12 Days of SSAP: Repacks and Derivative Wrapper Instruments

During the 2024 NAIC Summer National Meeting, the Statutory Accounting Principles Working Group (SAPWG) exposed revisions to SSAP No. 86—Derivatives with a proposal to require bifurcation of debt securities with derivative wrappers or components if the item did not reflect a structured note.

The issue came up when the regulators got concerned with the accounting and reporting of debt securities issued by a Special Purpose Vehicle (SPV) that reflect a combined debt security and a derivative under the principles-based bond definition:

• If the reporting entity held a traditional debt security backed by the creditworthiness of the issuer, it would be reported as an Issuer Credit Obligation (ICO). If that reporting entity also held a derivative (perhaps a cross-currency swap) that impacted what was received under the debt security, the derivative would be reported under SSAP No. 86 and reported on Schedule DB. There would be no change to the reporting of the debt security as a result of the separate derivative instrument.
• However, If the reporting entity sells that debt security to an SPV and reacquires a debt security that reflects cashflows from the original debt issuance and a derivative component/wrapper, the resulting security no longer reflects an ICO. Rather, the revised debt security is an asset-backed security (ABS), where payment is driven from the cash flows generated from the underlying collateral, as impacted by the derivative. Unless other features were incorporated to create a substantive credit enhancement, this security would fail the ABS requirements and would be considered a non-bond debt security captured in SSAP No. 21- Other Admitted Assets and captured on Schedule BA.

With this in mind, the regulators proposed a new guidance requiring separate accounting and reporting of derivatives captured in debt security structures. This would be a significant change from existing guidance that explicitly precludes the separation of embedded derivatives.

The industry immediately expressed some concerns related to applying the proposed guidance. Since an insurance company is not the counterparty to the derivative embedded within the SPV, the industry believes it would be inappropriate to report the derivative on Schedule DB because of the following:

• The investor does not control or own the derivative directly, and reporting the derivative in Schedule DB would be inconsistent with state law. Also, the investor would not have the requisite information to complete Schedule DB (e.g., when they are rolled into a new derivative, terms of the derivative, etc.),
• The insurer may not have the information to apply the requisite hedge accounting requirements, including determining whether the derivative qualifies as hedging, income generation, or replication (synthetic asset) transactions, and
• Companies would potentially need a new category within their derivative use plans.

Additionally, the industry expressed concerns that bifurcating the derivative and the bond in such SPVs might create a restricted asset (bond) as the derivative has no margin requirement. This could result in showing a liability on the books inconsistent with statutory accounting and reporting and/or legal requirements.

Regulators have yet to make a decision on this one, so we will be watching it closely.

Deep Dive – Learn more about what’s brewing at SAPWG:

https://content.naic.org/committees/e/statutory-accounting-principles-wg