The National Association of Insurance Commissioners (NAIC) held its 2017 Fall National Meeting from December 2 through December 4 in Honolulu, Hawaii. Despite the exotic locale, the Fall National Meeting was not as well attended as most NAIC national meetings, with only 27 Commissioners registered. As a result, the agenda for the Fall National Meeting was truncated, with a number of working groups meeting during interim teleconferences before the Fall National Meeting, and the NAIC took the unusual step of opening the Fall National Meeting to participation via teleconference.
The following are some highlights from the Fall National Meeting, as well as notable developments from recent interim meetings. We do not cover every meeting in this report; rather, we comment on select noteworthy developments and matters of interest to our clients.
A. International Issues
1. International Reinsurance and the Covered Agreement
The Reinsurance (E) Task Force met in the wake of the signing of the covered agreement between the United States and the European Union. (For the latest on the covered agreement, its timetable for implementation and the road ahead, see our Legal Alert: US-EU Covered Agreement: An Overview.) With the covered agreement now signed, the Task Force is now beginning the process of evaluating the reforms to state credit for reinsurance rules that will be required in light of the covered agreement. States now have five years to adopt reinsurance reforms that remove reinsurance collateral requirements for EU reinsurers if they meet certain qualifications. Motivating the NAIC and state regulators to meet this timetable is the ability of federal regulators to preempt state law under the Dodd-Frank Act to the extent they believe that state law: (1) is inconsistent with the terms of the covered agreement; and (2) results in less favorable treatment of EU-domiciled insurers than of US insurers domiciled, licensed, or otherwise admitted in that state.
As a first step toward implementation, the Task Force, led by Superintendent Maria T. Vullo of New York, has tentatively scheduled an initial public hearing for February 20, 2018, in New York City. The hearing will provide a forum to discuss potential approaches to implementing the covered agreement and how the Task Force should move forward. Of particular note, Superintendent Vullo highlighted that one of the key purposes of the hearing would be to gather information and perspectives on how to address risk for US ceding insurers under the agreement, including the possible need for additional guardrails to ensure the solvency of US ceding insurers.
During a subsequent meeting of the Executive and Plenary Committee on December 21, the NAIC requested comments from state regulators and interested parties addressing: (1) potential revisions to the NAIC Credit for Reinsurance Model Law and Regulation that may be required in light of the covered agreement; (2) whether the benefits provided to EU reinsurers should be extended to other qualified jurisdictions; and (3) potential guardrails that should be implemented. Comments are due by February 6, 2018. While most other business of the Task Force remains on hold pending implementation of the covered agreement, the Task Force did adopt a recommendation that the states consider Kroll Bond Rating Agency as a Nationally Recognized Statistical Rating Organization (NRSRO) for certified reinsurance purposes, although the Task Force acknowledged states will need to align Kroll’s rating designations to the designations specified in the NAIC’s Credit for Reinsurance Model Regulation for A.M. Best, S&P, Moody’s and Fitch. The Task Force additionally adopted the report of the Reinsurance Financial Analysis (E) Working Group, noting that the Working Group met on October 26, 2017, in a regulator-to-regulator meeting to discuss actions taken with respect to the passporting of certified reinsurers by states. Details of the discussion and the specific companies involved were not disclosed.
2. Group Capital Calculation
The Group Capital Calculation (E) Working Group did not meet in Hawaii, but the Financial Condition (E) Committee adopted a report of the Working Group detailing conference calls held by the Working Group on October 30-31, 2017. These conference calls were held by the Working Group with the express intention of making progress on the group capital calculation. During the conference calls, the Working Group exposed for comment three memos regarding aspects of the group capital calculation: one relating to captives, one relating to non-regulated entities, and one regarding the treatment of senior debt and surplus notes. There was also a discussion on the conference calls about permitted and prescribed practices, because there are two schools of thought on how they should be treated in a group capital calculation. Some regulators feel there should be an on-top adjustment for consistency and comparison purposes, while others think no such adjustment should be made as the practices were previously approved. NAIC staff is performing research relating to this matter and no conclusion has yet been reached.
In addition, during the Working Group’s interim conference calls there was a brief update on the Baseline Exercise, which started earlier this year with nine volunteer companies working with their lead state regulators to collect data intended to help inform the Working Group’s decisions. The Baseline Exercise is currently in round two (collecting data on the exposures addressed above), which will be the last round, and the Working Group then hopes to field-test a beta version of the group capital calculation. The Working Group has indicated that there is no set timeframe for completion of the group capital calculation, but noted that the Working Group should move as quickly as possible, aiming for an exposure at the end of the first quarter or beginning of the second quarter of 2018.
3. Update on FSOC and Systemic Risk
During the meeting of the Financial Stability (EX) Task Force, Director Peter Hartt (New Jersey), Chairman of the Task Force, provided a report on international and domestic activities related to assessments of systemic risk. Director Hartt reported that:
- The International Association of Insurance Supervisors (IAIS) is increasingly focusing on an Activities-Based Approach to systemic risk and an interim public consultation paper on the topic is currently open for comment through February 15, 2018.
- The Financial Stability Board (FSB), in consultation with the IAIS, issued a press release on November 21, 2017, announcing that it had decided not to publish a new list of globally systemically important insurers (G-SIIs) for 2017. The press release notes that the IAIS’s work to develop an Activities-Based Approach to systemic risk could have significant implications for the identification of G-SIIs and for G-SII policy measures. In the meantime, policy measures will continue to apply to the nine firms on the 2016 G-SII list (including three US firms).
- The Financial Stability Oversight Council (FSOC) met in September, October and November. During the September meeting, AIG’s designation as a systemically significant nonbank financial institution was rescinded. The decision acknowledged developments and enhancements to state insurance regulation since the original designation, including the work that is being done by the Financial Stability Task Force through the Macro-Prudential Initiative (MPI).
- The Treasury Department issued its report on non-bank designations on November 17, 2017. While the report does not recommend the elimination of FSOC’s designation authority, it does recommend that FSOC focus on an activities-based or industry-wide approach and work with primary regulators to address any systemic concerns. If, after such an approach is utilized, it is determined that one or more firms still may pose risks to financial stability, FSOC should consider an entity-based designation at that time. The report also endorses many of the issues for which state regulators have previously advocated.
The Financial Stability Task Force also released two proposals from the Liquidity Assessment (EX) Subgroup (a Baseline Blanks Proposal and a Note Blanks Proposal) for a 45-day comment period ending January 16, 2018, that would expand product category breakouts in the Analysis of Operations by Line of Business schedule and the Analysis of Increase in Reserves schedule, as well as establish notes disclosures for life products similar to what exist for annuity disclosures.
B. NAIC Continues Focus on Innovation and Technology
1. Regulating Big Data
The Big Data (EX) Working Group continued its work on three key initiatives related to the regulation of big data by insurance companies: (1) identifying and assessing the current regulatory framework for oversight of insurers’ use of consumer and non-insurance data; (2) assessing the needs of regulators for data and tools to monitor the use of big data in the insurance marketplace; and (3) developing and proposing a mechanism for sharing resources among regulators to facilitate technical analysis and data collection related to regulator review of complex models used by insurers.
Regarding current regulatory frameworks, the Working Group discussed its progress since the last meeting in identifying regulatory issues around the use of consumer and non-insurance data by insurers. As part of this initiative, the Working Group has developed a list of regulatory issues related to the use of such data, which includes a variety of issues raised by consumers, industry, and regulators. The Working Group will continue to take comments regarding regulatory issues surrounding the use of consumer and non-insurance data until January 12, 2018.
Growing out of this discussion was an agreement by the Working Group to conduct a survey of state insurance regulators to collect information on whether states currently have specific prohibitions regarding the use of certain data elements used in underwriting and rating private passenger automobile insurance and homeowners insurance. While this survey will be limited to these property and casualty products, the Working Group noted that, while it is focusing on the property and casualty market to begin with, its inquiry will expand in the future to address life insurance products as well.
The Working Group briefly addressed the second initiative on the data and tools needed by regulators to monitor the use of big data. To date, the Working Group has focused on exploring how existing data held by regulators could be better used to this end, but have yet to receive public comments. Accordingly, the Working Group will take comments regarding the data needs of regulators and how existing data may be used to monitor the use of big data until January 12, 2018.
The Working Group discussed several issues addressing the third initiative to develop and propose resource-sharing mechanisms. As a first step, the Working Group has identified three key principles that will inform any resource-sharing mechanism identified and recommended by the Group: (1) state regulators will maintain their current rate regulatory authority; (2) state regulators will work to share information that aids speed to market; and (3) state regulators will share expertise and discuss technical issues regarding complex predictive models. The Working Group additionally discussed a recommendation that it make a request to the Casualty Actuarial and Statistical (C) Task Force to appoint a “Predictive Analytics (C) Working Group” to draft potential changes to the Product Filing Examiners Handbook to address best practices for review of predictive analytics and models used by insurers. The Working Group agreed to draft and circulate a proposed set of charges for this new working group for the Big Data (EX) Working Group’s review.
The Working Group additionally discussed making a request to NAIC management to conduct research into the skills and potential resources that would be needed by the NAIC to support state insurance regulators in reviewing complex models used by insurers and to make appropriate recommendations to the NAIC Executive (EX) Committee.
2. Regulatory “Sandboxes” and InsureTech Engagement
The Innovation and Technology (EX) Task Force heard a variety of reports and presentations during its session at the Fall National Meeting. The most substantive discussion of the session focused on regulatory “sandbox” concepts following a presentation from the American Insurance Association (AIA) and the American Family Insurance Company. The AIA additionally presented a proposed draft of legislation designed to give insurance commissioners more flexibility in working with start-ups and incumbent insurers working on innovative products and services.
Regulatory “sandboxes” are arrangements where companies, often start-ups or new entrants to the market, are given additional flexibility by regulators to experiment with new business models and products that may not align with current regulatory standards. Several interested parties provided comments on the issue, with commenters generally expressing that they were not opposed to “sandboxes” in principle so long as they are fair to current market participants and consumers.
The Task Force additionally heard an update on NAIC and regulator participation in the InsureTech Connect conference and Silicon Valley programs held in October. The NAIC sponsored 25 regulators to attend InsureTech Connect, and held a series of four programs following the conference. The programs included: (1) a half-day workshop where 22 regulators sat down with 20 start-ups to discuss business models and regulatory considerations; (2) a day of presentations from InsureTech start-ups; (3) an event with Google focused on public policy considerations around autonomous vehicles; and (4) a day-long cybersecurity conference at Stanford University. The Task Force noted that it thought the programs were very successful, and that it intends to build on this effort in the future.
The Cybersecurity (EX) Working Group met for the final time during the fall meeting, where it decided to recommend to the Innovation and Technology (EX) Task Force that the Working Group be disbanded. The Working Group members agreed to the recommendation, noting that with the finalizing of the Insurance Data Security Model Law in October, the Working Group had completed work on its assigned charges. Director Ray Farmer (South Carolina) noted that the Innovation and Technology (EX) Task Force itself could address continuing and future issues related to cybersecurity.
The Working Group also heard an update regarding federal activity on cybersecurity, noting significant activity and interest regarding cybersecurity issues in the wake of recent high-profile data breaches. As a result, there has been renewed interest in Washington in establishing federal data breach legislation that would include a preemption of data breach reporting laws. The Treasury Department also recently put out a report on the insurance industry that recommended state adoption of the Insurance Data Security Model Law to promote uniformity. The report noted that if the Model Law does not result in uniformity within five years, Treasury’s recommendation is that Congress should act to create uniform requirements for insurance data security requirements. This could create additional pressure on states to adopt the Model Law, potentially speeding the rollout of a new class of multistate cybersecurity requirements. The update concluded by noting that federal banking regulators are not proceeding with rulemaking regarding enhanced cybersecurity requirements. As originally described, the enhanced standards would have applied to a range of entities with total consolidated assets of $50 billion or more, including insurance savings and loan holding companies.
C. Issues of Particular Interest to Life Insurers
1. Revised Statutory Framework for Variable Annuities
The Variable Annuities Issues (E) Working Group (VAIWG) conducted a four-hour meeting during the Fall National Meeting to discuss and expose a proposed revised statutory framework for variable annuities (VA). As background, the enactment by the NAIC of C3 Phase II, in 2006, and Actuarial Guideline XLIII – CARVM for Variable Annuities (AG 43), in 2009, introduced unprecedented complexity into VA statutory balance sheet and risk management, prompting the use of captive reinsurance transactions. The VAIWG was created in 2014 to “study and address, as appropriate, regulatory issues resulting in variable annuity captive reinsurance transactions.” In 2015, the NAIC commissioned an effort to identify changes to the statutory framework for VA that could remove or mitigate the motivation for insurers to engage in captive reinsurance transactions for VA and engaged Oliver Wyman to assist in the effort. Oliver Wyman produced a report in 2015 identifying motivations for captive use, and a Quantitative Impact Study (QIS I) in 2016 regarding recommended revisions to the existing framework. In 2017, with approximately 15 companies participating, the NAIC undertook a second QIS (QIS II) in order to evaluate and refine the recommended structural revisions with the benefit of industry experience data.
At the Fall National Meeting, the VAIWG adopted a December 1, 2017, update on QIS II from Oliver Wyman and heard a presentation from Oliver Wyman of that update document entitled NAIC VA Reserve and Capital Reform, Recommended Revisions to AG43 and C3P2. Oliver Wyman explained that the recommendations reflect extensive input from the industry and that a great deal of quantitative analysis was done to support the recommendations, but that the results in the presentation were limited due to the confidentiality of the information. They presented 28 recommendations, the key benefits offered by the recommendations, and their assessment of how effective the recommendations will be in reducing the motivation for insurers to engage in captive reinsurance transactions. Among the 28 recommendations: 8 are new; 6 are modified from QIS I; and 14 are unchanged from QIS I. The VAIWG exposed three documents for comments until March 2, 2018: (1) the presentation from Oliver Wyman; (2) proposed changes to AG 43; and (3) proposed changes to life risk-based capital (RBC). The Working Group intends to schedule an all-day meeting at the NAIC Spring National Meeting at which time the VAIWG will begin discussing formal comments.
2. Updates to Annuity Suitability
The Annuity Suitability (A) Working Group reviewed and discussed an initial Working Group chair draft of proposed revisions to the Suitability in Annuity Transactions Model Regulation, which was exposed for comment on November 24, 2017, and will remain open for comment until January 22, 2018. Most notably, the chair draft proposes incorporating a best interest standard of care into the Model Regulation’s existing suitability standards. More specifically, the proposed revisions to the Model Regulation include:
- Revising the Model Suitability Regulation to generally require that all recommendations are “suitable and in the best interest” of the consumer;
- Adding a definition of “best interest,” defining it as “at the time the annuity is issued, acting with reasonable diligence, care, skill and prudence in a manner that puts the interest of the consumer first and foremost,” and indicating it does not mean “a resulting recommendation is the least expensive annuity product, or the annuity product with the highest stated interest rate”;
- Adding definitions of “cash compensation,” “non-cash compensation,” “reasonable cash compensation,” and “material conflict of interest” and changing the definition of “suitability information” to include “changes in nonguaranteed elements in an annuity contract”;
- Adding new disclosure requirements, including disclosures addressing: (1) the types of financial products that can be provided; (2) whether only a specific insurer’s products or limited range of annuity products can be offered; (3) the scope of the services provided and the producer’s license; (4) all material conflicts of interest; and (5) the percentage of cash compensation above 3% and non-cash compensation that exceeds $100 per year that is tied to the sale of annuities; and
- Adding a list of prohibited practices, including receiving more than “reasonable cash compensation”; making materially misleading statements about the annuity transaction; and basing a recommendation on the producer’s or insurer’s own financial interest.
State insurance regulators, representatives of national life insurance, annuity and producer trade associations, and consumer groups provided preliminary comments, including:
- Concerns about the proposed definition of “best interest” and whether a suitability standard can be successfully blended with a best interest standard;
- How a “best interest” standard can be harmonized with the FINRA standard;
- How the proposed 3% cash compensation disclosure threshold would be determined and calculated and whether it is meant to implicitly provide a “safe harbor” for the “reasonableness” standard; and
- Concerns about the proposed use of the subjective terms and phrases, such as “reasonable,” “material” and “substantial financial benefit.”
It is expected that interested parties and regulators will provide more extensive comments before the comment period ends on January 22, 2018. Once the comment period ends, the Working Group intends to hold a conference call to review and discuss the comments received and is aiming to present the proposed model regulation provisions to the Life and Annuities (A) Committee for its consideration at the NAIC 2018 Spring National Meeting.
3. Long Term Care Insurance
On December 21, the Executive and Plenary Committee met by teleconference and adopted amendments to the Life and Health Insurance Guaranty Association Model Act. Most notably, the amendments: (1) expand the assessment base for long-term care insurance (LTC) policies; (2) add HMOs to the assessment base; (3) split the liability for an LTC insolvency by allocating 50% to life and annuity insurance companies and 50% to health insurance companies; and (4) clarify that guaranty associations have the authority to file for premium rate increases.
The changes reflected in the amended Model Act arose from negotiations between the life insurance industry and the major medical writers, in the wake of the Penn Treaty insolvency, after major medical writers in Colorado pushed to “realign” the way in which assessments are made for LTC so that the burden would be shifted from health carriers to life and annuity writers. Ultimately, the life and health carriers agreed to a 50/50 split, with the inclusion of HMOs. This puts them in opposition to the HMO community, some of which have suggested that the change is just a cash grab that will add millions of dollars of premium to HMO members. Now that the NAIC has adopted the revisions to the Model Act, the next step will be to get it enacted on a uniform basis across states. As each state’s health market is unique and there is some significant opposition to the changes reflected in the amended Model Act, passage of the revised model – especially uniform passage – may be a challenge. Washington state was the only state to vote in opposition to adopting the amendments to the Model Act, with Commissioner Mike Kreidler explaining that 80% of health insurers in Washington are not currently members of the state’s guaranty association and their involvement in LTC is minimal. As a result, Commissioner Kreidler explained, Washington would be more heavily impacted than any other state in the nation by these changes and he feels there is “zero to no chance” they’ll be adopted in Washington state.
4. State Implementation of PBR
The Principle-Based Reserving (PBR) Implementation (EX) Task Force heard an update from the PBR Review (EX) Working Group and from the Life Actuarial (A) Task Force (LATF) on PBR developments, which included the adoption of amendments to the 2018 Valuation Manual and the exposure of edits to Experience Reporting Requirements (VM-50) to reflect that the NAIC will serve as the experience collection agent on behalf of the states, effective January 1, 2020. The Task Force also heard a report on PBR data experience reporting including that the NAIC is working with the Society of Actuaries to develop aggregated experience data. As of October 31, 2017, PBR has been adopted by 47 states, so the Task Force adopted a proposal to recommend to the Executive Committee that it be disbanded, along with the PBR Review (EX) Working Group and the PBR Review Procedures (EX) Subgroup.
D. Surplus Lines – Possible Amendments to IID Plan of Operation
The Surplus Lines Working Group is considering changes to the NAIC International Insurers Department’s (IID) Plan of Operation, which includes requirements and guidelines for inclusion of non-US insurers (also known as “alien insurers”) on the IID’s Quarterly Listing of Alien Insurers (the Quarterly Listing). The most noteworthy of the proposed changes to the Plan of Operation are: (1) elimination of the “soft cap” on the minimum required funding amount for trusts held by IID-Listed insurers (currently set at $150 million); and (2) the creation of an internal review committee within the IID to analyze and make recommendations with respect to applications, appeals and de-listing of IID-Listed insurers. Comments on the proposed changes to the Plan of Operation are due to the Working Group by December 29, 2017. Neither the Surplus Lines Working Group nor the Surplus Lines Task Force met in Honolulu.
Pursuant to the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA), no state may prohibit a surplus lines broker from placing nonadmitted insurance with, or procuring nonadmitted insurance from, a nonadmitted insurer domiciled outside of the United States that is listed on the Quarterly Listing. As a result, the IID is the primary gatekeeper for alien insurers seeking nationwide eligibility to write excess and surplus lines risks in the United States, and the requirements for Quarterly Listing set forth in the IID Plan of Operation are effectively the sole requirements for nationwide eligibility.
One of the core requirements for inclusion on the Quarterly Listing is that an insurer maintain a US trust account on behalf of US policyholders (the IID Trust Account) funded at an “appropriate level” with cash, securities meeting certain requirements prescribed by the IID via the IID Standard Form Trust Agreement, or an acceptable letter of credit. Under the IID’s current Plan of Operation, insurers are required to maintain assets in the trust in an amount (the Trust Fund Minimum Amount) determined by a sliding scale based on the insurer’s US gross surplus lines liabilities (ranging from 15% to 30%), subject to a cap of $150 million and a floor of $5.4 million (Lloyd’s syndicates are not currently subject to the cap). Notwithstanding this cap, under the current Plan of Operation, the IID retains ultimate authority to determine what constitutes an “appropriate level” of funding based on a number of factors (including the types and amounts of coverage that the insurer writes) – thus, the reference to a “soft” cap. As currently proposed, the Plan of Operation would eliminate the $150 million cap on the Trust Fund Minimum Amount.
E. Briefly Noted
1. Updated Accreditation Standards
The Financial Regulation Standards and Accreditation (F) Committee adopted the Corporate Governance Annual Disclosure Model Act and the Corporate Governance Annual Disclosure Model Regulation as new accreditation standards, effective January 1, 2020. The Model Act and Model Regulation require insurers to annually provide a confidential disclosure regarding corporate governance practices to their lead state and/or domestic regulator.
The Committee then discussed whether the 2014 revisions to the Insurance Holding Company System Regulatory Act, which provide authority to a designated state to act as a group-wide supervisor for an Internationally Active Insurance Group (IAIG), should be added to the accreditation standards. After debating whether states that do not have domiciled IAIGs should be subject to such an accreditation standard, the Committee decided that it would be prudent to develop and review a recommendation that makes the revisions an accreditation standard for all states. The Committee also decided to provide guidance that, when assessing a state’s compliance with accreditation standards, it should be considered whether an IAIG is domiciled in the state. Thus, the Committee deferred consideration of the adoption of these revisions as an accreditation standard and is planning to discuss this further in 2018.
Separately, the Executive (EX) Committee and Plenary adopted the 2014 revisions to the Annual Financial Reporting Model Regulation, which include requirements related to an internal audit function, as an accreditation standard to be effective January 1, 2020. These revisions were adopted as an accredited standard by the Financial Regulation Standards and Accreditation (F) Committee at the Summer 2017 National Meeting.
2. Update on IAIS and International Capital Standards
During the International Insurance Relations (G) Committee meeting, Commissioner Katherine Wade (Connecticut) provided updates on the efforts of the IAIS, including those related to Insurance Core Principles (ICPs), the Common Framework for Supervision of Internationally Active Insurance Groups (ComFrame), Global Systemically Important Insurers (G-SIIs), and the IAIS Multilateral Memorandum of Understanding (MMoU). With respect to ICPs, in addition to adopting and revising certain ICPs, the IAIS currently has out for public consultation draft revised ICP 15 (Investment), ICP 16 (Enterprise Risk Management for Solvency Purposes), and portions of ICP 8 (Risk Management and Internal Controls), together with the ComFrame material that is integrated within each of these ICPs. The deadline for comments to revised ICP 8 is January 15, 2018, and the deadline for comments to revised ICPs 15 and 16 is January 31, 2018. Regarding ComFrame, Commissioner Wade reported that the IAIS is making progress on the implementation of Insurance Capital Standard (ICS) Version 2.0, which will include valuation, capital resources and capital requirements; however, she added that some issues related to capital resources and capital requirements must be addressed before ICS Version 2.0 is finalized.
3. Election of NAIC Officers
NAIC members elected the following 2018 officers: Julie Mix McPeak (Tennessee), president; Eric A. Cioppa (Maine), president-elect; Raymond G. Farmer (South Carolina), vice president; and Gordon I. Ito (Hawaii), secretary-treasurer.