The National Association of Insurance Commissioners (NAIC) held its Spring 2019 National Meeting (Spring Meeting) in Orlando, Florida, from April 6 to 9, 2019. The Spring Meeting was highlighted by the following activities.
1. Reinsurance (E) Task Force Considers Additional Revisions to the Credit for Reinsurance Model Law and Regulation to Implement Covered Agreements At the Spring Meeting, the Reinsurance (E) Task Force (Reinsurance Task Force) discussed comments to the latest exposed drafts of the revised Credit for Reinsurance Model Law (#785) and the Credit for Reinsurance Model Regulation (#786) (together, the CFR Model Laws) in an effort to implement the collateral reduction requirements set forth in the Bilateral Agreement Between the United States of America and the European Union on Prudential Measures Regarding Insurance and Reinsurance as well as the Bilateral Agreement Between the United Kingdom and the United States of America on Prudential Measures Regarding Insurance and Reinsurance (together, the Covered Agreements). U.S. state regulators risk federal preemption of state law unless they adopt such reinsurance collateral reforms within 60 months from September 2017 – the date the Covered Agreement with the European Union (EU) was signed.
The vote to adopt the prior versions of the proposed amendments to the CFR Model Laws was delayed in December 2018 after the U.S. Department of the Treasury and the Office of the U.S. Trade Representative issued comments that, among other things, found that certain features of the CFR Model Law drafts were inconsistent with the Covered Agreements. The March 7, 2019, exposure drafts of the CFR Model Laws have been revised to address those comments as well as certain other comments received from interested parties.
As a general matter, the latest exposure drafts provide for further deference to the terms of the Covered Agreements and limit the application of commissioner discretion to the extent that the exercise of such discretion is inconsistent with the Covered Agreements. Other notable revisions include the following:
- The definition of “Reciprocal Jurisdiction” was broadened to include U.S. jurisdictions that meet the requirements for accreditation under the NAIC financial standards and accreditation program, which means that a qualifying U.S. reinsurer that is not licensed in the state of domicile of a U.S. ceding insurer could be eligible for the same reduced collateral requirements that would apply to qualifying EU reinsurers under the revised CFR Model Laws.
- The effective date was revised to clarify that the reduced collateral requirements apply to reinsurance agreements entered into, amended or renewed on or after the date on which the assuming insurer has satisfied all requirements for such credit, and only with respect to losses incurred and reserves reported on or after the later of (i) the date on which the assuming insurer has met all such eligibility requirements or (ii) the effective date of the new reinsurance agreement, amendment or renewal.
Many comments to the latest exposure drafts expressed concern that the revisions do not entirely level the playing field for all Reciprocal Jurisdictions. For example, reinsurers from Reciprocal Jurisdictions that are not parties to a covered agreement remain subject to commissioner discretion in a number of areas and subsequently may be subject to additional requirements not applicable to reinsurers from Reciprocal Jurisdictions that are parties to a covered agreement. Regulators and interested parties noted that such disparate treatment may encourage additional jurisdictions to seek to enter into a covered agreement – a result the NAIC does not favor.
It is expected that the NAIC will finalize and adopt the revisions to the CFR Model Laws later this year to allow states sufficient time to enact the revised CFR Model Laws ahead of the Covered Agreement preemption deadline.
2. NAIC Prepares Group Capital Calculation Template and Instructions for Field Testing
The Group Capital Calculation (E) Working Group (GCC Working Group) continued to make progress in developing a U.S. Group Capital Calculation (GCC), with voluntary field testing expected to begin in early May 2019. During the Spring Meeting, the GCC Working Group discussed comments to the field-testing template and related instructions (Template), which were previously exposed for comment. To date, approximately 30 insurance groups, representing 15 lead states, have volunteered to participate in field testing. Volunteers will have 90 days to complete and submit the Template to their lead state, and lead states will have 60 days to review the results and make recommendations to the GCC Working Group. It is expected that aggregated information will be made available to other regulators and interested parties to assist in making final recommendations regarding the GCC once field testing is completed. Subject to the results of the field-testing process, the GCC Working Group intends to adopt the GCC by year’s end.
During the Spring Meeting, industry representatives raised concerns that the proposed timeline would not provide sufficient time for review of the field-testing results prior to finalizing the GCC by year’s end. In particular, industry members who are not participating in field testing expressed skepticism that they will have an opportunity to provide meaningful feedback to the GCC Working Group once aggregated field-testing results are made available. During the field-testing process, the GCC Working Group expects that it will provide a weekly Q&A so that issues arising during the field-testing process can be shared among volunteer groups and lead state regulators; however, it still has not been determined whether the Q&A will be open to interested parties and other regulators as the GCC Working Group evaluates how to provide transparency into the process while maintaining confidentiality for volunteer groups. The chair of the GCC Working Group reiterated that while the goal is to adopt the GCC by year’s end, the GCC Working Group will take additional time as needed to finalize the GCC in order to get it right and obtain all necessary feedback. In addition, the GCC Working Group acknowledged that ongoing adjustments to the GCC may be necessary as the GCC is implemented.
Volunteer groups also continued to request further clarity from the GCC Working Group as to how confidentiality will be maintained for the data such groups provide during the field-testing process. While the data will be reported directly by volunteers to their lead state, group-level information is also expected to be shared with the GCC Working Group to allow it to review and analyze group-level results. Currently, it is expected that group-level data will be held confidential pursuant to confidentiality agreements between volunteer groups and their lead states, with such agreements permitting the disclosure of group-level information to the NAIC; however, the GCC Working Group noted that confidentiality remains open for discussion to the extent volunteers continue to express concern with this approach.
3. NAIC Continues to Consider the Use of Big Data and Blockchain Technology in the Insurance Industry
The NAIC is continuing to consider the use of (a) big data for predictive modeling in rate filings by property and casualty insurers and (b) blockchain technology in the insurance industry. Additionally, the NAIC plans to expand the scope of its examination of big data usage by reviewing such use in connection with accelerated underwriting for life insurance and insurer claims practices.
With respect to property and casualty insurance, the Casualty Actuarial and Statistical (C) Task Force previously exposed a draft of its white paper regarding regulatory review of predictive models within insurer rate filings. The white paper identifies “best practices” currently used in a number of states and provides guidance for regulators implementing those best practices. In response to the exposed draft, industry submitted ten comment letters, and state insurance regulators submitted eight. While the comment letters remain subject to further review, one of the main concerns expressed is whether the identified best practices are too burdensome for application in all states. In addition, several common “policy-level” concerns have been raised, including how to maintain the confidentiality of data collected and the degree of transparency to a consumer regarding the data used in a model, its impact on premium and a consumer’s right to correct such data.
With respect to life insurance, the Big Data (EX) Working Group (BDWG) adopted a motion requesting that the Life Insurance and Annuities (A) Committee study the use of big data in accelerated life underwriting and draft best practices guidance for regulators. Accelerated life underwriting involves replacing medical exams and the collection of bodily fluids with information from data models similar to aspects of credit-based scoring. The Life Actuarial (A) Task Force is evaluating the actuarial soundness of those methods for predicting mortality.
Another area of regulatory concern the BDWG agreed to consider is the use of big data in insurer claim practices. This includes both antifraud efforts and claims valuation, such as whether insurers are using models for claims optimization. Those models evaluate the potential of settling a claim at a set amount based on the characteristics of the claimant.
In addition, the NAIC Center for Insurance Policy and Research (CIPR) hosted a panel of industry representatives to discuss the use of blockchain technology in the insurance industry. Blockchain is a ledger technology that creates a shared system of record through advanced encryption methods. Advocates of blockchain note that it has the potential to improve the efficiency, security and trustworthiness of a wide variety of transactions. Insurance companies, industry members and certain regulators are testing a variety of programs that use blockchain technology to explore its application in the insurance industry. For example, the American Association of Insurance Services has developed openIDL, a blockchain platform that streamlines regulatory reporting by allowing insurers and regulators to upload and share data to a secure blockchain platform, intended to lessen the time and costs associated with handling regulatory and compliance requirements for both insurers and regulators. The sole regulator on the CIPR panel was Commissioner Michael Pieciak of the Vermont Department of Financial Regulation (VDFR) who spoke about the VDFR’s January 15, 2019, study of the potential applications of blockchain technology within the banking and insurance industries. The VDFR has been active in exploring the uses of blockchain technology and recently announced its joint commitment with the Vermont Secretary of State to launch a pilot program to test the use of blockchain in state regulatory processes. The pilot program will test the use of blockchain technology in the registration process for new Vermont captive insurance companies. While the potential uses of blockchain are still being explored, many in the industry are optimistic that blockchain will continue to develop and have an impact across the insurance industry.
4. NAIC Resumes Efforts to Finalize Proposed Amendments to Suitability in Annuity Transactions Model Regulation
The Life Insurance and Annuities (A) Committee has instructed the Annuity Suitability (A) Working Group (ASWG) to resume efforts to finalize proposed amendments to the NAIC’s Suitability in Annuity Transactions Model Regulation (SAT). The proposed amendments are intended to better align the state standards governing the standard of care of insurance producers with the federal standards governing the standard of care of investment advisers. The November 2018 draft of the proposed amendments was exposed for comment until February 15, 2019, and 19 comment letters were received from regulators and interested parties. Comments were not discussed during the Spring Meeting; rather, it is expected that the ASWG will hold an in-person interim meeting in May or June to make further revisions to the proposed amendments in light of such comments. The ASWG was instructed to complete its work on the proposed amendments as soon as possible in anticipation of the U.S. Securities and Exchange Commission’s expected adoption of “Regulation Best Interest” in September 2019.
As currently proposed, the amendments to the SAT do not adopt a standard that expressly references the “best interest” of the consumer. Rather, the proposed amendments would require a producer (or an insurer where no producer is involved), when making a recommendation to an individual consumer regarding the purchase, exchange or replacement of an annuity, to “act in the interests of the consumer at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interests.” Under the current draft, a producer (or insurer) would comply with this requirement (in relevant part) by (a) “[a]cting with reasonable diligence, care, skill and prudence,” (b) making suitable recommendations (as further described in the SAT) and (c) making certain disclosures, including the cash and noncash compensation to be received by the producer in connection with the transaction and “[a]ny and all material conflicts of interest.”
5. NAIC Continues Discussions Related to the Regulation of Pharmacy Benefit Managers
The Health Insurance and Managed Care (B) Committee approved a request to develop a new NAIC model law establishing a licensing or registration process for pharmacy benefit managers (PBMs). The approval of the Executive (EX) Committee is required before resources can be devoted to the actual development or drafting of the proposed new model. In the interim, however, the Pharmacy Benefit Manager Regulatory Issues (B) Subgroup of the Regulatory Framework (B) Task Force may proceed with discussions related to the proposed new model.
The intended scope of the proposed new model is unclear, as the request was limited to establishing a licensing or registration process for PBMs, but by its charges, the subgroup responsible for drafting the proposed new model is authorized to consider including provisions on PBM prescription drug pricing and cost transparency. During discussion at (B) Committee, regulators expressed an interest in using the model law development process as a means to consider a broader scope of issues related to the regulation of PBMs and to discuss further whether the proposed new model or some other mechanism would be appropriate to address such issues.
6. Surplus Lines (C) Task Force Prepares Best Practices Guidance Related to Final Federal Flood Insurance Rule
At the Spring Meeting, the Surplus Lines (C) Task Force noted that the final rule released by federal banking agencies implementing the private flood insurance provisions of the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act) will become effective July 1, 2019. The NAIC provided the federal banking agencies with input and feedback throughout the course of drafting the final rule. The Surplus Lines (C) Task Force is in the process of drafting a best practices document that will identify aspects of the final rule that may conflict with state law and other related items. The Surplus Lines (C) Task Force expects to adopt the best practices document by year-end 2019.
The final federal rule requires regulated lending institutions to accept, in satisfaction of the mandatory flood insurance purchase requirement, flood insurance policies that meet the statutory definition of “private flood insurance” as set forth in the Biggert-Waters Act. Under the rule, if the policy or endorsement includes a statement that “[t]his policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation,” then the regulated lending institutions are not obligated to further review the policy to determine whether it meets the statutory definition of “private flood insurance.” The final rule also permits regulated lending institutions to use their discretion to accept flood insurance policies that do not meet the statutory definition of “private flood insurance” and to accept flood coverage provided by mutual aid societies, provided, in each case, that certain conditions are met.
7. NAIC Discusses Mechanisms for Voluntary Restructuring of Solvent Insurers
At the Spring Meeting, the new Restructuring Mechanisms (E) Working Group (the Restructuring Working Group) heard presentations from interested parties on mechanisms for voluntary restructuring of solvent insurers, including insurance business transfers (IBTs) and corporate divisions. The Restructuring Working Group is charged with preparing a white paper that, among other things, addresses the need for, and issues related to, such restructuring statutes.
Among the presentations, there were several interested parties that made comments in support of states that have adopted laws and regulations governing IBTs and corporate divisions. Some interested parties also highlighted similar mechanisms that are currently used in other countries, such as Part VII Transfers in the United Kingdom, as a potential guide for transactions in the United States. However, representatives from the National Organization of Life and Health Insurance Guaranty Associations and the National Conference of Insurance Guaranty Funds raised concerns about the application of existing guaranty association laws following IBTs and corporate divisions and how such transactions could negatively affect policyholders and the guaranty association assessment base.
8. NAIC Discusses Updates to the Life Risk-Based Capital Formula to Incorporate Longevity Risk
The Life Risk-Based Capital (E) Working Group (Life RBC Working Group) is considering changes to the life risk-based capital formula to incorporate longevity risk. At the Spring Meeting, the Life RBC Working Group heard a presentation by the American Academy of Actuaries (Academy). The Academy is recommending that a capital structure with longevity C-2 factors be applied to base statutory reserves. The Academy is also working to develop and further consider an approach to incorporate a covariance adjustment within C-2 to reflect the correlation between mortality and longevity risk. While there generally is consensus that a covariance adjustment is necessary, regulators and interested parties have yet to reach consensus around the appropriate amount of such adjustment.
9. NAIC Establishes Long-Term Care Insurance (EX) Task Force
Recognizing the importance of bringing stability to the long-term care insurance market, the NAIC membership voted unanimously to form the Long-Term Care Insurance (EX) Task Force (LTC Task Force), which will report to the Executive (EX) Committee. Virginia Insurance Commissioner Scott A. White and Colorado Insurance Commissioner Michael Conway will serve as Chair and Vice Chair, respectively, of the LTC Task Force. Other members of the LTC Task Force are still being determined. The charges of the LTC Task Force include, among others, “developing a consistent national approach for reviewing long-term care insurance rates that result in actuarially appropriate increases being granted by the states in a timely manner, and eliminates cross-state rate subsidization.” The LTC Task Force is charged with delivering its proposal to the Executive (EX) Committee by the NAIC’s Fall 2020 National Meeting. Unless otherwise affirmatively extended or modified by the Executive (EX) Committee, the LTC Task Force and its charges will expire on January 31, 2021. 10. NAIC Continues to Evaluate the Exposed Revisions to SSAP No. 41R — Surplus Notes
The Statutory Accounting Principles (E) Working Group (the SAP Working Group) is continuing to consider the August 4, 2018, exposed revisions to SSAP No. 41R — Surplus Notes (SSAP No. 41R) and the potential unintended consequences such revisions could have on existing transactions as raised in two comment letters submitted for the comment period ending November 30, 2018.
As currently proposed, the exposed revisions incorporate guidance into SSAP No. 41R that suggests that surplus notes linked to other structures do not qualify for surplus note accounting treatment and should therefore be treated as debt under SSAP No. 15 — Debt and Holding Company Obligations. The exposed revisions provide that linked transactions “include, but are not limited to, situations in which terms negate or reduce cash flow exchanges, and/or when amounts payable under surplus notes and amounts receivable under other agreements or assets can be netted or offset (partially or in full) eliminating or reducing the exchange of cash or assets that would normally occur throughout the duration, or at maturity, of the agreement, asset or surplus note.”
Comment letters submitted by interested parties and the Vermont Department of Financial Regulation — Captive Insurance Division raised concerns about how the exposed revisions would negatively affect existing reserve financing structures, including insurer-owned captive structures and note-for-note structures. For purposes of a regulator-to-regulator discussion, the SAP Working Group is collecting information on insurance reporting entities that file statutory financial statements with the NAIC, have linked surplus notes and would be affected by the exposed revisions to SSAP No. 41R. After such discussion, this item will be included on the SAP Working Group’s public hearing agenda for further consideration.
11. NAIC Adopts an Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office to Expand Fixed-Income Treatment to Certain Qualifying Funds
The Valuation of Securities (E) Task Force (VOS Task Force) adopted an amendment to the Purposes and Procedures Manual (P&P Manual) of the NAIC Investment Analysis Office to extend fixed-income treatment to certain qualifying funds. The amendment will be reflected in the 2019 P&P Manual; the proposed draft of which was also approved by the VOS Task Force at the Spring Meeting.
The amendment expands the existing framework so that certain investment companies organized as closed-end management companies and unit investment trusts regulated by the U.S. Securities and Exchange Commission can be submitted for analysis by the Securities Valuation Office (SVO) to determine whether the fund can be characterized as a “fixed-income-like” asset eligible to receive an NAIC designation.
Pursuant to the amendment, the following remains unchanged: (a) Investments in SVO-verified money market funds would continue to be reported as cash equivalents under SSAP No. 2R — Cash, Cash Equivalents, Drafts and Short-Term Investments, without a designation, (b) investments in SVO-identified bond exchange-traded funds (ETFs) would still be reported as bonds under SSAP No. 26R — Bonds, with an SVO-assigned NAIC designation and (c) investments in ETFs not on an SVO listing would continue to be reported as common stock under SSAP No. 30R, without an NAIC designation.
12. NAIC Exposes Revisions to Statements of Statutory Accounting Principles to Clarify Reporting of Affiliate Transactions
The Statutory Accounting Principles (E) Working Group (SAP Working Group) voted to expose for comment revisions to SSAP No. 25 — Affiliates and Other Related Parties to clarify that a transaction that involves an affiliate, or risks of an affiliate, is required be reported as a related-party transaction or an investment in an affiliate for purposes of statutory accounting, even if the transaction also involves a nonrelated intermediary. In addition, revisions will be made to SSAP No. 26R — Bonds, SSAP No. 32 — Preferred Stock, SSAP No. 43R — Loan-backed and Structured Securities and SSAP No. 48 — Joint Ventures, Partnerships and Limited Liability Companies, to identify that investment transactions are subject to the principles of related parties identified in SSAP No. 25. The deadline for comments is June 12, 2019.
The SAP Working Group noted that the revisions are intended to prevent situations in which affiliated debt is knowingly captured and repackaged to be recorded as “nonaffiliated” because of the involvement of a nonrelated party. For example, a reporting entity could hold securities issued by an “independent” trustee or SSAP No. 43R security issuer, which are backed by affiliated securities held in trust and, instead of reporting such investments as affiliated, the reporting entity could attempt to report the investment as independent even though such reporting entity only has direct recourse against the affiliated assets held in trust.
The SAP Working Group also noted in its recommendation for exposure the following principles for determining whether a transaction should be classified as an “affiliate” transaction for purposes of statutory accounting:
(a) Consideration should be paid to the substance of the agreement and the parties whose actions or performance materially affect the insurance reporting entity under the transaction.
(b) The mere inclusion of a nonrelated intermediary does not eliminate the requirement to assess and properly identify the related-party transaction in accordance with the provisions of SSAP No. 25.
(c) The presence of nonrelated assets in a structure predominantly comprised of related-party investments does not eliminate the requirement to assess and identify the investment transaction as an affiliate arrangement.
13. NAIC Continues to Consider Increasing Age Restriction on Indices Used in Annuity Illustrations
Although the Annuity Disclosure (A) Working Group (ADWG) did not meet at the Spring Meeting, in early March, the ADWG exposed for comment through April 26, 2019, proposed revisions to the Annuity Disclosure Model Regulation (Model 245). Currently, Model 245 prohibits annuity issuers from illustrating the performance of an index that is less than 10 years old. As further described below, the proposed revisions to Model 245 would expand the scope of the illustration prohibition to apply to indices less than 20 years old.
The ADWG began considering the relevant revisions to Model 245 in 2017. Based on industry proposals, in June 2018, the ADWG exposed for comment draft revisions to Model 245 that would permit illustrations of indexed returns for an index that has not been in existence for 10 calendar years, subject to certain conditions. In a comment letter regarding the June 2018 proposed revisions to Model 245, citing concerns that “ten years is too short a period of time to capture an economic cycle,” the Center for Economic Justice proposed increasing the index age restriction to 20 years.
As currently proposed, the amendments to Model 245 would prohibit the illustration of indexed returns for an index that has been in existence for less than 20 calendar years, unless certain criteria are met. The newly proposed revisions to Model 245 also set forth certain additional required disclosures that must be included in illustrations that use an index that has not been in existence for at least 20 years.
During a March 7, 2019, meeting of the ADWG by conference call, an interested party estimated that the current proposal would prohibit annuity issuers from illustrating index returns under approximately 70 percent of the indices currently used in indexed annuity products. The interested party suggested that revising the age restriction to 15 years instead of 20 years would reduce the commercial effect of the change, as only approximately 30 percent of the indices currently used in indexed annuity products have fewer than 15 years of history.
14. NAIC Considers Industry Comments on Key Projects of the International Association of Insurance Supervisors for 2019
The International Insurance Relations (G) Committee (G Committee) dedicated the majority of its time at the Spring Meeting to hosting a high-level discussion with a panel of interested parties on key 2019 projects of the International Association of Insurance Supervisors (IAIS). The discussion was focused on the development of the Insurance Capital Standard (ICS) and the Holistic Framework on Systemic Risk (Holistic Framework) and concerns regarding the direction and potential effect of such projects on U.S. insurers. The Chair of the G Committee noted that the views expressed by the panel will be taken into consideration internally by the G Committee and also shared with the IAIS.
The ICS is intended to act as a risk-based global groupwide prescribed capital requirement and is expected to be approved by year’s end for implementation in 2020. Prior to full implementation, the ICS will undergo a five-year “monitoring period,” during which the ICS will be used for confidential reporting to the groupwide supervisor and discussion in supervisory colleges. The general view of panel members was that the ICS, in its current state, is “not fit for purpose” as applied to U.S. insurance groups. The panel noted that while the ICS is intended to be a multijurisdictional tool, a single capital standard cannot reflect the variances among insurance markets or the varying structures of insurance groups.
Panel members expressed concern that a number of design issues on the ICS have remained open for some time and continue to present fundamental problems for application of the ICS to the U.S. market. In particular, the panel identified as the most pressing open issues (a) valuation of liabilities, (b) nondefault spread risk, currency risk and operational risk, (c) margin over current estimate and (d) tax matters. With regard to the treatment of capital resources in the group, the general view of the panel was that the ICS does not appropriately identify available capital resources in the group because capital is treated as if it is fungible when there are regulatory, legal and tax issues that may prevent the movement of such capital, particularly in times of financial stress within the group. The panel also expressed concern that despite the application of the monitoring period, once implementation of the ICS begins, it will be difficult to change course, particularly in the event of another financial crisis during the monitoring period when there has been no time to consider feedback or make necessary changes. To that end, the panel noted that the collective goal of the U.S. regulators and industry should be to work toward recognition of the U.S. risk-based capital aggregation approach as set forth in the proposed U.S. GCC (currently under development by the GCC Working Group) as being outcome-equivalent to the ICS to avoid the application of multiple capital standards to U.S. groups.
The Holistic Framework, on the other hand, will use an activities-based approach to assess and mitigate systemic risk in the insurance sector. In late 2018, the IAIS published the proposed Holistic Framework for a public consultation period that ended January 25, 2019. The Holistic Framework is slated for adoption in late 2019, with implementation beginning in 2020. In contrast to the concerns raised about the application of the ICS, panel members were generally supportive of the Holistic Framework. The most pressing concern they raised was the need to further identify those types of products or activities that fall into a widely accepted definition of systemic risk. They also noted that the Holistic Framework should apply a proportional approach to the analysis of systemic risk, with an ongoing cost-benefit evaluation that takes into account not only the effect of certain financial or market stress events but also their likelihood of occurring.