valuation of securities (e) task force...process, rmbs/cmbs modeled securities process, u.s....
TRANSCRIPT
© 2018 National Association of Insurance Commissioners 1
Date: 8/16/18
Conference Call
VALUATION OF SECURITIES (E) TASK FORCE Tuesday, September 4, 2018
12:30 – 1:30 p.m.
ROLL CALL
Jennifer Hammer, Chair Illinois Gary Anderson Massachusetts
James J. Donelon, Vice Chair Louisiana Bruce R. Ramge Nebraska
Lori K. Wing-Heier Alaska Barbara D. Richardson Nevada
Dave Jones California Marlene Caride New Jersey
Katharine L. Wade Connecticut Maria T. Vullo New York
Trinidad Navarro Delaware John D. Doak Oklahoma
David Altmaier Florida Jessica Altman Pennsylvania
Gordon I. Ito Hawaii Kent Sullivan Texas
Dean L. Cameron Idaho Todd E. Kiser Utah
Doug Ommen Iowa Scott A. White Virginia
Ken Selzer Kansas Mike Kreidler Washington
Al Redmer Jr. Maryland Ted Nickel Wisconsin
NAIC Support Staff: Charles A. Therriault/Robert Carcano
AGENDA
1. Consider Adoption of a Proposed Amendment to the Purposes and Procedures of the NAIC
Investment Analysis Office (P&P Manual) to Delete Valuation Rules and Methodology—Kevin
Fry (IL) and Robert Carcano (NAIC)
Attachments A
& A-1
2. Consider Adoption of a Proposed P&P Manual Amendment to Modify Securities Valuation
Office (SVO) Compilation Instructions—Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment B
3. Receive and Release a Proposed P&P Manual Amendment to Transfer the Description of
Financial Modeling used by the Structured Securities Group (SSG) to its Website—Kevin Fry
(IL) and Robert Carcano (NAIC)
Attachment C
4. Receive and Release a Proposed P&P Manual Amendment to Add Administration of Filing
Exemption to the Description of On-Going SVO Missions—Kevin Fry (IL) and Robert Carcano
(NAIC)
Attachment D
5. Receive and Release a Proposed P&P Manual Amendment to Modify the Administrative Symbol
NR—Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment E
6. Receive and Release a Proposed P&P Manual Amendment to Delete Old Filing Instructions—
Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment F
7. Receive and Release a Proposed P&P Manual Amendment to Modify the Current Definition of
Notching—Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment G
8. Receive and Release a Proposed P&P Manual Amendment to Improve and Expand Disclosure
on Transactions Not Eligible for Filing Exemption—Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment H
9. Receive and Release a Proposed P&P Manual Amendment to Modernize Credit Substitution
Methodology—Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment I
© 2016 National Association of Insurance Commissioners 2
10. Receive and Release a Proposed P&P Manual Amendment to Delete the Securities Under
Regulatory Review Procedure—Kevin Fry (IL) and Robert Carcano (NAIC)
Attachment J
11. Discuss Any Other Matters Brought Before the Task Force—Kevin Fry (IL)
12. Adjournment
G:\DATA\Vos-tf\Meetings\2018\September\Task Force 2 Sep 2018 Conf Call Agenda.docx
Attachment A
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MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
CC: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group
DATE: March 28, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) – Delete Valuation Instructions (Part Five, Section 1)
1. Introduction – The SVO recommends that the valuation instructions in Part Five, Section 1 of the P&P Manual
(Pricing of Unaffiliated Investments) and related guidance be deleted. The recommendation reflects that as a practical matter,
changes adopted by the Task Force in 2008 and changes to statutory accounting guidance adopted in 2010 have eliminated
the need for an SVO valuation function.
2. Background – Prior to 2008, the SVO was the sole source for valuation of insurer-owned investments. The SVO
obtained valuation information on public transactions from third parties’ vendors, and insurers filed for valuations for all
other securities that the SVO provided. In 2008, the Task Force amended the valuation rules to permit insurers to obtain and
report valuation from specified valuation sources. Although the SVO is an identified source for valuations in the instruction,
insurance companies do not appear to actively request SVO valuations. This may reflect the adoption by the Statutory
Accounting Principles (E) Working Group of Statement of Statutory Accounting Principles (SSAP) No. 100—Fair Value,
effective Dec. 21, 2010. SSAP No. 100 established a framework for determining fair value. Private securities, which the SVO
used to value, fit the guidance for Level 3 inputs in SSAP No. 100. A review of filing data suggests that in 2017, the SVO
assigned values to approximately 2,200 securities as part of its compilation function—not in response to insurance company
requests for valuations. Because valuation related workflow is nonexistent, the SVO cannot maintain professional valuation
staff or justify expending resources to modernize valuation methodology. This recommendation also proposes text to clarify
that the value assigned by the SVO under the compilation procedure is subject to limitations related the issues discussed
above.
3. Proposed Amendments
a. Text Proposed for Deletion – Please refer to the Appendix to this memorandum for the text that would be deleted
from the P&P Manual and for text to be added to the compilation function to address SVO processes related to the
compilation instructions to ensure the SVO List of Investment Securities is populated with pricing information. This
proposed amendment does not address required reporting instructions to eliminate the SVO as a valuation source and provide
appropriate instructions to insurers.
b. Proposed Clarification –
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Part One - Purposes, General Policies and Instructions to the SVO
Section 3. Internal Administration
k) Compilation and Publication of the SVO List of Securities
On a quarterly basis, the SVO shall:
1) Compile, or cause to be compiled, a list of Investment Securities from each of the VOS Process, Filing Exempt Securities Process, RMBS/CMBS Modeled Securities Process, U.S. Treasury Process and the Exempt U.S. Government Securities Process (each an SVO Sub-List bearing the name of the corresponding Process).
2) Exercise best efforts to identify any security in the VOS Process that has been filed by an insurance company without a valuation and to attempt to assign that security a valuation. The SVO may use whatever methodology may seem reasonable to it and may choose not to assign a valuation if doing so would be unreasonable. The VOS/TF considers that an imprecise valuation is of greater utility to the regulatory community than no valuation. However, the NAIC makes no representation that the SVO has the necessary expertise to produce accurate valuations. Accordingly, an insurance company that owns a security to which the SVO has assigned a value under this provision may substitute the SVO assigned value by obtaining or deriving a valuation in accordance with applicable NAIC annual statement reporting instructions and by reporting the valuation obtained to its insurance department on the NAIC Statement Blank.
3) Aggregate the content of each SVO Sub-List into a single SVO List of Investment Securities (hereafter, the SVO List of Securities) identifying each Investment Security by name and other pertinent information and showing the NAIC Designation assigned to them by the SVO or pursuant to such other methodology or procedure specified in this Manual.
4) Compile, or cause to be compiled, sub-lists from the informational content of the Derivative Counterparties Process, Exchange Rates Process, Ex-Dividend Process, Letter of Credit Process, Money Market and Exchange Traded Fund Process and Surplus Notes Processes (each an SVO Sub-List bearing the name of the corresponding Process and collectively the “Other Information”).
5) Publish, or cause the SVO List of Securities and the Other Information to be published, by being incorporated into the NAIC’s AVS + Product.
Attachment A
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Appendix
Part One Section 1. About the NAIC
b) The VOS/TF and the SVO Staff Function
The NAIC has determined that credit quality of insurance company investments and the Unit Price for a security provide a
sound empirical anchor for certain regulatory functions related to financial solvency regulation.
The VOS/TF formulates and implements NAIC's credit assessment and related , classification and securities valuation policy.
The SVO is the professional staff of the VOS/TF responsible for day-to-day credit quality assessment and valuation of
securities owned by state-regulated insurance companies. The SVO also performs such other duties as are specified by
VOS/TF.
Section 2. Policies Defining the SVO Staff Function
Directive to Conduct Ongoing SVO Operations
The SVO shall conduct the following ongoing operations:
(i) Analysis of credit risk for purposes of assigning an NAIC Designation.
(ii) Valuation analysis to determine a Unit Price.
(iii) Identification and analysis of securities that contain other non-payment risk and communication of this information
by assignment of the NAIC Designation subscript to such securities.
(iv) Other analytical assignments requested by the VOS/TF or members of the regulatory community; in accordance with
the directives, procedures and general methodologies described in this Manual.
(v) Compile and publish the AVS+ products in accordance with instructions in this Manual.
SVO Regulatory Products
…
(ii) Valuation of Securities
The result of SVO's valuation analysis shall be expressed as a Unit Price. The SVO does not intend, and its
methodology may not be appropriate, to yield an opinion of the price at which a security could or should be bought or
sold in the marketplace.
Section 3. Internal Administration
a) General
The staff of the SVO shall be organized in a manner that the NAIC Executive Vice President shall deem to be the most
appropriate and efficient for the conduct of day-to-day credit assessment and valuation operations, consistent with the
resources provided to the office by the NAIC. The staff shall promulgate such internal administrative procedures, protocols,
policies and guidelines, as it shall deem necessary for the proper execution of its delegated functions. Such procedures,
protocols, policies and guidelines as are promulgated by the staff shall be open to review and oversight by the VOS/TF.
b) Definitions of NAIC Designation Categories, Valuation Indicators, Administrative Symbols and Conventions
…
(v) SVO Administrative Symbols
SVO administrative symbols convey information about a security or an administrative procedure instead of an
opinion of credit quality or Unit Price. The administrative symbols in use by the SVO and their meanings are
described below.
(A) SVO analytical department symbols
All SVO analytical departments use the following administrative symbols:
A means that the Unit Price of the share of common or preferred stock has been
analytically determined by the SVO.
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V when used to report a Unit Price for common or preferred stock means the Unit
Price reported was not provided by the SVO or any market or exchange but was derived by the insurance
company itself or from some other source, pending a valuation analysis by the SVO.
L indicates that the Unit Price given for a share of common or preferred stock is the
price listed on the New York Stock Exchange, the American Stock Exchange or on the NASDAQ National
Market System.
U indicates that the price given for a share of common or preferred stock is the price
listed on any market or exchange, including a foreign exchange, other than the New York Stock Exchange, the
American Stock Exchange or the NASDAQ National Market System.
NOTE: The Administrative Symbols A, L, U and V which identify the manner or source of a Unit Price
assigned by the SVO, are collectively referred to as Market Indicators in the NAIC Annual Statement
Instructions.
UP means unable to price. This symbol is used with common or preferred stock and
indicates that a current market quotation was not obtainable or was not deemed reliable by the SVO.
F means that the NAIC Designation, Unit Price or both shown was determined by the
reporting insurance company and not by the SVO. Unlike the administrative symbol Z, the F symbol is used
by insurers that meet the definitional criteria for a “Sub-paragraph D Company” as defined in Part Three,
Section 1(a)(ii)(D)(4) of this Manual, to report ownership of a foreign security for which the company did not
have the information necessary to permit the SVO to conduct an assessment or a valuation.
…
(vi) Price Field Conventions
(A) Unit Price For Bonds and Common and Preferred Stocks
Expressed in decimal form with a maximum of seven significant digits before the decimal point and three
digits after the decimal point. For example, 32.375.
(B) — (Dash)
Indicates any Bond for which a Unit Price is not readily available or cannot be established pursuant to Part
Five, Section 1 of this Manual.
…
e) VOS Process
Upon determination of either component of an Association Value, (i.e., the NAIC Designation or Unit Price), and of a
classification, as the case may be for an Investment Security, as defined in Part Two, Section 2 (a) of this Manual, the SVO
shall enter such NAIC Designation, Unit Price and classification in the NAIC's VOS Process.
The SVO shall not add a Regulatory Transaction, as defined in Part Three, Section 2 (e) of this Manual, to the VOS Process.
f) Monitoring of VOS Process
(i) Monitoring
(A) General Directive
The SVO shall monitor improvements and deterioration of credit quality of securities which are not filing
exempt, defined in Part Two, Section 4 (d) of this Manual, in the VOS Process on an ongoing basis. Whenever
reports in the financial press, other reliable media, Subsequent Reports or Material Credit Event Filings
submitted by a reporting insurance company indicate that the issuer of a security has experienced a material
credit event or a change in financial condition, the SVO shall analyze whether the credit event or other change
is of sufficient materiality to require a change in the NAIC Designation, Unit Price or both then assigned to a
reported security.
Attachment A
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…
(ii) Annual Review
On at least an annual basis, the SVO shall review all NAIC Designations and Unit Prices assigned by the SVO to
securities in the VOS Process in light of the information presented by each issuer's most recent Audited Financial
Statements, or other pertinent information, to verify that the assigned NAIC Designation and/or Unit Price is
accurate. As necessary, the SVO shall modify such NAIC Designation and/or Unit Price for the previously reported
security as changed circumstances may require or delete any security that has matured or as to which there is a lack
of sufficient or timely information.
…
Preferred stock assigned the administrative symbol UP shall be deleted from the VOS Process if any information
deficiency is not rectified by the end of the first quarter following the previous year-end: provided, however, the SVO
will not delete any preferred stock assigned the administrative symbol UP from the VOS Process if an ATF annual
update filing for the Bond appears in VISION and the SVO has received the necessary information required to assign
an NAIC Designation to the preferred stock. If a preferred stock is not deleted in accordance with the foregoing
process in reliance on an annual update ATF that does not contain the necessary information to permit the assignment
of a valuation and/or NAIC Designation, the SVO shall subsequently delete that security from the database.
Common stock assigned the administrative symbol UP shall be deleted from the VOS Process if any information
deficiency is not rectified by the end of the first quarter following the previous year-end: provided, however, the SVO
will not delete any common stock assigned the administrative symbol UP from the VOS Process if an ATF annual
update filing for the common stock appears in VISION and the SVO has received the necessary information required
to assign an NAIC Designation to the common stock. If a common stock is not deleted in accordance with the
foregoing process in reliance on an annual update ATF that does not contain the necessary information to permit the
assignment of a valuation, the SVO shall subsequently delete that security from the database.
…
k) Compilation and Publication of the SVO List of Securities
On a quarterly basis, the SVO shall:
1) Compile, or cause to be compiled, a list of Investment Securities from each of the VOS Process, Filing Exempt Securities
Process, RMBS/CMBS Modeled Securities Process, U.S. Treasury Process and the Exempt U.S. Government Securities
Process (each an SVO Sub-List bearing the name of the corresponding Process).
2) Aggregate the content of each SVO Sub-List into a single SVO List of Investment Securities (hereafter, the SVO List of
Securities) identifying each Investment Security by name and other pertinent information and showing the NAIC Designation
and/or Unit Price assigned to them by the SVO or pursuant to such other methodology or procedure specified in this Manual.
3) Compile, or cause to be compiled, sub-lists from the informational content of the Derivative Counterparties Process,
Exchange Rates Process, Ex-Dividend Process, Letter of Credit Process, Money Market and Exchange Traded Fund Process
and Surplus Notes Processes (each an SVO Sub-List bearing the name of the corresponding Process and collectively the
“Other Information”).
4) Publish, or cause the SVO List of Securities and the Other Information to be published, by being incorporated into the
NAIC’s AVS + Product.
Section 5. NAIC Policies Pertaining to SVO Work Product
a) For NAIC Members Only – Official Source
…
The AVS+ Products is designated as the official NAIC source for publication of NAIC Designations Association Values
assigned by the SVO to the securities owned reported by insurance companies. To the extent that an NAIC member, acting in
Attachment A
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© 2018 National Association of Insurance Commissioners 6
its capacity as a state official, instructs an insurance company to incorporate Association Values in the filings made by that
company to the state insurance department, the NAIC member is advised that only NAIC Designations and Unit Prices
obtained from the most recently published AVS+ Products should be used by an insurance company to report an NAIC
Designation and/or a Unit Price on an NAIC Financial Statement Blank prepared in accordance with SAP.
b) This Manual
This Manual is the official expression of NAIC's credit assessment methodologies and valuation policies and takes
precedence over other SVO publications. The policies, procedures, methodologies or language of this Manual shall be
changed only through a resolution adopted by the VOS/TF in accordance with the NAIC Constitution and Bylaws.
NAIC Designations and Unit Prices are produced solely to provide NAIC members with a reliable, independent and uniform
source for credit risk and pricing information. Accordingly, the NAIC member must interpret the significance of an NAIC
Designation Association Value in a specific context by reference to the NAIC Financial Conditions Framework and
applicable state insurance laws, rules and regulations.
NAIC Association Values are not intended or designed to function as an aid to an investment decision.
…
Part Two
Section 1. General Definitions Used in This Manual
The following definitions are intended to have relevance only for this Manual. No suggestion is intended that these
definitions have any relevance to any other NAIC publication.
Association Value means, collectively, an NAIC Designation and the Unit Price published in the AVS+ Products
for a security.
…
Unit Price means the value determined for a security by the SVO pursuant to Part Five, Section 1 of this Manual for
purposes of valuation under SAP.
…
Section 2. General Reporting Framework
a) Obligation to Report
Insurance companies domiciled in any state of the United States, or any of its territories or possessions, and required by the
law of their domiciliary state or territory to report NAIC Designations Association Values for their Investment Securities in
the NAIC Financial Statement Blank, shall report purchases of Investment Securities to the SVO or, in the case of Investment
Securities exempt from filing with the SVO, for example, pursuant to Section 4 (d) of this Part below, to the NAIC, as
required by this Manual.
For purposes of this Part Two, Section 2 (a), an Investment Security means an instrument evidencing a lending transaction
between an insurance company as lender and a non-affiliated borrower, where the borrower’s sole motivation is to borrow
money and the insurance company’s sole motivation is to make a profit on the loan that the state of domicile regulates by
reference to the NAIC Financial Conditions Framework.
The SVO shall have no authority to issue NAIC Designations or any other NAIC analytical product to an insurance company
for a Regulatory Transaction under this Section 2 (a).
See Part Three, Section 2 (e) of this Manual below for the definition of Regulatory Transaction and a description of the
processes governing their assessment.
… d) Reporting Responsibilities
…
Attachment A
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No reporting is necessary if the security (i) is listed in the AVS+ Products with a recently assigned NAIC Designation/Unit
Price, (ii) is listed in the AVS with a current year review date and a symbol that is other than an NR or UP or (iii) has been
logged into VISION.
…
Section 10 Reporting Conventions and Required Documents
…
(c) Reporting Conventions and Required Documents
(viii) Public Common Stock, Private Common Stock, Warrants, Foreign Common Stock or Preferred Stock
Part Five, Section 1 of this Manual permits insurance companies to self-value common stock, preferred stock or
warrants.
Public common stock not restricted is exempt from filing with the SVO pursuant to Part Two, Section 4 (d) (i) (C)
of this Manual.
The following documentation requirements therefore apply only when these securities must be reported to the
SVO for whatever reason despite the primary instructions contained in because the insurer has elected to have the
SVO provide a valuation identified as methodology “e” under Part Five, Section 1 (b) (iii) Valuation
Methodologies and Corresponding Reporting Codes of this Manual. Such a filing with the SVO may be required,
for example, if the insurer wants to obtain a value for the security that the SVO has not previously valued for
another insurer or if the state insurance department has directed the insurer to file the security with the SVO for
valuation.
(A) Public Common Stock
If the common stock is listed on any exchange, the reporting insurance company must submit the most
recent Bloomberg Description Screen or other acceptable screen, if available, together with the issuer's
Audited Financial Statement.
If the public common stock is restricted as to transferability, the issuer's most recent annual report, a copy
of the common stock certificate showing the limitations on transferability (or any other document that
details such limitations), the issuer's Audited Financial Statement for the last three years and a written
description of the daily price trading range for the past six months must be submitted.
(B) Private Common Stock
For either restricted or non-restricted private common stock, the reporting insurance company shall submit
the issuer's annual report for the most current three years (together with Audited Financial Statements for
those years, if these are not a part of the annual report), the stock purchase agreement and the common
stock certificate (front and back) or other evidence of restrictions.
(C) Warrants
If the warrant is traded on the New York Stock Exchange, the American Stock Exchange or the NASDAQ
National Market System, the reporting insurance company shall submit the issuer's Bloomberg Description
Screen. For a warrant listed on any other domestic or Canadian exchange, the reporting insurance company
shall submit the issuer's Bloomberg Description Screen, together with the issuer's Audited Financial
Statement.
(D) Foreign Common Stock
The reporting insurance company shall submit the issuer's most recent annual report (together with the
issuer's Audited Financial Statement if it is not a part of the annual report) and/or the most recent
equity/credit research reports by NAIC CRPs or other rating organizations, if available.
…
Attachment A
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Section 5. Reporting Certain Schedule BA Assets with Underlying Characteristics of Bonds or Preferred Stock
… e) Directive to the SVO
Upon receipt of the reporting entity’s submission of a Schedule BA asset with underlying characteristic of a bond or other
fixed income instrument, the SVO is hereby directed to conduct a credit assessment, assess the reporting entity’s asset
classification decision and conduct a valuation analysis of the asset. Upon conclusion of its analysis, the SVO shall provide
the reporting entity with a written letter, in a form to be developed by the SVO, setting forth its determination as to the NAIC
Designation and , asset classification and the Unit Price assigned to the asset. Upon receipt of the aforementioned letter, the
reporting entity shall report the aforementioned analytical values obtained from the SVO for the asset, on the NAIC Financial
Statement Blank.
… g) Maintenance and Monitoring of SVO Determinations for Schedule BA Assets
...
(ii) Monitoring of Credit Quality
The SVO shall monitor improvement or deterioration of credit quality for Schedule BA assets entered into the VOS
Process. Whenever newly disclosed information suggests that the likelihood of payment associated with a Schedule
BA asset has changed, the SVO shall analyze whether the NAIC Designation or Unit Price then assigned to the
investment should be adjusted. The reporting entity is responsible for providing the SVO with information relative to
a change in the financial capability of the obligor. By way of illustration of the type of events that should be reported,
and not by way of limitation, the reporting entity should report any of the following or similar events: a
reorganization of the issuer or the obligation; any amendment of the payment terms in the contract; any request for an
extension of time for payment beyond contractual grace periods, or any other event which indicates that the financial
performance of the issuer or the investment has materially changed.
(iii) Annual Review Requirement
On at least an annual basis, reporting entities that have made an Initial Filing of a Schedule BA asset shall file a
Subsequent Report with the SVO (Initial Filing and Subsequent Filing is defined in Part Two, Section 10 and 11 of
this Manual.)
On at least an annual basis, the SVO shall conduct a review of the credit quality and value of the Schedule BA assets
in the VOS Process to determine whether the NAIC Designation and Unit Price assigned to the Schedule BA asset
should be adjusted to reflect the most recent information about the issuer’s performance. Upon the conclusion of its
annual review, the SVO shall make any necessary adjustment to the NAIC Designation and/or the Unit Price then
assigned to Schedule BA assets.
i) Administrative Procedures; Reporting Conventions; Pricing; Credit Assessment
…
(ii) Pricing Methodologies
The pricing methodologies contained in Part Five, Section 1 of this Manual are applicable to the valuation of
Schedule BA assets that have the underlying characteristic of a bond or other fixed income instrument.
Nevertheless, the SVO has discretion to use whatever other methodology would produce a reasonable
valuation for a Schedule BA asset reported to the SVO if the methodologies in Part Five, Section 1 of this
Manual are not appropriate to value a given Schedule BA asset.
…
Part Five. Valuation of Securities
Section 1. Pricing of Unaffiliated Investments
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Regulatory Objectives
A reporting entity that maintains an asset valuation reserve (AVR), for example a life insurance company, that owns a bond
that has been assigned a NAIC 6 Designation or a preferred stock with a NAIC 4, 5, or 6 Designation, and a reporting entity
that does not maintain an AVR, for example a property and casualty company, that owns a bond or a preferred stock that has
been assigned an NAIC Designation of 3, 4, 5 or 6 must carry the security at the lower of cost or fair value. In addition, a
reporting entity that does not maintain an AVR must carry a perpetual preferred stock that has been assigned a NAIC 1 or 2
Designation at fair value. In these cases, fair value determined in accordance with this Section 1 is extended to the fair value
column and the Book/Adjusted Carrying Value column of the NAIC Financial Statement Blank. In addition, and irrespective
of statutory accounting guidance, annual statement instructions require all insurers to report a fair value, irrespective of the
credit quality of the security or the nature of its owner’s insurance business. Accordingly, even an insurer entitled to use
amortized value in the “Book/Adjusted Carrying Value” column, must use fair value in the “Rate Used to Report Fair Value”
column.
See, the NAIC Accounting Practices and Procedures Manual, in particular;
SSAP No. 26R—Bonds;
SSAP No. 30—Unaffiliated Common Stock;
SSAP No. 32—Preferred Stock;
SSAP No. 43R—Loan-Backed and Structured Securities;
SSAP No. 97—Investments in Subsidiary, Controlled and Affiliated Entities; and
SSAP No. 100R—Fair Value;
and the NAIC Quarterly and Annual Statement Instructions.
General Valuation Process
(i) Obligation to Report a Fair Value
Any insurance company domiciled in any state of the Unites States, or any of its territories or possessions, and
required by the law of their domiciliary state or territory to report Association Values for their investments in the
NAIC Financial Statement Blank, shall follow the procedures described below to obtain a fair value to be used for
reporting consistent with Section 1(a) above.
The existence of a filing exemption for a security does not eliminate the requirement to report a value on the NAIC
Financial Statement Blank for the security in accordance with Part Five, Section 1 of this Manual.
(ii) Valuation Procedure
An insurance company shall either report the fair value determined by the SVO for a security or determine a fair
value in accordance with one of the valuation methodologies described in paragraph (c) below.
When selecting a valuation method, the insurance company shall seek to obtain a fair value that reliably reflects the
price at which the security would sell in an arm’s length transaction between a willing buyer and seller in possession
of the same information. Only where a market valuation based fair value is unobtainable, should the insurance
company select a valuation method that would yield an analytically determined fair value.
The insurance company shall identify the valuation method used to obtain fair price to determine the Rate Per Share
Used to Obtain Fair Value in Schedule D.
(iii) Valuation Methodologies and Corresponding Reporting Codes
The valuation methods permitted to an insurance company and the codes that correspond to the valuation methods are
as follows:
a - For securities where the rate is determined by a pricing service.
b - For securities where the rate is determined by a stock exchange
c - For securities where the rate is determined by a broker or the insurer’s custodian. To use this method: 1) the
broker must be approved by the insurer as a counterparty for buying and selling securities or be an underwriter
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of the security being valued and 2) the insurer shall obtain and retain the pricing policy of the broker or
custodian that provided the quotations.
d - For securities where the rate is determined by the insurer. The insurer is required to maintain a record of the
pricing methodology it used.
e - For securities where the rate is determined by the valuation published in the NAIC Valuation of Securities
database.
SVO Valuation Methodologies
(i) Instruction and Disclosure
The SVO shall apply the methodologies provided in this section to provide fair values for the regulatory purposes
discussed in Section 1 (a) of this Part above.
The fair value of any specific security produced by the SVO may be determined from application of one of many
methodologies, as may be deemed appropriate by the SVO to determine a reliable value for NAIC regulatory
purposes. These methodologies may include the use of public prices obtained from acceptable vendors of pricing
information, through the NYSE, AMEX, National NASDAQ or from acceptable financial institutions; use of pricing
models or matrices; application of book value; and any other method deemed appropriate by the SVO in fulfillment of
the regulatory objective.
Irrespective of the methodology used to determine a fair value, nothing in this Part shall be construed as implying that
the SVO intends, or that in a specific case the methodology employed to determine a fair value for the purposes
described in Section 1(a) of this Part above yield an opinion of the price at which a security could or should be bought
or sold in the marketplace.
(ii) Use of Publicly Available Prices as Fair Value
The SVO may use any publicly available pricing source that it deems to be reliable to determine a fair value for
any publicly traded security owned by an insurance company. Once selected, the SVO shall enter the fair value
into the VOS Process and subsequently publish it.
(A) Pricing of Shares of Exchange Traded Funds
The fair value of the shares of an Exchange Traded Fund (“ETF”), discussed in Part Six, Section 2 of this
Manual, reported by an insurance company on any day in which reporting of a fair value is required,
shall be the public price of the ETF shown on the listing exchange for the last trading day.
(iii) Analytical Determinations of Fair Value
Where a fair value cannot be obtained from a public source, the SVO shall attempt to determine a fair value
analytically in accordance with the procedures discussed below.
(A) Special Instruction for Private Placements
Where a price is not available because the security is a private placement which does not trade in the
public marketplace, the price field of the VOS Process will contain a (--). If a private placement requires
an estimated market price for valuation purposes, the SVO staff will analytically determine such value,
or the SVO, at its discretion, may accept a value determined by an independent organization approved by
the SVO.
(B) Bonds
(1) General Procedure
In conjunction with its credit assessment of a private placement bond, the SVO shall calculate a fair
value for the security using the spread over the equivalent credit curve updated at year end using the
interpolated yield curve on a spread basis.
An insurance company who desires to obtain a fair value other than as described above in this paragraph
may provide the SVO with the fair value, determined by two price quotes obtained from financial
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institutions acceptable to the SVO and written on the letterhead of such financial institutions, or another
method acceptable to the SVO. The SVO shall use such fair value to determine the unit price for the
bond.
If the SVO is satisfied that for whatever reason, it is not possible for the insurance company requesting
the fair value to obtain two price quotes from financial institutions acceptable to the SVO, the SVO may
apply the comparability analysis described immediately below.
• The SVO may in the first instance determine a fair value for the security by assigning the
price of a comparable publicly traded bond of the same issuer.
As used in this section, comparability refers to the credit standing and structure of the two bond issues.
Two bonds shall be considered to be comparable if they have been assigned equivalent credit rating
symbols by the same NAIC CRP, by two or more NAIC CRPs or if they have been assigned the same
NAIC Designation by the SVO.
• If a comparable publicly traded bond of the same issuer is not available, the SVO may
apply the price of a comparable publicly traded bond issued by another issuer in the same
industry.
• If a comparable publicly traded bond of another issuer in the same industry is not available,
the SVO may apply the price of a publicly traded bond issued by another issuer in a
different industry.
• The fair value of the comparable bond shall be used to determine a yield for the reported
bond and that yield, adjusted to the extent the analyst deems appropriate, will be used to
determine a price for the reported bond.
• If a fair value cannot be determined in accordance with this procedure, the SVO may apply
whatever other procedures it determines would yield a reasonable estimate of the fair value
of the asset.
(2) Pricing Bonds of Companies in Orderly Liquidation
For purposes of this paragraph, a company in orderly liquidation is any business entity for which the
owners have agreed to a voluntary cessation of business operations and dissolution of the business entity
(liquidating company).
The SVO may determine the fair value for the bond of a Liquidating Company by reference to an
appraisal submitted to the SVO by the insurance company, provided that the appraisal has been
conducted by a recognized independent appraisal firm acceptable to the SVO.
If such an appraisal is not available, or if the SVO determines that the appraisal is not acceptable, the
SVO shall determine the fair value by applying the following procedure. The SVO shall obtain the
Liquidating Company's latest Audited Financial Statement for the purpose of determining net realizable
value of assets. The analyst shall then identify appropriate criteria to be applied to each asset class shown
on the balance sheet. Using these criteria the analyst will determine the value of the company's assets.
This amount shall then be adjusted by an amount equal to the liability shown on the balance sheet, and
by any other amount that the analyst believes is unrealizable under the circumstances, to arrive at an
amount likely to be available to pay claims of creditors. A fair value for the bonds shall be determined by
apportioning the amount to the bonds and/or any other security issued by the company in accordance
with the bond's priority of claim on the assets of the Liquidating Company.
(3) Restructured Bond Obligations
For purposes of this paragraph, a Restructured Bond is one for which the lender and the borrower have
agreed to amend or waive a material credit term due to financial distress of the borrower. As used herein,
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a material term includes the interest rate on the loan, the maturity date of the bond or any financial
covenant in the agreement. Upon receipt of a Subsequent Report, as defined in Part Two, Section 11 of
this Manual, the SVO shall adjust the fair value of a Restructured Bond to reflect the restructured terms.
(4) Bonds in Default
For purposes of this paragraph, a Bond in Default is a bond for which the issuer has failed to perform a
term or condition required to be performed by the agreement (after all applicable grace periods have
expired). The fair value for a Bond in Default shall reflect SVO's estimate of the dollar value of the
defaulted bond as of the end of the reporting period, adjusted for the costs of the proceedings necessary
to protect bondholder rights and discounted to reflect the time period before payments will actually be
made. In estimating a fair value, the SVO may apply any procedure reasonably calculated to provide a
useful measure of recovery value and it may consider any factor that it deems relevant, such as the
reasons for the issuer's default, the value of the issuer's business operations to a competitor, the
likelihood of a liquidation or a successful reorganization and other similar factors. The fair value shall
reflect the status of discussions between the issuer and its creditors, in particular whether the bond is
newly defaulted, whether subsequent to bond default the issuer has filed for liquidation or for
reorganization, whether subsequent to the filing the issuer has proposed a reorganization plan or whether
a reorganization has been accepted and approved by a bankruptcy court. In the case of any negotiated or
accepted reorganization plan, the SVO may use the estimates of recovery value and payout time set forth
in the reorganization plan as a basis to arrive at a fair value.
(C) Preferred Stock
The fair value of preferred stock not publicly priced for the year in which the preferred stock has been
purchased by the reporting insurance company shall be the per share cost of the preferred stock to such
reporting insurance company.
For any subsequent year, and in conjunction with its credit assessment of a private placement security,
the SVO shall calculate a fair value for the security using the spread over the equivalent credit curve
updated at year end using the interpolated yield curve on a spread basis.
An insurance company who desires to obtain a fair value other than as described above in this paragraph
may provide the SVO with the fair value, determined by two price quotes obtained from financial
institutions acceptable to the SVO and written on the letterhead of such financial institutions, or another
method acceptable to the SVO. The SVO shall use these price quotes to determine a fair value for the
preferred stock.
If the SVO is satisfied that for whatever reason, it is not possible for the insurance company
requesting the fair value to obtain two price quotes from financial institutions acceptable to the
SVO, the SVO shall seek to apply the yield of a comparable publicly traded preferred stock of the
same issuer to determine a price.
As used in this section, comparability refers to the credit rating standing of the two preferred stock
issues. The two preferred stock issues shall be generally considered to be comparable if they have
been assigned equivalent credit rating symbols by the same NAIC CRP, by two or more NAIC
CRPs or if they have been assigned the same NAIC Designation by the SVO.
If a comparable publicly traded preferred stock of the same issuer cannot be identified, the SVO
staff will use the yields from any NAIC CRP index of preferred or convertible preferred stock
yields as of the close of the week preceding the end of the quarter and published in the AVS+
Products.
Fair value shall be derived from the yield either by application of a suitable pricing model or by
reference to the price of a preferred stock of a comparable yield.
In the case of a convertible preferred stock, the fair value may be set by reference to the price of
the issuer's common stock into which the preferred stock may be converted. If the method
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discussed above is inapplicable for any reason, the SVO may use any other procedure or method
reasonably calculated to result in a reasonable fair value.
(D) Limited Life Preferred Shares
Limited life preferred shares are defined as Medium Term Fixed Rate Preferred Shares, Dutch Auction
Rate Preferred Shares (DARTS), Fixed Rate Adjustable Preferred Stock (FRAPS), Stated Term Auction
Preferred Shares (STRAPS), Fixed Rate Exchangeable Preferred Stock (FREPS), Marketed Auction
Preferred Shares (MAPS), Stated Rate Auction Preferred Shares (STAR) and Share Adjusted Broker
Remarketed Shares (SABRES), or other similar preferred securities. The reporting insurance company
shall provide the SVO with at least two price quotes for the preferred shares from recognized financial
institutions on the letterhead of such institutions.
(E) Common Stock
The fair value of a common stock for the year in which the common stock has been purchased by the
insurance company, shall be the per share cost of the common stock to such reporting insurance
company.
For any subsequent year, the insurance company reporting ownership of the common stock of a private
company shall provide the SVO with two price quotes for the common stock. The price quotes shall be
obtained from financial institutions acceptable to the SVO and shall be written on the letterhead of such
financial institutions. The SVO shall use these price quotes to determine a fair value for the common
stock.
In the absence of two price quotes from financial institutions acceptable to the SVO, the insurer may file
a copy of the issuer's Audited Financial Statement with the SVO. The SVO shall use these statements to
derive shareholder's equity and issuer's retained earnings (net of the value of any preferred stock) and
then use these figures to calculate the price per share.
If the method discussed above is inapplicable for any reason, the SVO may use any other procedure or
method reasonably calculated to result in a reasonable fair value.
See Part Three, Section 1(a)(ii)(B) of this Manual for instructions for issuers of foreign common stock
with unaudited financial statements.
(F) Shares of Mutual Funds
Fair value of mutual funds, including money market fund shares, shall be equivalent to the net asset value
of such shares calculated as of the close of business of the reporting period.
(G) Common Stock of Insurance Companies
The fair value of a private common stock issued by an insurance company is its book value. Book value
shall be calculated by (i) ascertaining capital of the insurance company as reported on the company's
latest NAIC Financial Statement Blank or report of examination, (ii) ascertaining the company's surplus
(excluding from surplus any reserves required by statute and any portion of surplus properly allocable to
policyholders), (iii) subtracting the greater of par or redemption value of the company's preferred stock
and the face value of surplus notes (other than 144A note offerings) from the total amount of such capital
and surplus and (iv) dividing the remaining amount by the number of shares of the company's common
stock outstanding.
(H) Stock Warrants
The fair value of a warrant convertible into private common stock for the year in which the warrant has
been purchased by the reporting insurance company shall be the cost of the warrant to such reporting
insurance company.
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For any subsequent year, the fair value of a warrant convertible into private common stock shall be the
difference between the Association Value of the common stock as determined pursuant to either
Paragraph (E) or (G) of this section, as applicable, and the exercise price. The result is then discounted
for illiquidity.
The fair value for a warrant with no public market, exercisable into shares of common stock that do have
a public market, shall be the difference between the value of the common stock and the exercise price of
the warrant. In the case of a warrant exercisable into restricted common stock, the fair value shall be the
difference between the common stock share price determined pursuant to paragraph (I) below and the
exercise price.
Warrants for which the first exercise date is subsequent to the date of the NAIC Financial Statement
Blank shall have no value unless a publicly available price can be obtained for NAIC Financial Statement
Blank purposes.
(I) Common Stock and Preferred Stock Issued Under Investment Letter or Restricted As to Transferability
When determining the value to be assigned to shares of private common stock issued by a public
company whose public shares of the same class trade on a public exchange, the insurance company shall
provide the SVO with the information required in Part Two, Section 10 (c) (ix) of this Manual.
The restricted common or preferred stock of an issuer unaffiliated with the reporting insurance company
and held by the insurance company for a period of less than three years shall be priced by the insurance
company, and the fair value, together with a written justification of the fair value, shall be submitted to
the SVO.
The staff shall review the insurance company's analysis and render an opinion as to the reasonableness of
the price valuation basis used by the insurance company. Upon a finding that the valuation basis used is
reasonable under the circumstances, the staff will provide the results of its conclusion to the state
insurance department for the affected insurance company and, upon request, to other insurance
companies holding the restricted common or preferred stock.
The SVO shall not publish these opinions or the fair value for these securities in the AVS+ Products. If
the SVO disagrees with the price valuation basis used by the insurance company, the insurance company
may either accept the price as determined by the SVO or report its own price with a “V” suffix on the
NAIC Financial Statement Blank.
When Price Is Not Determinable
(i) General Procedures
If the SVO determines that there is no sound basis upon which to determine a fair value, or the fair value is not
readily available, it shall apply the Administrative Symbol “UP” if the security is a common or preferred stock,
the Administrative Symbol “--” if the security is a debt instrument that is rated, or the Administrative Symbol
“NR” if the security is a debt instrument that is not rated.
(ii) Restriction on Use of the Administrative Symbol NR
Notwithstanding any other instructions contained in this Manual, the SVO shall not apply the administrative
symbol NR to any private security that has been assigned an NAIC 6 Designation. If the application of the
analytical methods in this Part is insufficient to enable the SVO to determine a fair value for a private security
designated NAIC 6, the SVO shall assign that security a fair value of zero (0).
G:\DATA\Vos-tf\Meetings\2018\June\Task Force 2018 Amend P&P for Valuation Instructions.docx
AAmerican Council of Life Insurers North American Securities Valuation Association 101 Constitution Avenue, NW, Washington, DC 20001-2133 contact: Tracey Lindsey, President 202-624-2324 [email protected] 740-253-1016 [email protected] www.acli.com
Mike Monahan Tracey Lindsey Senior Director, Accounting President
August 10, 2018
Mr. Kevin Fry, Chair Mr. Stewart Guerin, Vice Chair NAIC Valuation of Securities (E) Task Force NAIC Valuation of Securities (E) Task Force 1100 Walnut Street, Suite 1500 1100 Walnut Street, Suite 1500 Kansas City, MO 64106-2197 Kansas City, MO 64016-2197
Re: NAIC Valuation of Securities (E) Task Force (“the Task Force”) Proposal to Amend the Purposes & Procedures Manual of the NAIC Investment Analysis Office (“P&P Manual”) to Replace Valuation Instructions with an Explanation of SVO Activity in the Compilation Function (“the Proposal”)
Dear Messrs. Fry and Guerin:
ACLI1 and NASVA2 (“the undersigned”) appreciate the opportunity to comment on the Proposal, which has an August 10, 2018 comment period deadline, as exposed by the Task Force during their recent conference call held on June 11, 2018.
The undersigned are supportive of the Proposal with the understanding that the deletions in Section 3, under SVO Administrative Symbols will not be effective until December 31, 2019, to coincide with a related recently adopted Blanks Working Group proposal.
Please do not hesitate to contact either of us should you have any questions. Thank you.
Sincerely,
Tracey Lindsey Mike Monahan Senior Director, Accounting Policy President American Council of Life Insurers North American Securities Valuation Association
cc: Mr. Charles Therriault, Director, SVO Mr. Robert Carcano, Senior Counsel
1 The AAmerican Council of Life Insurers (ACLI) is a Washington, D.C.-based trade association with approximately 290 member companies operating in the United States and abroad. ACLI advocates in state, federal, and international forums for public policy that supports the industry marketplace and the policyholders that rely on life insurers’ products for financial and retirement security. ACLI members offer life insurance, annuities, retirement plans, long-term care and disability income insurance, and reinsurance, representing 95 percent of industry assets, 93 percent of life insurance premiums, and 98 percent of annuity considerations in the United States. Learn more at www.acli.com.
2 The North American Securities Valuation Association (NASVA) is an association of insurance company representatives who interact with the National Association of Insurance Commissioners Securities Valuation Office (the SVO) to provide important input, and to exchange information, in order to improve the interaction between the SVO and its users. In the past, NASVA committees have worked on issues such as improving filing procedures, suggesting enhancements to the NAIC's ISIS electronic security filing system, and commenting on year-end processes. Find more information here.
Attachment A-1 Valuation of Securities (E) Task Force
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Attachment B
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© 2018 National Association of Insurance Commissioners 1
MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
CC: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group
DATE: May 1, 2018
RE: Proposals for Response to the Reinsurance (E) Task Force Referral on Regulatory Transactions Sent to the
Valuation of Securities (E) Task Force
Background – On Feb. 8, the Valuation of Securities (E) Task Force discussed the captioned referral and exposed it for a 60-
day public comment period ending April 9.1 The referral requests that the Task Force take the lead in creating a framework
for regulatory transactions.2 Related referrals were also sent by the Reinsurance (E) Task Force, the Statutory Accounting
Principles (E) Working Group and the Capital Adequacy (E) Task Force. This memorandum revises recommendations the
Securities Valuation Office (SVO) made on Feb. 8.3
The referral presents two distinct issues. The first issue involves the meaning of the phrase “SVO List of Investment
Securities” in the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) and its
relationship to the phrase “SVO Listed” in NAIC reinsurance model laws and regulations. The SVO recommends an
amendment to reflect the conclusions of the now disbanded Reinsurance Investment Security (E) Subgroup in the P&P
Manual.4 Although greater clarity in the P&P Manual would extend to the reinsurance guidance, the SVO notes that the
phrase “SVO Listed” is defined differently in three places. It may be desirable for the Reinsurance (E) Task Force to expand
its guidance5 to avoid confusion as to the meaning of that term in the reinsurance space.
The second issue involves the role of the Valuation of Securities (E) Task Force in building a framework to govern either the
investment component of regulatory transactions or regulatory transactions as a whole. That this referral was sent to the
Valuation of Securities (E) Task Force undoubtedly reflects the factual context of the Reinsurance Investment Security (E)
Subgroup charge: i.e., that it examine the status of an investment component and the larger regulatory transaction. However,
the Reinsurance Investment Security (E) Subgroup determined that it was necessary to evaluate the impact of the entire
transaction on a specific insurer and its affiliates—an effort not contemplated in the charge of the Valuation of Securities (E)
Task Force. This focus on the investment also seems to ignore that the investment component is likely to be proprietary and,
therefore, could not be publicly discussed, suggesting likewise that guidance for such investments could not be publicly
developed. These considerations suggest that the focus likely needs to be on the regulatory objectives of the transactions,
which are likely to encompass more than reinsurance and which can be publicly discussed. The Statutory Accounting
Principles (E) Working Group would seem to be better suited to take the lead on the project as defined. When the Statutory
Accounting Principles (E) Working Group has sufficiently advanced the project, coordination with or a referral to the
Valuation of Securities (E) Task Force to consider investment issues would certainly be appropriate.
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Proposed Amendment – The Securities Valuation Office proposes an amendment to the compilation instructions that would
add a clause reflecting the conclusions adopted by the Reinsurance (E) Task Force.6
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Attachment B
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Part One Purposes, General Policies and Instructions to the SVO;
Section 3. Internal Administration
k) Compilation and Publication of the SVO List of Investment Securities
On a quarterly basis, the SVO shall:
1) Compile, or cause to be compiled, a list of Investment Securities from each of the VOS Process, Filing Exempt Securities
Process, RMBS/CMBS Modeled Securities Process, U.S. Treasury Process and the Exempt U.S. Government Securities
Process (each an SVO Sub-List bearing the name of the corresponding Process).
2) Aggregate the content of each SVO Sub-List into a single SVO List of Investment Securities (hereafter, the SVO List of
Investment Securities) identifying each Investment Security by name and other pertinent information and showing the NAIC
Designation and/or Unit Price assigned to them by the SVO or pursuant to such other methodology or procedure specified in
this Manual.
3) Compile, or cause to be compiled, sub-lists from the informational content of the Derivative Counterparties Process,
Exchange Rates Process, Ex-Dividend Process, Letter of Credit Process, Money Market and Exchange Traded Fund Process
and Surplus Notes Processes (each an SVO Sub-List bearing the name of the corresponding Process and collectively the
“Other Information”).
4) Publish, or cause the SVO List of Investment Securities and the Other Information to be published, by being incorporated
into the NAIC’s AVS + Product.
l) Reference to SVO List of Securities
a. Acknowledgment – The NAIC, acting by and through its VOS/TF and its Reinsurance (E) Task Force,
acknowledges that the phrase “Securities Listed by the SVO,” used in Section 3 B. of the NAIC Credit for Reinsurance
Model Law (#785) and Section 10 A. (2) of the Credit for Reinsurance Model Regulation (#786) refers to the SVO List of
Investment Securities as defined in this Part One, Section 3 (k) provided that for purposes of the Model Law, the phrase
Securities Listed by the SVO also includes:
1) All US Treasury Securities whether or not on the US Treasury Securities Process Sub-List of the SVO List of
Securities as owned by an insurance company; and
2) Any security that meets the criteria specified in Part Two, Section 4 (c) (i) or (ii) of this Manual (pertaining to US
Government Exempt securities), not owned by an insurance company and therefore not on the SVO Exempt US Government
Securities Process Sub-List of the SVO List of Securities; and
3) Such other or additional type or class of securities as the Reinsurance (E) Task Force shall from time to time
determine are suitable for use as collateral in reinsurance transactions and are added to this definition by the VOS/TF at its
request.
To avoid confusion, and for purposes of this acknowledgment, the Filing Exempt Securities Process included in the definition
of SVO List of Securities includes the SVO listed securities referred to as those “deemed exempt from filing” in the cited
sections of the Model Law and Model Regulation.
b. Status of an Investment on the SVO List of Investment Securities
1) The reference to “Securities Listed by the SVO,” used in Model #785 and Model #786, refers solely to the
individual, stand-alone investment purchased by an insurer and filed with the SVO to obtain an NAIC Designation and to be
added to the SVO List of Investment Securities published in the AVS+ product.
References to “Securities Listed by the SVO” as eligible collateral for the purposes of reinsurance arrangements specified in
Model #785 and Model #786 reflect that the specific insurer owns the Investment Security and has a corresponding right to
receive the cash flow represented by the Investment Security from the security’s issuer, which is the right an insurer may
pledge as collateral.
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2) An Investment Security on the SVO List of Investment Securities cannot be assumed or presumed to constitute
“Primary Security” as defined in the phrase “SVO Listed” in Actuarial Guideline XLVIII—Actuarial Opinion and
Memorandum Requirements for the Reinsurance of Policies Required to be Valued Under Sections 6 and 7 of the NAIC
Valuation of Life Insurance Policies Model Regulation (#830) or in the NAIC Term and Universal Life Insurance Reserve
Financing Model Regulation (#787).
3) Whether an Investment Security on the SVO List of Investment Securities qualifies as “Primary Security” as defined
in the Valuation of Life Insurance Policies Model Regulation (#830) or #787 is not an issue within the scope of the charges
entrusted to the VOS/TF or within the analytical function or role of the or SSG.
4. Whether a Regulatory Transaction as defined in this Manual has any status under Model #785, Model #786, Model
# 830 or Model #787 is not an issue within the scope of the charges entrusted to the VOS/TF or within the analytical function
or role of the SVO or SSG.
1 A summary of concerns expressed by the SVO follows: 1) neither the Task Force nor the SVO and SSG have expertise on regulatory transactions that can be shared or a mission that requires that expertise; 2) given the Subgroup’s conclusion that a regulatory transaction must be evaluated in context of a specific
state, insurer and affiliates, development of expertise, if attainable at all, requires significant resources and time; 3) regulatory transactions are private
proprietary financial products that cannot be discussed in public with any specificity. It would, therefore, not be possible to formulate regulatory policy via public discussions; 4) a complex definition of regulatory transaction is inconsistent with the needs of the Valuation of Securities (E) Task Force, which is
only concerned with the single issue of a stand-alone investment and whether it can be assessed for credit risk consistent with the statutory framework; and
5) the P&P Manual contains a procedure that permits any state to ask for Investment Analysis Office (IAO) assistance with regulatory transactions. We should, therefore, verify that the states collectively need an NAIC-administered framework for regulatory transactions.
2 The referral solicits the Task Force to detail a definition of “regulatory transactions.” Insurers would report investments that are part of regulatory transactions, and the Task Force and SVO would provide guidance and otherwise assist the states with their assessment.
3 The SVO recommended that: 1) the Valuation of Securities (E) Task Force defer action until the Statutory Accounting Principles (E) Working Group developed statutory and accounting guidance; 2) the Reinsurance (E) Task Force consider using the Subgroup to develop expertise on regulatory
transactions; 3) the Reinsurance (E) Task Force clarify whether it envisions an ad hoc process or whether it seeks to create an ongoing capability; 4) staff could survey state insurance departments to gather information on issues and financially engineered solutions they consider to be regulatory transactions and
that industry survey its members to the same effect; 5) the Reinsurance (E) Task Force amend reinsurance model laws and regulations to define eligible
collateral as the stand-alone investment on the SVO List, excluding otherwise eligible collateral that is part of any regulatory transaction or any transaction intended to be used as primary security; and 6) the Task Force amend the P&P Manual to reflect the Subgroup’s determinations.
4 The Subgroup evaluated an instrument that, on a stand-alone basis, was eligible to be part of the SVO List of Investment Securities and the same investment when it is a part of a broader transaction. The Subgroup concluded that when the stand-alone investment was combined with a broader regulatory
transaction, it ceased to be eligible for the SVO List of Investment Securities. Accordingly, the Subgroup concluded that automatic treatment of investments
on the SVO List of Investment Securities as eligible for use as collateral in a reinsurance arrangement or as eligible as primary security should not be permitted because the impact of regulatory transactions must be understood in the context of a specific state, as well as the impact on a specific company and
its affiliates. These observations are applied with greater force to “primary security,” which is a higher standard than the SVO-listed reinsurance collateral
standard under Model #785 and the “admitted assets” standard under statutory accounting.
5 Section 3 B of the NAIC Credit for Reinsurance Model Law (#785) and Section 10 A of the Credit for Model Reinsurance Regulation (#786) refer to
“Securities Listed by the SVO” as eligible collateral for reinsurance arrangements. Actuarial Guideline XLVIII—Actuarial Opinion and Memorandum
Requirements for the Reinsurance of Policies Required to be Valued Under Sections 6 and 7 of the NAIC Valuation of Life Insurance Policies Model Regulation (AG 48) is part of a broader effort to develop a level of reserves (required level of primary security) that must be supported by certain defined
assets (primary security). AG 48 incorporates a modified version of “SVO Listed” in its definition of primary security. The NAIC Term and Universal Life
Insurance Reserve Financing Model Regulation (#787) also contains a definition of primary security like that in AG 48 except that the following clause is not found in AG 48: “… and excluding any securities issued by the ceding insurer or any of its affiliates … .” 6 The referral request from the Reinsurance (E) Task Force relates to guidance in Section 3 B of the NAIC Credit for Reinsurance Model Law (#785) and Section 10 A of the Credit for Model Reinsurance Regulation (#786) that refer to “Securities Listed by the SVO” as eligible collateral for reinsurance
arrangements. Actuarial Guideline XLVIII—Actuarial Opinion and Memorandum Requirements for the Reinsurance of Policies Required to be Valued
Under Sections 6 and 7 of the NAIC Valuation of Life Insurance Policies Model Regulation (AG 48) is part of a broader effort to develop a level of reserves (required level of primary security) that must be supported by certain defined assets (primary security). AG 48 incorporates a modified version of “SVO
Listed” in its definition of primary security. The NAIC Term and Universal Life Insurance Reserve Financing Model Regulation (#787) also contains a
definition of primary security like that in AG 48, except that the following clause is not found in AG 48: “… and excluding any securities issued by the ceding insurer or any of its affiliates … .” It would seem clear that NAIC state insurance regulators intended to refer to the stand-alone assets that the
insurance owns, which is a public or private security that represents the right to receive a stated periodic cash flow not a transaction that has broader
regulatory objectives and an embedded security that could qualify as a security on the Securities Valuation Office (SVO) List of Investment Securities.
Attachment C
Valuation of Securities (E) Task Force
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© 2018 National Association of Insurance Commissioners 1
MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
CC: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: July 25, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) – To Delete the Description of Financial Modeling in Structured Securities Group (SSG) Instructions from
the P&P Manual and Publish Them on the SSG Web-Site
1. Introduction – The Investment Analysis Office (IAO) recommends that the description of the financial modelling
process used by the Structured Securities Group (SSG) be deleted from the P&P Manual and be instead published on the SSG
website. The description of financial modeling was certainly necessary when the methodology was first introduced in 2009.
However, it is general and written at a high level and therefore not particularly instructive in understanding the operations of
the SSG. The proposal mirrors the transfer of text descriptive of SVO filing processes to the VISION platform which was
approved by the Task Force and also with the overall objective of the reformatting and reorganization of the P&P Manual to
remove text from the P&P Manual that is not of immediate relevance to Task Force constituencies. The text proposed to be
deleted and transferred is shown in Section 2 below. Section 3 below would insert a reference and link to the website as was
done with the SVO.
2. Text Proposed to be transferred to the SSG Web-Site
Part Seven - The NAIC Structured Securities Group
Section 6 Analytical Assignments
(a) RMBS and CMBS Subject to Financial Modeling
(ii) The Financial Modeling Process
The SSG shall obtain loan-level analysis of RMBS and CMBS using the selected vendor’s proprietary financial model. The
financial model used by the SSG is expected to provide for each of the analytical steps that follow: a macroeconomic process,
a mortgage loan credit process and a waterfall process.
The macroeconomic process projects the future performance of macroeconomic variables. These variables and various
scenarios to be employed in this step of the financial modeling process will have been determined through the meetings
described in subparagraph (i) above.
Attachment C
Valuation of Securities (E) Task Force
9/4/18
© 2018 National Association of Insurance Commissioners 2
The mortgage loan credit process projects loan performance based on the projected macroeconomic variables and loan
characteristics. The loan characteristics employed may be broadly identified and discussed in the Final Model Criteria
Document to the extent the VOS/TF deems it necessary to ensure attainment of regulatory objectives, but subject to
legitimate commercial and proprietary interests of the financial model vendor.
The results of the mortgage loan credit model provide the scenario inputs to produce a tranche level cash flow “waterfall.”
What follows is, therefore, intended as a general description of one such process.
LOAN-LEVEL ANALYSIS
RMBS – Loan-level analysis begins with historical loan performance. Loans are classified as performing or non-performing.
Based on loan characteristics and macroeconomic variables, transition probabilities are calculated. Because the parameters of
the model are path-dependent, Monte Carlo simulation is used. A random drawing against these calculated probabilities
decides the performance group or exit group (prepayment or default) that the loan will be assigned to during the next month.
The loan-level prediction is then aggregated into pool level projected curve. For purposes of loss severity, the same default
probabilities are applied to maintain consistency. Additional components that contribute to the ultimate loss severity analysis
include collateral deficiency (unpaid balance less REO sales price), lost interest (accrued as servicer advances), expenses
(legal fees, property taxes and brokerage fees) and mortgage insurance considerations.
CMBS – The vendor will review raw loan level data sourced from servicers and trustees for inconsistencies and inaccuracies,
correcting the data where applicable. Based upon SSG directions, the vendor will manually review and re-underwrite certain
loans in each pool based upon size, credit history or other criteria at the discretion of the SSG. In addition to loan level
performance, the vendor’s analysis will reasonably take into account other factors known to bear on long-term property
performance, such as age, size and locational characteristics. The vendor will then utilize market-derived income growth
curves and capitalization rates to project the collateral performance of each loan in a given CMBS issue. Based on parameters
and triggers such as debt service coverage levels, extension parameters and workout periods and costs, produce an outcome
and loss estimate for each loan in the pool.
RMBS and CMBS
Once generated, pool cash flows are passed through the bond waterfall. The “waterfall” is a set of rules derived from the
terms of the contract governing the RMBS or CMBS securitization that determine which bonds get paid principal and interest
and how losses are distributed at a particular point in time. Waterfall models for individual RMBS and CMBS securitizations
can be obtained from a reputable vendor (often referred to as a deal library).
The net present value for the insurer-owned RMBS or CMBS tranche is derived by applying a discount rate to the
projected/probability weighted cash flow. In multiple scenario approaches, the mortgage credit model and waterfall model are
used to calculate the present value of losses under each scenario.
The final valuation is the par value minus the probability weighted present value of losses. The interest rate used to discount
the bond cash flow will be the bond coupon.
(iii) Validation of Modeled Results
The NAIC and SSG staff shall ensure that the vendor has extensive internal quality-control processes in place. In addition,
however, the SSG shall conduct its own quality-control checks of the vendor’s valuation process.
(iv) Publication of Final Results
Attachment C
Valuation of Securities (E) Task Force
9/4/18
© 2018 National Association of Insurance Commissioners 3
Upon delivery by the vendor of values for the RMBS and CMBS portfolio and subject to the final modeling process and
completion of all SSG quality control and validation processes, the SSG shall cause the valuation file for the modeled
insurer-owned portfolio to be delivered to other appropriate NAIC staff for dissemination to insurance companies.
3. Proposed Text for the P&P Manual
Part Seven The NAIC Structured Securities Group
Section 6 Analytical Assignments
(a) RMBS and CMBS Subject to Financial Modeling
(ii) The Financial Modeling Process
Information about the financial modeling process can be found at:
https://www.naic.org/structured_securities/index_structured_securities.htm
G:\DATA\Vos-tf\Meetings\2018\September\Task Force 2018 Transfer SSG Modeling Info.docx
Attachment D
Valuation of Securities (E) Task Force
9/4//18
© 2018 National Association of Insurance Commissioners 1
MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
Cc: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: July 20, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) to Add Administration of Filing Exemption to Description of SVO Operations
1. Introduction – The SVO proposes to amend Part One, Section 2 (a) of the P&P Manual to reflect the transfer of the administration of the filing exemption (FE) to the SVO. The proposed amendment is shown below in red and underlined.
Section 2. Policies Defining the SVO Staff Function
(a) Directive to Conduct Ongoing SVO Operations
The SVO shall conduct the following ongoing operations:
(i) Analysis of credit risk for purposes of assigning an NAIC Designation.
(ii) Valuation analysis to determine a Unit Price.
(iii) Identification and analysis of securities that contain other non-payment risk and communication of this information by
assignment of the NAIC Designation subscript to such securities.
(iv) Other analytical assignments requested by the VOS/TF or members of the regulatory community; in accordance with the
directives, procedures and general methodologies described in this Manual.
(v) Compile and publish the AVS+ products in accordance with instructions in this Manual.
(vi) Administer the filing exemption for insurer owned securities that are assigned publicly available credit ratings and the
verification procedure for securities whose credit rating is communicated to the issuer in a private rating letter.
The SVO requests that the Task Force receive the memorandum and release it for a 30-day comment period.
G:\DATA\Vos-tf\Meetings\2018\September\Task Force 2018 Amend P&P Add FE to SVO Missions.docx
Attachment E
Valuation of Securities (E) Task Force
9/4/18
© 2018 National Association of Insurance Commissioners
MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
CC: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: July 20, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) to Modify the Administrative Symbol “NR”
1. Introduction – Part One, Section 3 of the P&P Manual identifies the Administrative Symbol “NR” and defines it as follows:
“NR” means Not Rated. The symbol is used in the AVS+ Products for bonds and communicates that the information required
to arrive at an NAIC Designation is not available to the SVO or that such information was received too late to be processed
and reflected in the most current AVS+ Products. Bonds assigned an “NR” symbol will be deleted from the Valuation of
Securities (VOS) Process if any information deficiency is not rectified by the end of the first quarter following the previous
year-end.
The SVO proposes an amendment to modify the symbol “NR” and preliminary text as follows:
“ND” means Not Designated.
The balance of the definition would not be modified. The amendment aligns the symbol with the text of the definition and the
description of the SVO assessment it contains. The symbol “NR” has been used in the P&P Manual for many decades. When
initially adopted the use of the word rating would have been intended as a generic description of SVO activity which does not
reflect the more technical and federal regulatory meaning the word rating has acquired. We believe the modification avoids
the possibility of confusion, for example, by associating the word “rating” solely with the SVO administered filing exempt
process.
The SVO requests that the Task Force receive the memorandum and release it for a 30-day comment period.
G:\DATA\Vos-tf\Meetings\2018\September\Task Force 2018 Amend P&P Change NR.docx
Attachment F
Valuation of Securities (E) Task Force
9/4/18
© 2018 National Association of Insurance Commissioners 1
MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
Cc: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: July 20, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) to Delete Old Filing and Documentation Instructions
1. Introduction – The SVO proposes the deletion of text in Part Two, Sections 10 and 11 in the P&P Manual
published as of Dec. 31, 2017, identified in Section 2 below. This proposal mostly involves a single clause that is applicable
to different classes of securities and is inserted with minor variations in a number of sections. The other proposed deletions
recommended in this memorandum are identified in Section 2 with comment balloons. The single clause provides that if a
rated security has to be filed with the SVO despite being filing exempt the reporting insurance company is to submit a
completed securities acquisition report with evidence of the NAIC credit rating provider (CRP) rating which can be in the
form of a copy of the rating letter or of the page of the CRPs rating publication. The clause does not explain the use the SVO
was to make of the rating information. However, the most likely reason for a filing exempt security to be filed with the SVO
is that a state insurance department has instructed the insurer to file the security. Such an instruction supersedes the filing
exemption (FE).1 And in that situation, we should presume that the rating is being rejected by the state regulator and that
SVO documentation requirements would depend on the nature of the security and the concerns held by the department. If the
motivation for the clause differed from above, the conclusion that the clause serves no purpose, can be seen by considering
that current policy requires the SVO to obtain credit ratings directly from the NAIC CRPs for public securities and securities
subject to private rating letter and SVO operations to implement that policy is clearly delineated in the P&P Manual.2 Where
a private letter (PL) rating is not on a data feed the insurer is to provide a copy of the rating letter to the SVO in a portable
document format (PDF). Although this proposal is made independently of the proposal to reformat and reorganize the P&P
Manual, its adoption would further development of the reformatted and reorganized P&P Manual by documenting the
rationale for not carrying these instructions forward into the new manual. We also highlight that the simplification
amendments adopted by the Task Force this year will almost empty the content of Part Two, Sections 10 and 11, (with some
exceptions that are the subject of other proposed amendments)3 making the purpose of this clause more difficult to
understand.
1 See Part Two, Section 2 (b) of the P&P Manual. 2 See Part Three, Section 1 (b) 3 The exceptions are: 1) General instructions for corporate securities which were revised and updated and inserted into Part Three of the reformatted and
reorganized P&P Manual; 2) General instructions for municipal securities which are the subject of a separate amendment; 3) instructions for rated CAPCOs
which are is the subject of a separate amendment; 4) Mutual Funds and Exchange Traded Funds which are the subject of the Comprehensive Fund Proposal
and 5) Valuation Instructions which are the subject of a proposal to delete the instructions from the P&P Manual.
Attachment F
Valuation of Securities (E) Task Force
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© 2018 National Association of Insurance Commissioners 2
The SVO requests that the Task Force receive and release the memorandum for a 30-day comment period.
2. Text Proposed for Deletion
Part Two. Filing with the SVO …
Section 10. Reporting Conventions and Required Documents …
(c) Reporting Conventions and Required Documents
Specific reporting conventions for initial reports that all reporting insurance companies should follow are described below.
(i) Corporate Issues
(A) Rated
In the case of a corporate issue that is rated by an NAIC CRP that must be reported to the SVO for whatever reason despite
the availability of the filing exemption provided in Section 4(d) of this Part, above, the reporting insurance company shall
submit a completed SAR with evidence of the NAIC CRP rating. The evidence can be in the form of a copy (or copies) of the
rating letter from the NAIC CRP or a copy of the page from each NAIC CRPs rating publication showing the date of the
publication. If the issue is rated below “A” or is rated differently by two or more NAIC CRPs, a prospectus and a rating
rationale memorandum from each NAIC CRP that rated the transaction must accompany the submission. Insurance
companies reporting bonds of not-for-profit entities shall follow the same filing conventions applicable to bonds of profit-
making entities.
…
(C) Rated Medium Term Notes
In the case of Obligations defined as medium term notes in the offering prospectus or private placement memorandum, where
the issuer is rated by an NAIC CRP, that must be reported to the SVO for whatever reason despite the availability of the
filing exemption provided in Section 4(d) of this Part, above, the reporting insurance company must file a completed SAR
and evidence of proof of rating or ratings. The evidence can be in the form of a copy of the rating letter from the NAIC CRP
or a copy of the page from each NAIC CRP rating publication showing the date of the publication.
…
(E) Investments in Certified Capital Companies
…
(4) Required Documentation
(a) Rated — In the case of a CAPCO issue that is eligible for filing exemption by virtue of its rating by an NAIC CRP
but filed with the SVO despite the availability of the filing exemption provided for in Section 4 (d) of this Part above the
reporting insurance company shall submit a completed SAR with evidence of the NAIC CRP rating. The evidence can be in
the form of a copy (or copies) of the rating letter from the NAIC CRP or a copy of the page from each NAIC CRP’s rating
publication showing the date of publication. If the issue is rated below “A” or is rated differently by two or more NAIC
CRP's, a prospectus and a rating rationale memorandum from each NAIC CRP that rated the transaction must accompany the
submission. …
(ii) Municipal Issues
(A) Rated
Comment [RC1]: Existing Policy is that the SVO produce NAIC Designations for filing exempt security by translating credit ratings to their designation equivalent using the filing exempt procedure. The SVO operation that implements that policy is to purchase or obtain NRSRO credit ratings, convert them into NAIC Designations using computer processes and publish the NAIC Designation in the AVS Plus. The SVO administrative apparatus for obtaining the credit ratings and getting them into NAIC computer systems is to contract for the delivery of electronic data feeds and in the case of securities subject to private letter ratings to obtain a copy of the letter from the insurer in a PDF format. This text assumes an insurer administered filing exemption and that despite SVO non-involvement in the process the SVO has been asked to assign an NAIC Designation. The most likely reason for an instruction to file a filing exempt security with the SVO is that an insurance department has instructed the insurer to file the security with the SVO. In that specific situation, the nature of the security and of the concerns held by the department would govern the documentation request. If the security is rated, the SVO may or may not decide to consult the research performed by the rating organization. If the SVO decides it needs information from the NRSRO it can discuss the matter directly with the NRSRO analyst for that security.
Attachment F
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© 2018 National Association of Insurance Commissioners 3
In the case of an NAIC CRP-rated municipal issue that must be reported to the SVO for whatever reason despite the
availability of the filing exemption provided in Section 4(d) of this Part above, the reporting insurance company shall file a
completed SAR with evidence of each NAIC CRP. Such evidence can be in the form of a printed copy of a computer screen
display showing the rating as reported by Bloomberg Financial Services, Interactive Data Corporation, JJ Kenny Co, Inc. or
Muller Data Corporation or may be evidenced by submission of a copy of the official statement if the issue is within one year
of the date given for interest payments to begin.
…
(iii) Structured Issues
(A) Rated
In the case of transactions that meet the criteria for Credit Tenant Loan-Variants Requiring an NAIC CRP Rating, as defined
in Part Four, Section 1(a)(vii) of this Manual, debt, common or preferred stock issued by a real estate investment trust,
commercial mortgage-backed securities, residential mortgage-backed securities, collateralized mortgage obligations, asset
backed securities, collateralized bond obligations and collateralized loan obligations, and that must be reported to the SVO
for whatever reason despite the availability of the filing exemption provided in Section 4(d) of this Part above, the insurance
company shall submit a completed SAR, evidence of a current rating from each NAIC CRP and a prospectus or private
placement memorandum for the transaction.
For purposes of this subsection, a current rating is defined as one issued or reviewed within the past 12 calendar months.
Evidence of a current rating may also be submitted in the form of a Bloomberg RCHG screen or other similar screen
acceptable to the NAIC from another information vendor. Evidence of a current rating may also take the form of a final
prospectus or complete private placement memorandum that contains "condition to issuance language." For purposes of this
paragraph, "condition to issuance language" means text within the prospectus or private placement memorandum which
unequivocally states that it is a condition to the issuance of the securities named in the prospectus or private placement
memorandum that the securities shall have been assigned specific ratings by one or more named NAIC CRPs.
…
(B) Unrated
…
(2) Residential Mortgage Backed Securities
Please refer to Part Seven, Section 5 (b) of this Manual for instructions applicable to residential mortgage backed securities
(RMBS).
…
(6) Commercial Mortgage-Backed Securities
Please refer to Part Seven, Section 5(b) of this Manual for instructions applicable to commercial mortgage-backed securities
(CMBS).
(7) Real Estate Investment Trust
In the case of debt or preferred stock of a real estate investment trust (REIT) not rated by an NAIC CRP, the reporting
insurance company shall provide the documentation specified in Section 10(c)(i)(B) of this Part below.
…
(viii) Public Common Stock, Private Common Stock, Warrants, Foreign Common Stock or Preferred Stock
…
Comment [RC2]: These references are proposed for deletion because Part Four of the P&P Manual discusses RMBS and CMBS securities.
Comment [RC3]: This text is proposed for deletion because REIT securities are another type of corporate security so that documentation requirements are the same as for other corporates. This has been clarified in the revised instructions for corporate securities in Part Three.
Attachment F
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© 2018 National Association of Insurance Commissioners 4
(E) Preferred Stock
(1) Rated
In the case of an NAIC CRP- rated preferred stock that must be reported to the SVO for whatever reason despite the
availability of the filing exemption provided in Section 4(d) of this Part above, the reporting insurance company shall submit
any stock purchase agreement and the issuer's Certificate or Articles of Incorporation setting forth the terms and
characteristics and the rights and preferences of the preferred stock and evidence of each NAIC CRP rating which may be in
the form of a copy of the rating letter from the NAIC CRP or a copy of the page from the NAIC CRPs rating publication
showing the date of the publication. If the issue is rated below "A" or is rated differently by two or more NAIC CRPs, a
prospectus or private placement memorandum, the most recent issuer's annual report and a rating rationale memorandum
from each NAIC CRP which rated the transaction must accompany the submission.
…
Section 11. Subsequent Reporting
a) Annual Filing Requirement
(i) Filing Exempt Securities
No subsequent report is required for the purposes of valuation of securities under Part Five, Section 1 of this Manual and no
subsequent report is required for filing exempt securities unless they no longer qualify as filing exempt. Instructions for filing
exempt securities are detailed in Section 4(d) of this Part.
(ii) All Other Securities
Any insurance company that owns a security listed in the VOS Process, which is not filing exempt as set forth in Section 4(d)
of this Part above can satisfy subsequent reporting requirements by filing the additional or annual information described
below. For purposes of this Manual, it is assumed that reporting responsibility is borne by the company that has filed the
Initial Report. However, the SVO recognizes the possibility that the initial reporting insurance company may have sold its
investment. Therefore, any insurance companies with an interest in a security may need to submit the information necessary
to enable the SVO to complete its annual review. Annual filings should be reported to the SVO on the Annual ATF.
…
e) Reporting Conventions and Required Documents
Specific reporting conventions that all reporting insurance companies should follow are described below.
…
(2) Specific Filing Conventions
(i) In the case of a corporate issue rated “A-/A3” or better by an NAIC CRP, that must be reported to the SVO for
whatever reason despite the availability of the filing exemption provided in Section 4(d) of this Part above, the insurer
requesting that the SVO update the NAIC Designation shall file evidence of an NAIC CRP rating. Evidence of a rating may
take the form of a printed copy of the complete Bloomberg Description Screen (“DES”) display, showing the rating(s)
assigned by an NAIC CRP.
(ii) In the case of a corporate issue rated less than “A-/A3” by an NAIC CRP, or rated differently by two or more NAIC
CRPs, the reporting insurance company shall file the issuer's Audited Financial Statement and evidence of rating(s) from all
NAIC CRPs that have rated the security.
…
(ii) Municipal Issues not Filing Exempt
Attachment G
Valuation of Securities (E) Task Force
9/4/18
© 2018 National Association of Insurance Commissioners 1
MEMORANDUM
TO: Kevin Fry, Chair Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
CC: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: August 1, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office
(P&P Manual) – To Align the Recently Adopted NAIC Designation Category with the Description of Notching
1. Introduction – The adopted NAIC Designation Category framework provides the NAIC its own “notching”
framework: i.e., the desired granularity of credit risk and symbols to represent the distinctions in credit risk made pursuant to
the framework.. There are to be seven NAIC Designation Categories for NAIC 1; three for each of NAIC Designations NAIC
2 through NAIC 5 and no NAIC Designation Categories for NAIC 6. SVO proposes to delete the existing definition of
Notches from the P&P Manual as having been replaced by the NAIC Designation Category framework. The deletion of the
notching definition would align the other guidance on notching practices with the NAIC Designation Category table. The text
in section 2 below identifies the proposed deletion and modifies some of the text to simplify the expression of some of the
guidance.
2. Proposed Changes
Section 3. Internal Administration
(b) Definitions of NAIC Designation, NAIC Designation Categories, Valuation Indicators, Administrative
Symbols and Conventions
(i) Definition of NAIC Designation
NAIC Designations are proprietary symbols that the NAIC SVO uses to denote a category or band of credit risk.
NAIC Designations are produced for statutory accounting, reporting, state investment laws and other purposes
identified in the NAIC Financial Regulation Standards and Accreditation Program and or other NAIC developed
regulatory guidance embodied in state law.
NAIC Designations are adjusted in accordance with the notching procedures described in subparagraph (iii) (A), (B)
and (C) below, so that an NAIC Designation for a given security reflects the position of that specific security in the
issuer’s capital structure.
NAIC Designations may also be adjusted by notching to reflect the existence of other non-payment risk in the specific
security in accordance with the procedures described in subparagraph (ii) and (iii) (C) below.
Attachment G
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© 2018 National Association of Insurance Commissioners 2
NAIC 1 is assigned to obligations exhibiting the highest quality. Credit risk is at its lowest and the issuer's credit
profile is stable. This means that interest, principal or both will be paid in accordance with the contractual agreement
and that repayment of principal is well protected. An NAIC 1 obligation should be eligible for the most favorable
treatment provided under the NAIC Financial Conditions Framework.
NAIC 2 is assigned to obligations of high quality. Credit risk is low but may increase in the intermediate future and
the issuer's credit profile is reasonably stable. This means that for the present, the obligation's protective elements
suggest a high likelihood that interest, principal or both will be paid in accordance with the contractual agreement, but
there are suggestions that an adverse change in circumstances or economic, financial or business conditions will affect
the degree of protection and lead to a weakened capacity to pay. An NAIC 2 obligation should be eligible for
relatively favorable treatment under the NAIC Financial Conditions Framework.
NAIC 3 is assigned to obligations of medium quality. Credit risk is intermediate and the issuer's credit profile has
elements of instability. These obligations exhibit speculative elements. This means that the likelihood that interest,
principal or both will be paid in accordance with the contractual agreement is reasonable for the present, but an
exposure to an adverse change in circumstances or economic, financial or business conditions would create an
uncertainty about the issuer's capacity to make timely payments. An NAIC 3 obligation should be eligible for less
favorable treatment under the NAIC Financial Conditions Framework.
NAIC 4 is assigned to obligations of low quality. Credit risk is high and the issuer's credit profile is volatile. These
obligations are highly speculative, but currently the issuer has the capacity to meet its obligations. This means that the
likelihood that interest, principal or both will be paid in accordance with the contractual agreement is low and that an
adverse change in circumstances or business, financial or economic conditions would accelerate credit risk, leading to
a significant impairment in the issuer's capacity to make timely payments. An NAIC 4 obligation should be accorded
stringent treatment under the NAIC Financial Conditions Framework.
NAIC 5 is assigned to obligations of the lowest credit quality, which are not in or near default. Credit risk is at its
highest and the issuer’s credit profile is highly volatile, but currently the issuer has the capacity to meet its obligations.
This means that the likelihood that interest, principal or both will be paid in accordance with the contractual agreement
is significantly impaired given any adverse business, financial or economic conditions. An NAIC 5 Designation
suggests a very high probability of default. An NAIC 5 obligation should incur more stringent treatment under the
NAIC Financial Conditions Framework.
NAIC 6 is assigned to obligations that are in or near default. This means that payment of interest, principal or both is
not being made, or will not be made, in accordance with the contractual agreement. An NAIC 6 obligation should
incur the most severe treatment under the NAIC Financial Conditions Framework.
(ii) NAIC Designation Categories
Upon the determination of an NAIC Designation, the SVO produces NAIC Designation Categories, as described and
defined in Part Two, Section 1 of this Manual below.
NAIC
Designation +
NAIC
Designation
Modifier =
NAIC
Designation
Category
1 A 1.A
1 B 1.B
1 C 1.C
1 D 1.D
Attachment G
Valuation of Securities (E) Task Force
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© 2018 National Association of Insurance Commissioners 3
NAIC
Designation +
NAIC
Designation
Modifier =
NAIC
Designation
Category
1 E 1.E
1 F 1.F
1 G 1.G
2 A 2.A
2 B 2.B
2 C 2.C
3 A 3.A
3 B 3.B
3 C 3.C
4 A 4.A
4 B 4.B
4 C 4.C
5 A 5.A
5 B 5.B
5 C 5.C
6 6
NAIC Designation Categories are a subset of NAIC Designations and are used by the VOS/TF to link the NAIC
risk-based-capital (RBC) framework adopted by the NAIC Capital Adequacy (E) Task Force to the VOS/TF’s credit
assessment process. The NAIC Capital Adequacy (E) Task Force assigns RBC factors to each NAIC Designation
Category as shown below.
(ii) NAIC Designation subscript S
(A) Regulatory Objectives
Regulators attach certain economic expectations to certain of the terms used to describe securities or financial
instruments owned by insurers and reported as invested assets. This reflects that the regulatory objective is to
assess the financial ability of an insurer to pay claims. For purposes of this provision, the regulatory
assumption is that any fixed income instrument denominated debt by its originator or issuer requires the
issuer to make scheduled payments of interest and requires the full repayment of the principal amount on a
date certain. The regulatory assumption for any fixed income instrument denominated preferred stock by its
originator or issuer is that the issuer will make scheduled payments of dividends and return principal subject
to a grant of financial flexibility to the issuer to not pay that is circumscribed by economic events quantifiable
in the context of the issuer’s credit risk profile.
Any contractual modification of these regulatory assumptions is deemed to create a rebuttable inference that
the security or instrument contains an additional or other non-payment risk; albeit one that is sanctioned by
the contract - that may result in the insurer not being paid in accordance with the underlying regulatory
assumption. The purpose of the procedure described in this subparagraph is to authorize and require the SVO
to identify securities that contain such contractual modifications and to quantify the possibility that such
contracts will result in a diminution in payment to the insurer so this can be reflected in the NAIC
Designation assigned to the security through the application of the notching process described in paragraph
(iii) below.
(B) Description of Other Non-Payment Risk
It may not be practical, desirable or possible to specifically define other non-payment risk given the
assumption that it originates as a result of a contractual agreement or the presence of a structural element of a
Attachment G
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© 2018 National Association of Insurance Commissioners 4
transaction that is agreed upon between the issuer and the insurer. Accordingly, what follows is intended as
general guidance to insurers and others.
Most typically, other non-payment risk has been associated with contractual agreements between the insurer
and the issuer in which the issuer is given some measure of financial flexibility not to make payments that
otherwise would be assumed to be scheduled, given how the instrument has been denominated, or the insurer
agrees to be exposed to a participatory risk.
Other non-payment risk differs from the type of issues encountered in credit risk. This is because typically,
credit assessment is concerned with securities in which the parties create subordination by modifying the
lender’s priority of payment (for example, senior unsecured versus junior subordinated) but in a context
where the contract otherwise specifies that the failure to make payments on a schedules basis (defined in the
contract) is an event of default (in the case of a bond) or triggers some other specific and identifiable lender
remedy (in the case of other fixed income securities).
Using the broad concepts identified above, non-payment risk may be present when:
A reporting insurance company takes on a participatory risk in the transaction;
Illustration – The contract promised payment of a dollar denominated obligation in non-US currency
but does not require an exchange rate that would yield foreign currency sufficient to buy a defined
principal amount of US dollars. The other non-payment risk in this illustration consists of the reporting
insurance company’s acceptance of currency risk which may diminish the principal amount of the
investment. Currency risk here is not related to the issuer’s ability or willingness to pay and therefore is
not appropriately reflected in the NAIC Designation of the issuer or captured by notching for credit risk.
The contract governing the loan provides for a degree of permanence in the borrower’s capital structure
that is incompatible with notions of a loan that is expected to be repaid;
Illustration – A loan stated to be perpetual and giving the issuer the right to miss interest or dividend
payments otherwise said to be scheduled where the missed payments are not required to be paid on a
subsequent date.
Illustration – An instrument denominated as a bond but lacking a maturity date, a mechanism to
determine a maturity dates (for example a mandatory redemption) or that states a maturity equal to or
exceeding 40 years.
Agrees to an exposure that has the potential to result in a significant delay in payment of contractually
promised interest and or a return of principal in an amount less than the original investment.
(C) Meaning of the Subscript Symbol
An SVO determination that a specific security contains other non-payment risk is communicated by assigning
the NAIC Designation subscript S to the specific CUSIP and applying the notching procedure described in
subparagraph (iii) (2) below. The subscript follows the NAIC Designation as follows: NAIC 2 S.
(D) Directive to Conduct Analysis for Other Non-Payment Risk
The SVO shall assess securities for other non-payment risk:
Routinely, for any security or financial product filed with the office;
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As part of the analysis of a security or financial product submitted to the SVO under the RTAS –
Emerging Investment Vehicle process discussed in Part Four, Section 3 of this Manual;
When requested to do so by any state insurance regulator acting pursuant to Part Two, Section 2(b) of
this Manual; and
When requested by the Task Force, including in support of the IAWG; or
In support of any other NAIC group engaged in the analysis of investment risks in new securities.
(iii) SVO Notching Guidelines
(A) Definition and Purpose
Notching is defined as the process used to make distinctions between different liabilities in an issuer capital
structure to reflect differences in credit or other non-payment risk smaller than a whole grade. Notching
expresses differences in expected loss (i.e., severity) of an issuer’s liabilities by their relative priority of claim
in bankruptcy.
With the exception of NAIC 6, notching distinctions are expressed by combining an NAIC Designation with
an NAIC Designation Modifier to produce an NAIC Designation Category. For example, as shown in the
table above, NAIC 1 is combined with NAIC Designation Modifier 1.A to produce the NAIC Designation
Category 1.A. Modifiers are used with or assigned to the NAIC 6 Designation.
(B) Notching NAIC Designation Categories (to Reflect Credit Risk)
(1) Illustration
The distinctions in credit risk made in the notching process involve (conceptually) the issuer’s actual
capital structure. The hypothetical capital structure below is shown to illustrate and explain notching:
Senior secured Notch up from the benchmark
Senior unsecured The bBenchmark NAIC DdDesignation
Category
Senior subordinated Notch down from the benchmark
Junior subordinated Notch down from benchmark
Preferred stock Notch down from benchmark
(2) Methodology
The SVO determines the benchmark NAIC Ddesignation Category for the senior unsecured obligation
of the issuer or its equivalent.
The SVO adjusts the benchmark NAIC Ddesignation Category up or down to reflect the difference in
risk between the benchmark security and the specific liability under review by the SVO.
(3) Definition of SVO Notches
The NAIC has not adopted pluses (+) and minus (-) symbols to express incremental gradations of
credit risk of less than a full NAIC category. However, the SVO uses plus and minus symbols
internally to enable more accurate monitoring of issuers and transactions and facilitate upgrades and
downgrades of NAIC Designations. Accordingly, for purposes of this paragraph, a notch is defined as
a movement in the NAIC Designation of less than a full grade. The following table shows all possible
notching possibilities:
NAIC 1; NAIC 1 (-);
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NAIC 2 (+); NAIC 2; NAIC 2 (-);
NAIC 3 (+) ; NAIC 3; NAIC 3 (-);
NAIC 4 (+); NAIC 4; NAIC 4 (-);
NAIC 5 (+); NAIC 5; NAIC 5 –;
NAIC 6.
In the table above, a movement from NAIC 1 to NAIC 2 is a movement of a full grade while a
movement from NAIC 1 to NAIC 2 (+) is a movement of two notches.
(4) SVO Guidelines for Notching
The SVO shall notch an NAIC Designation Category for an issuer up or down to reflect the position of
a specific liability in the issuer’s capital structure.
Notching upward from a benchmark NAIC Designation Category is almost exclusively associated with
transactions in which the SVO determines that covenants or collateral act to further reduce the
probability of default from that implied by the issuer’s senior unsecured NAIC Designation Category.
In determining the number of notches that should be applied to a security, the SVO shall apply the
following guidelines:
(A) Notching Investment Grade Issuers:
The capital structure of an issuer whose current senior unsecured NAIC Designation is NAIC 1
or NAIC 2 is not considered indicative of what the issuer’s capital structure is likely to be at
default. Notching for issuer’s whose senior unsecured benchmark NAIC Designation is NAIC 1
and NAIC 2 is therefore based on the following general guidelines:
Secured debt may beis generally rated one notch above the senior unsecured issuer designation.
Subordinated debt (including junior and senior subordinated) are generally designated one notch
below the senior unsecured rating.
Preferred will generally be designated one notch below subordinated debt (two below senior
unsecured or senior implied).
Holding company debt is generally designated at or below the lowest rated debt security that
would be assigned at the principal operating company.
(B) Notching for Non-Investment Grade Issuers
The capital structure of an issuer whose current senior unsecured NAIC Designation is NAIC 3,
NAIC 4 or NAIC 5 is considered to be more indicative of what the issuer’s capital structure is
likely to be at default.
A greater presumption that the current capital structure is the one with which the issuer will
default attaches as the issuer’s senior unsecured NAIC Designation decreases.
Given the risks associated non-investment grade issuers, nNotching for issuer’s whose senior
unsecured benchmark NAIC Designation is NAIC 3, NAIC 4 and NAIC 5 therefore requires
greater professional judgment and discretion.
As such, Nnotching differentials for issuers with NAIC 3, NAIC 4 and NAIC 5 Designations
aremay be wider than for issuer’s whose senior unsecured NAIC Designation is NAIC 1 or
NAIC 2.
Comment [RC1]: This text would be deleted
Comment [RC2]: Subsequent sections would be renumbered or re-lettered.
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(C) Notching for NAIC Designation Subscript (to Reflect Non-Payment Risk Unrelated to
Credit Risk)
(i) Grant of Significant Discretion
The SVO is granted significant discretion to determine the number of notches it will
assign to a security to reflect other non-payment risk. This discretion is to be exercised in
the context of the regulatory objective and purpose of this procedure. SVO
determinations made under this subparagraph are subject to review in accordance with
the procedures described of this Part, above.
(ii) Relevant Considerations
The name given to the security is not relevant to a determination whether this
subparagraph should be applied. The relevant criterion is whether the risks in the security
are clearly credit risks or whether they are not clearly credit risks.
Factors the SVO may deem relevant to the question of notching for other non-payment
risk may include:
Any security or financial instrument denominated with a term associated with fixed
income investments must contain a clearly stated obligation to pay a return and to repay
the amount of the principal repayment. Otherwise it is not rational or possible to assign
an NAIC Designation.
Any security or financial instrument denominated as fixed income that does not contain a
legally binding obligation to pay shall not be assigned an NAIC Designation and instead
will be reported to the Task Force and the Chief examiner of the State of Domicile.
Any security or financial instrument that is denominated as fixed income and that
contains a promise to pay that is otherwise conditional may be notched either under this
subparagraph to reflect other non-payment risks or under the notching procedure for
credit risk to reflect the expected loss of that obligation in the issuer’s specific capital
structure, depending on which approach seems more appropriate to the SVO.
The widest degree of notching for a security or financial instrument is likely to be for a
security that is denominated as fixed income but which is deemed to be a perpetual
investment and to not require payment of dividends.
In contracts that permit the issuer flexibility to not make payments, the SVO would focus
on the degree of financial discretion afforded the issuer to not make payments and the
circumstances under which that financial flexibility will be exercised;
In contracts where the insurer agrees to accept a risk or participate in an activity that may
reduce either the interest or dividend otherwise agreed on or the amount to be repaid to
less than the original principal investment, the SVO would consider whether the risk of a
loss is structurally or otherwise mitigated;
Notching differentials are expected to be wider for NAIC 3, NAIC 4 and NAIC 5 issuers
because the issuer’s credit risk is deemed to increase the likelihood that the issuer will
avail itself of contractually provided flexibility to not pay or increase the likelihood of a
loss as a result of the insurer’s participatory activity.
Deferral of dividends in a security denominated preferred stock is presumed to be subject
to notching for credit risk subject to an SVO determination that the denomination is not
truly reflective of the terms of the agreement in which case it may be more appropriately
notched for other than credit risk.
In a given capital structure, the priority of payment due to an investor may be so
subordinated as to require treatment under these guidelines for other non-payment risk.
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This is especially true where deep subordination is combined with a right to defer
interest.
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MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
CC: Charles A. Therriault, Director, NAIC Securities Valuation Office
DATE: July 27, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) to Improve Disclosure on Securities Not Eligible for Filing Exemption
1. Introduction – The SVO proposes an amendment to the P&P Manual to delete guidance from Part Three, Section 1
(b) (v) (reproduced below) and transfer it to Part Three, Section 1 (b) (i) as shown below. The recommended placement
would ensure guidance on securities that are not filing exempt is presented with the initial guidance explaining the filing
exemption. The SVO also proposes to expand the section by adding categories of securities that the P&P Manual already
identifies as not filing exempt but that were never added to the initial text. We insert comment balloons that cite the relevant
sections of the P&P Manual that specify that the indicated population of securities is not filing exempt.
2. Proposed Amendment – The proposed amendment and the text proposed for deletion are shown below.
Part Three Credit Assessment
b) Procedure Applicable to Filing Exempt (FE) Securities and to Private Letter (PL) Rating Securities
(i) Filing Exemption
Bonds, (excluding RMBS and CMBS) and Preferred Stock that have been assigned an Eligible NAIC CRP Rating, as
described in Part One, Section 4 (c) (ii) (B) of this Manual, are exempt from filing with the SVO (FE securities) with the
exception of Bonds and or Preferred Stock that fall into the categories identified below.
Specific Populations of Securities Not Eligible for Filing exemption
The filing exemption procedure does not apply to:
1) SCA investments
SCA investments are transactions between insurance company affiliates (called related parties) that are subject to special
regulatory considerations identified in Statement of Statutory Accounting Principles (SSAP) No. 25–Affiliates and Other
Related Parties. The P&P Manual specifies that such transactions are not subject to filing exemption and can only be
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assigned an NAIC Designation if the SVO has first concluded that the transaction is like those the SVO typically
assesses for credit risk. See the SCA section in this Part for further information about how the SVO determines whether
an SCA investment will be assigned an NAIC Designation.
2) Catastrophe-Linked Bonds
Catastrophe-Linked Bonds are deemed to be filing exempt but only if the NAIC CRP has assigned a credit rating based
on the type of methodology specified in this Manual.
3) Shares of Funds
This Manual provides for certain mutual funds, Bond Funds and Exchange Traded Funds be submitted to the SVO for a
determination that they meet characteristics identified by the VOS TF for more appropriate regulatory treatment.
4) Regulatory Transactions
The term Regulatory Transaction is broadly defined in this Manual as a transaction engineered to address a regulatory
concern one or more insurers have or may have that should or must be submitted to a state insurance department for
approval and that has as a component a security or other instrument which on a stand-alone version may be eligible for
assignment of an NAIC Designation by the SVO. The SVO is prohibited from assigning an NAIC Designation to a
Regulatory Transaction except in relation to a special assignment conducted for a state insurance department under the
Regulatory Transaction procedure discussed in this Manual. Also insurers are prohibited from claiming a Regulatory
Transaction as a filing exemption.
5) Credit Tenant Loan (CTL)
A Credit Tenant Loan is a mortgage loan made primarily in reliance on the credit standing of a major tenant, structured
with an assignment of the rental payments to the lender with real property pledged as collateral in the form of a first lien.
This Manual identifies four categories of CTLs as eligible for reporting on Schedule D conditioned on an SVO
determination that the transaction meets the criteria specified by the VOS/TF for Schedule D treatment. A transaction
that purports to be a Credit Tenant Loan, including one that is assigned a credit rating by an NAIC CRP, is not eligible
for Schedule D reporting unless the SVO confirms that the transaction is eligible for Schedule D reporting and assigns
the transaction an NAIC Designation.
6) Replication (Synthetic Asset) Transactions (RSATS)
Replication (Synthetic Asset) Transactions (RSATs) structured in accordance with any of the definitions of an Approved
RSAT are presumed to be an Approved RSAT but should be submitted to the SVO. RSATs structured to contain
elements of risk other than those normally associated with the Defined RSAT descriptions and transactions involving
assets that would not normally qualify for an NAIC Designation are not eligible for the Approved RSAT safe harbor and
must be submitted to the SVO.
7) Working Capital Finance Investments (WCFI)
WCFI are programs involving the purchase of confirmed receivables and are submitted to the SVO via the RTAS
process.
Part Three Section 1 (b) (v) would be deleted as shown below:
…
(v) Application of the FE Procedure to Specific Populations
The filing exemption procedure does not apply to investments required to be filed pursuant to Part Two, Section 8 of
this Manual (the reference is to SCA Investments);
Catastrophe-Linked Bonds are filing exempt provided the credit rating assigned to them by a CRP was derived in a
specified manner. Please refer to Part Four, Section 4 of this Manual.
Comment [RC1]: Part Two, Section 8 provides
that SCA investments are to be filed with the SVO.
Part Three Section 1 (b) (v) refers to Section 8 and
excludes SCAs from filing exemption.
Comment [RC2]: The rule is stated in Part Four,
Section 4 (a) (ii).
Comment [RC3]: Part Six, Section 2 provides for
the US Direct and Full Faith and Credit Exempt List,
the Bond Fund List and ETFs. The SVO is to verify
that funds proposed to be added to the US Direct and
Full Faith and Credit Exempt List or Bond Funds
Lists meet the specified eligibility requirements.
ETFs proposed to be added to the either the ETF
Bond or ETF Preferred Stock List have to be filed
with the SVO via the TAS process. In these three
cases, the SVO determination that specified criteria
is met permit the more appropriate reporting.
Comment [RC4]: The P&P Manual provides that
Regulatory Transactions cannot be entered into any
of the processes (i.e., databases) that are used to
create the SVO List of Investment Securities. See
Part One, Section 3 (e); (g) - (j) and Part Two
Section 2 (a).
Comment [RC5]: The P&P provides that CTLs
are mortgages if they do not meet specified criteria
and bonds if they do. Insurers are required to submit
the transactions to the SVO and the SVO is required
to make the determination. Part Four, Section 1 (a)
(C).
Comment [RC6]: Part Four, Section 2 (a) (i) A
and B specify submission to the SVO.
Comment [RC7]: Part Three, Section 6
authorizes the specific version of receivables
program and requires pre-approval of individual
programs by the SVO.
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MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
Cc: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: July 24, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) – To Modernize Credit Substitution Methodology
1. Introduction – The SVO proposes to amend Part Three, Section 2 of the P&P Manual (shown in Section 2 below)
by replacing it’s text with a modernized and more detailed description of credit substitution methodology (shown in Section 3
below). Credit substitution methodology refers to a technique in which an NAIC Designation is assigned to a security on the
basis of the credit strength of a third party (instead of the borrower/obligor) on the basis of an unconditional and legally
enforceable promise made by the third party to pay the insurance company the money due to it from the borrower. The
current text provides only general and conceptual guidance. The proposed text provides a framework for analysis. The SVO
requests that the Task Force receive the proposed amendment and release it for a 30-day comment period.
2. Text Proposed for Deletion
Part Three. Credit Assessment
Section 2. Corporate Bonds and Preferred Stock – Special Assessment Situations
Credit Enhanced Transactions
A credit enhanced transaction is one in which the application for an NAIC Designation is based on the substitution of the
credit rating of another party for that of a lesser rated obligor. The credit substitution is effected through the use of
contractual arrangements that bind the other party to make full and timely payment directly or indirectly to noteholders, to
make such payments upon obligor default or to purchase the obligation. The promise of the obligor to make the required
payments shall be represented by a guarantee, a revolving credit agreement, financial insurance policy or other credit
enhancement device.
The staff shall focus on the extent to which the legal documents ensure that the credit strength of the support entity flows
through unimpeded to the security holder. The SVO shall examine the degree to which the payment obligation of the other
party assures full and timely payment of all amounts due to security holders. Factors relevant to this analysis include:
irrevocability of the supporting party's obligation to pay, the effect of debtor insolvency on payments made by the debtor
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and/or the other party to the insurance company lender and the other party's credit rating. The analyst may review corporate
resolutions of the issuer, the guarantee or other agreements binding the other party to pay for the debt of the debtor, the
indenture or other similar document governing the remedies, opinions of counsel regarding enforceability of the obligation of
the other party, the payment stream under applicable insolvency laws or other regulatory regime, or any other documentation
that may be considered necessary.
3. Proposed Replacement Text
Part Three Credit Assessment
Section 2 Corporate Bonds and Preferred Stock – Special Assessment Situations
Credit Substitution
Filing Requirements
1) Executed copy of the 3rd Party Credit Substitution Instrument (defined below) covering all monies owed under the
underlying obligation and having a tenor at least equal to that of the underlying obligation.
2) If the provider of the Credit Substitution Instrument and the Issuer/Obligor has been assigned a credit Rating by an
NAIC CRP, the filer provides their most recent annual financial statements. If the provider of the Credit Substitution
Instrument and the Issuer/Obligor has not been assigned a credit rating by an NAIC CRP, then the filer follows the
documentation requirements for an Initial Filing.
3) A legal opinion of counsel in the jurisdiction where the obligation would be enforced is always desirable and may be
required, depending on the complexity of the transaction, discussing legal enforceability as described in the definitions of
Credit Substitution Instrument below.
Definitions
The following terms have the meaning shown below:
Credit Substitution Methodology means and refers to an analytical technique in which an NAIC Designation is assigned to a
security on the basis of the credit strength of a third party with a high credit worth who has made an irrevocable,
unambiguous, unconditional and legally enforceable promise to pay the insurance company lender on a full and timely basis
the money due to the lender from a named borrower (whether related or unrelated to such third party) of lower credit worth or
to purchase and perform the obligation itself; in either case in accordance with underlying written agreements.
Credit Substitution Instruments means and refers to any one of a number of instruments, known to be governed by
ascertainable legal frameworks that define the contractual, legal and other elements necessary to make a promise to pay the
debt of another enforceable in a given jurisdiction. Credit substitution instruments include documentary letters of credit,
guarantees, financial guaranty agreements, financial guaranty insurance (as these terms are defined below) and may include
other instruments provided the legal framework that governs such instruments is identified and legal enforceability of the
promise to pay the debt of another can be analyzed and incorporated into the credit assessment. Credit substitution
instruments do not include suretyships or comfort letters, as defined below.
Documentary Letter of Credit means an undertaking given by a third party issuer (typically a bank) to a beneficiary (i.e., the
insurance company lender) at the request or for the account of the applicant (the borrower) that requires the issuer to pay the
amount of the credit solely on presentation of a specified document that complies strictly with the terms and conditions of the
letter of credit (the document) and that prohibits non-documentary terms and conditions to payment such as the examination
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of questions of fact or of law pertaining to the underlying contracts or the assertion of defenses to payment derived from such
underlying contracts. Legal regimes that exclude non-documentary conditions to payment include the Uniform Commercial
Code (UCC), the Uniform Customs and Practices for Documentary Credits (UCP) and may include other legal regimes for
letters of credit.
Guarantee means a contractual arrangement negotiated between a third party (the guarantor) and the borrower and lender (an
insurance company) in which the third party agrees to pay promptly and in full, money due from the borrower to the
insurance company; unconditionally, or on the sole condition that the borrower has failed to make a payment; and in which
the third party promises not to pursue repayment from the borrower until the third party’s obligation to the insurance
company is fully performed. The term unconditional in the preceding sentence means that the third party expressly waives in
writing all common law and statutory defenses to payment pursuant to a stated intent to create a direct obligation to pay the
insurance company the amount of money owed by the borrower and which provides a procedure or mechanism for demand
for payment with the sole condition to payment being the borrower’s default as triggering the insurance company’s right to
demand payment and the third party’s obligation to pay. The term guarantee encompasses joint and several guarantee
arrangements in which multiple persons agree to pay the insurance company the debt owed to it by the borrower provided
each person so promising agrees to be bound for the entire amount due. The term guaranty excludes suretyships governed by
suretyship law in which the third party retains the right to assert defenses to payment under common law, statute or
transaction specific events or occurrences. The term guarantee excludes comfort letters as defined below. Guarantees are
governed by the general contract law of the jurisdiction.
Financial Guaranty Insurance means an absolute, unconditional, and irrevocable obligation to pay the named (insurance
company investor) insured for the non-payment of principal and interest when due by the named borrower, the underlying
obligation. The third party either waives all common law and statutory defenses to payment or structures the obligation so
that such defenses to payment are not implicated. Financial Guaranty Insurance are subject to state insurance laws, suretyship
law and general contract law.
Agreement to Purchase mean a written contract in which the third party agrees with the insurance company that in the event
the borrower defaults on its payment obligation, the third party will purchase the insurance company’s claim for the amount
of the monetary obligation consisting of outstanding principal and accrued interest and thereby assume and perform it.
Agreements to pay are governed by general contract law.
Comfort Letters means and refers to a number of documents that promise support of a limited kind to a subsidiary or
affiliated entity. Comfort letters may be called letters of assurance, keep-well letters, keep-well agreements, letters of
awareness, letters of responsibility and letters of support typically issued by a parent corporate entity. Some comfort letters
provide quantifiable support such as minimum net worth agreements, operating agreements and debt service reserve make-up
provisions and some comfort letters provide enforceable remedies. The SVO may reflect quantifiable support and the benefit
of legal enforceability of remedies in the NAIC Designation by notching upward from the subsidiary’s stand-alone NAIC
Designation but comfort letters are not Credit Substitution Instruments. In connection with a comfort letter to be evaluated
for the value of quantifiable support or legal enforceability of remedies for purposes of notching, an insurance company may
provide the SVO the insurance company’s internal assessment of the economic value and enforceability of the comfort letter,
an explanation of the procedures used by the insurance company to grade the comfort letter and a written legal opinion of
reputable local counsel on legal enforceability in the jurisdiction where the agreement would be enforced, translated into
English, if written in another language. The insurance company may also submit its assessment of the likely behavior of the
supporting entity in the event that the supported entity requires support.
Outline of Credit Substitution Methodology
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Transactions that are candidates for credit substitution analysis are structured to rely on the credit quality of the third party.
Documentation for such transactions would include the Credit Substitution Instrument and the agreements between the third
party, borrower and lender pertaining to the third party’s promise to pay for the debt of the borrower. The analyst:
1. Considers the stand alone credit quality of the borrower and that of the third party to determine if the difference in credit
quality of the third party and obligor warrant and justify the application of credit substitution methodology.
2. Reviews the documentation to confirm that credit substitution methodology provides the most accurate approach to
identify, measure, and quantify the business and operational risk of the obligor, business or transaction. The review also
confirms that the purpose of a credit substitution instrument in the transaction is not as collateral or as a structural
element to address structural subordination or for a purpose other than credit substitution. The review permits the analyst
to summarize the transaction in appropriate so that the obligation owed by the obligor to the insurance company can be
compared to that undertaken by the third party to the insurance company. The summary includes terms and conditions,
maturity, amount of the debt obligation, mandatory payment schedule, security, identification of borrower/issuer and
guarantors, descriptions of how demand is made to the third party for payment under the Credit Substitution Instrument
and how the third party makes the payment, events of default, key definitions and unique terms.
3. Identify the relationship of the third party to the borrower and that of other key parties in the transaction as well as the
wider business enterprise (including affiliates and subsidiaries) of which the third party and borrower are a part.
4. Quantifies the borrower’s payment obligation to the insurance company lender under all circumstances and conditions;
reviews the conditions under which the Credit Substitution Instrument can be amended or terminated and the maturity of
the Credit Support Instrument in relation to the tenor of the borrower’s obligation; evaluates the procedure governing
requesting and receiving payment under the Credit Substitution Instrument and whether it results in full and timely
payment and determines whether the third party is obligated to pay the entire amount due to the insurance company from
the borrower.
5. Determines whether the use of credit substitution as an analytical technique is appropriate.
6. Evaluates legal enforceability of the Credit Substitution Instrument. The analyst uses the information from the preceding
steps of the methodology and evaluates it against the principles expressed in the definition of the specific Credit
Substitution Instrument and opinions of legal counsel in the jurisdiction where the promise would be enforced, if
provided, to evaluate legal enforceability. The specific issues that are considered in the assessment of legal enforceability
vary in accordance with the facts of the transaction and the legal regime and legal principles applicable to the Credit
Substitution Instrument. However, the following are a general description of the type of issues the analyst confirms in
enforceability analysis:
a) The third party promises to pay the entire obligation and not only any deficiency remaining after the insurance
company exhausts all remedies against the collateral and the primary obligor(s);
b) The third party agrees to pay the obligations on the date due and waives demand, notice, marshaling of assets, and
any other defenses to payment;
c) The third party may not terminate or amend the support unless and until the obligation owed to the insurance
company has been fully performed.
d) The Credit Substitution Instrument:
Does not condition the promise to pay in relation to the value, genuineness, validity, or enforceability of the
guaranteed obligations;
Repudiates circumstances or conditions that would release it from the stated payment obligation.
Waives rights of set-off, counterclaim, and related rights;
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Provides that the obligation to make a particular payment reinstates if a payment made by the primary obligor is
recaptured as a result of the obligor's bankruptcy or insolvency;
Provides that the holders of the obligations are beneficiaries of the Credit Substitution Instrument and
Identifies that the Credit Substitution Instrument ranks not less than as a senior unsecured obligation pari- passu
with those of the third party’s existing creditors.
7. Evaluates the third party’s motivation and likely willingness to perform its promise under the Credit Substitution
Instrument and related documents and in context of the relationship of the borrower and the third party.
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MEMORANDUM
TO: Kevin Fry, Chair, Valuation of Securities (E) Task Force
Members of the Valuation of Securities (E) Task Force
FROM: Robert Carcano, Senior Counsel, NAIC Investment Analysis Office
Cc: Charles A. Therriault, Director, NAIC Securities Valuation Office
Eric Kolchinsky, Director, NAIC Structured Securities Group and the Capital Market Bureau
DATE: July 24, 2018
RE: Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P
Manual) – Delete the Process for Placing Securities Under Regulatory Review; When Analytical Instructions Are
Insufficient or Inadequate
1. Introduction – The SVO recommends that the Task Force delete the process for placing securities under regulatory
review (the process). The process was adopted in response to a determination of the Task Force to treat a widely held filing
exempt security differently than other regulators and inconsistently with the risk assumptions made by investors on the basis
of nationally recognized statistical rating organization (NRSRO) credit ratings. This surprised insurer and non-insurer
investors and was deemed by some to have disrupted the capital markets for the affected securities. Our recommendation
reflects that today more robust procedures exist to protect against disruption of capital markets than was the case in the period
2004 - 2005.1 The recommendation also reflects that the process assumes that SVO or Structured Securities Group (SSG)
Directors would have the tools, staff and funding to monitor rated and unrated market activity in sufficient depth to permit
them to “promptly inform the Chair of the Task Force” of the need to formulate new policy. The NAIC Open Meeting policy
and procedures, the process governing amendments to the P&P Manual and the Accounting Practices and Procedures Manual
(APPM);2 the policy on coordination
3 and the specialized knowledge of other regulators groups which requires referral to
such groups as well as changes to Task Force operations are stronger inducements and safeguards to public notice and
discussion than those provided by the process.
2. Discussion –The Task Force adopted and implemented a policy of complete reliance on NRSRO credit ratings.
Although the Task Force transferred administration of filing exemption to the SVO applicable policies limit SVO to
translation of credit ratings to NAIC Designations. SVO has no discretion to ignore an NRSRO credit rating and no authority
or discretion to require an insurance company to file a filing exempt security for an analysis. Neither SVO nor the SSG have
specified missions in the P&P Manual to comprehensively monitor or study activity in the filing exempt space. The decisions
made by the Task Force acknowledge that an intervention in the operation of the filing exemption would require an exercise
1 See, Improving Transparency in State Regulation of Insurer Investments, Subcommittee in Capital Markets, Insurance and Government Sponsored
Enterprises of the Committee on Financial Services, US House of Representatives, Sept. 20, 2006 and Report on Transparency of the NAIC Securities Valuation Office, Attachment Two in 2006-4 NAIC Proc. V II 1903; 1930. 2 See, Part One, Section 6 of the P&P Manual 3 See, NAIC Policy Statement on Coordination of the Accounting Practices and Procedures Manual and the Purposes and Procedures Manual of the NAIC Investment Analysis Office” adopted Feb. 8, 2018 as Part One, Section 2.
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of regulatory authority by the Task Force.4 Accordingly, the expectation expressed in the process that IAO Directors
promptly inform the Chair of the Task Force when market developments requires new policy is more expressive of a desire
than of reality, especially when interpreted against current SVO assignments and organization. The Task Force has publicly
discussed an expectation that as a result of the transfer of filing exemption, the SVO will be able to study and monitor the
filing exempt population and make recommendations as to risks to be examined and recommendations for the improvement
of filing exemption. SVO has publicly expressed that fulfilling this regulatory expectation will require the Task Force to
identify aims and objectives and to develop transparent procedures so the SVO, industry and other parties understand how
SVO activity can impact capital decisions. These discussions are consistent with the intent of the process. In the meantime,
the SVO believes that there have been a number of important developments that permits the dissemination of information on
regulatory expectations capital market participants can use to structure securities. One is the robust development of statutory
accounting guidance in relation to investment securities and the linkage to Task Force operations provided by the
coordination policy adopted by both groups. Among other mechanisms the most useful has been the regulatory treatment
assessment service (RTAS) which permits NAIC staff (at the SVO, SSG and FRS) to explain state regulatory standards to
broker-dealers and issuers of securities who can use that information to structure securities insurers may want to buy. RTAS
also permits NAIC staff to learn of issues that can be elevated to the appropriate NAIC regulator group.
3. Text Proposed for Deletion
Part One Purposes, General Policies and Instructions to the SVO
…
Section 2. Policies Defining the SVO Staff Function …
(f) Process for Placing Securities Under Regulatory Review; When Analytical Instructions Are
Insufficient or Inadequate
(i) Notice
The Director shall promptly inform the Chair of the VOS/TF of his or her conclusion that market or other
developments; the aspects of a new or existing security, financial instrument or analytical situation, requires the NAIC
to formulate new financial solvency policy or develop new or additional instructions and or methodologies for the
SVO. The Director shall prepare a written report for the VOS/TF explaining the reasoning that led to the conclusion.
(ii) Deliberation
The Chair shall call a meeting of the VOS/TF to consider and discuss the SVO report and the issues it presents and to
consider how to proceed. If the VOS/TF determines that the nature of the security and/or the issues raised by the SVO
requires formulation of new policy or regulatory instructions or the development of new or additional instructions
and/or methodologies, the VOS/TF shall consider whether to declare the security or financial product to be under
regulatory review.
On its own initiative or at the direction of the NAIC Executive Committee, the Financial Conditions (E) Committee
may instruct the VOS/TF to place a security under regulatory review. The VOS/TF may, on its own initiative place a
security under regulatory review as discussed in this section.
(iii) Hearing and Declaration
If the VOS/TF is instructed or if it determines that a security should be formally declared to be under regulatory
review, it shall hold a public hearing to discuss the issue and make a formal declaration of this decision. The staff shall
4 The Task Force authority to prescribe rules for filing exempt securities is expressed in the NAIC Policy on the Use of Credit Ratings of NRSROs in Part One, Section 4 of the P&P Manual.
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cause notice of the determination to be published to interested persons and to other NAIC groups that have jurisdiction
over reporting issues, have relevant expertise or would be affected by the activities of the VOS/TF.
(iv) Reporting Framework for Securities under Regulatory Review
Upon a public declaration that a security is under regulatory review, insurance companies that own the security shall
report it on the NAIC Financial Statement Blank with the administrative symbol NR* if the security is under review
for an assessment of regulatory policy for the investment or regulatory reporting instructions to implement applicable
policy or with the administrative symbol Z* if the security is under regulatory review for development by the VOS/TF
of the instructions or methodologies for application by the SVO in its risk assessment.
In September of each year, the VOSTF will publicly identify which classes of securities, if any, are under regulatory
review and therefore eligible to take the regulatory treatment prescribed for NR*/Z* in the Annual Statement
Instructions for that year's year-end NAIC Financial Statement Blank.
(v) Filing of Securities under Regulatory Review
Unless the VOS/TF shall provide other instructions to insurance companies, securities under regulatory review that
are otherwise reportable to the SVO shall continue to be filed with the SVO during the period of regulatory review.
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