NAIC 2020 Fall National Meeting – Statutory Accounting and SVO Updates
Global Insurance Solutions
- COVID-19 relief measures to partially expire
- Continuing SVO discussions on bespoke securities
- The SVO may require more documentation for private-rated securities
- The NAIC and state regulators have begun to reexamine which assets should be eligible for Schedule D bond treatment
- Credit tenant loans receive a guidance update for year-end 2020 reporting
As the national emergency related to COVID-19 still remains in place, these temporary adoptions continue to remain in effect:
- Troubled Debt Restructuring Due to COVID-19 (INT 20-03)
- Troubled Debt Restructuring of Certain Investments Due to COVID-19 (INT 20-07)
But the following temporary adoptions are being allowed to expire and will not be extended beyond 3rd quarter 2020:
- Mortgage Loan Impairment Assessment Due to COVID-19 (INT 20-04)
- Investment Income Due and Accrued (INT 20-05)
Discussions continue on bespoke securities and the reliance on CRP ratings
In a joint comment letter submitted by the ACLI1, PPIA2 and NASVA3, a potential framework was laid out to address some of the regulatory issues related to bespoke securities and credit rating provider (CRP) ratings that have been raised recently. Notable highlights within the letter include:
- A desire to discuss bespoke securities from a position of neutrality – i.e., avoid a presumption that all securities identified by the SVO as “bespoke” are guilty until proven innocent. This includes discussing security characteristics not as “red flags” but rather as “review factors” or “investment characteristics.”
- An emphasis on the important role CRPs, filing exemptions and private letter ratings play within the industry. CRPs have the scale to analyze the thousands of privately rated securities and the expertise to analyze the unique structures or risks that may exist. There is concern that the SVO would lack the resources to sufficiently fill that role if wholesale changes to the current process were made. Additionally, filing exemptions provide insurers with reasonable certainty into how a security will be treated for RBC purposes. Any changes that jeopardizes that certainty could materially affect future investment decisions.
- The idea of the industry relying more heavily on the NAIC’s RTAS4 process isn’t seen as a realistic, scalable alternative. Many also feel that the $15,750 - $25,000 fee associated with an RTAS filing is overly costly, particularly if regulatory changes result in an increased amount of security filings.
- Also highlighted is the sentiment that single-rated securities should not amount to a “red flag.” Securities with one CRP rating are common, as most insurers do not subscribe to all rating agencies. A more practical outcome would be for the SVO to be granted authority to obtain additional information regarding securities rated by a single CRP.
- With regard to instances where “assets backing the security do not generate bond-like cash flows (i.e., contractual requirements to pay periodic principal and interest),” the assessment of accounting classification and measurement, including consideration of whether the structural characteristics that establish statutory classification as a bond or otherwise, should be deliberated and decided by the Statutory Accounting Principles Working Group (SAPWG) in accordance with NAIC policy.
- There could be challenges in producing ratings analyses from the CRPs, including the need to potentially revise confidentiality provisions. It may take time to alter CRP confidentiality arrangements to permit insurers to share their full ratings rationales with the SVO (as an example, it took almost two years for all CRPs to amend their confidentiality agreements with borrowers in order to allow sharing of private ratings electronically via ratings feeds).
One suggestion within the comment letter that received significant pushback from regulators was the idea that the SVO should not have the authority to overturn individual CRP ratings. The Financial Condition Committee, to address any doubt on the SVO’s role in the CRP ratings process, directed the VOSTF to explicitly give authority to the SVO to oversee the NAIC’s administration of CRP ratings used in NAIC processes, which includes the administration of the filing exemption. This effectively affirms the SVO’s authority to have final say on any security’s NAIC designation.
Discussions on this topic will continue into 2021 at future SVO meetings.
Guidance amendment adopted to further clarify documentation and information requirements when filing securities with the SVO
This guidance amendment reinforces the expectation that insurers will provide the necessary documentation in a timely manner to the SVO, and further outlines the types of information the SVO may require when filing securities for an SVO assessment.
ETF-related guidance revisions were adopted to add instructions for ETFs that contain a combination of preferred stocks and bonds
Guidance amendments were adopted that allow the SVO to review ETFs that hold both bonds and preferred stock for possible inclusion on the SVO’s preferred stock ETF list.
EXPOSED ITEMS, TO BE FURTHER CONSIDERED
Private letter ratings – The SVO proposes to require additional documentation
The VOSTF has proposed a guidance revision that would require a private rating letter rationale report for any security that attains a private letter rating. This rationale report would be required to include an in-depth analysis of the transaction, the methodology used to arrive at the private rating and, as appropriate, discussion of the transaction’s credit, legal and operational risks. The additional information would be used by the SVO as part of its analysis to determine a security’s NAIC designation. Based on its analysis, the SVO would decide whether to assign an NAIC designation equivalent based on the CRP’s rating (i.e., filing exempt), require that the security be filed for further review or decline to assign any NAIC designation.
Working capital finance investments – Proposed SVO guidance revisions due to recent accounting updates
The proposed revisions would update the SVO guidance for working capital finance investments (WCFI) to remove any inconsistencies with the recently revised statutory accounting guidance (SSAP No. 105R). This proposed guidance amendment, which includes updates to key definitions, NAIC designation methodology and the SVO’s risk assessment process, is being re-exposed to incorporate recommendations submitted by the ACLI.
Working capital finance investments – Unrated subsidiaries
This proposed guidance revision addresses WCFI with unrated obligors/issuers that are wholly owned, but not guaranteed, by their CRP-rated parent entity. These revisions would give the SVO the ability to assign NAIC designations to WCFI transactions with unrated, non-guaranteed obligors, which would be based on the parent’s credit rating and the SVO’s analytical judgement.
Statutory Accounting Updates
Schedule D Project – Regulators to reexamine which assets should be eligible for Schedule D bond treatment (Ref #2019-21)
As part of its Investment Classification Project, SAPWG drafted an issue paper that introduces significant revisions to SSAP No. 43R—Loan-backed and Structured Securities. The issue paper covers topics such as the history and scope of SSAP 43R, along with the accounting and reporting of traditional and non-traditional securitizations. There are several items SAPWG will attempt to address over time, but the first part of this project will be to determine whether investments with certain unique characteristics should qualify as a Schedule D bond holding.
In response to the issue paper, the Iowa Insurance Division prepared a proposal that attempts to create a clear definition of a bond that can be reported on Schedule D. The Iowa proposal also highlights some common concerns held by regulators:
- The definition of a bond under current statutory accounting principles is very broad, and it is possible for an insurer to acquire any asset through a debt-issuing trust or special purpose vehicle and report it as a Schedule D bond, even if that asset would be otherwise inadmissible if held directly.
- Securitizations can create high-quality bonds out of a pool of otherwise non-investable assets through overcollateralization and the prioritization of payments to debtholder classes, but the current guidance is too broad to distinguish between those with economic substance and those without, leaving the reporting of these assets susceptible to abuse.
SAPWG has decided to expose the Iowa proposal for comment, which recommends that SAPWG focus its efforts on developing a principles-based definition for assets that qualify for Schedule D bond treatment as the initial step for this project. Additionally, plans have been made to dedicate future conference calls to this project beginning in 2021.
Credit Tenant Loans (Ref #2020-24)
The final statutory guidance for credit tenant loans (CTLs) continues to be a work-in-progress, but to clarify the applicable guidance for 2020 year-end reporting5, conforming CTLs6 will remain in scope of SSAP No. 43R (as a Schedule D bond), while non-conforming CTLs that do not have an SVO-assigned NAIC designation will be reported on Schedule BA. There is a limited-time provision to permit non-conforming CTLs to be reported on Schedule D if they have been filed and assigned an NAIC designation by the SVO. For CTLs reported on Schedule BA, CRP-determined NAIC designations (i.e., filing exempt NAIC designations) will not be permitted.
Separately, SAPWG will also seek guidance from the SVO and the Capital Markets Bureau on whether the 5% residual risk threshold7 is appropriate for determining whether a CTL is conforming.
NAIC Designation Categories for RMBS/CMBS Securities (Ref #2020-21)
This item details revisions to SSAP No. 43R to reflect the SVO’s updated final designation guidance for RMBS and CMBS securities. The SVO adopted an amendment to retain the financial modeling and book-adjusted carrying value price ranges for modeled RMBS/CMBS securities. The adoption also adds instructions to map financially modeled RMBS/CMBS securities to the expanded NAIC Designation Categories. The existing NAIC designations 1–6 will still apply for RBC, but the expanded NAIC Designation Categories will be captured to study the output data. This is a temporary measure until new RBC factors are adopted for each NAIC Designation Category and new price ranges can be developed.
Mortgage Loan Participations – Clarifying Edits (Ref #2020-19)
These revisions clarify that a participant’s financial rights may include the right to take legal action against the borrower (or participate in the determination of legal action), but do not require that the participant have the right to solely initiate legal action, foreclosure or, under normal circumstances, require the ability to communicate directly with the borrower.
Preferred Stock – Early Application of SSAP No. 32R (Ref #2020-31)
Allows for early adoption of the recent amendments to SSAP No. 32R, which updated the definitions, measurement and impairment guidance for all preferred stock. The revisions are effective January 1, 2021, but will now allow for early adoption in 2020 year-end financial statements.
Cash Equivalent Disclosures (Ref #2020-20)
This proposal expands current disclosure requirements from previously adopted guidance on Rolling Short-Term Investments, which added a disclosure to financial statements for short-term investments that remain on the short-term schedule for more than one consecutive year. This adoption expands that disclosure to include cash equivalents (excluding money market funds).
EXPOSED ITEMS, TO BE FURTHER CONSIDERED
Freddie Mac / Fannie Mae – Credit Risk Transfer Securities (Ref #2020-34)
In response to recent changes to the Freddie Mac Structured Agency Credit Risk (STACR) and Fannie Mae Connecticut Avenue Securities (CAS) programs, where it is anticipated that future Freddie Mac STACR and Fannie Mae CAS issuances will be solely conducted through a Real Estate Mortgage Investment Conduit (REMIC) trust, this agenda item proposes to allow credit risk transfer securities from Freddie Mac and Fannie Mae to remain in scope of SSAP No. 43R (as Schedule D bonds) when a REMIC structure is used in the STACR or CAS programs.
Accounting for Perpetual Bonds (Ref #2020-22)
This proposal seeks to revise the accounting treatment for perpetual bonds held as investments within scope of SSAP No. 26R. After some reconsiderations, suggested modifications include requiring ordinary bond treatment for perpetual bonds that have an upcoming, scheduled call date. These would be carried at amortized cost (utilizing the yield-to-worst concept) in instances where a termination date (i.e., call date) is known. For perpetual bonds that do not possess or no longer possess a call feature, fair value reporting would be required.
Accounting for Bond Tender Offers – Disclosure Update (Ref #2020-32)
This revision proposes to expand the existing called bond disclosures to include bonds that were early terminated through a tender offer.
Publicly Traded Preferred Stock Warrants (Ref #2020-33)
This agenda item aims to revise the accounting guidance for publicly traded preferred stock warrants to bring the guidance in line with publicly traded common stock warrants, which receive a special carve-out from being subject to derivative treatment, and are reported within SSAP No. 30R—Unaffiliated Common Stock. This revision proposes to 1) expand the scope of SSAP No. 32R—Preferred Stock to include publicly traded preferred stock warrants and 2) require publicly traded preferred stock warrants to be reported at fair value.
1 The American Council of Life Insurers
2 Private Placement Investors Association
3 North American Securities Valuation Association.
4 The Regulatory Treatment Analysis Service process permits insurance companies and other persons to ascertain the analytical position the SVO would take (or the recommendations it would make to regulators) with respect to credit and other investment risks embedded in a security and the related regulatory accounting and reporting treatment.
5 INT 20-10: Reporting Nonconforming Credit Tenant Loans – The guidance in this interpretation is applicable for the year-end 2020 statutory financial statements and through the first three quarters of 2021 (expiring formally on October 1, 2021).
6 Conforming CTLs generally reflect bond-like characteristics, which includes a principal amount that fully amortizes over the term of the loan and lease. The principal amortization component is a key element in determining whether a CTL meets SVO requirements for Schedule D eligibility.
7 Conforming CTLs cannot have a balloon payment or residual asset risk of greater than 5%. Non-conforming CTLs that have residual asset risk greater than 5% can be reclassified as conforming if a residual value insurance policy is obtained to address residual risk.