Download 2015-51 - National Association of Insurance Commissioners

Ref #2015-51
Statutory Accounting Principles Working Group
Maintenance Agenda Submission Form
Form A
Issue: Definition of Notional
Check (applicable entity):
P/C
Life
Health
Modification of existing SSAP
New Issue or SSAP
Description of Issue:
Questions have been received regarding the term “notional” for derivative contracts. Although questions have
been received regarding all derivatives, issues with the use of the term for futures has specifically been noted. In
researching these questions, the term “notional” was identified 15 times within SSAP No. 86—Derivatives (SSAP
No. 86), but no explicit definition is included. Although there are instances in which a definition may be implied,
these instances are noted as vague and inconsistent throughout the guidance. For example, in one disclosure,
reporting entities are requested to provide the “number of contracts or notional amount.” In another disclosure,
reporting entities are requested to provide the “notional or contract amounts”. The term “notional” is considered
significant in the reporting of derivatives as it is used in calculating other reported amounts (e.g., per SSAP No.
86, unrealized gains and losses, foreign currency premiums, etc.)
With regards to futures, although the term “notional” is a reported element in Schedule DB-Part B, it has been
communicated to staff that it is not a standard industry term for these types of contracts. In reviewing contract
specifications for these contracts, reference is given to the contract size and the number of contracts.
The term “notional” is defined in the blanks reporting instructions for Schedule DB – Part A (options, caps,
floors, collars, swaps and forwards), but there is no definition for Schedule DB – Part B (futures). The A/S blanks
definition seems to be in-line with the Commodity Futures Trading Commission (CFTC) definition. In reviewing
the FASB definition, it seems to be fairly generic, without providing clarity as to calculation.
As part of the research of this item, staff identified a survey completed in 2013 on the calculation of “notional
value” used in complying with regulatory requirements for over-the counter derivatives under the Dodd-Frank
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Although this survey focused on energy
companies and swap transactions, staff noted the following:
1. The term notional value is commonly used, but in practice there is not a single accepted definition.
2. There is uncertainty in the application of notional value.
3. There are different approaches used to calculate notional value.
As a result of the questions received regarding the term “notional” as well as the use of the notional amount in
calculating reported amounts for derivative contracts, this agenda item proposes to incorporate a definition in
SSAP No. 86, with subsequent revisions to clarify the guidance involving use of the term.
Existing Authoritative Literature:
FASB Definition:
Notional Amount: A number of currency units, shares, bushels, pounds, or other units specified in a
derivative instrument. Sometimes other names are used. For example, the notional amount is called a face
amount in some contracts.
CFTC Definition:
© 2016 National Association of Insurance Commissioners 1
Ref #2015-51
Notional Principal: In an interest rate swap, forward rate agreement, or other derivative instrument, the
amount or, in a currency swap, each of the amounts to which interest rates are applied in order to
calculate periodic payment obligations. Also called the notional amount, the contract amount, the
reference amount, and the currency amount.
Annual Statement Instructions:
Schedule DB – Part A – Sections 1 &2 (Options, Caps, Floors, Collars, Swaps and Forwards)
Notional / Contracts Definition
Notional Value:
The principal value upon which future payments are based in a derivative transaction as
at a specific period in time (the “as of” reporting date) in the reporting currency.
Converting the notional into reporting currency should be done in accordance with SSAP
No. 23, Foreign Currency Transactions and Translations.
Swaps, Forwards, Collars, Floors and Caps:
All use a “notional” amount to calculate future payments. If there is a notional schedule,
the reported notional would be that notional amount that is used to calculate the next
payment.
Options (Calls, Puts, Warrants):
All use notional amount [or number of contracts for exchange-traded instruments] to
calculate future payments. Both notional amount and number of contracts are reported.
Value of One (1) Point:
The monetary value of a one (1) point move in a futures position published by the exchange. May
also be referred to as “Lot Size,” “Lots” or “Points” by the exchange.
Interest rate and currency swaps (where receive/(pay) notional amounts are denominated in different
currencies), are filed under the “Foreign Exchange” swap subcategory.
Schedule DB – Part A – Section 1: (Owned on Dec. 31 of Current Year)
Column 9
– Notional Amount
Show the notional amount (i.e., the amount upon which the next cash payment is based).
Notional amounts are to be reported as an absolute (non-negative) value.
If the replication (synthetic asset) transactions are not denominated in U.S. dollar, convert it into
U.S. dollar equivalent in accordance with SSAP No. 23, Foreign Currency Transactions and
Translations.
Column 21 – Potential Exposure
Potential Exposure is a statistically derived measure of the potential increase in derivative
instrument risk exposure, for derivative instruments that generally do not have an initial cost paid
or consideration received, resulting from future fluctuations in the underlying interests upon which
derivative instruments are based.
For collars, swaps other than credit default swaps and forwards, the Potential Exposure = 0.5% x
“Notional Amount” x Square Root of (Remaining Years to Maturity).
© 2016 National Association of Insurance Commissioners 2
Ref #2015-51
For credit default swaps, enter the larger of notional amount or maximum potential payment.
For purchased credit default swaps bought for protection, the amount reported will be zero.
If the maximum potential exposure cannot be determined, enter zero and explain in the Notes to
Financial Statement.
Disclose in the footnotes to the annual statement any assets, held either as collateral or by third
parties that the reporting entity can obtain and liquidate to recover all or a portion of the amounts
paid under the derivative.
Schedule DB – Part A – Section 2: (Terminated During Current Year)
Column 11 – Notional Amount
Show the notional amount (e.g., the amount upon which the next cash payment is based).
Notional amounts are to be reported as an absolute (non-negative) value.
If the replication (synthetic asset) transaction is not denominated in U.S. dollar, convert it into
U.S. dollar equivalent in accordance with SSAP No. 23, Foreign Currency Transactions and
Translations.
Schedule DB – Part B – Section 1: (Futures Open Dec. 31 of Current Year)
Column 3
– Notional Amount
Show the total notional amount of the futures position on December 31 of the reporting year as
absolute (non-negative) value.
Schedule DB – Part B – Section 2: (Futures Terminated During Current Year)
Column 3
– Notional Amount
Show the total notional amount of the futures position terminated during the current year as
absolute (non-negative) value.
SSAP No. 86 – Derivatives (Only Paragraphs that Reference “Notional” are Included):
5.
Derivative instruments include, but are not limited to; options, warrants used in a hedging
transaction and not attached to another financial instrument, caps, floors, collars, swaps, forwards,
futures and any other agreements or instruments substantially similar thereto or any series or
combination thereof.
a. “Caps” are option contracts in which the cap writer (seller), in return for a premium, agrees
to limit, or cap, the cap holder’s (purchaser) risk associated with an increase in a reference
rate or index. For example, in an interest rate cap, if rates go above a specified interest rate
level (the strike price or the cap rate), the cap holder is entitled to receive cash payments
equal to the excess of the market rate over the strike price multiplied by the notional principal
amount. Because a cap is an option-based contract, the cap holder has the right but not the
obligation to exercise the option. If rates move down, the cap holder has lost only the
premium paid. A cap writer has virtually unlimited risk resulting from increases in interest
rates above the cap rate;
c. “Floors” are option contracts in which the floor writer (seller), in return for a premium,
agrees to limit the risk associated with a decline in a reference rate or index. For example, in
an interest rate floor, if rates fall below an agreed rate, the floor holder (purchaser) will
© 2016 National Association of Insurance Commissioners 3
Ref #2015-51
receive cash payments from the floor writer equal to the difference between the market rate
and an agreed rate multiplied by the notional principal amount;
36.
For all derivatives terminated, expired, or exercised during the year:
b.
A description, for each instrument, of the nature of the transaction, including:
iii.
54.
Number of contracts or notional amount;
Reporting entities shall disclose the following for all derivative contracts used:
b.
Disclosures by type of instrument outstanding, e.g., call options, floors, etc.:
1.
Notional or contract amounts;
SSAP No. 86 - Exhibit B - Assessing Hedge Effectiveness
5.
However, assessing hedge effectiveness can be more complex. For example, hedge
effectiveness would be reduced by the following circumstances, among others:
b.
Differences in critical terms of the hedging instrument and hedged item or hedged
transaction, such as differences in notional amounts, maturities, quantity, location, or
delivery dates.
Assuming Effectiveness in a Hedge with an Interest Rate Swap
7.
An entity may assume effectiveness in a hedging relationship of interest rate risk involving an
interest-bearing asset or liability and an interest rate swap (or a compound hedging instrument composed
of an interest rate swap and a mirror-image call or put option as discussed in paragraph 7.d.) if all of the
applicable conditions in the following list are met:
Conditions applicable to both fair value hedges and cash flow hedges
a.
The notional amount of the swap matches the principal amount of the interest-bearing
asset or liability being hedged.
Exhibit C – Specific Hedge Accounting Procedures For Derivatives
2.
Swaps, Collars, and Forwards (see also discussion in Introduction above):
b.
Statement Value:
iii.
Open foreign currency swap and forward contracts hedging foreign currency exposure on
items denominated in a foreign currency and translated into U.S. dollars where fair value
accounting is not being used:
(a)
The foreign exchange premium (discount) on the currency contract shall be
amortized into income over the life of the contract or hedge program. The foreign
exchange premium (discount) is defined as the foreign currency (notional)
amount to be received (paid) times the net of the forward rate minus the spot rate
at the time the contract was opened.
(c)
The unrealized gain/loss for the period equals the foreign currency (notional)
amount to be received (paid) times the net of the current spot rate minus the prior
period end spot rate;
(d)
The statement value of the derivative equals the amortized (premium) discount
plus the cumulative unrealized gain/(loss) on the contract. The cumulative
unrealized gain/(loss) equals the foreign currency (notional) amount to be
© 2016 National Association of Insurance Commissioners 4
Ref #2015-51
received (paid) times the net of the current spot rate minus the spot rate at the
time the contract was opened;
(g)
3.
If during the life of the currency contract it or a designated portion of the currency
contract is not effective as a hedge, valuation at amortized cost shall cease. To
the extent it ceased to be an effective hedge, a cumulative unrealized gain/loss
(surplus adjustment) will be recognized equal to the notional amount or
designated notional amount times the difference between the forward rate
available for the remaining maturity of the contract (i.e., the forward rate as of the
balance sheet date) and the forward rate at the time it ceased to be an effective
hedge.
Futures (see also discussion in Introduction above):
iii.
Open foreign currency futures contracts hedging foreign currency exposure on item(s)
denominated in a foreign currency and translated into U.S. dollars (where fair value
accounting is not being used):
(a)
The foreign exchange premium (discount) on the currency contract will be
amortized into net investment income over the life of the contract or hedge
program. The foreign exchange premium (discount) is defined as the foreign
currency (notional) amount to be received (paid) times the net of the forward rate
minus the spot rate at the time the contract was opened.
(b)
A foreign currency translation adjustment shall be reflected as an unrealized
gain/loss (unassigned funds (surplus) adjustment) using the same procedures as
is done to translate the hedged item. The cumulative unrealized gain/(loss) which
equals the foreign currency (notional) amount to be received (paid) times the net
of the current spot rate minus the spot rate at the time the contract was opened
shall be reported as recognized variation margin;
(f)
If during the life of the currency contract it or a designated portion of the currency
contract is not effective as a hedge, valuation at amortized cost ceases. To the
extent it ceases to be an effective hedge, an unrealized gain/loss will be
recognized equal to the notional amount or a designated portion of the notional
amount times the difference between the forward rate available for the remaining
maturity of the contract (i.e., the forward rate as of the balance sheet date) and
the forward rate at the time it ceased to be an effective hedge.
Activity to Date (issues previously addressed by SAPWG, Emerging Accounting Issues WG, SEC, FASB,
other State Departments of Insurance or other NAIC groups): None
Information or issues (included in Description of Issue) not previously contemplated by the SAPWG: None
Recommendation:
It is recommended that the Working Group move this item to the nonsubstantive active listing and expose a
proposed definition of “notional principal” based on the CFTC definition for inclusion in SSAP No. 86—
Derivatives. Staff believes further consideration will need to occur on the impact of the definition in SSAP
No. 86 and in the Annual Statement instructions, however, staff recommends that the initial exposure focus
on the definition, with subsequent consideration of changes after determining the appropriate definition.
(Staff specifically requests the involvement of those involved in derivative transactions to review the proposed
definition and communicate their suggestions to SSAP No. 86.)
© 2016 National Association of Insurance Commissioners 5
Ref #2015-51
13.
The term “notional principal/notional” shall apply to derivative transactions as follows:
a.
In an interest rate swap, forward rate agreement, or other non-future derivative
instrument, is the amount or, in a currency swap, each of the amounts to which interest
rates are applied in order to calculate periodic payment obligations. The term is also
referred to the contract amount, the reference amount, and the currency amount.
b.
For futures contracts, with a U.S. dollar-denominated contract size (e.g., Treasury note
and bond contracts, Eurodollar futures) or underlying, the notional amount is contract size
times the number of contracts.
c.
For equity index and similar futures, the number of contracts is multiplied by the dollarsper-point-value multiplied by the index points at reporting date. Non-US dollar contracts
must be multiplied or divided by the appropriate foreign currency rate.
Staff Review Completed by:
Julie Gann – October 2015
Status:
On November 19, 2015, the Statutory Accounting Principles (E) Working Group moved this item to the
nonsubstantive active listing and exposed nonsubstantive revisions to SSAP No. 86, as illustrated above, to
incorporate a definition of “notional principal.” In exposing the proposed definition, it was identified that
subsequent consideration would need to occur on the impact that the definition ultimately adopted has on the
existing guidance and Annual Statement Instructions, but it was requested that the focus first occur on
establishing an appropriate definition. Additionally, the involvement of those in derivative transactions was
specifically requested in reviewing the proposed definition, and in subsequent review of the impact to SSAP No.
86 and the reporting instructions.
On April 3, 2016, the Statutory Accounting Principles (E) Working Group exposed proposed revisions to define
“notional amount” as recommended by interested parties. The revisions shown below illustrate the differences
from the prior exposed definition.
13.
“Notional amount” is defined as the face value of a financial instrument in a derivatives
transaction as of a reporting date which is used to calculate future payments in the reporting currency.
Notional amount may also be referred to as notional value or notional principal amount. The notional
amount shall apply to derivative transactions as follows:
a.
In a non-futures derivative instrument, notional amount is either (1) the amount to which
interest rates are applied in order to calculate periodic payment obligations, (2) the
contractually stated notional amount or (3) the contract quantity amount multiplied by
applicable inception strike and currency rates. The term is also referred to the contract
amount, the reference amount, and the currency amount.
b.
For futures contracts, with a U.S. dollar-denominated contract size (e.g., Treasury note
and bond contracts, Eurodollar futures) or underlying, the notional amount is the number
of contracts at the reporting date multiplied by the contract size multiplied by the par
value of the underlying (typically 100).
c.
For equity index and similar futures, the number of contracts at the reporting date is
multiplied by the dollars-per-point-value multiplied by the transaction price. Non-US dollar
contract prices must be multiplied or divided by the appropriate inception foreign currency
rate.
On August 26, 2016, the Statutory Accounting Principles (E) Working Group exposed two approaches to define
“notional amount,” as shown below. As detailed, Option 1 is consistent with the prior exposure from April 3,
© 2016 National Association of Insurance Commissioners 6
Ref #2015-51
2016, with notional determined based on the type of contract. Option 2 is a new approach, with notional
determined based on the type of underlying item:
Option 1 – Calculate Notional Based on Type of Contract: This approach was previously exposed on Nov.
19, 2015 and April 3, 2016. All of the guidance is new text in SSAP No. 86, however, the tracked changes
show revisions from comments received after the Nov. 19 exposure and incorporated into the version exposed
on April 3. (There have been no proposed changes from the definition exposed on April 3, 2016.)
13.
“Notional amount” is defined as the face value of a financial instrument in a derivatives
transaction as of a reporting date which is used to calculate future payments in the reporting currency.
Notional amount may also be referred to as notional value or notional principal amount. The notional
amount shall apply to derivative transactions as follows:
a. In a non-futures derivative instrument, notional amount is either (1) the amount to which
interest rates are applied in order to calculate periodic payment obligations, (2) the
contractually stated notional amount or (3) the contract quantity amount multiplied by
applicable inception strike and currency rates. The term is also referred to the contract
amount, the reference amount, and the currency amount.
b.
For futures contracts, with a U.S. dollar-denominated contract size (e.g., Treasury note
and bond contracts, Eurodollar futures) or underlying, the notional amount is the number
of contracts at the reporting date multiplied by the contract size multiplied by the par
value of the underlying (typically 100).
c.
For equity index and similar futures, the number of contracts at the reporting date is
multiplied by the dollars-per-point-value multiplied by the transaction price. Non-US dollar
contract prices must be multiplied or divided by the appropriate inception foreign currency
rate.
Option 2 – Calculate Notional Based on Type of Underlying Item: This approach has been suggested in
lieu of the previous definition.
13.
“Notional amount” is defined as the face value of a financial instrument in a derivatives
transaction as of a reporting date which is used to calculate future payments in the reporting currency.
Notional amount may also be referred to as notional value or notional principal amount. The notional
amount shall apply to derivative transactions as follows:
a. For any derivative whose underlying item is a fixed income instrument, the notional is the par
value of the underlying. With this approach, there is no distinction between types of derivative
contracts (forwards, options, futures, etc.) and this approach would be applicable for the most
common insurance reporting entity’s derivative transactions (interest rate swaps, currency
swaps, credit default swaps, forward and futures contracts, etc.)
b. For any derivative whose underlying item is not a fixed income instrument, the notional is the
fair value of the underlying at the time the derivative contract was entered into. For example,
if the derivative contract was an option to buy 100 ounces of gold, and goal had a fair value of
$1,500 per ounce on the derivative contract date, the notional value would be $150,000.
G:\DATA\Stat Acctg\3. National Meetings\A. National Meeting Materials\2016\Summer\NM Exposures\15-51 - Definition of Notional.docx
© 2016 National Association of Insurance Commissioners 7