Key updates from the 2024 NAIC Summer National Meeting

The National Association of Insurance Commissioners (NAIC) recently held their Summer National Meeting in Chicago, and investments continue to be in the regulatory spotlight. Below are the key updates from the meeting on NAIC initiatives impacting insurer portfolios:

• Adoption of Securities Valuation Office (SVO) discretion to challenge filing-exempt NAIC designations
• Comprehensive review of risk-based capital (RBC) for funds
• Statutory accounting for credit repacks
• Collateralized Loan Obligation (CLO) RBC framework analysis behind schedule
• Release of principles-based bond definition issue paper and Q&A
• Debt securities issued by non-registered funds under bond definition

Adoption of SVO discretion to challenge filing-exempt NAIC designations

The NAIC has adopted the latest proposal for the SVO to have discretion to challenge NAIC designations assigned through the "filing-exempt" process (i.e., based on credit ratings) where they estimate a 3+ notch difference. The challenge process will include an open dialogue with insurers who hold the security and relevant parties who will be able to provide data and analysis supporting the original credit rating. It is unlikely to take effect until January 1, 2026, due to technological requirements to develop notification and data transfer systems. The final proposal can be found here: SVO Discretion Proposal.

It is unclear exactly how and where the SVO will use this discretion and how successful their challenges will be. Any filing-exempt security is in scope, whether public or private, credit obligation or structured, or rated by a small or large CRP. However, the NAIC has stated this discretion is "not expected to be used often," and that it will not target a specific asset class or credit rating agency. Practically, we expect they will focus their efforts on securities with certain characteristics that have raised concern before: single private letter ratings with weak rationale reports, complex structures, single or limited investor base, and relatively high spreads for the stated credit quality.

Comprehensive review of RBC for funds

The NAIC has stated that they intend to take a comprehensive look at RBC treatment for funds to better align RBC with the risk for different types of funds. This initiative is in reaction to several outstanding agenda items related to RBC for fund structures, which the NAIC hopes to tackle holistically through this process. Interested parties have been asked to provide initial education and guidance to regulators on important focus areas as they start this initiative. While it is unclear what the outcome of this process will be, the intent is to more appropriately reflect the differing risk profiles of different fund structures or fund investment types.

Statutory accounting for repacks and derivative wrapper instruments

The NAIC has exposed a conceptual proposal for the accounting treatment of "repack" investments due to questions they have been receiving on how such investments would be classified under the new bond definition effective next year. These structures combine a debt security and a derivative in an SPV to transform the debt investment in some way, such as from floating to fixed or to change the currency. This can be beneficial for the insurer compared to purchasing the debt and derivative separately for collateral, operational, and accounting treatment purposes, but also obfuscates the nature of the investment from regulators if reported as just a single debt security.

The NAIC's proposal would require insurers to bifurcate statutory reporting of the underlying debt security and the derivative as if they were held separately, with the underlying debt security evaluated under the new bond definition. This would provide regulators with more clarity into insurers’ derivative usage and exposure, but separate reporting of the derivative will likely increase the operational burden and balance sheet volatility for insurers invested in these structures. A comprehensive discussion of the investments and statutory considerations can be found here: SAPWG Meeting Materials.

CLO RBC framework analysis behind schedule

The American Academy of Actuaries provided an update that they are behind schedule on their original timeline for the analysis supporting a new framework for CLO RBC, due to challenges in receiving all necessary data. Their analysis will gather risk metrics for BSL CLOs from a number of different sources and regress those results against numerous "comparable attributes" of those securities. This will allow them to determine which attributes best explain the risk, if any, and inform the structure of the new framework. The Academy had originally planned to share initial results by the Fall National Meeting in November, but this will now be sometime in 2025.

Given this revised timeline for initial analysis, and the subsequent steps to iterate with regulators and interested parties based on the results, a final framework for CLO RBC will likely not be effective until 2026 or later.

Principles-based bond definition issue paper and Q&A released

The NAIC has put out two pieces to support the new bond definition implementation: 1) an issue paper that provides additional context and commentary supporting the official guidance and 2) a Q&A document which goes into additional detail on specific situations or common questions they have received. These documents are meant to provide context and clarification as insurers work through implementation of the new bond definition effective next year. The documents can be found here: Issue Paper (beginning page 299) and Q&A.

Debt securities issued by non-registered funds under bond definition

The NAIC is close to adopting a modification to the principles-based bond definition that would allow debt issued by non-SEC-registered funds to be considered issuer credit obligations (ICO). Small adjustments were made to the latest proposed language which are exposed through September 6^th, at which point it will likely be adopted. The revised guidance emphasizes that in order for the debt to be considered an ICO, the fund issuing the debt security must doing so as an “operating entity” acting primarily on behalf of equity holders in principle. If not, the debt security should be evaluated as an asset-backed security, and therefore will be subject to cash flow and credit enhancement evaluation. The intent is to prevent feeder funds structures from being considered ICOs.