In its final meeting before the end-of-June cutoff to make changes for insurers' 2024 risk-based capital (RBC) calculations, the insurance standard setter's working group opted to retain a higher level of risk-based capital for the portion of securitizations absorbing first losses. The decision could impact insurers' decisions whether to make or retain those investments.
The Risk-Based Capital Investment Risk and Evaluation Working Group (the working group) of the National Association of Insurance Commissioners (NAIC) decided June 21 to keep in place for 2024 a new risk-based capital requirement of 45% on asset-backed securities' (ABS) residual interests, or equity. Those unrated portions receive cash flow only after other tranches are paid principal and interest.
The decision implements an interim solution while the working group develops longer-term RBC requirements for ABS. If the NAIC completes that solution by June 30, 2025, insurers could be subject to the 45% requirement for only 2024, said Larry Hamilton, head of Mayer Brown's U.S. insurance regulatory practice, although whether the standard setter decides to retain that level or opt for a more nuanced approach as part of its long-term solution remains to be seen.
The working group initially voted to implement the 45% this year at its June 2023 meeting, up from 30% last year. Starting in Q1 2024, however, various industry groups sought to convince the working group to reconsider its position. In its March 17 meeting, the working group discussed analysis by Oliver Wyman that concluded the 45% RBC "does not reflect the actual risk when compared to the capital charges and losses of other assets." That includes corporate bonds and commercial real estate.
The American Council of Life Insurers and other parties later submitted additional quantitative data, and at the April 12 meeting insurance-industry representatives requested a one-year delay to implement the 45% charge, to allow further study. That request was denied, but the working group said it would consider the delay if proponents could present a detailed plan for the additional analysis and execute it.
At the working group's May 22 meeting, Everlake Life Insurance Company proposed a bifurcated approach, in which residential interests in asset classes–including middle-market CLOs, CMBS and RMBS–would return to a 30% RBC level. Other industry members supported similar changes.
The June 21 meeting was the "last call" for efforts to revise the RBC charges for 2024, prior to the June 30 deadline to set RBC calculations for the year. Hamilton said many speakers urged a return to 30% RBC or a bifurcated approach, and some who advocated the 45% factor across the board. He noted that several working group members favored the bifurcated approach, including the Iowa Insurance Division, which had circulated an earlier memo assessing ways to handle bifurcation.
The majority of the working group, Hamilton said, was unconvinced, either because they foresaw excessive tail risk, or they wanted more time to digest the alternative proposals.
One speaker representing MetLife and The Equitable argued for retaining the higher RBC level across the board. Hamilton said one of the regulators praised the analyses that largely supported a more nuanced approach, including one provided by the Iowa Insurance Division, but he noted there simply wasn't adequate time to digest them.
"Had the information arrived six months earlier, it might have been successful," Hamilton said.
The project has split the insurers, which usually speak with one voice on issues affecting the industry. Private equity-controlled insurers tend to invest in ABS residuals and low-rated tranches more so than large mutual or traditional stock insurers, which typically stick to higher rated tranches. The working group's decision to maintain the 45% RBC for all residuals in 2024 could weigh on insurers' decisions whether to invest in residuals and could potentially induce them to sell residuals on their books before year-end RBC calculations.
Research published May 23 by Citi estimates that U.S. insurers hold roughly $250 billion CLOs at the end of 2022, a 15% increase from the year before, and 92% were investment grade. A survey of 19 insurers by the American Council of Life Insurers found that their biggest residual holdings are private-credit CLO equity, which at $2.3 billion is 36% of their total residuals.
Going forward, Hamilton said, the working group will continue to hammer out the long-term RBC solution for all ABS, focusing first on CLOs. It is expected to receive a report on that project from the American Academy of Actuaries when it meets August 14 at the NAIC Summer National Meeting & Conference.
