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June 10, 2024

NAIC Finalizes Principles-Based Bond Guidance

The NAIC Statutory Accounting Principles Working Group (SAPWG) has finalized one of the largest changes to the statutory accounting principles in recent history with the adoption of the final portion of NAIC REF 2019-21 at its Spring National Meeting on March 16, 2024. NAIC REF 2019-21, better known as the Principles Based Bond Definition (PBBD) Project, is an overhaul of the definition and identification of bonds using a principles-based approach. The guidance significantly revises SSAP No. 26R, Bonds, No. 43R, Asset-Back Securities and No. 21R, Other Admitted Assets. Refer to the SAPWG website (‘Documents’ tab, ‘Bond Project Documents’) for all final guidance related to the PBBD project to date.

The accounting change is effective January 1, 2025, to provide insurance companies sufficient time to implement the guidance. The accompanying issue paper is still under review by the SAPWG as of the date of this publication.

What is a bond?

Under the principles based approach in the revised SSAP No. 26R, a bond is defined as: 

“Any security representing a creditor relationship, whereby there is a fixed schedule for one or more future payments, and which qualifies as either an issuer credit obligation or an asset-back security as described in this statement.” 

When making the decision on if a creditor relationship exists, insurers should look at the substance of the agreement, in addition to the legal form. A creditor relationship exists when a security has predetermined principal and interest payments (fixed or variable interest payments) that do not vary based on performance of underlying collateral or non-debt variables. Further, securities that represent an ownership interest or that possess equity-like characteristics, are not, in substance, bonds.

Issuer credit obligations 

Bonds that are issuer credit obligations are covered in SSAP No 26R, Bonds. Issuer credit obligations under the new guidance are defined as: 

“A bond, for which the primary source of repayment is the general creditworthiness of an operating entity or entities.” 

Operating entities include business entities, nonprofit organizations, governmental units, and other providers of goods or services.

Asset-backed securities

Bonds that are asset-backed securities are covered in SSAP No. 43R, Asset-Backed Securities. Asset-backed securities under the new guidance are defined as: 

“A bond issued by an entity (an “ABS Issuer”) created for the primary purpose of raising debt capital backed by financial assets or cash generating non-financial assets owned by the ABS Issuer, for which the primary source of repayment is derived from the cash flows associated with the underlying defined collateral rather than the cash flows of an operating entity.” 

For a bond to be considered an asset-backed security, a meaningful level of cash flows must be produced by the underlying financial or cash generating non-financial assets other than through the sale or refinancing of the underlying assets held by the ABS Issuer. As a practical expedient, the meaningful cash flow criteria is met if less than 50% of the original principal relies on sale or refinancing to generate cash flows.

What are the impacts?

Schedule D

Schedule D will be disaggregated into two parts:

  • Schedule D Part 1, Section 1: Long Term Bonds – Issuer Credit Obligations Owned, and 
  • Schedule D Part 1, Section 2: Asset Backed Securities Owned.  

The reporting categories of each part of Schedule D have been updated in conforming changes made by the Blanks Working Group (BWG) and additional columns of data may be required. Definitions for each reporting category will be included in the annual statement instructions.

Schedule BA

Insurance companies may determine that some securities reported as bonds no longer qualify for bond reporting under the principles-based definition. Securities that do not qualify for bond reporting will move to Schedule BA. Conforming changes to reporting categories on Schedule BA have also been made by the BWG.

Risk Based Capital (RBC) Calculation

No specific changes to the RBC calculation have been adopted as of the date of this publication. However the movement of securities between Schedule D and Schedule BA may have RBC impacts associated with them. In general, assets that were previously reported on Schedule D Part 1 that no longer qualify as bonds may incur a higher RBC charge on Schedule BA.

Start Preparing Now

Insurance companies will need to assess their bond portfolios to identify which securities are issuer credit obligations, asset-backed securities, or if they do not qualify as bonds and need to move to Schedule BA. Reasonable scoping may be applied to focus attention on the more complex securities. Transition guidance is included in the statutory revisions.

The PBBD Project is one of the most significant NAIC accounting changes in several years. A principles-based approach allows the bond guidance to stand as new investment structures are created, and places the responsibility on management to have internal controls in place to properly categorize investments held on the quarterly and annual statements to meet regulatory requirements. The guidance is effective January 1, 2025 and reporting will be required in the first Quarterly Statement of 2025.

Contact the Johnson Lambert team for the latest guidance related to the PBBD Project.

Lauren Darr

Lauren Darr

Partner

Mitchell Lipham

Mitchell Lipham

Senior Manager

Haley Louzader

Haley Louzader

Manager

NAIC Finalizes Principles-Based Bond Guidance

The NAIC Statutory Accounting Principles Working Group (SAPWG) has finalized one of the largest changes to the statutory accounting principles in recent history with the adoption of the final portion of NAIC REF 2019-21 at its Spring National Meeting on March 16, 2024. NAIC REF 2019-21, better known as the Principles Based Bond Definition (PBBD) Project, is an overhaul of the definition and identification of bonds using a principles-based approach. The guidance significantly revises SSAP No. 26R, Bonds, No. 43R, Asset-Back Securities and No. 21R, Other Admitted Assets. Refer to the SAPWG website (‘Documents’ tab, ‘Bond Project Documents’) for all final guidance related to the PBBD project to date.

The accounting change is effective January 1, 2025, to provide insurance companies sufficient time to implement the guidance. The accompanying issue paper is still under review by the SAPWG as of the date of this publication.

What is a bond?

Under the principles based approach in the revised SSAP No. 26R, a bond is defined as: 

“Any security representing a creditor relationship, whereby there is a fixed schedule for one or more future payments, and which qualifies as either an issuer credit obligation or an asset-back security as described in this statement.” 

When making the decision on if a creditor relationship exists, insurers should look at the substance of the agreement, in addition to the legal form. A creditor relationship exists when a security has predetermined principal and interest payments (fixed or variable interest payments) that do not vary based on performance of underlying collateral or non-debt variables. Further, securities that represent an ownership interest or that possess equity-like characteristics, are not, in substance, bonds.

Issuer credit obligations 

Bonds that are issuer credit obligations are covered in SSAP No 26R, Bonds. Issuer credit obligations under the new guidance are defined as: 

“A bond, for which the primary source of repayment is the general creditworthiness of an operating entity or entities.” 

Operating entities include business entities, nonprofit organizations, governmental units, and other providers of goods or services.

Asset-backed securities

Bonds that are asset-backed securities are covered in SSAP No. 43R, Asset-Backed Securities. Asset-backed securities under the new guidance are defined as: 

“A bond issued by an entity (an “ABS Issuer”) created for the primary purpose of raising debt capital backed by financial assets or cash generating non-financial assets owned by the ABS Issuer, for which the primary source of repayment is derived from the cash flows associated with the underlying defined collateral rather than the cash flows of an operating entity.” 

For a bond to be considered an asset-backed security, a meaningful level of cash flows must be produced by the underlying financial or cash generating non-financial assets other than through the sale or refinancing of the underlying assets held by the ABS Issuer. As a practical expedient, the meaningful cash flow criteria is met if less than 50% of the original principal relies on sale or refinancing to generate cash flows.

What are the impacts?

Schedule D

Schedule D will be disaggregated into two parts:

  • Schedule D Part 1, Section 1: Long Term Bonds – Issuer Credit Obligations Owned, and 
  • Schedule D Part 1, Section 2: Asset Backed Securities Owned.  

The reporting categories of each part of Schedule D have been updated in conforming changes made by the Blanks Working Group (BWG) and additional columns of data may be required. Definitions for each reporting category will be included in the annual statement instructions.

Schedule BA

Insurance companies may determine that some securities reported as bonds no longer qualify for bond reporting under the principles-based definition. Securities that do not qualify for bond reporting will move to Schedule BA. Conforming changes to reporting categories on Schedule BA have also been made by the BWG.

Risk Based Capital (RBC) Calculation

No specific changes to the RBC calculation have been adopted as of the date of this publication. However the movement of securities between Schedule D and Schedule BA may have RBC impacts associated with them. In general, assets that were previously reported on Schedule D Part 1 that no longer qualify as bonds may incur a higher RBC charge on Schedule BA.

Start Preparing Now

Insurance companies will need to assess their bond portfolios to identify which securities are issuer credit obligations, asset-backed securities, or if they do not qualify as bonds and need to move to Schedule BA. Reasonable scoping may be applied to focus attention on the more complex securities. Transition guidance is included in the statutory revisions.

The PBBD Project is one of the most significant NAIC accounting changes in several years. A principles-based approach allows the bond guidance to stand as new investment structures are created, and places the responsibility on management to have internal controls in place to properly categorize investments held on the quarterly and annual statements to meet regulatory requirements. The guidance is effective January 1, 2025 and reporting will be required in the first Quarterly Statement of 2025.

Contact the Johnson Lambert team for the latest guidance related to the PBBD Project.

Lauren Darr

Lauren Darr

Partner

Mitchell Lipham

Mitchell Lipham

Senior Manager

Haley Louzader

Haley Louzader

Manager