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MARKET INSIGHTS

NAIC Updates: July 2021

NAIC Updates: July 2021

MARKET INSIGHTS

The NAIC recently held a series of calls and meetings to discuss items from the Statutory Accounting Principles Working Group, the Valuation of Securities Task Force, and the Heath Risk-Based Capital Working Group. Below are updates related to investment accounting.

NAIC Statutory Accounting Principles Working Group

The Working Group e-voted to expose agenda item 2021-10 – SSAP No. 32R Clarification of “Effective Call Price” on July 21, 2021, with a comment deadline of August 6, 2021.

After both issue Paper No. 164 and substantive revisions to SSAP No. 32 were adopted by the Working Group in July 2020, NAIC staff have received implementation questions regarding the application of a valuation ceiling for certain callable instruments including perpetual preferred stock, mandatory convertible preferred stock, and publicly-traded preferred stock warrants in the scope of SSAP No. 32R. It clarifies that callable preferred stock generally have a five-year lock-out period in which the issuer cannot call the preferred stock and the issuer must send an official call redemption notice to the shareholders with details of the call redemption and call date.

NAIC staff agrees the current interpretation of valuation ceiling does not appear to appropriately reflect the economics of the equity investment when the instrument can be sold at its current fair value without incurring a loss. It proposes to add a new footnote to SSAP No. 32R, paragraph 11 to clarify that the valuation ceiling is only applicable when the call is: 

  1. Currently exercisable by the issuer; or 
  2. The issuer has announced that the instruments will be redeemed/called.

NAIC Valuation of Securities Task Force

The Valuation of Securities Task Force of the NAIC held a meeting on July 15, 2021. The following items pertain to investment accounting. 

Adopted Items Effective for 2021 Annual 

Discuss Comments and Consider for Adoption an Updated Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Add Additional Instructions to the Review of Funds

This exposed item is modified by incorporating interested parties’ edits — that is, it removes the proposed management assessment section that allows SVO to notch the final NAIC Designation down or to not assign any NAIC Designation, and it reduces to a single test (from the previously proposed two separate tests) for derivatives depending on which SVO Identified Fund List a fund is listed on. It adheres closely to Rule 18f-4 (adopted by the SEC in October 2020, effective February 2021) related to the use of derivatives by registered investment companies including funds. It limits the fund’s exposure to 10% of the fund’s net asset value in order to be considered as fixed income like funds for the following three investment types:

  • Gross notional amount of derivatives under which a fund is or may be required to pay during the life of the instrument through margin or settlement payments, or market value of derivatives under which a fund shall not be required to pay during the life of the instrument through margin or settlement payments;
  • Value of assets sold short for short sale borrowings; and
  • Proceeds received for reverse repurchase agreements or similar financing. 

Certain currency and interest rate derivatives that hedge currency or interest rate risk associated with other equity or fixed-income investments of the fund would be exempt from this 10% exposure calculation.

The only difference between this proposal and the SEC rule is that the P&P Manual requires a look-through assessment. A fund that invests in another fund which will also need the SVO’s approval and be maintained on the SVO-Identified Fund lists.

To remove the need for the SVO to review derivative legal documentation, the item proposes a new filing requirement to include certain derivatives information (e.g., derivative type, any future payment requirements, derivative is exempt from exposure calculation, counterparty credit rating, derivative exposure, and how the exposure is calculated). However, the SVO reserves the right to request the derivative legal document if they deem it necessary.

One of the interested parties recommended the VOSTF delay the adoption because fund companies do not need to fully comply with this SEC Rule until August 19, 2022.

Discuss Comments and Consider for Adoption a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Permit Filing Exemption for Real Estate Lease-Backed Securities

This item modifies the definition of Credit Tenant Loan (CTL) by clarifying that CTLs are direct mortgage loans in the scope of SSAP No. 37, are not eligible for filing exemption, and are required to be filed with the SVO for review and potential assignment of an NAIC Designation.

Real estate lease-backed securities (e.g., CTL-like or GLF-like securities) which meet the definition of securities that are in the scope of SSAP No. 26R or 43R are eligible for filing exemption. Insurers are allowed to file these with the SVO for NAIC Designation.

Interested parties are supportive of this amendment which allows real estate lease-backed securities be eligible for filing exemption.

Discuss and Consider for Adoption Proposed Amendments to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) on Guidance for Working Capital Finance Investments Consistent with the Statutory Accounting Principles (E) Working Group Adoption of Changes to SSAP No. 105R – Working Capital Finance Investments. 

This item modifies the P&P Manual on Working Capital Finance Investments to align with the updates to SSAP No. 105R and Issue Paper No. 163, which were made by the SAPWG in May 2020. Key revisions include:

  • Removed the requirement that the Securities Valuation Office (SVO) determine if:

          - the International Finance Agent is the functional equivalent of the U.S. regulator;

          - a first priority perfected interest has been obtained.

  • Removed the statement that the reporting entity may need to seek approval from the domestic regulator.
  • Removed the finance agent prohibitions on commingling.
  • Removed duplicative text regarding exercising of investor rights.
  • Broadened the independent review requirements to allow independent review of the finance agent by either audit or through an internal control report.
  • Changed the default provisions from 15 to 30 days so the default date and the cure period are consistent.

This item was exposed in October 2020 and the Task Force did not receive any comments during the public comment period.

Exposed Item with comment deadline of August 16, 2021 

Discuss and Consider for Adoption Proposed Amendments to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) on Permit the SVO to Rely Upon the Un-rated Subsidiaries of a CRP Rated Parent Entity for Only Working Capital Finance Investments

This exposed item is modified by incorporating interested parties’ edits (e.g., removing key participants). It proposes that the SVO can rely on the parent entity’s ratings to determine the NAIC Designation of the overall WCFI program when the subsidiary doesn’t have an NAIC CRP Rating and the SVO cannot assign an NAIC Designation to it. It proposes that the SVO has authority to notch such NAIC Designations based on its analytical judgement and in its sole discretion or choose not to assign any NAIC Designation to the WCFI program if they believe the program is unrelated to the relationship between the subsidiary and its parent entity.

It is exposed for 30 days, and the referral will be sent to the Statutory Accounting Principle Working Group.

Other Items

Updates from Statutory Accounting Principle Working Group 

The SAPWG will have three calls in the near future. The first two calls (July 29 and August 10) are regulator-only calls. The first call will focus on reviewing 2020 annual data. The second call will discuss the Schedule D project. The third call (August 26) will discuss Credit Tenant Loans and INT 20-10 that will expire in October 2021.

Updates from Structured Security Group (SSG)

Eric Kolchinsky, SSG director, said they received some excellent and very interesting requests for proposals (RFP) but they selected BlackRock Solutions, the same vendor that has been modeling financially-modeled structured securities owned by US domiciled insurance companies since 2015.

The Task Force received a comment letter from the American Council of Life Insurers (ACLI) and the North American Securities Valuation Association (NASVA) on July 9, 2021. Both the ACLI and the NASVA recommend:

  1. NAIC designation mapping of non-financially modeled structured securities follows the same filing exempt (FE) process as other FE-eligible bond investments;
  2. NAIC designation mapping of non-legacy financially-modeled securities that were issued on or after January 1, 2013 should follow the following process:

          a. No price breakpoints and the SSG continues to follow the adopted intrinsic price approach;

          b. SSG will provide a file with CUSIP-level designations that can be directly consumed by vendors;

          c. SSG will map “zero-loss” securities to 1.A and all other securities to the middle designation of their category.

  1. NAIC designation mapping of legacy modeled securities that were issued prior to January 1, 2013 should follow the following process:

           a. SSG will derive the CUSIP-level price breakpoints from the new RBC factor of the middle designation of each designation category and provide a file with CUSIP-level price points that can be directly consumed by vendors for Life and P&C respectively;

           b. Insurers will map “zero-loss” securities to 1.A and all other securities to the middle designation of their category.

Eric said he appreciates their letter and there are some issues the SSG will need to work on, like the zero-loss framework. He believes it is extremely important to move out from the breakpoints in 2022. He may need to propose some minor changes to the P&P Manual for 2021 and will draft a proposal for the Task Force review soon.

NAIC Health Risk-Based Capital Working Group

The Health Risk-Based Capital Working Group of the NAIC held a meeting on July 12, 2021. The following item pertains to investment accounting. 

Discuss Bond Factors 

The working group adopted the Academy’s proposed health bond factors for year-end 2021 reporting. As the Life Risk-Based Capital Working Group subsequently adopted the proposed Moody’s bond factors in June, it is recommended to reevaluate the bond factors due to major assumption differences in the models by the Academy and Moody’s. For example, Moody’s used a typical life bond portfolio, whereas the Academy’s analysis used a broad spectrum of bonds available out in the market. Additionally, Moody’s used a correlation model instead of the Academy’s economic state of the cycle model.

The Chair said the Working Group will need to assess if Moody’s assumptions are applicable to health RBC and will continue to discuss this item in the future.

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