In Brief

• Progress is being made toward the adoption of the expanded bond risk-based capital (RBC) factors
  
  
•  The proposal to revise real estate RBC for life companies receives another update, but remains a work in progress
  
  
•  RBC reporting guidance for mortgage loans has been updated to further align it with SAPWG’s temporary COVID-19 adoptions
  
  

Investment RBC Updates

Regulators continue to make progress on the new, expanded bond RBC factors for life insurers

Back in December 2020, Moody’s Analytics was hired by the NAIC to analyze the work that was previously done on the proposed RBC bond factors for life insurers. In February, Moody’s released its assessment¹, which provided recommendations and highlighted areas of concerns with the proposed factors.

Some of the concerns regarding the proposed factors include issues related to its data and modeling choices. This includes issues related to the methodologies used in estimating default and recovery rates, conservative risk premium assumptions and the lack of differentiation across fixed income sectors. There were also concerns pertaining to the lack of comparability amongst the NAIC’s approved credit rating agencies, along with dated discount rate and tax assumptions, as the initial work on the proposed factors was last updated in 2017.

In March, the American Academy of Actuaries (Academy) re-released its proposed factors (Exhibits 1 and 2) with updates that incorporated the current corporate tax rates, which weren’t in place when the proposal was originally released. The new factors have been exposed to the industry, accompanied with a 10-day comment period, as regulators attempt to continue moving the project forward. Moody’s Analytics continues on its own parallel track and will propose its own set of new bond factors, but regulators have acknowledged that, due to the time constraints of a year-end 2021 implementation, they are still likely to move forward with the factors proposed by the Academy. The current timeline has the final factors being approved by both the LRBCWG² and CATF³ by June 30.

Exhibit 1: Proposed Bond RBC C-1 Factors (pre-tax)

Source: American Academy of Actuaries, NAIC.

Exhibit 2: Proposed Portfolio Adjustment Factors

Source: American Academy of Actuaries, NAIC.

RBC for life insurers’ real estate holdings is poised to receive an update

The LRBCWG has restarted its efforts to reduce the RBC factors for real estate equity. This can be attributed to a general consensus within the industry that the current factors (15% for direct Schedule A real estate equity; 23% for indirect Schedule BA real estate) are too high, and that real estate could be an even more attractive asset class, with more appropriate capital charges.

Back in December, the ACLI⁴ released a proposal that had the capital charges for real estate equity being reduced to 10% for both Schedule A and Schedule BA real estate. Since then, deliberations have continued, with the latest proposal having Schedule A real estate RBC now being reduced to 11% and Schedule BA real estate equity RBC being reduced to 13%.

The ACLI’s analysis on real estate performance suggested that a 9.5% RBC factor would be appropriate for direct real estate, with a 1.5% cushion added to the factor to add conservatism for post-COVID-19–related unknowns and to acknowledge that the results from the analysis may differ from actual real estate portfolios held by life insurers. For Schedule BA holdings, a premium of about 20% was added to the proposed Schedule A factor, resulting in a proposed charge of 13%.

The proposal also includes an unrealized adjustment, whereby the capital charges for real estate can be further reduced if the market value of the property exceeds the statutory book value amount (the capital charge can also increase if the book value exceeds the market value). The goal of incorporating an unrealized adjustment would be to acknowledge that over time unrealized gains are a cushion against the loss of statutory capital, but isn’t currently recognized for RBC purposes. The applied base RBC factor would be adjusted using a ratio⁵ of 1/2 of the percentage difference between the reported fair value and statutory book value to the statutory book value, with a minimum floor capital charge of 1.3% (Exhibit 3).

Exhibit 3: Sample calculation of real estate RBC with the unrealized adjustment

Source: ACLI, NAIC. Proposed base real estate factor = 11%. The minimum real estate factor under the proposal is 1.3%

The proposal will also impact properties with encumbrances (i.e. a mortgage or leverage). The base RBC factor would be applied on the gross property value, then a credit will be applied for the value of the encumbrance based on the average mortgage risk, currently 1.75% (equivalent to the CM2 mortgage loan RBC charge). To assist with the new reporting requirements, new RBC worksheets will be provided to accommodate the new calculations related to unrealized gains/losses and any existing encumbrances.

In response to the current proposal, the Academy and some regulators highlighted a few areas of concerns. Those concerns include the use of market value to determine RBC (and the reliability of those reported market values), the design of the unrealized adjustment and the 1.3% minimum capital charge. There were also criticisms on the time horizon used in the proposal (2.5 years), along with the fact that the proposal essentially recommends identical treatment for all types of real estate. This differs from RBC on mortgages, which, for example, treats hotels differently from other commercial real estate sectors.

The latest proposal has been exposed to the industry for comment and continues to be a work in progress. Regulators have acknowledged that it will need to be approved by June to ensure implementation for year-end 2021.

Mortgage loan RBC reporting guidance for life insurers revised to further align with SAPWG’s temporary COVID-19 adoptions

Last year, the RBC guidance for mortgage loans was revised to provide relief from the negative effects of modifying loan terms due to COVID-19. To expand on that relief and align it with the Statutory Accounting Principles Working Group’s (SAPWG) temporary amendments on troubled debt restructurings, this adopted guidance revision emphasizes that no changes related to a loan’s origination date, valuation date, property value or its 90 days past due indicator are required for any COVID-19–related modifications. This amendment will remain in effect during the period ending on the earlier of January 1, 2022 or the date that is 60 days after the date on which the national emergency concerning COVID-19 ends.

Health RBC update

• The HRBCWG⁶ has agreed to perform an impact analysis on the two- and five-year time horizon risk factors (Exhibit 4) for the 20 bond designations for year-end 2020. Most states have a March 1 annual statement filing deadline, but some states allow for a March 31 or April 1 filing deadline. Therefore, only companies subjected to the March 1 filing deadline will be included in the impact analysis, which will ensure that the new bond RBC factors can be exposed to the industry by April 30.

Source: American Academy of Actuaries, NAIC.

¹ Moody’s Analytics: Assessment of the Proposed Revisions to the RBC C1 Bond
² Factors, February 2021.
³ Life RBC Working Group.
⁴ Capital Adequacy Task Force. 
⁵ The ACLI’s original proposal had the ratio set at 2/3. This has been reduced in the most recent proposal to 1/2
⁶ Health RBC Working Group