NAIC Spring 2020: Valuation of Securities Task Force Updates

The Valuation of Securities Task Force of the NAIC held a conference call May 14. The following are updates from that meeting.

Download Clearwater’s full NAIC Spring 2020 market insight paper here.

Adopted Items

Consider Adoption of an Updated Amendment to the P&P Manual of Instructions to Map Financial Modeled RMBS/CMBS Security NAIC Designations to NAIC Designations Categories

VOSTF exposed a draft amendment to the P&P Manual following a February interim meeting. The amendment retains the Financial Modeling and book/adjusted carrying value price ranges for modeled residential mortgage-back securities and commercial mortgage-backed securities and adds mapping instructions to produce a NAIC designation category for insurers to report.

This is a temporary measure until new risk-based capital factors are adopted. There would be no regulatory capital impact from the change.

This item was adopted with a friendly amendment for financially modeled 43R securities with zero losses and will be mapped to 1.A instead of 1.D.

Consider Adoption of a Proposed Amendment to the P&P Manual for Principal Protected Notes with an Updated Definition and Instructions

NAIC staff began working with industry members last fall on a definition for principal protected securities. Staff provided a recommended definition and suggested adding a new section in the P&P Manual that provides examples.

The proposed definition states: Principal Protected Notes (PPNs) are a type of security that repackages one or more underlying investments and for which contractually promised payments according to a fixed schedule are satisfied by proceeds from an underlying bond(s) but for which the repackaged security generates potential additional returns as described in the detail criteria for PPNs, along with examples, in Part Three of this Manual.

The amendment also states investments in PPNs must be submitted to the Securities Valuation Office (SVO) for review because they may possess other non-payment risks that the SVO must assess under its subscript S authority.

An interested party said they appreciate the transparency on the methodology SVO uses, and it will give insurers better understanding for capital planning. SVO Director Charles Therriault said he is happy to work with the interested party on the methodology.

This proposal was adopted effective January 1, 2021, with a friendly amendment. The amendment states the existing securities need to be filed with the SVO by July 1, 2021.

Discuss Temporarily Extending Insurer’s 2020 Initial Filing Deadline from 120-days to 165-days for Newly Acquired or Securities in Transition

Due to COVID-19, the NAIC understands insurers may need more time to file newly acquired securities or the securities in transition. The securities can be reported with a Z designation within 160 days instead of 120 days.

This proposal was adopted.

Exposed Items

Receive IAO Issue Paper on Staff Concerns about Bespoke Securities and Reliance on CRP Ratings

Staff at the IAO expressed concerns to the VOSTF about bespoke securities. The private nature of bespoke securities means they are not subject to or constrained by market forces and competition, and therefore their visible characteristics may substantially underrepresent actual risks, according to the group.

In a previous meeting, members of the IAO and VOSTF agreed over concerns that the NAIC relied too heavily on credit rating provider ratings to assess investment risk for regulatory purposes. The IAO was tasked with developing a summary of the issues related to bespoke securities and coming up with remediation.

Bespoke securities are often private securities, and there is no available third-party data sufficient to identify them. A CRP rating incorrectly reflects how NAIC guidance would treat or view that security. As the methodologies being used by the rating agency may not be appropriate for the assessment of investment risk for statutory purposes, the SVO would need to be given additional authority and discretion from the task force to manage and administer their appropriate use for NAIC purposes.

NAIC staff also said the SEC noticed some CRPs have changed their rating criteria in order to gain more business and increase their market shares. The SVO does not take part in the structuring of securities transactions for issuers nor have competitive pressures to obtain business from the issuers.

The IAO submitted an issue paper to the VOSTF outlining concerns and recommendations. For next steps, the IAO recommended sharing the issue paper with the Financial Condition (E) Committee and continuing this discussion next year.

The SVO recommended the insurer provide legal agreements for the SVO’s determination if the security and/or the CRP rating were appropriate for NAIC purposes. If the SVO determined the security is unacceptable, the SVO would work with the appropriate regulatory groups to address any policy matters. The security would need to be filed with the SVO for a complete analysis if the CRP rating was not appropriate. The SVO also suggested the use of ARO ratings should be highly selective and incorporate both supplemental and alternative risk assessment benchmarks.

The SVO pointed out on 43R securities that price points are used instead of CRP ratings. It was mentioned that the NAIC has better methodology for regulatory purposes, and CRP ratings do not work that well for this purpose.

This item was exposed with a 90-day comment period.

Receive a Proposed Amendment to the P&P Manual with Updated Instructions for Non-conforming Credit Tenant Loan (CTL) Transactions that Relied Upon Credit Ratings

SVO staff provided a recommendation to the VOSTF that it include additional guidance in the policy on “The Use of Credit Ratings of NRSROS In NAIC Processes” to clarify that there should be no presumption of permanent eligibility to receive an NAIC designation based upon an NAIC CRP rating. Any parties that would like to know the probable regulatory treatment and filing exempt eligibility of a security are encouraged to utilize the Regulatory Treatment Analysis Service (RTAS) to initiate such a regulatory review and interpretation by the SVO or SSG.

The current policy states the NAIC’s sole objective in obtaining and using publicly available credit ratings is because of limited regulatory resources, but the NAIC is not endorsing the credit rating or analytical product of any credit rating provider.

This proposal states the insurers may file the non-conforming CTL that was owned prior to January 1, 2020, and which have CRP ratings with the SVO. The SVO may assign a NAIC Designation if the risks posed by the non-conforming CTL are adequately mitigated and the non-conforming CTL has characteristics of a bond. A non-conforming CTL shall not be reported as a bond if it was acquired after December 31, 2019.

The SVO also recommended the VOSTF refer the proposed amendment to the SAPWG and request the working group affirm that they would consider these non-conforming CTLs to have the characteristics of a bond if assigned an NAIC designation by the SVO staff.

This item was exposed with a 30-day comment period.

Receive a Proposed Amendment to the P&P Manual for Technical NAIC Designation Category Corrections

The SVO recommended the VOSTF update guidance in the P&P Manual to identify several policy-based assignments of NAIC designations that did not receive a mapping when NAIC designation categories were introduced in 2018, e.g. certificates of deposit reported as long-term bonds, U.S. government securities, SVO Identified Bond Mutual Funds and U.S. domiciled exchanges that are assigned a NAIC Designation Category of NAIC 1.A. Securities with an insurer’s self-assigned NAIC 5GI designation are assigned a NAIC designation category of NAIC 5.B GI.

This item was exposed with a 30-day comment period.

Hear a Report from the Structured Securities Group (SSG) on RMBS and CMBS

COVID-19 related government mandated closures resulted in non-payment of commercial and residential mortgages. This is not typical delinquency and is expected to be temporary while some delinquencies may be permanent.

Regulators, including the NAIC, have responded by providing regulatory flexibility to avoid making the situation worse.

The SSG has been asked how COVID-19 will affect RMBS and CMBS year-end modelling. People realize they can work from home effectively during the shutdown. SSG Director Eric Kolchinsky referenced a news report on the real estate situation in Manhattan and office space in high-price areas could go down because people are looking for a cheaper alternative.

Kolchinsky said the VOSTF has exposed a set of RMBS economic scenarios in 2017, but they never developed CMBS portion.

The SSG will continue to monitor RMBS/CMBS holdings and will have a better understanding of the permanence of the effects of the COVID-19 non-payments. It will provide the task force with recommendations in the third quarter and intermediate results, “mid-year,” analysis in early fall.