Guidance Note - Application of Changes in US GAAP Accounting to the Statutory Financial Statements of Financial Guaranty Companies (April 2010)

Summary

This is a 2010 BMA guidance note addressing how Bermuda statutory financial statements of financial guaranty companies should treat changes introduced by new US GAAP accounting standards (ASC 944, formerly FAS 163) for financial guaranty insurance contracts. It builds on the Authority's earlier Clarification of Guidance Note 4 (CGN4) and works through eight specific accounting issues, giving the Authority's preliminary conclusions on each.

• Premium treatment for derivative-format contracts: Any consideration received for financial guaranty exposures, whether written as insurance or in derivative format (e.g. credit default swaps), should be included in line 1 of Form 2 Gross Premiums Written.
• Installment premiums: New US GAAP guidance on recognising future installment premiums is viewed as an improvement and should generally be applied, though recognition for CDS contracts is permitted but not required given practical data limitations.
• Solvency margin impact: The Authority acknowledges the cumulative catch-up adjustment under ASC 944 could understate written premium used in solvency margin calculations, but considers this a lesser concern pending a planned overhaul of the capital framework for financial guaranty business.
• Deferred acquisition costs: Immediate write-off of deferred acquisition costs arising from recognising future installment premiums may be unduly harsh on statutory capital; companies may need to apply to the Authority for alternative treatment (e.g. contra-liability against unearned premium).
• Premium earning methodology: Companies should adopt the ASC 944 approach for calculating unearned premiums in statutory financial statements, as it better reflects economic substance.
• Loss and liability recognition: Existing CGN4 guidance on loss and loss expense provisions (line 17), including discounting at risk-free rates, remains appropriate and does not need amendment.
• Fair value liabilities: For statutory reporting, liabilities must not be reduced to reflect a company's own non-performance risk; non-insurance liabilities should be recorded at nominal values, not discounted for time value of money.
• Disclosures: Additional US GAAP disclosure requirements for financial guaranty contracts will be addressed separately as part of a broader review of the regulatory approach to the sector.

The note is explanatory guidance rather than a binding rule change with a compliance deadline; it signals the Authority's current thinking and flags that further guidance and a revised regulatory framework for the financial guaranty sector are expected in due course.

Key obligations

• Include consideration received for financial guaranty exposures, whether in insurance or derivative (e.g. CDS) format, within line 1 of Form 2 Gross Premiums Written
• Calculate loss and loss expense provision (line 17) for CDS contracts to make adequate provision for expected losses, in accordance with CGN4 methodology
• Adopt ASC 944 guidance for calculating unearned premiums (premium earning methodology) in statutory financial statements
• Do not reduce a liability's carrying value to reflect the company's own non-performance risk for statutory reporting purposes
• Record non-insurance liabilities at nominal values, unadjusted for the time value of money
• Apply to the Authority if seeking to treat deferred acquisition cost write-off as a contra liability against unearned premium or if ASC 944 adoption causes a significant, unwarranted reduction in statutory capital

Applies to

financial guaranty companies, insurers writing financial guaranty business, companies with CDS (credit default swap) exposures reinsuring financial guaranty risk