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CECL could become part of statutory accounting for US insurers

Editor's note: This is the second of two articles looking at the impact of the new CECL standard on U.S. insurers. To read the first article, please click here.

The National Association of Insurance Commissioners must decide whether to change its accounting rules or face the possibility of being less stringent than its regulatory counterparts.

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As of now, the new current expected credit loss model, which goes into effect for SEC filers beginning in 2020, will only be applied to insurers' statements under Generally Accepted Accounting Principles. That provision, dubbed CECL, will significantly change the way institutions reserve for credit losses, by requiring them to estimate lifetime losses on a number of assets at origination.

The NAIC requires insurance companies to file a separate set of statements under its Statutory Accounting Principles, or stat, which does not yet include an expected credit loss standard. However, the NAIC strives to create a conservative accounting framework, including examining how GAAP standards compare to stat. As such, it has been considering adopting some form of expected credit loss criteria for quite some time.

Although it has been difficult to parse out exactly how CECL will affect insurance companies, it will be a drastic shift from the incurred loss model currently in use, which limits companies from reserving for loan losses until they are probable.

'Wait and see what FASB does'

There has been no proposal as yet to incorporate expected credit loss into statutory accounting, said Julie Gann, a senior manager with the NAIC who works closely with the Statutory Accounting Principles Working Group.

However, she added: "If we don't go toward something for expected credit losses, we would be the only standard setter still on the incurred loss model. We have conservatism in our statement of concept, so that would clearly not be more conservative than U.S. GAAP."

The NAIC has thus far released a preliminary discussion draft outlining key issues relating to CECL and statutory accounting, as well as NAIC staff recommendations.

The implementation of CECL is due to begin Jan. 1, 2020, although there are various efforts underway to delay and/or water down the measures, including bills introduced in both houses of Congress. The Financial Accounting Standards Board, which sets the reporting standards for companies following GAAP, has said it intends to press ahead on the current schedule.

"We're kind of on a wait and see what FASB does," Gann said. "So far we've just done discussion papers, different concepts that could be considered. There has been no traction to proposed revisions as well as no particular set of, 'this is how we're going to move forward,' at this point in time."

However, Jonathan Glowacki, a principal and consulting actuary for Milliman, said the implementation of some form of expected credit loss standard within statutory accounting is likely.

"It's just a matter of timing," he said.

Insurers largely opposed

Comment letters on the NAIC's discussion draft show that insurance companies are opposing several of the recommendations set out by staff on how to adopt an expected credit loss model.

Notably, they point out that CECL applies to assets held at amortized cost under GAAP, which means that bonds held as available for sale, a major chunk of insurers' investment portfolios, are not heavily impacted by the new rules. Under stat, however, virtually all bond investments are held at amortized cost, which means that directly transposing CECL would result in inconsistencies relative to GAAP.

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Life insurers, in particular, have also been increasing their investments in mortgages over the past several years and passed the half-trillion dollar mark under statutory accounting for the first time as of year-end 2018. Under CECL, insurers would need to estimate lifetime losses on mortgage assets, likely requiring them to set aside more reserves.

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Insurers also argue against the adoption of some form of expected loss metric based on the existence of risk-based capital, which already takes the credit risk of the portfolio into consideration when setting capital requirements.

From an operational point of view, the comments noted that not every insurance company is required to prepare GAAP financial statements, meaning additional processes would have to be put in place so insurers that hold commercial mortgage loans could calculate an allowance for expected losses. Smaller companies might not have the resources to do this.

Industry members also pointed out that a "pooled approach" to determining expected losses could result in allowances being recorded for a broad scope of investments, most of which may never experience a credit loss. They argued that the current method of evaluating each investment individually is, in fact, more conservative than such an expected loss approach.

There were also several comments that spoke out against CECL as having a negative impact on reinsurance recoverables. In one letter, Allstate Corp. argued that using the CECL model would incorporate an "unreliable estimate" of credit risk.

"Reinsurance is sufficiently different from lending activities, the activity for which CECL was designed, and should not be applied to reinsurance receivables," the company wrote.

Timing

Whereas CECL has a fixed implementation date, the NAIC is able to operate on its own time schedule and is expected to resume conversation around expected credit loss standards during its summer national meeting in August.

However, Gann said she would not necessarily agree with a suggestion that the NAIC might wait until after the GAAP deadline to make a formal proposal or decision.

"I don't know if we would wait that long," Gann said. "We definitely don't want to have a huge time delay from when we pick it up from when it becomes effective for FASB because that I think could be even more problematic, but again we're still in such limbo right now that we're not exactly sure where it's going to land."