NAIC Summer 2016 National Meeting Update – Valuation of Securities Task Force

At the NAIC Summer 2016 National Meeting, the Valuation of Securities Task Force (VOSTF) focused on the Reporting Exceptions Subgroup, debtor-in-possession financing, surplus notes, and more.

Reporting Exceptions Subgroup

The Reporting Exceptions Subgroup was created to investigate the large number of securities that are not included in the credit rating provider feeds sent to NAIC, yet still reported as filing exempt (FE). By definition, an FE security has been rated by one or more credit rating providers.

Upon analysis, the NAIC found that the exceptions fell into six main categories:

1. PRIVATE LETTER RATINGS

This is a contentious issue between Industry and the Subgroup. Privately placed securities comprise a large portion of Jumpstart exceptions because non-disclosure agreements prohibit nationally recognized statistical rating organizations (NRSRO) from disclosing private ratings to third parties. The NAIC does not currently have a mechanism in place to verify NRSRO ratings, and it has recommended that the VOSTF require insurers to file private letter ratings with the Securities Valuation Office (SVO) or file documentation with the NAIC to obtain a designation. Industry pointed out that private ratings were originally scoped out of filing with the SVO when FE was established. Insurers continue to provide rating letters to regulators upon request, and Industry questions the necessity of filing rating letters directly with the NAIC.

2. SECURITIES DROPPED FROM OR NEVER INCLUDED IN CRP DATA FEEDS

The SVO proposed an enhancement to their VISION (AVS+) application that would map the identifiers on the NRSRO’s website to the SVO’s identifier and resolve the exception.

3. USE OF BLOOMBERG

The NAIC gave a presentation with the goal of persuading Industry that Bloomberg is not an acceptable source to obtain CRP ratings and calculate NAIC FE designations for two reasons:

• Bloomberg does not capture ratings from all NAIC approved NRSROs
• Industry may use issuer ratings from Bloomberg, where NAIC designations are based on issue-level ratings. It is unclear whether there will be changes to the Purposes and Procedures Manual (P&P Manual) because of this exception.

4. PRE-REFUNDED SECURITIES

Per the P&P Manual, pre-refunded securities must be filed once (and not annually renewed) so the SVO can verify the pre-refunding agreement. Industry has not been following these practices and has raised concern about the cost of the initial filing ($1,500). This cost outweighs the work required by the SVO to verify the agreement.

5. GOVERNMENT GUARANTEES

This is not a high priority. To reduce exceptions, three ideas have been proposed:

• Create a separate designation (1US)
• Create a new subcategory for government sponsored enterprises (GSE), as they are currently mixed with municipal governments
• Establish more explicit guidance in the instructions stating these securities should have a one NAIC rating, not “1FE”

6. INTERNATIONAL SECURITIES USING ISINS

The majority of these exceptions should be addressed by the SVO adding ISIN to their VISION (AVS+) application.

On August 31, a call was held for the subgroup to hear a brief presentation on the issues and discuss next steps.

Clarifying Treatment of DIPs

Debtor-in-possession (DIPs) financings are loans granted to a debtor to finance a business organization under bankruptcy code. Since DIPs are considered a type of bank loan, they can be assessed for quality and assigned an NAIC designation under the scope of SSAP No. 26.

After further review, the Financial Regulatory Services staff noted that DIPs are not specified in the Accounting Practices and Procedures Manual (AP&P Manual) and their characteristics are more similar to collateral loans. Collateral loans are accounted for under SSAP No. 21 – Other Admitted Assets and filed on the Schedule BA (Other Long Term Assets). The VOSTF referred this issue to the Statutory Accounting Principles Working Group (SAPWG), recommending that they clarify the treatment of DIPs under the AP&P Manual.

Surplus Notes

The SAPWG recently adopted revisions to SSAP No. 41 – Surplus Notes that expanded amortized cost treatment from one NAIC designation class security to both one and two NAIC designation class securities. In addition, these revisions eliminated the need for a financial assessment of surplus notes rated two through six. In response, the SAPWG referred this issue to the VOSTF to consider related adjustments to the P&P Manual.

Upon review, the SVO identified that the P&P Manual contains a list of surplus notes rated one and also contains instructions relating to the financial assessment of surplus notes. In response to the SAPWG referral, the VOSTF adopted a proposal which would delete this information from the P&P Manual.

Proposed Changes to RMBS and CMBS

The Structured Securities Group (SSG) presented proposed changes to the modeling process for residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). Currently, it is difficult for insurers to gauge capital efficiency because fundamental assumptions in the modeling process change yearly based on economic conditions. Rather than relying on BlackRock to provide modeling results, the SSG proposed a through-the-cycle modeling approach. This would result in less fluctuation in modeling RMBS/CMBS and increase transparency since the NAIC would own the model rather than relying on a proprietary model from BlackRock, PIMCO, or other vendors. The proposed model would be more conservative during economic booms, and less conservative (or punitive) during economic downturns. The SSG’s report was exposed for comment, and the earliest these changes would take effect is year-end 2017.

BlackRock is also updating its model for CMBS, which will be effective for 2017 (if a through-the-cycle framework is not adopted by then). The updates are expected to have a moderate effect on CMBS price points, and the net effect will be a more conservative model.

Changes are in discussion regarding the assumptions on macro-economic scenarios determined by the NAIC and the credit model created by BlackRock that uses those scenarios. Both of these projects will continue to be under deliberation in 2017.

Addition of Belgian GAAP

Belgian GAAP was added to the P&P Manual’s list of National Financial Presentation Standards. This means that financial statements can be presented to the SVO following Belgian GAAP reconciling to US GAAP or IFRS.

New Adoptions

HR Ratings de Mexico, S.A. de C.V., was officially adopted as a Credit Rating Provider on the NAIC Credit Rating Provider list and added to the P&P Manual.