SSAP 43R: Accounting for Structured Securities

Statutory Accounting Principles (SAP) provide a specialized accounting framework for insurance companies in the United States. This framework prioritizes measuring an insurer’s ability to pay future claims, focusing on liquidation value rather than the going-concern basis found in Generally Accepted Accounting Principles (GAAP). Within this system, Statement of Statutory Accounting Principles (SSAP) No. 43R establishes the specific accounting and reporting rules for investments in asset-backed securities.

The primary purpose of SSAP No. 43R is to create a uniform method for insurance entities to account for these complex financial instruments. It ensures that the values reported in statutory financial statements are consistent and reflect the regulator’s emphasis on solvency and policyholder protection. The standard provides guidance for initial valuation, subsequent measurement, impairment assessment, and financial statement disclosure.

Scope and Applicability of the Standard

SSAP No. 43R applies to investments in asset-backed securities where the holder has a beneficial interest. An asset-backed security is an instrument that represents an ownership interest in a pool of underlying financial assets, such as loans, where cash flows from principal and interest payments are passed through to the security holder. Examples include residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS).

The standard covers securities that have been tranched, meaning their cash flows are distributed to different classes of investors sequentially rather than proportionally. This structure creates different risk and return profiles for each tranche. Collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs) are common examples of such securities that fall under this guidance.

A beneficial interest is the right to receive all or portions of the cash flows from the underlying assets of a trust or special purpose entity that issues the securities. An insurer holding such an interest is subject to the accounting and reporting rules of this standard.

The standard’s applicability is determined by a security’s structure, not just its issuer. For example, certain securitized products issued by Government-Sponsored Enterprises (GSEs), such as specific credit risk transfer securities, fall within the scope of SSAP No. 43R if they meet the definition of an asset-backed security.

Initial and Subsequent Measurement

Upon acquisition, securities falling under SSAP No. 43R are recorded at their initial cost, which includes the purchase price plus any directly related acquisition fees. This establishes the initial amortized cost basis of the investment and is recorded on the insurer’s balance sheet.

Following the initial purchase, investment income is recognized by adjusting the amortized cost basis through either accretion of a discount or amortization of a premium. If a security is purchased for less than its face value, the discount is added to the carrying value over time. Conversely, if purchased for more, the premium is subtracted.

This adjustment process utilizes the interest method to produce a constant effective yield over the investment’s expected life. This calculation relies on estimated future cash flows from the underlying assets, which insurers must project and periodically update.

The carrying value of the security on the balance sheet is its amortized cost, adjusted for cumulative accretion or amortization and any principal paydowns received. This measurement approach continues as long as the security is not deemed to have an other-than-temporary impairment.

Determining Other-Than-Temporary Impairment (OTTI)

The process for determining if an other-than-temporary impairment (OTTI) exists begins when the fair value of an asset-backed security falls below its current amortized cost basis. This unrealized loss position prompts an investigation to determine if the decline in value is temporary or requires a permanent write-down.

Once a security has an unrealized loss, the insurer must first assess its own intentions and capabilities. An OTTI must be recognized if the insurer has the intent to sell the security before its value recovers. An impairment is also triggered if the insurer does not have the ability to hold the security for a period sufficient to allow for the anticipated recovery of its amortized cost basis.

If the insurer determines it has both the intent and ability to hold the security, the analysis shifts to the underlying cash flows. The insurer must assess whether it is probable that it will be unable to collect all contractually required principal and interest payments. This is not about market price fluctuations but about the fundamental credit performance of the underlying assets.

This cash flow analysis involves evaluating numerous factors. Insurers must consider the performance of the underlying collateral, such as delinquency and foreclosure rates, changes in credit ratings, prepayment speeds, and any credit enhancements built into the security’s structure. If the present value of these expected cash flows is less than the amortized cost, an impairment exists.

Accounting for an OTTI

Once an insurer has determined that an OTTI exists, specific accounting procedures must be followed. The loss is measured as the difference between the security’s amortized cost basis and its fair value on the measurement date.

The mechanics of recording the impairment involve a direct write-down of the investment’s carrying value. The security’s amortized cost basis is reduced to its current fair value on the balance sheet, and a realized loss equal to the write-down is recognized on the insurer’s income statement.

Following the recognition of the OTTI, the new, lower fair value becomes the security’s new cost basis. This new basis is not subsequently changed for later recoveries in fair value. Going forward, investment income is recognized based on this new cost basis by accreting it up to the newly estimated future cash flows over the remaining life of the security.

Required Disclosures

SSAP No. 43R mandates a series of detailed disclosures in an insurer’s annual statutory financial statements to provide transparency about its holdings of asset-backed securities. These requirements ensure that regulators and other stakeholders can understand the nature and risk of these investments. The disclosures are both quantitative and qualitative, covering the following:

• The aggregate amortized cost and aggregate fair value of all securities under this standard, broken down by security type.
• Information about securities that are in an unrealized loss position, including the length of time they have been in such a position.
• The aggregate losses recognized in earnings during the period for securities where an OTTI has been recognized.
• The inputs and techniques used to determine the fair value of its securities.
• The process and key assumptions used in its cash flow analysis for determining whether an OTTI exists, including how factors like credit losses and prepayment speeds were incorporated.
• Enhanced disclosures for transactions involving related parties.