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IASA 86TH ANNUAL EDUCATIONAL CONFERENCE & BUSINESS SHOW
Financial Instruments
Insurance Accounting, Risk Management and Finance
Session 705
Learning Objectives
Review current FASB proposals on Financial Instruments
• Classification & Measurement
• Impairments
Highlight recent changes/updates from FASB & IASB
Highlight specific changes that will need to be made in
reporting/accounting processes
Compare and contrast proposed guidance with the current
Statutory & International guidance
Panel Members
Don Dilmore
Vice President – Investment
Accounting
BLACKROCK
8+ years insurance accounting
experience
Works with clients on regulatory
& financial statement filings
Member - Pennsylvania
Institute of Certified Public
Accountants
Maria Bifulco
Director – Project
Management
Prudential
25+ years insurance accounting
experience
Lead Business Analyst/Project
Manager for Investment
Related Systems, Reporting,
and Workflow projects
LOMA Investment Accounting
Working Group member
Michael Herling
Vice President – Consulting
Services
Princeton Financial Services
30+ years insurance accounting
experience
23 years at PFS
Consults with clients on best
practices, accounting issues,
optimizing workflow
Classification and Measurement Project
Part of FASB and IASB’s joint Financial Instruments project
• Original proposal would’ve moved US GAAP closer to IASB, but
recent revisions have moved them further apart
Similar classifications would remain, but would be renamed
to be more consistent with IFRS
• “Fair Value through Net Income” instead of “Trading”
• “Fair Value through OCI” instead of “Available for Sale”
• “Amortized Cost” replaces “Held to Maturity”
FV-OCI would remain the ‘residual’ category
• Amortized Cost and FV-NI will be defined, while FV-OCI is not
• Original proposal would have FV-NI as the residual
FASB Timeline
Q3 2009: IASB issues
Exposure Draft
Q4 2009: IASB
issues IFRS 9
Q1 2013: FASB issues
new Exposure Draft
Q2 2010: FASB issues
Exposure Draft requiring
all instruments to be
reported at Fair Value
Q1 2011: FASB moves
away from full fair value
to mixed measurement
Q4 2011: IASB delays
IFRS 9 effective date,
considers amendments
Q1 2012: FASB and IASB
begin joint discussions
Q2 2012: FASB and IASB
agree on three-category
approach for debt investments
Q4 2012: IASB exposes
amendments to IFRS 9
Q1 2014: FASB abandons
Converged Business Model
Assessment / FASB removes
Cash Flow Characteristics Test
Q4 2013: FASB
abandons SPPI Test
Late 2014: FASB expected
to issue final ASU
2015 – 2017: Expected
Implementation for
FASB updates
Q3 2013: FASB & IASB plan
redeliberations. IASB
indefinitely defers mandatory
effective date of IFRS 9
FASB Process
Q2 2010: FASB issues
Exposure Draft requiring
all instruments to be
reported at Fair Value
Q1 2011: FASB moves
away from full fair value
to mixed measurement Q2 2012: FASB and
IASB agree on three-
category approach for
debt investments
Q1 2013: FASB issues
new Exposure Draft
Q4 2013: FASB
abandons SPPI Test Q1 2014: FASB abandons
Converged Business Model
Assessment / FASB removes
Cash Flow Characteristics Test
Late 2014: FASB expected
to issue final ASU
And…we’re essentially
right back where we
started.
Start: FAS 115
Trading, AFS, HTM
Proposed GAAP – Debt Securities
After numerous debates, FASB has abandoned the two
primary principles proposed for debt securities
• Solely Payments of Principal and Interest (SPPI) Test/Cash Flow
Characteristics Test
• Business Model Assessment
IFRS and US GAAP are once again significantly different
FASB felt that the SPPI test would be trading known
complexity for unknown complexity
• i.e., Bifurcation guidance in ASC 815-15 vs. SPPI
Essentially, debt securities are right back where they started
• FASB may refine tainting guidance in ASC 320 for HTM securities
Proposed GAAP – Equity Securities
FASB reaffirmed their proposal to require equity securities
to be measured at FV-NI
• Change from current GAAP
Equities would not have an option for FV-OCI
• Differs from proposed IFRS, where a one-time irrevocable election to
report equities at FV-OCI exists
Exception would exist for
• Certain securities reported under the equity method
• Certain securities that qualify for the practicability exception
• i.e., no readily determinable fair value
Current GAAP Measurement
Neither intend to
sell in near term, nor
have intent/ability to
hold until maturity
Intend and are able
to hold security until
maturity
Debt Security
Held to Maturity
Carry at
Amortized Cost
Available for Sale
Carry at Fair
Value; FV
changes through
OCI
Trading
Carry at Fair
Value; FV
changes through
Net Income
Intend to sell
security in near term
Investment Type
Equity Security
Hybrid Security with
Embedded Feature
(i.e., Bifurcation)
Non-Hybrid
Carry at:
Fair Value; FV
changes through
Net Income
Embedded Feature Debt Piece
Proposed GAAP Measurement
Neither intend to
sell in near term, nor
have intent/ability to
hold until maturity
Intend and are able
to hold security until
maturity
Debt Security
Amortized Cost
Carry at
Amortized Cost
Fair Value - OCI
Carry at Fair
Value; FV
changes through
OCI
Fair Value - NI
Carry at Fair
Value; FV
changes through
Net Income
Intend to sell
security in near term
Investment Type
Equity Security
Hybrid Security with
Embedded Feature
(i.e., Bifurcation)
Non-Hybrid
Embedded Feature Debt Piece
Carry at:
Fair Value; FV
changes through
Net Income
Current STAT – Debt and Equity
While intent is the principal classification driver in GAAP,
STAT is primarily based on certain risk characteristics of
the security
• Type of asset
• NAIC Designation
• Insurance Company type
Intended use of the security is irrelevant in STAT
Measurement is determined cusip-by-cusip
• May create inconsistencies in carrying value with similar assets
In general, more debt securities are reported at Amortized
Cost than Fair Value
• STAT also does not have an equivalent concept of Fair Value – NI
GAAP / STAT Differences
TOPIC PROPOSED FASB MODEL CURRENT STAT MODEL
Categories of
Classification
• Trading (FV – NI)
• Available for Sale (FV – OCI)
• Held to Maturity (Amort. Cost)
• Based on security type and
other risk characteristics
Classification
Decision
• Solely based on business
model/intent
• (Save equities in HTM)
• Type of asset
• NAIC Designation
• Insurance Company type
Debt Securities • All three categories allowed
• Reported at B/ACV
• Other options not allowed
• No equivalent idea of FV-NI
Equities • Only Fair value – Net Income
• Fair value – OCI eliminated
• Fair value – with changes
through Capital & Surplus
• No equivalent idea of FV-NI
Proposed IFRS – Debt Securities
IFRS would require two tests to determine how debt
securities are reported
• Solely Payments of Principal and Interest (SPPI) Test/Cash Flow
Characteristics Test
• Business Model Assessment
Same three classifications would exist in IFRS
• However, determination of where a security would be placed differs
Option to report at Fair Value through Profit and Loss (FV-PL)
• One-time irrevocable election
• Must be made at acquisition
• Only allowed when doing so eliminates or significantly reduces an
accounting mismatch
Proposed IFRS – Equity Securities
IFRS 9 requires equity securities to be measured at Fair
Value through Profit and Loss (FV-PL)
• Matches current proposed GAAP
However, equities would have an option for FV-OCI under
IFRS
• One-time irrevocable election
• Must be made at acquisition
• Requires all unrealized and realized gains and losses to flow through
Other Comprehensive Income
• Never recycled into Realized Gain/Loss
Proposed IFRS Measurement
Source: E&Y IFRS Developments
Cash Flow
Characteristics Test
Hold to both collect
contractual cash flows
and to sell
Hold to Collect
Contractual Cash
Flows
Fair Value OCI
Option Elected
Debt Security
Amortized
Cost Fair Value
through OCI
Fair Value
through Profit
and Loss
Sell immediately or in
the near term
Business Model Test
Equity Security
Fair Value through OCI
Unrealized and Realized
Gains/Losses never
recycled to Income
Investment Type
Cash Flows represent
Solely Payments of
Principal and Interest
Cash Flow
Characteristics Test
Cash Flows represent
Solely Payments of
Principal and Interest
GAAP / IFRS Differences
TOPIC PROPOSED FASB MODEL PROPOSED IASB MODEL
Categories of
Classification
• Trading (FV – NI)
• Available for Sale (FV – OCI)
• Held to Maturity (Amort. Cost)
• Fair value through Profit/Loss
• Fair value through OCI
• Amortized cost
Classification
Decision
• Solely based on business
model/intent
• (Save equities in HTM)
• Business model/intent
• Cash flow characteristics
(SPPI)
Debt Securities • All three categories allowed • All three categories allowed
Equities • Only Fair value – Net Income
• Fair value – OCI eliminated • Fair value – Net Income
Fair Value OCI
Option: Equities • Not allowed
• Allowed if elected at purchase
• Irrevocable
• Cannot recycle Unrealized G/L
into Realized when sold
Impairment Project Background
Joint project with the FASB and IASB
FASB Accounting Standard Update, Financial
Instruments—Credit Losses (Subtopic 825-15)
IASB Exposure Draft ED/2013/3 Financial Instruments:
Expected Credit Losses
Q4 2012: FASB issues
revised Exposure Draft
Q4 2009: IASB issues
Exposure Draft
Q2 2010: FASB issues
Exposure Draft
Q1 2011: FASB & IASB
issue supplementary
document
Q4 2014: Final GAAP
Standard expected to
be issued
Q2 2014: Final IFRS
Standard expected
to be issued
Q1 2018: Anticipated
Effective Date for IFRS
guidance
Q1 2013: IASB issues revised
Exposure Draft
GAAP guidance Effective
Date To Be Determined…
Overview – FASB Credit Losses Exposure Draft
Current Expected Credit Loss (CECL) Model
Generally applies to instruments that are measured at
amortized cost
• Removes the probability threshold for recognizing credit losses
• Credit losses include estimates of future events
• An allowance account (contra asset) is established to track losses
For Fair Value through OCI, expected credit losses is
determined
• When an asset’s fair value is less than its amortized cost
• Credit losses would be recognized in net income under the CECL
model
Comparison Current GAAP to Proposed Model
TOPIC CURRENT FASB MODEL PROPOSED FASB MODEL
Timing of
Recognition
• Loss is probable/likely to have
occurred • Estimated Losses recorded Day 1
Measurement
Calculation
• Incurred Loss Model
Current conditions & experience
• Expected Loss Model
• Includes multiple forecast of future
events
Recognition • Adjust Cost Basis • Record an Allowance
Overview - IASB Exposure Draft on Credit Losses
Expected credit losses
• 12 month expected credit losses for good assets
• Lifetime expected credit loss when there is significant deterioration
Calculation
• Not a best or worst case scenario
• Probability that a loss will occur and a probability a loss will not occur
Assessment
• Includes estimates about future events
• No loss calculations for investment grade securities
Exposure Drafts on Credit Losses
Comparison of FASB and IASB Models
• Notion of good versus bad assets
• Length of time when estimating into the future
Suggestions to Help Monitor Progress
Collect Information:
Check with your external auditors
• Can they give you regular updates or sign up to get regular updates from
their website?
Check with your accounting system vendor
Listen to or read the minutes from FASB discussions
Work with industry groups to see what information they may have
• LOMA, ACLI, etc.
Discuss with peer insurance companies
When exposure drafts are released, try to send a comment letter and
read other company comment letters
Suggestions to Help Monitor Progress
Use the Information:
In 2013, Balance sheet compare current GAAP classification to
proposed GAAP classification
In 2014, adjusted the compare as receive new information
Quarterly Accounting update meetings internally
• Help make sure we have consistency between pronouncements
• Insurance Contracts
For impairments, taking a look at our asset manager models
Implementation Preparation
Develop an outline for implementation:
Identify where processes and systems will need to change
If you need to follow STAT, GAAP and IFRS, can your company handle
multiple accounting bases?
What resources would you need?
Additional Information
FASB Financial Instruments Projects
• Classification and Measurement • http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=1176159267718
• Impairment • http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=1176159268094
IASB
• Classification and Measurement • http://www.ifrs.org/current-projects/iasb-projects/financial-instruments-a-replacement-of-ias-39-
financial-instruments-recognitio/phase-i-classification-and-measurement/Pages/Phase-I-
Classification-and-measurement.aspx
• Amortized Cost and Impairment of Financial Assets • http://www.ifrs.org/current-projects/iasb-projects/financial-instruments-a-replacement-of-ias-39-
financial-instruments-recognitio/impairment/Pages/Financial-Instruments-Impairment-of-Financial-
Assets.aspx
Questions?
Maria Bifulco
Director | Prudential
Project Management – Investment Operations
[email protected] | 973.802.6720
Don Dilmore
Vice President | BLACKROCK
Investment Accounting Group
[email protected] | 302.797.2498
Mike Herling
Vice President | Princeton Financial Systems
Consulting Services
[email protected] | 609.514.4631
IASA 86TH ANNUAL EDUCATIONAL CONFERENCE & BUSINESS SHOW
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