Accounting Standard Updates

NAIC’s COVID-19 Impact Decisions: INT 20-01 – Reference Rate Reform

Hot Take:

Hot Take

The NAIC Statutory Accounting Principles Working Group (SAPWG) met on April 15 to discuss four important topics and decisions of the Coronavirus impact on insurers’ financial processing. One of the four items adopted, with minor modification, is Accounting Standards Update (ASU) 2020-04 – Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 was issued in March 2020 as transitional, elective guidance emanating from recent reference rate reform.

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Background

The global financial community was made aware during 2017 that the London Interbank Offering Rate (LIBOR) had come under regulatory scrutiny for various reasons. It soon became apparent a transition would be afoot to replace its long-standing position as a benchmark rate for a vast number of contractual calculations. JLK Rosenberger recently wrote about the LIBOR issue here.

During 2017, the responsible parties for regulating LIBOR publicized that after 2021 it would no longer require banks to submit LIBOR-based data, which in turn signaled the demise of this benchmark as a central source of reference. A supplemental note – though LIBOR currently represents the celebrated interbank offering rate, there are similar interbank offering rates (IBORS) that could be affected by reference rate reform. So, what is reference rate reform?  It characteristically relates to moving toward alternative reference rates that are more transaction-based and away from LIBOR and IBORs. There are numerous existing financial contracts and underlying transactions that reference LIBOR and IBORs, thus posing the challenge of selecting a reference rate that maintains the spirit of the original contract without creating a contract modification calling for setting up a new contract.

What’s the Rub?

The intent of ASU 2020-04 is to establish the premise that a “qualifying modification,” resulting specifically from rate reform, is not to be intended as a situation requiring reassessment of previous accounting methodology.  Since the reference rate issue is a global initiative, primarily a result of LIBOR transition, the Financial Accounting Standards Board (FASB) resolved the rate change is outside the control of reporting entities and the only reason for an entity to make the contract change. Accordingly, the FASB decision centered on not concentrating on traditional financial reporting requirements that would call for having to discontinue an existing contract and treat it as a new contract. The FASB guidance provides an approach to continue financial reporting in a fashion that retains the intended continuation of contracts during the global rate transition, therefore not requiring a contract remeasurement or hedge dedesignation when the general criteria are met. This promulgation is considered an “optional expedient and exceptions guidance.”  The exceptions are only effective from March 12, 2020, through December 31, 2022, with the reason being that the promulgation provides accounting requirement relief during the global transition period while the market adjusts and aligns into an established routine. FASB has noted it will monitor the process and adjust the dates if deemed necessary.

SAPWG Adoption

SAPWG posed four accounting matters to consider in its assessment of the rate reference FASB promulgation.  They are clearly laid out in INT 20-01.  Those four items concentrated on:

(a) acceptance of the ASU concept in general,

(b) debt and other service agreements,

(c) lease transactions, and

(d) derivative transactions.


SAPWG adopted ASU 2020-14 in every aspect other than areas where SAP has previously rejected GAAP or where statutory accounting is not applicable (e.g. the option to sell debt currently classified as held-to-maturity as it is not applicable to statutory accounting).

Other SAPWG Conference Call Decisions:

Three additional INT promulgations were adopted during the April 15 conference call. You can click below to read more about each issue.