June Update: NAIC Valuation of Securities Task Force

The Valuation of Securities Task Force of the NAIC held a meeting on June 9. They exposed three proposals pertaining to investment accounting for comment with a July 9 deadline. They also received a memorandum of support from the Financial Condition Committee, comment letters from the industry regarding fixed income analytical risk measures, and an update on modeling and scenarios.

Clearwater provides frequent updates of NAIC activity to help our clients stay current on regulatory guidance updates and discussion from the NAIC.

Items Exposed for 30 Days with a Comment Deadline of July 9, 2022

Update the Role of the Securities Valuation Office (SVO) Regarding Interpreting Accounting and Reporting

The item proposes revising the SVO P&P Manual Part One, Paragraph 40, to be consistent with the rest (e.g., Paragraph 32, 33, and 34) of the SVO P&P Manual.

It emphasizes the SVO can assign NAIC Designations to investments that are not eligible for Schedule D or BA reporting as long as it has the methodology to do so. The SVO is allowed to notify the appropriate regulators of any investments which, in its opinion, would not or might not be reported on Schedule D or BA at its discretion. The SVO would also maintain its authority to offer its accounting and reporting opinion as part of its Regulatory Treatment Analysis Service when they are requested to do so, but those opinions would not be authoritative and might not reflect the opinion of the relevant state regulator. It is aligned with Section V of the Preamble – the accounting P&P Manual is the highest level of authoritative guidance.

Update Part Four for NAIC Designation Category and Additional Price Points

This proposal is to update the SVO P&P Manual to reflect a consistent reference to NAIC Designation Category and the additional price points needed to determine them for legacy residential mortgage-backed securities/commercial mortgage-backed securities (RMBS/CMBS) that were issued prior to January 1, 2013. The proposed updates include the number of price breakpoints changed from five to 19, RBC factors updated for each of the NAIC Designation Categories, and the mapped NAIC Designation Category be removed from the SVO P&P Manual Part Four.

IAO Issue Paper on the Risk Assessment of Structured Securities – Collateralized Loan Obligations (CLOs)

This item proposes revising the SVO P&P Manual to allow the Structured Securities Group (SSG) to model CLOs by evaluating all tranche-level losses across all debt and equity tranches under a series of calibrated and weighted collateral stress scenarios to assign NAIC Designations that eliminate the RBC arbitrage.

The proposed modeling approach will be similar to the current RMBS/CMBS modeling approach, which the SSG will do annually at year-end and publish the single designations or breakpoints via AVS+.

NAIC staff illustrated an example of how the insurers can gain an RBC arbitrage benefit by securitizing a CLO. The RBC factor would be 9.535% if the insurers hold a direct investment in a pool of corporate loans with a B rating versus 2.917% if the insurers securitize those same loans into a CLO and hold the entire transaction.

The staff recommends adding modifiers to the NAIC Designation 6, i.e., 6.A, 6.B, and 6.C, and sending referrals to both the Capital Adequacy Task Force and Risk-Based Capital Investment Risk Evaluation Working Group to consider adding two new RBC factors (i.e., 75% for 6.B and 100% for 6.C) that can account for the tail risk in those structured tranches.

Other Items

Memorandum of Support from the Financial Condition Committee to the Valuation of Securities Task Force

The Financial Condition Committee showed their support to the VOSTF, other task forces and working groups.

The committee noticed the wide range of risk management practices within the industry. It is necessary to establish standards to address issues that could become material disaster without proper and timely consideration within the NAIC solvency framework.

The ongoing discussions include:

1. Risk-Based Capital Investment Risk Evaluation Working Group: Life Risk-Based Capital charge for certain structured securities with a greater tail risk
2. Statutory Accounting Principles Working Group: Proposed principle-based bond definition, improved transparent accounting and reporting for bonds
3. Valuation of Securities Task Force: Possible reduction of reliance on credit rating agencies’ ratings, possible use of risk indicators, e.g., market data
4. Life Insurance and Annuities Committee: Using a modified economic scenario generator that more appropriately captures the low interest rates experienced, and consideration of certain “high-yielding” assets within the annual asset adequacy analysis testing.

The committee encouraged all states and the SVO to continue to take all appropriate actions under existing rules and standards.

Referral to the Blanks Working Group to Add Fixed Income Analytical Risk Measures to Investments Reported on Schedule D Part 1

This item was exposed on April 5, 2022, for 45 days. More details on this update can be found in our market insight paper. The task force received three comment letters from the industry. They expressed they want to provide the regulators with meaningful data but the concerns they have is it may not be cost beneficial to report those analytic values and find out in a few years they didn’t hit the nail on the head.

The chairwoman encouraged the industry to suggest what type of data or matrix they should utilize to measure risks. She asked the NAIC staff to continue working with the interested parties.

Presentation from Structured Securities group (SSG) on Modeling and Scenarios

Eric Kolchinsky, SSG director, said they added three additional macroeconomic scenarios between the current four scenarios and a tail scenario for both RMBS and CMBS in order to better differentiate among 20 NAIC Designation Categories. The scenarios are supposed to be through-the-cycle. They are still optimizing and fine tuning.

They haven’t finalized the work on probabilities, but the goal is to lower the probabilities at the tail and increase at the belly.