The following are some highlights from the Spring National Meeting of the National Association of Insurance Commissioners (NAIC), held in Houston, Texas from April 6-9, 2013. This was the first national meeting in 2013 and much of the work involved teeing up issues for action by year end. The arrival of newly appointed NAIC Chief Executive Officer Ben Nelson generated a special buzz.
We do not cover every meeting in this report, but comment on noteworthy developments and matters of interest to our clients.
A. Issues of General Interest
1. International Regulatory Issues: A Common Theme in Houston
FSAP Review. As the next Financial Sector Assessment Program (FSAP) review of U.S. insurance regulation approaches, we continue to see the impact of international insurance regulatory issues across the regulatory landscape. By way of background, the U.S. agreed with the G-20 nations during the financial crises to participate in the FSAP program, and the next assessment is expected to be conducted in 2014. Reviewers from the International Monetary Fund (IMF) will assess whether insurance regulation in the U.S. complies with International Association of Insurance Supervisors (IAIS) Insurance Core Principles (ICPs). The last assessment in 2010 noted shortcomings in group-wide supervision. The ICPs have been expanded and updated since the last assessment, and regulators here have been working hard to head off any findings that the U.S. falls short. See, for example, Section A(2) below.
ComFrame. Secretary General of the IAIS, Dr. Yoshihiro Kawai, was an active participant in several committee and working group meetings in Houston and presented updates on various IAIS initiatives, most notably the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame). ComFrame’s main objectives include: (i) developing methods of operating group-wide supervision of internationally active insurance groups, and (ii) establishing a comprehensive framework for supervisors to address group-wide activities and risks. However, some regulators and industry representatives have voiced concerns that ComFrame will go beyond these objectives and add an additional unnecessary layer of regulation and costs for the insurance industry. A representative from the American Insurance Association (AIA) noted during a meeting of the NAIC/Industry Liaison Committee that language included in Module 2 of the 2012 ComFrame draft appears to provide prescriptive requirements for insurers. Dr. Kawai addressed these concerns by explaining that ComFrame’s purpose is to establish a common framework for insurance regulation, so that when international regulators communicate they “speak the same language,” not to create one set of rules for all insurers to follow. Dr. Kawai explained that ICPs are the foundation of IAIS’s supervisory principles, but that they are too conceptual and lack the specifics that ComFrame will provide. Missouri Insurance Commissioner John Huff noted that he was happy to hear that IAIS’s goal is not to establish strict rules for insurers but instead to develop a flexible regulatory framework. When asked to explain the interplay between ComFrame and the need for individual nations and states to enforce their own laws, Dr. Kawai responded that it would be much like the relationship between the NAIC and the states. When asked what he envisions the timeline for completion of ComFrame to be, Dr. Kawai responded that he expects the final ComFrame consultation paper to be finalized in the third or fourth quarter of 2013, but that this would only be the first step in a continuing process.
Other Initiatives. Separately, various committees and working groups reported on international regulatory initiatives. On the EU front, Pennsylvania Insurance Commissioner Michael Consedine reported in the International Insurance Relations (G) Committee that the Federal Insurance Office (FIO) continues its work with the European Insurance and Occupational Pensions Authority (EIOPA) on the EU-U.S. Dialogue Project to break down barriers and increase consistency in the regulation of insurance in the EU and the U.S. The FIO and EIOPA are working on a wide range of regulatory issues, including confidentiality, group supervision, capital and solvency requirements, and reinsurance collateral requirements. Even in meetings that were not expressly focused on international issues, the international influence was readily apparent. As discussed in Section A(6) below, the NAIC continues to push for state implementation of the Risk Management and Own Risk and Solvency Assessment (ORSA) Model Act and amendments to the Credit for Reinsurance Model Law and Model Insurance Holding Company System Regulatory Act, which were adopted in large part to address perceived deficiencies in U.S. insurance regulation.
2. NAIC on Corporate Governance – “We Touch Your Food”
The Corporate Governance Working Group finalized its recommendations for enhancing regulation and oversight of the governance practices of U.S. licensed insurers. The recommendations include:
Develop a model law that will require licensed insurers to file an annual report describing the insurer’s governance practices.
Revise the Annual Financial Reporting Model Regulation (aka the “model audit rule”) to require larger insurers to have an internal audit function.
Revise the Financial Analysis Handbook to clarify existing procedures for the review of the suitability of directors and officers on an ongoing basis, develop a common methodology for reviewing corporate governance practices, and consider procedures in these areas at the group level.
Change the NAIC Annual Statement Supplemental Compensation Exhibit to collect additional detail on compensation paid to top executives and directors. The Working Group recommends adding more detailed disclosure about the components of compensation (salary, stock awards, options, sign-on payments, severance and other benefits) and a narrative description of material factors necessary to understand the compensation.
Require the appointed actuary for life companies to present the full life actuarial report to the board of directors on an annual basis.
Give state insurance commissioners the same authority to deem a property/casualty actuary unsuitable that they have for life companies under Actuarial Opinion and Memorandum Regulation.
3. Group Solvency Issues – Regulators Expose Drafts Delineating Role of U.S. “Lead State”
The Group Solvency Issues Working Group exposed two documents for comment. Both relate to the role of a lead state in connection with insurers that are part of an insurance holding company system. Both documents have been in development for some time, and there was very little discussion about them at the meetings in Houston.
The first document is entitled, “Financial Analysis Review Team Guidelines Regarding Holding Company Analysis.” It provides for the lead state to be responsible for developing and documenting an analysis of the holding company group and distributing the analysis to other domestic states in the group by October 31 of each year. The analysis is to cover the overall financial condition of the group, significant events and any material strengths and weaknesses of the group. The lead state is to notify other domestic states if it has material concerns with respect to the overall financial condition of the group. The document can be found here. Comments are due by May 22, 2013.
The second document is an addition to the NAIC’s Financial Analysis Handbook entitled, “Roles and Responsibilities of U.S. Lead State/U.S. Group Wide Supervisor.” The Working Group Co-Chair (Danny Saenz, Texas) described the Handbook as offering something to non-U.S. regulators to demonstrate how the U.S. coordinates regulation of insurers within a group, and it also weaves together information regulators receive via the ORSA and the holding company act. He emphasized that the intent is not to usurp the regulatory authority of domestic states, but rather to describe the lead state’s role as a coordinator of the work undertaken by the various domestic states. The exposure draft can be found here. Comments are due by June 7, 2013.
4. Reinsurance Task Force Hopes to Have Procedures for Recognizing “Qualified Jurisdictions” in Place by Year End
The Reinsurance Task Force received a report on state implementation of the revised NAIC Model Credit for Reinsurance Law and Regulation that allow reduced collateral for highly rated unauthorized reinsurers (Reinsurance Models). According to NAIC staff, changes to allow reduced collateral have now been adopted by 11 states, representing 45% of the total U.S. domestic insurance premium (the states are California, Connecticut, Delaware, Florida, Georgia, Indiana, Louisiana, New Jersey, New York, Pennsylvania and Virginia). Staff reports indicate proposed legislation is pending in an additional 12 states. If all of the pending bills are passed, reduced collateral legislation will have been enacted in states representing 75% of total U.S. domestic insurance premiums.
The Task Force also discussed the latest draft of the “Process for Developing and Maintaining the NAIC List of Qualified Jurisdictions.” An exposure draft of this document was released during the 2012 Fall National Meeting. The draft was revised based on industry and regulator feedback received during the comment period that pressed for a more streamlined review that relies on existing work and speeds up recognition of those jurisdictions that have already been recognized by Connecticut, New York and Florida – the only three U.S. states that have actually approved reinsurers for reduced collateral.
Some context: Under the Reinsurance Models, the insurance department in the state of domicile of a ceding insurer may certify an unauthorized reinsurer for collateral reduction if the reinsurer is licensed and domiciled in a “qualified jurisdiction.” The Task Force has been developing a process to evaluate the reinsurance supervisory systems of non-U.S. jurisdictions for the purpose of developing and maintaining a list of jurisdictions that are recommended for recognition as “qualified jurisdictions.” Ultimately, approval of a qualified jurisdiction is left to individual states; however, the Reinsurance Models provide that a list of qualified jurisdictions will be created through the NAIC committee process, and individual states must consider the list when approving jurisdictions, and explain their reasons if they choose not to follow the NAIC’s recommendations.
As now proposed, the NAIC’s Process document provides for expedited review of Bermuda, Germany, Switzerland and the U.K. (these are the jurisdictions approved by Florida and New York). These jurisdictions are eligible for a conditional designation based on an initial review of publicly available information, as supplemented by information necessary to update the public information. Conditionally qualified jurisdictions may be subsequently upgraded to fully qualified status. The conditional qualification lasts for one year, but can be extended. Review of other jurisdictions will be prioritized by “objective” factors such as ceded premium volume and reinsurance capacity, but the NAIC will also act upon individual state requests.
The NAIC’s review is described as an “outcomes-based comparison to financial solvency regulation under the NAIC Accreditation Program, adherence to international supervisory standards and relevant international guidance for recognition of reinsurance supervision.” It further provides that “the NAIC must reasonably conclude the jurisdiction’s reinsurance supervisory system achieves a level of effectiveness in financial solvency regulation that is deemed acceptable for purposes of reinsurance collateral reduction, that the jurisdiction’s demonstrated practices and procedures with respect to reinsurance supervision are consistent with its reinsurance supervisory system, and that the jurisdiction’s laws and practices satisfy the criteria required of qualified jurisdictions as set forth in [the Reinsurance Models].” In applying these standards, the NAIC will consider the following information:
Laws and regulations.
Regulatory practices and procedures.
Jurisdiction’s requirements applicable to U.S. reinsurers.
Regulatory cooperation and information sharing.
History of performance of domestic reinsurers.
Enforcement of final U.S. judgments.
Solvent schemes of arrangement.
Insurance industry representatives generally praised the expedited review and outcomes-based approach, although some commentators expressed the view that more jurisdictions should be eligible for expedited review. The Association of Bermuda Insurers and Reinsurers put in a plug for prioritizing Bermuda, noting that approval of Bermuda results in approval of potentially two dozen certified reinsurers. By contrast, other jurisdictions have potentially one or two.
The Task Force Chair (Michael Consedine, Pennsylvania) indicated that the Task Force is targeting approval at the Summer National Meeting, so that final procedures can be in place by year-end 2013 to begin conditionally approving jurisdictions.
The Task Force also received a report from the Reinsurance Financial Analysis Working Group, dubbed “Re-FAWG.” Despite the name, Re-FAWG’s mission is not to replicate for certified reinsurers the workings of the FAWG, which focuses more on coordinated review and action for troubled companies. Re-FAWG will focus on helping states review reinsurance collateral reduction applications. The Reinsurance Task Force approved a Procedures Manual for Re-FAWG, which is not public, but is summarized in a document that was included in the Task Force’s public materials. The document describes the planned interaction between Re-FAWG, individual states and the NAIC, but does not set out any substantive review standards, other than that it will consider the evaluation/rating criteria in the Reinsurance Models and will work to facilitate consistency among states. In his remarks describing this document, the Working Group Chair (Steve Johnson, Pennsylvania), emphasized the group’s advisory role, noting the Model Law gives each state authority to approve reinsurers. He expressed the Working Group’s goal to be to allow the various states to use the same work product for the same company to avoid the duplication of efforts.
5. Inaugural Meeting of Financial Stability (EX) Task Force
The Financial Stability (EX) Task Force held its inaugural meeting on April 6. The Task Force is charged with considering (i) “issues concerning domestic or global financial stability as they pertain to the role of state insurance regulators and mak[ing] recommendations to International Insurance Relations (G) Committee, Government Relations (EX) Leadership Council or the International Insurance Relations (EX) Leadership Group, as appropriate” and (ii) “state insurance regulators’ input to national and international discussions on macro-financial vulnerabilities impacting the insurance sector.” The Task Force is also charged with serving as a forum to coordinate the perspective of state insurance regulators on a wide variety of issues arising from the designation of U.S. insurance groups as “systemically important,” including:
Where appropriate, developing policy recommendations and/or guidance regarding the role, responsibilities and activities of state insurance regulators in the context of consolidated supervision resulting from designation.
Analyzing proposed rules by the federal agencies that relate to financial stability.
Analyzing proposed policy measures regarding supervisory standards for globally systemic important insurers.
Developing comment letters on such analysis for further consideration by the International Insurance Relations (G) Committee, Government Relations (EX) Leadership Council, or the International Insurance Relations (EX) Leadership Group, as appropriate.
New York Superintendent of Financial Services Benjamin Lawsky, Vice Chair of the Task Force, read the Task Force’s charge, while Connecticut Insurance Commissioner Thomas Leonardi, Task Force Chair, explained that the Task Force’s goal is to focus on financial stability in a very holistic manner, at a policy level.
During its first meeting, the Task Force discussed (i) the role of supervisory colleges in meeting the requirements of IAIS ICP 25, (ii) the need to clarify with international regulators how the U.S. system of group supervision works and how effective it has been historically, (iii) macro-prudential regulation of insurance, and the danger of using regulatory tools geared towards past economic crises and not those of the future, and (iv) federal developments in the regulation of insurance, including new rules on the designation of non-bank financial institutions as systemically important (SIFIs) and the importance of ensuring that insurers and policyholders are not inadvertently swept up in new federal regulation of financial institutions.
6. NAIC State Accreditation Standards Reflect Solvency Modernization Initiative Developments
If anyone questioned the NAIC’s commitment to its Solvency Modernization Initiative (SMI), those questions were answered in Houston. The NAIC has continued at a rapid pace to update its state accreditation standards to ensure that states adopt the new requirements that have already been created as part of SMI.
In the Fall of 2012, the NAIC adopted the ORSA Model Act as part of SMI. At the Spring National Meeting, the NAIC released the ORSA Model Act for a 30-day comment period for consideration as a state accreditation standard.
In November 2011, as part of SMI, the NAIC adopted amendments to its Credit for Reinsurance Model Law and Regulation (the Credit for Reinsurance Amendments) that permit U.S. ceding insurers to take full credit for reinsurance ceded to qualified non-U.S. reinsurers based upon less than 100% collateralization. At the Spring National Meeting, the NAIC adopted revised state accreditation standards that permit states to adopt reduced reinsurance collateral requirements, provided that such requirements are substantially similar to the Credit for Reinsurance Amendments. The revised accreditation standards, which were adopted by the NAIC on an expedited basis, also permit states to maintain their existing full collateral requirements.
In 2010, the NAIC adopted amendments (the Holding Company Act Amendments) to the NAIC Model Insurance Holding Company System Regulatory Act (the Holding Company Act) that include several key changes to the regulation of holding company systems, including a requirement that the ultimate controlling person of any U.S. insurer file an “enterprise risk report” (Form F) identifying risks posed to the insurer by its insurance and non-insurance affiliates annually. State adoption of the Holding Company Act, or a “substantially similar” law, is required for NAIC accreditation. The Financial Regulation Standards and Accreditation (F) Committee is considering which provisions of the Holding Company Act Amendments states will be required to adopt to maintain accreditation, but state adoption of the enterprise risk reporting requirement is expected to be required. The Committee rebuffed a request by the National Association of Mutual Insurance Companies (NAMIC) that the Committee consider (i) adopting an exemption to the enterprise risk reporting requirement for “small companies” (companies with less than $500 million in direct written premiums) or (ii) including a drafting note indicating that states that adopt a similar “small company” exemption will be deemed compliant for accreditation purposes.
B. Other Issues of Particular Interest to Life Insurers
1. NAIC Continues Work on Principles-Based Reserving for Life Insurers
In Houston, the NAIC continued down the long and uncertain path towards implementation of principles-based reserving (PBR) for life insurers. PBR would modernize the methodology for life insurance reserving so that it has a less formulaic approach and is more focused on specific product designs and models. The goal of PBR is to “right size” the reserves for specific products with the hope of also addressing the issue of reserves, widely viewed as redundant, that result from the NAIC’s Regulation XXX and Actuarial Guideline 38 (AG 38). In 2009, the NAIC adopted a revised Model Standard Valuation Law, which authorizes PBR, and a Valuation Manual that sets forth the minimum reserve and related requirements for certain products under PBR. In 2012, the NAIC adopted the Valuation Manual, in spite of strong opposition from several key states (including New York and California). Now, the NAIC is considering whether states have the resources necessary to implement PBR.
The Principles-Based Reserving Implementation (EX) Task Force has been tasked with serving as the coordinating body for all NAIC technical groups involved with PBR-related projects. According to Rhode Island Superintendent Joseph Torti, Co-Chair of the Task Force, the primary mission of the Task Force is to implement PBR. At the Spring National Meeting, the Task Force exposed the Revised Draft Principles-Based Reserving Implementation Plan for a 30-day public comment period. The Plan includes eight priority actions that must be taken before PBR can be implemented:
1. Ensuring adequate regulatory support for the PBR review and Valuation Manual updates.
2. Defining the experience data collection process for PBR.
3. Establishing standardized financial reporting and analysis tools that are appropriate for PBR.
4. Assessing the solvency implications of life-insurer-owned captives and other alternative mechanisms in the context of PBR.
5. Training state insurance department staff.
6. Determining when PBR will become an accreditation standard.
7. Implementing new charges for relevant NAIC Working Groups and Task Forces.
8. Establishing a timeline for PBR implementation.
PBR will not be implemented until the amended Standard Valuation Law is adopted by 42 states and state adoption reflects 75% of total life insurance premium written in the U.S. This means that New York and California, two of the most vehement objectors to PBR, which have large volumes of life insurance premium written in their states, could, with one other state, derail the process. Even states that have voted for the adoption of PBR, including Texas and Delaware, have stated that before they will ask their lawmakers to move on it, they will spend time conducting their own research on what PBR really means and evaluating and testing the new model. During the Task Force meeting, Mike Boerner, Director of the Actuarial Office of the Texas Department of Insurance, presented preliminary data from 40 states provided in response to a Task Force survey of resource needs for PBR implementation. The survey showed that 32 states indicated a need for additional staff training, with 16 states indicating that they have limited or no expectation of assistance from the NAIC. Fifteen states indicated that they would like to receive support and training from the NAIC, while eight states said they were not sure how the NAIC could help.
California Insurance Commissioner Dave Jones has argued against PBR because states would lack the resources to implement it successfully, and New York Superintendent of Financial Services Benjamin Lawsky has echoed these concerns. Whether state insurance departments have the resources to implement PBR, and whether advocates of PBR will have sufficient support from the states to implement PBR, remains to be seen.
Separately, the Financial Regulation Standards and Accreditation (F) Committee waived its standard procedure and delayed voting on the 2009 revisions to the Standard Valuation Law as a state accreditation standard until at least the 2014 Spring National Meeting so that the Committee can monitor the PBR implementation process. PBR-related legislation (i.e., the revised Standard Valuation Law and/or revised Standard Nonforfeiture Law) is currently being considered in 10 states: Arizona, Connecticut, Indiana, Louisiana, Maine, New Hampshire, New Mexico, Rhode Island, Tennessee and Texas.
2. Contingent Deferred Annuity (A) Working Group Issues its Recommendations on the Regulation of CDAs
The Contingent Deferred Annuity (A) Working Group issued a report to the Life Insurance and Annuities (A) Committee that includes its recommendations on the regulation of contingent deferred annuities (CDAs).1 The Working Group was charged with evaluating the adequacy of existing laws and regulations as applied to CDAs and whether additional solvency and consumer protection standards are required. The Working Group’s work was built on a previous working group’s findings, including that CDAs are a hybrid life product and should be sold by life insurers. Notably, New York abstained in the vote to adopt the Working Group report.
The Working Group’s report includes a number of recommendations:
1. The adequacy of existing laws and regulations applicable to the solvency of annuities, as such laws are applied to CDAs, be referred to the existing NAIC Committees, Task Forces or Working Groups with the appropriate subject matter expertise, and that the following issues be reviewed: (i) reserving requirements, (ii) RBC requirements, and (iii) financial reporting requirements.
2. A template/checklist of questions be developed that states could use to facilitate the review of a company’s risk management program at the time of CDA form filings.
3. CDAs should be filed with state regulators as CDAs, not variable or fixed annuities.
4. Absent a specific exemption (e.g., CDAs offered within ERISA retirement plans), CDAs should be registered as securities under federal law (and should be sold by FINRA registered broker-dealers), because they are considered a derivative of a security.
5. Various NAIC consumer protection model laws and regulations be revised to make clear that the models apply to CDAs, with a recognition that the models currently do apply to CDAs.
One question that regulators wrestled with during the Working Group’s meeting in Houston is what to do about CDA products that have already been approved as fixed or variable annuity products. Some states indicated that they may require reapproval of these form filings, while others may simply require notification that a CDA product was previously approved. The Working Group acknowledged a finding by the American Academy of Actuaries (AAA) that capital and reserving requirements set forth in Actuarial Guideline 43 (AG 43) and Risk Based Capital C3 Phase II (C3P2) are applicable and appropriate for CDAs, but noted that evaluation of the capital and reserving requirements for CDAs should be ongoing at the NAIC level, and that states will need to monitor the actuarial assumptions, hedging effectiveness, and the adequacy of risk management techniques used by insurers issuing CDAs.
Interested parties should keep an eye out for an NAIC white paper on CDAs that the Working Group recommended be developed to serve as a reference for states interested in modifying their annuity laws to clarify their applicability to CDAs. The Working Group recommended that the white paper include information similar to the recommendations in the Working Group’s report.
C. Other Issues of Particular Interest to Property and Casualty Insurers
1. Industry Considers Overhaul of Private Mortgage Guaranty Insurance Regulation
The Mortgage Guaranty Insurance (E) Working Group is considering what changes, if any, are necessary for the solvency regulation of Private Mortgage Insurance (PMI), including changes to the NAIC Mortgage Guaranty Insurance Model Act. The Working Group has identified three problems currently facing the PMI market that suggest the need to reform the Model Act: (i) the over-concentration of mortgage origination activity, (ii) the market’s tendency toward long periods of profitability, punctuated by periods of varying duration of catastrophic loss, and (iii) the disincentive for attentive underwriting of PMI created by the market’s tendency toward long periods of great profitability.
To address these problems, the Working Group has identified 12 potential changes to the regulation of PMI insurers (the Concepts-List of Potential Regulatory Changes). The Concepts-List, which was previously released for public comment, was the subject of the Working Group’s meeting in Houston. The Concepts-List includes the following potential changes for the regulation of PMI insurers:
1. Require minimum underwriting standards.
2. Change minimum capital requirements.
3. Update and modify contingency reserve requirements.
4. Abolish reinsurance requirements to concentrate resources and cut unnecessary overhead expenses.
5. Prohibit captive reinsurance arrangements with originating banks.
6. Create limitations on dividends beyond those required within the Holding Company Act that force insurers to retain capital in long profitable time periods for availability during periods of severe losses.
7. Create a mutual reinsurance company that all insurers are required to use to house additional reserves for the bad times.
8. Create some type of FDIC-like government entity as a backstop where premiums are paid over the entire business cycle.
9. Require new reporting requirements that break out types of risks/exposures (similar to the Financial Guaranty Exhibit) and are used to help determine/assess leverage and perhaps could even be used for capital requirements.
10. Re-establish the Home Owners’ Loan Corporation to facilitate greater uniformity in the workout process for borrowers that meet criteria indicating viable prospects for retaining home ownership.
11. Modify investment limitations to strengthen enforcement of prohibition of investments by mortgage guaranty insurers in mortgages and real estate that are not directly related to the ordinary conduct of their business in good faith.
12. Establish rights and responsibilities for PMI insurers concerning rescissions of insurance policies and certificates.
A critical issue identified by regulators and industry representatives alike is the need for updated solvency requirements for PMI insurers. Noting that the Model Act has not been amended in 30 years (before risk-based capital (RBC) requirements were established), regulators and interested parties discussed moving from a fixed solvency ratio requirement to a RBC regime (similar to the RBC requirements applicable to general insurers), with varying regulatory actions triggered at different solvency levels.
An RBC requirement for PMI insurers would take an insurer’s underwriting experience into account in determining applicable solvency requirements (and would supplement existing minimum capital and surplus requirements). The Private Mortgage Guaranty Insurance Industry Group has commissioned a study by an outside consultant to advise on potential capital modeling choices and the factors that would be considered in determining an insurer’s solvency under an RBC regime, with the end goal of constructing a capital model appropriate for the PMI industry.
The Working Group will be considering whether to prohibit captive reinsurance arrangements between PMI insurers and originating banks. Comments on the Concepts-List provided by the Center for Economic Justice proposed that the Model Act be amended to prohibit all mortgage originators and servicers (and their affiliates) from receiving any consideration in connection with the sale of PMI (other than the protection provided to lenders under the insurance coverage). Such a provision would include a prohibition on captive reinsurance arrangements with lender affiliates. Birny Birnbaum, on behalf of the Center, argued that lenders that have a financial interest in the sale of PMI then have an incentive to dictate terms to PMI insurers that maximize the financial gain of the lender. He noted a recent settlement agreement between the Consumer Financial Protection Bureau and four national PMI insurers related to alleged kickbacks paid to mortgage lenders via captive reinsurance arrangements.
Yet another issue that the Working Group will be considering is what regulators can do to help address the over-concentration of PMI business in a few insurers. State monoline requirements for PMI – that is, prohibitions on insurers licensed for lines other than financial guaranty insurance from writing PMI – are a significant obstacle to would-be PMI insurers. One potential solution discussed during the Working Group meeting was permitting general insurers to reinsure PMI coverage, despite state monoline requirements. Industry representatives asked that regulators consider issuing guidance clarifying that the monoline requirement is not applicable to reinsurance coverage.
2. Commercial Lines Deregulation 2.0?
The push for more efficient and consistent regulation of the insurance industry was front and center when the Commercial Lines (EX) Working Group met for the first time in Houston on April 5. The Working Group is tasked with considering reforms to the regulation of commercial lines and providing “recommendations to the NAIC as to what it and the states can do to assist in making commercial lines regulation as effective and efficient as possible.” During its meeting in Houston, the Working Group adopted a Work Plan that calls for the Working Group to:
1. Develop a summary of the state laws and regulations concerning commercial lines rate and form filing and approval requirements, including the authority to exempt certain lines and whether that authority has been used, and the definition of large-scale commercial risk exceptions.
2. Conduct a survey of the average time for approval of forms and rates by the states, to include the extremes, for various types of commercial lines insurance products.
3. Document the experience of the states that have recently proposed or enacted legislation and/or implemented regulatory measures to streamline commercial lines regulation and what lessons have been learned from these efforts.
4. Receive recommendations from interested parties on how the states could improve the filing and approval process.
If this sounds familiar, it’s because the NAIC undertook an almost identical initiative 15 years ago. In 1998, an NAIC special committee published the “White Paper on Regulatory Re-engineering of Commercial Lines Insurance: Streamlining of Commercial Lines Insurance Regulation.” The White Paper was the result of several years of work by the special committee, which was charged with evaluating regulatory practices to promote efficiency and coordination among regulators and industry, and to explore a possible means of streamlining certain aspects of commercial lines insurance regulation. The White Paper’s recommendations led to states adopting commercial lines deregulation laws that exempt certain large commercial policyholders (i.e., policyholders with net worth and annual commercial insurance premiums that meet statutory thresholds) from state form and rate filing requirements. Birny Birnbaum, a representative of the Center for Economic Justice, noted during the Working Group’s inaugural meeting a concern that the vastly different state rules on commercial lines regulation present an opportunity for the industry to pursue further deregulation of commercial lines, although he doubted that the Working Group would do so; ironically, one of the areas in which state commercial lines insurance laws vary most is the threshold for treatment as an exempt commercial policyholder.
Recommendations from interested parties on how the states can improve the commercial lines form and rate filing and approval process are due by May 20, 2013, and Working Group Chair Lee Barclay, Senior Actuary at the Washington State Office of the Insurance Commissioner, is pushing for the Working Group to complete its work by year-end.
D. Briefly Noted
1. Subgroup Considers Exemption to CAT Risk RBC Charge for Small Insurers
The Catastrophe Risk (E) Subgroup is considering providing an exemption to the catastrophic risk charge in the RBC calculation of certain small insurers. NAMIC has proposed that an exemption be granted to companies that (i) write less than $75 million in property direct written premium countrywide, or (ii) have wind and/or earthquake exposure in certain states deemed “catastrophe-prone areas” totaling less than 15% of policyholder surplus. One issue that the Subgroup will be considering is whether such an exemption would permit small insurers with high exposure to catastrophe risks (e.g., an insurer with $65 million in property direct written premium for coastal Florida risks) to avoid the CAT risk charge. The Subgroup is also considering how to structure the exemption so that companies cannot avoid the CAT risk charge by simply restructuring their intercompany pooling arrangements.
During its meeting in Houston, the Subgroup agreed that initially, for informational purposes, the exemption thresholds should be set high to avoid imposing unnecessary costs on small insurers, with the understanding that the Subgroup would review the thresholds in two years for possible adjustment. Robert Marcks, Chief Actuary for the Connecticut Department of Insurance, noted that the CAT risk charge will not go into effect for several years and, in the meantime, there is no downside to setting a high exemption threshold. The Subgroup has asked NAMIC to provide a summary of the number of insurers that would qualify for the exemption under its proposed threshold.
2. Update on Captive and SPV Use (E) Subgroup
The NAIC subgroup that has been examining the use of captives did not meet in Houston. The state of its work is as follows:
Prior to the 2012 Fall National Meeting, a draft white paper released by the Captive and Special Purpose Vehicle (SPV) Use Subgroup of the Financial Condition (E) Committee2 prompted widespread industry comment, particularly with regard to the draft’s references to “shadow banking,” IAIS standards and an increase in the use of captives for life insurance reserve financing transactions. The meeting of the Subgroup at the Fall National Meeting provoked an animated exchange among regulators. On March 14, 2013, the Subgroup released a revised draft of the white paper which eliminated the reference to “shadow banking” and reordered the discussion of IAIS standards to address industry concerns that a similar IAIS study is a primary input to the Subgroup’s study. Furthermore, the discussion of reserve financing transactions was clarified to state that a focus of the Subgroup was to identify transactions that involved commercial insurers transferring risk to captives or SPVs in lieu of the formerly broad language that these transactions represented a significant portion of the increase in captive insurers and captive domiciles generally. On the conference call releasing the revised draft for comment, regulators agreed that the revised draft addresses the majority of industry comments while continuing to focus on the issues of concern to regulators, such as accounting considerations, transparency and confidentiality. Comments on the revised draft were due by April 22, 2013.
3. Consumer Liaisons Speak Out on Sandy and Tiered Rating
At the meeting of the NAIC/Consumer Liaison Committee, a representative from United Policyholders provided a presentation on claims problems reported to them relating to Sandy. The principal complaints related to flood claims under the National Flood Insurance Program. Complaints cited included no knowledge by consumers that they needed separate policies for flood, basement exclusions for split-level homes, the $250,000 coverage limits for flood and lack of leverage and accountability in disputes with flood adjusters. The presentation also listed various complaints regarding consumer confusion about homeowners’ claims.
Representatives from the Center for Economic Justice (CEJ) presented the results of a survey CEJ conducted on state laws that prohibit risk classifications for race, sex, national origin, sexual preference and religion. CEJ found that use of these classifications in underwriting was not prohibited by the laws in many states. This met with skepticism from the Committee Chair (Stephen Robertson, Indiana), who indicated his department would not approve rates based on those classifications, and by another Committee member (Louis Savage, Oregon), who asked if CEJ had considered state public accommodation laws that prohibit discrimination in “providing services.” CEJ expressed its concern about the use of other classifications, like credit scores and zip codes, that it regards as proxies for suspect classifications because of their disproportionate impact on low-income consumers. This prompted a heated exchange with the representative from Consumer Advocate, who bristled at CEJ equating poor credit with minority status. Despite the exchange, CEJ indicated concern that data mining, predictive modeling and tiered placement have a disproportionate impact on protected classes and that regulators don’t see it because insurers “call it underwriting, not rating.” CEJ pressed for tiered placement to be considered a rating factor that should be submitted for review and scrutinized.
4. Surplus Lines Task Force Continues Work on State Surplus Lines Eligibility Requirements under the NRRA
The Surplus Lines (C) Task Force was scheduled to meet in Houston to continue its work to ensure that state surplus lines eligibility requirements comport with the Nonadmitted and Reinsurance Reform Act (NRRA), which became effective in 2011 as part of Dodd-Frank, but their meeting was cancelled. The NRRA confers nationwide surplus lines eligibility on U.S.-domiciled insurers that satisfy the minimum capital and surplus requirements set out in the NAIC’s Nonadmitted Insurance Model Act, and bars states from prohibiting surplus lines brokers from doing business with nonadmitted insurers listed on the Quarterly Listing of Alien Insurers maintained by the NAIC’s International Insurers Department. However, some states continue to enforce eligibility requirements that are inconsistent with the NRRA.
The Surplus Lines Requirements (C) Subgroup has recently been working on drafting the “Suggestions for Improving Regulatory Uniformity with Respect to the Nonadmitted and Reinsurance Reform Act,” which recommends, in part: (i) that states discontinue their requirements regarding hard copy annual or quarterly statement submissions, (ii) that state insurance department websites provide access to readily available information regarding nonadmitted insurers, and (iii) that states no longer enforce regulations that are inconsistent with the NRRA. The Subgroup has been receiving and discussing regulator and interested party comments regarding the Suggestions, with interested parties recently focusing on the methods that the NAIC will use to ensure uniformity among the states. The result of the Subgroup’s last conference call on March 21 was that the Subgroup will further revise the Suggestions and send a draft to regulators and interested parties for additional comments. The revisions will include expanding the recommendation that state insurance department websites provide links to insurer licensing and financial information available from the NAIC, and other fine-tuning of the Suggestions. The Subgroup plans to have a conference call on April 24 to discuss the latest revisions and attempt to finalize and submit the Suggestions to the Surplus Lines (C) Task Force.
5. Operational Risk Charge In Development
It was reported to the SMI Task Force that the RBC Subgroup has been busy clearing its plate so that it can focus exclusively on an Operational Risk charge for RBC.
1 The Working Group’s report defines a CDA as “an annuity contract that establishes a life insurer’s obligation to make periodic payments for the annuitant’s lifetime at the time designated investments, which are not owned or held by the insurer, are depleted to a contractually-defined amount due to contractually-permitted withdrawals, market performance, fees and/or other charges.”
2 The Subgroup is made up of representatives from the Financial Analysis Working Group, the Reinsurance Task Force and the Life Actuarial Task Force.
If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed or the Sutherland attorney with whom you regularly work.