Latest Exposure Draft from NAIC Working Group May Facilitate Rated Feeders, CFOs and Other Structured Investments for US Insurers

At its March 2, 2022 meeting, the National Association of Insurance Commissioners (NAIC) Statutory Accounting Principles (E) Working Group (SAP WG) approved the exposure for further comment through May 6, 2022, of a revised definition of “bond” for purposes of Statement of Statutory Accounting Principles (SSAP) No. 26R and SSAP No. 43R and a related draft issue paper. A summary of the changes to the proposed “bond” definition and an overview of the Issue Paper was provided in the advance materials for the meeting.

As we have described previously in a workshop and a Legal Update, the NAIC’s SAP WG has been engaged in the “bond” definition project since 2019, and the revised definition that was exposed for comment yesterday reflects several positive developments, including:

1. Removal of a proposed requirement that debt and equity interests in a feeder not be “stapled” (that is, not subject to relatively common requirements that such debt and equity interests may only be transferred to the same person proportionally); and
2. Expansion of the factors that may be considered to rebut the presumption that a debt instrument secured by underlying equity interests does not have the required creditor relationship.

In connection with the removal of the previous no-“stapling” requirement, the SAP WG notes that the effect of a debt instrument’s leverage may result in an increase (or “concentration”) of risk in the equity/residual interest, and, while that may not be an issue for characterization for statutory accounting purposes, such increased risk may have consequences to the related risk-based capital charges for such equity/residual interest. The SAP WG specifically noted that the recently formed Risk-Based Capital Investment Risk and Evaluation (E) Working Group is considering this and related issues.

The additional factors that may be considered in determining whether a debt instrument secured by underlying equity interests reflects a creditor relationship and therefore qualifies as a “bond” include the “[s]ource(s) of expected cash flows to service the debt (i.e., dividend distributions from the underlying collateral vs. sale of the underlying collateral).” As the proposed revised definition explains:

While reliance of the debt instrument on sale of underlying equity interests or refinancing at maturity does not preclude the rebuttable presumption from being overcome, it does require that the other characteristics mitigate the inherent reliance on equity valuation risk to support the transformation of underlying equity risk to bond risk. As reliance on sale or refinancing increases, the more compelling the other factors needed to overcome the rebuttable presumption become.

Following the comment period, the SAP WG will continue its discussion of the proposed definition. Additionally, it was announced that the SAP WG will post some comment letters that were received on the prior proposed definition.