States Continue to Adopt NAIC Liquidity Stress Test Updates

In December 2020, the National Association of Insurance Commissioners (the NAIC) adopted revisions to the Insurance Holding Company System Regulatory Act (the “Model Law”) that require large life insurers to report the results of a specific year’s Liquidity Stress Test (“LST”). The 2020 revisions also added group capital calculation reporting for all insurance company holding systems, which we explore further here.¹

According to the NAIC’s Financial Analysis Handbook, the primary goals of the LST, and the specific stress scenarios utilized, are:

• First, for macroprudential uses to allow the Financial Stability (E) Task Force to identify amounts of asset sales by insurers that could impact the markets under stressed environments. Thus, the selected stress scenarios are consciously focused on industry‐wide stresses that can impact many insurers within a similar timeframe.
• Second, the LST is also meant to assist regulators in their microprudential supervision, in the context of being helpful for domiciliary and lead state regulators to better understand LST programs at those legal entities’ insurers and insurance groups.

Additionally, the NAIC clarified that while liquidity risks exist in other insurance segments, the task force focused on large life insurers due to the long-term cash buildup involved in many life insurance contracts and potential for large-scale liquidations of assets.

Filing Requirements

Generally, the 2020 Model Law revisions to the Enterprise Risk Filings section require all insurers that are scoped into the NAIC Liquidity Stress Test Framework to file the results of a specific year’s LST to the insurance holding company system’s lead state commissioner as determined by the procedures within the Financial Analysis Handbook adopted by the NAIC. See Model Law Section 4(L)(3).

Like the Form F filing, the LST results only need to be prepared for and submitted to the insurance holding company system’s lead state. See Model Law Section 4(L)(3) (“The filing shall be filed with the lead state commissioner of the insurance holding company system. . . .”). Accordingly, if an insurance holding company system’s lead state has not adopted the 2020 Model Law revisions, it is not required to perform and file the LST for those entities that are scoped in (adoption status of the 2020 Model Law revisions is discussed below.)

Furthermore, the performance and filing of the results from a specific year’s LST shall comply with the NAIC LST Framework’s instructions and reporting templates for that year. See Model Law Section 4(L)(3)(b). The deadline for filing the LST results is also set forth in the annual NAIC LST Framework’s instructions.²

Scope Criteria

As shown in the NAIC 2021 LST Framework, the Scope Criteria applies minimum threshold amounts to the following six activities: (1) Fixed and Indexed Annuities, (2) Funding Agreements; (3) Derivatives, (4) Securities Lending, (5) Repurchase Agreements, and (6) Borrowed Money. See NAIC 2021 LST Framework pg. 10 and Annex 1. The Scope Criteria applicable to a specific data year are reviewed at least annually by the Financial Stability (E) Task Force and any change to the LST Framework or the data year for which the Scope Criteria are to be measured shall be effective on January 1 of the year following the calendar year when such changes are adopted. See Model Law Section 4(L)(3)(a).

Any life insurance legal entity or life insurance group exceeding at least one threshold of the Scope Criteria is considered scoped into the LST Framework for the specified data year while those that do not trigger at least one threshold of the Scope Criteria are considered scoped out. Id. As such, for those entities that are scoped in, a liquidity sources and uses report must be generated for each legal entity within the group that is subjected to stress testing, using the NAIC’s templates, and those results are aggregated to present a group level report. See NAIC 2021 LST Framework pg. 30. Furthermore, according to the Financial Analysis Handbook, “[a]lthough the P/C and health insurers are not subject to the Scope Criteria in 2021, if a P/C or health legal entity insurer is deemed, by the insurer group, to pose material liquidity risk to a U.S. group that triggered the Scope Criteria in a future year, then the P/C and health legal entity insurer within the group will perform the LST.”

Notwithstanding these fairly mechanical thresholds for being scoped-in or scoped-out of the LST framework, the 2020 Model Law revisions allow flexibility for a lead state commissioner to make a discretionary determination, in consultation with the NAIC Financial Stability Task Force, that an insurer should or should not be scoped into the Framework for the data year. See Model Law Section 4(L)(3)(a). This helps avoid having insurers scoped in and out of the LST Framework on a frequent basis. See Model Law Section 4(L)(3)(a)(i).

State Adoption

Based on tracking done by the NAIC, as of August 1, 2022, twenty-two (22) states have adopted the LST Model Law revisions, including: Alabama, California, Connecticut, Delaware, Georgia, Iowa, Illinois, Kentucky, Louisiana, Maine, Missouri, Montana, Nebraska, New Hampshire, New Jersey, Nevada, Ohio, Pennsylvania, Rhode Island, Utah, Virginia and Wisconsin. Additionally, there are three states with bills pending that would enact the Model Law revisions: Massachusetts, Michigan and New York.³

State adoption of the 2020 Model Law revisions has in part been driven by the Covered Agreements between the U.S. and the European Union (EU) and UK on reciprocity in insurance regulation. See Bilateral Agreement Between the United States of America and the European Union on Prudential Measures Regarding Insurance and Reinsurance (September 22, 2017) and the corresponding agreement between the U.S. and U.K. (December 18, 2018) (the “Covered Agreements”). US states have until November 7, 2022 to conform their laws to the requirements in the Covered Agreements, or risk having the EU or UK impose their own LST requirements on international insurance holding company systems, including any US insurers in such systems.