Regulatory Update: NAIC Fall 2021 National Meeting

a. NAIC to Evaluate Rating Information and Process for Privately Issued Securities 

The NAIC is concerned that private credit rating provider (CRP) ratings do not adequately represent the risks of privately issued securities purchased by insurers, which can affect an insurer’s RBC calculation, resulting in a lower RBC charge for higher-risk investments. The Valuation of Securities (E) Task Force (VOS Task Force) previously adopted an amendment to the P&P Manual requiring the submission of private rating letter rationale reports with certain private rating letters filed with the NAIC Securities Valuation Office (SVO). Beginning in January 2022, insurers are required to file such reports with the SVO to provide additional details regarding the private letter ratings obtained with respect to their ownership of privately issued securities. The report must provide an analytical review of the privately issued security that mirrors the work product that a CRP would produce for a similar publicly rated security, including an explanation of the transaction structure, methodology relied on and, as appropriate, analysis of the credit, legal and operational risks and mitigants supporting the assigned CRP rating.

Additionally, on November 9, 2021, the SVO issued a memorandum to the VOS Task Force expressing concern regarding the NAIC’s extensive reliance on CRP ratings to assess investment risk for regulatory purposes and proposing changes to the SVO’s “filing exempt” process, which grants an exemption from filing with the SVO for bonds and preferred stock that have been assigned a current, monitored rating by a nationally recognized statistical rating organization (NRSRO). The memorandum noted that the SVO staff conducted an in-depth review of a sample of 43 privately rated securities and found material differences between the private ratings and the SVO staff’s estimates, with the private ratings being three to six or more notches higher than the SVO staff’s estimates. The memorandum suggested four alternatives that the NAIC should consider in 2022 to begin the process of actively managing and overseeing its use of CRP ratings, which alternatives may be considered independently or may be combined or phased in over different time periods. The proposed alternatives include:

• requiring at least two CRP ratings for every security and using the lowest rating to determine the NAIC designation; if a security has only one rating, then requiring it to be reviewed by the SVO to determine whether the SVO deems the rating reasonable (i) pursuant to its own analysis, (ii) when benchmarked to NRSRO peers and methodology, or (iii) compared to a spread implied rating, and, if not, to determine whether a full filing and SVO analysis would be appropriate
• conducting an in-depth study of the NAIC’s use of CRP ratings and SVO-assigned NAIC designations as to their consistency and comparability for regulatory purposes, specifically the determination of RBC factors
• offering NRSROs the opportunity to respond to a request for qualifications (RFQ), with the NAIC contracting only with those CRPs that adequately meet the RFQ criteria
• having the SVO remove any rating agency from the CRP list at any time upon the request of the VOS Task Force

The VOS Task Force indicated that the memorandum provides a starting point to evaluate the rating process, and the VOS Task Force expects to form a subgroup charged with conducting such evaluation, which would include participation by CRPs, insurers and other stakeholders.   

b. NAIC Removes Residual Tranches From Receiving NAIC Designation

The VOS Task Force adopted an amendment to the P&P Manual to remove residual tranches and interests from receiving an NAIC designation. Specifically, the amendment provides that securities that are residual tranches or interests, as defined in Statement of Statutory Accounting Principles No. 43R–Loan Backed and Structured Securities, must be reported on Schedule BA (Other Long-Term Invested Assets) without an NAIC designation and are not eligible to be assigned an NAIC 5GI or NAIC 6* Designation. Residual tranches or interests generally refer to securitization tranches, beneficial interests and other structures that reflect loss layers without any contractual payments, whether principal, interest or both. Payments to investors in residual tranches or interests (i) occur after contractual interest and principal payments have been made to other tranches and interests and (ii) are based on any remaining available funds. For 2021 year-end reporting only, residual tranches or interests previously reported on Schedule D-1 (Long-Term Bonds) may be reported on Schedule D-1 with an NAIC 6* Designation but not an NAIC 5GI Designation. 

c. NAIC Exposes Amendment to Definition of Principal Protected Securities

The VOS Task Force exposed an amendment to the PPS definition in the P&P Manual to address alternate securities with “performance assets” that do not fit within the current PPS definition but nevertheless should be categorized as PPS. By way of background, in May 2020, the VOS Task Force adopted an amendment to the P&P Manual to include PPS as a new security type that is not eligible for the SVO’s “filing exempt” process. At that time, the types of PPS considered were combinations of (i) a typical bond or bonds and (ii) additional performance assets with various characteristics, including derivatives, common stock, and/or commodities and equity indices, that were intended to generate additional returns. The performance assets generally included undisclosed assets and were typically not securities that would otherwise be permitted on Schedule D, Part 1 as a bond. In each case, the private CRP rating was based solely on the component dedicated to the repayment of principal and ignored the risks and statutory prohibitions of reporting the performance asset on Schedule D, Part 1.

The impetus for the proposed amendment was the SVO’s receipt of a proposed security that had many of the same risks as PPS but was structured in a way that did not fit squarely within the PPS definition in the P&P Manual. The proposed security was not issued by a special purpose vehicle holding both the bond and the performance asset; rather, the security was the direct obligation of a large financial institution that was obligated to pay principal at maturity and any additional return based on the performance of certain referenced indices of equities, fixed-income instruments, futures and other financial assets. Although the financial institution issuing the security was the sole obligor under the security, such that there were no underlying bonds or performance assets, the structure posed the same risk of exposure to a performance asset because the amount of the issuing financial institution’s payment obligation depended directly on the performance of the referenced indices. Additionally, unlike a PPS transaction with an underlying bond and performance asset, the likelihood of payment of any performance asset return was linked directly to the creditworthiness of the issuing financial institution. The proposed amendment to the PPS definition is intended to address such alternate structures that pose similar risks, so that such structures would be covered under the PPS definition and ineligible for the SVO’s “filing exempt” process.

d. NAIC Forms New RBC Investment Risk and Evaluation (E) Working Group

The Financial Condition (E) Committee approved the formation of a new RBC Investment Risk and Evaluation (E) Working Group following a recommendation from the Capital Adequacy (E) Task Force. The new working group has been charged with performing a comprehensive review of the RBC investment framework for all business types and will coordinate with other NAIC groups in an effort to achieve a more holistic evaluation of investment-related proposals and their RBC impact.

 

a. LTCI Task Force Adopts LTCI MSA Framework

During the Fall Meeting, the LTCI Task Force adopted the LTCI MSA Framework, which is intended to provide a consistent national approach for reviewing current long-term care insurance rates that results in actuarially appropriate increases being granted by the states in a timely manner and eliminates cross-state rate subsidization.  

Industry comments with respect to the adoption reflected continued concern with a perceived lack of transparency and consistency, specifically with respect to the methodology used to calculate increases recommended by the Multi-State Actuarial Team under the LTCI MSA Framework. However, the comments recognized that such questions would be addressed over time as regulatory and industry experience with the LTCI MSA Framework evolves.

The LTCI MSA Framework is expected to be considered by the Executive (EX) Committee and Plenary at the Spring 2022 National Meeting, in advance of becoming fully operational by September 2022.

b. LTCI Task Force Adopts Checklist for Premium Increase Communications

The LTCI Reduced Benefit Options (EX) Subgroup adopted a checklist for premium increase communications on November 19, which was subsequently adopted by the LTCI Task Force at the Fall Meeting. The checklist is intended to establish a consistent approach to drafting and reviewing LTCI reduced-benefit options policyholder communications. Specifically, use of the checklist by insurers and state regulators is intended to ensure that consumer communications (i) are written in a clear, logical, not overly complex manner, (ii) present options fairly and (iii) include appropriate referrals to external resources, definitions, disclosures and visualization tools.

While the LTCI Task Force recommended that state regulators adopt the checklist and adapt it to local needs, it noted that the checklist is to be used as guidance and does not carry the weight of law or impose any legal liability. 

c. LTCI Model Update Subgroup Continues Review of LTCI Model Act and Regulations

The LTCI Model Update Subgroup continued its review of Model 640 and Model 641 to determine whether the models remain compatible with the evolving delivery of long-term care services in the changing LTCI marketplace, specifically focusing on Sections 7-19 of Model 641 during its November and December 2021 meetings. These sections relate to, among other things, requirements to offer inflation protections, reporting requirements and prohibitions against postclaims underwriting. The LTCI Model Update Subgroup’s review of the models began in May 2021 and remains ongoing. Model 640 and Model 641 have not been fully reviewed since 2010 and were most recently updated in 2016. To the extent that the LTCI Model Update Subgroup determines that an update to the models is necessary, it will report such determination to the Senior Issues (B) Task Force, which would then begin work.

The topic of PE ownership of insurers has recently garnered renewed interest at both the state and federal levels in the U.S., as well as by regulators internationally, as a result of a noted increase in PE acquisitions of insurers and the recent release of several reports regarding PE ownership of insurers, including the report issued by the NAIC Capital Markets Bureau as of year-end 2020 (a copy of which can be found here). The Financial Stability (E) Task Force noted that recent concerns are focused on the increase in complex group structures and affiliate agreements, which may not be appropriately captured by the existing holding company regulatory framework. Superintendent Eric Cioppa (Maine), who serves as the state insurance commissioner representative on the Financial Stability Oversight Council, specifically noted that the Federal Insurance Office (FIO) and others at the federal level have raised questions about the PE business model related to insurance entities, including affiliated transactions, investment transparency and fee structures and reiterated support for oversight enhancements at the NAIC. Going forward, such oversight will be conducted through the Macroprudential (E) Working Group, which will serve as the coordinator of considerations related to PE owners of insurers.  

In addition, the Financial Stability (E) Task Force exposed for a 30-day public comment period ending January 18, 2022, the initial draft List of PE Considerations, which includes 13 areas noted for further review by the NAIC to assess whether further work is needed to address concerns. The list currently includes as considerations, among others:

• structuring contractual agreements in a manner to avoid regulatory disclosures and requirements  
• control considerations that may exist with less than 10% ownership (such as control through contractual arrangements)
• material terms of investment management agreements and whether they are at arm’s length
• operational, governance and market conduct practices affected by the different priorities and level of insurance experience
• material increases in privately structured securities (both by affiliated and nonaffiliated asset managers)
• use of offshore reinsurers and complex affiliated sidecar vehicles

Once the List of PE Considerations is finalized, the Macroprudential (E) Working Group will further assess each consideration to determine whether additional work is deemed necessary and, if so, by which NAIC committee. For all work that is ongoing, the Macroprudential (E) Working Group’s staff will maintain status information and provide oversight of such activities.

Under the existing regulatory framework, “contracts that provide for annuity benefits that vary according to the investment experience of a separate account” are exempt from Model 805 and instead are subject to requirements for nonforfeiture benefits under the Variable Annuity Model Regulation (Model 250). Thus, traditional variable annuities with unit-linked values are subject to Model 250, and the market values of the separate account assets are the basis for contract benefits, including surrender values.  

The NAIC is evaluating how this framework should apply to “hybrid” annuity products, commonly referred to as index-linked variable annuities, which provide periodic credits based on the performance of a specified portfolio of assets (e.g., an index), which typically are not unit-linked and do not invest in the assets whose performance forms the basis for the periodic credits.  

Actuarial Guideline ILVA clarifies the application of Model 805 and Model 250 to these hybrid products. The guideline is based on certain principles, including that the products should provide equity to contract holders with reference to a hypothetical portfolio containing fixed-income assets and derivatives designed to perfectly hedge the benefit guarantees at the end of the contract term.  

The American Council of Life Insurers expressed concern regarding Actuarial Guideline ILVA and requested an opportunity for an industry drafting group to collaborate with the ILVA Subgroup to create a revised version of the guideline before it was exposed for comment. The ILVA Subgroup elected to expose the guideline for comment, explaining that such collaboration can occur through the comment process. The current comment period ends January 27, 2022.

The White Paper discusses new statutory processes that certain states have adopted to govern insurance business transfer (IBT) and corporate division (CD) transactions. The White Paper includes a survey of U.S. restructuring statutes and regulations (including a summary of transactions completed to date) and a summary of the significant legal issues related to IBT and CD laws (including guaranty association issues). The White Paper concludes by making the following recommendations: 

• The Restructuring Mechanisms (E) Subgroup will continue its work to develop financial best practices to be used in considering the approval of proposed restructuring transactions. 
• The Guaranty Association Model Act should be amended to address issues related to guaranty association coverage following IBT and CD transactions. 
• IBT and CD transactions should be subject to a robust regulatory process, which may require the application of certain statutory minimums (e.g., court approval, independent expert, notice to stakeholders) in some transactions but not others.
• The NAIC should consider developing licensing standards for insurers formed for the purpose of effectuating restructuring mechanisms.  

The White Paper does not establish an official position by the NAIC regarding IBTs or CDs.  

Ten comment letters were submitted during the exposure period. The Restructuring Mechanisms Working Group plans to work with NAIC staff at the beginning of 2022 to review the comments, find areas of overlap and develop a plan for finalizing the White Paper.

a. NAIC Adopts Revisions to “Substantive” and “Nonsubstantive” Terminology 

The NAIC adopted revisions to the NAIC Policy Statement on Maintenance of Statutory Accounting Principles to modify the historical use of the terms “substantive” and “nonsubstantive” to classify proposed modifications to the NAIC Accounting Practices and Procedures Manual. Such revisions provide that, effective January 1, 2022, substantive modifications will be identified as a “new SAP concept,” while nonsubstantive modifications will be identified as a “SAP clarification.” The Statutory Accounting Principles (E) Working Group (SAPWG) also exposed for comment editorial revisions to statutory accounting guidance to reflect the revised terminology.

Historically, the procedural requirements for adopting modifications to statutory accounting guidance was different depending on whether such modifications were classified as “substantive” or “nonsubstantive.” The use of the historical terminology became controversial in the context of the NAIC’s recent revisions to SSAP No. 71 — Policy Acquisition Costs and Commissions. The NAIC elected to maintain the distinction in the terminology and the related procedural requirements, notwithstanding the fact that some industry commentators suggested that the same procedural requirements should apply regardless of which classification a proposed modification receives.

b. NAIC Considers Additional Reporting for Investment Transactions Involving Affiliates and Related Parties

Regulators are requiring additional information on investment transactions involving related parties, regardless of whether the related party is “affiliated” pursuant to the Insurance Holding Company System Regulatory Act (Model 440). To that end, SAPWG exposed for comment revisions to SSAP No. 25 — Affiliates and Other Related Parties and SSAP No. 43R — Loan-Backed and Structured Securities. Specifically, the revisions 

• clarify the reporting of affiliate transactions within existing reporting lines in the investment schedules, consistent with the definition of “affiliate” under Model 440, SSAP No. 25 and SSAP No. 97 — Investments in Subsidiary, Controlled and Affiliated Entities 
•  incorporate new reporting requirements for investment transactions with related parties regardless of whether the related party is “affiliated” under Model 440

The comment period applicable to these proposed revisions ends February 18, 2022.

The Revised CFR Model Laws eliminate reinsurance collateral requirements for certain reinsurers and limit the worldwide application of prudential group insurance measures on insurance groups that are domiciled in a “reciprocal jurisdiction.” A reciprocal jurisdiction includes a non-U.S. jurisdiction that has entered into a covered agreement with the United States (such as the European Union, or EU, and the United Kingdom, or UK) as well as “qualified jurisdictions” that meet certain additional requirements consistent with the terms and conditions of the covered agreements, including that the jurisdiction “recognizes the U.S. state regulatory approach to group supervision and group capital.” To date, Bermuda, Japan and Switzerland have been approved as reciprocal jurisdictions.

The NAIC previously adopted the Process for Evaluating Qualified and Reciprocal Jurisdictions to specify how qualified jurisdictions that meet the requirements under the Revised CFR Model Laws are recognized as reciprocal jurisdictions. During the Fall Meeting, the NAIC Executive (EX) Committee and Plenary adopted the Reinsurance Financial Analysis (E) Working Group (ReFAWG) Review Process for Passporting Certified and Reciprocal Jurisdiction Reinsurers for reciprocal jurisdictions, under which a state may defer to another state’s determination with respect to the requirements for reciprocal jurisdiction reinsurers. To be eligible for passporting, a reinsurer must first seek recognition as a reciprocal jurisdiction reinsurer from an initial state for certification, referred to as the “Lead State,” which will coordinate with ReFAWG on the review of the application to analyze the criteria required for certification and eligibility for the reinsurer to apply for passporting into other states.  

During the Fall Meeting, the NAIC Executive (EX) Committee and Plenary also adopted the Process for Evaluating Jurisdictions that Recognize and Accept the Group Capital Calculation (GCC) (referred to as “Recognize and Accept” Jurisdictions), which process will be similar to the Process for Evaluating Qualified and Reciprocal Jurisdictions. Under the 2020 revisions to Model 440 relating to the GCC, a non-U.S. jurisdiction may meet the standards for its insurance groups to be exempt from the GCC (i) if the jurisdiction has been determined to be a “reciprocal jurisdiction,” which already includes a requirement that the jurisdiction “recognizes the U.S. state regulatory approach to group supervision and group capital,” or (ii) if the jurisdiction has otherwise been determined to “recognize and accept” the GCC through the adopted Process for Evaluating Jurisdictions that Recognize and Accept the GCC. Through this process, the Mutual Recognition of Jurisdictions (E) Working Group will evaluate non-U.S. jurisdictions and a list of “Recognize and Accept” Jurisdictions will be published through the NAIC committee process. 

As of December 9, 2021, 46 U.S. jurisdictions had adopted the 2019 revisions to the Credit for Reinsurance Model Law, while four jurisdictions had action under consideration. In addition, 25 U.S. jurisdictions had adopted the revisions to the Credit for Reinsurance Model Regulation, and 10 jurisdictions had action under consideration. The Revised CFR Model Laws must be adopted by the states prior to September 1, 2022, the date at which the FIO must complete its federal preemption reviews under the covered agreements with the EU and the UK. The NAIC is encouraging all states and jurisdictions to adopt the Revised CFR Model Laws as soon as possible and no later than July 1, 2022, to give the FIO time for its federal preemption analysis.

Specifically, the report provided summaries of consumer privacy protections provided by (a) NAIC models, including the Health Information Privacy Model Act (Model 55), the Insurance Information and Privacy Protection Model Act (Model 670) and the Privacy of Consumer Financial and Health Information Regulation (Model 672); and (b) the General Data Protection Regulation and recently adopted state consumer privacy protection laws. The Working Group ultimately recommended that Model 670 and Model 672 be revised to modernize their applicability to the current technology-based insurance market.

The objectives of the (H) Committee are to  

• provide a forum for state insurance regulators to learn and have discussions regarding cybersecurity, innovation, data security and privacy protections, and emerging technology issues 
• monitor developments in such areas that affect the state insurance regulatory framework 
• maintain an understanding of evolving practices and use of innovation technologies by insurers and producers in various lines of business
• coordinate NAIC efforts regarding innovation, cybersecurity and privacy, and technology across other committees 
• make recommendations and develop regulatory, statutory or guidance updates  

The (H) Committee will also oversee the activities of the Big Data and Artificial Intelligence (H) Working Group, Speed to Market (H) Working Group, E-Commerce (H) Working Group and Cybersecurity (H) Working Group.

The December 2020 revisions to Model 440 and Model 450 implement (i) the GCC, for the purpose of group solvency supervision of U.S. insurance groups, and (ii) the liquidity stress test (or LST), for macroprudential surveillance of certain large life insurance companies that meet the in-scope criteria outlined in Model 440. With respect to the GCC, the December 2020 revisions require that a group file an initial GCC before it is able to seek an exemption from further filings; however, as exposed, the significant elements for the GCC Accreditation Standard were modified to allow state regulators to grant exemptions to groups meeting the qualifications set forth in Model 450 without the requirement to file a GCC at least once. 

The proposed effective date of the updates to the Accreditation Standard is January 1, 2026; however, the NAIC has encouraged all states with a group affected by the covered agreements with the EU and the UK to adopt the GCC revisions to Model 440 and Model 450 effective November 7, 2022, and all states with a group affected by the LST to adopt the relevant revisions to Model 440 as soon as possible.