NAIC Spring 2018 National Meeting Update – Investment Risk-Based Capital Working Group & Capital Adequacy (E) Task Force

The Investment Risk-Based Capital Working Group (IRBCWG) and Capital Adequacy (E) Task Force (CATF) met March 24 at the NAIC Spring 2018 National Meeting in Milwaukee, Wisconsin, to discuss numerous items that were reviewed and exposed.

Adopted Items

2017-14-P: PROPERTY/CASUALTY AFFILIATED BONDS

The CATF received a proposal from the Property and Casualty Risk-Based Capital Working Group (P&C RBCWG) to move the risk-based capital (RBC) charge of affiliated bonds from the PR003, PR004, and PR005 to the PR006. During their March 24, 2018, meeting, the P&C RBCWG noted that the change added consistent treatment and value to the full RBC formula. The National Association of Mutual Insurance Companies (NAMIC) spoke in favor of the proposed change during the P&C RBCWG meeting and noted that the charges to be assessed to bonds on the PR006 would allow the bonds to be more risk-sensitive. No further stakeholder feedback was received during the CATF meeting.

A motion to adopt the proposal was carried.

2017-07-CA: ADJUST UNAFFILIATED COMMON STOCK FOR MONEY MARKET MUTUAL FUNDS

In correspondence with changes made in 2017 to reclassify money market mutual funds (MMFs) as cash equivalents, the CATF reviewed a proposal to remove a reference to nongovernment MMFs on the “Unaffiliated Common and Preferred Stock” for life, property/casualty, and health RBC.

The proposal would avoid a duplicate charge to MMFs, which were included as cash equivalents for 2017 annual reporting purposes. No stakeholder feedback was received during the CATF meeting.

A motion to adopt the proposal was carried.

Additional Items

UPDATES RECEIVED FOR RBC FORMULA MODEL REVISIONS

The IRBCWG heard updates from NAIC staff and the American Academy of Actuaries (AAA) regarding revisions to bond structure and factors in the risk-based capital formula model.

Staff advised that their work had primarily been focused on the bond factors, rather than the underlying structure. Staff clarified that updating the bond granularity was a significant undertaking; despite the required effort, they advised they are considering for adoption a memo detailing the increased bond granularity and believed there was enough information for adoption to take place in 2019. Discussions will continue to take place between NAIC staff and the AAA prior to exposure and adoption.

UPDATES RECEIVED FOR AAA’S JOINT P&C/HEALTH BOND FACTORS ANALYSIS WORKING GROUP

The IRBCWG heard updates from Lauren Cavanaugh of the AAA related to the AAA’s joint P&C and Health bond factors analysis working group. Cavanaugh advised that the working group’s focus had been to consider the C-1 working group’s work, including differences in the nature of business and overall differences in accounting. One of the key components discussed during the meeting was a proposed difference in time horizon between P&C and Health companies. Although Cavanaugh recommended using the C-1 model as a starting point and changing a few of the assumptions to apply to both P&C and Health, the liability run-off period would differ between P&C and Health companies. This proposed change would mark a noticeable difference in the current bond factors applied to P&C and Health companies and raised concerns from regulators during the meeting. Staff advised that further modeling and discussions would need to occur prior to adopting or exposing for further comment from Interested Parties.

DISCUSSION OF BOND PORTFOLIO ADJUSTMENT TREATMENT FOR EXCHANGE-TRADED FUNDS

The IRBCWG continued discussion on the treatment of Exchange-Traded Funds (ETFs) related to the bond portfolio adjustment. In its October 23, 2017, conference call, NAIC staff proposed three ideas for treatment:

1. Count each fund as one issue
2. Apply a pro-rata percentage (based on the size of the ETF in proportion to the entire portfolio) to the number of issuers of the ETF
3. Allow a look-through approach and apply a single factor to each bond within the ETF

Staff discussed allowing ETFs to be included with bonds to determine RBC charges. This idea gained support due to the potential for thousands of bonds to be included in ETFs. Rather than receiving credit for several thousand bonds (as noted in the previously-discussed third idea), an insurer would receive credit for one bond. However, during their discussion staff emphasized the importance of considering the impact on small insurers and encouraged examining each option to find a fair solution.

Interested Parties requested that NAIC staff consider the impacts on both Life and P&C/Health companies since base factors were not revised in 2006 for bond ETFs. Staff advised they would continue discussing the item prior to exposing or adopting.

IT WORK-RELATED BOND GRANULARITY MEMO

During the Summer 2017 National Meeting, the Valuation of Securities Task Force (VOSTF) referred a proposal to the CATF to direct NAIC staff to begin necessary IT work for implementation of designation expansion. The proposed IT work would allow for both the IRBCWG and the VOSTF to continue their review of the proposed expansion to twenty bond designation categories. During the spring meeting, NAIC staff noted that the proposal was not an adoption of the IRBCWG’s work to increase the bond designations from six to 20; however, the proposal would allow for continued work and review from both committees.

The CATF carried a motion to direct staff to perform the necessary IT work to accommodate the potential increased bond designations.

DISCUSSION OF FEDERAL TAX REFORM AND IMPLICATIONS

The IRBCWG and CATF heard updates related to the Tax Cuts and Jobs Act of 2017 and its potential implications for insurers. During both meetings, regulators and Interested Parties discussed the importance of addressing the updates in a timely and comprehensive fashion.

The tax changes were of significant importance to the calculation of risk-based capital for Life companies, because the calculations are made on an after-tax basis. As such, the Life Risk-Based Capital Working Group (LRBCWG) advised that it was attempting to complete the necessary review and updates within five weeks of the spring meeting in order to have the changes implemented for 2018 annual reporting.

The ACLI commented during the meeting and advised that bond factors would need to be revised due to the tax changes. While the ACLI asked that the revisions be implemented in 2019 to ensure completeness, they asked that regulators use their best judgment to determine an appropriate time frame of implementation.

NAIC staff asked the working groups to address the issue as expeditiously as possible for a quality product, with further updates to be given by the LRBCWG and IRBCWG to the CATF as available.