US Life Insurers Face Modest Benefits From NAIC’s Risk Based Capital for CLOs – Moody’s

Most U.S. life insurers with CLO holdings of at least $1 billion would see their risk-based capital charges fall under the preliminary loss scenario probability distribution published in December by the National Association of Insurance Commissioners, or NAIC, according to Moody’s Investors Service, but the impact would be modest.

Across the five insurers potentially most affected by the move to risk-based capital, the total impact on required capital was $405 million. Only two firms, however (Wilton Re US and Fidelity & Guaranty Life), would experience declines of over 5%.

The NAIC is seeking to eliminate what it considers capital arbitrage related to CLOs and other structured securities, whereby in the existing framework the capital charges for all the tranches in a securitization can be less than for the underlying portfolio. The regulator has said it plans to implement the final rules by the end of 2025.

In December 2024, the NAIC published preliminary distributions for 10 default and recovery rate scenarios, substantially increasing the weight of the more adverse scenarios from the previously proposed distribution. The four most stressed scenarios now total 11%, against under 2% before.

Moody’s applied these distributions to the insurers’ year-end 2023 CLO holdings, calculating a capital loss for each tranche and mapping it to an NAIC Securities Valuation Office, or SVO, designation. Compared with the CLO tranches’ existing designations, most tranches originally rated single-A or better saw an improvement in designation (or flat for triple-A), while those rated lower mostly deteriorated, resulting in higher capital charges.

As previously reported, shorter-dated tranches “had less onerous capital impacts” than longer-dated ones. Moody’s noted that if the new rules are implemented as proposed by the end of this year, the SVO approach could further incentivize insurers to invest toward the top of the capital structure and also in CLOs “later in their life cycle or in their amortization period.”

The NAIC’s Risk-Based Capital Investment Risk and Evaluation Working Group is due to hold a meeting on Monday, March 24, in which the American Academy of Actuaries will give an update on its work on CLO collateral modelling and identification of comparable attributes for C-1 factors.