March 25, 2024

US NAIC Spring 2024 National Meeting Highlights: Major Investment-Related Initiatives


The US National Association of Insurance Commissioners (“NAIC”) held its Spring National Meeting in Phoenix on March 14-18, 2024. This Legal Update reports on a number of important investment-related initiatives that were addressed in sessions during the Spring National Meeting. These are not exhaustive reports of all of the agenda items covered at the meetings of the various groups, but rather a selection of agenda items that we consider to have particular relevance to insurance company investments.

Statutory Accounting Principles (E) Working Group

(meeting materials and official summary)

The Statutory Accounting Principles (E) Working Group (“SAPWG”) met on March 16, 2024.

Treatment of Debt Issued by Unregistered Funds

(Ref. # 2024-01)

For background, on January 10, 2024, SAPWG exposed for comment a proposed revision to the principles-based bond definition, which would permit debt securities issued by unregistered funds (not just 1940 Act-registered funds) to be classified as issuer credit obligations (“ICOs”), rather than asset-backed securities (“ABS”), if the fund qualifies as an operating entity. The proposal was intended to put debt leverage issued by unregistered funds on the same footing as debt leverage issued by 1940 Act-registered funds.

The proposal describes the distinction between operating entities and ABS issuers as follows:

  • A fund representing an operating entity has the primary purpose of raising equity capital and generating returns to its equity investors, and any debt issued by such a fund is in service to meeting the fund’s primary objective of generating returns to its equity investors.
  • In contrast, an ABS issuer has the primary purpose of raising debt capital and generating returns to its debt investors.

Aside from the obvious rationale for using a uniform set of principles to classify debt leverage issued by registered and unregistered funds, there is a lot riding on the ICO versus ABS classification.

  • ABS must satisfy additional tests that ICOs do not. ABS structures need to provide substantive credit enhancement, and the underlying collateral needs to consist of either financial assets or non-financial assets that produce meaningful cash flows. If the underlying collateral consists of equity interests, there is a presumption that the instrument is not a bond, which can only be rebutted by a documented analysis performed at the time an insurer acquires the investment.
  • Additionally, while common equity issued by a fund that is an operating entity receives a risk-based capital (“RBC”) charge of 30%, residual interests at the bottom of an ABS capital stack receive an RBC charge of 45%.

After the January 10 proposal was exposed for comment, the desirability of an ICO classification led some wishful thinkers to suggest that rated feeder notes could qualify as ICOs under the proposed revisions.

  • The argument ran that since the master fund underlying a rated feeder fund had a primary purpose of raising equity capital, the feeder fund should be able to qualify as an operating entity, and the rated feeder notes should be able to qualify as ICOs rather than ABS.

Fast forward to the SAPWG meeting on March 16, 2024, where the NAIC staff expressed its rejection of the view that rated feeder notes could qualify as ICOs—and actually withheld support for adopting its own January 10 proposal on that basis.

Instead, the staff asked SAPWG to re-expose the proposal until May 31, 2024, with a request for regulators and the industry to provide comments that address the following two issues:

  • Proposed language to clarify the types of funds that should be considered to be operating entities, such that their debt securities would qualify as ICOs.
  • Proposed language to better define the amount of debt that funds that are considered operating entities may issue. (The January 10 proposal referred to “marginal” amounts of debt. Some commenters suggested changing “marginal” to “prudent,” but NAIC staff did not agree with that suggestion and is looking for different language.)
Accounting Treatment Adopted for Residual Interests

(Ref. # 2019-21)

SAPWG adopted the previously proposed revisions to Statement of Statutory Accounting Principles (“SSAP”) No. 21R—Other Admitted Assets that will permit two alternative methods of accounting for residual interests: an effective yield method with a cap on income, and a cost recovery method.

Consolidation of References to Residual Interests in SSAP No. 21R

(Ref. # 2024-08)

SAPWG exposed for comment (until May 31, 2024) revisions to SSAPs No. 21R, 26R, 30R, 32R, 43R and 48, so that all SSAPs will refer to SSAP No. 21R—Other Admitted Assets for the formal definition of, and accounting and reporting guidance for, residual interests.

Concept Proposal to Add New Disclosure of Funds Withheld Assets and Modco Assets to Annual Statement Reinsurance Schedules

(Ref. # 2024-07)

The intent of this agenda item is to make it easier for regulators to identify assets of an insurer that are subject to a funds withheld or modco arrangement.

SAPWG exposed for comment (until May 31, 2024) a concept proposal to add a new part to Schedule S in the Life/Fraternal and Health annual statement blanks and Schedule F in the Property/Casualty (“P&C”) and Title annual statement blanks, which would list all assets held under a funds withheld arrangement and would include a separate signifier for modified coinsurance assets.

Crypto Assets as Nonadmitted Assets

(Ref. # 2024-03)

SAPWG exposed for comment (until May 31, 2024) revisions to SSAP No. 20—Nonadmitted Assets to clarify that directly-held crypto assets are nonadmitted assets for statutory accounting and to adopt the definition of crypto assets from ASU 2023-08, Intangibles—Goodwill and Other—Crypto Assets (Subtopic 350-60), Accounting for and Disclosure of Crypto Assets.

Technical Revisions to Clarify Categories of Investments that are Not Permitted to be Reported as Short-Term Investments

(Ref. #2024-09)

SAPWG exposed for comment (until May 31, 2024) revisions to SSAP No. 2R—Cash, Cash Equivalents, Drafts, and Short-Term Investments to eliminate lingering references that implied that ABS, mortgage loans or Schedule BA assets are in scope of SSAP No. 2R.

Valuation of Securities (E) Task Force

(meeting materials and official summary)

The Valuation of Securities (E) Task Force (“VOSTF”) met on March 16, 2024.

Definition of an NAIC Designation

At the Fall National Meeting on December 2, 2023, VOSTF had exposed for comment (until January 26, 2024) a revised proposal from the Securities Valuation Office (“SVO”) to amend the definition of an NAIC designation in the Purposes & Procedures Manual (see Attachment Two of the meeting materials for the exposed proposal, the comment letters received, and the SVO’s recommended responses to the comments). At the March 16, 2024 meeting, VOSTF discussed the comments received and directed the SVO to continue to work with interested parties and VOSTF members to produce a revised draft of the amendment.

SVO Discretion over NAIC Designations

At the Fall National Meeting, VOSTF had exposed for comment (until 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 (see Attachment Three of the meeting materials for the exposed proposal, the comment letters received and the SVO’s recommended responses to the comments).

VOSTF Chair Carrie Mears addressed the following key themes:

  • In her view, the comment letters provide “constructive feedback” that will be incorporated in the final version of the proposal.
  • The process will provide transparency; i.e., insurers will be informed of the reasons for the SVO’s decision, including the methodology the SVO used in arriving at its decision.
  • The process will include a robust oversight role for the state regulators.
  • The discretionary override process will be targeted to specific securities and is not intended to address concerns about a whole asset class, since there are other mechanisms for doing that.
  • Regarding timing, VOSTF will be holding a “regulator-only” meeting in May to discuss the comments with SVO staff, so that the SVO can work on a revised draft of the proposal, which will then be exposed for comment in the summer and discussed at the NAIC Summer National Meeting in August.
  • After the discretionary override process is adopted, it will take one to two years to develop the infrastructure to operationalize it.
  • The SVO override process will be complementary to the enhanced due diligence review process for credit rating providers (“CRPs”) that the Financial Condition (E) Committee (“E Committee”) is pursuing under the holistic framework document and work plan. In other words, the NAIC is concurrently pursuing both initiatives.

A number of interested parties provided oral summaries of their comment letters. Their suggestions included the following (a partial list):

  • The need for transparency as to the methodology used by the SVO in reaching its decision to override a CRP rating.
  • Ensuring that state regulators have a robust role in the decision-making and the appeal process.
  • Retaining an independent third-party auditor to review and report at least annually on the operation of the process, and to recommend potential improvements.
  • Conducting a “road test” of the SVO challenge process before adopting it.
  • Potentially restructuring the SVO into a separate policymaking and analytical unit.
Update on CLO Modeling Methodology

During the meeting, Eric Kolchinsky, Director of the NAIC Structured Securities Group (“SSG”), provided an update on collateralized loan obligation (“CLO”) modeling methodology.

Mr. Kolchinsky reported that the CLO Ad Hoc Working Group continues to work diligently on developing a methodology for assigning NAIC credit designations for CLOs through a financial modeling process. He stated that he is collaborating closely with the C1 Subcommittee of the American Academy of Actuaries (“Academy”). This represents a potentially significant shift from when the SSG’s CLO initiative was operating independently of the RBC IRE WG.

He requested that the effective date for implementing the CLO modeling be extended to December 31, 2025, stating that this will allow for an alignment of his committee’s work with the Academy and the E Committee’s holistic framework.

In our view, this revised timetable will allow for the possibility that the E Committee, VOSTF and the Risk-Based Capital Investment Risk and Evaluation (E) Working Group (“RBC IRE WG”) may ultimately decide not to implement a modeling process for CLOs after all.

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

(meeting materials and official summary)

The RBC IRE WG met on March 17, 2024.

ABS RBC Update from Academy’s C-1 Subcommittee

Steve Smith, Chair of the Academy’s C-1 Subcommittee, provided a status update on the Subcommittee’s three current workstreams (see Attachment B of the meeting materials).

1. RBC Framework for CLOs (long-term project)

The CLO workstream will be conducted in accordance with the following step-by-step plan:

  • Identify as many candidates as possible for “comparable attributes” (i.e., anything that can be used to differentiate risk, such as CRP rating, thickness of residual tranche, credit support)
  • Run CLOs through a range of scenarios and multiple available models
  • Narrow comparable attributes to the most informative ones and evaluate whether a subset of attributes determine most of the tail risk.
    • If a small set of easily identifiable attributes explain most of the tail risk, then these become candidates for determining C-1.
    • On the other hand, if a large/complex set of attributes are required for determining risk, then modeling individual securities may be necessary.

Mr. Smith also reported that Eric Kolchinsky of the SSG is assisting the Academy with this analytical process.

2. Review of CRP Rating Methodologies (medium-term project)

Mr. Smith reported that the C-1 Subcommittee is taking the following approach to its review of CRP rating methodologies:

  • Focusing on Moody’s, S&P, KBRA, and DRBS, because they rate ABS.
  • Studying the CRPs’ methodologies, focusing on tail risk.
  • Reviewing historical data on default and loss experience by rating.
  • Integrating results with the comparable attributes workstream described above.
  • Planning for completion by the NAIC Summer National Meeting in August.

3. Review of Oliver Wyman Study on Residual Interests (short-term project)

Mr. Smith noted that the Academy has also undertaken, as a short-term project, a review of the Oliver Wyman study on residual tranches, and in particular is considering whether it aligns with the core principles for ABS RBC that were endorsed by the RBC IRE WG at the Fall National Meeting in December 2023. He said that the Academy is expected to complete this review by April 8, 2024.

Discussion of Residual Tranche Risk Analysis Provided by Oliver Wyman

(see Attachments C and D of the meeting materials).

RBC IRE WG Chair Philip Barlow stated that, although the RBC IRE WG had already adopted an interim 45% RBC factor for residual interests for life insurers effective in 2024, it had also expressed a willingness to consider proposals supported by data that could potentially support a different factor.

Chair Barlow stated that the 45% RBC factor had been chosen as a “reasonably conservative” factor and that any alternative proposal would also need to satisfy the “reasonably conservative” criterion. He noted that the Alternative Credit Council (“ACC”), the private credit affiliate of the Alternative Investment Management Association (“AIMA”), had commissioned research by Oliver Wyman, and that Oliver Wyman’s report, together with a February 26, 2024 letter from the ACC, had been included in the materials for the meeting.

He then asked the ACC representatives to address the RBC IRE WG and respond to questions and comments from the regulators.

Joseph Englehard of the ACC, accompanied by two insurance company representatives, discussed the Oliver Wyman report and highlighted the following points.

  • Oliver Wyman modeled portfolio average losses for residual tranches of five asset classes: broadly syndicated CLOs (“BSL CLOs”), middle market CLOs, student loan ABS, subprime auto loan ABS and prime auto loan ABS.
  • Scenarios modeled included the “dot com” scenario, the “great financial crisis” (“GFC”), mid-tail, long mid-tail, and deep-tail.
  • The Oliver Wyman study concluded that, on a portfolio basis, ABS residuals performed better than common equity under all modeled stress scenarios, which the ACC letter suggested provided a justification for moving the RBC factor for residual interests from 45% back to 30%.

There were extensive comments and questions from RBC IRE WG members.

  • RBC IRE WG members, including Chair Barlow, generally expressed the view that the Oliver Wyman study in its current form justified the 45% RBC factor that is currently in place.
  • Among other things, it was pointed out that the portfolio average losses for BSL CLOs in the “dot com” and GFC scenarios were 45% and 42%, respectively, and that of the ABS asset classes that Oliver Wyman had analyzed, BSL CLOs were the most significant asset class in life insurer portfolios.
  • It was also pointed out that ABS backed by underlying equity were not addressed in the Oliver Wyman study.
  • One of the state regulators made a point of asking whether the two insurer representatives were affiliated with private equity-owned insurers, and expressed the view that residual interests are a “potentially vanishing asset” that behaves differently from common stock.

Chair Barlow expressed a willingness to continue to work with the ACC proposal and Oliver Wyman study to see if, with revisions, they would support a reasonably conservative RBC factor other than 45%.

  • He directed that the Oliver Wyman report be exposed for a 21-day comment period, ending April 8, 2024.
  • He explained that the reason for the short exposure period was that any proposed change to the RBC factor for residuals would need to be exposed for comment by April 30, 2024, in order to have sufficient time for adoption by the Capital Adequacy (E) Task Force (“CapAd TF”) by June 30, 2024, to be able to go into effect for year-end 2024.
  • He also said that the RBC IRE WG was not going to agree to the request from the American Council of Life Insurers (“ACLI”) for a one-year deferral of the 45% interim RBC factor.
  • He announced that NAIC staff would be compiling statistics on residual holdings of insurers based on the 2023 annual statements, that the statistics would be shared with regulators, and that an anonymized version of the report would be made publicly available.
Review of RBC Matters for Funds

Chair Barlow directed attention to a March 4, 2024 memo (see Attachment E of the meeting materials) outlining a two-pronged project assigned to NAIC staff relating to treatment of funds:

  • Review and consider changes to the RBC treatment for funds on the “NAIC Fixed Income-Like SEC Registered Fund List” (which currently receive a 30% RBC factor), particularly whether these registered funds should receive similar RBC treatment to funds on the “SVO-Identified Bond ETF List” and funds on the “NAIC List of Schedule BA Non-Registered Private Funds with Underlying Assets Having Characteristics of Bonds or Preferred Stock” (both of which currently receive a bond RBC factor based on their SVO-assigned designation).
  • Review and consider changes to the RBC calculation in the context of asset concentration charges, to align with, if applicable, what is prescribed in the Supplementary Investment Risks Interrogatories (“SIRI”) in relation to treatment of diversified vs. non-diversified funds.

Chair Barlow expressed the view that funds with comparable risk profiles should be treated similarly regardless of structure.

Capital Adequacy (E) Task Force

(meeting materials and official summary)

The CapAd TF met on March 17, 2024.

Discussion of Whether to Continue Including RBC Data in Annual Statements

The CapAd TF received a report from its RBC Purposes & Guidelines Ad Hoc Subgroup (the “Subgroup”) (see Attachment Seven to the materials). The Chair of the Subgroup led a discussion of the current disclosure of the authorized control level (“ACL”) and total adjusted capital (“TAC”) in the five-year history page of insurers’ annual statements, and whether this is necessary and useful or may lead to an unintended reliance on RBC outside of its intended scope. An extensive discussion ensued.

Regulators who favored removal of ACL and TAC from the annual statement blanks noted that RBC data is generally supposed to be confidential and expressed concerns about the ACL and TAC being misinterpreted as equivalent to financial strength ratings.

Other regulators and interested parties pointed out that this RBC information has been included in the annual statements for a long time and questioned the reduced transparency that would result from deleting it.

After discussion, CapAd TF Chair Tom Botsko directed the Subgroup to give further consideration to this topic.

Proposal of Increased RBC Factor for Residual Interests for P&C and Health Insurers

As discussed above, the CapAd TF has already increased the RBC factor for residual interests from 30% to 45% for life insurers on an interim basis, whereas the RBC factor for residual interests for health and P&C insurers has until now remained at 20%.

After discussion at the March 17, 2024 meeting, the CapAd TF decided to expose for comment (until April 16, 2024) a proposal to increase the RBC factor for residual interests for health and P&C insurers from 20% to 45%, matching that for life insurers.

Financial Condition (E) Committee

(meeting materials and official summary)

The E Committee met on March 18, 2024.

Development of a Request For Approval to Design a Due Diligence Framework for NAIC Use of CRPs

On February 14, 2024, E Committee Chair Nathan Houdek sent a memo to the NAIC Executive (EX) Committee Chair, Andrew Mais, requesting approval to develop a request for proposal (“RFP”) for purposes of engaging a consultant to design and help implement a new due diligence program relating to the NAIC’s ongoing use of CRPs. (See Attachment Eleven to the meeting materials.)

At the E Committee’s March 18, 2024 meeting, Chair Houdek announced that the Executive (EX) Committee had approved the request to develop such an RFP, and that accordingly the E Committee would initiate that process in the near future.

VOSTF Chair Mears stated at the E Committee meeting that the VOSTF is very supportive of the RFP process. Although this RFP process is clearly relevant to the work of the VOSTF and the SVO, it is worth pointing out that it is the E Committee, rather than the VOSTF, that “owns” this RFP process.

Some highlights from the E Committee’s February 14, 2024 memo to the Executive (EX) Committee, outlining the initial considerations for the RFP:

  • The objective is to eliminate blind reliance on CRPs while maintaining responsible use of the invaluable service they can provide.
  • The due diligence process for CRPs will need to be consistent across rating agencies, repeatable over time, one that fosters communication and engagement with the CRPs, and both quantitative and qualitative in nature.
  • The due diligence process for CRPs should be designed to set minimum standards for inclusion.
  • The process should utilize existing resources to the extent possible (such as disclosures made by the nationally recognized statistical rating organizations to the US Securities and Exchange Commission (“SEC”) or to other regulators), recognizing that the NAIC’s requirements, as a consumer of credit ratings, to produce NAIC designations for insurance regulatory purposes, go beyond the mandate of SEC oversight.
  • The process may want to consider different standards for public versus private ratings given the market validation and transparency of public ratings (e.g., require the full filing of private security documentation to provide regulators with transparency), ways to minimize or ameliorate the incentive for insurers to ratings shop (e.g., obtaining the highest public or private rating by selecting the weakest methodology), such as requiring multiple ratings, and how to best utilize the SVO to ensure the reasonability of NAIC designations.
  • The process should be designed not to impede innovation and, therefore, have alternative ways to measure past or potential future performance for emerging asset types.
Framework for Regulation of Insurer Investments

On February 15, 2024, the E Committee’s exposed a revised draft of a Framework for Regulation of Insurer Investments (“Framework”), a work plan for implementing the Framework and a memorandum and appendix that summarized regulators’ reaction to previously submitted comments on the Framework.

Although the comment period is still open, running until April 1, 2024, the E Committee provided an opportunity at its March 18, 2024 meeting for preliminary oral comments on these documents.

The following are highlights of the oral comments presented by various speakers:

  • A speaker asked for a recognized process of coordination to be established among the various NAIC subunits and interested parties to ensure that work is conducted in accordance with the holistic framework, and that the overall impact of the various initiatives is being considered, including through a cost-benefit analysis.
  • A speaker expressed the view that while attention to tail risk is important, the principle of “equal capital for risk” should not be limited to “equal capital for equal tail risk.” That speaker also said that, while supportive of the NAIC developing a due diligence process for CRPs, he believes the use of CRPs should continue to be the primary resource for assigning credit designations.
  • A speaker suggested that the NAIC could use historical performance statistics (and other data analytics as needed) to objectively measure the durability and thus reliability of CRP ratings. He also suggested that a similar assessment should be performed with respect to the SVO.
  • A speaker urged that regulators be equipped with the tools and resources to assess the impact on insurers of new and emerging risks, such as risks flowing from the recent rise in interest rates, with its negative impact on fair valuations and prepayment cash flows.
  • A speaker expressed support for the principle of “equal capital for equal tail risk,” and for the use of modeling as an alternative to CRP ratings, in order to properly focus on subordinated structure investments, which carry the greatest risk.

Risk-Focused Surveillance (E) Working Group

(meeting materials and official summary)

The Risk-Focused Surveillance (E) Working Group (“RFS WG”) met on March 16, 2024.

The RFS WG discussed the progress of its Affiliated Investment Management Agreement Drafting Group (“Drafting Group”), which was formed to address issues referred from the Macroprudential (E) Working Group in 2022. (See Attachment A to the meeting materials for details of the Drafting Group’s proposals.)

  • The Drafting Group has referred issues relating to capital maintenance agreements and surplus note issuances to the Financial Analysis Solvency Tools (E) Working Group.
  • The Drafting Group has developed a blanks proposal to revise general interrogatory 29.05 in the annual statement blanks, to clarify that insurers need to disclose any investment sub advisors (not just primary advisors) in their response to the interrogatory. That proposal was exposed for comment (until April 23, 2024) by the Blanks (E) Working Group.
  • The Drafting Group has developed proposed edits to the NAIC’s Financial Analysis Handbook and Financial Condition Examiners Handbook (the “Handbooks”) to provide additional guidance to regulators in reviewing affiliated investment management agreements and services provided to an insurer. The RFS WG exposed the Drafting Group’s proposed changes to the Handbooks for a 45-day comment period, ending April 30, 2024.

To view additional updates from the US NAIC Spring 2024 National Meeting, visit our meeting highlights page.

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