2024 NAIC Spring National Meeting Update

The 2024 NAIC Spring National meeting, which concluded March 18, yielded important developments for insurers that ran the gamut from principles-based bond definitions to residual capital charges. Here’s a quick look at the highlights: 

• The last remaining document of the principles-based bond definition was adopted: the Statement of Statutory Accounting Principles (SSAP) No. 21, which covers “other assets” on Schedule BA. Other related workstreams are still in progress.
• Residual risk treatment received much attention, with discussion of a new study from Oliver Wyman and debate on returning to a lower 30% capital charge rather than 45% for 2024. There was also a proposal to raise the charge to 45% for P&C and health insurers to align with the charge for life insurers. We expect a lot of action over the next few weeks and months.
• The ETA for CLO modeling has been postponed. The workstream on comparable attributes for CLO tail risk is narrowing the set of attributes, hoping to form the basis for determining CLO C1 RBC charges. CRP-rating methodologies are also under review, at this point focused squarely on CLOs.
• The latest iteration of a proposal related to a key initiative, the SVO’s discretion, was presented. Previously raised concerns were addressed, and a dozen or so comment letters submitted in response to the most recent draft were reviewed. Additionally, a related initiative—CRP due diligence—moved to the RFP stage.
• An ACLI-led initiative to propose aligning risk-based capital treatment of repurchasing agreements with that of conforming securities-lending programs is currently on pause while the feasibility of this convergence is assessed. Items to address relate to collateral as well as reporting consistency and transparency.
• In other developments, changes were made to the treatment of perpetual and mandatorily redeemable preferred stock, with realized gains/losses on sale flowing through AVR. Work is also underway to address covariances in the RBC formula, and more comments were fielded on a holistic framework to regulate insurers’ investments.

Principles-Based Bond Definition Is Complete  

It’s officially done! At its March 16 session, the Statutory Accounting Principles Working Group (SAPWG) adopted the last remaining document of the principles-based bond definition: the Statement of Statutory Accounting Principles (SSAP) No. 21. Of the three major SSAPs that comprise the definition, the first two (SSAP No.26--Bonds and SSAP No.43--Asset-backed securities) were adopted in 2023. The final piece, SSAP No.21 covers “other assets” on Schedule BA. Highlighting the significance, the entire room broke into applause after the vote—the first time we’ve witnessed a celebration of that kind at an NAIC meeting after adopting a regulatory document. The NAIC will now work on comprehensive guidance and education materials to help industry participants implement the new bond definition.

Other workstreams related to the principles-based bond definition are still in progress: 

Schedule BA changes, which aim to expand collateral loans’ reporting categories, are expected to be adopted in May. We discussed these changes in our February NAIC update. 

The Debt Securities Issued by Funds proposal first came to light at the January 10, 2024 SAPWG call. As SSAP No.26 stands now, it considers SEC registration of certain operating entities an automatic qualifier for their debt securities to be classified as issuer credit obligations (ICOs). Therefore, securities issued by two otherwise very similar funds—one SEC-registered and the other not—might be classified differently. The proposal’s intent was to eliminate this SEC registration-based qualification, instead ensuring that debt securities issued by funds are classified consistently based on fundamental principles, not rules. 

We expected the proposal to be adopted at the Spring National Meeting, but it has been postponed and re-exposed to address an unintended interpretation of the guidance—some market participants signaled informally that they would classify debt securities issued by feeder funds as ICOs. Such an interpretation exceeds the proposal’s original intent, so more work is needed to address the issue. As a first step, regulators would need to understand how this interpretation is even feasible, given that the proposal and the accompanying issue-paper draft specifically attempt to distinguish between funds whose purpose is to raise equity capital (operating entities, leading to an ICO qualification for their debt securities) and those vehicles designed to raise debt capital (asset-backed securities, or ABS). Feeder funds are in the latter category, while the proposal’s original scope was limited to funds intended to raise primarily equity capital.  

The SAPWG stressed that, while the work continues, the current version of SSAP No.26 remains the authoritative guidance. So, for now, SEC registration of a fund continues to guarantee that the bonds it issues are ICOs, and debt issued by non SEC-registered funds must be assessed as ABS. The proposal is exposed for comments until May 31, 2024. 

Residuals: A New Study and More Debate on Capital Charges 

Residuals received much attention at the Spring National Meeting. For some time, the NAIC has argued that these first-loss tranches in asset-backed securitizations are riskier than, say, public equities. Also, regulators were unhappy with the perceived arbitrage: securitizations sometimes achieved a lower weighted-average capital charge than underlying assets. For these reasons, the NAIC believed that residuals should receive a higher capital charge than equities—currently 30% for life insurers’ risk-based capital (RBC) calculation. Until this year, residuals were also charged at 30%, before a 2023 interim compromise raised the charge to 45% starting in 2024, unless compelling research supports a different factor. 

At the March 17 session of the Risk-Based Capital Investment Risk and Evaluation Working Group (RBCIRE WG), Oliver Wyman’s new study on residual risks was discussed. Commissioned by the Alternative Credit Council (ACC), it’s one the first comprehensive studies of this kind, setting a precedent for similar future studies of other asset classes. The study’s guiding principle was the desire for a reasonable, conservative interim residual capital charge. The authors highlighted that any solution, including interim solutions, should be supported by data. To this end, the study modeled five securitization subclasses, covering—in aggregate—over 60% of all outstanding ABS. It concluded that residuals generally outperformed common equity in all modeled stress scenarios (more so in less-extreme scenarios); residuals for one sub class—broadly syndicated loan CLOs—performing roughly in line with common equity. Therefore, the study makes the case that the 45% interim residual capital charge is too high, and that the 30% charge should be considered reasonably conservative. 

In the ensuing discussion, regulators questioned specific aspects of the study, seeming hesitant to even consider returning to the 30% factor. Comments from the American Council of Life Insurers (ACLI) comments suggested considering varying charges for residuals in different structures (e.g., debt-backed versus equity-backed), and it requested a one-year delay in implementing the 45% factor to permit more work. The RBCIRE rejected both ideas: there’s not enough time to pass the structural change for 2024, and a 45% charge starting in 2024 was approved last year, so delay isn’t possible either. However, the RBCIRE WG committed to work with stakeholders on this proposal. The study has been exposed for 21 days for comments. The 45% factor could still be reduced for 2024, but any potential change must be exposed by the end of April and adopted by the end of June in order to take effect for the end of 2024. 

The Academy also committed to review the Oliver Wyman residual study—or any other serious study of that nature. In doing so, the Academy will particularly emphasize the six structured-securities C-1 principles presented to the RBCIRE WG at the 2023 Fall National Meeting in December. For each principle, the Academy will try to determine whether the study aligns with it or not, aiming to complete the project in April. 

At the Capital Adequacy Task Force (CATF) meeting on March 17, a proposal was put forward to increase the residual capital charge from 20% to 45% for P&C and health insurers, in order to be consistent with the charge for life insurers. We doubt the validity of this argument for several reasons: 

• The 45% residual factor on the life insurance side was extensively debated before implementation. While it’s not based on any quantitative analysis, sensitivity testing was conducted before it went into effect (the 30% base factor plus an added 15% sensitivity charge for 2023 year-end reporting). To our knowledge, no such analysis nor discussions have occurred so far for P&C or health insurers.
• P&C/health C-1 charges for all assets are numerically different from life factors, implying that they were calibrated differently. Therefore, there’s no compelling reason for the residual charges to be identical.
• Nominal life C-1 charges are subsequently tax-adjusted in the RBC template, so effective charges are lower by the amount of this tax adjustment. The 45% charge is adjusted down by the full 21% tax rate, so it effectively becomes 45%*(1 – 21%) = 35.55%. There’s no similar tax adjustment for P&C or health. At a minimum, then, the life-equivalent residual C-1 charge for P&C and health should be 35.55%, not 45%. The proposal is exposed for comments for 30 days, until April 16, 2024.

We expect a lot of action on the residuals front over the next few weeks and months, and we’ll provide further updates as this topic develops. 

CLO Modeling Time Frame Pushed Back 

The ETA for CLO modeling has been postponed until the end of 2025. Progress on modeling has been steady, but slower than initially anticipated. The Structured Securities Group (SSG) recently published cash flows on six CLO deals for 10 scenarios and is now collecting feedback, with stress scenarios the next step. The SSG continues to work closely with the ACLI C1 Working Group, as well as the American Academy of Actuaries (“Academy”). We view the postponement as an unfortunate, albeit expected, occurrence. Many insurers are reluctant to invest in CLOs before modeling specifics are finalized and RBC impacts on various CLO tranches are better understood. It now appears that the uncertainty period around CLO modeling results has been extended by one more year. 

Separately, the Academy provided an update on a couple of CLO-related workstreams they’re involved with: 

• Comparable attributes for CLO tail risk. This project was introduced at the 2023 Summer National Meeting in Seattle. In general, comparable attributes are asset characteristics highly correlated with asset riskiness, and therefore useful risk proxies. For example, credit rating is such an attribute for bonds; loan-to-value (LTV) ratio together with debt-service coverage ratio (DSCR) are the two main comparable attributes for commercial mortgage loans (CMLs). In other words, they facilitate comparing one security to another to distinguish them for risk purposes. Currently, the Academy is collecting data for CLOs, trying to identify as many plausible attributes as possible.
  
  At this stage, there are about 30 comparable-attribute candidates. Attributes can be viewed as independent variables in a regression model whose output is an asset-class risk characteristic—in the present context, the RBC capital charge. The next step would be to model CLO risk using as many vendor models as possible, trying to narrow the set of attributes. The Academy is trying to determine the minimal information required to represent CLO tail risk. If a small number of attributes explains most of the risk, this would be the best outcome—they would form the basis for determining CLO C1 RBC charges. If a small number isn’t explanatory enough, regulators may need to resort to modeling individual securities. This longer-term project is expected to be finished by the 2024 Fall National Meeting.
• CRP rating methodologies review. While review generally isn’t limited to CLOs, it’s currently focused squarely on this asset class, with the goal to expand it to others. The Academy is reviewing the methodologies of five rating agencies (Moody’s, S&P, Fitch, DBRS and KBRA), emphasizing tail risk as well as historical data on default and loss experience. This workstream is supposed to proceed hand-in-hand with the comparable-attributes search. A medium-term project, the review is expected to wrap up by the 2024 Summer National Meeting.

Latest SVO Discretion Proposal Unveiled and CRP Due Diligence RFP Started  

The full name of this key initiative, which has been in progress for many months, is a mouthful: P&P Manual Amendment Authorizing the Procedures for the SVO’s Discretion Over NAIC Designations Assigned Through the Filing Exemption Process. At a March 16 session, the Valuation of Securities Taskforce (VOSTF) presented the proposal’s latest iteration, addressed previously raised concerns, and reviewed a dozen or so comment letters submitted in response to the most recent draft. The proposed process now includes 15 steps, with provisions for the SVO’s internal checks and balances, information gathering, reporting, appeals by affected insurers, and external reviews. The proposal is still not final, and will take 1–2 years to implement once finalized. 

Below are regulators’ responses to some of the previously raised concerns: 

• Transparency: Insurers affected by the SVO’s decision on a particular security will have full transparency into the analysis and rationale.
• Methodology: The SVO is not a rating agency—it relies on the methodologies of rating agencies and other entities, so it can’t publish those. Use of a particular methodology does not indicate endorsing one CRP over another.
• Oversight: There’s an explicit step for regulator approval. The SVO’s role is to provide independent investment expertise, but domiciliary regulators have the final authority.
• Scope: The focus of the proposal is not on broader asset classes but on individual issues. There are other pathways for addressing broader concerns, but they’re beyond this proposal.
• Coordination with Investment Framework: The filing exempt (FE) discretion proposal complements the E-Committee’s proposed framework, so there’s no need to delay work on the proposal in anticipation of the framework implementation.
• FE securities universe: The proposal is not about reviewing all FE designations—it’s about creating a process for challenging the anomalous ones, because no such capability exists right now.
• SVO’s Remit: The SVO isn’t a regulator. NAIC designations aren’t credit ratings; they’re produced solely for NAIC members and only for insurance regulatory purposes.

Many comments on the most recent draft had similar themes, with concerns broadly revolving around: 

• The potential negative market impact of SVO review and/or rating override; due-process effectiveness
• Transparency of both the process and information shared with stakeholders; clarity of security-screening criteria and the SVO’s overall methodology
• Better communication and coordination between insurers, issuers, CRPs, and NAIC staff, workgroups and committees
• A need to consider alternative approaches and road test a variety of solutions
• Conflicts of interest and separation of duties within the SVO
• Potentially narrowing the competition between CRPs
• CRP due diligence supposedly being a more efficient and higher-priority solution than SVO discretion

Work on the proposal’s next revision continues, with the goal of incorporating the most-recent comments and feedback into an expected final draft before the Summer National Meeting. In addition, the E-Committee submitted a request to the Executive Committee in February for an RFP for the due-diligence program around the use of CRPs. CRP due diligence is one of the initiatives under the E-Committee’s Investment Framework umbrella, parallel but complementary to the SVO discretion proposal. The Executive Committee has approved the request, and work on the RFP should start soon. The NAIC plans to hire a consultant to craft and help implement this CRP due-diligence framework. We expect significant progress on both the SVO’s discretion and CRP due-diligence workstreams in the next few months. 

Conforming Repurchase (“Repo”) Agreements: Seeking RBC Alignment 

We previously reported on this ACLI-led initiative following last year’s Summer National Meeting in Seattle. It aims to align the RBC repo treatment with that of conforming securities-lending programs by creating the “conforming repo” category. Conforming securities-lending has existed since 2006, with a current C0 RBC charge of 0.2%. Repos, in contrast, have received a much higher 1.26% charge since the 1990s. However, the two asset classes are similar in many ways, and that’s why ACLI is looking to align their RBC treatment. 

Originally, the proposal was in the hands of the Life Risk-Based Capital Working Group (LRBCWG), which sent a referral to the SAPWG in January of this year. The SAPWG responded in February, acknowledging accounting and reporting differences between the two programs. It asked the LRBCWG to pause its work on the proposal while the SAPWG takes time to assess the feasibility of this convergence.  

The items the SAPWG wants to address relate to collateral as well as reporting consistency and transparency: 

• The collateral for securities lending is reported on Schedule DL, but repo collateral isn’t. Consistency is needed, which could include expanding Schedule DL to include repo collateral.
• A review of year-end 2022 financial statements revealed that some conforming securities-lending collateral reported on Schedule DL was outside of the guidance for “acceptable collateral.” Clarification would be needed to eliminate any interpretation differences as to what is conforming or nonconforming.
• Revisions to blanks reporting would be required to incorporate conforming repo collateral. Moving the guidance on conforming programs from RBC instructions to annual statement instructions is also advised.

Other Developments 

Changes were made to treatment of perpetual and mandatorily redeemable preferred stock. Realized gains/losses on the sale of these two categories of preferred stock are to flow through AVR. As we expected (see our February NAIC update), the SAPWG adopted revisions to annual-statement instructions at the spring meeting. The original revisions exposed at the 2023 Fall National meeting in December only included perpetual preferred stock. After the Fall meeting, , as per comments from interested parties, mandatory convertible preferred stock was also added to the proposal, regardless of its perpetual or redeemable status. This move synchronizes AVR/IMR guidance with the measurement method for perpetual and mandatory convertible preferred stock, which is fair value per SSAP No.32R. 

The Academy is working on addressing covariances in the RBC formula. We first reported on this initiative following the 2023 Spring National Meeting, when it was only a conceptual idea. Fast forward one year, and the Academy presented its first draft at the LRBCWG session on March 17. Many aspects of the RBC calculation have been updated and refined over the last 30 years, but covariances were not one of them. The draft presents one potential correlation structure— pairwise linear correlations, à la Solvency II, both between and within major risk categories. Actual numerical values for the correlations are TBD, and must be calibrated to historical data. This data is readily available for market variables (credit losses, equities and rates), but not as much for dimensions such as insurance or business risks. Next steps of the project would involve collecting and analyzing historical data, producing preliminary correlation factors and evaluating the impacts of the proposed changes on RBC. We expect some progress by the Summer National Meeting, but we think this workstream will spill well into 2025. 

The Academy began work on C-3 convergence. Just as with the item directly above, C-3 convergence was another concept flagged by the Academy at the 2023 Spring National Meeting for potential future development. At the same March 17 LRBCWG meeting, the Academy presented a non-VA principle-based reserving framework update, and C-3 methodology was included. C-3 Phase 1 (fixed annuities and single premium life) and C-3 Phase 2 (variable annuities) differ in many respects. For example, assumptions, scenarios, and metrics differ. The goal is to bring the methodologies closer, ideally moving to the Phase 2 framework where possible. There’s also C-3 Phase 3 for life products, but extending the scope of the project to that arena would have to come later. In short, the work is still in its preliminary stages, and it’s safe to say we’re still very far from seeing a unified C-3 methodology that would include all life insurance products. 

The E-Committee heard more comments on its framework initiative. The E-Committee continues to socialize the holistic framework for regulating insurers’ investments that it first presented at the 2023 Summer National Meeting. In addition to the updated proposal itself, the E-Committee also unveiled in February the first draft of the work plan to guide the Framework’s implementation and a detailed memo summarizing its views on implementation next steps. Comments in response to those documents came from the ACLI, Athene and MetLife as well as two independent consultants (Anderson Insights and RRC). They included the following:  

• Several commenters stressed that coordination is key in moving the initiative forward, especially since the committee won’t pause any existing work.
• A couple of commenters touched on the change in the revised draft of the framework, which now refers to “equal capital for equal tail risk.” Opinions diverged: one commenter found this formulation too limiting, the other praised it.
• SVO modeling could be supporting due diligence on CRPs, but shouldn’t replace the use of CRP’s ratings in designations.
• A better process is needed for screening problematic bonds and a better tool is needed than yield. Historical rating agency performance data is an example. These track records exist and, combined with other hard data obtained with the help of AI and data mining, may provide the right approach. And SVO’s performance should also be regularly assessed using the same tools.
• A focus on regulators’ future needs is warranted, given all the changes in insurers’ investment practices over the years as well as new market realities (including higher interest rates, increased volatility, negative IMR and greater liquidity needs).

Conclusion 

The adoption of the last document in the principles-based bond definition suite, SSAP No.21, was undoubtedly the highlight of the 2024 Spring National Meeting. With this out of the way—and with some peripheral updates still pending—the NAIC will now work on developing guidance and educational materials to help the industry navigate the transition to the new bond definition. 

The most interesting thing to watch now is the fate of the 45% residual capital charge. P&C and health insurers may get the same residual treatment as life insurers, a proposal that seemed to come from left field at the spring meeting, and one we expect to be heavily challenged by the industry. The ensuing drama could prove worthy of an Academy award.  

To summarize, a lot’s going on at the NAIC this year. On top of a number of quantitative initiatives in various stages of development—such as CLO modeling, which was just delayed for a year—there’s a healthy roster of foundational initiatives in the works. Examples are SVO’s discretion, CRP due diligence, and the overall E-Committee’s holistic framework for insurance-investments regulation. We’ll keep our collective ears to the ground and provide timely updates and perspectives as things develop.

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