The Summer 2024 National Meeting of the National Association of Insurance Commissioners (NAIC) turned out to have a lighter agenda than in the recent past. This may be due to the near completion of the principles-based bond definition project, slated to go into full force on January 1, 2025. That said, a couple of new initiatives were launched and several existing workstreams are winding their way through multiple rounds of revisions and comments.
Several Adoptions and Re-Exposures from SAPWG
In its August 13 session, the Statutory Accounting Principles Working Group (SAPWG) adopted or re-exposed several updates to statements of statutory accounting principles (SSAPs):
SSAP No. 21R – Other Admitted Assets: Consistency revisions would put the accounting and reporting of all residuals within the purview of this SSAP and explicitly exclude them from any other SSAPs; all residuals are to be reported on Schedule BA. The changes become effective on January 1, 2025 (adopted).
SSAP No. 2R – Cash, Cash Equivalents, Drafts and Short-Term Investments: This update clarifies that asset-backed securities (ABS), mortgage loans and Schedule BA items can’t be classified as cash equivalents or short-term investments, and it removes all SSAP references implying otherwise (adopted).
Debt Securities Issued by Funds: We previously reported on this workstream in our February and April updates. The proposal’s motivation is to eliminate the SEC registration of a fund as the necessary requirement for its debt securities to be classified as issuer credit obligations (ICOs). Instead, debt securities issued by a fund are to be classified based on fundamental principles and the issuer’s primary purpose, not based on rules or the fund’s registration status.
The original proposal looked fairly straightforward on the surface, and we initially expected its adoption at the spring 2024 national meeting. This hasn’t happened, though, as the regulators had to address an unintended interpretation of the guidance: debt securities issued by feeder funds and other similar structures potentially classified as ICOs. Revised language clarified that while the SEC registration is a practical expedient, it shouldn’t be extended to unregistered funds by analogy. However, these revisions haven’t been formally exposed for comments. Correcting this oversight, the working group voted to expose the revised proposal for an abbreviated comment period ending September 6. If uncontested, it can then be adopted in short order by an e-vote.
Conforming Repos: We wrote about this initiative following the Summer 2023 meeting in Seattle, and more recently on the heels of the Spring 2024 national meeting in Phoenix. If adopted, it would align repo RBC treatment with that of conforming securities-lending programs by creating the “conforming repo” category with similar documentation, governance, and collateral reporting requirements, as well as identical—more capital-friendly—RBC treatment.
The NAIC has drafted a memo comparing and contrasting securities lending and repos, recommending the expansion of Schedule DL to include repo collateral, clarifying the collateral compliance with the “conforming” requirements, and clarifying which amount—the lent security or the collateral received – should be reported. Simultaneously, the American Council of Life Insurers (ACLI) is working on a chart of the differences between the two programs. The memo is exposed for comments until September 27.
ALM Derivatives: This is a new statutory concept item that could result in a brand new SSAP down the road. It’s supposed to cover so-called macro hedges (interest rate derivatives not qualifying as accounting effective under SSAP No.86 – Derivatives) that are nevertheless economically effective. They reduce aggregate portfolio risk by either reducing asset-liability mismatches or aligning assets with liability targets. No timeline is specified for this workstream, but it’s already clear that it may become a pretty significant agenda item going forward. To be fair, there’s already an accounting standard that deals with a narrow class of macro hedges: SSAP No.108—Derivatives Hedging Variable Annuity Guarantees. It’s expected that the new SSAP will follow its lead in many ways. However, while SSAP No.108 does not incorporate IMR, this concept is a core issue for ALM derivatives.
So, if work on the new guidance goes ahead, the NAIC would have to decide on many fundamental aspects regarding ALM derivatives’ treatment including: the effectiveness definition; accounting specifics; gain or loss recognition and/or amortization; admissibility of, and limits on net deferred losses; disclosure, reporting, and governance issues. The agenda item is exposed until November 8. The Fall National meeting is less than three months away, so no significant discussion of this initiative is anticipated there, but we expect it to pick up steam by the Spring 2025 meeting.
Repacs and Derivative Wrapper Investments: Another new derivative-related agenda item is intended to cover all debt securities with derivative components that don’t qualify as structured notes. These investments are already widespread in Europe and becoming more popular in the US too, hence the impetus for updated statutory guidance. A credit repack involves an SPV acquiring a debt security, adding a derivative, and issuing a new redesigned debt-like security to an insurer. Such a structure would normally fail to satisfy the definition of a bond, thus falling into the non-bond debt security category. SSAP No.86 – Derivatives currently prohibits separating an embedded derivative from the host contract.
However, reporting the combined credit repack structure as a single debt instrument presents several issues. Transparency is reduced, because there’s no separate reporting and no effectiveness assessment of the embedded derivative. The derivative’s impact also might not be explicitly captured in RBC. Essentially, the derivative would “fly under the radar.” The proposal, therefore, calls for a revision to SSAP No.86, requiring bifurcation—or separation of the debt component from the derivative for accounting and reporting purposes. (That said, structured notes would still fall under SSAP No.86, and there would still be no bifurcation for them.) The proposed revisions to SSAP No.86 are exposed with a September 27 due date, to be further discussed at the Fall National meeting in November.
Collateral loan reporting: The last time we reported on this workstream was after the Fall 2023 National meeting. Since then, there’s been more progress. In May, the SAPWG incorporated an interim change allowing collateral loans backed by mortgage loans to flow through the AVR. As for other types of collateral loans, the NAIC is still hammering out the details of its more granular reporting and whether they should flow through the AVR. The proposed structure for reporting collateral loans on Schedule BA, as well as the new AVR category for collateral loans, is exposed for comments until September 27. The NAIC anticipates a January 1, 2026 implementation date for these changes.
Two Adoptions: NAIC Designation Definition and SVO Discretion Proposal
On the same day, August 13, the Valuation of Securities Task Force (VOSTF) adopted a pair of proposals that were in the works for quite some time:
NAIC Designation Definition: This amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (“P&P Manual”) passed almost exactly one year to the day after the initial discussion of this proposal at the NAIC Summer meeting in Seattle on August 14, 2023. It took longer than we expected, as we initially viewed the amendment as more of a technical update to the P&P Manual, consolidating definitions found in Part 1 and Part 2 and clarifying the meaning, purpose, and use of an NAIC designation. In the end, the definition of an NAIC designation was removed from Part 2 and consolidated entirely within Part 1.
It's now a single uniform definition covering both filing exempt (“FE”) and SVO-assigned designations. The definition also emphasizes the idea that an NAIC designation isn’t the same thing as a credit rating. The latter measures credit risk only, which reflects an issuer’s ability to make contractual payments. In contrast, the NAIC designation is a wider concept; it measures more generally the investment risk of a security, which may include other risks beyond credit risk, as well as a security’s performance aspect. (But not volatility/interest rate, prepayment, extension or liquidity risks.) The NAIC designation thus focuses on the likelihood that an insurer will receive full and timely principal and expected interest.
With the advent of this more holistic definition, the NAIC was compelled to drop the current regulatory assumption that debt instruments pay scheduled interest and principal at maturity, as well as the subscript “S” for “other non-payment risks.” It remains to be seen exactly how the new definition will be implemented, since concrete methodologies and processes for reflecting investment risk aren’t part of the proposal and would have to be specified separately.
The SVO Discretion Proposal: This was another P&P amendment adopted by the VOSTF in Chicago, and admittedly one of the meeting’s most notable accomplishments. But just as with the NAIC designation definition update, the implementation devil is going to be in the details—perhaps more so in this case. As a result, the NAIC estimates it will take one to two years; the expected effective date is January 1, 2026. This initiative was launched at the Spring 2023 National meeting in Louisville, Kentucky. We extensively covered its progress, from the first draft unveiled at the Summer 2023 National meeting, to the second one presented at the Spring 2024 National meeting in Phoenix, and the comments received in response to each draft. The final version of the proposal incorporates the feedback from these two rounds of comments.
The way it now looks on paper, the process for challenging an FE-assigned designation is largely clear. However, a few significant procedural questions remain around the confidentiality of discussions, anonymized summaries and credit-rating providers’ (CRP) involvement. Following its adoption at the Summer National meeting, SVO Discretion has been further addressed at the VOSTF’s parent E-Committee WebEx call on August 29. The discussion was not without its fair share of contention, though. The largest debate was about the extent to which a CRP should be involved in the process if one of its ratings is challenged by the SVO. The proponents argue that CRPs have to be informed and given an opportunity to explain their ratings rationale. CRPs themselves signal they would gladly participate if offered a seat at the table.
Otherwise (especially if an insurer decides not to appeal a given designation challenge), a CRP may not be notified at all. Consequently, they wouldn’t have a chance to respond to and defend their analysis; reputational damage may ensue. To this point, the NAIC countered that it has no regulatory authority to require CRPs’ participation, and at most can only “encourage” it. The confidentiality of the conversation between the NAIC, authorized insurers and other involved parties is an additional complicating factor. In the end, the motion to adopt the amendment passed unanimously. The CRP
involvement conundrum remains unresolved for now. The NAIC will look into it again after implementation, to ensure the process is working as intended.
RBC Framework Evaluation Continues
The NAIC continues its in-depth reevaluation of the RBC framework. The Capital Adequacy Task Force (CATF) met on August 14, and one of the more notable items on its agenda was a request for the new working group. Introducing the new name, and the new acronym to memorize: the Risk-Based Capital Risk Research Working Group (RBCRRWG)! This working group will be charged primarily with reviewing non-investment RBC factors and the RBC framework in general.
Asset-related C1 charges traditionally received most of the attention; they were extensively studied, debated ad nauseum and modified repeatedly since the RBC inception 30+ years ago. Other risk charges received a considerably smaller share of the spotlight, but their importance is increasingly coming to the forefront. Anecdotally, the majority of insurance failures over the last 30 years happened not because of assets but from other factors, such as product mispricing and the resulting negative net income. Therefore, it’s time to look closer at other RBC components like C2 and C3 risks. Another example would be the operational risk charge, introduced a decade or so ago—by now, we should have enough data to evaluate its appropriateness. More generally, the new working group would document the analysis and reasoning behind different RBC components, maintain the history of changes, and conduct impact and cost-benefit analysis for proposed RBC framework modifications. The request is exposed for 30 days until September 13.
E-Committee Discusses Two Big-Picture Items
The Financial Condition Committee, also known as E-Committee, is one of the highest bodies in the NAIC hierarchy. It traditionally meets on the conference’s last day. Among the items discussed at its August 15 session were two “big- picture” documents: a newly unveiled draft of the CRP due-diligence RFP and the updated holistic framework proposal for regulation of insurance investments. Both are exposed for 60 days until October 14.
CRP Due Diligence RFP First Draft: Think of CRP due diligence as a counterweight to the SVO discretion: better due diligence around CRP ratings for insurance use means less need for the SVO to exercise its discretion and challenge those ratings… and vice versa. Since the NAIC has stated the goal of exercising its discretion only occasionally as a backstop, this implies the CRP due-diligence process must be extremely robust and comprehensive. The ultimate goal is to reduce or eliminate blind reliance on CRP ratings, while at the same time retaining overall use of CRPs ratings. This proposal was publicly posted only a few days before the national meeting. The document is not a true RFP yet; it’s only the first draft intended to solicit an open dialogue with all interested parties on what the actual RFP should include.
Based on this RFP, the NAIC will select a consultant that will create the CRP due-diligence framework and process. The NAIC itself will then be responsible for implementing and administering it on an ongoing basis. However, in our opinion, there’s somewhat of a disconnect in the NAIC’s thinking between SVO discretion and CRP due diligence. On one hand, the NAIC swears off any authority over CRPs, to the point that it’s not even able to require them to participate if their ratings are challenged by the SVO. On the other hand, the due-diligence process is being conceived to require collaboration with CRPs, specifying quantitative and qualitative parameters that they and their credit ratings must conform to. It remains to be seen how this contradiction will be resolved. Regardless, the project is still at the very beginning and will likely require significant time and multiple iterations to complete.
Holistic Investment Framework: The E-Committee first dropped this bombshell of a proposal a year ago, on the last day of the 2023 Summer National meeting in Seattle. Then, in February of this year, it exposed an updated draft along with the proposed implementation workplan. These documents and comment letters were further discussed at the Spring 2024 meeting as we reported. And at the Summer 2024 National meeting, the next iteration of the documents was presented, including fairly minor changes to the framework document itself, which remains a program manifesto and a roadmap. The workplan is more relevant for the actual execution: it contains a list of specific action items. The workplan saw a few minor modifications as well, such as recognizing the CRP due-diligence RFP status change. Also, updates to Action Item #7 language acknowledged a continued review of the ways to include RBC recommendations in the final framework.
An Academy Update
Finally, to wrap up this report, a quick update from the Academy:
- CLO Comparable Attributes Project: See our Spring 2024 report for more details. This workstream has now entered its second year. The Academy originally planned for results to be presented at the Fall 2024 National meeting, but issues with obtaining reliable data moved the due date back to early 2025.
- CRP Rating Methodology Review: A related workstream that we also touched on in the same Spring 2024 update is a medium-term project. The review was supposed to wrap up by the 2024 Summer National meeting, yet there was no update on its progress in Chicago. Since the project was going to proceed hand in hand with the comparable-attributes search, we think its delay is explained by that project’s postponement.
Conclusion
The NAIC has a healthy portfolio of initiatives in various stages of development:
- Some are wrapping up or almost done, including various remaining items in the bond definition project and the debt securities issued by funds proposal.
- A few are already adopted, starting their journey on a long and winding road to implementation—most notably the SVO Discretion.
- Others are currently in mid-flight, among them the Investment Framework, CLO modeling, conforming repos and collateral-loans reporting
- Still others are either early stage, just launching or even being contemplated: CRP due-diligence RFP; ALM Derivatives; Repacks and Derivative Wrappers; and the Comprehensive Fund Proposal (systematizing different fund categories and their RBC treatment).
In summary, there were a lot of yummy treats in NAIC’s kitchen, as usual. Some are fully cooked; for others, the ingredients must still be purchased. Some entrees are plain vanilla, while others call for an acquired taste. The NAIC continues its work to ensure that the insurance regulation in the US stays current and relevant. And AB is staying on top of the chefs and tasting the dishes for our insurance clients.
Have questions on this insight or anything insurance-related? Contact our insurance team.
