Valuation of Securities Task Force
The Valuation of Securities Task Force (VOSTF) of the NAIC held a conference call March 22, 2021. The following updates are from that meeting.
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 Update the Financial Modeling Instructions for RMBS/CMBS Securities and Direct IAO Staff to Produce NAIC Designation and NAIC Designations Categories for Non-Legacy Securities
IAO staff made a recommendation to the NAIC that all Non-Legacy Securities (those financially modelled Residential Mortgage-Backed Securities/Commercial Mortgage-Backed Securities that closed on or after January 1, 2013) move to a single NAIC designation and NAIC designation category with no SVO Administrative Symbol, e.g., 3.C. This was first proposed by IAO staff in 2019, but the VOSTF opted to defer the change at a February 2020 meeting due to concerns from industry about significant adverse risk-based capital consequences.
The current practice provides a series of book adjusted carrying value price breakpoints to companies to determine the NAIC designation then map to the mid-point modifier. The effects of the 2020 pandemic on RMBS and CMBS securities in year-end financial modeling showed several securities no longer qualified as zero-loss because of the more conservative scenarios being applied to reflect the economic impact of the pandemic. As a result, these became subject to the book adjusted carrying value price breakpoints process.
After reviewing year-end 2020 modeling, industry and IAO staff agreed that the price break points caused insurer-owned securities with otherwise strong credit to be reported as NAIC 2, NAIC 3, and NAIC 4. This is because many of these securities are held at a premium due to the low-interest rate environment and received these designations because of their book adjusted carrying value and not for a credit concern.
During a December 2020 meeting of the VOSTF, there was discussion and concern that the current process was causing possible market disruptions. Moving away from financial modeling price breakpoints process for these non-Legacy Securities will avoid further and future market disruptions and permit a clearer assessment of the credit risk assessment for these securities that will not be impacted by their book adjusted carrying value.
Staff recommended a referral to the SAPWG because of potential impact to SSAP 43R - Loan-Backed and Structured Securities.
There was dialog to see if some of the problematic breakpoints could be resolved in the future. The NAIC is open to identifying additional disclosures at a more granular level so an insurance company can better understand what was driving the problematic modeling.
This item was adopted for a 2021 implementation date. The date could change to 2022 if it is not able to be implemented from a technology standpoint, but that will be reviewed at a later date.
Discuss Comments Received and Consider for Adoption an Updated Proposed Amendment to the P&P Manual to Require the Filing of Private Rating Letter Rationale Report
In February 2020, the VOSTF exposed a memo from IAO staff expressing concerns over bespoke securities and the NAIC’s overreliance on credit rating provider ratings to assess investment risk and for regulatory purposes. The VOSTF then asked the SVO to make recommendations addressing these concerns.
Further, the Financial Condition (E) Committee directed VOSTF in October 2020 to include a new charge for 2021 to, “implement policies to oversee the NAIC’s staff administration of rating agency ratings used in NAIC processes, including, staff’s discretion over the applicability of their use in its administration of Filing Exemption.”
As a result of these actions and concerns, the SVO proposed moving forward with implementation of some of its recommendations and increasing SVO scrutiny of PL (privately rated) securities. Many PL securities are bespoke securities. In a memo, the SVO had concerns that its lack of authority to use its judgment in determining whether a CRP rating is useful for NAIC purposes has led to an increase in the use of bespoke securities, many of which are assigned NAIC designations through the Filing Exempt (FE) process.
To receive an NAIC designation for PL securities, the SVO must receive the private rating letter and a rationale report that provides more in-depth analysis of the transaction, private rating methodology, as well as risks and mitigants. This information will allow the SVO to determine if the private credit rating is an Eligible NAIC CRP Rating and eligible to be reported on Schedule D. The SVO will also determine if it agrees with the private credit rating. If the SVO deems a PL security is ineligible for Filing Exemption or is outside the scope of SSAP No. 26R – Bonds, SSAP No. 32R – Preferred Stock, or SSAP No. 43R – Loan Backed and Structured Securities, the SVO will provide a brief explanation in VISION why the security will not be provided an NAIC Designation Category.
In November, the VOSTF directed the SVO to update its proposed amendment to have the rationale reports filed with SVO, but without the SVO’s discretion over evaluating the appropriateness of the rating or methodology utilized. A regulator-only call will be scheduled to review transactions that appear to be ineligible for filing exemption, Schedule D reporting or if there is a difference in opinion on risk.
The interested parties (American Council of Life Insurer (ACLI), North American Securities Valuation Association (NASVA), and Private Placement Investors Association (PPiA)) agree to increase the level of transparency and information sharing with the SVO and regulators to address potential concerns with bespoke securities by providing private rating letters, rating rationale reports and even the deal documents upon the SVO’s request if necessary. However, they also raised the practical challenges resulting from the contractual agreements between credit rating providers, insurers, and issuers. The insurers are not allowed to share ratings rationale reports with the SVO in accordance with the current agreements. For the PL securities issued between January 1, 2018 and January 1, 2022, they will work to persuade issuers and credit rating providers to amend existing contractual agreements. However, they expect this process will take time and they will ensure the SVO is continually aware of their progress.
The SVO incorporated the edits by the interested parties and proposed amendments to Parts One and Three of the P&P Manual to require insurance company filers to provide private rating letter rationale reports for each PL security effective January 1, 2022. Insurers are required to report those PL securities issued between January 1, 2018 and January 1, 2022, on the General Interrogatory (i.e., a PL GI security) if they cannot provide the SVO a copy of a rating rationale report due to confidentiality or contractual reasons. If there are no such limitations, the PL securities will be reported with a self-designated NAIC Designation Category of NAIC 5.B GI.
Charles Therriault with the NAIC team is working with the taskforce to clean up the wording on some of the amendments and will release the changes for a 30-day exposure period.
Discuss Comments Received and Consider for Adoption a Proposed Amendment to the P&P Manual to Update the List of NAIC Credit Rating Providers to Reflect NRSRO Changes
Following Morningstar, Inc.’s acquisition of DBRS, the SVO recommended adoption of a non-substantive amendment to the P&P Manual to remove references to the legacy entities and refer to the new combined entity, DBRS, Inc., doing business as “DBRS Morningstar Credit Ratings” or “DBRS Morningstar.” This change will update the rating agency names on the List of NAIC Credit Rating Providers to match those on the U.S. Securities and Exchange’s Office of Credit Ratings list of current nationally recognized statistical ratings organizations (NRSROs) and the CRP Credit Rating Equivalents to NAIC Designations and NAIC Designation Categories.
It also removes the Morningstar ratings from the P&P Manual Part Three Paragraph 23 – mapping table for both long- and short-term ratings.
There were no comments on this item from the task force or interested parties.
Exposed Item for 45 days with comment deadline ending May 6, 2021
Discuss and Receive a Proposed Amendment to the P&P Manual to Clarify Guidance for Fund Leverage
In response to requests from VOSTF members for a more definitive limitation on the use of derivatives, the SVO proposed creating two new tests aimed at providing greater clarity and predictability to fund sponsors and investors regarding the acceptable use of derivatives and to allow some funds to have greater flexibility in their use of derivatives. One test would cover all funds not on the NAIC Fixed Income-Like SEC Registered Funds List, and the second test would apply only to funds on that list.
For funds on the SVO-Identified Bond ETF List, the SVO-Identified Preferred Stock ETF List and the NAIC List of Schedule BA Non-Registered Private Funds with Underlying Assets Having Characteristics of Bonds or Preferred Stock, the SVO proposed a threshold rule in which “the gross notional amount of derivatives which impose no future payment or margin posting obligation on the fund, cannot exceed 10% of the net asset value of the fund, under normal market conditions, except for certain currency and interest rate hedges, certain futures or forwards on fixed-income or preferred stock to be held in the fund’s portfolio, reverse-repurchase agreements associated with specific fixed-income or preferred stock investment held by the fund, and non-margin borrowing for purposes other than investment, each of which could impose a future payment or margin posting obligation on the fund.”
Funds on the NAIC Fixed Income-Like SEC Registered Funds List are in scope of SSAP No. 30R-Unaffiliated Common Stock and reported on Schedule D, Part 2, Section 2. In this case, NAIC Designations assigned to those funds could be permitted to include assessments of risk other than credit risk, including market and liquidity risk, and it would increase the range of funds eligible to receive NAIC Designations. These funds would also be allowed a larger derivative threshold of up to 20% of the net asset value of the fund, under normal market conditions, preventing violation of the P&P Manual fund methodology’s “predominantly hold” requirement, according to the SVO.
The SVO is not proposing any types of derivatives be exempt from the 20% threshold calculation.
Capital Adequacy Task Force
The Capital Adequacy Task Force (CADTF) of the NAIC held a conference call March 23, 2021. The following are important updates from that meeting.
Consider Adoption of Proposal 2020-10-CA Bond Structure for Health and P&C Insurers
This item was exposed for a 45-day comment period in October 2020. It modifies the structure for the bonds to pull directly from the Book Adjusted Carrying Value Footnotes of Schedule D Part 1, Schedule DA Part 1, and Schedule E Part 2 for the 20 NAIC Designation Categories. It removes hybrid securities from equity assets pages, i.e., XR010 and PR007, and they will be included as a bond on the Bonds pages and asset concentration (i.e., XR012, PR011).
The Task Force will expose the RBC bond factors by the end of April and adopt for 2021 Annual by June 30, 2021.