NAIC Spring 2013 National Meeting Update

Relevant investment accounting items from the NAIC Spring 2013 National Meeting are examined below, including updates on C-1 bond factors, RMBS securities, and more. Read this entire post for a full recap, or click below to jump to the section that most interests you.

  1. The Investment Risk-Based Capital Working Group (IRBCWG)
  2. The Valuation of Securities Task Force (VOSTF)
  3. The Blanks Working Group (BWG)

The Investment Risk-Based Capital Working Group (IRBCWG)

The Working Group continues to move forward with the C-1 bond factors, currently being developed by the American Academy of Actuaries (AAA).  In their update to the Working Group, the AAA discussed current questions they are working through in order to finalize default probability assumptions. In addition, they are working to select the recovery assumptions that will be used in the new model. The AAA has been working for some time to finalize default and recovery assumptions, but say they are now close to making their selection.

A report summarizing recommendations to Life RBC for derivatives was presented to the Working Group, who then voted to expose the report for 40 days. The group also exposed recommended updates for common stock for Life RBC. Both items are open for comment until May 16, 2013. The meeting closed with a discussion on the RBC framework for directly owned real estate, which has not yet been finalized.

The Valuation of Securities Task Force

The first item on the agenda was an update to the proposed guidance for Quarterly Reporting of RMBS and CMBS securities. As we discussed in our Fall 2012 National Meeting Update article, the Task Force heard a proposal by industry that would allow insurance companies to use a Modified Filing Exempt process for quarterly reporting of newly purchased modeled securities. The guidance eliminates the costly expense of purchasing the previous year’s modeling assumptions, which are typically already outdated for quarterly reporting. The Task Force referred the agreed-upon interim guidance to the Statutory Accounting Principles Working Group (SAPWG) for inclusion into SSAP 43R (Loan-Backed and Structured Securities).

Next, the task force adopted an amendment to the Purposes and Procedures Manual of the NAIC Securities Valuation Office (SVO P&P Manual) on mandatory convertible securities, which was also discussed at the Fall 2012 meeting. This change was necessary due to a Security Valuation Office amendment that now identifies bonds with a mandatory conversion into common stock with a new subscript – “S.” During the Spring 2013 Meeting, the SAPWG adopted changes to SSAP No. 26, which included updating the pre-conversion valuation method to the lower of amortized cost or fair value and adding a new definition of mandatory convertible securities. The VOS Task Force adopted changes to the SVO P&P Manual to be consistent with the new SSAP No. 26 revisions.

The Task Force exposed a proposal to consider two changes in the assumptions used in the RMBS and CMBS modeling process. The proposal from New York (NY) State Department of Financial Services asks industry to consider:

  1. Using the risk-free curve as the discount rate (instead of each security’s coupon rate) in determining the net present value of expected loss for modeled securities.
  2. Taking into account interest (coupon) shortfall in addition principal loss when calculating the expected loss.

The NY department’s concern is that with the current process of utilizing the net present value of discounting at coupon rate, two securities with the same risk characteristics can result in different NAIC designations and RBC charges. Its position is that getting a lower RBC due to a higher coupon rate is inaccurate. It will be interesting to see how this proposal progresses through industry as the NY proposal will indirectly impact an insurers’ RBC charges, as designations on RMBS/CMBS will likely change. The proposal is exposed for a 30-day comment period ending on May 8, 2013.

In other proceedings, the VOS Task Force received comment letters on the proposed definitions for the NAIC Designations categories for corporate, municipal, and asset-backed securities under the proposed SVO Recalibration Project. As previously discussed in our VOS Fall update, the re-calibration project that was originally presented in September 2011 has started to move forward again. The goal is to further define SVO ratings to get more precise credit quality ratings and would expand the number of NAIC ratings from 6 to 10 for certain subclasses of securities. Comment letters were received by the American Council of Life Insurers and the American Academy of Actuaries. Both comment letters agreed with the scope of the re-calibration project but felt the timing is premature until the Investment Risk-Based Capital Working Group (formerly the C-1 Factor Subgroup) completes their current work. The VOS Task Force intends to meet with the American Academy of Actuaries to better understand the project and discuss ideas to align efforts being performed by the Investment Risk-Based Capital Working Group.

Finally, the VOS Task Force received a letter from Egan-Jones Ratings Company that instructed the SVO staff to begin negotiations to include them as an authorized Credit Rating Provider. Once complete, the SVO P&P Manual will be amended to include Egan-Jones as an authorized rating provider.

The Blanks Working Group (BWG)

Adopted Items

A new category for Working Capital Finance Investments (WCFI) was added to the quarterly and annual statement instructions for the Schedule BA (2012-38BWG). Two lines and corresponding factors were also added to the AVR reports for WCFI. The Blanks working group adopted this change, effective for annual 2013 reporting, in anticipation of the Statutory Accounting Principles Working Group’s (SAPWG) adoption of the associated SSAP for WCFI.

The BWG adopted 2012-35BWG which modifies the instructions and illustration for Note 17C (Wash Sales) to now include other securities besides bonds and preferred stocks, along with unrated securities. This update will be effective for Annual 2013 reports.

A new code “G” was added to the Foreign Code table for U.S. securities issued in Canada that are denominated in U.S. dollars. This was considered an editorial change and therefore was immediately adopted and not exposed for comment. This will be effective immediately for quarterly and annual reporting.

Exposed Items

The Working Group exposed instructions for new disclosures related to Working Capital Finance Investments (2013-13BWG). The new Note 5H(1) will show WCFI amounts by NAIC Designation, divided between admitted and non-admitted amounts, while Note 5H(2) will provide a maturity distribution for WCFI holdings. The last piece of the disclosure discusses any default events. While Note 5H(2) and 5H(3) are required both quarterly and annually, Note 5(H)1 is only required annually, unless there is a material change from the previous year.

Item 2013-01BWG adjusts the instructions for numerous schedules in the annual and quarterly statements to now include information for Preferred Stock Exchange Traded Funds (ETFs). As discussed in a previous post, the Valuation of Securities Task Force previously added a new Preferred Stock ETF list that allows certain ETFs with characteristics of Preferred Stock to be reported on the Schedule D Part 2, Section 1. This update also creates a new Bond Characteristics (column 5) code for mandatory convertible bonds on the Schedule D Part 1.

The instructions and illustrations were modified for Note 21C to reflect corresponding changes to SSAP No. 1Disclosure of Accounting Policies, Risks & Uncertainties, and Other Disclosures, by the SAPWG. This update (2013-16BWG) is directly related to the discussions various NAIC groups have participated in regarding Restricted Assets. There is a current push by regulators to see additional information regarding what assets are pledged as collateral, how much, and the nature of the restrictions.

Other Items

Before closing, the BWG changed the name of the Derivative Investment Reporting Subgroup to the Investment Reporting Subgroup and directed the Subgroup to address changes to all investment schedules. The Investment Reporting Subgroup will specifically coordinate with the Investment Risk-Based Capital Working Group to adjust the blanks and instructions for technical changes.

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Richard has more than 15 years of insurance investment accounting experience. He is an expert in statutory accounting and investment systems and is Clearwater's liaison for the NAIC, NASVA, and the IASA. He has an MBA in finance from the University of Hartford and a bachelor's in accounting from York College of Pennsylvania.