Key Updates from the 2023 NAIC Spring National Meeting

The 2023 National Association of Insurance Commissioners (NAIC) Spring National Meeting recently took place March 21-25 in Louisville, Kentucky. Several key updates to existing proposals were provided which could have implications for insurers’ investment portfolios. Below we highlight updates related to the Structured Equity and Funds, CLO and residual tranches, and IMR initiatives.

Valuation of Securities Task Force (VOSTF) Asks the Securities Valuation Office (SVO) to Outline a More Concrete, Transparent Process Around Private Letter Ratings (PLRs)

At the VOSTF session on March 23^rd, discussion centered around the scope of the Structured Equity and Funds proposal released by the SVO late last year. Many industry participants believe the scope of the initial proposal is too broad and not clearly defined. The SVO’s original proposal highlighted several concerns, particularly regarding Rated Note feeder fund structures, including a reliance on ratings from Credit Rating Providers (CRPs) through the Filing Exempt (FE) process. It proposed an amendment to define and add guidance for “Structured Equity and Funds” to the Purposes and Procedures (P&P) Manual and to exclude such investments from FE eligibility.

At the VOSTF session, further refinement of the proposal’s scope was provided, limiting the focus to securities with private letter ratings, whereas previously the proposal did not explicitly differentiate between public and private securities. VOSTF Chair Carrie Mears tasked the SVO with defining a more formal, transparent process around what would trigger an SVO review of a PLR and potentially prevent FE eligibility. Chair Mears provided the analogy of a stoplight, likening the current process to a green light (FE) and red light (not FE) situation. She noted she would like to include a yellow light, whereby SVO staff will be able to filter, and review select PLRs to best determine FE eligibility. Industry is hopeful the SVO’s response will include clearly defined criteria specifying what would disqualify a Rated Note security from FE eligibility as well as the criteria which would allow a security to remain FE. Importantly, the outcome of the SVO’s process proposal back to VOSTF may result in the SVO being granted the authority to reject PLRs in the future, an authority it does not currently have.

While specifics around timing were not provided during the session, it is believed the NAIC staff will proceed with urgency given they have expressed concern with the extreme growth of PLRs over the last few years (PLRs reported by US insurers have grown from a total of 2,850 in 2019 to 5,580 in 2021)¹ and with the risk that insurers are potentially undercapitalized against the market risks from Rated Note feeder investments.

Structured Securities Group (SSG) Details Next Steps for Ad Hoc Modeling Group

Also during the VOSTF session, Eric Kolchinsky, director of the NAIC’s SSG provided an update on the latest work being done on the CLO RBC project. Eric noted the formation of the ad hoc modeling group and described its purpose, which is to provide interested parties with a better understanding of the NAIC’s approach to modeling CLOs as well as to resolve and clarify technical and modeling issues. He outlined that the main short-term goal for the ad hoc group will be to demonstrate the effects of pre-pay/discount purchases to regulators, a process which should take about two months and will be modeled off of three to four proxy CLO deals from industry, which will be run through Stress Scenarios A, B and C from the NAIC’s Annual CLO Stress-testing analysis. In the intermediate term, the goal for the ad hoc group will be the work around developing macroeconomic scenarios and the fine tuning of the probabilities of those scenarios.

SSG’s proposed timeline to have the final methodology and scenarios take effect January 1, 2024 remains in place.

Risk-Based Capital Investment Risk and Evaluation Working Group (RBCIREWG) Proposes to Move Forward with the Interim Solution for Residual Tranches of Securitizations

At the RBCIRE session on March 23^rd, audience members heard from interested parties both in favor of and opposed to the interim solution of adding new risk factors for the residual tranches of CLOs. Representatives from MetLife and Global Atlantic spoke before the committee highlighting details from their comment letters. MetLife spoke in favor of the interim solution and advocated for a residual tranche factor of at least 45%. Global Atlantic, meanwhile, argued against the interim solution claiming that CLOs do not pose a material solvency risk to the insurance industry as a whole. Global Atlantic recommended a more comprehensive and thoughtful approach to updating securitized RBC akin to what was undertaken during the C1 bond factor project. The American Council of Life Insurers (ACLI) also spoke during the session and noted its support for more quantitative analysis before a final factor is implemented. The ACLI also noted its support for sensitivity testing to complement the quantitative analysis to be performed as well as its backing of a single factor solution as opposed to three new factors.

Chair Philip Barlow noted during the session the RBCIRE WG’s goal remains to adopt an interim solution by year end. Practically speaking, this means adoption of a structural change by the end of April and the adoption of a new factor(s) by the end of June in order to implement by year end. Chair Barlow also commented that once the interim solution for CLOs is finalized it could be used as a guidepost for other types of structured ABS in the future. Lastly, he commented that sensitivity testing would be welcome in addition to but not as a substitute for the other modeling work to be done.  

The Working Group has scheduled its next meeting, the purpose of which is to discuss comments on and the consideration of the adoption of the residual tranche structure change and sensitivity test, for Thursday, April 20th. Drafts of the Revised Residuals Structure² and Sensitivity Test³ have been exposed for public comment with a deadline of April 12^th.

Statutory Accounting Principles Working Group (SAPWG) Elects for Consideration of Negative Interest Maintenance Reserve (IMR)

IMR is a concept which was established for life insurers’ statutory accounting in 1992 to amortize realized, interest-related capital gains and losses on fixed income assets into statutory earnings over the remaining life of the asset. It serves to stabilize statutory surplus and earnings against interest-related realized gains/losses. Interest-related realized gains result in an offsetting IMR increase, and vice versa for losses. However, aggregate IMR cannot go below zero ─ at which point realized losses would be reflected immediately.

During periods of falling interest rates, IMR has been used to smooth interest-related realized gains into earnings and surplus. However, given 2022’s rapid and significant rise in interest rates, insurers are starting to realize losses, potentially depleting their IMR. Since IMR cannot become negative, insurers may have to realize losses immediately, which in turn reduces statutory earnings and total statutory surplus.

During the SAPWG session on March 22^nd, the Working Group elected to develop guidance for future consideration that would allow the admission of negative IMR up to 5% of statutory surplus, subject to certain limitations, using the type of limitation calculation like that used for goodwill admittance. While most public life insurers still have positive IMR balances, and thus no immediate negative impact to statutory surplus and RBC ratios, the potential allowance of negative IMR balances in the future would be an overall positive for the life insurance industry.

In terms of timing, SAPWG has expressed an intent to work on both a 2023 solution as well as a long-term solution. The Working Group noted it would need a first draft completed by June 30^th in order to adopt a near-term solution by year end.