The Federal Insurance Office in its September 2015 "Annual Report on the Insurance Industry" criticizes state insurance regulators for inadequate efforts to develop consistent captive reinsurance standards.

Revisiting its recommendations made in a December 2013 report, titled “How to Modernize and Improve the System of Insurance Regulation in the United States” (2013 Modernization Report), the Federal Insurance Office (FIO) criticized state insurance regulators for not addressing all transactions between life insurers and reinsurance captives.

The FIO noted that the National Association of Insurance Commissioners (NAIC) has been moving forward with a new principles-based reserving (PBR) method to calculate reserves for life insurance products, which relies upon an insurer’s individualized risk modeling to more closely tailor reserving calculations to an insurer’s actual economic risk. The FIO nevertheless criticized the XXX/AXXX captive reinsurance framework (Captive Framework) that state insurance regulators are developing as a stopgap until PBR requirements are fully implemented.

In its 2013 Modernization Report, the FIO recommended that states develop “a uniform and transparent solvency oversight regime for the transfer of risk to reinsurance captives” by an affiliated or parent life insurer. The FIO is concerned that state insurance regulation has focused exclusively on individual legal entities within a group rather than on the group as a whole, which the FIO claims “allows life insurers to shift capital among affiliates to take advantage of state-by-state regulatory inconsistencies.”

Following years of study and deliberation within the industry, state insurance regulators are developing a Captive Framework, which aims to enhance the regulation of reserve financing transactions between life insurers and captive reinsurers, and which proposes standards that a ceding insurer would be required to satisfy in order to receive credit for reinsurance ceded to reinsurance captives. The FIO does not believe that this framework goes far enough, however. On the contrary, the FIO asserts that the Captive Framework largely misses the mark, as the framework would not apply regulatory requirements directly to reinsurance captives and covers only transactions involving cessions of reserves for term life and universal life with secondary guarantees. According to the FIO, the framework’s “limited scope and its exclusive focus on ceding insurers” would allow captive reinsurers to continue to be subject to “a wide variety of less stringent requirements across the states.”

The FIO also criticize states for the uncertain timeframe for implementation of the Captive Framework:

The framework is expected to be implemented in phases, including the development of a new reinsurance standard pertaining to term life and universal life with secondary guarantee products—thereby requiring state-by-state adoption over the course of an uncertain number of years.

And while the NAIC expects that the incentives to create reinsurance captive transactions will “be almost, if not fully, eliminated” once PBR becomes effective, insurers have not conceded that expectation. The timeframe for adoption of PBR is equally uncertain. Accordingly, the FIO (quoting A.M. Best) fears that the “stopgap” measures established in the Captive Framework “may become the new regulatory reality and, thereby, not eliminate the use of reinsurance captives.”