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MARKET INSIGHTS

Update: NAIC Modified Filing Exempt Process

Update: NAIC Modified Filing Exempt Process

MARKET INSIGHTS

Last spring, the NAIC eliminated the Modified Filing Exempt process for non-modeled structured securities, simplifying the accounting and reporting for these investments back to the way it was done before the financial crisis. This primarily affected non-mortgage backed securities, such as those backed by consumer debt, CDOs, and corporate debt.

This year, we expect a similar change to be passed for modeled residential mortgage-backed (RMBS) and commercial mortgage-backed (CMBS) securities (SAPWG Ref # 2019-41) which will effectively roll back a major part of the changes introduced by the passing of SSAP 43R at the beginning of the last decade.

These changes are necessary, partly due to the expansion of the designation framework from 6 to 20 NAIC designations that will begin to take effect at the end of this year (i.e., the blanks update, not the actual impact to RBC and AVR.) Implementing a system of 19 price breakpoints for each modeled security seems unnecessarily complex and would require a lot of work for a marginal benefit.

The benefits of these two changes are numerous. Although the sticker price for modeled data is not large, this is a cost insurers will no longer have to pay; regulators will benefit from increased comparability as one security will have one designation regardless of its carrying value or type of insurer; auditors who test designations will spend less time walking through the process one by one for 43R securities; and the question of how to report a security with multiple lots with different designations is now a moot point.

This has the potential to either improve or worsen the designation quality, carrying value, and RBC for any individual security and affect the RBC of the portfolio as a whole if a reporting entity holds a significant amount of these assets.

So — how should an entity make sure they are prepared for this change?

Preparing for Upcoming Changes

Of the approximately $400 billion in modeled securities on the Clearwater system, approximately 46% of the face value is on zero-loss securities that automatically receive 1FM designations; the market value is similar. Roughly half of those zero-loss securities have credit rating equivalents of lower than A-, which means the designation the insurer will report will fall. In general, life insurers hold more non-zero loss MBS (and the zero-loss they do hold are more likely to have a lower designation).

While analysis for the non-zero loss population is less straightforward, the majority of this population is rated below investment grade by the rating agencies, meaning that insurers won’t be able to receive a 1 or 2 designation on these. We expect the average insurer will see a decline in designation quality allowed on their non-zero loss modeled securities as well.

Given these facts, insurers that are concerned about their asset RBC should be aware of these changes and the impact it will have on their portfolio to ensure they are not surprised by an unfavorable swing in their RBC charges at the end of the year.

My colleagues and I continue to monitor these changes closely to ensure Clearwater clients are prepared, and our technology is updated ahead of time.

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