Regulatory Update: NAIC Summer 2022 National Meeting

The National Association of Insurance Commissioners (NAIC) held its Summer 2022 National Meeting (Summer Meeting) August 9–13, 2022. This post summarizes the highlights from this meeting in addition to interim meetings held in lieu of taking place during the Summer Meeting. Highlights include a proposal for a new consumer privacy protections model law, continued discussion of considerations related to private equity ownership of insurers, continued development of accounting principles and investment limitations related to certain types of bonds and structured securities, and initiatives to address climate risks in the insurance sector.

1.  NAIC to Develop New Privacy Model Law

The NAIC approved the request of the Privacy Protections (H) Working Group (Privacy Working Group) to draft a new model law to enhance consumer protections and specify the corresponding obligations of licensed entities.

The Privacy Working Group has been reviewing state insurance privacy protections regarding the collection, ownership, use, and disclosure of information gathered in connection with insurance transactions. As a result of this review, the Privacy Working Group had started drafting revisions to the NAIC Insurance Information and Privacy Protection Model Act (#670) (Privacy Model Act) and the Privacy of Consumer Financial and Health Information Regulation (#672) (Privacy Model Regulation). However, following the NAIC’s Spring 2022 National Meeting, the Privacy Working Group received comments from various industry and consumer representatives asking for one new model to replace the Privacy Model Act and Privacy Model Regulation rather than updating the existing models. After further consideration, the Privacy Working Group determined that because the existing models were adopted several decades ago, a new model law would be necessary to enhance consumer protections and the corresponding obligations of licensed entities to reflect the extensive innovations that have been made in communications and technology over the years.

The Privacy Working Group expects to expose a draft of the new model by the NAIC’s Fall 2022 National Meeting (Fall 2022 Meeting), with final adoption by the Privacy Working Group expected to occur by the NAIC’s Summer 2023 National Meeting. To meet this timeline, the Privacy Working Group intends to incorporate the work already completed on revisions to the Privacy Model Act and to remain consistent with work done on the Privacy Model Regulation.

In parallel with its development of the new model, the Privacy Working Group is continuing to draft a white paper on data ownership and use rights. The Privacy Working Group expects to expose an initial draft of the white paper in advance of the Fall 2022 Meeting.

2. NAIC Progresses Revisions to Statements of Statutory Accounting Principles

The Statutory Accounting Principles (E) Working Group (SAP Working Group) continued its ongoing work on a principle-based bond definition, including revisions to the following Statements of Statutory Accounting Principles (SSAPs): SSAP No. 26R — Bonds (SSAP No. 26R) and SSAP No. 43R — Loan-Backed and Structured Securities (SSAP No. 43R). The SAP Working Group also adopted or considered changes to other SSAPs, including SSAP No. 4 — Assets and Nonadmitted Assets (SSAP No. 4) and SSAP No. 5R — Liabilities, Contingencies, and Impairments of Assets (SSAP No. 5R) — to address new concepts included in the Financial Accounting Standards Board (FASB) revisions to the definition of an “asset” and a “liability.” The Financial Condition (E) Committee ((E) Committee) and the Accounting Practices and Procedures (E) Task Force (Accounting Task Force) also adopted changes to SSAP No. 25  — Affiliates and Other Related Parties (SSAP No. 25) and SSAP No. 43R to clarify related party reporting requirements that the SAP Working Group recently adopted.

a. SAP Working Group Exposes Revisions to SSAPs in Connection With Bond Project

In furtherance of the SAP Working Group’s bond project, the SAP Working Group exposed an updated principle-based bond definition and related issue paper as well as new proposed amendments to SSAP No. 26R and SSAP No. 43R, which incorporate the principle-based bond definition as part of the authoritative statutory accounting guidance. In addition to such items, on a July 18, 2022, conference call held prior to the Summer Meeting, the SAP Working Group exposed proposed reporting changes to Schedule D-1: Long-Term Bonds (Schedule D-1) as part of the bond project, which would require identification of bonds as either “issuer credit obligations” or “asset-backed securities.” Comments to all of the items exposed during the Summer Meeting and the July 18, 2022, meeting are due by October 7, 2022.

The proposed revisions to SSAP No. 26R and SSAP No. 43R and proposed revisions to the reporting guidance are the most recent revisions exposed as part of the continuing work by the SAP Working Group to establish principle-based guidance for determining which securities qualify as a bond. Such guidance is intended to address regulator concerns regarding expanding investment structures that were being reported on Schedule D-1. The principle-based bond definition, initially exposed in May 2021, will be used for all securities in determining whether they qualify for reporting on Schedule D-1. Within the bond definition, bonds are classified as an “issuer credit obligation” or an “asset backed security.” An “issuer credit obligation” is defined as a bond where repayment is supported by the general creditworthiness of an operating entity, and an “asset backed security” is defined as a bond issued by an entity created for the primary purpose of raising debt capital backed by financial assets. The exposed revisions to SSAP No. 26R and SSAP No. 43R would incorporate these concepts into the SSAPs.

At its July 18, 2022, meeting, the SAP Working Group also exposed revisions to the annual statement general instructions to clarify that only those investments that meet the bond definition or are otherwise in scope of SSAP No. 26R or SSAP No. 43R may be reported on Schedule D-1. The proposal would require that Schedule D-1, Section 1 detail issuer credit obligations (within scope of SSAP No. 26R) while Schedule D-2, Section 2 would detail asset-backed securities (within scope of SSAP No. 43R). It is expected that in addition to these proposed changes, additional revisions to other standards and reporting schedules affected by the bond project will be forthcoming and likely exposed during the Fall 2022 Meeting. At this time, no referral for the reporting changes has been made to the Blanks (E) Working Group, as the SAP Working Group intends to gather initial feedback regarding the proposed changes prior to making a referral.

While the SAP Working Group still hopes to finalize its work on the bond project by January 1, 2024, given the timing requirements needed to implement any blanks reporting changes, it is possible that revisions to the SSAPs and any reporting changes made in connection with the bond project may not become effective until January 1, 2025. The SAP Working Group has emphasized that investments that do not qualify as bonds after such revisions are adopted will not be permitted to be reported as bonds on Schedule D-1 thereafter as there will be no grandfathering for existing investments that do not qualify under the revised SSAPs. However, it is expected that certain accommodations will be made to prevent undue hardship for reporting entities complying with the new guidance.

b. NAIC Adopts Revised Definition of “Asset” But Re-Exposes Revisions to Definition of “Liability”

The SAP Working Group has been considering revisions to SSAP No. 4 and SSAP No. 5R that would revise the definition of an “asset” and a “liability.” At the Summer Meeting, the SAP Working Group adopted revisions to SSAP No. 4 to incorporate the revised definition of an “asset” but re-exposed draft revisions to SSAP No. 5R that would incorporate a new definition of “liability” with no changes from the prior exposure in order to provide additional time for interested parties to undertake a review of the potential consequences of the new definition. Comments on the re-exposed revisions to SSAP No. 5R are due by October 7, 2022.

In December 2021, FASB issued two new chapters of its conceptual framework, which FASB uses to set standards and concepts to consider with respect to proposed accounting and reporting guidance. One such chapter of the new FASB concepts included revisions to the definition of an “asset” and a “liability.” Under the FASB concepts, an “asset” is defined as “a present right of an entity to an economic benefit, and a “liability” is defined as “a present obligation of an entity to transfer an economic benefit.”

As the FASB concepts are not automatically authoritative, the SAP Working Group undertook a review of the newly issued chapters and proposed updates to incorporate those concepts into the statutory accounting guidance. In April 2022, the SAP Working Group exposed revisions to SSAP No. 4 and SSAP No. 5R to incorporate the new definitions of an “asset” and a “liability” into the statutory accounting guidance. The exposure also included two issue papers, each articulating the changes for SSAP No. 4 and SSAP No. 5R and FASB’s rationale for the changes. Both SSAP No. 4 and SSAP No. 5R are regarded as foundational statements for statutory accounting as many other statements reference them.

Interested parties raised concerned with respect to the change of the definition of a “liability” as proposed in SSAP No. 5R, noting that FASB itself recognized that the revised definition “potentially expands the population of liabilities to include certain obligations to issue or potentially issue an entity’s own shares rather than settle an obligation exclusively with assets,” which could result in instruments with characteristics of both liabilities and equity being in fact classified as liabilities in certain situations. At the Summer Meeting, interested parties asked the SAP Working Group to undertake a SSAP-by-SSAP analysis to identify potential effects of the new definition prior to adoption to avoid unintended consequences and to determine whether the adoption of the exposed liabilities guidance would have an expansive impact. The SAP Working Group, however, sent this request back to interested parties, who will complete the in-depth review during the additional exposure period.

As there were no further comments on the adoption of the definition of an “asset,” the SAP Working Group adopted the proposed revisions to SSAP No. 4 (and the related issue paper).

c. NAIC Adopts Revisions to SSAP No. 25 and Proposal Regarding Related Party Reporting

At the Summer Meeting, the Accounting Task Force and the (E) Committee adopted changes to SSAP No. 25 and SSAP No. 43R regarding the identification of related party involvement with investments, as well as new reporting requirements, which were recently adopted in May 2022 by the SAP Working Group and Blanks (E) Working Group, respectively. The adopted changes incorporate new reporting requirements for investment transactions with related parties in order to provide more transparency into the nature of the involvement of related parties. While not standard for all changes adopted by the SAP Working Group and Blanks (E) Working Group, the revisions to SSAP No. 25 and SSAP No. 43R and the related reporting changes were separated for individual consideration by the (E) Committee and the Accounting Task Force because of the impact of such changes on all insurance reporting entities, and the discussion included affiliate identification. Both the revisions to the SSAPs as well as the reporting changes have a December 31, 2022, effective date.

The revisions to SSAP No. 25 clarify that the reporting of affiliate transactions within existing reporting lines in the investment schedules must be consistent with the definition of an “affiliate” pursuant to the Insurance Holding Company System Regulatory Act (#440) (Holding Company Model Act) and add a new paragraph clarifying that if direct or indirect control exists, whether through voting securities, contracts, common management, or otherwise, the arrangement will be considered “affiliated” under SSAP No. 25. For entities not controlled by voting interests, such as limited partnerships, trusts, and other special purpose entities, control may be held by a general partner, servicer, or by other arrangements. The ability to direct the management and policies of an entity through such arrangements constitutes control, and indirect control may exist through such arrangements. For example, consistent with the definition of “affiliate” in the Holding Company Model Act, if a limited partnership were to be controlled by an affiliated general partner, and that limited partnership held greater than 10% of the voting interests of another company, indirect control by the affiliated general partner must be presumed to exist unless the presumption of control can be rebutted.

In addition, the revisions to SSAP No. 43R clarify the requirement to identify related party investments in the investment schedules, regardless of whether the related party is “affiliated” pursuant to the Holding Company Model Act. Such revisions also clarify that although a loan-backed or structured security may be acquired from a nonrelated issuer, if the assets held in the trust predominantly reflect assets issued by affiliates of the insurance reporting entity, and the insurance reporting entity has only direct recourse to the assets held in trust, the transaction must be considered an affiliated investment. For example, if a related party sponsors or originates the loan-backed or structured security or any type of underlying servicing arrangement, the security is a related party investment.

The changes to the reporting requirements adopted by the Blanks (E) Working Group add new reporting codes to several investment schedules (including Schedules D – Long-Term Bonds, DB – Derivatives, BA – Other Long-Term Invested Assets, E2 – Cash Equivalents, and DL – Securities Lending Collateral Assets). The reporting changes require the identification of related party involvement for every investment using certain codes. The related party identification field is mandatory, meaning that a “blank or null” field will not be allowed on these investment schedules.

3. NAIC Continues its Review of Private Equity Ownership in the Insurance Industry

The NAIC continued its review of private equity ownership in the insurance industry as the NAIC Executive (EX) Committee and Plenary adopted the Regulatory Considerations for Private Equity (PE) Owned Insurers (List of PE Considerations) and various NAIC working groups received referrals from the Macroprudential (E) Working Group for further assessment of the considerations described in the list. A copy of the final List of PE Considerations can be found here.

The NAIC’s review of PE ownership in the insurance industry was prompted after the recent release of several reports regarding PE ownership of insurers, including a noted increase in PE acquisitions of insurers. Following such reports, the topic of PE ownership in the insurance industry gained attention internationally as well as at the state and federal levels in the U.S. In particular, in March 2022, Sen. Sherrod Brown, D-Ohio, Chairman of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, sent a letter to the Director of the Federal Insurance Office (FIO) and the President of the NAIC requesting that the FIO, in consultation with the NAIC, work to gather data and study the involvement of PE in the insurance industry, including with respect to pension risk transfer transactions. Both the NAIC and the FIO responded to this request, and, in doing so, the NAIC highlighted the work of the Macroprudential (E) Working Group to review the List of PE Considerations to address, among other things, any gaps with respect to the increase in PE ownership of insurers, the role of asset managers more generally in insurance, and the increase of private investments in insurers’ portfolios.

The List of PE Considerations includes activities frequently attributed to PE firms, but the NAIC has made clear that such considerations are not limited to any specific ownership structure, PE or otherwise. The list includes as considerations, among others:

• attempts to structure contractual agreements in a manner to avoid regulatory disclosures and requirements
• control considerations that may exist with less than 10% ownership (such as control through contractual arrangements)
• material terms of investment management agreements and whether they are at arm’s length
• operational, governance, and market conduct practices affected by the potentially different priorities and level of insurance experience of PE owners of insurers
• material increases in privately structured securities (both by affiliated and nonaffiliated asset managers)
• use of offshore reinsurers and complex affiliated sidecar vehicles

Each consideration also includes comments received from regulators as well as interested parties that will be considered by each of the NAIC committee groups in determining the appropriate next steps to identify where existing disclosures, policies, control and affiliation requirements, and other procedures may need to be modified or created. The Macroprudential (E) Working Group will continue to serve as the coordinator of considerations related to PE ownership of insurers to streamline regulatory review of such considerations within the NAIC and is expected to publish regular updates on its website of the progress of the work on each consideration. It is expected that the NAIC committee groups that received referrals from the Macroprudential (E) Working Group will present proposed next steps at the Fall 2022 Meeting.

4. NAIC Discusses Comments to International Association of Insurance Supervisors Consultation on Draft Criteria to Assess the Aggregation Method Comparability to the Insurance Capital Standard

On July 21, 2022, the International Insurance Relations (G) Committee ((G) Committee) heard comments from interested parties on the International Association of Insurance Supervisors (IAIS) public consultation on the draft criteria that will be used to assess whether the aggregation method (AM) provides comparable outcomes to the insurance capital standard (ICS). The IAIS approved release of this consultation at its meetings in June, and comments were requested by August 15, 2022. While interested parties were still in the process of assessing the draft criteria at the time of the (G) Committee meeting, interested parties provided initial general comments to the consultation, which generally centered around concerns that the draft criteria would be precluded at the outset as an outcome equivalent approach to the ICS.

In November 2019, the IAIS adopted the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) and the ICS, which is the group-capital component of ComFrame, as part of a set of reforms designed to enable effective cross-border supervision of internationally active insurance groups and contribute to global financial stability. The ICS is being implemented in two phases, the first of which is a five-year monitoring period (which commenced in January 2020) that will be followed by full implementation of the ICS as a groupwide prescribed capital requirement (PCR).

The U.S. and other jurisdictions have developed the AM as an alternative to the ICS to avoid the application of multiple capital standards to groups domiciled in the U.S. and such other jurisdictions. The AM will be used as a PCR under ComFrame only if the AM is determined to provide “comparable outcomes” to the ICS. If the IAIS determines by the end of the monitoring period that the AM provides comparable (i.e., substantially the same) outcomes to the ICS, then the AM will be considered an outcome-equivalent approach for implementation as a PCR in lieu of the ICS.

In November 2019, the IAIS agreed on a process and timeline for developing criteria to assess whether the AM provides comparable outcomes to the ICS. The IAIS developed draft high-level principles (HLPs) from which detailed criteria were developed for each HLP. Stakeholders were asked to provide feedback on whether each individual criterion was clear, adequate, sufficient, or too restrictive, considering the HLP to which it relates. Information regarding the consultation and the draft criteria that were exposed for comment can be found here.

As a general matter, interested parties noted that the criteria could preclude comparability insomuch as the criteria disregard fundamental differences between the two approaches to group capital and set up a comparison that expects the AM to operate the same as the ICS. Other commenters noted that the criteria appeared to not sufficiently weight both qualitative and quantitative data, with the current draft criteria focused on a quantitative comparison and not a qualitative comparison. In addition, commenters noted that the process of comparing AM appeared to be unduly burdensome as they would require a large amount of work while ignoring the existing data previously provided during field testing and the monitoring period.

All comments to the IAIS’ consultation are expected to be made available on the IAIS website. Following consideration of consultation comments, the IAIS is expected to finalize the criteria toward the end of 2022, with the assessment scheduled to begin in the third quarter of 2023.

During the IAIS Secretariat Q&A Session with Interested Parties, there was a discussion of the assessment team selection process to determine who will analyze whether the AM provides comparable outcomes to the ICS. The comparability assessment team will be selected by the ICS and Comparability Task Force (ICSTF) and consist of employees of the Secretariat. The assessment team will be responsible for delivering the necessary technical analysis of the AM and ICS to support the ICSTF in making an informed recommendation to the IAIS Executive Committee (IAIS ExCo) on the outcome of the comparability assessment. The ICSTF will oversee the assessment team’s work and review the interim and final results of its analysis. Based on the ICSTF’s recommendations, the IAIS ExCo will make the final decision on whether the AM provides comparable outcomes to the ICS.

5. NAIC Reopens the Property and Casualty Insurance Guaranty Association Model Act to Address Restructuring Mechanisms

The NAIC approved a model law development request to amend the Property and Casualty Insurance Guaranty Association Model Act (#540) (Guaranty Association Model Act) to address the effect of certain restructuring mechanisms on the availability of guaranty association coverage. The amendments were prompted by the Restructuring Mechanisms White Paper, which discusses new statutory processes that certain states have adopted to govern insurance business transfer (IBT) and corporate division (CD) transactions. The white paper includes a recommendation that the Guaranty Association Model Act should be amended to address issues related to guaranty association coverage following IBT and CD transactions. Many in the industry consider national uniformity on guaranty association coverage following IBT and CD transactions to be a gating issue to such transactions being used more widely.

6. NAIC Continues Efforts to Encourage Uniformity in the Implementation of the Revisions to the Suitability in Annuity Transactions Model Regulation

The Annuity Suitability (A) Working Group is drafting a frequently asked question (FAQ) document to address the comparable standards safe harbor included in the 2020 revisions to the Suitability in Annuity Transactions Model Regulation (SAT).

The revised SAT, which the NAIC adopted in February 2020, incorporates a requirement for producers to act in the “best interest” of a retail customer when making a recommendation of an annuity. To meet this standard, a producer must not place his or her own financial interest ahead of the consumer’s, and the producer must also satisfy the four key obligations of care, disclosure, conflict of interest, and documentation. Under the comparable standards safe harbor in the revised SAT, the requirements of the SAT are deemed to be satisfied if the recommendation and sale of an annuity is “made in compliance with comparable standards.”

In an attempt to facilitate uniformity in the implementation of the comparable standards safe harbor, the FAQ document addresses topics such as when a producer would be considered to be acting as a financial professional for purposes of the safe harbor provision, what comparable standards meet the criteria for the safe harbor, and obligations of insurers with respect to producers seeking to rely on the safe harbor. The Annuity Suitability (A) Working Group is in the process of reviewing public comments received on a draft FAQ that was exposed for comment in May 2022.

7. NAIC Considers Enhancements to Financial Solvency Regulation Manuals to Address Climate Risk

Climate-related risk and resiliency issues continued to be areas of NAIC interest during the Summer Meeting. In furtherance of its charge to evaluate financial regulatory approaches to climate risk and resiliency, the Climate and Resiliency (EX) Task Force made a series of referrals to various task forces and working groups under the (E) Committee intended to explore potential enhancements to existing solvency monitoring processes with respect to climate risk and resiliency.

Over the course of 2021, the Solvency Workstream of the Climate and Resiliency (EX) Task Force held a series of public panels on existing regulatory tools in relation to climate issues and their potential effect on insurer solvency and solicited public input on potential enhancement to such tools. As a result of comments received, the Solvency Workstream suggested that the applicable task forces and working groups under the (E) Committee consider modifications to the NAIC’s Financial Analysis Handbook, Financial Condition Examiners Handbook, and ORSA Guidance Manual.

The proposed enhancements include the following, among others:

• incorporation of procedures into the Financial Analysis Handbook for using Climate Risk Exposure Survey results in conducting ongoing financial analysis
• addition of sample interview questions to the Financial Condition Examiners Handbook related to climate change risks for various executive and board member positions
• enhancements to repository risks in the Financial Condition Examiners Handbook to encourage consideration of energy transition and physical risks in an insurer’s investment portfolio and strategy
• provision of guidance in the ORSA Guidance Manual indicating that the insurer should include a description of how climate change risk is addressed through its risk management framework

The proposed enhancements were presented as high-level principles for the (E) Committee to consider and develop as appropriate.

8. NAIC Adopts Amendment to Definition of Principal Protected Securities to Expand Securities Ineligible for “Filing Exempt” Process

The Valuation of Securities (E) Task Force (VOS Task Force) adopted an amendment to the definition of principal protected securities (PPS) in the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to include alternate securities (Alternate PPS) that pose many of the same investment risks as PPS but are structured in a manner that does not fit squarely within the P&P Manual’s current PPS definition as further described below. As PPS are ineligible for the “filing exempt” process of the NAIC’s Securities Valuation Office (SVO), the rationale for the amendment is to include Alternate PPS within the PPS definition, such that Alternate PPS also will be ineligible for the SVO’s “filing exempt” process.

By way of background, in May 2020, the VOS Task Force adopted an amendment to the P&P Manual to include PPS as a new security type that is ineligible for the SVO’s “filing exempt” process. At that time, the types of PPS considered were combinations of (i) a typical bond or bonds and (ii) additional performance assets with various characteristics, including derivatives, common stock, and/or commodities and equity indices, that were intended to generate additional returns. The performance assets generally included undisclosed assets and were typically not securities that would otherwise be permitted on Schedule D, Part 1 as a bond. In each case, the private credit rating provider (CRP) rating was based solely on the component dedicated to the repayment of principal and ignored the risks and statutory prohibitions of reporting the performance asset on Schedule D, Part 1.

The impetus for the current amendment to address Alternate PPS was the SVO’s receipt of a proposed security that had many of the same risks as PPS but was structured in a way that was not captured by the PPS definition in the P&P Manual as adopted in May 2020. Specifically, the proposed security was not issued by a special purpose vehicle holding both the bond and the performance asset; rather, the security was the direct obligation of a large financial institution that was obligated to pay principal at maturity and any additional return based on the performance of certain referenced indices of equities, fixed-income instruments, futures, and other financial assets. Although the financial institution issuing the security was the sole obligor under the security, such that there were no underlying bonds or performance assets, the structure posed the same risk of exposure to a performance asset because the amount of the issuing financial institution’s payment obligation depended directly on the performance of the referenced indices or assets. Additionally, unlike a PPS transaction with an underlying bond and performance asset, the likelihood of payment of any performance asset return was linked directly to the creditworthiness of the issuing financial institution.

The revision to the PPS definition, which was coordinated by the SVO and industry representatives, is intended to capture the Alternate PPS structure within the PPS definition. Accordingly, Alternate PPS also will be ineligible for the SVO’s “filing exempt” process.

9. NAIC Proposes to Eliminate Risk-Based Capital Arbitrage Regarding Collateralized Loan Obligations

On June 9, 2022, the VOS Task Force exposed for comment an issue paper (Issue Paper) prepared by the NAIC’s Investment Analysis Office regarding the risk assessment of structured securities, including collateralized loan obligations (CLOs). The Issue Paper identified risk-based capital (RBC) arbitrage concerns with respect to CLOs and proposed remedial recommendations as described below. Notably, the Issue Paper asserted that an insurer that purchases every tranche of a CLO holds the exact same investment risk as if the insurer had directly purchased the entire pool of loans backing the CLO; therefore, the aggregate RBC factor for owning all of the CLO tranches should be the same as the required factor for owning all of the underlying loan collateral, and a lesser factor would constitute RBC arbitrage. In response to comments received from interested parties regarding the Issue Paper, the NAIC’s Structured Securities Group (SSG) prepared a presentation deck, Staff Discussion of Responses to CLO, which is available here (SSG Deck). The VOS Task Force has exposed the SSG Deck along with the NAIC CLO Stress Tests Methodology (Year-End 2020 Update), which is available here, for comments that are due by September 12, 2022.

The Issue Paper proposed the following recommendations to address the RBC arbitrage concerns with respect to CLOs:

• Revised CLO Modeling – a proposal for the SSG to model CLO investments and evaluate all tranche level losses across all debt and equity tranches under a series of calibrated and weighted collateral stress scenarios to assign NAIC Designations that eliminate RBC arbitrage
• New RBC Factors – a proposed referral to the Capital Adequacy (E) Task Force and its Risk-Based Capital Investment Risk and Evaluation (E) Working Group (RBCIRE Working Group) to request consideration of adding new (i) RBC factors to account for the tail risk in any structured finance tranche and (ii) subcategories within the 6th NAIC Designation Category (e.g., 6.A, 6.B and 6.C) with recommended RBC factors of 30%, 75%, and 100%, respectively

The SSG Deck currently exposed for comment includes a summary of interested party responses regarding the Issue Paper. The responses were cautiously supportive but expressed the following concerns with the recommended proposal described above: (i) timeline concerns insofar as there should be sufficient timing for interested parties to provide comments on the proposal as it develops, (ii) policy arguments regarding the importance of CLOs to U.S. capital markets and the excellent historical performance of the CLO asset class, (iii) transparency, and (iv) methodology. The SSG Deck generally acknowledges that if the proposal is approved, there will be many opportunities for interested parties to comment on all elements of the proposal, including with respect to process, methodology, scenarios, and probabilities, and the process is intended to be transparent. The SSG Deck also includes additional information regarding methodology, transparency, and tail risk considerations in response to comments from interested parties.

The SSG Deck concludes with a recommendation that the VOS Task Force proceed with the proposal, which specifically contemplates (i) authorizing NAIC staff to draft for exposure an amendment to the P&P Manual permitting the SSG to model CLO investments, (ii) referring the RBC matters to the RBCIRE Working Group, and (iii) directing the staff to work with interested parties to fine tune the methodology and develop scenarios and probabilities.

Noting that this proposal will involve a long-term process, the RBCIRE Working Group expressed the need for an interim step to be implemented relatively quickly to address RBC discrepancies involving residual tranches of securitizations. The plan would be for the interim step to apply until the updated RBC methodology with respect to CLOs has been finalized and implemented. The RBCIRE Working Group has requested input from interested parties regarding proposals for the interim step and/or reasons why the interim step is unnecessary.

10. NAIC Proposes Alternatives for Reporting Additional Market Data Fields for Bond Investments on Statutory Financial Statements

Prompted by the desire to reduce the SVO’s reliance on CRPs with respect to the assessment of bond investment risks, the VOS Task Force previously exposed for comment a proposed referral to the Blanks (E) Working Group to add certain fixed income analytical risk measures to bond investments reported on Schedule D, Part 1, of an insurer’s statutory financial statements pursuant to the SVO’s recommendation. Industry comments expressed concerns that the proposal would be operationally burdensome and suggested that the NAIC produce the additional market data fields for the bond investments. The SVO is considering the pros and cons of the SVO’s taking responsibility for producing the analytical data elements or having insurers produce the analytical data elements. To that end, the VOS Task Force has exposed for comment an SVO memorandum, which is available here, discussing these items. Comments are due by September 12, 2022.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.