The US insurance regulator, the National Association of Insurance Regulators (NAIC), has issued a request for comment on it risk-based capital (RBC) treatment of asset backed securities (ABS), including collateralized loan obligations (CLOs), collateralized fund obligations (CFOs), and other securities carrying similar types of tail risk.
Specifically, the NAIC wants feedback, by 28 February, on:
- Methodologies for capturing the risk (including tail risk) that exists with such assets
- How a consultant or consulting actuary could be used by the NAIC to determine the appropriate charge based upon certain data.
- The need for review outside of Life RBC (Health, P&C).
- Whether residual tranches in ABS structures can be evaluated in conjunction with and under similar methodologies as the debt tranches.
- Specific proposals for addressing RBC treatment of residual tranches to reduce arbitrage incentives.
A framework under scrutiny
The NAIC's capital rating methodology has come under scrutiny in recent times.
Amnon Levy, who led the Moody's Analytics team that helped redesign regulatory guidelines for insurers' credit-product investments and who has now founded his own firm Bridgeway Analytics, explains that current regulatory tools for understanding insurer credit risks are insufficient.
Currently, the NAIC uses C1 factors – essentially a capital charge applied to the credit holding based on its rating –to assess risk, but that creates an "inherent challenge of designing a framework where you're using something [i.e. ratings] that's not cardinal to define a loss that is cardinal".
The C1 factors do not differentiate across maturity or asset classes - CLOs and municipal bonds of different maturities carrying the same rating would receive the same capital charge under RBC. Yet there are nuances in the risk spectrum within the same rating, Levy argues.
Since 1980, securities rated AAA had six credit defaults within 10 years of achieving the top rating, he says. Three were Icelandic banks and two – Exxon and Mobil – were more technical default in nature.
"So you're assigning a capital charge or loss rate based off [those] six observations, does it really make sense?," he asks. "Does it really make sense to just naively apply the data?"
Similarly the NAIC ratings factors do not take into account asset maturities. Levy argues that companies that issue 30-year credit are different from companies that issue one-year or five-year credit. "But for a rating, an A is an A, and yet it is very different if you hold a 30-year A-rated credit versus a three year A-rated credit."
The NAIC has recognised the need for greater granularity and at the end of last year set up a RBC Investment Risk and Evaluation Working Group, charged to perform a comprehensive review of the RBC investment framework for all business types in 2022.
The regulator has a pretty "aggressive" timeline, Levy says, with a desire to have something rolled out this year. This would mean having modified the statement blanks (the statements insurers file to the regulator on a quarterly basis) by Q2 2022.
Yet Insurance Asset Risk understands the NAIC in conjunction with the American Council of Life Insurers is looking to outsource the work to a third party, and that process alone will take time.
Notwithstanding the need to find a consensus amongst all the different stakeholders and interest groups within the industry.
On one side stand private equity-backed insurance companies have more aggressive investment strategies and are increasingly investing in CLOs and other alternative assets. And on the other side, the more traditional mutuals insurance companies are more conservative even if they still hold CLOs.
"You have these voices. Now the question is, how do you generate consensus?," Levy asks.
People:Amnon Levy