982 with the belief that insurance companies require the expertise of an independent investment advisor with the practical knowledge of the regulatory and competitive environment in which insurance companies operate.
 

 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.