7 Updates to Know from the NAIC Summer 2019 Meeting

I recently attended the NAIC 2019 Summer National Meeting on August 3-6 in New York City to hear the latest investment accounting updates and stay informed of new guidance from the NAIC.

The meeting included updates from the Statutory Accounting Principles Working Group (SAPWG), the Valuation of Securities Task Force (VOSTF), and the Investment Risk-Based Capital Working Group (IRBCWG).

My colleague Lindsay Gee and I provided a detailed summary of key topics during a Clearwater-hosted webinar on August 14. You can read about all the updates Clearwater is following from the NAIC’s summer meeting and a recent conference call in our market insight paper.

Here is a snapshot of seven topics you should know from the summer meeting.

Statutory Accounting Principles Working Group

The following items were exposed for comment through October 11, 2019.

1. REF #2019-22: WASH SALE DISCLOSURE

A proposal was made to clarify what would be subject to the wash sale disclosure: only investments that meet the definition of a wash sale in accordance with SSAP No. 103R, which are purchased or sold prior to a reporting period-end and sold or repurchased after that reporting date.

This proposed change eliminates the need to report transactions that meet the wash sale criteria in SSAP No. 103R that are sold and repurchased within the same reporting period.

This item stems from revisions to the wash sale disclosure captured in 2017 in SSAP No. 103R – Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

Since the 2017 revisions, industry has told NAIC staff that the tracking of wash sales can be very time-consuming and uses a large amount of resources while not necessarily responding to the main risks associated with these transactions. The investments sold and repurchased within the same reporting period do not pose any greater risk than if the investments had been held throughout the reporting period and at the period-end date. The real risk is investments that are sold prior to the period-end date and repurchased shortly after that date.

2. REF #2019-18: “OTHER” DERIVATIVES

This proposal would incorporate guidance for “other” derivatives to SSAP No. 86 – Derivatives. Current guidance only addresses derivatives involved in hedging, income generation, or replication transactions. This item was exposed at the spring meeting, when changes were adopted regarding structured notes for which the contractual principal amount to be paid at maturity is at risk for other than failure of the borrower to pay the contractual amount due to be reported as other derivatives under SSAP No. 86 (Ref #2018-18).

This proposal recognizes “other” derivatives at fair value but specifies they are nonadmitted under SSAP No. 4 – Assets and Nonadmitted Assets and would be subject to state investment law. If permitted under state laws, they would be admitted under a prescribed practice.

Interested parties commented on the treatment of structured notes in the proposal and proposed aligning the definition for structured notes in SSAP No. 86 with the definition in SSAP No. 26R, addressing structured notes separately from “other” derivatives, and incorporating structured notes in the guidance as admitted assets.

NAIC staff do not think the structured notes are prevalent and recommended the working group adopt the exposed revisions to SSAP No. 86, and not reflect the interested parties’ comments, instead recommending they be considered in a separate agenda item to capture information on structured notes reported as “other” derivatives. However, the interested parties asked for extra time and will come back with more concerns. The working group decided to expose the proposal again.

3. REF #2019-20: ROLLING SHORT-TERM INVESTMENTS

This proposal would affect SSAP No. 2R – Cash, Cash Equivalents, Drafts and Short-Term Investments and SSAP No. 103R – Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. It considers statutory accounting guidance for short-term investment structures that are being purposely designed to mature at or around 364 days (often with affiliates), with the full expectation that the investment structure would be renewed (rolled) continuously for subsequent years. It also addresses investments reported as cash equivalents, with the same dynamic, but structured to comply with the cash equivalent timeframes.

NAIC staff said it is only allowed to show those investments as short-term (Schedule DA) or cash equivalent (Schedule E) once in the schedules. Those investments should not be reported on Schedule DA or E continuously. The proposed revisions permit the insurers to report the security as a long-term investment at acquisition regardless of the maturity date.

NAIC staff noted the proposal was structured specifically to apply to affiliated bond investments (SSAP No. 26R), all loan-backed and structured security investments (SSAP No. 43R), and all investments that would be captured on Schedule BA. In doing this, it excludes a variety of cash equivalent/short-term investments that are often purposely rolled/reacquired to ensure a continuous balance of available short-term liquidity (e.g., treasury-bills, commercial paper, certificates of deposit, etc.) from being classified as long-term investments. Non-affiliated SSAP No. 26R investments would be exempt from the proposed change.

Valuation of Securities Task Force

4. REPORT ON THE PROJECT TO REVIEW EXISTING CREDIT TENANT LOAN GUIDANCE AND POSSIBLE NEW GUIDANCE ON OTHER LEASE-BASED TRANSACTIONS

NAIC staff noted they held a meeting June 23, 2019, to discuss this guidance, and have hired a new general counsel who will review associated legal documents. They also stated that there may be new guidance for other lease-based transactions — that is, other types of high-quality, well-structured, credit-supported, project loan, infrastructure, and lease-backed securities that are not expressly contemplated by the P&P Manual but have been rated by credit rating providers (CRPs) and purchased as Schedule D investments. These other assets, which have evolved out of assets contemplated by the NAIC, have undergone considerable scrutiny by investors and rating agencies. Staff will continue working with the interested parties.

The VOSTF agreed insurers can report the other lease-based transactions as-is. Insurers do not have to file these securities with the SVO and can continue converting CRP ratings into NAIC designations for those securities until the SVO establishes a better approach.

Interested parties responded that they look forward to working further on this issue with the SVO.

5. REPORT ON THE IMPACT OF RMBS/CMBS PRICE BREAKPOINTS WITH UPCOMING CHANGES TO NAIC DESIGNATION CATEGORIES

NAIC staff said the consensus is to provide a single NAIC designation instead of 19 breakpoint prices after the granularity of the NAIC designation category and removal of modified FE process. Eric Kolchinsky, Director of the NAIC Structured Securities Group, said the SSG could provide breakpoint prices, but there is concern it would be costly for the insurers to change their investment platform. In addition, they may change the financial model later. Providing a single designation for financially modeled residential mortgage-backed securities/commercial mortgage-backed securities and mortgage-referenced securities is more efficient for both the vendors and insurers.

Interested parties said they look forward to seeing the memo of proposed changes.

Investment Risk-Based Capital Working Group

6. DISCUSS PROPOSED CHANGES TO THE RBC CHARGE FOR UNAFFILIATED COMMON STOCK SUPPORTING LONG-HORIZON CONTRACTUAL COMMITMENTS

On July 22, industry submitted a proposal to reduce RBC factors for unaffiliated common stock supporting long-horizon contractual commitments. This is still in its 60-day exposure period and tentatively scheduled to be discussed during a September conference call when the exposure period is over. As this would be a significant change, there was a call for any interested parties to submit comments. The working group brought up the following concerns if the proposal moves forward:

• Should we view it through the C-1?
• Would this create a need to change accounting standards?
• This proposal assumes a diversified portfolio; what is the effect on other portfolio types?
• How do we ensure that this is strictly for payout annuities and structured settlements?
• If we establish the standard, how will states roll it out in a uniform manner?
• What are the implications for PRBC?
• The low interest rate environment is what is driving this proposal; is it appropriate in other environments?
• This proposal is based on historical information that the stock market always goes up; would the change still apply if this changes?

7. DISCUSS PROPOSED CHANGES OF BOND PAGES IN THE P/C RBC FORMULA

Updates were proposed to the Bond Pages, including the elimination of the separation of Hybrid Securities and RBC factor changes on the PR006.

This item was exposed for 45 days ending on July 1. No comments were received during the exposure period, nor at the meeting, and the NAIC recommended adoption. The proposed changes have been forwarded to the IRBCWG for further discussion.