US NAIC Summer 2023 National Meeting Highlights: Financial Condition (E) Committee

At the Summer 2023 US National Meeting of the National Association of Insurance Commissioners (“NAIC”), the Financial Condition (E) Committee (the “Committee”) met on August 15. The Committee considered several topics and heard several updates. Below are highlights from the meeting:

Adoption of the Macroprudential Reinsurance Worksheet:

The Committee adopted a Cross-Border Reinsurance Comparison Worksheet that had been developed by the Macroprudential (E) Working Group. The worksheet is an optional tool designed to assist lead state and domestic regulators to assess the economic impacts of cross-border reinsurance treaties, particularly treaties between affiliates. The worksheet is not intended to be used for every reinsurance contract or to duplicate information available from other sources. The worksheet will not be included in the NAIC’s Financial Analysis Handbook or Examination Handbook, but will be available to state insurance regulators through the NAIC’s StateNet web portal.

Adoption of INT 23-01 Net Negative (Disallowed) Interest Maintenance Reserve:

The Committee adopted INT 23-01 Net Negative (Disallowed) IMR, as developed by the Statutory Accounting Principles (E) Working Group (“SAPWG”), to provide guidance for the limited admittance of negative interest maintenance reserve (“IMR”) amounts, effective immediately and through year-end 2025 (which gives industry, regulators and others a few years to develop a long-term approach).

IMR is a reserve that life insurers are required to maintain under statutory accounting principles to deal with fluctuations in interest rates. It is used to accumulate realized capital gains and losses resulting from interest rate fluctuations. These results are then amortized and used to adjust net investment income levels over the estimated holding period of those assets. This ensures that life insurers are not subject to wild swings in their balance sheet due to losses or gains resulting from changes in interest rates.

• A positive IMR means that the net realized interest related gains, which are amortized in the IMR calculation, are greater than net realized interest related losses, which are being amortized in the IMR calculation. A positive IMR is reported as a statutory liability and amortized to income over time.
• A negative IMR means that net realized interest related losses, which are amortized in the IMR calculation, are greater than net realized interested related gains, which are amortized in the IMR calculation. A disallowed negative IMR is reported as a nonadmitted asset and amortized to income as a loss over time.

Since 2022, the US economy has experienced a rapid and sustained increase in interest rates. The resulting nonadmitted negative IMR has created the appearance of decreased financial strength through lower surplus and risk-based capital (“RBC”). At the request of the American Council of Life Insurers, the SAPWG developed INT 23-01, which the Financial Condition (E) Committee has now adopted.

• As adopted, the interpretation reflects the following key features:
  • The insurer’s RBC must be over 300% authorized control level (“ACL”) after adjustment to remove admitted positive goodwill, electronic data processing (“EDP”) equipment and operating system software, deferred tax assets (“DTAs”), and admitted negative IMR (referred to as softer assets).
  • The insurer is allowed to admit negative IMR in an amount up to 10% of adjusted capital and surplus (excluding those softer assets), first in the general account, and then—if all disallowed IMR in the general account is admitted and the percentage limit is not reached—to the separate account proportionately between insulated and non-insulated accounts (those that have assets at book value).

Presentation from the Canadian Office of the Superintendent of Financial Institutions (“OFSI”) on the Use of Artificial Intelligence:

Jacqueline Friedland, Executive Director of OSFI’s Risk Assessment and Intervention Hub, provided an overview of OSFI’s use of data analytics as a supervisory tool, including the use of artificial intelligence.

Exposure of Proposed Framework for Regulation of Insurer Investments:

Committee Chair Elizabeth Kelleher Dwyer (Director of the Rhode Island Department of Business Regulation) led a brief discussion of a document titled “Framework for Regulation of Insurer Investments – A Holistic Review” (the “Framework document”), which had been included in the meeting materials.

The Framework document focuses on a central question: what is the most effective use of regulatory resources in the modern environment of insurance regulation for investments? The Framework document questions whether certain approaches currently being advanced by subgroups of the Committee with respect to regulation of insurer investments would constitute the best use of regulatory resources in order to enhance such regulation. The Framework document instead offers concrete alternatives, grouped into two categories, to the approaches currently under discussion.

First, the Framework document notes that the NAIC has been “blindly reliant” on rating agencies (referred to as “credit rating providers” or “CRPs”) for NAIC credit designations. NAIC designations currently are assigned either by the NAIC Securities Valuation Office (the “SVO”) based on its own credit assessment of filed securities or by a direct translation of a credit rating from a CRP for those securities that are exempt from filing (“FE”). The Framework document notes that there is no current mechanism for overall due diligence over the use and effectiveness of CRPs, nor an ability to challenge an individual rating for not conforming to regulator expectations of how it was determined.

In place of current proposals to enhance the powers of the SVO to determine or adjust credit ratings—referred to in the Framework document as an attempt “both inefficient and impractical for the SVO to effectively replicate the capabilities of CRPs on a large scale”—the Framework document suggests modernizing the SVO in the following ways:

1. Reduce/eliminate “blind” reliance on CRPs, but retain overall utilization of CRPs while implementing a strong due diligence framework. The Framework document says that this initiative should be a primary focus of the NAIC and should utilize an external consultant/resource for design and implementation.
2. Retain the ability within the SVO to perform individualized credit assessment and utilize regulatory discretion when needed, under well-documented and governed parameters.
3. Enhance the SVO’s portfolio risk analysis capabilities with investment in a risk analytics tool and corresponding personnel—which could perform both company-specific risk analytics at the request of regulators—and industry-wide risk analytics for use in macroprudential efforts, including potentially increasing staffing to include analysts with investment actuarial and risk management backgrounds.
4. Enhance structured asset modeling capabilities in line with the above-noted function with less focus on individual designation production, but in support of the CRP due diligence function (e.g., providing tools for validation of CRP designations), company and industry stress testing, and emerging risk identification.
5. Build out a broad policy advisory function at the SVO that can consider and recommend future policy changes to regulators under a holistic lens, considering input from all impacted processes. The Framework document suggests that key external consultants be hired to be on retainer to provide key guidance on policy related issues, assess market impact and provide recommendations.
6. Consider establishing a broad investment working group under the Committee that acts in an advisory capacity to various investment processes that would ultimately need more intensive regulator engagement and analysis on confidential basis, including: (1) review of bond reporting analysis under the principles-based bond definition; (2) challenges to individual designations provided by CRPs; and (3) review of work provided by external consultants for investment-related projects for broad impacts to the Framework.
7. If the multitude of the above recommendations are implemented, rename the SVO and the Valuation of Securities (E) Task Force (“VOSTF”) to better reflect the responsibilities of the groups beyond securities valuation, empower the SVO to utilize the tools and analysis available to raise key issues to other applicable working groups, such as SAPWG or the Life Actuarial (A) Task Force, and consider a reduction in the size of the VOSTF or its successor to encourage active regulator engagement on core issues.

Second, with respect to the ongoing review of RBC factors for investments, the Framework document suggests that the following guidelines be considered during the course of the review:

1. Changes in RBC factors should consider market impacts and consistency across asset classes in determining when and how to implement such changes.
2. The Risk-Based Capital Investment Risk and Evaluation (E) Working Group (“RBC IRE WG”) should consider and address areas where inconsistencies in treatment across asset classes incentivize a particular legal form.

The inclusion of the Framework document in the meeting materials had raised hopes that the Committee would “take a step back” and reevaluate the initiatives being undertaken by its subgroups based on the holistic perspective outlined in the document. Those hopes were dashed when Chair Dwyer announced at the outset of the discussion that there was no plan to pause any of the three current workstreams of (i) the RBC IRE WG to reevaluate the RBC factors for asset-backed securities, (ii) the VOSTF to replace the FE status of collateralized loan obligations with a financial modeling process, and (iii) the VOSTF to implement a process for the SVO to challenge and potentially override CRP ratings of FE securities. (For more information on those workstreams see our recent Legal Update.)

The only persons who were asked to comment on the Framework document at the meeting were regulators. Regulators from three states spoke, all of whom expressed support for the document in broad, general terms. The Framework document was then exposed for comment until October 2, 2023.

Looking Ahead

There will likely be further developments on these matters, particularly with respect to the Framework document. We will continue to track and report on these developments.

To view additional updates from the US NAIC Spring 2023 National Meeting, visit our meeting highlights page.