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Investment Management

Not Full Faith and Credit-Backed? Get Out

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May 31, 2018

NAIC plans on kicking off exempt list securities that aren’t backed by the US government

Accounting with BenjaminsAlthough institutional money market funds have managed to inch back from precipice after new and to some, stifling, rules kicked in in 2016, they still occasionally get pushed back toward the edge. Take for instance a coming deadline in which insurance companies will not be able to invest (without penalty) in some government funds because they invest in assets that are not backed 100% by the US government.

Effective July 1, 2018, the National Association of Insurance Commissioners (NAIC), an organization that supports state insurance commissioners, will no longer allow MMFs that invest in securities issued by certain US government agencies that don’t meet new criteria from the association. Specifically, these securities are no longer on the “Direct Obligations/Full Faith and Credit Exempt List” for mutual fund investment. This means they are no longer exempt from paying risk-based capital charge for being in the funds.

The NAIC realized a year ago that its Securities Valuation Office (SVO) had included approximately 40 funds to the list that do not qualify to be on it. These now rogue funds invest in securities that while are very low risk, are not “direct and full faith and credit obligations of the US government or collateralized repurchase agreements comprised of such obligations at all times.” These include agency securities such Federal Agricultural Mortgage Corporation (Farmer Mac), Federal Farm Credit Banks (FFCB), Federal Financing Bank (FFB) as well as securities from more well-known Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae).

Brandon Semilof, managing director at StoneCastle Partners, said the new designation of these funds doesn’t mean insurance companies need to jettison the funds. It just means they are going to have to pay the risk-based capital charge if they stay with them: 0.40% for life companies and Property & Casualty companies: 0.30%.

Where insurance companies that own these funds with the non-exempt securities go is up in the air. Diversification is key, but options are limited. The SVO says that insurer investment in the funds is approximately $6 billion dollars. They could move some of this cash into commercial paper, CDs or bank accounts. Other options include insured bank deposits and vehicles like StoneCastle’s Federally Insured Cash Account (FICA). In fact, using the latter option could enhance returns: FICA returns 1.70% vs. a benchmark of US Treasury funds, i.e., Crane Institutional US Treasury MMFs at 1.45%.

In the meantime, the NAIC could change its mind. It said the SVO can reverse its error “by not renewing the non-compliant funds.” However, the SVO recommends that the NAIC’s valuations task force “consider expanding the list to include the issuers/securities.”

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