FASB Statement No. 140 provides implementation guidance for as

sessing isolation of transferred assets and for accounting for transfers o f partial interests, servicing of financial assets, securitizations, transfers o f sales-type and direct financing lease receivables, securities lending transactions, repur­

chase agreements including "dollar rolls," "wash sales," loan syndications and participations, risk participations in banker's acceptances, factoring arrange­

ments, transfers of receivables with recourse, and extinguishments o f liabilities.

Accounting for Derivative Instruments and Hedging Activities**

5.77 FASB Statement No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative

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In March 2008, FASB issued FASB Statement No. 161, Disclosures about Derivative Instru­

ments and Hedging Activities—an amendment o f FASB Statement No. 133. The statement was issued due to the significant increase in the use and complexity o f derivative instruments over the past several years. FASB believes that FASB Statement No. 133 does not provide adequate information about how derivative instruments and hedging activities affect an entity's financial position, income statement, and statement o f cash flows. Accordingly, FASB Statement No. 161, Disclosures about Derivative In­

struments and Hedging Activities—an amendment o f FASB Statement No. 133, increases disclosures about an entity's derivative and hedging activities in order to improve financial transparency. FASB Statement No. 161 is effective for financial statements issued for fiscal years and interim periods be­

ginning after November 15 , 2008. Early adoption is encouraged. FASB Statement No. 161 encourages,

tives) and for hedging activities. FASB Statement No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those investments at fair value. If certain con­

ditions are met, a derivative may be specifically designated as (a) a hedge o f the exposure to changes in the fair value of a recognized asset or liability or an un­

recognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted trans­

action. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use o f the derivative and the result­

ing designation. FASB Statement No. 133, as amended, (paragraphs 44-47) also contains extensive disclosure requirements. Refer to the full text o f the statement when considering accounting and reporting issues related to deriva­

tive instruments and hedging activities. FASB has established the Derivatives Implementation Group (DIG) to assist the Board and its staff in providing im­

plementation guidance regarding FASB Statement No. 133. The following is a list of insurance specific DIG issues. Issues addressed by the DIG and the status of related guidance can also be found at the FASB's Web site at www.fasb.org.

• Issue A16— Definition o f a Derivative: Synthetic Guaranteed In­

vestment Contracts

• Issue B7—Embedded Derivatives: Variable Annuity Products and Policyholder Ownership of the Assets

• Issue B8— Embedded Derivatives: Identification o f the Host Con­

tract in a Nontraditional Variable Annuity Contract

• Issue B9—Embedded Derivatives: Clearly and Closely Related Criteria for Market Adjusted Value Prepayment Options

• Issue B 10— Embedded Derivatives: Equity-Indexed Life Insur­

ance Contracts

• Issue B25— Embedded Derivatives: Deferred Variable Annuity Contracts with Payment Alternatives at the end of the Accumula­

tion Period

• Issue B26— Embedded Derivatives: Dual-Trigger Property and Casualty Insurance Contracts

• Issue B27—Embedded Derivatives: Dual-Trigger Financial Guar­

antee Contracts

• Issue B28— Embedded Derivatives: Foreign Currency Elements o f Insurance Contracts

• Issue B29—Embedded Derivatives: Equity-Indexed Annuity Con­

tracts with Embedded Derivatives

• Issue B30—Embedded Derivatives: Application o f Statement 97 and Statement 133 to Equity-Indexed Annuity Contracts

• Issue B31—Embedded Derivatives: Accounting for Purchases of Life Insurance

• Issue B34— Embedded Derivatives: Period Certain Plus Life Con­

tingent Variable Payout Annuity Contracts With a Guaranteed Minimum Level of Periodic Payments. (Refer to section B, Issue B25)

• Issue B36— Modified Coinsurance Arrangements and Debt Instru­

ments that Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor Under Those Instruments16

• Issue B40—Application o f Paragraph 13(b) to Securitized Inter­

ests in Prepayable Financial Assets

• Issue C 1— Scope Exceptions: Exception Related to Physical Vari­

ables

• Issue G4— Cash Flow Hedges: Hedging Voluntary Increases and Interest Credited on an Insurance Contract Liability

• Issue G26— Hedging Interest Cash Flows on Variable-Rate Assets and Liabilities That are Not Based on a Benchmark Interest Rate 5.78 FASB Statement No. 155 changed derivative accounting by amend­

ing paragraphs 1 4 , 16, 44 and 200A-D o f FASB Statement No. 133. In summary, FASB Statement No. 155

• amends paragraph 16 o f FASB Statement No. 133 to allow finan­

cial instruments containing embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole in­

strument on a fair value basis (with changes in value recognized in earnings).17 However, hybrid financial instruments that are elected to be accounted for in their entirety at fair value can­

not be used as a hedge instrument in a FASB Statement No. 133 hedge.18,19 Financial guarantees and investment contracts are al­

lowed the paragraph 16 fair value election. However, hybrid in­

struments described in paragraph 8 o f FASB Statement No. 107

16 Issue B36, as amended by FASB Statement Nos. 155 and 156, should be applied to all ar­

rangements that incorporate credit risk exposures that are unrelated or only partially related to the creditworthiness o f the issuer o f an instrument. The issue may apply directly to modified coinsur­

ance arrangem ents (modco arrangements) and coinsurance with funds withheld arrangements. An instrument that incorporates credit risk exposures that are either unrelated or only partially related to the creditworthiness o f that instrument's obligor has an embedded derivative that is not consid­

ered "clearly and closely related" to the economic characteristics and risks o f the host contract. B36 affects the accounting for credit-linked notes that incorporate a third party's credit (or default) risk and modified coinsurance and coinsurance with funds withheld arrangements between reinsurers and ceding insurance companies and similar arrangements. The scope o f B36 encompasses any receivable or payable where the interest is determined by reference to an actual pool o f assets (unless the pool were comprised entirely o f risk-free debt securities, real estate or, both) or determined by any index other than a "pure" interest rate index.

17 The fair value election may also be applied upon its adoption for hybrid financial instruments that had been bifurcated under paragraph 12 o f FASB Statement No. 133 prior to the adoption of FASB Statem ent No. 155. Earlier adoption is permitted as o f the beginning o f an entity's fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period, for that fiscal year. FASB Statement No. 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning o f an entity's first fiscal year that begins after September 15, 2006.

18 Paragraph 25 o f EITF Issue No. 99-20, "Recognition o f Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized F inancial Assets," states that a hybrid financial instrument that is elected to be accounted for in its entirety at fair value cannot be used as a hedging instrument in a FASB Statement No. 133 hedging relationship.

19 For those hybrid financial instruments measured at fair value under the practicability excep­

tion discussed in paragraph 16 o f FASB Statement No. 133, FASB Statement No. 159 requires that the entity disclose inform ation specified in paragraphs 18—22 o f FASB Statement No. 159.

surance contract hosts, such as equity-indexed annuities or non- traditional variable annuity contracts with minimum guarantees, would not be eligible for the fair value measurement election.

• amends paragraph 14 to clarify which interest-only strips and principal-only strips are not subject to the requirements of FASB Statement No. 133.

• adds paragraph 14(a) to require a holder o f interests in securitized financial assets to evaluate interests in order to identify those in­

terests that are freestanding derivatives or that are hybrid finan­

cial instruments that contain an embedded derivative requiring bifurcation. This paragraph eliminates the temporary exemption provided by Implementation Issue D 1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." (In turn; however, FASB Statement No. 155 amended paragraphs 35 and 40 of FASB Statement No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument because all securi­

tized instruments now need to be evaluated for embedded deriva­

tives.)

• adds paragraph 14(b) to clarify that concentrations of credit risk in the form of subordination are not embedded derivatives. How­

ever, this does not in any way negate current FASB Statement No.

133 credit risk requirements, including the identification of credit risk that continues to represent credit risk that is not clearly and closely related to the host contracts such as with modified coinsur­

ance arrangements and debt instruments discussed in DIG B36.

Other DIG Issues affected by FASB Statement No. 155 include, but are not limited to, A l, B1-B2, B4—B6, B10-B11, B15, B17, B20, B23-B24, B29-B30, B35 (as amended by FASB Statement No. 157), B37, B39, C4 and D 1.