The NAIC Captive and Special Purpose Vehicle Use (E) Subgroup held a public meeting on 29 November 2012 at one of the sessions of the NAIC National Meeting held near Washington, DC. The purpose of the session was to discuss comments received on the draft White Paper the Subgroup had issued on 16 November 2012.

The Subgroup was formed in early 2012 by the NAIC Financial Condition (E) Committee to study the use of captives and special purpose vehicles ("SPVs”) to transfer policyholder risk, as distinct from self-insured risk, and to recommend regulatory responses.

According to the draft White Paper, the Subgroup determined that the majority of cessions to captives and SPVs by commercial insurers are reinsurance transactions used by life insurance companies to finance reserves required by Regulations XXX and AXXX that the companies perceived to be “redundant”. Among the structures utilized to finance such reserves are:

  • captives as a conduit to securitizations that provide capital market financing of redundant reserves;
  • captives capitalized by letters of credit accounted for as assets in support of redundant reserves; and
  • captives or SPVs capitalized by parental guarantees accounted for as assets in support of redundant reserves

The Subgroup’s draft White Paper made recommendations in five areas:

  1. Accounting considerations

While recognizing the need to deal with perceived XXX and AXXX reserve redundancies, the consensus of the Subgroup was that it is inappropriate for captives and SPVs to be used as a means to avoid statutory accounting. The Subgroup expressed the view that it would be more appropriate to deal with accounting and reserving issues within the ceding company, thereby eliminating the need for a separate transaction outside of the commercial insurer. (See the separate article on “principles-based reserving” in this bulletin.) The Subgroup suggested that the NAIC also consider modifications to the statutory accounting framework to recognize, in limited situations, alternative assets, such as “tier 2 type assets” to support specific situations (e.g. less likely to develop liabilities), thereby eliminating the need for a separate transaction outside of the commercial insurer.

  1. Access to alternative markets

The draft White Paper expressed support in principle for the availability of solutions designed to shift risk to the capital markets or provide alternative forms of business financing. The Subgroup noted that the NAIC’s Special Purpose Reinsurance Vehicle Model Act (#789) had been developed to provide a uniform framework for the implementation of capital market securitizations of commercial insurers’ reserves. Recognizing that securitization structures have evolved beyond those provided for in the model act, the Subgroup proposed that the NAIC re-evaluate the model act and update it as necessary to reflect alternative market solutions acceptable to state regulators so that the model act could serve its intended purpose of providing a uniform framework for the implementation of alternative market solutions. The Subgroup also suggested that the NAIC encourage states to adopt the model act and consider making the model act an accreditation standard in those states that have an active captive and SPV market.

  1. International Association of Insurance Supervisors (“IAIS”) standards

The draft White Paper expressed support for the IAIS Guidance Paper on the Regulation and Supervision of Captive Insurers, which takes the view that captives and SPVs that are owned by, or under common control with, insurers or reinsurers and are used for purposes other than self-insurance should be subject to a similar regulatory framework as commercial insurers.

  1. Credit for reinsurance

The draft White Paper noted that captive or SPV reinsurance transactions involving conditional letters of credit or parental guarantees effectively permit the use of assets to support reinsurance recoverables, either as collateral or as capital, in forms that are otherwise inconsistent with requirements under the NAIC credit for reinsurance model law and regulation or other financial solvency requirements applicable to US-domiciled commercial assuming insurers. The consensus of the Subgroup was that those types of transactions are not consistent with the NAIC credit for reinsurance requirements and that redundant reserve concerns are more appropriately addressed through accounting for the underlying business at the primary insurer level, thereby eliminating the need for a separate reinsurance transaction. The Subgroup again expressed its support for the use of solutions designed to shift risk to the capital markets or provide alternative forms of business financing and reiterated its view that the NAIC should develop a uniform framework for the implementation of such alternative market solutions.

With respect to existing captive/SPV transactions, the Subgroup recommended enhanced disclosure in the statutory financial statements of ceding insurers regarding the impact of the transactions on the financial position of the ceding insurers. The Subgroup suggested that financial statement Note 10 M be enhanced to provide for disclosure of non-trade secret captive information and disclosure of the overall utilization of captives.

  1. Balance between confidentiality and transparency

The topic of confidentiality versus transparency was the one on which the Subgroup achieved the least consensus. Some Subgroup members advocated for greater transparency of reinsurance transactions involving captives and SPVs. Other members recognized a valid basis for maintaining the confidentiality of certain commercial terms of captive and SPV transactions. Given that captives and SPVs owned by commercial insurers are typically utilized for a single transaction, those members pointed out that it would be relatively easy for competitors and other parties to learn the economics of the transactions from the disclosures in financial statements, which could cause harm to the ceding company and other parties to the transactions. Accordingly, in the draft White Paper, the Subgroup recommended that the NAIC Financial Condition (E) Committee study the issue of confidentiality related to commercially-owned captive and SPVs more closely. The Subgroup suggested that the study pursue greater clarity regarding the specific reasons for and against the use of confidentiality for captives and SPVs, as well as the types of information that should and should not be held confidential, and that it seek to develop a framework that would provide greater uniformity in this area, possibly in the context of an updated framework for alternative market solutions as discussed in recommendation 2 above. The Subgroup also expressed the view that each state that has a domestic insurer in its holding company structure should be notified of a transaction of an affiliate that involves captives or SPVs, even if that state’s domestic insurer is not a party to the transaction.

The 29 November 2012 meeting

At the 29 November 2012 meeting, the Subgroup reviewed comments received from both state insurance regulators and insurance industry participants regarding the 16 November 2012 draft of the White Paper. There was considerable debate, at times verging on the acrimonious, between commenters in the audience and members of the Subgroup, and in some cases even between members of the Subgroup. Speakers on the one side emphasized the concerns raised in the draft White Paper, while speakers on the other side pointed to the significant costs that would be imposed on life insurers if their ability to utilize captive and SPV financing structures were taken away. In conclusion, while the Subgroup indicated that certain clarifying changes would be made to the draft White Paper to address a number of the points raised in the comments, it does not appear that the basic thrust of the five recommendations discussed above will be significantly altered. The next step will be for the Subgroup to meet via teleconference to discuss a revised draft of the White Paper and, once a revised draft White Paper is approved by the Subgroup, it will then be forwarded to the NAIC Financial Condition (E) Committee for its consideration.