Sabrina Wilson, CPA, FLMI
Sabrina serves as a subject matter expert for regulatory filings at Clearwater. In this role, she works with internal teams for the ongoing enhancement of NAIC reports. Sabrina has over 20 years’ of statutory accounting and reporting experience and uses her background to communicate industry best practices and comment on regulatory guidance and procedures. She also handles complex statutory accounting and analytics questions posed by our user community.
Sabrina is a certified public accountant, has earned the designation of Fellow, Life Management Institute (FLMI), and has a master’s degree in accounting and taxation from Boise State University.
Several working groups from the National Association of Insurance Commissioners (NAIC) held meetings in May.
During the meetings, the Statutory Accounting Principles Working Group (SAPWG) proposed:
NAIC staff emphasized the Notes to Financial Statement 7 is not limited to bonds only. Insurers are required to disclose the gross, non-admitted and admitted interest income and accrued, aggregate deferred interest, and PIK interest included in the current principal on this note for all assets including mortgage loans, bonds, structured securities, preferred stocks, BA assets, etc.
Recently, the RBC factor for residual tranches has been a hot topic in the life insurance industry. The analysis performed by NAIC staff showed the factor increase from 30% to 45% has a minor impact on the ultimate RBC requirement. The potential adoption date for this factor increase proposal is June 14, 2023. This potential adoption will likely be supported by the Capital Adequacy Task Force and the Financial Condition Committee in their meetings on June 30 and July 19 respectively.
The Valuation of Securities Task Force (VOSTF) has proposed granting the SVO discretion to notch down the NAIC designation when the CRP rating is more than two notches different than the IAO’s own assessment. Interested parties are expected to protest this proposal.
The following updates pertain to investment accounting.
The Statutory Accounting Principles Working Group (SAPWG) of the NAIC held a virtual meeting on May 16, 2023.
Ref #2023-11EP: Editorial Update
This item replaces intrinsic value with volatility value in SSAP No. 86R paragraph 43.a.ii. This change was proposed by the industry to clarify the disclosure category for the excluded component to the BWG (2022-17BWG).
Ref #2023-12: Residuals in SSAP No. 48 Investments
The SAPWG previously adopted a change in SSAP No. 43R – Loan-Backed and Structured Securities, that requires the residual tranches or interests to be reported on Schedule BA on designated reporting lines beginning 2022 year-end. After reviewing the 2022 annual statements filed by the insurers, it was identified that the residuals may be underrepresented because of the various legal forms that residual investments can take. NAIC staff said the SAPWG received a referral from the VOSTF, which will be attached to the agenda & materials for Summer National Meeting. For example, some residual tranches or interests are in the form of limited partnerships, joint ventures, or other equity fund investments within the scope of SSAP No. 48. To ensure ALL residual tranches/interests are reported consistently on designated reporting lines on Schedule BA, this agenda item proposes guidance to clarify the reporting of in-substance residuals on designated reporting lines on Schedule BA regardless of the structure or legal form of the investment vehicle. With this clarification, the insurers will have to move those residual interests down from non-registered private funds, joint venture, partnership, or limited liability company to the designated reporting lines for residual tranches within Schedule BA.
NAIC staff emphasizes that residual interests are different from equity interests. Residual tranches are included in the investment structures that are backed by a discrete pool of collateral assets and could be backed directly or indirectly through a feeder fund. The collateral assets generate cash flows that provide interest and principal payments to the investors of debt and residual tranches. It impacts the distribution of cashflows when there are some collateral assets that do not perform as expected. The residual interest holder absorbs losses before the debt tranche holders who receive interest and principal payment until the cashflows are exhausted. The residual holder may end up receiving nothing, a reduced principal and interest repayment from original projection, or large returns, based on how the underlying collateral assets perform. To determine if a security is a residual interest or tranche for reporting purposes, the insurers are required to look at the substance or characteristics of the investment rather than its legal form. Staff provides common characteristics of residual interests, which should not be used as rules governing whether a security reflects a residual interest. For example, residuals often do not have contractual principal or interest payments, but they may have stated principal or interest payments with the terms & conditions that allow for significant variation in the timing and amount of cashflows without triggering a payment default when the investment structure becomes stressed. Residuals do not have credit ratings or NAIC assigned designations, but their subordination supports the credit quality of the rated debt tranches. Residual holders may receive payment throughout the holding period, but the payments received continue to reflect the residual amount permitted after other tranche holders receive contractual principal and interest payments.
This item proposes adding clarifying language to SSAP No. 48 that investments that reflect residual interests or that predominantly hold residual interests shall be reported in the residual interest reporting category with underlying asset characteristics on Schedule BA, even if the legal form is in joint venture, partnerships, limited liability company or other equity fund structure. It also proposes adding the corresponding definition and common characteristics of a residual interest to SSAP No. 43R Loan-Backed and Structured Securities and removing footnote from SSAP No. 43R paragraph 26.c. that limits the residual interest to the scope of SSAP No. 43R only.
Ref #2023-13: Paid-in-kind “PIK” Interest Disclosure Clarification in SSAP No. 34
The SAPWG adopted 2022-17 at Spring National Meeting this year. It requires insurers to report the aggregate cumulative PIK interest included in the current par on notes to financial statement 7 effective December 31, 2023.
NAIC staff received questions related to how paydowns/disposals would impact cumulative PIK interest included in the current par. As the newly adopted guidance in SSAP No. 34 is up to multiple interpretations, NAIC staff proposed adding clarifying language to ensure consistent application among the insurers and they believe it will streamline the calculation as well. NAIC staff emphasized this proposed change neither changes the accounting treatment nor affects the income statements.
This item proposes adding a new footnote to SSAP No. 34 paragraph 7, that paydowns and disposals are first applied to any PIK interest included in the current principal. As a practical expedient, it proposes allowing an insurer to calculate the cumulative PIK interest included in the principal by subtracting the original principal/par value from the current principal/par value, but not less than $0.
The SAPWG will provide a memo to BWG for 2023 year-end application and revising the formal instructions for 2024.
Ref #2022-14: New Market Tax Credits / Tax Equity Investments
To encourage the investors to invest in programs that helps low-income housing community, the Congress established a new market tax credits (NMTC) program in December 2000 that allows individual and corporate taxpayers to receive a non-refundable tax credit (39% of the total cost of the investment over a seven-year period) against federal income taxes. It is expected a portion or perhaps all the equity investment will be unpaid without an obligation from the program. The NMTC program will expire on December 31, 2025, but the NMTC Extension Act of 2023 would make this program permanent, modify the credit to provide for an inflation adjustment to the limitation amount for the credit after 2023, and allow an offset against the alternative minimum tax for the credit. Community Development Fund Institutions (CDFI) is a division of the US Treasury responsible for implementing the NMTC program and grant tax credits (aka NMTC Allocation) to Community Development Entities (CDEs) which are financial intermediaries who pass through the tax credits to the cash investors in return of their investments in the qualifying project – Qualifying Active Low-Income Community Business (QALICB). This program specifies that investors must provide cash as an equity investment, and it must stay invested in the CDE and the resulting QALICB project for a period of seven years. Previous tax credits will be recaptured if the criteria are no longer met, e.g., the programs are no longer qualified within the seven-year timeframe etc.
The existing statutory accounting guidance does not encompass federal NMTC, or other federal tax credits, as SSAP No. 93 is limited to Low-Income Housing Tax Credit (LIHTC) Property Investments and SSAP No. 94 is limited to state tax credits. NAIC staff said there are investment structures that have been designed to resemble fixed-income notes that provide tax credits as interest returns instead of regular cash interest. NAIC staff said those fixed income like investment and equity investment in a corporation or partnership, are for tax credits and not for interest or equity returns, and should be treated as equity investments in tax credits as long as they meet specific criteria to qualify for tax credits under the Internal Revenue Service (IRS) rules, e.g., Form 3800 – General Business Credit.
This item proposes expanding:
NAIC staff will draft the related issue paper for both SSAP revisions and will present them for the SAPWG later as both SSAP No. 93 and SSAP No. 94R are substantively revised and renamed the SSAP No. 93 from “LIHTC Property Investments” to “Investments in Tax Credit Structures” and SSAP No. 94R from “Transferable and Non-Transferable State Tax Credits” to “State and Federal Tax Credits.”
VOSTF Referral Response
NAIC staff said the SAPWG reviewed the referral sent from the VOSTF on the acquisition of commercially available analytical data. As the investment classifications follow the provisions in the SSAPs and are not dependent on investment analytical data, the SAPWG decided not to provide a response letter, but the working group members are encouraged to respond directly to the VOSTF if they have comments.
Verbal Update on the Life Actuarial Task Force (LATF) Update on Negative Interest Maintenance Reserve (IMR) Referral
Rachel Hemphill, the Chair of LATF, provided an update on LATF consideration related to the referral from SAPWG on negative IMR. They do not believe it is acceptable to admit negative IMR, and they recommend the SAPWG to not rely on the asset adequacy test for admissibility. The asset adequacy test is not formulated, lacks guardrails, and relies on subjectivity. LATF will provide written response to the SAPWG by the end of June.
The SAPWG will discuss negative IMR in the next meeting on June 28, 2023.
The Risk-Based Capital Investment Risk and Evaluation Working Group (RBCIREWG) of the National Association of Investment Commissioners (NAIC) held a virtual meeting on May 17, 2023.
Philip Barlow, the Chair of the IREWG, said he does not expect a vote for the RBC factor for residual tranches in this meeting, but he would like to go through all the comment letters and have discussions with the working group members to see if they need any additional information or if he may answer some of their questions. He plans to get a motion to vote after hearing final comments in the next meeting on June 14, 2023. He said the group will have two things to decide: factors for both the residual tranches and the sensitivity test.
Review of Year End 2022 Data Reported for Residual Tranches
Julie Gann, Assistant Director – Solvency Policy at the NAIC, put together a memo based on reviewing the residual tranches reported on the 2022 annual statement. Because company specific information such as individual insurer’s RBC cannot be shared publicly, she aggregated the data for the IREWG. She reported the materiality of residual tranche holdings (762 securities) by life companies. Here are her findings:
Review of comment letters from the regulators and interested parties
Barlow said all assets on the insurers’ balance sheet must get an RBC charge each year which depends on which investment schedules they are reported on, asset types, and ratings. Insurers put new asset types on the investment schedule where they think they should be, and that may result in different RBC charges for different insurers. He would like IREWG to develop a conservative and appropriate RBC charge for new asset types before those assets turn into material for the insurance industry and warrant full analysis of RBC charge determination. He said while it is true that the current 30% and proposed 45% charge are not backed by complete RBC analysis, he wants to point out a complete RBC analysis requires a lot of work. He does not expect any additional work to be done for this interim solution project. He emphasizes IREWG previously reviewed some structured assets and determined the risks. They looked at some situations where the CLO may lose up to two-thirds of the principal. They also looked at capital charges from their peers, e.g., bank regulators who charge 100% for residual tranches. He does not think the current RBC factor of 30% is appropriately conservative, and he thinks the current proposed factor of 45% is better than the current factor of 30%, though neither are backed by complete RBC analysis. He said the determination of RBC factor for residuals is not a one-off or unique situation and he wants to start a process dealing with the new asset types systemically. He said IREWG should not defer their responsibility to other groups, e.g., VOSTF, and they do not have options to defer this decision. They created a residual bucket and now they need to establish a factor for it.
Eleven comment letters were received from the regulators and interested parties.
The commenters that support adopting the current proposed RBC factor of 45% (e.g., Regulators from District of Columbia, New York, etc.), are concerned about having liabilities, e.g., pension risk transfers, annuities, rely on those under-capital-charge asset class. They pointed out that while no full RBC analysis was conducted for the proposed RBC factor of 45%, there was also no full RBC analysis for the current RBC factor of 30%. They questioned why there is now a call to conduct a full RBC analysis for the proposed 45% factor, when the issue never arose with the 30% factor. 2022-year end data showed the residual holding is low now, but the allocation is rising sharply. They emphasized that a common feature of the residuals is the first losses, and that it is worse than any of the S&P 500 stocks. Continually using a 30% RBC charge shall be precluded from RBC arbitrage perspective.
For the commenters that do not support adopting the current proposed RBC factor increase (e.g., Regulators from Connecticut, Illinois, Iowa, etc.), they suggest the regulators utilize the sensitivity test tool to identify the insurers that invest heavily in the residuals instead of raising the RBC factor. They said NAIC deviates from the standard process of developing RBC factors with a full analysis. This interim solution remains in place until the long-term solution is adopted, and it may take years to accomplish. Iowa regulators do not think the interim solution is necessary because the current exposure does not pose material risk to the life insurance industry, and they suggest using a solicitation approach, figuring out how to handle new asset types, and setting up a formal process. There will be unintended consequences if IREWG adopts the factor increase, and one of the known consequences is that it may affect the capital market for CLOs.
Some interested parties said they could move the residuals that have less leverage to a trust and get CRP ratings on the trust, file the trust with the SVO for NAIC Designation, or ask the SSG for modeling the trust. Charles Therriault, the SVO Director, said his office will decline assigning NAIC Designation to those structures, and Eric Kolchinsky, the SSG Director, said they will also decline modeling those structures. The SSG currently model RMBS/CMBS except for those residual tranches.
Barlow said he wants to focus on new comments in the next IREWG meeting on June 14, 2023. He also urges some states that object to what the IREWG is doing, to send comment letters directly to the IREWG because he does not understand what the objection is about.
The Valuation of Securities Task Force (VOSTF) of the National Association of Investment Commissioners (NAIC) held a national meeting on May 15, 2023.
Proposed Authorizing the Procedures for the SVO’s Discretion Over NAIC Designations Assigned Through the Filing Exemption Process
The VOSTF directed the Securities Valuation Office (SVO) to draft a distinct process on how the SVO would recommend challenging an NAIC Designation assigned from a credit rating provider “CRP” rating in the filing exemption “FE” process when the SVO thinks the rating is not a reasonable assessment of risk for regulatory purposes during the discussion of proposed amendment on Structured Equity and Funds at the Spring National Meeting in 2023.
Pursuant to SVO P&P Manual Part One paragraph 80, the VOSTF is resolved to ensure that the benefit gained from using the credit ratings (i.e., conservation of limited regulatory resources) must be balanced against the risk of blind reliance on them. Both the SVO and SSG (collectively known as Investment Analysis Office (IAO)) are charged with administration of the FE process defined in the SVO P&P Manual Part Three.
This item proposes granting the SVO some level of discretion over the FE process to address both the NAIC’s current blind reliance on credit ratings and the Financial Condition Committee’s (FCC) charge to the VOSTF. FCC charged the VOSTF to establish criteria to permit the SVO staff’s discretion over the assignment of NAIC designations for securities subject to the FE process to ensure greater consistency, uniformity, and appropriateness to achieve the NAIC’s financial solvency objectives.
An interested party asked Carrie Mears, the Chair of the VOSTF, why there is no indication of the costs in the proposal and how the policyholders can benefit from this proposed change. He said FE has not been a problem and no insurers ever have materially or even slightly overstated risk-based capital. Carrie said some insurers tend to invest in more private assets that may have more complexity and liquidity risk that will pass on to the policyholders. The current regulatory framework was not designed to handle the complexity or magnitude of the structured securities the insurers hold. She said regulations are reactive instead of proactive. They observed those trends and recommended the appropriate regulatory guidance updates. Another interested party asked Charles Therriault if this proposed guidance change would fix the CMBS/RMBS issues that occurred between 2008 and 2010. Charles said it would if the SVO had this authority in 2008 to address or overrule those mis-rated securities instead of blindly relying on CRP ratings. Carrie asked the industry to provide alternatives that are feasible if they disagree with any of the proposed changes.
Proposed Update the Definition of an NAIC Designation
The reformatted SVO P&P Manual in 2019 unintentionally scattered the definition of an NAIC Designation into two places – those converted from the CRP ratings through filing exempt process in the SVO P&P Manual Part One and those assigned by the SVO in Part Two.
This item proposes consolidating the instructions that define an NAIC Designation (Part One paragraph 37 through 39, 88, and Part Two paragraph 18 through 32) with the current “NAIC Designation Subscript S” section (Part One Paragraph 90 and Part Two Paragraph 33 through 39) into one in Part One. Other than combining the existing instructions, this item proposes adding clarifying language to the instructions:
Proposed Amendment to Clarify the meaning of Repurchase Agreement in the Derivatives Transaction Definition for Funds in the NAIC Fund Lists section of the SVO P&P Manual Part Three
The VOSTF adopted amendments to the SVO P&P Manual two years ago after the Securities and Exchange Commission adopted rule 18f-4, which governs funds’ use of derivatives in November 2020 under the Investment Company Act of 1940. As the SSAP No. 103R reverse repurchase agreement definition is the opposite of the SEC definition, it proposes adding clarifying language to the SVO P&P Manual to maintain consistency between the SVO P&P Manual and SSAP No. 103R and eliminate any misconception that a fund cannot be the purchaser of securities/lender of cash.
This item proposes replacing reverse repurchase agreement with repurchase agreement under which the fund sells securities and simultaneously agrees to repurchase the same or substantially the same securities at a stated price on a specified date irrespective of accounting treatment in SVO P&P Manual Part Three paragraph 293.
Updates on the Proposed CLO Modeling Methodology and Ad-hoc Working Group
SSG Director Eric Kolchinsky said they had two meetings in April and released cashflows for six CLOs. They had tieout calls with several parties and they are very helpful. The next meeting will be on May 17, 2023. They will add more details to previously released cashflows to help parties to tieout.
Security Filing Fee included in AVS+ Fee Structure
SVO Director Charles Therriault said he has been thinking about the fee structural change for 7 years. His goal is to find an equitable way and operationally efficient to cover security filing fees. He proposes there would be a single fee based upon Schedule D Part 1 assets that would cover nearly all VISION filing fees and AVS+ valuation fees. The goal is to have VISION filing fees borne by all AVS+ users. He will include this proposal in the 2024 budget for implementation in 2025, once it is submitted, accepted, and approved by the NAIC’s Executive Committee and plenary.
The Blanks Working Group of the NAIC held a virtual meeting on May 31, 2023.
Ref #2023‐11BWG – Add additional instructions and illustration for Note 7 – Investment Income for all asset types (2022-17)
This item was developed to reflect changes to SSAP No. 34 – Investment Income Due and Accrued, adopted by the SAPWG in agenda item 2022-17 on March 22, 2023. It adds new additional disclosure requirements for gross, non-admitted and admitted interest income due and accrued, aggregate deferred interest, and cumulative paid-in-kind interest included in the current principal balance. It will allow the regulators to identify any admitted interest income that was deferred past the originally scheduled payment date, but where the terms and conditions allow them to not be classified as past due.
NAIC staff incorporated some clarifying languages suggested by the interested parties into the instructions, e.g., gross interest income should equal Assets Page Line 14 Column 1. They disagree with the interested parties’ comment that limits the scope to bonds only for Note 7C, as SSAP No. 34 covers all asset types and is not limited to bonds only.
NAIC staff emphasized that interest income due and accrued that is 90 days past due is non-admitted except for mortgage loan interest income due and accrued that has a different threshold. Interest income due and accrued that is 180 days past due and collectible is non-admitted for a mortgage loan that is determined to be in default per the contractual terms of the loan pursuant to SSAP No. 34 paragraph 6.
Ref #2022-17BWG – Add new disclosure paragraph for Note 8 and add code “%” for excluded component and three electronic only columns related to derivatives with excluded components to both Annual and Quarterly Schedule DB, Parts A and B (SAPWG 2021-20)
This item adds new disclosure requirements for derivative instruments, which reflect changes to SSAP No. 86 adopted by the SAPWG in agenda item 2021-20. It adds a new disclosure paragraph for Note 8 – Derivative Instruments. It also adds a new code “%” for excluded components, and three electronic only columns related to derivatives with excluded components, to both annual and quarterly Schedule DB Parts A & B.
NAIC staff incorporated several recommendations from the interested parties into the instructions, e.g., replacing intrinsic value with volatility value for Note 8A(9) and stating the unrealized gain/loss is not applicable to foreign currency forwards and currency swaps for Schedule DB Parts A and B where the forward points or cross currency basis, respectively, are the excluded component.
Ref #2023‐08BWG – Add clarifying language for mutual insurance companies on Schedule Y, Part 3.
This item stemmed from questions NAIC staff received consistently from the insurers about whether mutual insurance companies should be included in Schedule Y Part 3. Dale, the Chair of the SAPWG, said the mutual insurance company should be included in Schedule Y Part 3 if it is part of the holding company system.
Ref #2023-06BWG – Split the Schedule D Part 1 into two sections: one for Issuer Credit Obligations (ICO) and the other for Asset-Backed Securities (ABS). Update the other parts of the Annual Statement that reference the bond lines of business. (SAPWG 2019-21)
This item was exposed on March 7, 2023, with a longer exposure period until June 30, 2023. It refers to splitting Schedule D Part 1 into two parts – Issuer Credit Obligations and Asset Backed Securities. The SAPWG and NAIC staff are still working on a couple of outstanding items on the statutory accounting side and would love to hear comments from the industry. NAIC staff have been working with interested parties and fixing anything that needs to be fixed prior to adoption. They are trying to make this guidance update an easier process.
The proposed effective date is January 1, 2025.
Ref #2023‐07BWG – Update the code column and delete the Legal Entity Identifier (LEI) column for the following investment schedules: Schedules A, B, BA, D Part 2, D Part 6, and E Part 1.
This item proposes updating the code column and removing the LEI column from all investment schedules, except for Schedule DB. This proposed revision was identified during the bond project. As it is not related to the bond project directly, the SAPWG decided to keep this out of the agenda item 2023-06BWG, but to share the same proposed effective date of January 1, 2025.
Some insurers said it is burdensome for them to verify if the LEIs in their record are still valid annually. After NAIC staff realized there are currently no requirement for the issuers to have or maintain a valid LEI, and no regulators were identified to have been using the LEI, they proposed removing this from all investment schedules, but maintaining the LEI for derivatives on Schedule DB. This is because the counterparties are required to maintain valid LEI to participate in derivative transactions.
This item is deferred to coincide with agenda item 2023-06.