Key Updates from the NAIC Fall 2022 National Meeting

The 2022 National Association of Insurance Commissioners (NAIC) Fall National Meeting recently took place December 12-16 in Tampa, Florida. Several key updates were discussed during the meeting which could have implications for insurers’ investment portfolios, including updates on Rated Notes, CLOs, and IMR.

Securities Valuation Office (SVO) proposes new definition for structured equity and funds¹

On November 28, 2022, the NAIC’s SVO issued a proposed amendment to the Valuation of Securities Task Force (VOSTF) to define and add guidance for “Structured Equity and Funds” to the Policies and Procedures (P&P) Manual.

The SVO highlighted several concerns particularly regarding feeder fund structures including:

• Circumvention of regulatory guidance
• Reliance on ratings from Credit Rating Providers (CRP) through the Filing Exempt process
• Risk-based Capital (RBC) / State Investment Limit arbitrage
• An overall lack of transparency into the true underlying risks, credit exposure, and nature of the investment

In its memo, the SVO provided two numerical examples of feeder fund structures which enable RBC arbitrage opportunities ranging from 5.4% to 26.6%. The SVO is proposing to amend the P&P Manual to include a definition for Structured Equity and Funds and to exclude such investments from Filing Exemption eligibility. The proposal was exposed for a 60-day public comment period ending on Monday, February 13, 2023.

Structured Securities Group’s (SSG) proposed methodology for modeling of CLOs²

On December 14, 2022, Eric Kolchinsky, Director of the NAIC’s SSG delivered an update on the SSG’s proposed methodology recommendation for the modeling of CLOs. The proposed methodology will be based on SSG’s annual CLO stress tests. Critically, the proposal excludes the specific Macroeconomic Scenarios to be used in the process. SSG believes that the discussion of the Scenarios will be in depth and will take place after the methodology is officially agreed upon.

In the initial modeling phase, only Broadly Syndicated Loan (BSL) CLOs will be included. The initial modeling phase will exclude the following:

• Commercial Real Estate (CRE) CLOs – SSG noted different assumptions are required for modeling commercial real estate risk
• Re-securitizations, asset-backed securities (ABS), collateralized debt obligations (CDOs) and trust preferred securities (TruPS) CDOs are out of scope
• Middle Market (MM) CLOs are temporarily excluded as the asset class requires specialized assumptions. SSG hopes to return to these assets after the implementation of BSL modeling is complete

In terms of timing, SSG’s goal is to have the final methodology and scenarios approved and in effect by January 1, 2024. This would effectively allow for another year of iteration with industry participants before insurers are required to use the new designation methodology to report their December 31, 2024 CLO holdings in their Statutory filings.

Numerical examples were not provided in the proposal and are expected to come in the first half of 2023. The SSG’s proposal was exposed for a 60-day public comment period ending on Monday, February 13, 2023.

Lastly on the topic of CLOs, the C1 Work Group (C1WG) of the American Academy of Actuaries (AAA) delivered a presentation during the Risk-Based Capital Investment Risk and Evaluation Working Group (RBCIREWG) session on Wednesday, December 14, 2022.³ 

The presentation was intended as a commentary and response to the Investment Analysis Office (IAO) issuer paper dated May 25, 2022, proposing a new approach to C-1 RBC factors for CLOs. Key highlights of the presentation included the following C1WG opinions:

• The traditional corporate bond RBC factors are not appropriate for CLOs given different probability of default and loss given default figures for corporate bonds and CLOs
• CLOs are not a material risk to the aggregate solvency of the life insurance industry currently given life insurers’ relatively small (albeit growing) exposure to CLO investments
• Disagreement with the premise that there should be no risk arbitrage between the total CLO underlying collateral versus a vertical slice of each of the CLO tranches

Life insurers advocate for the allowance of negative Interest Maintenance Reserve (IMR)⁴

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 Fall Meeting Statutory Accounting Principles Working Group (SAPWG) session on December 13, 2022, the American Council of Life Insurers (ACLI) October 31, 2022 letter was presented and discussed. The letter raised urgent concerns with existing statutory accounting requirements pertaining to disallowing negative IMR.

At the conclusion of the session, the NAIC staff recommended that the SAPWG include negative IMR on its maintenance agenda as a new SAP Concept for discussion and documentation. In addition, the SAPWG exposed SSAP No. 7 and the negative IMR issue for guidance and requested industry participants provide details for consideration including potential guardrails. The comment period deadline is Friday, February 10, 2023.