New year, new NAIC bond mandate
The National Association of Insurance Commissioners’ (NAIC’s) principles-based bond definition (“the Bond Project”) becomes effective on January 1, 2025.
The Bond Project is the NAIC’s multi-year project to modernize accounting and classification of investments and will have a significant impact on the investment portfolios of many insurers. Insurers must navigate the complexities of the updated bond definition and ensure compliance with the new requirements. In a nutshell, all existing and new investments will need to be evaluated to determine if they fall within NAIC’s definition. ?
NAIC’s principles-based definition
The definition separates bonds into two categories: issuer credit obligations and asset-backed securities. Issuer credit obligations are reported on Schedule D Part 1 Section 1 and fall under the scope of SSAP #26 – “Bonds.” Asset-backed securities are reported on Schedule D Part 1 Section 2 and fall under the scope of SSAP #43 – “Asset-Backed Securities.”
Complying with the classification and reporting requirements of the new bond definition will require a significant amount of time and effort, as well as careful analysis of each investment to determine if it meets the new definition. The analysis will involve considering factors such as the creditworthiness of the issuer, the presence of equity-like characteristics, and the level of credit enhancement. ?
Any new processes developed to comply with NAIC’s principled-based definition should also address specific types of investments, such as feeder funds and hybrid securities. The analysis for these investments should consider the presence of meaningful cash flows and substantive credit enhancement. Guidance on hybrid securities is still being developed by NAIC.
Implementation - keys to success
We’re now in the fourth quarter with the NAIC’s principles-based definition effective on January 1, 2025. If you’re in the final stages of updating compliance processes to meet the new standard, congratulations. For every other insurer just starting their analysis - or for those insurers somewhere along the project timeline - here are three keys to success for implementation.
Engage stakeholders
Engage with investment analysts and traders, investment advisors, software vendors, the capital management team, auditors, and legal teams. Implementing the new bond definition will require coordination and collaboration across various departments within an insurance company. Bringing these key players together is a strategic and essential step.
Stay informed
Stakeholder engagement on emerging issues, including NAIC's exposed "Bond Definition Q&A" and related topics like the level of aggregation for disclosing securities in the audited financial statements, is crucial due to the ambiguity of this principles-based regulatory change. The shift from a rules-based to a principles-based framework requires insurers and industry participants to interpret new guidelines without the extensive prescriptive details they are accustomed to. This change necessitates a collaborative approach to navigate areas of uncertainty and achieve a common understanding.
Industry discussions and consensus-building efforts play a critical role in this context. These forums allow for the identification of common challenges and the development of best practices, helping to align interpretations and applications of the new principles. Moreover, these engagement activities provide a platform for stakeholders to voice concerns and suggest improvements to the evolving regulatory framework. This iterative feedback loop is essential in refining the guidelines to ensure they are practical and effective. By fostering an environment of open communication and collaboration, the industry can work together to elucidate complex issues, ultimately leading to enhanced clarity and more robust guidance on the principles-based regulatory changes.
Beware of overreliance
Ensure that you actively communicate with your software solution providers to gain valuable insights from their expertise. While technology can be useful for the initial sorting or stratification of securities, it's crucial not to over-rely on software solutions that promise to automate the entire compliance process. Doing so poses a significant compliance risk.
The shift from a rules-based to a principles-based classification places greater importance on substance over form. Insurers will need to apply judgment at critical points, potentially impacting risk-based capital (RBC) calculations. Reclassifying assets from Schedule D to Schedule BA may prompt insurers to reconsider their bond holdings and investment strategies to comply with new regulations. Essentially, accounting practices will likely drive future investment strategies.
KPMG. Make the Difference
Our approach tailors an industry-proven methodology with your current state of readiness across each business team to accelerate and drive efficiencies. KPMG is ready to help you assess the impact of the new bond definition on your investment strategies, policies, capital management, and financial reporting. Our goal—be the difference. ??
How KPMG helps insurers comply with NAIC’s principles-based definition
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Michael Lammons
Partner, KPMG Insurance Accounting Change Co-Lead
Email: [email protected]
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Pixi Sofian
Director, Accounting Advisory Services
Email: [email protected]
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William Chan
Managing Director, Accounting Advisory Services
Email: [email protected]
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Brandon Honnold
Director, Accounting Advisory Services
Email: [email protected]
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Finance Supervisor | Middle-Office Investment Operations Specialist | FINRA SIE
2 周Hi Michael Lammons, thanks for the article. I'm curious, how are insurance companies able to make assessments on ABS securities when info is limited, e.g. privates? Or on issuances when there are only a few investors in a tranche and the other holders have made a different assessment, do they defer to the lead in the tranche or the series for reporting? I imagine vendor info would be limited in these cases and it would be a judgement call by the company - are there industry-standard flow charts for determinations, or does each company create their own process for determining if it qualifies for bond classification and thus inclusion on Schedule D-2? (the creditor relationship requirement might be straightforward, but the cash flow and credit enhancements and equity-like features I think would be very subjective)