CECL Tactical Implementation Updates - SIFM...CECL requires an entity’s allowance for credit losses to reflect the risk of loss, even when that risk is remote. This is required whether

CECL Tactical Implementation Updates The Society of Insurance Financial Management Annual Conference

September 16, 2019 | Borgata Hotel Atlantic City

2 © 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. NDPPS 895437

Agenda

Smaller reporting companies*

Public business entities

January 1, 2021

Loans receivable considerations 01

AFS securities filtering 02

Smaller reporting companies*

Public business entities

January 1, 2021

Reinsurance trends 03

2019 CECL updates and insurance survey 04


With you today

Scott Bain Director, Accounting Advisory

Tel: 770-687-3108 Cell: 404-222-1808

[email protected] Dave Anderson

Director, Risk Analytics Tel: 919-664-7224 Cell: 309-337-8211 [email protected]

CECL: Loans Receivable Considerations


Commercial mortgage loans hot topics

With four months remaining until CECL goes live, most insurers have solidified their expected credit loss processes for CMLs. We will focus on some of the challenges and solutions many of our client have faced working through implementation.

—  Strict underwriting standards leads to minimal historical loss experience

—  Data sourcing: Internal / External / Hybrid

—  Data adjustments —  Lookback period time

horizon

—  Anticipated prepayments over entire contractual life of asset based on historical experience at a pool level

—  Requirement to reserve for unfunded commitments

—  Disaggregation by asset classification

—  Loan risk rating process is new to many insurers

—  Pooling assets with similar risk characteristics

Disaggregation Considerations and Pooling of Assets

Data Challenges Prepayments and Unfunded Commitments

—  Internal vs external forecasting

—  Appropriateness of the time horizon

—  Common reversion approaches

Reasonable and Supportable Forecasting

CECL: AFS securities filtering


AFS securities – Impairment identification process

No

Does the entity intend to sell the security, or more likely than not

will be required to sell the security before recovery of the

amortized cost basis?

Yes

Write-off previously recognized allowance for credit losses, if

any, and write down the security’s amortized cost basis to

its fair value through earnings

Yes

Is the decline in fair value below the amortized cost basis a result

of credit losses?

Record through other comprehensive income (OCI),

net of applicable taxes

No

No

Record the credit related impairment through an allowance

for credit losses limited to the amount that fair value is less

than the amortized cost basis.

Yes

Is the fair value of the debt security less than its amortized

cost basis?

The debt security is not impaired. No allowance is recognized.


There are numerous factors to be considered in determining whether a credit loss exists. The length of time a security has been in an unrealized loss position should not be a factor, by itself or in combination with others, that an entity would use to conclude that a credit loss does not exist. The following factors were included as examples in the standard (ASC 326-30-55-1):

AFS securities – Filtering

Extent FV is less than amortized

cost

Adverse conditions related

to the security, industry, or

geographic area

Payment structure of the security

Delinquency of principal or interest

payments Security ratings

changes


The following is an example of various types of filtering being considered by companies to supplement existing filtering options, which will be revised to remove the length of time criteria among others eliminated by the new standard.

AFS securities – Filtering, continued

Filter Filter Type GOVT CORP CMO AGY

Undiscounted Projected Cash Flows Test Quantitative

Ratings Migration Test Qualitative Market Value/Book Value Test Quantitative

Implied Yield vs Benchmark Yield Test Quantitative

Issuer Level Analysis Qualitative ! ! ! !

!

! !

! ! ! !! ! ! !

CECL: Reinsurance trends


Reinsurance recoverables – Common questions

How do we evaluate paid claim recoverables versus reserve based recoverables? 1 Is an entity required to estimate expected credit losses on reinsurance recoverables? 2 Could the expected credit loss on reinsurance recoverables be zero? 3 What factors should an entity consider when determining whether reinsurance recoverables have similar risk characteristics and should be evaluated collectively? 4 What is the emerging practice for measuring an allowance on reinsurance? 5 How does collateral and credit enhancement impact my estimate of expected credit losses? 6


Reinsurance recoverables – Emerging practice

Many insurers are pooling assets by counterparty exposure. —  Further segregation is

needed by length of exposure.

—  Some consideration may be given to type of exposure.

Pool Assets PD/LGD Approach Apply LGD Collateral

The emerging trend is use of a PD first approach. —  Use of an internal risk

rating and resulting PDs. —  Comparison to externally

available PDs from a third party

—  Calibrating the internal ratings to external ratings/PDs

A “worst case” scenario is emerging as a first step. —  Insurers are applying a

100% LGD factor to the calculation to understand the highest possible loss.

—  Further refining of LGD for portfolio specific factors necessary for the “best estimate” of losses

Depending on the results of worst case, record loss or refine. —  Some insurers are

presenting the worst case as immaterial and considering options to record/not record.

—  Application of collateral or credit enhancements may impact estimate of credit losses


Reinsurance recoverables – Emerging practice, continued

—  Internal or external (third-party) credit score or credit ratings

—  Risk ratings or classification —  Collateral type —  Size —  Term —  Geographical location —  Vintage —  Historical or expected credit loss patterns —  Reasonable and supportable forecast periods

Pooling Considerations

—  Collateral –  Top off provisions/maintenance –  Real estate assets

—  Funds withheld —  Assets in trust account —  Letters of credit

Credit Mitigation

2019 CECL Updates and Insurance Survey


CECL requires an entity’s allowance for credit losses to reflect the risk of loss, even when that risk is remote. This is required whether the entity is estimating the allowance for a group of assets or an individual asset. Therefore, even if it is remote that an entity will incur a loss on a financial asset carried at amortized cost, it is required to estimate and recognize an allowance for credit losses. There are at least two types of financial assets for which an entity might determine that the zero loss expectation exception applies.

No allowance?

Securities issued or

guaranteed by a government entity

Financial assets

secured by collateral provided by the

borrower


Accrued interest Transfers between classifications or

categories for loans and debt securities

Recoveries

Projections of interest rate

environments for variable rate

financial instruments

Considerations of prepayments in

determining effective interest

rate

Considerations of estimated cost to

sell

Vintage disclosures – line-of-credit arrangements

converted to term loans

Contractual extensions and

renewals

CECL recent updates – ASU 2019-04


CECL recent updates – ASU 2019-05

Fair value option

On adoption of the credit losses standard (ASU 2016-13), an entity may elect the fair value option for financial instruments within the scope of Subtopic 326-20, that are also eligible under Subtopic 825-10

Election is irrevocable

Election is made on an instrument-by-instrument basis

Election does not apply to held-to-maturity debt securities

The difference between the instrument’s fair value and carrying value is recognized as a cumulative-effect adjustment

1

2

3

4


Auditor initial areas of focus

Completeness, accuracy, reliability and relevance of data that is purchased from third party vendors and/or data that was not subject to controls in the past

Forecasts that are not based on consensus and are out of the “range” of consensus.

Methods that are not in accordance with ASC 326 such as using a weighted average life instead of contractual maturity.

Use of third party models whereby management and the auditor do not have insight into how the model works – black box situations.

Model validation controls and management documenting what the expectations are when performing model validation tests.

1

2

3

4

5

6 Management Overlays


The FASB tentatively decided to defer the effective dates of its CECL ASU for SEC filers that are smaller reporting companies, non-SEC filers and all other companies. A company’s determination about whether it is a smaller reporting company would be based on its most recent filing status prior to the date the proposed ASU becomes final.

ASC 326 – Proposed change in effective dates

Company type Current effective date for calendar year-end companies

Proposed effective date for calendar year-end companies

SEC filers that are not smaller reporting companies

January 1, 2020 January 1, 2020

SEC filers that are smaller reporting companies


Public business entities that are not SEC filers


All other companies, including not-for-profit companies and employee benefit plans


2019 CECL Insurance survey results

Selected Topics


B: [PERCENTAGE] A: [PERCENTAGE]

C: [PERCENTAGE]

ASU 2016-13 Insurance industry survey (continued)

Are you primarily a:

Only 5% of the respondents are primarily a Reinsurance Provider, as 95% of the respondents described themselves as a “P&C Insurer” or a “Life Insurer”.

Q2

# Respondents 22/22

A: P&C insurer

B: Life insurer

C: Reinsurance Provider



Do you plan to:

Most of the responses indicate that they will build a model(s) for purposes of calculating CECL on their investments in loans.

Q4

A: Build a model(s) for purposes of calculating CECL on your investments in loans

B: Utilize a simplified approach that does not use a formal model (likely via Excel)

C: Other

# Respondents 22/22

A: [PERCENTA

GE]

C: [PERCENTA

GE]

B: [PERCENTA

GE]

C

Additional comments:

—  Not sure yet —  A vendor model currently in use. —  Leverage external modeling solution —  Buy a model —  Model is from Vendor



Have you considered new filtering criteria related to impairment of AFS securities?

Majority of respondents have considered new filtering criteria related to impairment of AFS securities.

Q10

# Respondents 22/22

A: Yes

B: No

C: 0%

B: [PERCENTAGE] A:

[PERCENTAGE]

C: N/A

Additional comments: —  “We considered whether changes to our

filtering criteria were necessary. Ultimately, we did not believe significant changes were needed to the qualitative criteria or process used to identify whether a credit loss has occurred. Our process and documentation improvements will primarily be focused on the measurement and bifurcation of the credit loss when identified.”


Do you currently use OTTI gating criteria (unrealized loss position less than 12 months, historical volatility, etc.) that are largely eliminated by the requirements of 326-30?

Most responses indicate that they currently use OTTI gating criteria that are largely eliminated by requirements of 326-30.

Q14


# Respondents 22/22

A: Yes

B: No

C: Not sure/not applicable

B: [PERCENTAGE]

C: [PERCENTAGE] A: [PERCENTAGE]



Are you considering using different filtering criteria for different types of securities?

* Only survey participants who have considered quantitative filters for questions Q10a were asked to respond.

More than 50% of the respondents confirm that they are considering using different filtering criteria for different types of securities.

Q10b

# Respondents 12/12

A: Yes

B: No

C: 0%

C: NA B: [PERCENTAGE]

A: [PERCENTAGE]

This question was applicable only for 12 of the 22 survey participants



Related to AFS/HTM securities, what do you believe is the amount of securities (individual CUSIP level) above which it will be burdensome on your current process to analyze cash flows on a quarterly/annual (for private insurers) basis?

Q16

A: Over 50 B: Over 100 C: Over 250 D: Over 500 E: Our process/resources can handle any amount

of individual CUSIP cash flows analysis F: Not sure/not applicable

# Respondents 22/22

C: 0% D: 0% E: 0%

Around one-third respondents say “Over 50” to be burdensome amount of securities. Also, 54% of the respondents were not sure about this number.

F: [PERCENTAGE]

B: [PERCENTAGE]

A: [PERCENTAGE]



Will you use an outside vendor to automate the accounting and disclosure process under CECL?

More than two-third respondents indicate that they will not use an outside vendor to automate the accounting and disclosure process under CECL.

Q28

A: Yes

B: No

# Respondents 22/22

B: [PERCENTAGE]

A: [PERCENTAGE]

Questions?


Resources

https://frv.kpmg.us/reference-library/2017/credit-impairment.html

https://advisory.kpmg.us/articles/2019/new-afs-debt-securities-accounting-rules.html

Thank you

© 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. NDPPS 895437

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CECL Tactical Implementation Updates - SIFM...CECL requires an entity’s allowance for credit losses to reflect the risk of loss, even when that risk is remote. This is required whether