Overseeing Designations and the Prudent Use of Agency Ratings

The post-Global Financial Crisis (GFC) low-yield environment had insurers move more heavily toward higher-yielding alternative assets. These included strategies using private placements of debt and equity, structured products, and lower-cost, efficient investment vehicles, often bespoke private, non-SEC registered funds designed to address insurers’ unique needs. To date, the changes to investment guidelines have tactically responded to changing market conditions. The Financial Condition (E) Committee August 2023 memo outlines a holistic rethink of how insurers' investments are regulated, recognizing the need to modernize the framework.

This report addresses one aspect of the proposal by outlining candidate principles along with roles and responsibilities for overseeing designations and a mechanism that would allow for the prudent use of rating agencies–without mechanist reliance on such ratings or wholesale outsourcing of risk analysis to the NAIC. The mechanisms we propose to oversee designations deliberately consider the efficient use of resources, including NAIC staff, rating agencies, and other external solution providers. They also deliberately address challenges in credit risk measures and assessing their performance, including:

• Measures of default risk, an inherently remote event, cannot be assessed robustly given the dearth of default data.
• Level-setting risk across asset classes is challenging because different risk factors impact different credit segments (e.g., corporate vs. municipal).
• Controlling for variation in methods and standards across Credit Assessment Providers whose methods necessarily involve subjectivity.
• Avoiding conflicts of interest driven by rating agencies’ commercial incentives and insurers’ desire to, all else equal, minimize capital.

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