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Noticeable shifts in insurers’ investment strategies toward private structured and complex assets had the NAIC embark on significant multi-year updates to the RBC and STAT frameworks ranging from asset classification, designations, reserving (e.g., Actuarial Guideline (AG) 53) to capital assignment. Progress was made on several fronts at the 2023 NAIC Summer Meeting, including on three ongoing initiatives with potentially far-reaching implications for insurers’ investment strategy and capital markets:
- Classification of investment vehicles, including bonds and residual interest of structured products. The principles-based bond definition was adopted at the NAIC Summer National Meeting and will go live on January 1, 2025. Principles that guide the classification of ‘bonds’ that receive favorable regulatory treatment include interest and principal payments that vary with the performance of an underlying value or variable, generally not qualifying for bond treatment with exceptions such as inflation. The definition differentiates reporting requirements for Issuer Credit Obligations, which represent credit obligations to the likes of corporate entities, from Asset-backed securities (ABSs), which represent credit obligations to the broad set of investment vehicles whose primary purpose is raising debt capital.
- Revisions oversight of ratings-based designations that rank credit risk and help determine capital requirements. A desire to move away from NRSROs since the financial crisis and NAIC staff stated concerns over ratings lacking comparability across rating agencies had the NAIC embark on efforts to establish criteria to permit staff’s discretion over NAIC rating-based designations. The two most recent proposals, Defining NAIC designations and Procedures for discretion over NAIC designations, met with broad concerns, ranging from lack of scope and transparency to needing an independent third party to facilitate checks and balances and unintended consequences for capital markets.
- Revisions to the capital framework to potentially differentiate Collateral Loan Obligations (CLOs) and structured assets. The efforts were intended to address limitations with the RBC C-1 framework and arbitrage strategies that have been pointed out by NAIC staff, whereby capital assigned to the entire stack of CLO tranches can be substantially lower than the capital of the underlying collateral loans, with the two strategies arguably housing the same economic risks. There are two related initiatives:
- Interim changes to treating residual interests of structured assets held by life companies. As a stop-gap measure, regulators have instated a 15% sensitivity test on residual interests in 2023, and absent a detailed and evidence-driven alternative proposal from the industry, the capital charge will automatically increase from 30% to 45% in 2024 (with a 0% sensitivity). The adoption was a compromise, with strong and differing views expressed by a bifurcated industry and with some regulators.
- A broader effort to design a capital framework for structured assets. The NAIC initiated efforts with the Academy of Actuaries to develop a framework to differentiate capital for CLOs and structured assets broadly. The Summer Meeting Materials include a proposed set of principles to determine whether and how to differentiate the treatment of structured assets. Once regulators agree on candidate principles, the Academy will presumably develop a capital framework.
Against this backdrop, the investment community was undoubtedly focused on a memo deliberated by the E-Committee, one of the seniormost NAIC committees. It proposes a holistic rethink of how insurers' investments are regulated, reacting to the multi-year updates to RBC and STAT frameworks that have tactically responded to changing market conditions but have left essential framework elements disjointed.
At the most basic level, the memo explores the most effective use of regulatory resources in the modern environment of insurance regulation for investments, with aspirations of achieving the principle of “Equal Capital for Equal Risk.” While it is suggested that the SVO "retain ability within the SVO to perform individualized credit assessment," it also describes this as a “ backstop “ that "would be rarely used.”
