Highlights:

• Considerable regulatory changes are in the works for collateralized loan obligations (CLOs)
  
  
• Additional oversight planned for rated notes backed by equity and funds
  
  
• Regulators clarify rules on the filing exemption for related party transactions
  
  
• Progress continues to be made on the NAIC’s Schedule D bond project
  
  
• Accounting regulators to reconsider its rules regarding negative IMR balances
  

Considerable Regulatory Changes Are in the Works for CLOs

To eliminate RBC arbitrage and assume more control over the risk assessments for CLOs, regulators will look to financially model debt and equity CLO tranches under a series of calibrated and weighted collateral stress scenarios. This will remove the reliance on rating agencies to perform credit assessments and create equivalency between securitization and the direct holdings of the structure.

The Structured Securities Group (SSG) has also exposed the methodology that will be used to perform the modeling, which will be based on the SSG’s annual CLO stress tests. As of now, the proposed methodology excludes the scenarios to be used in the process, as those discussions are expected to be more in depth and require more time once the methodology is agreed upon.

The project’s initial focus will only model tranches of broadly syndicated CLOs, leaving out middle market CLOs, commercial real estate CLOs and other types of ABS. Regulators have stated that their intention is to eventually model middle market CLOs, but they will be out of scope until specialized assumptions and additional data can be attained. Regulators will also continue to look to the industry for assistance in the overall design of the process. For CLOs that cannot be financially modeled, the CLO will be filing exempt if it is rated by a credit rating agency. If there is no credit rating, the CLO must be filed with the SVO.

In conjunction with the modeling process, the CATF³ and RBCIREWG⁴ will look further into adding interim RBC factors of 30%, 75% and 100%, while regulators decide whether to invest time and effort into making large, wholesale changes to the capital framework for CLOs.

Adopted Items

Guidance Amendment Adopted to Clarify SVO Rules on Related Party Transactions

Following the adoption of new statutory accounting rules on affiliated and related party transactions, additional clarity was needed as to what types of debt transactions would continue to qualify for the filing exemption, and which transactions would need to be filed with the SVO.

Current SVO rules only require insurers to file with the SVO, bonds or preferred stock issued by a subsidiary, controlled and affiliated entity (SCA). Therefore, a transaction with an affiliate or related party obligor, sponsor or underlying obligor, as opposed to issuer, or other non-issuer party that transfers risk, directly or indirectly, to an insurer, would not constitute an SCA investment as currently defined. This could lead to insurers entering into structured finance transactions that may not reflect economic reality, such as unaffiliated loans originated by an affiliated or related party, then sold to a SPE, which issues a note back to the insurer. There could also be situations where the underlying credit exposure has a relationship to the insurer, even though the issuer of the debt does not.

To clarify filing exemptions going forward, SVO guidance for SCAs will include structures in which the non-issuer underlying credit exposure would qualify as a related party under the rules in SSAP No. 43R – Loan-Backed and Structured Securities (these would be required to be filed with the SVO).

The SVO is also creating a new SCA and related party category for investments issued –

a) by an affiliate or related party special purpose entity (SPE) that itself is not an obligor or ultimate source of the investment repayment, or

b) as part of a SPE structure in which the originator, sponsor, manager, servicer or other influential transaction party is an affiliate or related party of the reporting insurance company.

Investments in this new category will be eligible for filing exemption unless otherwise ineligible (for reasons other than their affiliate or related party status, or due to a filing requirement by a state regulator).

Exposed Items, to be further considered

Structured Equity and Funds Transactions – Filing Exemption Eligibility of Rated Notes

The SVO plans to add a new category to its guidance for “structured equity and funds” transactions, that would cover notes issued by structured vehicles that are backed by equity, limited partnership interests or fund investments (including feeder funds, CFO debt, etc.). The goal of the guidance is to:

• Reduce the ability to circumvent regulatory guidance, i.e. limiting the ability of non-debt instruments to receive bond treatment
  
  
• Reduce the reliance on credit ratings and the filing exemption
  
  
• Limit RBC arbitrage opportunities for investments that are in-substance equity or fund investments but uses structuring to improve RBC treatment
  
  
• Add transparency for regulators when structuring is used for bond investments
  
  

Due to the new bond accounting rules currently being proposed, some of these structures will qualify for Schedule D-1 bond treatment, while others will not. Nevertheless, because the use of these structures creates opportunities for abuse, the SVO is proposing a guidance amendment that would exclude these investments from filing exemption eligibility, requiring them to be filed with the SVO and receive a look through credit assessment to obtain a NAIC Designation.

Schedule D Bond Project (Ref# 2019-21)

The SAPWG⁵ continues to work on its project to define what will be a Schedule D bond for regulatory purposes. This includes making clarifying revisions on a few topics, including:

• ABS where the issuer does not own the underlying collateral – Guidance modifications will clarify the analysis required in situations where collateral is in the form of a note that has been legally assigned, but the issuer does not have an ownership interest in the collateral.
  
  
• Feeder funds – NAIC staff continues to emphasize that a feeder fund structure that predominantly holds debt may, in substance, be a debt investment, despite the direct holding being a fund investment. The guidance also specifies that a feeder fund that relies on equity interests for repayment would have to meet the requirements of the bond proposal to determine if the structure is, in substance, debt and permitted for Schedule D-1.
  
  
• Transition of securities from Schedule D-1 to Schedule BA – For securities that are reclassified from Schedule D-1 to Schedule BA, the draft guidance specifies that unrealized gains should not be recognized as a result of reclassification. For securities previously reported at amortized cost on Schedule D-1, if the security is required to be recognized at fair value upon reclassification (under the lower of amortized cost or fair value method), the transition impact would result in an unrealized loss.
  
  
• Working capital finance investments, surplus notes and structured settlements – Because these investments are specifically covered under separate SSAP guidance, SAPWG continues to reject requests to address these in relation to the bond project. If a need develops to further address these investments, it will be done as a separate agenda item.
  
  
• Embedded derivatives – Clarity is being requested on bonds with embedded derivatives. There’s a concern that if a bond doesn’t meet the requirements detailed for certain types of embedded derivatives, it would not be allowed to be reported as a bond on schedule D. Guidance revisions would be needed to address:
  
  
  • RSATs to clarify between securities that are reported as bonds on Schedule D (to ensure their eligibility) and bonds that hereafter may be reported on Schedule BA
  
  
  • Structured notes, so it is clear whether they belong on Schedule BA or Schedule DB

Additionally, there is a request to specifically address three types of securities with embedded derivatives to ensure they will not run afoul of the proposed guidance for Schedule D-1 inclusion:

1. Securities where the variable interest is linked to SOFR or another similar benchmark interest rate


2. Securities where the variable interest is linked to credit risk characteristics of the issuer


3. Securities where the interest or principal is denominated in a foreign currency
   
   

There are also other notable security types that may run afoul of the proposed guidance, even though it wasn’t the original intent of the guidance to do so, including:

• ESG bonds, where the coupon may change if certain sustainability targets are or are not met


• Highly rated CLO transactions where the senior tranche may get additional interest if the equity or residual tranche returns meet a certain threshold


• Certain public ABS transactions backed by prime student loans having interest payments that vary based on the composition of the underlying pool of loans (e.g., if high interest loans prepay early, the interest due to the senior tranche may decline)


• Certain ABS that include an anticipated repayment date (ARD) function that requires a step-up in interest rates payable to the holder if the securitization is not paid in full on or before the ARD
  

Regulators continue to target January 1, 2025 as the implementation date for the guidance, once finalized. A revised draft of the latest edits is being exposed for industry comment, with the comment period ending February 10, 2023.

Adopted Items

Corporate Alternative Minimum Tax – Temporary Guidance (INT 22-02)

In response to the Inflation Reduction Act and the new corporate alternative minimum tax (CAMT⁶), statutory regulators are issuing a few temporary clarifications on how insurers must disclose the effects of the new law. Due to a lack of CAMT guidance from the U.S. Treasury, more time is needed to determine how the law will affect insurers’ statutory financials, including the admissibility of certain deferred tax assets (DTAs).

Regulators have adopted provisions that would:

• Extend the effective date to which no reasonable CAMT estimates can be made to encompass year-end 2022 and March 31, 2023 financial statements. No recognition of anything CAMT related is required during this time.
  


• Require disclosures that would identify whether an insurer expects to be a CAMT payer
  


• Expand the subsequent event⁷ exception to include events identified after December 31, 2022, through when audited financials are available
  
  
• Clarify that this temporary guidance becomes automatically null on June 15, 2023
  

Related Party Exemptions – Foreign Open-end Funds (Ref #2022-13)

Recently adopted guidance pertaining to related parties clarified that investments in ETFs and mutual funds do not reflect ownership in an underlying entity, regardless of the ownership percentage an insurer has, unless that ownership results in “control” with the power to direct the activities of an underlying company. Regulators have adopted similar provisions for foreign open-end funds that are within the scope of SSAP 30R—Unaffiliated Common Stock. This would exempt these investments from the look-through provisions required by SSAP 25.

Fair Value Hedging – Portfolio Layer Method and Partial Term Hedges (Ref #2022-09)

Under U.S. GAAP, guidance changes were adopted in 2017 that made hedge accounting more accessible for portfolios of prepayable financial assets. The revisions also included changes that permitted partial term hedging, allowing fair value hedges of interest rate risk that only cover a portion of the term of the hedged financial instrument. The changes were in response to the difficulties companies had getting their interest rate hedges to qualify for hedge accounting. Additionally, recent U.S. GAAP adoptions in 2022 expanded the scope of the hedge accounting guidance to include:

• Hedges of multiple layers are allowed for a single closed portfolio (in what is now known as the “portfolio layer method”). Previously, only one hedged layer was permitted for a single portfolio of assets (formerly referred to as the “last-of-layer” method).
  
  
• Non-prepayable assets can be included in a hedged closed portfolio.
  
  
• Eligible hedging instruments in a single-layer hedge may include spot-starting or forward-starting constant-notional swaps or spot-starting or forward-starting amortizing-notional swaps. Also, the number of hedged layers (single or multiple) should align with the number of hedges designated.

Statutory accounting regulators have adopted guidance edits to incorporate the aforementioned aspects of the U.S. GAAP guidance for portfolio hedges and partial term hedges into SSAP No. 86. One statutory-specific limitation is that the proposed hedge accounting methods will only be applicable to assets and will not be permitted when hedging liabilities.

The effective date of the new guidance is January 1, 2023.

Exposed Items, to be further considered

Negative IMR (Ref# 2022-19)

The NAIC has been asked by the ACLI to reconsider its rules toward negative IMR balances. Under current statutory rules, a net negative IMR balance is a nonadmitted balance, with the offset resulting in a direct charge to surplus. The original purpose of IMR was to minimize the effects of realized gains and losses in declining and rising interest rate environments. As interest rates have risen from their previous lows, realized losses on disposed bonds will cause IMR balances to decline. The life insurance industry is now questioning the impacts of IMR, as a negative IMR balance can create the perception of decreased financial strength through lower surplus and risk-based capital. There’s also a concern that negative IMR balances could impact rating agency views of the industry or incentivize companies to engage in transactions that minimizes the impact but is not in the best long-term interest of the insurer. In response to industry concerns, regulators have agreed to place this item on the current agenda for further discussion and review.

New Market Tax Credit Structures / Tax Equity Investments (Ref# 2022-14)

Regulators are proposing new accounting guidance covering tax equity investments, in an expansion of the current rules on investments involving tax credits. There are several federal and state investment programs where tax credits can be received for making investments in low-income communities, rehabilitation projects, clean energy production and activities aimed at reducing carbon emissions. SSAP No. 93 currently covers tax credits, but the guidance is only specific to low-income housing tax credits. Guidance revisions will likely consider changes that expand the scope of SSAP No. 93, making it more inclusive of other types of tax equity investment programs.

Collateral Loans (Ref #2022-11)

To address any inconsistencies regarding the collateral loan guidance in SSAP 20—Nonadmitted Assets and SSAP 21—Other Admitted Assets, regulators are proposing guidance edits to clarify that the assets pledged as collateral for admitted collateral loans must also qualify as admitted invested assets. This topic remains a work in progress as some regulators have expressed concerns with having unaudited LLCs, LPs or JVs pledged as collateral.

Exposed Items, to be further considered

Mortgage Loans – CM6 and CM7 Mortgage RBC Factors

Life regulators are considering an RBC change for non-performing mortgage loans. Due to the RBC reductions for real estate equity adopted last year, the RBC for non-performing loans (rated CM6 and CM7) were no longer in alignment with the RBC for Schedule A and Schedule BA real estate investments.

Prior to the 2021 change, the CM7 RBC factor for In Process of Foreclosure Commercial and Farm Mortgages reconciled with the 23% factor for Schedule BA real estate equity, while the CM6 factor for 90-days Delinquent Commercial and Farm Mortgages was aligned with the 18% factor for Schedule A real estate equity. Those RBC factors have subsequently dropped to 13% for Schedule BA and 11% for Schedule A. The proposed change is designed to retain consistency within the Life RBC framework for mortgages and real estate investments. Regulators will conduct further analysis before officially adopting any changes.

¹ Valuation of Securities Task Force
² Securities Valuation Office
³ Capital Adequacy Task Force
⁴ Risk-Based Capital Investment Risk and Evaluation Working Group
⁵ Statutory Accounting Principles Working Group
⁶ The CAMT is 15% of the corporation’s (or group of entities under common control filing a consolidated tax return) “adjusted financial statement income” for the tax year, reduced by corporate alternative minimum foreign tax credit.
The CAMT will only apply to corporations (determined on an affiliated group basis) with average adjusted financial statement income in excess of $1 billion for the three prior tax years. This threshold is reduced to $100 million in the case of certain foreign-parented corporations.
A corporation's adjusted financial statement income is the amount of net income or loss the corporation reports on its applicable financial statement. The applicable financial statement income is based on book value, which may be GAAP, IFRS or regulatory reporting based on a hierarchy.
⁷ Subsequent events are defined as events or transactions that occur subsequent to the balance sheet date, but before the issuance of the statutory financial statements and before the date the audited financial statements are issued, or available to be issued.

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