SVO / VOSTF Updates

Adopted Items

The SVO adopts new procedures, asserting additional authority over the use of credit ratings and the filing exemption

The Securities Valuation Office (SVO) has adopted new rules that will increase its authority over NRSRO credit ratings and the filing exemption (FE). This new authority will give the SVO the ability to challenge and potentially disallow a credit rating if they feel that there’s a material misrepresentation of a security’s investment risk. This is a significant change for the industry, as it could affect the attractiveness and RBC profile of the affected securities. 

The SVO’s new guidance, as detailed in the adoption, includes the process for when a rating is subject to a challenge from regulators:

1. The SVO identifies a FE security with an NAIC Designation determined by a rating that appears to be an unreasonable assessment of investment risk.
2. The SVO’s Credit Committee (CC) meets to determine if it agrees that the rating appears to be an unreasonable assessment of investment risk and, if so, places the security “Under Review.”
3. If the SVO CC votes to put the security “Under Review,” the suffix symbol “UR” will be assigned to the NAIC Designation to highlight that the security is under review by the SVO.
4. If the information request is not responded to, the SVO may reach out to the domiciliary chief financial regulator.
5. Upon receipt of all necessary documentation through the information request, the SVO will then perform a full analysis of the security. During its review, the SVO will coordinate with the insurer(s) authorized to discuss the security to review questions or issues the SVO may have about the security, and to respond to any questions the authorized insurer(s) staff may have about the SVO’s analysis. This communication is intended to be an open dialogue.
6. The SVO CC re-convenes to determine, based on its full analysis of all necessary information, whether the FE NAIC Designation is three or more notches different than the SVO CC’s opinion and, therefore, whether the SVO should proceed in requesting the removal of the NRSRO rating from the FE process.
7. If the SVO CC’s decision is to proceed with the NRSRO rating removal request, the SVO CC and a sub-group of the Valuation of Securities Task Force (VOSTF) will meet to discuss the security. The domiciliary regulators of the affected insurers will be invited to the VOSTF sub-group meeting and be provided with relevant documentation through a confidential website. The affected insurer(s) staff and other authorized parties requested by those insurers to participate, will be invited to present their analysis to the joint meeting. Also at that meeting, the SVO CC will present its analysis, which may include any information provided to it or independently sourced. Following the presentations, the SVO CC and VOSTF sub-group will deliberate privately and the VOSTF sub-group will vote on whether it agrees with the SVO CC’s recommendation and whether the NRSRO rating will be removed from the FE process. At the conclusion of the joint meeting, the NAIC’s Investment Analysis Office (IAO) will communicate the decision to the affected insurer(s).
8. At any time during this process, an alternate NRSRO rating may be applied for. If an alternative NRSRO rating is received, it will be incorporated into the FE process, if applicable.
9. An anonymized summary of each unique issue or situation will be published on the SVO webpage or some other insurer accessible location for transparency.
10. The SVO will use the suffix symbol “ER” for a security when a NRSRO rating(s) has been removed from the FE process.
11. At every Spring National Meeting, the SVO Director will summarize FE challenge actions taken during the preceding year. These summaries will be anonymized and will not disclose information on specific securities, NRSROs or impacted insurers.

The new guidance also clarifies that this process will be applied consistently to all NRSROs, with no preferential treatment given to any rating agency over another.

Because of the system enhancements needed to ensure confidentiality and a smooth transition, the rules are expected to become effective on January 1, 2026, though regulators noted that there could be a need to potentially push back the effective date depending on the progress made on the enhancements.

CLO NAIC Designation modeling – Project delays pushes effective date to year-end 2025

The SVO has amended the timeline for its CLO modeling project, which removes broadly syndicated CLOs from the filing exemption. The result of the project will have these CLOs modeled for NAIC Designation purposes in an attempt to limit capital arbitrage opportunities within the asset class. To allow for more time to work on its modeling methodology, the go-live date has been delayed a year, with the effective date now being year-end 2025.

SVO to allow NAIC Designations for short-term ABS

Late last year, the Statutory Accounting Principles Working Group (SAPWG) adopted guidance, which becomes effective January 1, that would limit the types of investments that are permitted to be reported as cash equivalents or short-term investments. The goal of the guidance was to restrict insurers from using shortened maturities to circumvent other SSAPs, thereby improving regulatory treatment.

To support the new accounting guidance, regulators have adopted an amendment that would allow NAIC Designations for ABS that are excluded from cash equivalent or short-term reporting, if eligible to reported on Schedule D, Part 1, Section 2 under SSAP 43.

SVO adopts new guidance to modernize the definition of an NAIC Designation

Following various forms of feedback from regulators and industry participants, the SVO has adopted its revised definition for an NAIC Designation. The key elements of the definition emphasizes that:

1. NAIC Designations will focus investment risk – i.e. the likelihood that an insurer will receive full and timely principal and expected interest, as opposed to just focusing on credit risk. There could be situations where the focus on credit risk is too narrow, limiting the SVO’s ability to assess the risk of the performance component of a security (e.g., principal protected securities).
2. An element of the VOSTF’s role is to support regulators in the assessment of the financial ability of an insurer to maintain financial solvency.
3. Remove the current regulatory assumption that debt instruments pay scheduled interest and principal at maturity.
4. Remove the application of Subscript “S” and the concept of other non-payment risks¹ from the guidance.

These changes will be reflected in the 2024 version of the SVO’s Purposes and Procedures Manual.

Investment RBC Updates

Adopted Items

Residual tranche capital charge finalized for 2024 (2024-19-I)

Over the past few months, regulators have held numerous conversations on the appropriate capital charge for residual tranches. In an effort to limit capital arbitrage in the ABS sector, life regulators previously adopted a 45% pre-tax capital charge for residuals, to be applicable for year-end 2024. Nevertheless, throughout 2024, regulators entertained and ultimately rejected various industry proposals that would either delay the adoption or lessen the impact by exempting certain type of residuals from the more punitive 45% charge.

For 2024, the following capital factors apply for residual tranches:

• Life – 45% RBC
• P&C and Health – 20% RBC

Because these adoptions are technically interim solutions, regulators will continue its work toward a more permanent capital charge, better supported by analysis on the various collateral types within the ABS space.

Collateral loans backed by mortgages – reporting change adopted to ensure Schedule BA mortgage RBC treatment (2024-15-L)

Regulators have adopted an RBC mapping change that effectively allows look-through for collateral loans backed by mortgages. This would allow these type of collateral loans to receive capital charges based on the loan’s collateral, which mirrors the treatment of Schedule BA funds that holds mortgages (where the RBC is primarily based on the mortgage loan’s seniority – CM1/2/3 equivalents). The change will result in collateral loans backed by mortgages having a significantly lower capital charge than other types of collateral loans.

In 2025, it is anticipated that new reporting requirements for collateral loans will result in Schedule BA disclosures with breakouts driven by the underlying collateral type. This may result in additional RBC mapping changes in the future to accommodate look-through treatment for other collateral loan types. Nevertheless, the reduced capital requirement for collateral loans backed by mortgages will remain in place going forward.

Life RBC factor added for affiliated Schedule BA residential mortgages (2024-17-L)

Life regulators have adopted an RBC factor of 0.68% for affiliated residential mortgages held on the Schedule BA. A revision was warranted, as the Asset Valuation Reserve (AVR) schedule within the annual statement did not reconcile with the RBC instructions for Schedule BA mortgage reporting. The adopted factor mirrors the RBC requirement for Schedule B residual mortgages in good standing.

Statutory Accounting Updates

Adopted Items

Residual tranches – Accounting guidance streamlined into SSAP 21R (Ref #2024-08)

To create consistency within the bond accounting guidance, regulators are removing guidance for residuals out of all other existing SSAPs, and adding instructions that directs insurers to the centralized guidance located in SSAP 21R – Other Admitted Assets. Because the treatment for residuals is consistent regardless of its structural form, specific accounting language within the guidance for bonds, equities or limited partnerships is no longer needed.

Schedule BA categorizations (Ref #2023-16 / 2023-12BWG) 

Guidance revisions have been adopted to incorporate more detailed definitions for Schedule BA investments that fall under SSAP 48 – Joint Ventures, Partnerships and Limited Liability Companies. Schedule BA investments have primary reporting categories and subcategories that denote the underlying characteristics of a particular asset. The instructions and examples for Schedule BA’s categories are being redefined to better reflect market convention and improve consistency. There is also a desire at the NAIC to prevent the misreporting of investments, particularly where the goal is to improve regulatory treatment or RBC.

Adopted Schedule BA edits include:

• New reporting lines for debt securities that do not qualify as bonds under SSAP 26 or SSAP 43 (i.e., Schedule D, Part 1 securities).
• The “Non-Registered Private Funds” category was removed to prevent confusion with the “Joint Venture, Partnership and Limited Liability Company Reporting Category.”
• Additional language included to ensure that all residuals are included in the “Residual Tranches or Interests” category regardless of investment form.
• A statement added to the general instructions clarifying that all investments shall be reported in the dedicated reporting line category. Investments that do not fit within any specific reporting line shall be captured as an “Any Other Class of Asset.”
• Joint Venture, Partnership and Limited Liability Company Reporting Category – 
  • Only investments in scope of SSAP 48 shall be reported in this category.
  • Guidance clarifying that the “underlying characteristics of bonds” subcategory shall include “collateral that has contractual principal and/or interest payments, excluding mortgage loans.”
  • Structured settlements in scope of SSAP 21 that have an SVO-assigned NAIC designation are also included in this category within the “underlying characteristics of bonds” subcategory. Any structured settlements without an SVO-assigned NAIC designation shall be reported as an “Any Other Class of Asset.”
  • This category should not include directly owned non-bond debt securities, intercompany loans or collateral loans (see 2024-15-L above for separate proposal on collateral loans).

Crypto assets – Guidance codifies non-admitted status for statutory purposes (Ref #2024-03)

Regulators have adopted new language into SSAP 20—Nonadmitted Assets that will permanently clarify that directly held crypto assets are non-admitted assets for statutory purposes. This is in response to new FASB guidance for crypto assets that establishes the accounting and reporting requirements for U.S. GAAP purposes. The statutory guidance edits will formally codify the treatment for statutory accounting.

Exposed for comment

Debt securities issued by funds (Ref #2024-01)

Earlier this year, regulators proposed a guidance amendment to clarify the treatment of bonds issued by funds. Under the recently adopted bond definition, bonds issued by business development corporations, closed-end funds, or similar operating entities are considered issuer credit obligations (i.e., Schedule D bonds), provided they were registered under the ’40 Act. This gave preferential treatment to registered funds, even if an unregistered fund was structured in a similar manner. The proposed revision removes the emphasis on registration status and will instead focus on how the fund functions as an operating entity, and whether the fund’s primary purpose is to raise equity capital (as an operating entity) or debt capital (as an ABS issuer).

The distinction regarding a fund’s primary purpose is an important one, as it will determine whether a debt security should be classified as an ABS issuer (or securitization vehicle), which will subject the security to the credit enhancement and cash flow requirements contained in the new bond definition (this determines whether a security meets the qualifications for Schedule D inclusion).

To further assist in distinguishing whether a fund represents an operating entity or an ABS issuer, regulators have exposed amending guidance to lessen the ambiguity by focusing on the purpose of the capital being raised (e.g., debt being raised by a fund for ancillary or return enhancing purposes versus debt being raised for ABS issuance, which commonly consists of instruments like CFOs or feeder funds).  This should help insurers with the classification of their fund-related debt and ensure the proper regulatory treatment.

Because of its impact to the new Schedule D bond definition, this re-exposure will have a shortened comment period so that its adoption can be considered by e-vote in September.

IMR and derivatives – new accounting guidance to be considered for interest-rate hedges that don’t qualify as effective hedges (Ref #2024-15)

Regulators are considering statutory guidance changes for interest-rate hedging derivatives under SSAP No.86—Derivatives. The proposal highlights the Interest Maintenance Reserve (IMR) impact of macro hedges, which can be economically effective for asset-liability management purposes but do not qualify for effective hedge accounting treatment.

Many within the life industry report the fair value volatility for their open derivatives positions through unrealized gains and losses and allocate realized amounts to IMR once the derivatives are terminated or closed. This defers the realized impact on income since it is subsequently amortized into income over time.

In the case of negative IMR, the ability for an insurer to recognize realized derivative losses into IMR is dependent on their ability to prove that they’ve historically recognized derivative gains into IMR. Therefore, SAPWG will begin to assess whether there is support for the development of special accounting guidance that would, more broadly defer and amortize over time into income, derivative gains/losses for structures that hedge interest rate risk. If so, several specifics would need to be considered:

a)  Would there be a specific effectiveness threshold for a derivative program to qualify for the special accounting treatment?

b)  Should net deferred losses (reported as assets) be admissible, and if so, would there be any admittance limitations?

c)  Should there be macro-limits on admittable net deferred losses and other soft assets?

d)  Should there be time ,frames over which deferred items are amortized into income?

Because of the complexity of the issue, there will be an extended exposure period for this item, with detailed discussions with industry participants to continue into 2025.

Reporting of Funds Withheld and Modco Assets (Ref #2024-07)

Regulators continue to assess whether it is feasible to make reporting changes that would make it easier to identify assets that are subject to funds withheld or modified coinsurance (modco) arrangements. Some in the industry have concerns that making funds withheld and modco assets public could affect reinsurance pricing, as investment strategy plays a big role in pricing, which is considered proprietary. This has led to worries that the reporting changes may reduce the availability of funds withheld deals in the marketplace.

Within the P&C industry, some also highlighted that it could be difficult to identify specific assets in funds withheld arrangements for reporting purposes since assets are allowed to be co-mingled with other cash or invested assets held by the insurer.

NAIC staff is exposing new parts to the Schedule S (Life/Fraternal/Health) and Schedule F (P&C) for comment and will continue to work with the industry on the next steps.

Repack transactions – regulators to review the accounting for debt securities that are structured with derivative components (Ref #2024-16)

This agenda item has been developed to address the accounting treatment for repack transactions, per a desire from regulators to have consistent reporting within statutory financials. Repacks, defined as structured debt instruments with derivative components, typically consists of an SPV acquiring a debt security and “repackaging” it, adding or removing features through the use of accompanying derivatives. Not to be confused with structured notes², which are considered derivatives for statutory purposes, repacks don’t meet the requirements for bond treatment under the new bond definition, as they are considered ABS without credit enhancement.

While popular in Europe because of their structural benefits, repacks are unlikely to become commonplace with U.S. insurers without a more accommodating accounting treatment, and therefore, regulators have begun to assess whether changes in accounting treatment are warranted. This includes assessing whether embedded derivatives in the repack should be separated from the debt instrument for accounting purposes. This would allow for bond accounting for the debt instrument and derivative accounting for the derivative – a more favorable outcome than having the entire instrument denied bond accounting.

Because repacks can come in numerous forms with varying levels of complexity, regulators will work with industry to create a more detailed set of guidance amendments that would allow insurers to potentially benefit from these types of instruments, particularly when created for risk-reducing purposes.

¹ Non-payment risks under NAIC rules pertain to contractual agreements between the insurer and the issuer in which the issuer is given some measure of financial flexibility not to make payments. This also includes situations where the insurer agrees to be exposed to participatory risk.

² Structured notes are defined as an investment that is structured to resemble a debt instrument, where the contractual amount of the instrument to be paid at maturity is at risk for other than the failure of the borrower to pay the contractual amount due. These instruments incorporate both the credit risk of the issuer, as well as the risk of an underlying variable/interest, such as the performance of an equity index or the performance of an unrelated security. Due to the underlying variable that determines principal repayment, these structures (regardless of if it is in a trust/SPV) do not qualify as creditor relationships and do not qualify for Schedule D-1 reporting. Existing guidance specifies that structured notes shall be captured in SSAP No. 86 – Derivatives.