Regulatory Update: National Association of Insurance Commissioners Spring 2023 National Meeting

The SAP Working Group began its work on the Bond Project in October 2020 through the development of a principle-based bond definition to 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 proposed additional revisions to SSAP No. 26R include a new paragraph that excludes securities that do not qualify as bonds pursuant to the principle-based bond definition, including first loss positions that lack contractual payments or substantive credit enhancement (Residual Tranches). Corresponding proposed revisions to SSAP No. 21R were also exposed to add language that requires Residual Tranches to be reported on Schedule BA: Other Long-Term Invested Assets. Residual Tranches will be initially reported at cost, or allocated cost if acquired along with debt tranches from the securitization and thereafter will be required to be reported at the lower of amortized cost or fair value, with changes in fair value (or from amortized cost to fair value) reported as unrealized gains or losses. Residual Tranches are permitted to be admitted if debt securities from the same securitization qualify, or would qualify, as admitted assets.

Related to the Bond Project, the Blanks (E) Working Group (Blanks Working Group) also developed two proposals, the first of which proposes that Schedule D-1 be split into two sections: one for issuer credit obligations and a second for asset-backed securities, the second of which will update other parts of the annual statement that reference the bond lines of business. Comments on the exposed Blanks Working Group proposals are due by June 30, 2023.

While the SAP Working Group is in the process of finalizing its proposed changes to the SSAPs, it is currently expected that the Bond Project will not be completed and effective until January 2025 once all related workstreams are completed. As the SAP Working Group has noted, 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, certain accommodations may be made to prevent undue hardship for reporting entities complying with the new guidance.

The SAP Working Group first discussed the treatment of negative IMR at the 2022 Fall National Meeting (2022 Fall Meeting), following the receipt by the SAP Working Group of a letter from the American Council of Life Insurers (ACLI) raising concerns regarding negative IMR. The ACLI’s letter was sent in connection with discussions among the Life Actuarial (A) Task Force (LATF) on recommended guidance for year-end 2022 on the allocation of IMR for asset adequacy testing and principle-based reserving purposes in response to concerns that, given the rising interest rate environment over the last year, insurers selling fixed income assets for a loss would see their IMR balances decrease or become negative. A negative IMR occurs when net realized interest-related losses are greater than net realized interest-related gains, both of which are amortized in the IMR calculation.

The current statutory accounting guidance regarding IMR is limited but generally provides that a negative IMR balance is a nonadmitted asset. The ACLI’s letter noted that with the inclusion of a negative IMR balance in asset adequacy testing, the disallowance of a negative IMR can result in double counting of losses (i.e., through the disallowance on the balance sheet and the potential asset adequacy testing-related reserve deficiency). The ACLI’s letter argued that such treatment is contrary to the original intent of IMR, which recognized that interest-related gains and losses are transitory, without any true economic substance, as the proceeds would be reinvested at offsetting lower or higher interest rates, respectively, and therefore proposed the allowance of a negative IMR balance under statutory accounting in order to fulfill its original purpose.

Since the 2022 Fall Meeting, in response to an initial exposure on the topic from the SAP Working Group, the SAP Working Group held regulator-only meetings to hear company presentations on the issue. At the Spring Meeting, following discussion among members of the SAP Working Group and interested parties, the SAP Working Group directed NAIC staff as follows in order to begin the process for the SAP Working Group to formally consider a short-term and long-term solution regarding the treatment of negative IMR:

• develop guidance for future SAP Working Group consideration that would allow the admission of negative IMR up to 5% of surplus using the type of limitation calculation similar to that used for goodwill admittance that also provides for a downward adjustment if an insurer’s risk-based capital (RBC) ratio is less than 300; while the SAP Working Group determined to initially use a threshold of up to 5% of surplus, it noted that such threshold was intended to serve only as a proxy for discussion in the initial exposure and the final percentage may be higher or lower depending on the other guardrails agreed on
• review and provide updates on any annual statement instructions for excess withdrawals, related bond gains/losses, and noneffective hedge gains/losses to clarify that those related gains/losses are through asset valuation reserve, not IMR
• develop accounting and reporting guidance to require the use of a special surplus (account or line) for net negative IMR
• develop governance-related documentation to ensure that sales of bonds are reinvested in other bonds
• develop a footnote disclosure for quarterly and annual reporting

NAIC staff was also directed to draft referrals to LATF and the Capital Adequacy (E) Task Force (Capital Adequacy Task Force). The referral to LATF will be to consider the asset adequacy implications of negative IMR, including (i) developing a template for reporting within asset adequacy testing (AAT); (ii) considering the actual amount of negative IMR that is admitted to be used in the AAT; (iii) considering cash flows within AAT (and documentation) as well as any liquidity stress test (LST) considerations; (iv) ensuring that excessive withdrawal considerations are consistent with actual data (sales of bonds because of excess withdrawals should not use the IMR process); and (v) ensuring that any guardrails for assumptions in the AAT are reasonable and consistent with other aspects. The referral to the Capital Adequacy Task Force will be to consider the impact of eliminating any admitted net negative IMR from total adjusted capital in connection with RBC calculations and the consideration of sensitivity testing with and without negative IMR.

In May 2022, the SAP Working Group adopted revisions to SSAP No. 25 that clarified the reporting of affiliate transactions and incorporated new disclosure requirements for investments acquired through, or in, related parties, regardless of whether they meet the “affiliate” definition under the Insurance Holding Company System Regulatory Act (No. 440). In connection with such adoption, the SAP Working Group identified the need to further clarify when an investment is considered an affiliated investment and reported on the “parent, subsidiaries, and affiliates” reporting lines (referred to as the “affiliated” lines) in the investment schedules.

The adopted amendments to SSAP No. 25 clarify that any invested asset held by a reporting entity that (i) is issued by an affiliated entity or (ii) includes the obligations of an affiliated entity should be categorized as an “affiliated investment” for purposes of SSAP No. 25. Specifically, under the amendment, SSAP No. 25 is revised to add language to specifically state that “[a]ny invested asset held by a reporting entity which is issued by an affiliated entity, or which includes the obligations of any affiliated entity is an affiliate investment.”

Under the previously exposed P&P Manual amendments, any investment meeting the criteria of a Structured Equity and Fund would be ineligible for filing exemption, and an insurance company investing in a Structured Equity and Fund issuance would be required to provide information sufficient for the SVO to conduct a look-through assessment and credit risk assessment. The proposed amendments were previously exposed for a 60-day public comment period ending on February 13, 2023. In response to the exposure, the VOS Task Force received three comment letters raising various concerns regarding the proposed amendments.

The SVO proposed the amendments in response to its recent review of several private letter rating (PLR) filings for investments in notes issued by, and of equity or limited partnership interests in, a special purpose vehicle, trust, limited liability company, limited partnership, or other legal entity that operates as a feeder fund that itself invests, directly or indirectly, in one or more funds or other equity investments. The SVO cited a number of concerns with respect to such investments, including (i) the potential to circumvent regulatory guidance established by the VOS Task Force, SAP Working Group, and Capital Adequacy Task Force with respect to the reporting of equity investments, (ii) the reporting of such investments as bonds in order to receive favorable RBC treatment, and (iii) the lack of transparency regarding the true underlying risks, credit exposure, and nature of the investment.

The proposed amendments define “Structured Equity and Fund” as “a note issued by, or equity or limited partnership interest in, a special purpose vehicle, trust, limited liability company, limited partnership, or other legal entity type, as issuer, the contractually promised payments of which are wholly dependent, directly or indirectly, upon payments or distributions from one or more underlying equity or fund investments.” The SVO noted that any structure that circumvents the definition (including through the inclusion of an intervening legal entity (or entities) between the Structured Equity and Fund investment issuer and the underlying equity or fund(s)), which in substance achieves the same ends or poses the same risk, will be deemed a Structured Equity and Fund.

In the comment letters received in response to the prior exposure of the proposed amendments, interested parties commented that the proposed definitional change to the P&P Manual would potentially capture more traditional fixed income securities, which industry does not believe were intended to be in scope and may be difficult for the SVO to evaluate. Interested parties also noted concerns that a lack of transparency and applied consistency with the SVO’s designation methodologies will lead to material capital uncertainties and inconsistent designations. In addition, interested parties noted confusion on how to respond to the exposure due to the overlap of the proposed amendments with other initiatives and exposures ongoing at the NAIC, specifically the SAP Working Group’s Bond Project that includes determining eligibility for reporting on Schedule D (described above) and the Investment RBC Working Group activities, including the current project to determine the appropriate RBC charge for Residual Tranches.

After considering the issues raised by interested parties, the VOS Task Force decided to defer action on the proposed P&P Manual amendment and directed NAIC staff to draft a referral to the SAP Working Group for the SAP Working Group to consider the definition of Structured Equity and Funds in its guidance concerning Residual Tranches in order for the VOS Task Force to consider such items as this workstream continues. Citing interested parties’ request for consistency, including the need for a clear and documented process for insurers to challenge ratings, the VOS Task Force also directed SVO staff to draft an amendment that would create a more distinct process for how PLR filings can be reviewed and steps insurers could take to challenge those ratings.

Related to this work, during the Spring Meeting of the Investment RBC Working Group, there was significant discussion among regulators and interested parties on the development of an interim solution to address Residual Tranches, which is proposed to take effect January 1, 2024, and remain in place until a long-term solution can be developed for structured assets. Parties discussed whether an interim solution is necessary, but Iowa noted that companies were required, for the first time, to report residual tranches separately in their 2022 annual statutory financial statements and urged the Investment RBC Working Group to review the newly collected data to evaluate the materiality of the issue in order to better inform next steps.

An industry representative, speaking on behalf of a coalition of PE-owned life insurance companies, opposed the interim solution and asked the Investment RBC Working Group to focus its efforts on developing the correct long-term solution. In contrast, another industry representative, speaking on behalf of traditional life insurance companies, supported the efforts to implement an interim solution and suggested that 45% would be the appropriate factor to apply for purposes of the interim solution. The Investment RBC Working Group decided that it would hold regulator-only calls to evaluate the newly reported residual tranche data but would simultaneously move forward with developing an interim solution. To that end, the Investment RBC Working Group exposed for a comment period ending April 12, 2023, both a revised structural proposal (with one factor rather than three factors) and a sensitivity test proposed by the ACLI to help determine the appropriate factor to apply for purposes of the interim solution.

The VOS Task Force previously adopted an amendment to the P&P Manual to add reporting instructions for the financial modeling of CLOs. Specifically, the P&P Manual amendment makes CLOs ineligible to use CRP ratings to determine an NAIC designation if the NAIC’s Structured Securities Group (SSG) can model the security. The P&P Manual Amendment was introduced after the NAIC’s Investment Analysis Office (IAO) identified that CLOs had inconsistently assigned NAIC designations when relying on CRP ratings and had recommended this change to the VOS Task Force to ensure reporting equivalency for NAIC regulatory purposes. The amendment will become effective January 1, 2024, with insurers first reporting the financially modeled NAIC designations for CLOs with their year-end 2024 financial statement filings.

After the adoption of the P&P Amendment, to ensure transparency, the SSG asked the VOS Task Force to form an ad hoc group to model CLO deals. Review by the ad hoc group of the CLO modeling is expected to begin in mid-April 2023 and take approximately two months. The ad hoc group intends to use three or four proxy CLO deals from industry, which will be run through the exposed stress scenarios. Interested parties are encouraged to suggest the specific proxy deals to be included, and NAIC staff has asked that industry participants submit CLOs that are commonly held by insurance companies. While meetings of the ad hoc group are expected to be open, regulatory policy discussions will be limited at the ad hoc group meetings and will instead be brought back to the VOS Task Force.

In addition, related to the CLO modeling project, the Investment RBC Working Group also continued discussion on updating the C-1 factors for CLOs. An informational referral had been sent to the Investment RBC Working Group to continue discussions on the RBC charges for CLOs and develop a potential interim approach to address the concern regarding potential RBC arbitrage in the structuring of assets through CLOs and other similar assets. At the request of the Investment RBC Working Group, the C-1 Work Group of the American Academy of Actuaries (Academy) has been investigating CLOs to understand the risk they pose to life insurers’ statutory capital and considerations for establishing capital requirements. During the 2022 Fall Meeting, the Academy presented a report to the Investment RBC Working Group regarding the status of the Academy’s work on this topic, including commentary on the IAO letter proposing a new approach to CLO C-1, including modeling by the SSG and the introduction of new subcategories of NAIC-6 having 30%, 75%, and 100% factors.

At the Spring Meeting, the Academy noted that it intends to develop a model specification document that takes a de novo look at how to model CLOs for RBC purposes. The Investment RBC Working Group acknowledged this is a large project, thus updating the C-1 factors for CLOs will be a longer-term project.

The VOS Task Force’s review of CRPs initially began in August 2022 when the VOS Task Force developed an ad hoc study group consisting of selected VOS Task Force members, other state regulators, NAIC staff, and industry representatives in response to a memorandum received by the VOS Task Force from the IAO noting concerns regarding the NAIC’s reliance on CRP ratings.

The study group drafted a list of 22 questions intended to be completed by CRPs. After responses from the CRPs have been received, SVO staff will follow up with the CRPs to schedule a private meeting with the VOS Task Force members and NAIC staff to discuss the responses and answer any additional questions from the CRPs.

The VOS Task Force requested that any recommendations on the proposed list of questions be sent to SVO staff. The VOS Task Force expects to publish a final list of questions for the CRPs prior to undergoing its review with the CRPs; however, such meetings will be held in regulator-only session.

The List of PE Considerations was developed in connection with the NAIC’s review of PE ownership in the insurance industry after 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. The Macroprudential Working Group developed the List of PE Considerations to address, among other things, any regulatory gaps with respect to the increase in PE ownership of insurers, the role of asset managers more generally in insurance, and the increase in private investments in insurers’ portfolios. The List of PE Considerations was adopted by the NAIC in August 2022, after which various NAIC groups received referrals from the Macroprudential Working Group for further assessment. A copy of the List of PE Considerations as adopted by the NAIC is available here.

At the Spring Meeting, the Macroprudential Working Group focused its update on the List of Considerations on Item 14 (Offshore/Complex Reinsurance), which is the only item that remains under direct review by the Macroprudential Working Group. Recently, the Macroprudential Working Group met in regulator-to-regulator sessions with both the Cayman Islands Monetary Authority (CIMA), where the parties discussed CIMA’s regulatory regime, and the Bermuda Monetary Authority (BMA), where the parties discussed the BMA’s recently released public consultation on proposed enhancements to its regulatory regime.

Following these discussions, the Macroprudential Working Group prepared the draft Reinsurance Comparison Worksheet, which can be viewed here. It is proposed that the Reinsurance Comparison Worksheet be used by state insurance regulators to assess cross-border reinsurance treaties where there are different regulatory systems involved to enhance regulators’ ability to monitor these transactions. As proposed, regulators would have discretion to determine whether to require the use of the Reinsurance Comparison Worksheet. It is expected that the Reinsurance Comparison Worksheet will mainly be used for review of new treaties when regulators are considering approvals; however, it could also be used for treaties already in place where there are significant and material questions or concerns on the existing reinsurance arrangement.

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 (IAIGs) 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 ICS is entering the fourth year of the five-year monitoring period.

The U.S. and other jurisdictions 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. The NAIC was critical of the IAIS’s initial consultation of the draft criteria, noting that as drafted, the initial criteria could preclude comparability of the AM with the ICS, as the criteria did not take into account fundamental differences between the two approaches. Following this initial consultation, the IAIS decided to delay the approval of the comparability criteria to allow additional time to consider scenarios and sensitivity analysis that will be workable for the assessment process. The IAIS approved the final criteria on March 9, 2023.

In response, the NAIC released a supportive position statement, which can be found here, noting that the NAIC is “confident that these criteria provide a viable and fair path forward for the AM to be deemed an outcome-equivalent approach for implementation of the ICS.”

Data collection for the assessment will begin later this year with specifications for both the ICS and AM data to be released in late April and final data due to the IAIS by August 31, 2023. A decision on whether the AM provides comparable outcomes to the ICS is expected in the third quarter of 2024.

In response to comments received at the 2022 Fall Meeting, the MGI Working Group exposed for comment a revised draft of the amendments to the MGI Model Act. The revised draft authorized the amount of the required contingency reserve to be calculated net of contingency reserves maintained by reinsurers. Because many reinsurers do not file statutory financial statements that show a contingency reserve liability, the Private Mortgage Guaranty Insurance Industry Group suggested further changes to clarify that the reinsurer’s establishment of the contingency reserve includes maintaining separately held collateral in a trust or segregated account to support the reinsurer’s obligation. The industry group also suggested further changes to clarify that the contingency reserve calculation should also be credited in an amount equal to a ceding company’s recorded liability for funds held under a funds withheld reinsurance treaty.

The revised draft of the amended MGI Model Act also included a provision that prohibited a private right of action to enforce compliance with the MGI Model Act. Consumer groups were critical of this provision, while industry groups were supportive.

The MGI Working Group expects to prepare a further revised draft of the amended MGI Model Act, which will be discussed during interim conference calls this spring. The MGI Working Group’s stated goal is to adopt the amended MGI Model Act during interim working group meetings to allow the amended MGI Model Act to be presented for final adoption at the 2023 Summer National Meeting.

The Request for NAIC Model Law Development to amend the Guaranty Association Model Act to address cybersecurity insurance coverage was prompted by the trending of such coverage into the admitted market as reported by the National Conference of Insurance Guaranty Funds. The proposed amendments to the Guaranty Association Model Act include (i) clarification that cybersecurity insurance is included within guaranty association coverage; (ii) an optional definition of “cybersecurity insurance,” which is not defined in the current Guaranty Association Model Act; (iii) a coverage limitation of $500,000 per single cybersecurity incident and an authorization for the guaranty association’s engagement of service providers to mitigate losses from a cybersecurity incident; and (iv) optional pay and recovery language for guaranty association coverage that is subject to net worth exclusions.

The Request for NAIC Model Law Development to amend the Unfair Trade Practices Act is pursuant to a charge of the Improper Marketing of Health Insurance (D) Working Group to review existing NAIC models and guidelines that address the use of lead generators for sales of health insurance products and to identify models and guidelines that need to be updated or developed to address current marketplace activities. The proposed amendments to the Unfair Trade Practices Act include (i) defining a “health insurance lead generator,” (ii) prohibiting a health insurance lead generator from engaging in an unfair trade practice, and (iii) defining the marketing-related activities of health insurance lead generators that constitute unfair trade practices.

As revised, the handbook includes guidance related to reviewing the fairness and reasonableness of agreements that provide for services to be provided at cost or at market value. The working group noted that in some cases where services provided by an affiliate are not directly comparable to services available in the open market, affiliate service agreements contemplate a “cost-plus” fee structure.

While the proposed revisions to the handbooks do not include guidance for reviewing “cost-plus” arrangements, the working group is requesting input on whether the handbooks should include such guidance and, if so, what tools or benchmarks are available for regulators to assess whether such an arrangement is fair and reasonable. The comment period ends May 5, 2023.

a. Actuarial Guideline 49-A

The NAIC adopted revisions to Actuarial Guideline 49-A during the Joint Meeting of Executive (EX) Committee and Plenary on March 25, 2023. The Life Insurance and Annuities (A) Committee previously adopted the revisions to Actuarial Guideline 49-A on February 24, 2023.

The revisions to Actuarial Guideline 49-A are intended to address regulators’ concerns that illustrations prepared in accordance with the Life Insurance Illustrations Model Regulation (Model No. 582) produce more favorable results for unbenchmarked indices than for benchmarked indices. In particular, the revisions are intended to address concerns related to illustrations for indexed universal life products with uncapped volatility-controlled funds and a fixed bonus. The revisions to Actuarial Guideline 49-A apply to policies sold on or after May 1, 2023.

The revisions to Actuarial Guideline 49-A are the first step in the NAIC’s phased approach to addressing life insurance illustration issues, and the Life Insurance and Annuities (A) Committee has emphasized that it will continue to consider whether to pursue more significant changes to the life insurance illustration regulations.

b. Actuarial Guideline 54

The NAIC adopted Actuarial Guideline 54 during the Joint Meeting of Executive (EX) Committee and Plenary on March 25, 2023. The Life Insurance and Annuities (A) Committee previously adopted Actuarial Guideline 54 on February 24, 2023. Actuarial Guideline 54 prescribes the conditions under which index-linked variable annuities (ILVAs) can be considered variable annuities exempt from the scope of the Standard Nonforfeiture Law for Individual Deferred Annuities (Model No. 805).

Actuarial Guideline ILVA sets forth principles and requirements for determining interim values (including death benefit, withdrawal amount, annuitization amount, or surrender values) such that an ILVA may be considered a variable annuity and thereby exempt from Model No. 805. In particular, a basic principle of Actuarial Guideline ILVA is that an ILVA must provide for interim values consistent with the market value of a hypothetical portfolio (composed of a fixed-income asset proxy and a derivative asset proxy) supporting the ILVA. The market value of the assets may be determined by a fair value methodology or by applying a market value adjustment to the book value. While the final version of Actuarial Guideline ILVA does not codify alternative methods of determining interim values that industry commenters had suggested, the final version does allow a contract to provide for a different methodology for determining interim values, provided that the insurer demonstrates that the interim values determined using such methodology will be “materially consistent” over the crediting period with the interim values that would be produced using the hypothetical portfolio methodology.

Actuarial Guideline ILVA requires an insurer to provide an actuarial memorandum with each ILVA product filing that includes actuarial certifications that

• the interim values defined in the contract provide equity between the contract holder and the insurance company
• the assumptions used to determine the market value of the derivative asset proxy are consistent with the observable market prices of derivative assets whenever possible
• contractually defined interim values are “materially consistent” with the interim values that would be produced using the hypothetical portfolio methodology (less a provision for the trading costs at the time the interim value is calculated)
• any trading costs represent reasonably expected or actual costs at the time the interim value is calculated

Actuarial Guideline ILVA will apply to all contracts issued on or after July 1, 2024. For ILVAs issued after this date, if an ILVA does not comply with the principles and requirements of Actuarial Guideline ILVA, such ILVA will not be considered a variable annuity and therefore will be subject to Model No. 805.

The 2023 White Paper emphasizes the increasing need for accessible, affordable, and adequate insurance for the cannabis industry and, to that end, the importance for state insurance regulators to fully comprehend and carefully consider the needs and risks of the cannabis industry and encourage insurance participation in the cannabis industry. Among other items, the 2023 White Paper outlines the complexities of the cannabis industry, including the different designs of cannabis businesses, jurisdictional variations, current insurance types and offerings, potential future insurance products, differences presented by insuring hemp versus cannabis, and the importance of developing consistent regulatory practices for state cannabis insurance regulation. The 2023 White Paper also covers cannabis history and terminology, cannabis policy trends at the state and national levels, current landscapes of cannabis regulation, licensing and education, cannabis business operating structures, and cannabis industry insurance market considerations. The 2023 White Paper concludes with a brief discussion on the future state of cannabis insurance, including possible next steps for relevant parties.