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The National Association of Insurance Commissioners (NAIC) recently held its Summer National Meeting and provided updates regarding proposals related to insurance company investments.
The National Association of Insurance Commissioners (NAIC) recently held its Summer National Meeting and provided updates regarding proposals related to insurance company investments. Two areas we highlight that are of high importance to insurers are:
The new proposals are currently taking public comments until October 7, 2022. If the proposals are approved, the likely effective date of the new rules is January 1, 2025.
These changes will have material impact on U.S. insurers, by requiring additional filing information on existing holdings and potentially moving assets that now qualify as bonds to a different reporting schedule with more punitive capital treatment.
What is changing?
1. The NAIC is making structural changes to insurance investment reporting, by separating bonds into two separate schedules (currently all bonds are located on the same schedule):
a) Schedule D – Part 1-1
b) Schedule D – Part 1-2
2. The NAIC is updating the definition of bond to be principle based:
“A bond shall be defined as any security representing a creditor relationship, whereby there is a fixed schedule for one or more future payments, and which qualifies as either an issuer credit obligation or an asset backed security.”
3. In the proposal, regulators remove the restriction on stapled structures. If an insurer holds the entire capital stack of a securitization, the guidance amendment would allow the debt portion(s) to be a Schedule D bond, while the equity tranche would be a Schedule BA asset, unlike current standards which largely forces staple structures to entirely Schedule BA.
Insurance companies are responsible for interpreting the proposed bond definition guidance and for self-reporting financial instruments on the appropriate schedules. There will be no further guidance or evaluation of whether an investment is qualified as a bond from NAIC. However, if a financial instrument is reported inaccurately, the company might receive additional scrutiny from auditors or other external stakeholders.
Currently, the NAIC is not making further changes to the Risk Based Capital framework. If a bond is recategorized to a Schedule BA asset, it will receive the capital charge of Schedule BA assets.
Why make these updates?
The current reporting structure has a limited scope for the definition of a bond and does not provide granularity on what could qualify. The NAIC intended to develop a more robust illustration of proposed reporting structures on Schedule D, helping to define what qualifies to ensure the more aggressive structuring of equity into debt-like structures no longer endangers policyholders.
What does this mean for investment strategies?
The proposed changes should have minor practical impact on most insurers. Most insurance companies’ financial instruments reported on Schedule D will still fall within the scope of the proposed bond definition. However, the proposal will have a profound impact on certain investment managers/funds that will no longer qualify for Schedule D treatment, increasing the capital charge from roughly 1.0% to 30.0%.
Going forward, it will be paramount for insurers and their asset managers to vet current and future holdings, ensuring there are no surprise capital implications as additional regulatory updates are published.
The information in this paper is not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information contained in this paper.
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