Life Perspectives, Summer 2023

Highlights From Life Perspectives

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Q&A – Up Close with CLOs

SmithThe C1 Work Group of the Life Capital Adequacy Committee has been working toward a rigorous approach for setting C-1 for collateralized loan obligations (CLOs), including for CLO residual tranches. The work group sent a letter to the NAIC’s Risk-Based Capital Investment Risk and Evaluation (E) Working Group (RBCIRE) in May outlining its basic approaches to the issue, citing its CLO presentation to the working group during NAIC’s Fall National Meeting in December.

Life Perspectives did a Q&A with C1 Work Group Chairperson Stephen Smith about some of the key issues around CLOs.

Why is the CLO issue important for policymakers?

The purpose of risk-based capital (RBC) is to help regulators identify weakly capitalized companies. Two recent developments have raised the salience of C-1 factors for CLOs, causing regulators to question whether the current C-1 framework is sufficient for identifying weakly capitalized companies:

1. CLO allocations have increased in recent years, from 1.9% of total U.S. life insurance general account assets in 2017 to 3.9% in 2022. And the average credit rating of life insurers’ CLO holdings has decreased over this period.
2. A small number of life insurers hold very large CLO allocations, including to mezzanine tranches.

In our December presentation to RBCIRE, we explained that CLOs use the corporate bond C-1 factors. These factors were calibrated to corporate bond risk and are likely not appropriate for CLOs. Mezzanine and residual CLO tranches have higher loss-given-default than corporate bonds, causing a more positive skew in their loss distribution. As the materiality of this issue has increased over time, regulators’ focus has increased accordingly.

What are the consequences of potential outcomes on this issue?

While RBC is only intended as a tool to help regulators identify weakly capitalized companies, in practice changes to C-1 factors may lead to changes in life insurers’ investment portfolios. The immediate effect of higher C-1 factors on residual and mezzanine tranches of CLOs would likely be a reduction in life insurers’ holdings of these assets.

While the AAA tranche is the largest CLO allocation for life insurers, the proportion of life insurance holdings to total outstanding issuance is highest in the A and BBB tranches. Any significant changes to life insurers’ purchases in the A and BBB tranches may have broader effects on the CLO market.

What if any are the trade-offs between different outcomes?

Two issues are at play here—the level of C-1 factors and the system for assigning C-1 factors.

The trade-offs involved with the level of C-1 factors are straightforward. Higher factors would likely lead to reduced CLO allocations and thus reduced risk from CLOs in life insurers’ portfolios. But the returns generated by CLOs have supported product pricing in recent years, with value being passed on to some combination of policyholders and company owners—a reduction in CLO allocations also reduces this value.

The current system for C-1 factors is simple in its implementation—an NAIC designation can be assigned through the filing-exempt process (using the rating assigned by a rating agency) and the CLO is then assigned the same C-1 factor that a corporate bond of the same rating would draw. The Valuation of Securities Task Force is considering a more complex system for assigning an NAIC designation, where each security would be individually modeled as is currently done for RMBS and CMBS. This process would aim to assess risk more precisely for each security, but at the expense of a more complex implementation.

Does the work group have upcoming presentations planned at the NAIC Summer National Meeting in August, or elsewhere?

At the NAIC Summer National Meeting in August, we plan to present again to the RBCIRE. NAIC staff introduced the concept of “RBC arbitrage” to this discussion last year, which has become a key focus for regulators and interested parties when discussing C-1 factors for CLOs. Our August presentation this year will dig deeper into this concept, aiming to generate discussion among regulators about what should be meant by “RBC arbitrage.”

What other projects are in the pipeline for the C1 Work Group?

CLOs are part of the broader Phase II of the bond project. When bond factors were updated in 2021, there was an expectation of tackling structured securities next in Phase II. While every type of structured security has its own peculiar characteristics, we are working on CLOs within the context of looking for a framework that can be applied across structured securities.

Life Webinar Examines Assets

An April 4 life webinar, “Assets: Regulatory Updates in Life Insurance,” focused on asset risks and how regulators are responding to them.

Speakers were Philip Barlow, associate commissioner with the District of Columbia’s Department of Insurance, Securities & Banking, and chair of NAIC’s Risk-Based Capital Investment Risk and Evaluation (E) Working Group; Carrie Mears, chief investment specialist with the Iowa Insurance Division and chair, NAIC’s Valuation of Securities (E) Task Force; and Dale Bruggeman, chief of risk assessment policy and development, foreign analysis, and administration with the Ohio Department of Insurance and chair of NAIC’s Statutory Accounting Principles (E) Working Group. Academy Senior Life Fellow Nancy Bennett moderated.

They addressed regulatory concerns; statutory accounting; reporting; designation of assets based on risk, with updates on activities from the NAIC’s Valuation of Securities (E) Task Force and Statutory Accounting Principles (E) Working Group; and capital requirements, with updates on activities from NAIC’s Risk-Based Capital Investment Risk and Evaluation Working Group.

Slides and an on-demand recording are available free as a member benefit.

White Paper Looks at LDTI

The Life Financial Reporting Committee released a white paper, FASB Long-Duration Targeted Improvements—A Discussion of Enhanced Disclosures, which focuses on certain considerations in implementing FASB’s required enhanced disclosures around LDTI.

Much of the paper is presented in a Q&A format. It concludes that for many actuaries, enhanced disclosures will require more data and model analyses than pre-LDTI generally accepted accounting principles (GAAP) reporting as well as the addition of new judgment areas.

New “roll-forwards” will necessitate numerous successive valuation runs (layered step-by-step) to quantify each movement’s impact on the reserve balance to satisfy LDTI requirements and intent. These enhanced disclosures will require quantifications and qualitative narratives covering new prospective actuarial assumptions and judgments as well as explanations of adverse developments relative to the prior period’s actuarial assumptions.

Life Groups Release Papers

• The Life Experience Committee released Actuarial Review of Investments in Actuarial Modeling—A Resource & Discussion Guide, which aims to provide an overview of assets in actuarial modeling, relevant resources to further explore, and a number of considerations that may be relevant when modeling assets in relation to the underlying liabilities being projected.
• The Tax Work Group released a white paper, 2017 and 2021 Legislative Changes to the Definition of Life Insurance, that focuses on summarizing changes to the relevant sections of sections 7702 and 7702A of the Internal Revenue Code.

Academy Presents on Life Issues at NAIC Spring National Meeting

Slutsker (left) and Barry-Moilanen present to LATF

Life Practice Council (LPC) volunteers presented at the NAIC’s Spring National Meeting in Louisville, Ky., in March.

Academy Life Vice President Ben Slutsker and Life Policy Analyst Amanda Barry-Moilanen presented to NAIC’s Life Actuarial (A) Task Force (LATF) on current and future workstreams.

Professionalism presentations included virtual updates to LATF by representatives of the Actuarial Standards Board (ASB) and Actuarial Board for Counseling and Discipline (ABCD).

Academy Past President and ABCD member Shawna Ackerman presented on the ABCD’s 2022 Annual Report. ASB Chairperson Rob Damler focused on Actuarial Standard of Practice (ASOP) Nos. 12 and 41, and offered information on life- and health-specific ASOP Nos. 10, 28, and 57.

Life volunteers, and Senior Life Fellow Nancy Bennett, presented to NAIC working groups on a number of issues, discussing matters of importance to the public and to the U.S. actuarial profession.

ASB Approves ASOP No. 40 Revision Exposure Draft

The Actuarial Standards Board (ASB) approved an exposure draft of a proposed revision of Actuarial Standard of Practice (ASOP) No. 40, now titled Compliance with the NAIC Valuation of Life Insurance Policies Model Regulation with Respect to X Factors. The comment deadline is Sept. 15. Details and information on how to submit comments are in the exposure draft.

Life Public Policy in Brief

Life Practice Council committees and work groups commented to LATF and other NAIC groups.

• The Life Reserves Work Group submitted a comment letter to LATF on the extended April 20 exposure of APF 2023-06 and on proposed changes to VM-20 outlined in APF 2023-03 (Part 1).
• The Life Valuation Committee submitted a comment letter to the LATF on the Optional AOM and PBR Actuarial Reporting Template for Interest Maintenance Reserve.
• The Life Valuation Committee submitted a comment letter to the NAIC’s Statutory Accounting Principles Working Group on 2023 Net Negative (Disallowed) Interest Maintenance Reserve (INT 23-01T).
• The Variable Annuity Reserves and Capital Work Group submitted a comment letter to LATF on APF 2023-05; specifically, hedging language to address index credit hedging in VM-21.
• The Life Valuation Committee submitted a comment letter to LATF on the Valuation of Securities Task Force’s referral to LATF on Bond Risk Measures.
• The C1 Work Group submitted a comment letter to NAIC’s Risk-Based Capital Investment Risk and Evaluation (E) Working Group on Exposure 2023-09-IRE—Interim Residual Tranche C1 Factor.
• The Index-Linked Variable Annuity Work Group submitted a comment letter to the ILVA Subgroup of the Product Standard Committee of the Interstate Insurance Product Regulation Commission on 2023 Compact Requirements for Index-Linked Variable Annuity Products.