SSAP 26R: Bond Accounting and Reporting for Insurers
Examine the statutory accounting rules for insurer bond holdings under SSAP 26R, linking credit quality to balance sheet valuation for regulatory solvency.
The insurance industry operates under accounting rules known as Statutory Accounting Principles (SAP). The objective of SAP is to conservatively measure an insurer’s financial condition for regulators, ensuring the company can meet policyholder obligations. Bonds represent a substantial holding in many insurers’ investment portfolios, and their accounting is governed by regulations that support this focus on solvency.
Scope of Bond Accounting Rules
The National Association of Insurance Commissioners (NAIC) defines what constitutes a bond for statutory accounting. An investment is classified as a bond if it represents a creditor relationship where the holder receives contractual payments of principal and interest over a defined period. This includes U.S. government and agency securities, corporate bonds, and municipal bonds.
Certain securities are explicitly excluded from being accounted for as bonds. Traditional preferred stock is not treated as a bond because it represents an ownership interest, though an exception exists for preferred stock with mandatory redemption features. Mortgage loans are accounted for separately under different guidance, as are structured notes where the repayment of principal is at risk.
Updates effective January 1, 2025, have refined the accounting framework for bonds. Under the new guidance, an investment must first meet a broad definition of a bond within SSAP No. 26R. Once qualified, it is further classified as either an “issuer credit obligation” or an “asset-backed security.” Issuer credit obligations remain within the scope of SSAP No. 26R, while asset-backed securities are accounted for under a revised SSAP No. 43R, Asset-Backed Securities.
Valuation and Measurement of Bonds
The NAIC’s Securities Valuation Office (SVO) oversees the valuation of an insurer’s bond portfolio by assessing credit quality. The SVO assigns an NAIC Designation, a category indicating credit risk. Designations range from NAIC 1 for the highest quality investments to NAIC 6 for bonds in or near default.
The NAIC designation dictates how a bond is reported. Bonds designated NAIC 1 through NAIC 5 are carried at amortized cost, which is the initial purchase price adjusted over its life for any premium or discount. This method provides a stable valuation not subject to daily market fluctuations.
For bonds with the lowest credit quality, the treatment changes. A bond with an NAIC 6 designation must be reported at the lower of its amortized cost or current fair value. Fair value is the price an asset would sell for in an orderly transaction, ensuring a conservative valuation for high-risk securities.
Recognizing Investment Impairment
Insurers must monitor their bond portfolios for potential impairments. An Other-Than-Temporary Impairment (OTTI) occurs when an insurer will likely be unable to collect all principal and interest payments due on a bond. Identifying and recording an OTTI ensures losses are recognized in a timely manner.
The assessment for an OTTI is a two-step process. First, the insurer must assess whether it has the intent to sell the bond before its value recovers. It must also determine if it is more-likely-than-not that it will be required to sell the security before the recovery of its amortized cost basis.
If an OTTI has occurred, the insurer must recognize the associated loss. This means writing down the security’s carrying value to its current fair value and recording the amount as a realized loss on the income statement. This action permanently reduces the investment’s cost basis.
After an OTTI is recognized, the bond is accounted for as if purchased on the impairment date. The new, lower cost basis is used for future accounting, and subsequent increases in fair value are not recognized as gains. This prevents insurers from reversing impairment losses.
Required Financial Statement Disclosures
Insurers must provide extensive disclosures in their financial statements for transparency into their bond portfolios. A primary disclosure is the aggregate book-adjusted carrying value and fair value of bonds, broken down by NAIC designation category. This shows the portfolio’s credit quality distribution and compares recorded value to market value. Disclosures must also detail any gross unrealized gains and losses.
Insurers must also detail any non-income producing bonds, which can indicate credit problems. The notes must also include information about any Other-Than-Temporary Impairments recognized during the period, including the write-down amounts and the reasons for the impairment.