b'Insurance Regulatory | US/NAIC | NAIC Investment-Related InitiativesThe PPS with the underlying Treasury zero-coupon1, 2021, and all newly-acquired PPS need to be filed bond and the S&P 500 Index-linked return wouldwith the SVO within 120 days after acquisition. The have a CRP rating of AAA/AA+ or an NAIC 1.A,goal is that all PPS included in an insurers December based solely on the risk of the Treasury bond. In31, 2021, statutory financial statements will have been contrast, the Weighted Average Ratings Factorreviewed and assigned a designation by the SVO. (WARF) methodology applied by the SVO would result in an NAIC 4.B when it includes the expo- NAIC Takes Aim atsure to the call options on the S&P 500 Index. Bespoke Securities The PPS with the underlying corporate bond andAt its May 14, 2020, meeting, the VOS Task Force the other performance assets would have a CRPexposed for comment an issue paper written by the rating of BBB or NAIC 2.B, based solely on thestaff of the NAIC Investment Analysis Office (IAO) corporate bonds. In contrast, the WARF methodol- (of which the SVO is a part). The IAO issue paper ogy would result in an NAIC 4.C when the exposuredeveloped two concerns that had been expressed to all of the underlying investments is included.by the IAO to the VOS Task Force in a May 2019The combo note would have a BBB rating or NAICeducational session:2.C on the notional based on payments from the A concern about bespoke securities, defined as underlying investment grade tranches. By contrast,financial instruments typically constructed by or the WARF methodology would result in an NAICfor a small group of investors, which, due to their 4.B when the exposure to the below investmentprivate nature, are not subject to or constrained grade and unrated tranches is included. by market forces and competition. As such, their To illustrate the impact on an insurers RBC calcula- visible characteristics may substantially underrep-tions: the pre-tax RBC factors for a life insurer areresent actual risks.currently 40 bps for an NAIC-1 investment, 130 bps for A concern about what the IAO staff deem to be an NAIC-2 investment and 1,000 bps for an NAIC4the NAICs excessive reliance on CRP ratings to investment. That means that receiving a designation ofassess investment risk for regulatory purposes. NAIC-4 instead of NAIC-1 (as in the first exampleThe IAO staff does not believe that every CRPs above) will increase the RBC charge to 2500% of themethodology is appropriate for, or consistent with, current charge, and receiving a designation of NAIC4the assessment of investment risk for statutory instead of NAIC-2 (as in the other two examples) will(i.e., regulatory) purposes.increase the RBC charge to 769% of the current charge.The issue paper identifies six red flags that indi-Prior to the May 14, 2020, adoption of the PPScate the presence of a bespoke security:amendments, industry representatives advocated that existing investments of insurers should be1. Rating from a single CRP; grandfathered and retain the NAIC designations2. Private letter rating;corresponding to their CRP ratings. However, the SVO staff convinced the VOS Task Force not to allow3. Assets backing the security were primarily owned by grandfathering, arguing that the risks they hadthe insurer or its affiliates before the transaction and identified needed to be addressed with respect to allwere reported differently (i.e., regulatory arbitrage);insurer investments in PPS, regardless of when they4. Assets backing the security do not generate were acquired. Accordingly, all PPS owned prior tobond-like cash flows (i.e., contractual requirements January 1, 2021, need to be filed with the SVO by Julyto pay periodic principal and interest);MAYER BROWN 59'