skip navigation
Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

REGULATORY
10 September 2021

New RBC Factors Adopted for P&C and Health Insurers. Now What?

By Keith Luna, Alex Warren
Download the Article

Stay up to date on timely topics and market events. Subscribe to our Blog now.

At the National Association of Insurance Commissioners’ (NAIC) Summer 2021 National Meeting, the Risk-Based Capital (RBC) working groups for P&C and health insurers both adopted their respective proposals for new bond-level factors.1 The adoption of these new bond factors parallels work already completed by the life insurer RBC working group, and the new factors will go into effect at the end of this year. Essentially, these new factors in almost all cases are more punitive to health and P&C insurers than are the existing factors. In the following, we show a comparison of the current factors and the new factors, and provide some brief comments about how this will change the investment allocations for these insurers going forward.

New Factors

Exhibits 1 and 2 illustrate the change in the bond-level factors, broken down by issue ratings.

Exhibit 1: Risk-Based Capital Factors for Property & Casualty Insurers2
Explore Risk-Based Capital Factors for Property & Casualty Insurers
Source: NAIC. As of 01 Jul 21. Select the image to expand the view.
Exhibit 2: Health Insurer RBC Factors3
Explore Health Insurer RBC Factors
Source: NAIC. As of 01 Jul 21. Select the image to expand the view.

As expected, the NAIC is looking to further protect the interests of policy holders and is thus subjecting more risky investments to increased capital requirements. This proposal has been expected for a number of years. The absolute percentage increases are greatest for the upper tiers of the high-yield space (generally speaking), while the greatest ratio increases (new factor divided by old factor) are in the bottom end of the NAIC 1 designation category (followed closely by the BB/NAIC 3 category). The adoption of the updated RBC factors eliminates the prior incentive for insurers to go down in credit quality (e.g., to A- or BBB-) for yield pickup while staying within the NAIC rating bucket.

We can draw a few conclusions about the attractiveness of risk for these insurers on a go-forward basis, as well as suggest some possible changes that may occur in asset allocation (book yield not being a consideration here).

Investment Implications

Using our preferred measure of return-on-capital (ROC)—in this case, looking at spread per unit of RBC—we find that most sectors do indeed suffer a decline in ROC; however, they don’t all decline to the same degree. The absolute percentage decline is greatest for CLOs, US private placements and USD-denominated emerging market (EM) corporates, in that order. However, relatively speaking, the attractiveness of CLOs, for example, remains quite high due to their higher spreads versus like-rated securities. There are a few sectors that show relatively mild declines (the securitized asset classes), and one that actually increases in attractiveness (agency MBS).

Exhibit 3: Risk-Based Capital Factors for Property & Casualty Insurers
Explore Risk-Based Capital Factors for Property & Casualty Insurers
Source: NAIC. As of 01 Jul 21. Select the image to expand the view.
Exhibit 4: Risk-Based Capital Factors for Health Insurers
Explore Risk-Based Capital Factors for Health Insurers
Source: NAIC. As of 01 Jul 21. Select the image to expand the view.

So, what does this likely mean for insurers’ asset allocations going forward? We continue to believe that CLOs are attractive for all types of insurers—with the change in ROC doing relatively little to dent the comparative advantage CLOs offer relative to other asset types. We would expect somewhat less investment in high-yield on a go-forward basis, with spreads having compressed to a point that reduces their attractiveness versus the capital required. Within the investment-grade corporate and non-corporate spheres, EM bonds do maintain an advantage over domestic corporate bonds and therefore should continue to benefit from marginal flow. As a result, we continue to expect healthy allocations to agency MBS and will look to continue to increase holdings in commercial MBS (CMBS).

In addition, investment-grade private placement securities may be an option for portfolios of P&C and health insurers as the additional spread on those securities gives them a significant ROC advantage over their public peers. While the majority of issuers do not issue in public markets, the market contains many recognizable organizations including US sports leagues, auditing firms, asset managers, REITs and manufacturers. Western Asset recently participated in two new issues for a marquee alternative asset manager with new issue spreads of 225 bps and 250 bps versus their three- and five-year reference Treasuries, respectively. In the current low-yield environment, the trade-off of a higher premium received from investment-grade private placements for lower liquidity may help clients meet their income needs. For health insurers, many of whom carried more than a quarter of their investment assets in cash as of year-end 2020, according to S&P Market Intelligence, the added flexibility to purchase investment-grade pure privates may make even more sense.

The RBC factor changes for P&C and health insurers are here and with change comes opportunity. While the asset allocation changes to new factors will be slow and steady, we believe US insurers may be able to fine tune their fixed-income exposure to get the most capital efficient bang for their buck.

END NOTES
1. https://content.naic.org/sites/default/files/call_materials/072221%20PC%20RBC%20summary.pdf, https://content.naic.org/sites/default/files/call_materials/Health%20RBC%20%28E%29%20Working%20Group%20Summary_0.pdf
2. https://content.naic.org/sites/default/files/call_materials/7-12-21%20HRBCWG%20Agenda%20%26%20Materials_1.pdf
3. https://content.naic.org/sites/default/files/call_materials/7-12-21%20HRBCWG%20Agenda%20%26%20Materials_1.pdf

© Western Asset Management Company, LLC 2024. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").
Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.
These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.
Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.
Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.
Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.
These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.
Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.