RBC, find out what it means to me
U.S. life insurance bond factor changes
- Proposed changes to RBC bond factors will increase required capital and decrease RBC ratios for U.S. life insurers.
- The impact of the proposed changes is uneven, as some asset classes are targeted for much greater RBC charge increases than others, while some even have RBC charge decreases.
- The proposed RBC changes will result in much more flexibility in what constitutes an RBC efficient portfolio and RBC focused insurers should consider changing their strategic allocation and increasing tactical flexibility.
- The fixed income that will become more capital efficient includes very high quality investment grade (AA- to AAA), high quality below investment grade (BB+/BB) and various commercial mortgage loan strategies (CMLs) including mezzanine debt.
- Since RBC charges will increase on most fixed income, many types of alternative assets will look relatively more attractive and life insurers should consider them—furthermore, RBC covariance changes will result in a 10%–20% decrease in post-diversification capital charges on equity-like alternatives for many life insurers.
- We expect the median RBC ratio for life insurers to fall by about 36 points, but the impact will vary widely and ultimately depend on implementation details.
- In a future paper, we will address how insurers that are constrained by both RBC and rating agency capital models should respond to the changes in RBC factors.
1. A Long time coming
In 2014, I wrote my first piece for our insurance clients about potential changes to RBC bond factors, the consequences of those changes and how insurers should respond. The proposed RBC changes have been a long time coming, to say the least, but there is now reason to think there is momentum toward adoption of the proposed RBC factors. For YE2020 statutory financials, life insurers are required to report more granular information on the ratings of their bonds than just NAIC ratings. The current timeline from the NAIC indicates that new factors will be released formally for industry comments during April 2021 and the factors will be finalized in June 20211 . The effective date for adoption of new factors is scheduled for YE2021. There is some skepticism about the timing of the adoption of the new factors given that past deadlines were shown to be flexible. At least two key issues may delay the adoption of the factors. The first is an additional review of the proposed factors in response to feedback from insurers. Moody’s is conducting the review. If Moody’s proposes significant changes, that could delay implementation. A second issue relates to the treatment of the size factor, which is a capital adjustment factor related to the diversification of an insurer’s fixed income portfolio. Smaller insurers are worried that they will be put at a disadvantage without changes to the size factor calculation. Although this is a material issues related to total level of RBC for some insurers and, it does not impact the relative RBC charges within fixed income.2
1 See NAIC Life Risk Based Capital (E) Working Group, Financial Condition (E) Committee memo “RBC Bond Factors,” October 5, 2020.
2 Another potential issues that may arise is that, to our knowledge, the research on the development of the factors has been focused on corporate credit, while the factors will apply broadly to fixed income. These universal factors are inconsistent with the broad industry view that some securitized assets like CLOs have more risk of principal loss risker than corporate bonds with equivalent ratings.