COVID-19 and the Impact
on CECL Requirements

March 2020

The historic market volatility associated with the COVID-19 global health emergency is creating a new set of challenges for institutions in meeting a variety of regulatory obligations.

For insurance companies, new rules from the Financial Accounting Standards Board (FASB) are governing the calculation and impairment of debt securities and loans, known as the Current Expected Credit Losses (CECL) model. This will be used to calculate impairment allowances for the first time today (March 31, 2020), which is the first reporting date for calendar year-end companies.

The new standard, originally designed in response to the financial crisis of 2008, has been postponed for certain financial institutions, but remains in force for insurers.

As a result, insurers must perform renewed assessments of the likelihood of default on a variety of the fixed-income securities in their portfolios. Since the CECL model considers macro-economic conditions and forward-looking estimates, the assessment may produce greater estimates of default than the previous impairment model that only considered other than temporary impairments.

This regulation already had serious implications for institutions’ balance sheets, portfolio values and internal resources, in terms of meeting the CECL requirements. But in an unprecedented environment of swift market downturn and volatility, it presents a series of new challenges.

First, securities that would not have been considered impaired in normal market circumstances, or even a normal bear market, must now be taken into consideration for impairment. Bonds of too short a duration will typically carry significant default risk, or those with high credit ratings, are now potentially riskier assets than before.

Where the terms of loans are changed, this could invoke specialized accounting if the loan modification constitutes a troubled debt restructuring (TDR). FASB has, however, concurred with the federal and state banking agencies that: short-term modifications made on a good faith basis in response to COVID-19 borrowers who were current prior to any relief are not TDRs. So insurers must make an assessment of individual securities where changes have been made to loans and decide whether they qualify as TDRs or not.

Available-for-sale (AFS) debt securities are analyzed for impairment if fair value is less than that in the insurer’s books. In the current market, more AFS debt securities may reach this threshold requiring more securities to be evaluated for impairment.

It is difficult to gauge the impact of this regulation on insurance portfolios, as the rules come into force at a time when the market remains so volatile. But it represents a clear challenge to the insurance industry’s profits and resources at an already difficult moment.

As institutions prepare and evaluate their readiness for this major accounting change, we will continue to follow developments in the market. Please reach out to your State Street representative with any questions.