US NAIC Fall 2024 National Meeting Highlights: Investment-Related Highlights (2025)

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The US National Association of Insurance Commissioners (NAIC)held its Fall National Meeting in Denver, CO on November 16-19,2024. This article reports on some highlights of the November 17meetings of the Statutory Accounting Principles (E) Working Group(SAPWG) and Valuation of Securities (E) Task Force (VOSTF) and alsoreflects on some of their implications.

The SAPWG adopted thepreviously exposed Q&A Guide relating to the new PPBD

As readers are likely aware, the new principles-based bonddefinition (PPBD) will become effective on January 1,2025—with no "grandfathering." Beginning on thatdate, all debt securities owned by insurance companies will need tosatisfy the PPBD in order to be treated as bonds for statutoryaccounting purposes and reported on Schedule D of the statutoryinvestment schedules.

By way of background, on August 13, at the NAIC Summer Nationalmeeting, the SAPWG exposed for comment a Question-and-AnswerImplementation Guide (the "Q&A Guide"), providingresponses to eight questions about how the PPBD should be appliedto specific situations. On October 6, the SAPWG exposed for commentthree additional Q&As plus edits to one of the originalQ&As. On November 17, the SAPWG adopted the enlarged Q&AGuide (with minor editorial changes suggested in one of the commentletters) and designated it as a new statutory interpretationcaptioned INT 24-01. Statutory interpretations are Level 2 of thestatutory accounting hierarchy, ranking just below Statements ofStatutory Accounting Principles (SSAPs), which are Level 1.

The adopted version of the Q&A Guide is available here and includes responses to the followingquestions:

When assessing whether a security has substantive creditenhancement, how should future cash flows be considered? Shouldfuture expected cash flows be incorporated into theovercollateralization disclosure?
Are securities issued by foreign governments or foreigngovernment agencies considered Issuer Credit Obligations?
Are "Municipals" always Issuer Credit Obligations(ICO)?
Should common types of "Sports Deals" be classifiedas ICO or asset-backed securities (ABS)?
Do cashflows produced by non-financial assets backing an ABShave to actually be used to make interest and principal paymentsthroughout the life of the debt security for an investment toqualify as a non-financial backed ABS under the meaningful cashflow test?
How should CMBS Interest Only (IO) strips be assessed under thePBBD?
How should debt securities that reflect Single Asset SingleBorrower (SASB) Commercial Mortgage Loan (CML) securitizations beassessed under the PBBD?
Do synthetic or referenced pool structures within an ABSdisqualify the ABS for reporting on Schedule D-2-1?
Can expected but non-contractual cash flows (e.g. from futureleases) be considered in determining the meaningful cash flowpractical expedient for non-financial ABS?
How should hybrid securities be accounted and reported?
When do non-bond debt securities need to be assessed foradmittance based on underlying collateral?

We examine Q&As 7, 10 and 11 in more detail below.

Q&A 7: SASB CMLsecuritizations must be assessed as ABS under the PPBD and willgenerally fail to qualify as bonds if they have a uni-tranchestructure

Q&A 7 addresses SASB commercial mortgage-backed security(CMBS) structures that securitize a single mortgage loancollateralized by one property owned by a single borrower. SASBCMBS structures can issue multiple tranches with differentpriorities of payment, or they can issue a single tranche (a"uni-tranche structure") that simply passes through thecash flows of the underlying CML. It had been suggested by someobservers that SASB structures where the underlying CML was fullyamortizing could qualify as ICOs under subparagraph 7.g. of SSAP No. 26—Bonds; i.e., as"securities for which repayment is fully supported by anunderlying contractual obligation of a single operatingentity."

However, Q&A 7 rejects the foregoing analysis and requiresSASB CMBS structures to be analyzed under the ABS side of the PPBD.The main reason is that, even though the CML has a single borrower,the ultimate cash flows for repayment of the CML and the CMBS arethe lease cash flows, which are typically derived from multiplelessees. Under the ABS criteria, an ABS must have substantivecredit enhancement that puts the holder of the debt security in aneconomically better position than if it held the underlyingcollateral directly. If the CMBS has a multi-tranche structure,then the senior tranche(s) receive credit enhancement from thesubordinate tranche(s). But if the CMBS has a uni-tranchestructure, there is no substantive credit enhancement for thesingle CMBS tranche (absent some other form of credit support suchas an external guarantee), with the result that the uni-trancheCMBS will fail to qualify as an ABS and will be a "non-bonddebt security" (NBDS). There are a number of consequences ofNBDS classification. In the case of life insurers, NBDSs do notqualify for filing exemption and need to be filed with theNAIC's Securities Valuation Office (SVO) in order to beassigned an NAIC designation. See the VOSTF discussion below for adescription of steps the NAIC staff is taking to facilitate theassignment of NAIC designations to uni-tranche SASB CMBS.

Q&A 10: Hybrid securitieswill need to be analyzed under the PPBD. If a hybrid security isdetermined to be a non-bond debt security, the RBC charge forP&C and health insurers that hold that security will increasesignificantly

Q&A 10 explains that under the old, pre-PPBD version of SSAPNo. 26, hybrid securities—which have characteristics of bothdebt and equity—were automatically "scoped into"the bond definition. However, the new SSAP No. 26 willrequire hybrid securities to satisfy the PPBD in order to beclassified as bonds, and hybrid securities that fail to satisfy thePPBD will be classified as either NBDS or surplus notes. A commentletter submitted to the SAPWG by an asset-management firm (seepages 101 to 104 of the meeting materials) pointed out the risk-basedcapital (RBC) impact that an NBDS classification would have on aP&C or health insurer. While a life insurer can file an NBDSwith the SVO to obtain an NAIC designation and receive the RBCcharge associated with that designation, a P&C or healthinsurer does not currently have that ability. The RBC factor for"other invested assets" for a P&C or health insureris 20%, which would be a dramatic increase from the RBC factors of1.5% or 1.9%, respectively, for a bond rated A−.

The SAPWG responded to the above concern by formally referringthis topic to two other NAIC working groups—the P&CRisk-Based Capital (E) Working Group and the Health Risk-BasedCapital (E) Working Group—to consider whether to provide formore granular RBC factors for P&C and health insurers for (i)NBDS based on SVO-assigned NAIC designations and (ii) surplus notesbased on NRSRO ratings.

Q&A 11: If a debtsecurity fails to qualify as a bond under the PPBD, the underlyingcollateral must qualify as an admitted asset in order for the debtsecurity to qualify as an admitted asset

There are multiple disadvantages of a life insurer of having toclassify a debt security as an NBDS rather than a bond. An NBDS isreported on Schedule BA of the investment schedules, rather thanSchedule D. An NBDS is reported at the lower of cost or fair value(in contrast to a bond, which is reported at amortized cost so longas its designation is above NAIC-6). An NBDS must be filed with theSVO in order to be assigned an NAIC designation, rather thanreceiving a designation based on an NRSRO rating. And, as Q&A11 makes clear, there is a potentially more serious consequence: ifthe underlying collateral would not be an admitted asset if held bythe insurer directly, then the NBDS will be a nonadmitted asset.(The concept of a nonadmitted asset is a distinctive feature ofstatutory accounting and refers to an asset that is charged againstan insurer's surplus because it is generally consideredunusable to satisfy the insurer's obligations topolicyholders.) For example, if a mortgage-backed security fails toqualify as a bond—such as the uni-tranche SASB CMLsecuritization in Q&A 7—it will be an NBDS but still anadmitted asset, because the SASB CML is an admitted asset that theinsurer could have invested in directly. By contrast, if a debtsecurity backed by railcar leases fails to qualify as a bond underthe PPBD, that debt security would be nonadmitted, because railcarsare not admitted assets that an insurer could have invested indirectly. Other examples of collateral that would not be admittedassets if held directly by an insurer are consumer loans andstudent loans. Q&A 11 underscores the point emphasized in ourdiscussion of Q&A 7—the importance of looking to theultimate source of repayment when applying the PPBD.

The SAPWG directed NAIC staffto prepare an agenda item to classify issue papers in Level 5 ofthe statutory hierarchy

NAIC staff has often pointed out that NAIC issuepapers—unlike SSAPs and statutory interpretations—donot provide authoritative guidance. Rather, they provide historicaldocumentation of the discussions behind the development of new orrevised SSAPs. However, that may be about to change. A commentletter on the first exposure of the Q&A Guide urged that issuepapers be added to the statutory hierarchy, as they often includeinterpretive guidance that is not found elsewhere. An example citedwas the discussion of feeder funds under the PPBD in Issue Paper No. 169. In response, the SAPWGdirected NAIC staff to prepare an agenda item to classify issuepapers in Level 5 of the statutory hierarchy. As such, issue paperswould still be subordinate to SSAPs (which are Level 1) and tostatutory interpretations (Level 2), but it would no longer be truethat they do not provide authoritative guidance.

The SAPWG abandoned theproposal it had exposed at the Summer National Meeting to requirebifurcated reporting of "credit repacks" and otherderivative wrapper structures

As discussed in our report on the NAIC Summer National Meeting,on August 13, the SAPWG exposed for comment (until September 27,2024) proposed revisions to SSAP No.86—Derivatives that would have addressed, not just"credit repacks," but all debt security investments withderivative wrappers/components. The proposed revisions would haverequired bifurcation—separate accounting for the derivativeand the underlying debt security—in contrast to currentstatutory accounting guidance, which explicitly precludes theseparation of embedded derivatives.

The comment letter submitted by interested parties (see pages 95to 97 of the meeting materials) was rather critical of thebifurcation proposal and, among other things, pointed outsignificant obstacles to an insurer even being able to report thederivative on Schedule DB or to apply the requisite hedgeaccounting requirements, since the insurer would not control or ownthe embedded derivative directly. The letter also pointed out thatbifurcating the derivative and the bond would potentially cause thebond to be reported as a restricted asset. The letter concluded itscomment on this topic by recommending that insurers should simplybe required to evaluate the repacked instrument in its entiretyunder the PPBD.

In response to the comments, the SAPWG decided not to pursue thebifurcation proposal and limited its action to sponsoring blanksrevisions to clarify that if an insurer already holds a bond thatis "dropped" into an SPV to create a repacked security,then the insurer must account for that transaction as a disposal ofthe bond and an acquisition of the repacked security.

Some readers may be aware that in informal conversations earlierin 2024, the NAIC staff seemed at least receptive to the idea thatsimpler types of credit repacks (e.g., repacks that convert thepayment currency or convert fixed to floating interest payments orvice versa) could potentially be analyzed as ICOs undersubparagraph 7.g. of SSAP No. 26—Bonds, i.e., as"securities for which repayment is fully supported by anunderlying contractual obligation of a single operatingentity." However, that is no longer the case in the wake ofthe abandonment of the bifurcation proposal. In a privatecommunication subsequent to the Fall National Meeting, seniorstatutory accounting staff stated that all credit repacks will needto be analyzed as ABS and, if they lack substantive creditenhancement, will be classified as NBDS.

The SAPWG exposed for comment(until January 31, 2025) a new agenda item (Ref. #2024-21) to clarify statutory accountingguidance for investment subsidiaries of insurance companies, withresulting implications for statutory reporting and RBC

The term "investment subsidiary" is defined in Section2TT of the NAIC Investments of Insurers Model Act (Model280) as "a subsidiary of an insurer engaged or organized toengage exclusively in the ownership and management of assetsauthorized as investments for the insurer." For purposes ofcompliance with any investment limitations applicable to theinsurer, the insurer's direct investments are aggregated withany indirect investments that are made through its investmentsubsidiaries. A similar description of an investment subsidiary isfound in Section 2B(2) of the NAIC Insurance Holding Company System RegulatoryAct (Model 440), although the term "investmentsubsidiary" is not used.

In the realm of statutory accounting, the concept of investmentsubsidiary appeared in a now-superseded SSAP No.46—Investments in Subsidiary, Controlled and AffiliatedEntities, which referred to "investments in noninsurancesubsidiary, controlled or affiliated entities (SCAs) that have nosignificant ongoing operations other than to hold assets that areprimarily for the direct or indirect benefit or use of thereporting entity or its affiliates." For these SCAs, SSAPNo. 46 required an equity measurement method adjusted to beconsistent with the accumulated measurement of the underlyingassets if they had been held by the insurer directly, i.e., a"look through." However, when SSAP No. 46 wassuperseded by SSAP No. 88 as of January 1, 2005, theconcept of an investment subsidiary was eliminated from statutoryaccounting guidance for SCAs, and the concept is similarly absentfrom SSAP No. 97, which superseded SSAP No. 88 asof December 31, 2007, and is the current authoritative guidance forSCAs. The concept of investment subsidiary is still found inSSAP No. 25—Affiliates and Related Parties, whichhas a number of parallels to the NAIC Insurance Holding CompanySystem Regulatory Act.

Under current guidance in SSAP No. 97, unless the SCAis itself an insurer or engages in specific transactions on behalfof the parent insurer, the SCA will be captured under paragraph8.b.iii of SSAP No. 97 and reported based on the auditedUS GAAP equity value—which may not be the same as the valueof the underlying assets on a "look through" basis. Basedon SSAP No. 97, the audited US GAAP equity value is usedwhen reporting the investment subsidiary on Schedule D-2-2,Common Stocks. The valuation in Schedule D-2-2 is to then becarried over onto Schedule D-6-1, Valuation of Shares ofSubsidiary, Controlled or Affiliated Companies.

The 2005 removal of the investment subsidiary concept from theSSAP guidance for SCAs has led to a number of disconnects. Theannual statement instructions for Schedule D-6-1 limit the valuereported for an investment subsidiary to the "imputed value ona statutory basis" of the underlying assets held by theinvestment subsidiary, which harks back to the "lookthrough" methodology of the now superseded SSAP No.46. Similarly, the Life RBC LR044 instruction for AffiliateType 4 states: "The risk-based capital charge for theownership of an investment subsidiary is based on the risk-basedcapital of the underlying assets, pro-rated for the degree ofownership. The basis for this calculation is the assumption thatthe charge should be the same as it would be if the life insurerheld the assets directly." Both of those approaches differfrom the valuation guidance in SSAP No. 97, which is basedon the audited US GAAP equity value of the subsidiary.

To address these disconnects, the NAIC staff has recommendedthat the SAPWG consider the following measures:

Revisions to SSAP No. 97 that would provide for SCAsthat are investment subsidiaries to be valued using a "lookthrough" to the underlying assets (similar to thelong-superseded SSAP No. 46), potentially excluding anyunderlying assets that would be nonadmitted if held by the insurerdirectly.
Revisions to the statutory reporting blanks to capture newinvestment schedules—or perhaps expansions to existinginvestment schedules—to detail the underlying assets heldwithin an investment subsidiary.
Referrals to the Capital Adequacy (E) Task Force and relatedRBC Working Groups to incorporate details that allow regulators toverify the RBC calculation for the underlying assets in investmentsubsidiaries.

NAIC staff made an additional noteworthy observation in theSAPWG meeting materials for this agenda item, noting thatsituations have been identified in which insurers have reportedSchedule BA items (in scope of SSAP No. 48—JointVentures, Partnerships and Limited Liability Companies) asinvestment subsidiaries for RBC "look through" purposes.Staff commented that SSAP No. 48 Schedule BA investments should notbe captured within the "investment subsidiary"classification, which is limited to common and preferred stockinvestments reported as SCAs in scope of SSAP No. 97. Thisraises the question of whether insurers can usetrusts as investment subsidiaries to holdunderlying assets. The current status of trusts for statutoryaccounting purposes is not entirely clear. SSAP No.30—Unaffiliated Common Stock generally limits the term"common stock" to the common stock of a corporation,while "scoping in" a limited number of additional typesof investments, e.g., master limited partnerships, common stockwarrants and shares of registered investment companies (which insome cases are organized as trusts rather than as corporations).That said, we are not aware of statutory guidance relating toinvestments in trusts that are not registered investment companies,although we have noticed that some insurers do report investmentsin trusts as common stocks on Schedule D-2-2, and as investmentsubsidiaries on Schedule D-6-1.

We also note that under the NAIC model acts cited above, aninvestment subsidiary does not need to be organized as acorporation. The NAIC Insurance Holding Company System RegulatoryAct defines a "subsidiary" of a person as "anaffiliate controlled by such person directly or indirectly throughone or more intermediaries." That model act defines a"person" as "an individual, a corporation, a limitedliability company, a partnership, an association, a joint stockcompany, a trust, an unincorporated organization, any similarentity or any combination of the foregoing acting in concert."So under the NAIC model acts (and state statutes that follow themodel acts), a subsidiary—and thus an investmentsubsidiary—could be organized as a corporation (subject toSSAP No. 97), or a partnership or limited liabilitycompany (subject to SSAP No. 48) or a trust (unclear as towhat SSAP it is subject to). Whatever the SAPWG ultimatelydetermines to be the appropriate valuation method for investmentsubsidiaries (audited GAAP equity or "lookthrough")—and whatever the Capital Adequacy (E) TaskForce decides is the appropriate methodology for the RBCcalculation (carrying value of the investment subsidiary or"look through")—we do not see anyprinciples-based reason for those outcomes todiffer based on whether the investment subsidiary is organized as acorporation, a partnership, a limited liability company or a trust,when the function is the same regardless of entitystructure, namely, to engage exclusively in the ownership andmanagement of assets authorized as investments for the insurer.

The SAPWG Chair andVice-Chair offered informal advice regarding the use of third-partyvendors and checklists when implementing the PPBD

Toward the end of the SAPWG meeting, SAPWG Chair Dale Bruggemansaid he was aware that some insurance companies are usingthird-party vendors and checklists to analyze the classification oftheir fixed-income investments under the PPBD. He and SAPWGVice-Chair Kevin Clark each commented that insurance companiesshould use such tools with caution and not "blindly accept theresults" because (i) the PPBD is principles-based rather thanrules-based, so there are limitations on how well an algorithm cando in performing a principles-based analysis; and (ii) theinsurance company itself is responsible for the classification, andif it uses such third-party tools, it must verify and"own" the results of the analysis.

The VOSTF adopted anamendment to the P&P Manual to clarify the ability of CRPs toprovide ratings on specific classes of securities

Because "ABS" is a key term used in the PPBD, theadoption of the PPBD created a potential ambiguity as to whether acredit rating provider's (CRP) NRSRO registration statuswith the SEC needs to include the ability toprovide credit ratings for issuers of asset-backed securities inorder for the CRP's rating to qualify a bond that is classifiedas an ABS under the PPBD to be eligible forfiling-exemption. The VOSTF resolved that ambiguity on November17by adopting an amendment to the P&P Manual to add thefollowing sentence to paragraph 57 of Part One of the Purposesand Procedures Manual (P&P Manual):

The NAIC only recognizes NAIC Credit Rating Provider ratings forthose classes of credit ratings (each as defined by the SEC) forwhich an NAIC Credit Rating Provider is registered with the SEC asan NRSRO. For the avoidance of doubt, SEC definitions are distinctfrom those used for statutory accounting asset classificationpurposes in the Statements of Statutory Accounting Principles.

The added text clarifies that a CRP that is not registered withthe SEC to provide credit ratings for issuers of ABS is notprecluded from rating securities that fall within thePPBD's definition of ABS unless thosesecurities also fall within the SEC'sdefinition of ABS.

The NAIC's SSG ProvidingExpedited CMBS Modeling for SASB CMBS Uni-Tranche Deals in Advanceof January 1, 2025

As discussed above in our report on the SAPWG meeting, SASB CMLsecuritizations will need to be assessed as ABS under the PPBD, andwill generally fail to qualify as bonds if they have a uni-tranchestructure. That means that they will no longer qualify for filingexemption as of January 1, 2025, and will need to be filed with theNAIC in order to be assigned an NAIC designation. At the VOSTFmeeting, Eric Kolchinsky, Director of the Structured SecuritiesGroup (SSG), announced the SSG's readiness to provide expeditedmodeling to assign NAIC designations to SASB SMBS uni-tranche dealsbefore January 1, 2025. He asked that insurers start sending theSSG the specific CUSIPs involved to facilitate the process. Thereis a detailed process that insurers need to follow, which issummarized in a November 18, 2024 memo from the SSG.

The SVO Will BeginDeactivating the Filing Exemption of PL Securities Issued SinceJanuary 1, 2022 and for which a Private Letter Rating RationaleReport Has Not Been Filed

Effective January 1, 2022, the VOSTF amended the P&PManual to require the filing of the private letter ratingrationale report for Securities with a Private Letter Rating (PLSecurities) with the SVO. The consequence that the P&PManual prescribes for failure to file is deactivation of thePL Security's filing exemption. At the November 17 VOSTFmeeting, Charles Therriault, Director of the SVO, explained that,until now, the SVO has deferred enforcing this requirement whilethe NAIC's technology was being updated, but that the SVO isplanning to begin the deactivation process in 2025 for PLSecurities issued on or after January 1, 2022. The consequence ofdeactivation is that the NAIC designation derived from the CRPrating will be removed from NAIC systems and an insurer that ownsthe PL Security will need to, within 120 days, either (i) file thePL Security with the SVO for the assignment of a designation; or(ii) self assign an NAIC-5.B GI designation to the PL Security andfollow the General Interrogatory procedure in the statutorystatements. Therriault also stated that the SVO had identifiedapproximately 1,700 PL Securities issued since January 1, 2022 forwhich the private letter rating rationale report had not beenfiled, and that the SVO was reviewing the list with NASVA toconfirm that this list is correct and that there are no dataquality issues. He said that if it emerged that there are suchissues, then the deactivation process would be deferred pendingresolution of those issues. He added that if a PL Security isrenewed at year-end, then a 120-day grace period would be providedfor filing the private letter rating rationale report.

The SSG Continues to Developa Modeling Methodology for CLOs

At the VOSTF meeting, Eric Kolchinsky provided a brief update onthe Collateralized Loan Obligations (CLO) modeling project. Hereported that, after analyzing data for approximately 1,800 CLOsheld by insurers, the ad hoc group had selected a preliminaryprobability distribution designed to minimize the mean squareerror. He said that the ad hoc group would meet again inDecember, and would start posting monthly data in early 2025. Healso reported that the C1 Subcommittee of the American Academy ofActuaries (which is working on a parallel project for the NAICRisk-Based Capital Investment Risk and Evaluation (E) WorkingGroup) is currently processing data received from Moody's, andthat the Academy's results will be compared with the model theSSG is developing.

Following the VOSTF Meeting,a Special Session was Held on Impact Investing

Following the VOSTF meeting, Connecticut Insurance CommissionerAndrew Mais convened a special session on impact investing. Hedescribed the work that had been done by an ad hoc groupof insurance regulatory staff from California, Connecticut, Iowa,New York and Wisconsin. He then introduced Joseph Pursley, fromNuveen, who gave a slide presentation describing five key criteriafor impact investing, as well as a proposed structure for a pooledinvestment vehicle that would qualify as an ABS (and thus as abond) under the PPBD.

To view additional updates from the US NAIC Fall 2024 NationalMeeting, visit our meeting highlights page.

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