IRS Releases Guidance on Uniform Mortgage-Backed Securities for Purposes of § 817(h)
On October 16, the IRS released an advanced version of Revenue Procedure 2018-54, which provides guidance and procedural rules that allow taxpayers (i.e., issuers of variable contracts in this case) to elect to utilize a “deemed-issuer ratio” for “generic GSE securities” in order to comply with IRC § 817(h) diversification requirements. As we have reported previously, the FHFA has been working on an initiative to create common mortgage-backed securities that are to be issued by the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA). The common securities will be referred to as a Uniform Mortgage-Backed Security (UMBS) and will be issued by both agencies, with substantially similar terms. These securities are expected to be issued beginning in the second quarter of 2019.
Under unstipulated TBA trades, UMBS will not specify the issuer of the securities. As a result, investors that acquire UMBS in unstipulated TBA trades will not know the issuer until the security to be delivered is identified 48 hours prior to settlement. A known issue that arises from this development is the challenge of complying with § 817(h) diversification requirements, particularly for agency-MBS focused portfolios with concentrations in FNMA and FHLMC securities already.
In Rev. Proc. 2018-54, the IRS sets forth a procedure whereby a taxpayer can elect to utilize a “deemed-issuance-ratio” for all generic GSE securities acquired during the applicable tax year. The deemed-issuance-ratio would be used regardless of the actual underlying composition of a particular security. It is worth noting that the deemed-issuance-ratio would not be applicable in any trades that stipulate the issuer.
The FHFA will determine the ratio in advance each year based on the ratio of TBA-eligible securities issued by Fannie Mae and Freddie Mac during a 24-month period ending not earlier than October 31 immediately preceding the year to which the new ratio will apply. The FHFA will announce this ratio at least three weeks before the end of the year.
Rev. Proc. 2018-54 also sets forth a procedure for a taxpayer to make this election. The election is to be provided as an attachment to the taxpayer’s income tax return for the first taxable year in which the taxpayer wants the election to apply. Once made, the election is revocable only with prior consent of the IRS (to be obtained through a Private Letter Ruling).
We will be monitoring this development to determine if BOLI carriers intend to utilize this Revenue Procedure.
New Proposed Rule for Calculating Exposure Amount of Derivative Contracts
On October 30, the federal bank regulatory agencies jointly issued a Notice of Proposed Rulemaking (NPR), which would amend the regulatory capital rules to implement a new approach for calculating the exposure amount for derivative contracts. The regulators call this approach the “standardized approach for counterparty credit risk (“SA-CCR”).
According to the press release, the NPR would require advanced approach institutions to use the SA-CCR for their standardized RWA calculations. Non-advanced approach institutions would be given the option of using the SA-CCR or continue using the existing approach, called the current exposure methodology (or “CEM”).
Comments will be due within 60 days from the date the NPR is published in the Federal Register.
We will review the rule proposal closely in an effort to understand the potential impact on BOLI portfolios that have exposures to derivative contracts.
COI Litigation – Feller vs. Transamerica
On October 5, the Central District Court of California granted preliminary approval of a proposed settlement in a class action suit involving Transamerica. The plaintiffs alleged that cost of insurance rate increases on certain policies in 2015 and 2016 were imposed by Transamerica in an attempt to recoup prior losses, which is in specific violation of the contracts. Transamerica had argued that increases were instead issued in response to adverse changes in expectations of future mortality and interest rates.
The settlement is in the amount of roughly $195 million and affects roughly 70k universal life insurance policies issued by Transamerica between 1983 and 2008. The settlement agreement states that the gross cash settlement benefits equate to roughly 62% of the alleged past overcharges.
The settlement class includes: “all persons or entities who own or owned a Policy encompassed by the MDR Increases during the Class Period.” According to the settlement agreement:
“MDR Increases” means, collectively, the Wave 1, 2A, 2B and 3 MDR increases on the Policies beginning in August 2015, which increased the scheduled MDRs for the Policies. These MDR increases were applied to the age-based changes to MDRs included within the Policies’ pre-existing MDR schedules.
The settlement agreement also includes an Exhibit listing the Transamerica plans and product groups that comprised each of the “waves.” Upon review of this exhibit, it does not appear that any Transamerica BOLI policies that we administer are included in this class action settlement. The COI provisions in the BOLI policies appear to have a materially different form and substance.
Citation: Gordon and Mary Feller vs. Transamerica Life Insurance Company (US District Court, Central District of California, 16-cv-01378)
COI Litigation – Davydov vs. John Hancock
On October 24, a class action complaint was brought against John Hancock in the Southern District of New York, with the class consisting of policyholders of certain universal life policies. The plaintiffs allege that John Hancock increased cost of insurance rates in order to subsidize the cost of meeting minimum interest rate guarantees, to recoup prior losses (in violation of the terms of the policies), and to induce policy lapses and/or surrenders by the policyholders.
This lawsuit differs from the proposed class action settlement which we reported on previously in that the policy contracts appear to give John Hancock discretion to base cost of insurance rates on factors other than expectations of future mortality experience. We will continue to monitor for further developments.
Citation: Yuriy Davydov vs. John Hancock Life Insurance Company of New York and John Hancock Life Insurance Company (U.S.A.) (US District Court, Southern District of New York, 18-cv-09825)
American Bankers Association Seeks Quantitative Impact Study and Delay in the Implementation of CECL
On October 25, the American Bankers Association submitted a letter to the U.S. Department of the Treasury, recommending that the FSOC seek a delay in implementation of FASB’s Current Expected Credit Losses (CECL) standard until a thorough quantitative impact study is completed.
In June 2016, FASB released the final CECL standard in Accounting Standards Update 2016-13 (ASC Topic 326). The main provisions of ASU 2016-13 include requiring financial assets measured at amortized cost (e.g., hold-to-maturity portfolios) to be presented as the net amount expected to be collected, whereas current GAAP applies an “impairment” model that generally delays recognition of credit losses until such losses are “probable” of occurring. ASU 2016-13 also impacts the accounting for Available-for-Sale (AFS) securities, though the change appears less significant.
The CECL standard doesn’t modify any of the Accounting Standards Codification entries under ASC 325-30 (Investments in Insurance Contracts); however, we continue to review the CECL in an effort to determine if it might have any indirect implications for BOLI accounting. For example, since the net realizable value of a variable BOLI policy is determined, at least in part, by the fair value of the fixed income investment securities held in the underlying separate account, might that valuation become subject to CECL? At present, the standard appears unlikely to apply.
Finally, at its October 24 Board Meeting, FASB agreed to further delay the implementation of CECL for certain businesses (to 12/15/2021). However, it is our understanding that the implementation date for businesses that are SEC filers remains 12/15/2019.
California Consumer Privacy Act Amendment Signed into Law
On September 23, California’s Governor Jerry Brown announced that he signed SB 1121 into law. SB 1121 modifies the California Consumer Privacy Act of 2018 (the “Act”). The Act is a comprehensive consumer privacy law including provisions allowing consumers to request disclosure of the categories of information collected and a right to request such data be deleted.
The law only refers to “consumers” and “businesses”; it does not use terms “employees” or “employer.” We will continue to monitor developing privacy laws closely, as they could impact aspects of BOLI programs and/or the administration of BOLI programs.