NAIC 2020 Summer National Meeting – Capital Framework Discussion
Global Insurance Solutions
- COVID-19’s impact on mortgage loan RBC
- Continuing discussions on Health bond RBC factors
- Adoption of the new bond RBC structure, but no new factors yet
Investment RBC Updates
COVID-19’s impact on mortgage loan RBC
The Life RBC working group (LRBCWG) met to discuss the impact of COVID-19 on RBC for mortgage loans. Due to the fallout from COVID-19, owners of properties that secure mortgage loans are experiencing temporary decreases in income. This would affect RBC requirements for 2020, along with future years because of the design of the RBC formula. And because of the impact on future mortgage loan allocations and capital planning, regulators felt it was best to provide some clarity on what the RBC requirements for mortgage loans will look like in the coming years.
LRBCWG has taken up the task of addressing four items of note pertaining to RBC guidance for mortgages: 1) contemporaneous property values, 2) construction loans, 3) RBC inputs if a COVID-19–related restructuring has taken place and 4) net operating income (NOI).
For contemporaneous property values, the property value used within the LTV1 calculation is a computation that incorporates a ratio based on the NCREIF2 Price Index. To adjust out any shock effect that could be in the index, LRBCWG adopted guidance to use the average of the 2019 and 2020 NCREIF values for 2020 RBC reporting.
For construction loans, RBC instructions require that these are categorized as CM5 if “construction issues exist” based on a determination by the loan servicer. The NAIC previously provided relief from the effects of COVID-19 for March 31 and June 30, 2020 RBC reporting. LRBCWG has adopted guidance to expand that relief to all of 2020, so that no RBC category change is required for 2020 for COVID-19–related construction delays or issues.
Additionally, there are RBC inputs – origination date, valuation date, property value and 90 days past due – where filers are instructed to update these values if the loan has been restructured (including loan modifications or forbearance), extended, otherwise re-written or refinanced. Regulators had previously provided relief from adjusting these inputs for modifications that occurred through June 30, 2020. Newly adopted guidance will extend this relief to COVID-19–related modifications that occur throughout the remainder of 2020.
For NOI, to prevent 2020 NOI values affected by the temporary impacts of COVID-19 from overstating credit risk, the latest proposal recommends that, where a value of 2020 NOI is an input into the computation of the rolling average NOI3, insurers would use the greater of:
- 2020 NOI or
- 85% of 2019 NOI
The NOI proposal is intended to provide relief only to loans that were performing loans prior to the pandemic and that both (1) suffer a drop in NOI in 2020 and (2) are performing loans in 2021. The proposal is not intended to mask or shelter the increased riskiness of loans that suffer a severe drop in 2020 NOI that are not performing loans in 2021 or later years (e.g., loans that have become delinquent).
The NOI portion of the proposal has not been finalized and continues to be a work in progress. Discussions will continue at future LRBCWG meetings scheduled for later in the year.
Continuing discussions on Health bond RBC factors
The American Academy of Actuaries (Academy) provided an update on a request from the Health RBC working group (HRBCWG) to provide the Health bond factors over both a two-year and five-year time horizon (Exhibit 1). Initial reactions from the working group highlighted that two-year time horizons didn’t seem compatible with amortized cost4, and may be more compatible with market risk. There were also concerns that the variance between the two-year and five-year horizons appeared to be too great at first glance. In response to initial concerns, HRBCWG agreed to expose the Academy’s letter for comment from the broader industry, while also incorporating plans to perform an impact analysis based on 2020 filings to better understand what the impact would be from two-year versus five-year durations. The goal is to continue toward a conclusion on the resulting Health bond factors by early 2021.
Exhibit 1: Proposed health base risk factors over a two-year and five-year time horizon before any adjustments have been made to account for minimum risk factors.
The Academy also provided a response to previously received comment letters on the treatment of investment income within the Health RBC formula. The Academy noted that it did not think it would be appropriate to ascribe all investment income to offset asset default risk. Its view is that a more appropriate approach would utilize investment income to offset specific risk charges. Using the property and casualty RBC formula as an example, investment income is explicitly included as an offset to underwriting risk factors by considering the investment income related to claims and claim adjustment expenses unpaid as well as unearned premium. The HRBCWG stated that it would draft a letter back to the Academy, in response to its comments, to consider investment income within the underwriting risk factor.
Adoption of the new bond RBC structure, but no new factors yet
The Capital Adequacy Task Force (CATF) has adopted the new bond structure that incorporates the 20 designations into the RBC formula for 2020 year-end reporting. The reported designations will flow into the RBC formula but will not include factors. The current factors for NAIC designations 1-6 will remain in place until an impact analysis can be done to confirm the new factors for the 20 designations. Discussions around the new factors currently sit with the individual RBC working groups (Life, P&C and Health).
- The NAIC’s Investment RBC working group has been officially disbanded, effective August 5, 2020. All work related to investment RBC topics will be handled by the Life, P&C and Health working groups, along with CATF going forward.
- The CATF has plans to discuss and determine whether hybrids should be included with the new bond RBC structure.
2 National Council of Real Estate Investment Fiduciaries
3 To dampen the direct impact of changes in NOI on RBC reporting, current RBC guidance uses a weighted-average approach to applying NOI values. This average uses 50% of preceding year NOI, 30% of next preceding year NOI and 20% of next preceding year NOI. So while 2020 NOI will not impact 2020 RBC, it will impact RBC reporting for 2021, 2022 and 2023.
4 Investment-grade bonds are carried at amortized cost for health companies. Bonds that are rated below investment grade are carried at the lower of amortized cost or market value.