The NAIC Valuation of Securities (E) Task Force held a telephonic meeting on May 14, 2020, and adopted amendments to the NAIC Purposes and Procedures Manual that will significantly change the way insurers treat investments in "principal protected securities" ("PPS") for risk-based capital ("RBC") purposes.

The PPS definition is designed to capture notes with underlying components where the noteholder obtains a more favorable RBC treatment based on the NRSRO rating assigned to the note than if it held the underlying components directly. The notes must also satisfy other criteria to be considered PPS investments. When the new provisions become effective, securities meeting the PPS definition will need to be filed with the NAIC Securities Valuation Office ("SVO") for analysis in order to receive an NAIC designation, instead of being "filing exempt" (i.e., automatically assigned the NAIC designation equivalent to the NRSRO rating on the security). As the examples show, the SVO-assigned designations will generally be significantly lower than the NRSRO equivalents.

The Task Force softened the impact a bit by establishing a long transition period: the new regime will become effective in 2021 for the December 31, 2021 statutory financial statements. Any PPS investment acquired on January 1, 2021 or later will need to be filed with the SVO within 120 days after acquisition (this is the standard filing schedule for securities that are not filing exempt). Any PPS investment owned prior to January 1, 2021 will need to be filed with the SVO by July 1, 2021.

The NAIC Statutory Accounting Principles (E) Working Group has a parallel initiative underway to amend Statement of Statutory Accounting Principles No. 43R – Loan-Backed and Structured Securities to exclude certain types of CFOs that are deemed not to have debt-like cash flows. That initiative is on a much longer timeline. At its March 18, 2020 telephonic meeting, the SAP working group exposed a preliminary (and partial) draft of an issue paper. The original deadline for comments was June 26, 2020, but it has since been extended to July 31, 2020. The intent is for the working group to discuss the comments, and perhaps a revised draft of the issue paper, at the NAIC National Meeting scheduled for August 8-11, 2020 in Minneapolis (or the virtual equivalent thereof if travel is still not practicable). Any changes to SSAP No. 43R would only be considered after the issue paper is adopted. Given that the draft issue paper is still preliminary and incomplete, it is unlikely that any changes to SSAP No. 43R could be put in place before 2020 year-end.

Another initiative of the Valuation of Securities (E) Task Force that was discussed was an issue paper of the NAIC Investment Analysis Office (of which the SVO is a subdivision). The issue paper identifies six "red flags" for "bespoke securities" that would become a new analytical category midway between "filing exempt" and "subject to filing." For "bespoke" securities, the SVO would review the underlying legal agreements and make a decision on whether the rating agency's rating is acceptable for determining the NAIC designation or whether the security needs to be filed for an SVO-determined designation. The Task Force voted to expose the issue paper for a 90-day comment period.

Mayer Brown's insurance team discussed the NAIC's development on a webinar, a recording of which can be found here. Read more about this topic in our May 28, 2020 Legal Update.

Originally published May 28, 2020.

Originally published in REVERSEinquiries: Volume 3, Issue 5.
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