NAIC Fall 2020: Valuation of Securities Task Force

The Valuation of Securities Task Force of the NAIC held a conference call November 18. The following are updates from that meeting.

Adopted Items

The following item was adopted effective immediately.

Consider Adoption of a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Update Guidance on Initial and Subsequent Annual Filings, and Methodologies and Documentation

This item addresses a recent common scenario where the SVO did not receive proper documentation from insurance companies to support a request for clarification or overall analysis. The proposed amendment updates guidance in the P&P Manual “for initial and subsequent annual filings and assessment methodologies to reinforce documentation and information requirements.”

Interested parties were supportive of the amendments but they would like to have a list of required documents from the SVO. For guidance on documentation requirements, click here.

Exposed Items

The following items were exposed for a 60-day public comment period ending January 18, 2021.

Receive an Updated Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) on Guidance for Working Capital Finance Investments Consistent with the Statutory Accounting Principles (E) Working Group Adoption of Changes to SSAP No. 105R – Working Capital Finance Investments

This item proposes to amend the Working Capital Finance Investments (WCFI) section of the P&P Manual to remove inconsistencies with SSAP No. 105R which was updated by SAPWG on May 20, 2020:

• Removed the requirement that the Securities Valuation Office (SVO) determine if the International Finance Agent is the functional equivalent of the U.S. regulator
• Removed the finance agent prohibitions on commingling
• Removed duplicative text regarding exercising of investor rights
• Removed requirements, with revisions allowing the SVO to determine if a first priority perfected interest has been obtained
• Broadened the independent review requirements to allow independent review of the finance agent by either audit or through an internal control report
• Changed the default provisions from 15 to 30 days so the default date and the cure period are consistent
• Removed the statement that the reporting entity may need to seek approval from the domestic regulator

This proposed amendment was exposed for 45 days, which ended August 17, 2020. The ACLI submitted proposed detailed changes to the SVO’s amendments. In turn, the SVO has responded to the ACLI’s recommendations with new proposed changes, as well as an explanation for where it does not agree with the ACLI’s direction that would impede the SVO’s ability to assess investment risk in WCFI transactions.

Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Permit the SVO to Rely Upon the Un-Rated Subsidiaries of a CRP Rated Parent Entity for Only Working Capital Finance Investments

The SVO has received feedback from some insurers and others that it should “assign NAIC Designations to issues of non-guaranteed, unrated subsidiaries of NAIC Credit Rating Provider (CRP) rated parent entities, based on implied support from the parent to the subsidiary.”

SVO Director Charles Therriault said Moody’s does not support the process to imply a rated parent’s support for its unrated, non-guaranteed subsidiary because some parent companies decided to cease support their subsidiaries in the past. Without legally binding support, e.g. guarantee, parental support of a subsidiary is entirely discretionary, ultimately reliant on the best interest of the parent and should not be the basis for a rating on the subsidiary. Reliance on implied support (e.g. comfort letters, keep-well agreements, or other statements of intended support) of a parent for its subsidiary also conflicts with the “Credit Substitution” guidelines in the P&P Manual.

As the VOSTF considers it essential that the SVO be able to assign designations to WCFI transactions with unrated, non-guaranteed obligors, the SVO proposes certain amendments (see below) to Part One and Part Three of the P&P Manual.

• SVO may rely upon the credit quality of the obligor’s parent entity if the obligor isn’t rated and its operations are at least 25% of the parent entity’s assets, revenue and net income.
• SVO may notch the NAIC Designation of a subsidiary based on its analytical judgement and in its sole discretion.
• SVO may choose not to assign any NAIC Designation to the WCFI program based on other attributes of the WCFI program which are unrelated to the obligor or its parent entity.

Other Updates

Discuss IAO Staff Concerns About Bespoke Securities, and NAIC Reliance on CRP Ratings

During an educational session in May 2020, IAO staff shared concerns with the VOSTF regarding bespoke securities. In short, there is concern that typical ratings assigned by CRPs do not effectively capture the risk of bespoke securities, which tend to be private and unconstrained by normal market forces.

This item is to build toward an issue paper outlining the risks associated with bespoke securities, recommendations to mitigate these risks, and other issues related to CRP ratings.

The IAO recommends sharing the resulting issue paper with Financial Conditions (E) Committee and continuing the discussion next year.

The interested parties said they look forward to working with the Task Force and the SVO to develop principles and a framework to address the regulatory issues raised in the issue paper. The interested parties said many of the securities identified by the SVO as “bespoke” are legitimate. Insurance companies working with asset managers to design investment products that meet insurance company asset-liability matching, cash flow matching, and risk appetites is a positive, appropriate, and necessary goal for industry. Effective asset-liability matching contributes to keeping insurers resilient under market stress. They asked the VOSTF to use the security characteristics as review factors instead of assuming those features are per se problematic.

The Financial Condition (E) Committee sent a memorandum to the VOSTF in September 2020 and expressed their concerns with the comment letter that states that SVO staff should not have the authority to determine eligibility for Filing Exemption of an individual CRP rating on a deal-by-deal basis. The Committee directed the VOSTF to implement policies in the next year to oversee the NAIC staff’s administration of rating agency ratings used in NAIC processes, including staff’s discretion over the applicability of their use in its administration of Filing Exemption.

Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Require the Filing of Private Rating Analysis

During a May 14 meeting, IAO staff shared concerns with the VOSTF regarding bespoke securities and the NAIC’s reliance on CRP ratings to assess their associated risk and for regulatory purposes. The VOSTF exposed the IAO’s memorandum, and requested the SVO make incremental recommendations to address the concerns.

The SVO has proposed the first incremental change to increase its scrutiny of PL securities, which are commonly bespoke. The SVO included its specific amendments to Parts One and Three to the P&P Manual. It proposes to require insurers to provide a copy of the Private Letter Rating with a copy of the related private letter rating rationale report from the Credit Rating Provider for each security, effective January 1, 2022. The rationale report should include an analytical review of the privately rated security, e.g. transaction structure, methodology relied upon, analysis of the credit, legal and operational risks and mitigants supporting the assigned NAIC CRP rating, in a report issued by an NAIC CRP on its letterhead or its controlled website to an issuer or investor. The SVO may not assign the equivalent NAIC Designation Category if it deems the privately rated security ineligible to receive a NAIC Designation with a NAIC CRP Credit Rating.

Charles Therriault said the rationale report will allow the SVO to be able to determine if the securities are eligible to be filing exempt. He said there are several thousand methodologies from the CRP. It is inefficient if they have to talk to the task force whenever it disagrees with the CRP methodologies. The task force chair said it will make it more adoptable form if the “discretionary” is taken out from the proposal. Interested parties said it would cause capital uncertainty for the insurers if the NAIC Designation may be different from the relevant CRP ratings.