Keeping Your Portfolio Afloat with Alternative Investments
By Alex Murray, CPA, Senior Manager, Johnson Lambert LLP
Does the downturn in the market have you contemplating changes to your investment portfolio? You aren’t alone. Given current market conditions, many insurance companies are turning to alternative asset classes, which frequently offer substantially higher returns. Some commonly utilized alternative investments include limited partnerships and syndicated notes.
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However, alternative investments may mean alternative accounting treatment. As usual, there are several differences in the accounting and reporting of alternative investments under both generally accepted account principles (GAAP) and statutory accounting principles (STAT).
One of the most common alternative investments are limited partnerships (LPs), which are similar to investment fund vehicles, guided by explicit investment strategies and only available to specific investors. LPs often require significant monetary commitments and have redemption restrictions. Valuing these investments tend to be the most difficult aspect of their accounting. Under GAAP, LPs can be accounted for under the fair value method or equity method.
GAAP – Fair Value Method
As a practical expedient, a LP investor can elect to use the net asset value as the fair value if the LP meets two criteria: 1) has a not readily determinable fair value and 2) meets the qualifications of an investment company (this is disclosed in the accounting policy footnote). For insurance companies, if the LP does not meet these criteria, the investor must record its investment at fair value, which is characteristically difficult because LPs are not actively traded. With the issuance of ASU 2016-01 earlier this year and effective for year ending December 31, 2019 for non-public companies, some of the changes may affect the accounting for LPs so be on the lookout.
GAAP – Equity Method
The equity method is used when an investor can exert significant influence over the operations and financial policies of a LP. Typically, 20% or more ownership of voting stock is considered significant influence. Valuation of this investment is based on the investor’s percentage ownership of the LP. The investment is initially recorded at cost and the earnings or losses of the LP are recorded as increases or decrease in the value. These earnings are recorded as part of investment income.
If the investor owns 10% or less and does not control the LP, the investment is accounted for under SSAP 48, which follows closely the GAAP equity method. However, if the investor owns more than 10% and has the ability to exert control over the LP, look to SSAP 97 to determine the proper accounting treatment.
Syndicated notes are privately placed corporate debt that are not required to file with the Securities Exchange Commission. A syndicated agent bank collects payments and distributes funds to bond holders.
Accounting for syndicated notes falls in line with traditional bond portfolio accounting. Investments classified as available-for-sale or trading are accounted for at fair value and held-to-maturity investments are accounted for at amortized cost. The fair value option is also an option.
Syndicated notes follow traditional bond portfolio accounting under SSAP 26. The NAIC rating determines whether the investment is recorded at amortized cost or the lower of amortized cost or fair value. Life and accident & health companies must also establish asset valuation reserves (AVR) and interest maintenance reserves (IMR). The AVR is established to offset potential credit related investment losses, while the IMR captures realized capital gains and losses resulting from changes in interest rates. These reserves are amortized into income over the life of the syndicated note.
As evidenced by the variety of accounting treatments detailed above, it is important to understand the accounting implications of investing in non-traditional asset classes. However, complicated accounting should not stand in the way of obtaining the necessary investment yield to keep your insurance company profitable.
For more information, click here to view Breaking Down Non-Traditional Asset Classes, our recent webinar hosted by Johnson Lambert & Clearwater Analytics.
For more information, contact Alex Murray, at email@example.com.