North America Insurance Regulatory Update — NAIC Proposal Could Increase RBC Requirements by 2026

On May 1, the NAIC heard a proposal to decrease the RBC covariance benefit for equity investments. The correlation assumption between equity and credit risk would increase from 0% to 50%. According to this report from the American Academy of Actuaries, a typical life insurer today faces an after-tax equity (C-1cs) RBC requirement of 13.3%. Under the proposal, this would increase to 19.7%.

 

The actual impact will vary by company, as it depends on each company’s mix of equity risk vs. credit risk under the RBC formula. The proposal includes other changes, some of which result in an offsetting improvement to companies’ RBC ratio. The net effect for a typical company is an increase to total RBC requirements of 1.6%. For an insurer targeting a 400% RBC ratio, this is approximately equal to a 6 percentage point reduction to the RBC ratio.

 

The Academy report was not formally exposed, making 2026 the earliest possible time for adoption. If adopted, this will increase capital requirements for investments that have grown in recent years including private equity and rated note feeder funds. We will continue to follow this proposal through the NAIC process and provide updates.

Regulatory Update February 2025

The NAIC announced a new commissioner-level task force on Risk-Based Capital (RBC) model governance. It will develop RBC principles and will educate international stakeholders on RBC.

 

The development of RBC principles will be a crucial step towards resolving ongoing and future debates. De facto principles have emerged over the years but are incomplete and have never been codified. The most directly impactful principle involves potentially updating statistical safety levels, which would require recalibration of capital charges. This task force won’t change any capital charges, but it may direct the Capital Adequacy Task Force to do so. Therefore, I don’t expect any RBC changes to result from this task force’s work for at least 3 years.

 

The international trend has been for countries to imitate Solvency II, not RBC, when updating capital standards. These differences in capital standards have implications for cross-border reinsurance transactions. US insurers will benefit from their international regulators better understanding RBC. A brief list of RBC myths that I hope the task force can dispel includes:

 

• RBC is factor based, which is inferior to a scenario-based approach under Solvency II
• RBC factors are not based in sophisticated modeling
• Market-consistent frameworks such as Solvency II are inherently more useful for regulators than RBC, which is based on statutory accounting
   

 

Stephen Smith, CFA, FSA 

Managing Director, Head of Insurance Analytics & Institutional Solutions

Conclusion of UK Solvency II Review - PS15/24: Restatement of assimilated law - Nov 2024

PRA has released PS15/24, the final policy statement to wrap up the Solvency II Review in the UK. This policy statement restates relevant EU Solvency II rules (“the assimilated law”) into PRA policy material without making significant changes to the policy substance. Major reforms to Solvency II including use of the Matching Adjustment have already been stated in prior PRA policy statements, which will also take effect on 31 December 2024 (PS2/24,  PS3/24, and PS10/24)

 

Key restatements:

1. PRA restates the risk margin formula and parameters in line with that outlined in HMG’s legislation. The new formula decreases the cost of capital rate from 6% to 4% and introduces risk tapering factors. This change will lead to a significant capital release, reducing the risk margin by 65% for long-term life insurance and by 30% for general insurance.
2. PRA restates SCR standard formulas with minor clarificatory changes. Several Standard Formula articles in the CDR contain amounts denominated in euros (EUR). The PRA proposes converting all EUR-denominated amounts in the CDR articles to GBP, using the same conversion rate applied in PS2/24 for a similar purpose.

 

Key changes from consultation paper CP5/24 to policy statement PS15/24:

1. A transitional rule has been established, allowing firms to delay obtaining approval from the PRA for including future taxable profits (FTP) in their Loss Absorbing Capacity of Deferred Taxes (LACDT) calculations until December 30, 2025.
2. Amendments have been made to the proposed 'ring-fenced fund' (RFF) definition, which preserves the link to 'restricted own funds' and explicitly excludes matching adjustment portfolios (MAPs) from this definition.
    

North America Insurance Regulatory Update — SVO Authority to Challenge Ratings - Sept 2024

A long-debated proposal allowing the SVO to challenge ratings was finally adopted by the NAIC’s E Committee on August 29. Comments from the SVO indicate that bonds with the following attributes are less likely to be challenged:

• Multiple ratings
• Ratings from larger rating agencies (SVO has distinguished between large and small rating agencies)
• Public ratings

Despite the above, the SVO retains the authority to challenge any rating. The SVO has indicated that challenges will be rare and will only apply to cases where the SVO disagrees with a rating by at least three notches. This goes live in 2026.

North America Insurance Regulatory Update — Principles-Based Bond Definition - Sept 2024

In our November regulatory update email, we detailed how typical rated note feeder funds are likely to qualify as bonds when evaluated as ABS. We further outlined how CFOs may also qualify. We believe this analysis stands—the update below confirms that the ABS framework we applied is the appropriate framework.

In language exposed for public comment, SAPWG clarifies that rated note feeder funds and CFOs must be evaluated as ABS (instead of Issuer Credit Obligations (“ICO”), e.g. corporate bonds) for purposes of determining whether they qualify as bonds. This matters for two reasons:

• Qualification as an ABS requires a thorough evaluation of the security, creating more work and a potential for some to fail to qualify as bonds
• Because the debt tranches are considered ABS, the residual tranche will be reported as such and draw a higher capital charge for life insurers

A key sign that a security is an ABS instead of an ICO is if the cash flows produced by the collateral are contractually required to follow a waterfall to one or multiple debt tranches. Alternatively, a structure where the equity tranche retains discretion over when to pay down the debt may potentially qualify as an ICO.

North America Insurance Regulatory Update — Principles-Based Bond Definition - Nov 2023

The Blanks Working Group of the NAIC adopted a proposal for more granularity on Schedule D, dividing asset-backed securities (ABS) from issuer credit obligations (ICO). This move is part of the larger bond project and follows the adoption of the principles-based bond definition in August. The updated bond definition and corresponding blanks structures are both effective January 2025. But, importantly, the rules are finalized. It will be important for insurers to analyze any new structure for compliance with the new bond definition. For further detail on what’s required for rated feeder funds and CLOs to qualify as bonds, please reach out to your local NB Insurance Solutions contact.

Brief Summary of the Principles-Based Bond Definition: To be classified as a bond, an investment must be either an ICO or an ABS. ICOs include Treasuries, corporate bonds, municipal bonds, etc., while ABSs include structured credit.

S&P Insurance Regulatory Update - Nov 2023

After an almost two-year development, S&P is finally implementing its updated capital model to rate insurance companies. This final version maintains most of the changes shared at the end of 2021, while removing the most controversial aspects of the original proposal. Overall, the quantum of change versus the current capital model remains significant, as S&P has entirely overhauled both the method and assumptions underpinning the quantitative aspect of ratings. On the investment front, one significant innovation is the differentiation of credit risk charges based on the seniority/nature of the obligation and a recalibration that results in lower charges for senior secured debts and the sub-investment-grade universe compared to the previous model.

APAC Insurance Regulatory Update - Sept 2023

To better reflect the risk embedded in their balance sheet and enhance policyholder protection, regions across Asia are examining and updating the insurance solvency regimes. The underlying philosophy tends to share similarities of regulations in Europe Solvency II. In addition, increasing consideration is being given to consistency with the new International Reporting Standard 17 (IFRS 17) and International Capital Standards (ICS). The framework details and implementation pace of the new capital regimes differ among countries. In China the CBIRC unveiled the new rules of C-ROSS Phase II on 30 December 2021. In January 2023 South Korea has implemented K-ICS, an economic value-based capital framework similar to ICS. The new rules are effective in 2024 for Hong Kong, in 2025 for Japan and in 2026 for Taiwan. Most of the solvency regimes have moved to an economic balance sheet framework, with an objective to assess assets and liabilities on a fair-value basis, which highlights the importance of better asset liability management and duration matching. Matching adjustments are adopted by some regimes such as HK RBC and Singapore RBC2, which aims to reduce the impact from short-term fluctuation in asset values and enhance asset liability cash flows matching. Neuberger Berman has worked with insurers across different Asia regions for more effective asset liability management under the new rules and portfolio optimization under the matching adjustments.

North America Insurance Regulatory Update — Residual Tranches - June 2023

On today’s RBCIRE call (June 14, 2023), the C-1 factor and RBC sensitivity test for residual tranches were updated. 2023 C-1 factor will remain at 30%, and there will be a 15% sensitivity test. 2024 C-1 factor will increase to 45% and the sensitivity test will be removed.

The 2023 sensitivity test will allow regulators to assess the impact of a 45% factor (30% base factor + 15% sensitivity test = 45%) before it is imposed next year. The sensitivity test is a what-if scenario, not an actual RBC requirement.

The change applies to all residual tranches that are recorded in Schedule BA. There is a parallel project ongoing at SAPWG to update the definition of residual tranches—this new 45% factor in 2024 will apply to anything captured by this updated residual tranche definition.

Regulators on RBCIRE expressed that before the 45% factor comes into effect in 2024, they would like to revisit the issue and consider additional information. But in the absence of additional information, the default result would be for a 45% factor beginning in 2024.

North America Insurance Regulatory Update — Residual Tranches - April 2023

On the NAIC’s RBC Investment Risk and Evaluation Work Group conference call Thursday, a specific C1 factor for residual tranches was formally exposed for the first time—45% pre-tax. Adoption of a structural change to RBC that allows for a separate residual tranche C1 factor was on the agenda and passed unanimously, but at the end of the call during the “any other matters” section the specific 45% factor was proposed for an exposure.

Debate amongst regulators ensued, mostly around whether to expose a specific number or a range. 30–45% was mentioned as a range. A regulator expressed concern that 45% may lead to insurers effectively being required to hold more than a dollar of capital per dollar of residual tranche investment if they are targeting a high enough RBC ratio. While regulators focused on ranges capped at 45%, the industry letter where the 45% factor was first seen had recommended a factor of “at least” 45%. The 45% number is still up for debate—the reason given for exposing this particular number is that it’s a number that interested parties are already familiar with due to the industry letter.

In summary: 45% pre-tax residual tranche factor exposed; This would be an interim factor that applies to all residual tranches identified on Schedule BA regardless of underlying collateral, LTV, or other characteristics of the securitization (CLO residual tranches are likely to be the first to get a new factor distinct from this interim factor); Comment period is 21 days (through May 12, 2023).