Insurers and other capital markets participants, including sponsors of structured assets, should note an important development from the National Association of Insurance Commissioners (NAIC) that could result in regulatory challenges to ratings assigned by rating agencies to securities held in insurance companies’ portfolios. On Aug. 29, 2024, the NAIC’s Financial Condition (E) Committee voted to adopt new procedures by which the NAIC’s Investment Analysis Office (IAO) can essentially override such a rating for the purpose of denying a security “filing exempt” (FE) status when the IAO concludes that the rating agency rating is an overly optimistic view of the security’s investment risk. (The IAO comprises the Securities Valuation Office (SVO) and the Structured Securities Group (SSG).) This proposal, which takes the form of amendments to the Purposes & Procedures Manual of the NAIC Investment Analysis Office, has drawn controversy from industry and would go into effect Jan. 1, 2026, although this effective date could be amended. The proposal adopted by E Committee is accessible here.

Generally, FE status refers to the assignment of an IAO designation based on mapping an existing rating agency rating to a preassigned IAO designation (e.g., a Fitch rating of A– through AAA automatically maps to an NAIC 1 designation, BBB– through BBB+ maps to NAIC 2, etc.). This FE grant of an NAIC designation is in lieu of requiring a formal submission to the IAO regarding the security. NAIC designations determine how much additional capital insurers have to hold against the applicable security under the NAIC’s risk-based capital (RBC) rules. Under the new proposal, the IAO would be able to rescind the FE status of a security, and require a formal submission regarding such security, even where a rating has been granted by a rating agency, if the IAO concludes that the NAIC designation equivalent “does not provide a reasonable assessment of investment risk for regulatory purposes.”

The proposal adopted by E Committee reflects changes to a prior version of the proposal, discussed here, adopted by the NAIC’s Valuation of Securities Task Force (VOSTF) at the NAIC’s Summer National Meeting in mid-August. The changes between the VOSTF-approved version and the new E Committee version, as outlined by the NAIC in an accompanying memorandum, include the following:

• Clarification that the process will be consistently applied to all rating providers.
• The term “authorized insurers” is defined as “holders of the affected securities that agree to the confidentiality provisions required by the NAIC.”
• Clarification that the IAO will provide a written summary of its analysis and its view of why it believes the rating agency’s risk assessment is an “unreasonable assessment of investment risk.”
• Including other “authorized parties that have agreed to the confidentiality provisions required by the NAIC” to discuss the security with the IAO.
• The IAO shall communicate in writing its opinion of the appropriate NAIC designation category.
• The annual summary will be anonymized and will not disclose information on specific securities, rating providers or impacted insurers.
• The IAO will publish, within 45 days of a security’s being removed from the FE process, an anonymized summary (without references specific to the security or rating provider, to avoid disclosing confidential information).
• Impact to issuers that have multiple securities within the same debt class. The proposal specifies that if an issuer has multiple securities within the same debt class (i.e., position in the capital stack) whose ratings are placed under review, for purposes of the review process, insurers must only provide requested information materials once. After a final determination is made regarding the ratings for the affected securities, should the IAO’s proposed IAO designation category prevail, insurers would then need to file all securities/identifiers individually to receive an IAO-assigned NAIC designation upon NAIC designation renewal.