3. If an insurer does not calculate RBC, does it have to employ this methodology to rate its RMBS securities? Yes

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1 Questtiions and Requestted Cllarriiffiicattiion Perrttaiiniing tto Resiidenttiiall Morrttgage Backed Securriittiies ((RMBS)) Polliicy fforr Yearr End 2009 FIINAL DOCUMENT as off Decemberr 29,, 2009 POLICY/CONCEPT 1. This changes the methodology used to derive NAIC credit designations. These designations are not only used for determining investment risk (C-1) capital, but are also reported on Schedule D and used for AVR/IMR, Supplemental Risk Interrogatory, etc. Would this new methodology be used throughout the Annual Statement and would it be reflected on all applicable Schedules and in all relevant calculations. Yes 2. This policy is applicable to Life, P/C, Health, etc? Yes 3. If an insurer does not calculate RBC, does it have to employ this methodology to rate its RMBS securities? Yes 4. Can an insurer continue to use FE or SVO ratings for AVR/IMR (utilizing its SSAP 43R carrying values)? No 5. Does the proposal extend to all RMBS or just non-agency securities? All non-agency RMBS, including ABS where the loan is to an individual/s/family, with the dwelling as collateral, including e.g. home equity, HELOC, and mobile homes. Also those agency bonds where the collateral is not guaranteed by the agency. (Please note manufactured housing was originally included in the scope. It was removed on December 16 and instructions on how to handle these assets are described in Section 2D of the NAIC s Interim Reporting Instructions which are posted on the NAIC website.) 6. Does the NAIC plan to release a definition or set of criteria by which industry can easily determine what is/should be included in the RMBS universe? As indicated in Q5, RMBS refers to and includes non-agency residential mortgage-backed securities, where the collateral consists of loans pertaining to non-multi-family homes. Included: Prime, subprime, Alt-A mortgages, home equity loans, home equity lines of credit and loans against mobile homes. Excluded: Agency RMBS where the mortgages (loans) are guaranteed by federal or federally sponsored agencies such as GNMA (Government National Mortgage Association, FNMA (Federal National Mortgage Association), or FHLMC (Federal Home Loan Mortgage Corporation). The exclusion covers bonds (or collateral) December 29, 2009

2 issued and guaranteed by, or only guaranteed by the agency. Also not included are loans guaranteed by the United States Department of Veteran Affairs, the Rural Housing Services, or manufactured housing. 7. Will this modeling process also be employed for quarterly reporting in 2010 and thereafter? Although the Executive and Plenary vote only addressed the applicability of this policy for YE 2009, this process is in place until a long term solution is adopted. VOSTF will develop a long-term solution, which may be the same, or similar to this process. 8. Should insurers plan to use the recovery values and price breaks that PIMCO provides in 2009 for quarterly reporting in 2010? If so, how will newly issued or purchased RMBS be modeled and/or reported next year? If not, how frequently does the NAIC plan to model RMBS in 2010? Yet to be determined by the Executive Committee. 9. Does the proposal affect RMBS held in separate accounts, trust accounts, and the like, or is it limited to general account assets? The proposal is not limited to general account assets, but to all where the NAIC designation is reported. 10. Has the NAIC considered a Plan B if it determines the logistical hurdles are too great to overcome prior to 12/31/09? There is no Plan B. 11. The proposal implies the NAIC no longer believes NRSRO ratings are valid tool of measurement for RMBS. Yet, many state statutes currently include references to NRSRO rating criteria when determining the admissibility of assets. How is an insurer expected to reconcile this seemingly inconsistent approach to the treatment of RMBS assets? The policy does not reflect an NAIC opinion that NRSRO ratings are no longer a valid tool NRSRO ratings remain in effect for other purposes, such as limits in state statutes. 12. How might the policy be impacted by the recently adopted SSAP 43R? SSAP 43R will not impact the policy. However, paragraph 26 of SSAP 43R has been amended to include language which describes the effect of the new ratings methodology, i.e. multiple designations for a single security, and its effect upon the determination of the carrying value. 13. There will obviously be a cost to engage PIMCO to model the industry s RMBS portfolio as well as to fund the NAIC s consultant, Oliver Wyman. On the Executive and Plenary call, NAIC staff indicated the industry is expected to pay December 29, 2009

3 these costs. If industry is expected to pay, what is the expected cost and what methodology will be used to allocate the cost? When does the NAIC plan to release the allocation method? The specific details were announced on December 4 and are posted to the NAIC website. 14. If RMBS are not Filing Exempt, does the NAIC plan to adjust the manner in which the SVO Assessment Fee is calculated? If so, how? Yes. The NAIC will announce this change during the Spring 2010 National Meeting. 15. Please describe the role of Oliver Wyman, the consultant the NAIC retained to assist with this project. Oliver Wyman assisted the NAIC in vendor selection and the selection of the assumptions, and the implementation process. 16. Please confirm the NAIC plans to send a memo to the Chief Examiners explaining the new policy for RMBS. At the Chief Financial Officer s Forum during the Winter 2009 National Meeting, NAIC staff will be delivering a memo describing the RMBS Methodology. (Did this happen can we confirm with Dan?) PIMCO/MODEL/ASSUMPTIONS 17. Who is responsible for determining the model assumptions? Will industry have any input? The VOSTF, in consultation with the SVO, Oliver Wyman (the consultant), and the PIMCO (the modeler) determined the model assumptions. The general assumptions include forecasts of: home price inflation, overall inflation, unemployment and other macroeconomic assumptions. Detailed assumptions will include loan type and vintage. Industry had an opportunity to offer comments before the VOSTF vote in early December. 18. When will PIMCO begin its modeling efforts and when will it provide industry with the results? The target date for PIMCO to deliver the initial data file results is 12/18/09. The NAIC will provide insurers with the data on 12/28/09. If any RMBS were omitted from the initial data file provided to PIMCO, these securities will be modeled in January with a target delivery date of January 25, Does an insurer have any recourse if it disagrees with the results of PIMCO s model? Insurers may address questions and concerns to the SVO or the VOSTF. However, as a practical matter, given the time frames involved, it is unlikely an insurer would be able to resolve its issues prior to 12/31/ December 29, 2009

4 20. What data should industry expect to receive from PIMCO? What format will this data take and how will it be transmitted? The NAIC will deliver an excel file containing each CUSIP number and its corresponding NAIC Designations for the five price breaks for each RMBS, separate for Life and P&C/Health (because of different RBC charges). The final file format was distributed on 12/14/ When does the NAIC plan to release the sample file format to industry? The final file format was distributed on 12/14/ When will industry be told which securities can and cannot be modeled? The data file provided to insurers on 12/28/09 will contain a worksheet with a list of non-modeled RMBS. It is probably safe to assume that none of the private placements (identified with the presence of * # in the CUSIP) can be modeled. Further, foreign RMBS will not be modeled. 23. How will PIMCO determine the price breaks for each NAIC designation? Price breaks are based on the midpoints between the NAIC RBC charges which are based on expected losses and not tail risk. 24. Why are the price breaks provided in various sample documents different for Life vs. P/C and Health? The differences in accounting (amortized cost vs. fair value) and AVR/IMR already address the difference in RBC. So it appears the use of different price breaks will either be too conservative for P/C or too generous for Life. Has Capital Adequacy reviewed the methodology which will be used to arrive at the price breaks? The differences are due to the different RBC charges. 25. Will PIMCO be able to model non-us RMBS? At the current time, non-us RMBS will not be modeled. 26. How will PIMCO treat wrapped/insured RMBS? Because of the lower enhancement levels (and hence the wrap), it is expected these RMBS will receive a lower recovery value from PIMCO, resulting in a lower NAIC rating and higher capital charge. PIMCO will first model the RMBS without consideration of the wrap. The expected losses will then be modified according to the monoline s CDS spread. IMPLEMENTATION 27. Please explain how insurers should determine the designation and carrying value for RMBS using this new policy. To determine the carrying value: The current book price is compared to the range of values assigned to the six (6) NAIC designations for each CUSIP to December 29, 2009

5 establish the initial NAIC designation. The carrying value method, either the amortized cost or the lower of amortized cost or fair value, is then determined as described in paragraph 25 of SSAP 43R based upon the initial NAIC designation. To determine the designation: If the carrying value equals the amortized cost, the initial NAIC designation is used and shall be applicable for all statutory accounting and reporting purposes. If the carrying value equals fair value, the market price is compared to the range of values assigned to the six (6) NAIC designations for each CUSIP. This final NAIC designation shall be applicable for all statutory accounting and reporting purposes, except for establishing the appropriate carrying value method in Step 1(paragraph 26 b.i.). 28. Please confirm that paragraph 26b of SSAP 43R applies to all RMBS loan-backed securities. Further, please confirm that all non-rmbs securities subject to SSAP 43R should follow paragraph 26a. Confirmed. 29. Is it realistic to expect auditors will now require insurers to incorporate the recovery values provided by PIMCO into the impairment analysis required under SSAP 43R? Will this data also impact the amount of OTTI taken for GAAP? Dealing with external auditors is up to company management, not up to regulators. 30. How should insurers calculate the book price used to derive the designation and carrying value? Acknowledging the manual processes insurers will likely have to employ to implement this policy for year end, we believe a practical solution to the problem is to use the weighted average book price of the various lots within an individual reporting company. (Note: there are four areas where accounting is specified by lot.) 31. Who will create the list of RMBS securities to be modeled? Will this information be taken from Schedule D filings or will individual insurers be responsible for submitting a list? If the later, what is the expected timeframe and manner of transmittal? The NAIC will compile a list of RMBS CUSIPS for securities reported by insurers as of 9/30/2009. The SVO will provide this list to PIMCO and will post the list on the NAIC website. Insurers will be required to review the list and will have to notify the SVO of additions to this list by 12/31/09. The SVO will furnish the supplementary list of additional RMBS CUSIPs to PIMCO as soon as practicable and will publish it on the NAIC website December 29, 2009

6 32. How will the CUSIP list be maintained and updated throughout 2010? Has the NAIC explored creating a database on its website to collect and maintain this data? Yet to be determined. 33. How should un-modeled securities which are FE or SVO rated be treated? These RMBS should report a modified rating. For RMBS with NRSRO ratings, the second lowest rating along with the insurer s book price and market price will be used to derive the modified rating. For RMBS without any NRSRO ratings, if the insurer filed the security with the SVO in 2009 and received a NAIC 1-6 designation, it should use the designation along with its book price and market price to derive the modified rating. If the security was filed in 2009 and carries a 5*/6* rating this rating should be reported and no modified rating is applicable. (Note: This answer indicates insurers should use a modified SVO rating if they have a non-modeled RMBS which carries a SVO rating.) If the security does not have a NRSRO rating or current SVO designation, the insurer must file the security with the SVO and request a 5*/6*. 34. What is the expected turn-around if an insurer requests a full credit analysis from the SVO for a non-modeled RMBS? For all practical purposes, the SVO does not have the resources to review the RMBS filings so insurers should not expect to receive anything other than a 5*/6*. 35. It seems logical to assume Filing Exempt will no longer be applicable for RMBS securities. Please confirm. Correct. 36. Is there a scenario under which a RMBS security would need to be filed with the SVO? Yes, RMBS will need to be filed with the SVO if it is not modeled, is not rated by a NRSRO, and does not carry a 2009 rating from the SVO. 37. If the above is answered No, does the NAIC plan to adjust the SVO budget since RMBS securities will no longer be filed with the SVO? The NAIC does not plan to adjust the budget as a result of this policy. 38. If RMBS are not Filing Exempt and do not need to be filed with the SVO, does the VOSTF plan to modify the P&P Manual? If so, when will the proposed language be exposed for comment? December 29, 2009

7 Details regarding the new approach to RMBS will be placed in the Regulatory Review Section of the P&P Manual. No changes will be made to the text of the P&P Manual therefore no exposure is necessary. 39. An individual security may now be reported with multiple NAIC credit designations. Does the NAIC plan to modify its Examination Jumpstart Reports to address this? If so, how? Yes. The NAIC s FRS department is working to develop new reports. 40. An individual security may now be reported with multiple NAIC credit designations. How does the SVO plan to modify the Valuation of Securities Database/CD-Rom? Will it remove all RMBS from the FE database as well remove all SVO assigned designations? Yes, all RMBS will be removed from the FE database. Further the SVO assigned designation for all modeled RMBS will be removed the VOS database. Any unmodeled RMBS which is filed with the SVO for a designation will be flagged in the database with a Z* rating. 41. What type of suffix should be assigned to NAIC credit designations for RMBS at 12/31/09? Are FE and Z still applicable? All RMBS should be reported throughout the Annual Statement with a Z* suffix. FE and Z are no longer applicable. 42. It appears the proposal impacts the SVO s 5*/6* rule as these designations would no longer be applicable for RMBS. Please confirm. Incorrect. Any un-modeled RMBS can be submitted to the SVO for a 5*/6* designation. 43. Is there any scenario under which an insurer could still rely upon a NRSRO rating or SVO designation for a given RMBS security? No. 44. Has the NAIC performed a study to determine how this policy will impact insurer s preparation of the Annual Statement? Has the NAIC worked with insurers who use an in-house accounting system and the vendors who produce a third party accounting package to ensure the accounting systems can accommodate the multi-designations for YE 2009? No 45. It is still not clear what insurers should do if the security is not modeled by PIMCO. If the security is rated by a NRSRO, use the 2 nd lowest rating, modified to take the carrying value into account December 29, 2009

8 If the security is not NRSRO rated, use the 2009 SVO rating (excluding 5*/6*), modified to take the carrying value into account. If neither is applicable, file the security with the SVO for a 5*/6* rating. 46. With respect to the question above, if the SVO does not have the resources to rate RMBS filings, what should an insurer do with a non-modeled, unrated RMBS? For practical purposes, an insurer should file the security with the SVO for a 5*/6* rating. If the insurer does not receive the SVO designation prior to the closing of its books, the insurer should assign a 5Z* (if current on P&I) or a 6Z* (if in default) itself (and don t forget to document the status of the P&I payments). 47. Please confirm insurers should use the 2 nd lowest NRSRO rating to determine the modified designation. Confirmed. 48. Please confirm insurers should follow the two-step process when determining the modified designation and carrying value. Confirmed. 49. Since 5*Z* and 6*Z* are not valid combinations per the Annual Statement Instructions, please confirm that 5*/6* designations should be reported as 5Z* and 6Z*. Confirmed. 50. The SVO s pertaining to Final RMBS Instructions (dated Dec 16) indicates all non-modeled RMBS with a NRSRO rating equal to D should be reported as NAIC-6Z* and should not follow the modified designation process. Please clarify if this only applies to D rated RMBS or if it applies to all NAIC-6 equivalent ratings. Any non-modeled RMBS should report a NAIC-6Z* if the security carries a NAIC-6 rating from the SVO or the 2 nd lowest NRSRO rating is equivalent to NAIC-6. These RMBS should not report a modified rating. 51. Please confirm insurers should employ the modified designation approach for non-modeled RMBS which were filed with the SVO prior to adoption of the RMBS methodology (and received a designation). In this instance the SVO designation is substituted for the NRSRO rating. Confirmed. If an insurer filed a RMBS and received a SVO rating (excluding 5*/6*) in 2009 it should follow this process. 52. What is the timing of the January supplement? Unknown at this time December 29, 2009

9 53. For companies that have separate accounts, please confirm if the rating can be assigned based upon the total legal entity or whether a rating needs to be calculated separately for the general account and the total separate account. Technically, the NAIC designation should be determined for each lot separately. If that cannot be done, determine the weighted average amortized cost basis, use that to determine the initial and final NAIC designation, and use that for all the lots for the same CUSIP, within the same legal entity. General accounts and separate accounts should calculate weighted averages individually. 54. Should the initial or final rating be used to determine the IMR/AVR classification on sold securities? Based on the text (from the annual statement instructions), we believe the designation should be the final, based on the sale price. IMR: All realized capital gains/(losses), due to interest rate changes on fixed income investments, net of related capital gains tax, should be captured in the IMR and amortized into income (Column 2, Lines 1 through 31) according to Table 1 or the seriatim method. Realized capital gains/ (losses) must be classified as either interest (IMR) or credit (AVR) related, not a combination. Purchase lots with the same CUSIP are treated as individual assets for IMR and AVR purposes. Include realized capital gains/(losses) on: Debt securities, mortgage-backed securities and preferred stocks whose National Association of Insurance Commissioners (NAIC)/Securities Valuation Office (SVO) rating classification at the holding period is NOT different from its NAIC rating classification at the beginning of the holding period by more than one NAIC rating classification. Exclude any such gains/ (losses) exempt from the IMR. AVR Report all realized capital gains/ (losses), net of capital gains tax, on each debt security and mortgage backed security whose NAIC/SVO rating classification at the end of the holding period is different from its NAIC/SVO rating classification at the beginning of the holding period by more than one NAIC/SVO rating classification. The holding period is defined as the period from the date of purchase to the date of sale. For end of period classification, the most recent available rating should be used. For bonds acquired before January 1, 1991, the holding period is presumed to have begun on December 31, Determination of AVR gain/ (loss) on multiple lots of the same fixed income securities should follow the underlying accounting treatment in determining gain/ (loss). Thus, the rating classifications, on a purchase lot basis, should be compared to the rating classification at the end of the holding period to December 29, 2009

10 determine IMR or AVR gain or loss. Permanent impairment write-downs are treated as credit-related (losses). In addition, all gains/ (losses), net of capital gains tax, on mortgage loans where: Interest is more than 90 days past due, or The loan is in the process of foreclosure, or The loan is in course of voluntary conveyance, or The terms of the loan have been restructured during the prior two years Would be classified as credit-related gains/ (losses). The gain/ (loss), net of capital gains tax, on any debt security or mortgagebacked security that has had an NAIC/SVO rating classification of 6 at any time during the holding period should be reported as a credit related gain/ (loss). 55. If an insurer holds non-agency RMBS that are not in the 12/28/09 file, does any action need to be taken to report the list of CUSIPs to the NAIC? Yes. Any additional RMBS will need to be reported to the NAIC by 5 PM Eastern Standard Time on December 31, There is a template spreadsheet provided on the RMBS Web site you can download and fill out to inform the NAIC of any missing securities. Please your spreadsheet to rmbsmissingsecurity@naic.org. The NAIC will evaluate this list of CUSIPs for potential assessment following the 2009 Annual Statement Filing process. 56. Will the NAIC provide insurers with the price breaks to use for modified ratings? No. Insurers should use the implied intrinsic prices provided on 12/16/09 to calculate the price breaks themselves. Refer to the Interim Reporting Instructions, Section 2D and Section 3 for details as to how to calculate the price breaks. 57. Will the final Q&A be posted on the NAIC website? No 58. How will any IMR/AVR classification/routing issues in 2009 relating to any RMBS sales be treated as the new ratings will not be in existence until year-end Are we only talking sales that occur after 2009 on these items? Post Yearend Questions: 59. It was our understanding that the PIMCO modeling process is scheduled to be run Quarterly going forward. For those companies that perform monthly valuation processes, how should they handle new securities that are purchased in January 2010? December 29, 2009

11 a. Do we use the intrinsic Value (Modified FE method) for those cusips not listed on the PIMCO Model file at 01/25/10? b. If these cusips are not included in the universe to be modeled, how would they be submitted for modeling to PIMCO? c. Would this be the same procedures for any off quarter month? December 29, 2009