At the Spring 2023 National Meeting of the US National Association of Insurance Commissioners (“NAIC”), the NAIC Risk-Based Capital Investment Risk and Evaluation (E) Working Group (“RBC IRE WG”) held its meeting on March 23, 2023. Below are updates from the RBC IRE WG meeting, which was chaired by Philip Barlow of the District of Columbia Department of Securities, Insurance and Banking.

Afte approving the minutes of the February 2023 and December 2022 meetings, the RBC IRE WG received updates from Carrie Mears, chair of the Valuation of Securities (E) Task Force, and Dale Bruggeman, chair of the Statutory Accounting Principles (E) Working Group.

The RBC IRE WG then received a report from Stephen Smith, chair of the C1 Work Group of the American Academy of Actuaries (the “Academy”), which is assisting the RBC IRE WG in its review of the risk-based capital (“RBC”) treatment of collateralized loan obligations (“CLOs”), both on an interim and long-term basis. Mr. Smith said that the Academy is working on a document to clarify definitions of key terms, such as “RBC arbitrage.” In response to a question from Ms. Mears, he stated that he anticipated this would take about two months.

Mr. Barlow then turned to the topic of developing a new RBC factor or factors for residual tranches of asset-backed securities (“ABS”). He stated that the charge the RBC IRE had received from the Financial Condition (E) Committee (“E Committee”) was to address RBC for residual tranches of all ABS, not just CLOs. He expressed the hope that the current work on a solution for CLOs would also produce a methodology that could be applied to residual tranches of other ABS.

A discussion ensued among members of the RBC IRE WG, and the question was raised as to whether it was necessary to adopt an interim solution in the form of a higher RBC factor for residual tranches, or whether it would be better to complete the more extensive analysis that the Academy is facilitating before making RBC changes. Chair Barlow expressed the view that the E Committee had given the RBC IRE WG a mandate to develop both an interim and a long-term solution, and that the RBC IRE WG could not alter that mandate without permission from the E Committee.

Based on the discussion among members of the RBC IRE WG and comments from interested parties (which referenced comment letters they had submitted in advance of the meeting), it was evident that there are two schools of thought on how to deal with RBC factors for residual tranches:

  • The “take the time to get it right” school of thought reflects the following perspectives:
      • Changes to the RBC system need to be based on thorough analysis.
      • It is not clear whether these investments pose a material solvency risk to insurance companies.
      • There is not yet a consensus definition of what constitutes “RBC arbitrage,” or even a residual tranche.
      • Precipitous changes could have unintended consequences, including the opposite of what is intended.
  • The “something must be done now” school of thought reflects the following perspectives:
      • The current treatment of residual tranches (an equity RBC charge of 30 percent) is too low and does not reflect the tail risk.
      • This is a bigger issue than some people realize, and there are insurance companies with material exposures that need to be addressed now.
      • An interim solution should be implemented now without waiting for the long-term solution to be developed, and it can be done easily by adopting an interim RBC charge on residual tranches that is higher than the current level of 30 percent.

The next meeting of the RBC IRE WG has been scheduled for April 20, 2023, to discuss comments on and consider adoption of a structure change and sensitivity test for RBC of residual tranches. There is a strong possibility that the RBC IRE WG will expose for comment a proposed interim RBC factor for residual tranches at that meeting. In addition, a meeting of the RBC IRE WG’s parent group, the Capital Adequacy (E) Task Force, which has ultimate authority over RBC, has been scheduled for April 28, 2023, presumably to address the same topic. In order for any new RBC factor to be effective for the 2023 annual reporting cycle for insurance companies, it would need to be adopted by June 30, 2023, so the scheduling of these April meetings may be looking ahead to that timing.

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