décembre 14 2023

US NAIC Fall 2023 National Meeting Highlights: Major Investment-Related Initiatives

Authors:

The US National Association of Insurance Commissioners (“NAIC”) held its Fall National Meeting in Orlando on November 29–December 4, 2023. This Legal Update reports on a number of important investment-related initiatives that were addressed in sessions at that meeting. These are not exhaustive reports of all of the agenda items covered at these sessions but rather items that we consider particularly relevant to insurance company investments.

Statutory Accounting Principles (E) Working Group (materials and official summary)

The Statutory Accounting Principles (E) Working Group (“SAPWG”) met on December 1, 2023.

Accounting Treatment for Residual Interests (Ref. #2019-21)

SAPWG exposed proposed revisions to Statement of Statutory Accounting Principles (“SSAP”) No. 21R—Other Admitted Assets for a comment period ending January 22, 2024.

The proposed revisions would permit two alternative methods of accounting for residual interests: an effective yield method with a cap on income and a cost recovery method.

Residuals in Preferred Stock and Common Stock (Ref. # 2023-23)

SAPWG adopted revisions to SSAP No. 30R—Unaffiliated Common Stock and SSAP No. 32R—Preferred Stock, effective on December 31, 2023,to clarify that investments that are in substance residual interests must be reported as residual interests on Schedule BA even if they are issued in the form of common or preferred stock.

SAPWG staff explained that they were aware of an example where a principal protected security was repackaged as a debt security plus an additional performance interest issued in the form of preferred stock in order to avoid the loss of filing exemption and to avoid treatment of the principal protected security as a non-bond debt security after January 1, 2025.

SAPWG staff stated that such a repackaging could be done but that the preferred stock investment, because it is based on the additional interest/performance of the dedicated pool of assets within the structure, would in substance be a residual interest and would need to be treated as such.

Further Restrictions on Categories of Investments That Are Permitted to Be Reported as Short-Term Investments (Ref. #2023-17)

SAPWG adopted previously exposed revisions to SSAP No. 2R—Cash, Cash Equivalents, Drafts, and Short-Term Investments, with an effective date of January 1, 2025 (concurrent with the effectiveness of the “principles-based” bond definition).

The revisions will exclude all investments that are reportable on Schedule BA from being reported as short-term investments, including but not limited to:

Non-bond debt securities in scope of SSAP No. 21R
Collateral and non-collateral loans in scope of SSAP No. 21R
Surplus notes in scope of SSAP No. 41R—Surplus Notes

The revisions will also exclude mortgage loans in scope of SSAP No. 37—Mortgage Loans from short-term investment reporting.

Revisions to Schedule BA Reporting Categories (Ref. # 2023-16)

SAPWG staff reiterated their prior recommendation to combine the Schedule BA reporting category for “non-registered private funds” with the reporting category for “joint ventures, partnership or limited liability company interests” on the basis that all those asset types are in scope of SSAP No. 48—Joint Ventures, Partnerships and Limited Liability Companies.

Industry representatives objected that “warehouse loans” that have historically been reported in the “non-registered private funds” category would not fall within scope of SSAP No. 48, and they expressed concern that this could cause them to lose the relatively favorable risk-based capital (“RBC”) treatment accorded to Schedule BA mortgage investments.

SAPWG exposed the industry representatives’ proposed edits to the Schedule BA instructions for a comment period ending January 22, 2024, in order to gather more regulator and industry feedback.

Expansion of Schedule BA Reporting of Collateral Loans (Ref. # 2023-28)

SAPWG exposed for a comment period ending January 22, 2024, a proposal to subdivide the Schedule BA reporting category for collateral loans into separate subcategories based on the type of underlying investment collateral securing the loan.

Risk-Based Capital Investment Risk and Evaluation (E) Working Group (materials and official summary)

The Risk-Based Capital Investment Risk and Evaluation (E) Working Group (“RBC IRE WG”) met on December 2, 2023.

RBC for Structured Securities

Steve Smith, chair of the C-1 Subcommittee of the American Academy of Actuaries (“Academy”), presented updated “candidate” principles for modeling and determining RBC for structured securities—which he had revised in response to regulators’ comments on his prior draft.

A summary of the updated “candidate” principles are below (for details, see Attachment C of the meeting materials):

The purpose of RBC is to help regulators identify potentially weakly capitalized insurers; therefore, changes that have a small impact on RBC ratios may not justify a change to the RBC formula.
Emerging risks require regulatory scrutiny.
C-1 requirements reflect the impact of risk on statutory surplus. Changes in accounting treatment (e.g., mark-to-market instead of amortized cost) will affect RBC.
C-1 requirements on a given tranche align with that tranche’s risk.
C-1 requirements on asset-backed securities (“ABS”) should treat the collateral as a dynamic pool of assets.
C-1 requirements for ABS should be calibrated to different risk measures where appropriate.

After the presentation, which included extensive questions and comments from regulators, the RBC IRE WG agreed that the updated candidate principles were ready for the Academy to use in developing an RBC methodology for collateralized loan obligations (“CLOs”).

RBC Factor for Residual Interests (for Life Insurers)

RBC IRE WG Chair Philip Barlow addressed the topic of the 45% RBC factor for residual interests that will become effective in 2024.

Chair Barlow said that some have proposed that there be more than one RBC factor, rather than a single factor, for residual interests. In response, he noted that the 45% factor had been adopted as an interim step in anticipation of more extensive work in the future to determine the appropriate factor(s), and he pointed out that this work could potentially lead to establishing multiple factors for years after 2024.

Valuation of Securities (E) Task Force (materials and official summary)

The Valuation of Securities (E) Task Force (“VOSTF”) met on December 2, 2023.

Historical Presentation

Marc Perlman, managing investment counsel at the Securities Valuation Office (“SVO”), gave a slide presentation on the history of the filing exemption and reliance on rating agencies (see Attachment Two of the meeting materials).

RBC Treatment of Non-Bond Debt Securities

The VOSTF discussed a referral from SAPWG to the Capital Adequacy (E) Task Force regarding the RBC treatment of non-bond debt securities reported on Schedule BA.

In that referral, SAPWG had recommended that Schedule BA debt securities with an NAIC designation receive the RBC factor associated with that credit designation. In response, the SVO staff issued a memorandum (see Attachment Three of the meeting materials) strongly recommending the continuation of the existing policy of only allowing credit quality designations assigned by the SVO to be used for that purpose. The VOSTF agreed with the SVO staff’s recommendation and directed that it be communicated to the Capital Adequacy (E) Task Force (see our summary under that heading below).

Definition of an NAIC Designation

VOSTF exposed for a comment period ending January 26, 2024, a revised proposal from the SVO to amend the definition of an NAIC designation in the Purposes & Procedures Manual of the NAIC Investment Analysis Office (“P&P Manual”).

SVO Discretion Over NAIC Designations

VOSTF exposed for a comment period ending January 26, 2024, a revised proposal from the SVO to establish a process under which the SVO would have the discretion to override NAIC designations assigned through the filing exemption process.

VOSTF Chair Carrie Mears made the following introductory comments:

The SVO had taken to heart the comments received on the prior draft proposal and had worked to incorporate many of them.
The revised proposal is the result of a deliberative process that regulators believe has been thorough and fair.
The intention is not to replace or compete with rating agencies but, rather, to help regulators be responsible consumers of ratings.

SVO Director Charles Therriault then reviewed the revised proposal, which consists of a 15‑step process, and discussed each of the steps.

A noteworthy, new feature of the proposed process is the ability of an insurer to appeal the SVO’s assessment to an independent third party that would perform a blind review of the security at the insurer’s expense, and if the third party’s evaluation is within one notch of the designation derived from the credit rating provider (“CRP”), then the SVO challenge would fail, and the CRP-derived designation would remain in effect.

Several interested parties commented, and Chair Mears responded to their comments:

One commenter questioned the blind nature of the third-party review and suggested that the third-party reviewer ought to have access to the SVO’s and CRP’s work.
Another commenter questioned the absence of a requirement for the SVO to disclose its reasoning, which he suggested would limit an insurer’s ability to effectively appeal the SVO’s decision.
Chair Mears responded that the insurer would gain visibility into the SVO’s reasoning during the earlier stage of the process when the SVO is communicating its questions and issues regarding the security to the insurer.
Chair Mears also stated that confidentiality considerations would limit the SVO’s ability to distribute the details of its analytical assessment in written form.

Private Letter Ratings

Two VOSTF agenda items related to the requirement to file a private letter rating (“PLR”) rationale report with the SVO.

VOSTF exposed for a comment period ending January 26, 2024, a proposed amendment to the P&P Manual that would permit the SVO to assume that any PLR security that was acquired by an insurer after January 1, 2022, was issued on or after January 1, 2022, unless documentation showing an earlier issue date is provided.
Separately, Director Therriault stated that the SVO would defer the deactivation of PLRs for failure to file a required PLR rationale report until year-end 2024.

Update on CLO Modeling Methodology

Eric Kolchinsky, director of the NAIC Structured Securities Group (“SSG”), provided an update on the development of a CLO modeling methodology. He reported that the CLO Ad Hoc Working Group has exposed 10 scenarios, including tail scenarios, and associated cash flows, and that the next step is to set probabilities based on those cash flows. He said he considers the CLO Ad Hoc Working Group’s approach to be consistent with the principles presented by the Academy to the RBC IRE WG. He also pointed out that the CLO modeling process would not become operational until the development of the methodology is complete, which might be January 1, 2025, rather than January 1, 2024.

Capital Adequacy (E) Task Force (materials and official summary)

The Capital Adequacy (E) Task Force (“CATF”) met on December 2, 2023.

RBC Treatment of Non-Bond Debt Securities

The CATF discussed a referral from SAPWG regarding the RBC treatment of non-bond debt securities reported on Schedule BA.

SAPWG had recommended that Schedule BA debt securities with an NAIC designation receive the RBC factor associated with that credit designation.
VOSTF had endorsed an SVO recommendation (see the VOSTF report above) that only credit quality designations assigned by the SVO be usable for that purpose.
The American Council of Life Insurers (“ACLI”) had submitted a comment letter (see Attachment Eleven in the materials) emphasizing the need to address RBC considerations to avoid non-bond debt securities inappropriately defaulting to a punitive 30% RBC charge after January 1, 2025.
The ACLI suggested that to the extent it is impractical for the RBC IRE WG to determine the appropriate RBC charges by January 1, 2025, insurers should be allowed to use both SVO-assigned NAIC designations and CRP ratings for purposes of RBC.

At the conclusion of the discussion, the CATF referred this matter to the RBC IRE WG.

Financial Condition (E) Committee (materials and official summary)

The Financial Condition (E) Committee (“‘E’ Committee”) met on December 3, 2023.
The “E” Committee received two-minute oral summaries from 15 of the 17 parties who had submitted written comments on the document exposed at the Summer NAIC National Meeting in August called “Framework for Regulation of Insurer Investments—A Holistic Review.” Needless to say, the comments were “all over the map,” with divergent views expressed by the various commenters.

As at the August meeting, it was clear that while work on the framework document continues, there will be no pause in the workstreams underway at the SAPWG, VOSTF and RBC IRE WG.

All the commenters made important points, and some will have more impact than others, but we would keep an eye on how the “E” Committee and VOSTF will address the comments from Moody’s.

The Moody’s comment letter suggested that “more opaque and potentially riskier investments in insurers’ portfolios and increased regulatory reliance on private ratings from a single CRP – may give rise to regulatory capital arbitrage and rating shopping.”
This type of concern, which has been voiced by the SVO and SSG as far back as a February 27, 2020, issue paper, has the potential to lead to changes in the current filing-exempt system that could target private ratings from single CRPs, which in turn could have major implications for the RBC treatment of investment structures such as rated feeder notes and collateralized fund obligations.

As always, if you have any questions or want to discuss any of these topics, just let any of us at Mayer Brown know. To view additional updates from the US NAIC Fall 2023 National Meeting, visit our meeting highlights page.