NAIC principles-based bond classification: A data driven approach

This article was written by Kate Lee, Global Head of Regulatory Enterprise Data, Jason Palsgrove, Regulatory Product Manager, and Thomas Labbe, Global Regulatory Product Manager at Bloomberg

How much will this new regulation impact my company’s capital requirements? How can I make sure I have a robust process in place to ensure compliant classification of holdings? Are there any grey areas where consensus on interpretation has still not been met? These are some of the questions we receive on a daily basis from industry participants in the insurance sector. 

The National Association of Insurance Commissioners (NAIC) has introduced significant changes regarding how insurance companies must report assets beginning in January 2025. In a nutshell, the revised guidance stipulates that insurers must classify bonds with an emphasis on the substance of a bond, as opposed to a legal form, which was previously a determining criterion. 

Ongoing efforts and data challenges

Insurance companies filing periodic reports with their respective state insurance regulators must implement a process to classify all existing positions on their books, as well as assign classifications automatically and systemically to new investments going forward. Significant time has been spent during 2024 by companies evaluating solutions and reviewing their portfolios.  

While much progress has been made, intensive efforts continue, and this change will require continued effort and vigilance throughout the coming year, as the industry adapts and clarifies some of the remaining questions surrounding the classification. 

This can largely be characterized as a data problem in which filing firms need to identify data elements, understand how they can be used to drive classification of assets, and formulate a plan to store attributes to be able to adequately demonstrate compliance. The biggest challenge by far sits with Asset-Backed Securities (ABS), around which guidance is vague, and collateral data is not consistently available. Add to that the fact that “substantive credit support” continues to be open to interpretation with a lack of consensus among insurance companies. 

Considerations for ABS evaluation

When evaluating ABS, the first question that must be answered is whether the bond represents a financial or non-financial asset. Financial assets include loans on residential properties, commercial properties, and automobiles, among other things. The level of original credit enhancement is the primary determining factor regarding these assets. The combination of the seniority of the bond in the structure as well as the overcollateralization of the structure contribute to this number. Ultimately, determining whether a bond has a “substantive” level of enhancement is subjective. Notably however, Bloomberg provides quantitative data, where available, to enable systemic evaluation of large numbers of securities. 

Non-financial assets are most commonly lease payments, but can also extend to other payment rights and receivables as well as royalties. These have proven to be the most difficult and require the most effort. The guidance stipulates that in the case of these exposures, one must analyze the cashflows to the bondholder and confirm that the bond is not overly reliant on a refinancing event to repay principal to the holder.  

Bloomberg’s extensive database of securitized positions, along with cashflow projections, both modeled and contributed, provides a basis for analysis that can help to minimize the manual effort in these cases. Where cashflows are projected to pay in excess of 50% of principal prior to the final payment date, one may choose to apply the “practical expedient”, saving time and manual effort that would otherwise be required for non-financial securities. Ideally, this leaves firms with relatively few positions that require prospectus examination and manual classification. 

In conclusion, insurance companies cannot completely remove the subjectivity that is inherent in regulatory guidance such as this. However, using a trusted data source and applying data in a consistent and automated way allows firms to demonstrate a robust compliance program to regulators, while minimizing time spent performing manual and labor-intensive research. 

How can we help?

The Bloomberg NAIC Principles-Based Bond solution provides firms with an automated classification indicator that communicates with four data fields: 

• NAIC Principles-Based Bond Class whether securities are issuer credit obligation (ICO), qualified asset-backed securities (ABS), or not a principles-based bond 

• NAIC Principles-Based Bond Attribute whether securities have been tested to meet the conclusion with a specific rationale such as the availability of credit support 

• NAIC ABS Asset Type whether securities are financial assets or cash-generating non-financial assets in the case of ABS 

• NAIC Principles-Based Bond Characteristic whether securities have any specific characteristics such as callable or sinkable feature 

To learn more about Bloomberg’s NAIC Principles-Based Bond solution click here.