Regulatory Update: NAIC Spring 2022 National Meeting

a. Privacy Protections (D) Working Group

At the Spring Meeting, the Privacy Protections (D) Working Group adopted its 2022 workplan, pursuant to which it will review state insurance privacy protections regarding the collection, ownership, use, and disclosure of information gathered in connection with insurance transactions and begin drafting proposed revisions, as needed, to the NAIC Insurance Information and Privacy Protection Model Act (#670) (Privacy Model Act) and the Privacy of Consumer Financial and Health Information Regulation (#672) (Privacy Model Regulation). The Privacy Protections (D) Working Group expects to expose drafts of its revisions to the Privacy Model Act throughout 2022, with revisions to the Privacy Model Regulation to follow in 2023.

In parallel with its revisions to the Privacy Model Act and Privacy Model Regulation, the Privacy Protections (D) Working Group will draft a white paper on data ownership and use rights (Privacy White Paper). An initial draft of the Privacy White Paper is expected to be exposed in advance of the NAIC’s Fall 2022 National Meeting.

Some interested parties expressed concern with the workplan, suggesting that rather than launching a drafting process, the Privacy Protections (D) Working Group should first perform a gap analysis to identify any gaps in the current state privacy protection regime. Although this concern was ultimately overruled, the Privacy Protections (D) Working Group emphasized that it will address questions as to what portions of the current regime need modernizing and what provisions should be added as part of the overall review and drafting process.

Also at the Spring Meeting, the (D) Committee and the (H) Committee agreed that the Privacy Protections (D) Working Group will report to the (H) Committee in the future. Going forward, the Privacy Protections (D) Working Group will be known as the Privacy Protections (H) Working Group. 

b. Collaboration Forum Project on Algorithmic Bias

The (H) Committee established a new Collaboration Forum that will serve as a platform for multiple NAIC committees to interact to identify and address foundational issues and develop a common framework with respect to innovation, technology, and cybersecurity topics of broad impact across various NAIC workstreams. The objective is to assure that such matters are addressed and decided with the full complement of relevant subject matter experts and disciplines to inform the specific workstreams of relevant NAIC committees. 

The Collaboration Forum’s initial project is “algorithmic bias,” which refers to systematic errors in computing systems driven by predictive models, artificial intelligence, and machine learning that result in unfair discrimination with respect to insurance consumers. The focus of the project will be developing methods that regulators can use to evaluate predictive models (e.g., a set of models that use statistics to predict outcomes for insurance products, including rating plans) for any unfair bias. The project aligns with activities of the Special (EX) Committee on Race and Insurance, whose charges include research and analysis of insurance, legal, and regulatory approaches to address unfair discrimination, disparate treatment, proxy discrimination, and disparate impact as well as coordinating with other NAIC workstreams on issues or practices that affect or potentially disadvantage people of color and/or historically underrepresented groups, particularly in predictive modeling, price algorithms, and artificial intelligence. 

c. Innovation in Technology and Regulation (H) Working Group

The (H) Committee appointed a new working group, the Innovation in Technology and Regulation (H) Working Group, and adopted its proposed charges. The Innovation in Technology and Regulation (H) Working Group will be co-chaired by Evan Daniels (Arizona) and Dana Popish Severinghaus (Illinois). The Innovation in Technology and Regulation (H) Working Group is intended to function as a sort of regulatory sandbox to provide a forum for discussion among all stakeholders regarding technology and the ways in which regulators are facilitating innovation. The Innovation in Technology and Regulation (H) Working Group’s specific charges are the following: 

• develop forums, resources, and materials for discussing innovation and technology regarding companies, producers, state insurance regulators, and licensees relevant to the state-based insurance regulatory structure, including new products, services, business models, and distribution mechanisms
• in conjunction with NAIC staff, explore developing a forum that provides insurers or third parties working with insurers the opportunity to confidentially brief state insurance regulators regarding innovation and technology applications, tests, use cases, and results
• identify and discuss regulatory models or programs that may assist state insurance regulators to identify and better understand innovation taking place within the insurance industry
• monitor innovation work occurring in other NAIC letter committees, task forces, and working groups and identify areas of possible coordination for the (H) Committee

a. SAP Working Group Exposes Revisions to Principle-Based Bond Definition and Related Issue Paper

The SAP Working Group exposed for comment revisions to the draft principles-based bond definition, which will be used for all securities in determining whether they qualify for reporting on Schedule D-1: Long-Term Bonds (Schedule D-1), as well as an initial draft of the issue paper (Issue Paper) that details past discussions in drafting the exposed bond definition. The comment period for the revisions to the bond definition and the Issue Paper ends on May 6, 2022.

The SAP Working Group’s review of the proposed bond definition is part of its ongoing work on the “Investment Classification Project,” which is intended to address a variety of issues pertaining to definitions, measurement, and overall scope of the investment SSAPs. The principle-based bond definition was initially exposed in May 2021 and was the product of several meetings between regulators from the Iowa Insurance Division, NAIC staff, and a small subset of interested parties in response to a concern regarding expanding investment structures that have been reported on Schedule D-1. Going forward, investments eligible for reporting on Schedule D-1 must either comply with the principles-based definition of a bond (and be classified as either an “issuer credit obligation” or an “asset backed security”) or be specifically enumerated as within the scope of SSAP No. 26R or SSAP No. 43R. 

Since its initial exposure, NAIC staff has continued to work on the proposed bond definition with a small group of regulators and industry participants to discuss concepts, review proposed language, and consider various investment designs. As a result of those discussions, the SAP Working Group exposed revisions to the draft bond definition that

clarify that for purposes of determining whether there is sufficient support for repayment in order for an instrument to be considered an “issuer credit obligation,” with respect to investments that are in the form of securities supported by an underlying contractual obligation of a single operating entity (such as credit-tenant loans, equipment trust certificates, or funding-agreement-backed notes), such instrument’s repayment is deemed to be “fully-supported” by the underlying operating entity obligation if the instrument provides cash flows for the repayment of all interest and at least 95% of the principal

• remove hybrid securities from the list of instruments automatically deemed to be “issuer credit obligations”; instead, hybrid securities may be reported as bonds only if they are assessed and determined to qualify under the requirements of the proposed definition
• clarify that investments with “stated” interest and “additional returns” to which the holder of the debt instrument is entitled (such as principal-protected notes, principal-protected securities, and structured notes), the “stated” interest and “additional returns” must be collectively considered as interest and must be assessed together in determining whether the investment has variable principal or interest due to underlying equity interests; the bond definition will require a structural assessment inclusive of all investment components and will not permit segregation of components within a structure, such as bond collateral supporting principal and interest payments to determine Schedule D-1 reporting when the structure also includes other collateral with the potential to generate additional interest or returns
• include additional factors to be considered in determining whether a debt instrument reflects a creditor relationship with respect to instruments issued by a special purpose vehicle that owns underlying equity interests; such an instrument may qualify as a bond if the characteristics of the underlying equity interests lend themselves to the production of predictable cash flows and the underlying equity risks have been sufficiently redistributed through the capital structure of the issuer
• remove a previously included example with respect to the treatment of “stapled” investments as it has been acknowledged that where bond and equity investments are “stapled” and held by the same reporting entity, the bond instrument can still qualify to be reported as a Schedule D-1 bond even if the equity tranche cannot (and instead would be reported as a Schedule BA asset).

Details on these proposed changes, as well as the background on the previous discussions regarding the proposed bond definition, are set forth in the draft Issue Paper. The draft Issue Paper does not cover proposed revisions to the SSAPs at this time, as such revisions will be considered once the bond definition and Issue Paper have been finalized. As an initial step with respect to such changes to the SSAPs, during the Spring Meeting, the SAP Working Group directed NAIC staff to proceed with developing a more robust illustration of proposed reporting options to revise Schedule D-1 to include more granular reporting lines to capture investments in scope of SSAP No. 26R and SSAP No. 43R as well as a new subschedule that will detail bond investments with certain characteristics. The goal is to expose the reporting options during the SAP Working Group’s May 2022 conference call. 

b. SAP Working Group Exposes Revisions to Clarify Requirements for Identifying and Reporting Affiliated Transactions

In response to recent discussions on the reporting and disclosure requirements for investments with related parties, the SAP Working Group has exposed revisions to SSAP No. 25 that would (i) clarify the reporting of affiliate transactions within existing reporting lines in the investment schedules to be consistent with the definition of an “affiliate” pursuant to the Insurance Holding Company System Regulatory Act (#440) (Holding Company Model Act) and (ii) incorporate new reporting requirements for investment transactions with related parties. The proposed revisions were exposed for a shortened comment period until May 6, 2022, to allow for a year-end 2022 effective date.

The proposed edits to SSAP No. 25 would add a new paragraph clarifying that if direct or indirect control exists, whether through voting securities, contracts, common management, or otherwise, the arrangement will be considered “affiliated” under SSAP No. 25. For example, consistent with the definition of “affiliate” in the Holding Company Model Act, if a limited partnership were to be controlled by an affiliated general partner, and that limited partnership held greater than 10% of the voting interests of another company, indirect control by the affiliated general partner must be presumed to exist unless the presumption of control can be rebutted.

The proposal also includes revisions to SSAP No. 43R to note the requirement to identify related party investments in the investment schedules. Pursuant to recent discussions, regulators requested additional information on investment transactions involving related parties regardless of whether the related party is “affiliated” pursuant to the Holding Company Model Act. To preserve the affiliate definition and reporting categories, these additional proposed reporting elements will be captured outside of the current affiliate reporting requirements. Related changes to the annual statement reporting requirements are set forth in a related blanks proposal, which was exposed by the Blanks (E) Working Group for comment through April 25, 2022.

c. SAP Working Group Adopts Agenda Item to Add New General Interrogatory Related to Cryptocurrencies

The SAP Working Group also adopted an agenda item proposing to add a new general interrogatory to require disclosure pertaining to cryptocurrencies directly held by insurers or permitted for the remittance of premiums to insurers. This agenda item did not result in statutory revisions; however, adoption reflects support for the proposal sponsored by the Blanks (E) Working Group.

The proposal would add new questions to General Interrogatories Part 1 on whether the reporting entity accepts cryptocurrency for payment of premiums, which cryptocurrencies are accepted, and whether they are held for investment or immediately converted to U.S. dollars. Comments on the Blanks (E) Working Group exposure are due by April 25, 2022.

Following adoption of the List of PE Considerations, the Macroprudential (E) Working Group met in regulator-only session to start the process of assessing each consideration to determine whether additional work is deemed necessary and, if so, by which NAIC committee. Prior to the Spring Meeting, only the first six considerations had been reviewed. The remaining seven considerations will be discussed in a later regulator-only meeting of the Macroprudential (E) Working Group. Once all of the considerations have been reviewed, the List of PE Considerations and proposed next steps will once again be exposed for a brief comment period.

With respect to the first six considerations, the first consideration (relating to structuring to avoid disclosure) and second consideration (regarding disclosures of owners with less than 10% ownership) will be referred to the Group Solvency Issues (E) Working Group for further consideration. The third consideration (relating to investment management agreements) and fourth consideration (relating to short-term focus vs. long-term nature of liabilities) will be referred to the Risk-Focused Surveillance (E) Working Group. The fifth consideration (relating to market conduct practices) and sixth consideration (relating to the definition of private equity) will not be referred to other NAIC committees. Specifically, with respect to the sixth consideration, which notes the impact of the lack of a widely accepted definition of private equity, the Macroprudential (E) Working Group determined that no such definition is necessary to develop given that the focus of the List of PE Considerations is activity-based and should apply to any ownership structure, beyond just private-equity-owned insurers.

Following its initial review of these first six considerations, the Macroprudential (E) Working Group noted certain areas where additional disclosures may be warranted for various filings submitted under the Holding Company Model Act. Such additional disclosures may include enhancements to the Form A Statement that would require disclosure on the goals of the potential owner in acquiring the insurer, how the potential owner will be paid and in what amounts, and the ability of the potential owner to provide capital support as needed. Such additional disclosures may also include enhancements to the Form B Registration Statement that would require disclosure of owners with less than 10% interest.

The Macroprudential (E) Working Group also emphasized the need for additional training and guidance for states unfamiliar with complex ownership and transaction structures in order to identify and address certain issues with respect to such structures. 

The revised List of PE Considerations also includes examples of stipulations (both limited time and continuing) that regulators could use when approving an acquisition to address solvency concerns as well as for use in ongoing solvency monitoring.

Such limited time stipulations include:

• requiring risk-based capital (RBC) to be maintained at a specified amount above company action level/trend test level or requiring RBC reports on a quarterly basis
• prohibiting any dividends, even ordinary dividends
• requiring a capital maintenance agreement or prefunded trust account
• requiring a plan to be submitted by the group that allows all affiliated agreements and affiliated investments to be reviewed, despite being below any materiality thresholds otherwise required by state law

Examples of continuing stipulations include

• requiring prior commissioner approval of material arms-length, nonaffiliated reinsurance treaties or risk-sharing agreements
• requiring notification within 30 days of any change in directors, executive officers or managers, or individuals in similar capacities of controlling entities, and biographical affidavits and such other information as shall reasonably be required by the commissioner
• requiring disclosure of equity holders (both economic and voting) in all intermediate holding companies from the insurance company up to the ultimate controlling person or individual

The Macroprudential Risk Assessment will be used to proactively identify and assess industrywide insurance risks to allow insurance regulators to consider and incorporate, as needed, various macroprudential surveillance measures across the insurance sector. NAIC staff and state insurance regulators will identify, aggregate, and track the performance of targeted insurance industry and macroeconomic risk indicators on a biannual basis. Each of the quantitative and qualitative risk indicators will be sourced from aggregated NAIC Annual Statement data as well as public data sources, which will be reviewed and updated as needed to quantify emerging material risk exposures.

Macroprudential risks will be presented to the Financial Stability (E) Task Force for general policy consideration, which could include the development of additional tasks, policies, practices, or disclosures to address sectorwide risk exposures. In addition, assessments may be shared with federal and international regulators for broader financial sector and macroprudential surveillance purposes.
The Macroprudential Risk Assessment incorporates both quantitative and qualitative assessment factors to facilitate regulator identification of key risk exposures. 

Quantitative factors will be used to track and measure risk exposures by establishing key risk indicators for ongoing monitoring and assessment. The quantitative assessment categories include (a) macroeconomic factors affecting the broader economy and most likely to impact the insurance industry, (b) interconnectedness with other financial sectors and the overall financial stability of the insurance industry, (c) the overall capitalization of the insurance industry and perceptions of financial strength (i.e., ratings and outlooks), (d) exposure to risks associated with insurance underwriting performance, reserve development, and overall profitability, (e) credit exposure, (f) changes in interest rates and/or prices adversely affecting the value of investments and liabilities, and (g) liquidity exposure, as well as other risks. 

In addition, qualitative factors may be used to supplement the risk indicators by incorporating information from a broader range of sources into the risk assessment process to identify emerging issues and industry trends for consideration. Such tools and resources may include results of company surveillance efforts (such as the NAIC Own Risk and Solvency Assessment reviews), industry news, and internal/external research studies (including those performed by the NAIC’s Capital Markets Bureau, Center for Insurance Policy and Research, and rating agencies) as well as insights from federal resources (such as Financial Stability Oversight Council, Federal Reserve, Federal Insurance Office, and Office of Financial Research as well as international resources, including the International Association of Insurance Supervisors’ (IAIS) Global Monitoring Exercise).

Insights from both the quantitative and qualitative reviews will be aggregated to reach a baseline assessment of industry exposure to various macroprudential risks, which will then be evaluated, adjusted as needed, and approved by the Macroprudential (E) Working Group going forward. 

State insurance regulators may use the results of the macroprudential risk assessment process for identification of sectorwide risks and potential systemic risks and may focus their supervisory resources toward identifying individual insurers that contribute to such higher-assessed sectorwide risks and potential systemic risk or activities. It has been noted that further analysis may warrant additional supervision and oversight of select insurers.

By way of background, the Restructuring Mechanisms (E) Working Group is drafting a Restructuring Mechanisms white paper (Restructuring Mechanisms White Paper) that discusses new statutory processes that certain states have adopted to govern insurance business transfer (IBT) and corporate division (CD) transactions. The Restructuring Mechanisms White Paper includes a recommendation that the Guaranty Association Model Act should be amended to address issues related to guaranty association coverage following IBT and CD transactions.

The Restructuring Mechanisms (E) Working Group referred the matter to the Receivership and Insolvency (E) Task Force for further consideration. As a result of the referral, the Receivership and Insolvency (E) Task Force exposed for comment a new Model Law Development Request Form to amend the Guaranty Association Model Act. The proposed amendment would revise the definition of “Covered Claim” in the Guaranty Association Model Act to ensure that where there was guaranty fund coverage before the IBT or CD transaction (and potentially other transactions), coverage continues after such transaction.

After receiving comments on the proposal, the Receivership and Insolvency (E) Task Force will determine whether any revisions to the Model Law Development Request Form are necessary and return it to the Restructuring Mechanisms (E) Working Group, which plans to submit the Model Law Development Request Form to the Financial Condition (E) Committee for consideration at the NAIC’s Summer 2022 National Meeting.

Many in the industry consider national uniformity on guaranty association coverage following IBT and CD transactions to be a gating issue to such transactions’ being used more widely.

The TCFD was developed by the Financial Stability Board as a global voluntary framework for public disclosure of climate-related risks and opportunities. Use of the TCFD framework has been supported by various industries both within and outside the U.S. as mandates for climate-related disclosures grow and regulators look for a more standardized method of reporting. Use of the TCFD framework by the insurance industry has been supported by both the IAIS and the United Nations–convened Sustainable Insurance Forum, a network of insurance supervisors and regulators that includes as members the U.S. Department of the Treasury and the NAIC, as well as certain individual state insurance regulators from California, New York, Vermont, and Washington. In March 2021, the Securities and Exchange Commission published its proposals for climate-risk disclosures that would also require disclosures in line with the TCFD framework.

The Climate Risk Disclosure Survey applies to insurers that meet the reporting threshold of $100 million in countrywide direct premium and are licensed in one of the participating jurisdictions. The following 15 states/jurisdictions have committed to utilize the Climate Risk Disclosure Survey in 2022 for insurance companies licensed in their jurisdictions: California, Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts, Minnesota, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Vermont, and Washington. Insurance companies that are required to respond to the Climate Risk Disclosure Survey will need to comply with reporting by November 30, 2022.

Industry comments on the Climate Risk Disclosure Survey focused on the deadline for initial reporting, expressing concern that the new disclosure framework will require additional time for insurance companies to provide complete responses. Members of the Climate and Resiliency (EX) Task Force emphasized that adoption of the Climate Risk Disclosure Survey is voluntary for each state and that the states that have committed to utilize the survey in the coming year have the flexibility to work with insurers if there are concerns about compliance.

a. Proposal for Reporting Additional Market Data Fields for Bond Investments on Statutory Financial Statements 

Based on a recommendation from the Securities Valuation Office (SVO) prompted by the desire to reduce the SVO’s reliance on CRPs with respect to the assessment of bond investment risks, the Valuation of Securities (E) Task Force exposed for comment a proposed referral to the Blanks (E) Working Group to add fixed income analytical risk measures to bond investments reported on an insurer’s statutory financial statements. Comments with respect to the proposal are due by May 20, 2022.

The SVO proposal provides for the addition of the following market data fields (and related descriptions as set forth in the proposal) to the annual statement instructions for all bonds reported on Schedule D-1 (i.e., investments within the scope of SSAP No. 26R and SSAP No. 43R): (i) market yield, (ii) market price, (iii) purchase yield, (iv) weighted average life, (v) spread relative to U.S. Treasuries and average life, (vi) option-adjusted spread, (vii) effective duration, (viii) convexity, and (ix) NAIC VISION system ID. The SVO referenced certain examples of how these factors could assist in measuring a security’s risk. For example, if a security’s market yield and spread differ from similarly rated securities, the implied market-perceived risk of that security may be greater than the risk indicated by the CRP rating assigned to the security. The SVO further recommended that such changes be implemented as electronic-only fields beginning with December 31, 2023, annual statements to allow time for insurers to update their systems.

b. CRP Study Group

The CRP Study Group, which is composed of regulators, insurer personnel, and NAIC staff, held its initial meeting on March 11, 2022, during which the following objectives for the CRP Study Group were agreed upon:

• establish a framework of qualitative and quantitative criteria for being an NAIC-accepted CRP
• eliminate and minimize RBC arbitrage opportunities between CRP ratings and asset classes
• define a repeatable quantitative process to evaluate rating performance for all rating agencies consistent with NAIC RBC factors
• incorporate market data to help identify potential misalignments of risk, as recommended by the Rating Agency (E) Working Group in 2010

The CRP Study Group also discussed the mapping and analysis framework that a certain CRP uses to map ratings issued by other CRPs to its rating scale. The CRP Study Group plans to meet monthly to further its objectives, and any recommendations will be presented for the Valuation of Securities (E) Task Force’s consideration.

Consumer representatives expressed concern regarding the Educational Report’s definition of accelerated underwriting, suggesting it was too vague to show how it differs from traditional underwriting. Consumer representatives also criticized the Educational Report as lacking specific guidance for state regulators. Following adoption of the Educational Report, the Accelerated Underwriting (A) Working Group now intends to draft additional specific guidance for state regulators on the use of external data and data analytics in accelerated underwriting for life insurance products.