Insurance Regulatory Update
The National Association of Insurance Commissioners (“NAIC”) held its Summer 2014 National Meeting in Louisville, Kentucky, from August 16 - 19, 2014. The meetings were highlighted by the NAIC’s adoption of the Rector Framework, the adoption of the Corporate Governance Model Act and Model Regulation by the Corporate Governance Working Group and the Financial Condition (E) Committee and the extensive discussion across various meetings of the need for a coordinated U.S. voice on issues of international standard setting. These and other important topics are discussed in more detail below.
Principle-Based Reserving and XXX/AXXX Transactions
The leading item at the Summer 2014 National Meeting was the NAIC’s adoption of the new XXX/AXXX framework (“Rector Framework”). The Rector Framework is based on the Third Report issued by Rector & Associates, which addresses principle-based reserving (“PBR”) and the use of affiliated captive insurers, particularly XXX and AXXX reserve transactions. Rector & Associates is a third-party consultant to the NAIC’s Principle-Based Reserving Implementation (EX) Task Force (“PBR Task Force”).
After a fulsome discussion of issues raised by the New York Department of Financial Services (“NY DFS”) and the explanations and views of the Co-Chairs of the PBR Task Force, the Rector Framework, as well as the accompanying implementation charges to the various NAIC task forces and working groups, was adopted by Executive/Plenary. This occurred despite strident opposition by the NY DFS, which issued a pointed press release just prior to the Summer 2014 National Meeting, criticizing the Rector Framework and imploring the NAIC to “get its house in order” and better police captive insurance vehicles. In a response letter, the NAIC defended the Rector Framework and criticized New York’s approach to addressing reserve redundancy.
The Rector Framework provides an overall plan for more transparent treatment of XXX/AXXX transactions involving affiliated captive insurance companies. This plan will ultimately be documented in amendments to the Credit for Reinsurance Model Law (#785) and Credit for Reinsurance Model Regulation (#786) (together, “CFR Model Laws”). The plan requires that the portion of the cedent’s reserves that are determined by the “Actuarial Method” (currently expected to be the VM-20 reserves with certain adjustments) for the XXX/AXXX book of business be backed by collateral consisting of assets that satisfy a new “Primary Security” definition (also referred to as “hard assets”), while the portion of the reserves that exceed that level can be collateralized by “Other Security,” which will be specifically defined. The Rector Framework also involves enhanced disclosure in the cedent’s financial statements, requires that at least one party to the XXX/AXXX transaction maintain a related risk-based capital (“RBC”) cushion, and requires that the entire transaction be approved by the cedent’s domiciliary regulator. In addition, the cedent’s actuary is required to issue an opinion as to whether the XXX/AXXX transaction follows the Rector Framework.
NAIC task forces and working groups charged with implementing the Rector Framework have already started work on specific projects. A detailed discussion of the status of those workstreams follows:
- Blanks Reporting. Under the Rector Framework, a new Supplemental XXX/AXXX Reinsurance Exhibit will be filed by cedents in the life and fraternal annual statement blanks for 2014. The supplement will provide information about assets and reserves pertaining to policies subject to XXX/AXXX reserving and is meant to enhance transparency, especially in cases where the assuming reinsurer is not subject to public disclosure requirements. The PBR Task Force is seeking to have the proposal finalized and adopted quickly because software vendors will need to update the 2014 blank.
- Actuarial Guideline 48 and Related Guidance. The NAIC’s Life Actuarial Task Force (“LATF”) has exposed, for public comment, the new Actuarial Guideline 48 (“AG 48”), which implements the Rector Framework. The purpose of the new AG 48 is to provide guidance concerning the Actuarial Opinion Memorandum Regulation, Section 3 of which gives insurance commissioners authority to specify methods of actuarial analysis and assumptions when necessary for an acceptable opinion to be rendered concerning adequacy of reserves. The draft of AG 48 would mandate that an opining actuary for a cedent must: (i) follow the methods and assumptions developed as individual components of the Rector Framework to determine whether the cedent’s net reserves are appropriate and (ii) issue a qualified actuarial opinion if the cedent has entered into a reserve financing transaction that does not adhere to the Rector Framework. The draft of AG 48 includes the Actuarial Method to establish the required level of “Primary Security,” which varies for (a) term life insurance, (b) universal life with secondary guarantees (“ULSG”) and (c) Covered Policies (as defined) other than term and ULSG. The Actuarial Method is to be applied on a gross basis to reserves ceded with respect to all Covered Policies. “Covered Policies” are defined in the draft of AG 48 as those (1) issued on or after January 1, 2015 or (2) issued prior to January 1, 2015, but ceded pursuant to a “New Reinsurance Agreement” on or after January 1, 2015, in either case, assuming the policies are required to be valued under Section 6 or 7 of the NAIC Valuation of Life Insurance Policies Model Regulation (#830) and are not exempt. A “New Reinsurance Agreement” is defined in the draft of AG 48 as an agreement (A) entered into on or after January 1, 2015 or (B) entered into prior to January 1, 2015 that is amended, renewed, or restructured on or after January 1, 2015, with some exceptions. LATF is also at work on the 2014 CSO Mortality tables and the VBT tables needed to implement the Rector Framework.
- “Primary Security” Definition. The Statutory Accounting Principles Working Group (“SAP Working Group”) will develop the “Primary Security” definition and an audited note to financial statements to indicate whether the cedent (unless otherwise exempt) is complying with the Rector Framework. One open issue is whether letters of credit may be included as “Primary Security,” and, if so, what types and to what extent.
- Amendments to CFR Model Laws. The Reinsurance Task Force will create a new Credit for Reinsurance Model Regulation to establish requirements regarding the reinsurance of policies subject to XXX/AXXX reserving. Exhibit 4 to the Rector Framework will be considered for this model regulation, modified as deemed appropriate by the task force. The task force will also amend the Credit for Reinsurance Model Act (#785) to reference the new regulation.
- Capital Adequacy and RBC Matters. The Life RBC Working Group (on referral from the Capital Adequacy Task Force) will (i) develop an appropriate “RBC Cushion” for an insurer ceding policies subject to XXX/AXXX reserving when the assuming reinsurer does not file an RBC report using the RBC formula and instructions; (ii) develop appropriate asset charges for the forms of “Other Security” used by insurers under the Rector Framework (which charges will be considered for incorporation into the “RBC Cushion”); and (iii) determine whether the current RBC C-3 treatment of qualified actuarial opinions is adequate for the purposes of the risks of XXX/AXXX reinsurance transactions that are subject to qualified actuarial opinions.
After many months of work, the Corporate Governance Model Act and Model Regulation were adopted by the Corporate Governance Working Group and the Financial Condition (E) Committee. However, the two models were not placed on the agenda of the Joint Executive and Plenary Committee meetings, and instead are expected to be on the agenda at the NAIC Fall 2014 National Meeting in November. The delay in final deliberations over these two models is likely due to two competing views that have been expressed in recent months with respect to the confidentiality provision.
The NAIC’s Private Equity Issues Working Group, which is charged with evaluating perceived risks associated with private equity/hedge fund ownership or control of insurance companies and/or their invested assets, has invited the U.S. Securities and Exchange Commission (“SEC”) to give a presentation at the NAIC Fall 2014 National Meeting concerning compliance of SEC-registered private equity firms with laws governing such entities, including the Investment Advisers Act of 1940. Specifically, the working group has asked the SEC to focus on the issue of allocation of expenses by fund advisers. The working group indicated that it will not finalize proposed changes to the NAIC’s Financial Analysis Handbook until after it receives the SEC’s input regarding these expense issues. The proposed changes address acquisitions by private equity firms and are meant to enhance regulatory review of risks associated with private equity ownership in the context of Form A regulatory approvals.
Unclaimed Life Insurance Benefits
The Unclaimed Life Insurance Benefits Working Group discussed unclaimed property cases that have been decided recently in several courts and their potential impact on the Regulatory Settlements Agreements (“RSAs”) that the NAIC Investigations of Life and Annuity Claims Settlement Practices Task Force has entered into with 13 insurance companies/groups. In these cases, insurance companies have been successful in challenging states’ interpretations of the unclaimed property laws. The California representative on the working group attempted to distinguish the issue under these cases from the issue under the RSAs, arguing that asymmetric use of the Death Master File is an unfair trade practice, so the RSAs should remain enforceable to address violations of insurance unfair claims practices statutes (rather than unclaimed property laws as reviewed by the courts in the recent cases).
The Group Solvency Issues Working Group is drafting an amendment to the NAIC Holding Company Act (#440) to provide explicit authority for a state insurance commissioner to act as a group-wide supervisor for an internationally active insurance group (“IAIG”). Several states (Connecticut, Delaware, Florida, Iowa and Nebraska) have recently introduced similar bills, and Pennsylvania has already enacted such a law. The working group determined to use the Pennsylvania law as a starting point for the draft amendment. Issues that will need to be addressed in connection with finalizing the amendment include whether the group-wide supervisor for an IAIG should be the state of domicile of the insurance company (similar to the default “lead state” under the Financial Examination Handbook) or the state of domicile of the holding company, and how to account for states that do not have any IAIGs or other large insurance groups.
State Adoption of NAIC Amendments to CFR Model Laws
As of the Spring 2014 National Meeting, 23 jurisdictions had enacted some form of the NAIC’s amendments to the CFR Model Laws, which the NAIC adopted in November 2011. Most recently, Colorado, Hawaii, Vermont and New Mexico enacted the amendments to the CFR Model Laws. States that have enacted the amendments to the CFR Model Laws (or similar laws) account for approximately 60% of all direct insurance premium written in the U.S. across all lines of business. Five additional jurisdictions (District of Columbia, Illinois, Massachusetts, Michigan and Texas) are currently considering adoption of the amendments to the CFR Model Laws in 2014 or 2015, which would raise the market share to approximately 80%.
Qualified Jurisdictions and Certified Reinsurer Uniform Application/Passporting
The amendments to the CFR Model Laws allow for a reduction in posted collateral from an unauthorized reinsurer that is approved by states as a “Certified Reinsurer.” Whether a reinsurer is certified depends on, among other things, whether it is domiciled in a “Qualified Jurisdiction” (i.e., one that “effectively” regulates reinsurers domiciled in the jurisdiction). Using the NAIC’s Process for Developing and Maintaining the NAIC List of Qualified Jurisdictions (“Qualified Jurisdiction Process”), the following countries have been granted “Qualified Jurisdiction” status on a conditional basis, with a full review to be completed before year-end 2014: Bermuda, Germany, the United Kingdom, and Switzerland. Ireland and Japan have accepted the NAIC’s invitation to begin the Qualified Jurisdiction Process and the Qualified Jurisdiction Working Group expects to complete its review (for purposes of conditional approval) before the Fall 2014 National Meeting in November.
The Reinsurance Task Force adopted a Uniform Application Checklist for Certified Reinsurers (“Uniform Application”), which facilitates the process of “passporting,” wherein a reinsurer applies to an initial state (“Lead State”) for certification as a Certified Reinsurer and, after consideration by the Reinsurance Financial Analysis Working Group (“RFAWG”), another state can choose to defer to the Lead State’s recommendation concerning certification. Once it receives its certification by a Lead State, the reinsurer can then utilize the Uniform Application to seek a “passport” to certification in other states. As of July 25, 2014, 25 reinsurers’ applications had been approved by a Lead State and the reinsurers were in the process of passporting in other states.
Investment Risk RBC
At the direction of the Capital Adequacy Task Force and with the assistance of the American Academy of Actuaries (“AAA”), the Investment RBC Working Group will analyze the effect of including investment risk in the RBC formula applicable to insurers other than life insurers. Life insurers are unique in that they hold an asset valuation reserve (“AVR”), which is the liability set aside in life insurers’ annual statements to protect statutory surplus against large fluctuations in asset value. To date, much of the working group’s analysis has focused on insurers that are subject to AVR. In a memorandum to the task force, the working group noted that although it generally takes the view that asset risk is the same regardless of the holder of the investment (e.g., life, health, property-casualty insurer, etc.), there may be cases where asset risk factors would be different among insurers, such as life insurers holding AVR, and therefore, the working group is examining the degree to which asset risk factors should be adjusted due to differences in reserve requirements. The working group is also investigating other dissimilarities in investment characteristics driven by the difference in a liability’s duration, capital structure, or in statutory accounting requirements.
Changes to 2014 RBC Filing Guidance and 2015 RBC Instructions
The 2014 RBC filing guidance and the official 2015 RBC instructions will prohibit an insurer whose domestic regulator has granted it an RBC permitted practice from applying that permitted practice in RBC calculations. Specifically, the Management Discussion and Analysis RBC instructions will provide that permitted practices are not allowed for RBC and that RBC requirements, Total Adjusted Capital (“TAC”) and RBC factors cannot be modified for the calculation of Authorized Control Level RBC. These changes are intended to address concerns of the Capital Adequacy Task Force upon learning that some states had granted domestic insurers certain RBC permitted practices (allowing the insurers to modify the RBC requirement for calculation of Authorized Control Level RBC).
In its Draft Stakeholder Procedures, the International Association of Insurance Supervisors (“IAIS”) is revising its consultation process and how it receives input from stakeholders in an effort to increase efficiency. Pursuant to one such change, the IAIS will no longer allow observers to participate in meetings, but rather observers will only be invited when necessary to “provide targeted, technical input.” In its comments on the Draft Stakeholder Procedures, the International Insurance Relations (G) Committee expresses concern regarding the fact that the IAIS revisions provide for decreased, rather than increased, transparency of the regulatory process.
Contingent Deferred Annuities
The Contingent Deferred Annuity (“CDA”) Working Group exposed the following for public comment:
- possible revisions to four annuity-related model acts to reflect CDAs, specifically, the approach that should be taken with regard to (i) adding drafting notes regarding CDAs; (ii) amending the model acts’ text to account for CDAs specifically; or (iii) closing the model acts without revisions and relying on the existing language to cover CDAs as “annuities.” (Separately, in a letter to the Life Insurance and Annuities (A) Committee, the Receivership and Insolvency Task Force concluded that under the NAIC Life and Health Guaranty Association Model Act (#520), where a particular CDA product falls within the definition of “annuity” under the applicable state guaranty association law, then that CDA product should benefit from guaranty association coverage.);
- the draft Guidelines for the Financial Solvency and Market Conduct Regulation of Insurers Who Offer Contingent Deferred Annuities, which guidelines include, among other issues, a discussion of recommended areas of financial and non-financial regulation of CDAs, including a financial checklist being developed by the Financial Condition (E) Committee and reserving and capital guidance to be developed by the Life RBC Working Group; and
- proposed charges for an NAIC group to review whether CDAs should have a non-forfeiture or similar benefit. (In the course of its work on the Standard Non-Forfeiture Law (“SNFL”), LATF previously determined that the SNFL should not apply to CDAs; however, the working group is exploring whether the issue merits further discussion.)
Resolution Plans for Large Insurers
The Financial Condition (E) Committee adopted a report from the Receivership and Insolvency Task Force regarding the task force’s assessment of resolution plans for large insurance groups. The report’s conclusion was that resolution plans for all large insurers are not recommended at this time (although the issue may be revisited at a later time). Instead, the report suggests that it may be beneficial to establish a template of information that a receiver could request from an insurer that may need to plan for potential receivership.
Terrorism Risk Insurance Act of 2002 and NARAB II
The NAIC has been active in lobbying federal lawmakers to extend the federal Terrorism Risk Insurance Act of 2002 (“TRIA”), which is set to expire on December 31, 2014. Bills to extend TRIA have passed both the House of Representatives and the Senate. The Senate bill (SB 2244) provides for a seven-year extension, whereas the House bill (HR 4871) proposes a five-year extension. The Senate bill would increase the “co-pay” for private insurers from 15% to 20%. The House bill proposes an increase from $100 million to $500 million for the amount of loss from a terrorist attack using “conventional” weapons (i.e., not a nuclear, biological, chemical or radiological attack). Both bills include language creating a national registry of insurance producers (a provision often referred to as “NARAB II”). NARAB II reflects a long-standing effort by legislators, industry and trade groups to ensure uniformity among states for insurance producer licensing. Under the House and Senate bills, a board would be created to issue multi-state licenses to producers in accordance with standards established by state regulators, thus creating a centralized licensing process. In anticipation of the re-authorization of TRIA, the NAIC is already working on revisions to a related model bulletin for state insurance regulators to issue, as well as related updates to policy filing forms and policyholder disclosures.
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