The National Association of Insurance Commissioners (the “NAIC”) held its 2011 Fall National Meeting (the “Fall Meeting”) from 3-6 November in Washington, D.C. The Fall Meeting was especially eventful this year due to the cancelling of the Summer meeting in the wake of Hurricane Irene. While there were many happenings, debates and events occurring during the packed agenda, highlights were seen in the areas of reinsurance reform, consideration of Actuarial Guideline 38, the monitoring of captive insurance companies and the ongoing progress of the Solvency Modernization Initiative (the “SMI”).

Reinsurance Reform

After many years of deliberation, the NAIC Executive Committee and Plenary approved amendments to the NAIC Credit for Reinsurance Model Law (#785) and Credit for Reinsurance Model Regulation (#786). The amendments incorporate new ratings-based reinsurance collateral reductions and set a floor for collateral requirements that many states may follow. One of the key provisions of the amended Model Regulation is the creation of a category of “certified reinsurers” that are subject to reduced collateral requirements.

Despite years of consideration of the amendments, last minute language changes were put in place during the Fall Meeting. A sub-group of regulators was formed to craft the final language for the amendments to the NAIC models in a closed-door session. The new language added by the sub-group included a concentration risk limit based upon a similar limit that was added in recent amendments to New York’s Regulation 20, Credit for Reinsurance from Unauthorized Insurers. After the addition of the new language, the amendments to the NAIC models now provide that a ceding insurer must take steps to manage its reinsurance recoverable proportionate to its own book of business and notify a commissioner after reinsurance recoverable from any single assuming insurer or group of affiliated assuming insurers exceeds 50% of the domestic insurer’s last reported surplus to policyholders. The amendments now also provide that a ceding insurer must take steps to diversify its reinsurance program and notify a commissioner after ceding to any single insurer or group of affiliated assuming insurers more than 20% of the ceding insurer’s gross written premium in the prior calendar year. In both situations the notification to the commissioner should demonstrate that the exposure is safely managed by the domestic ceding insurer. The sub-group of regulators also added language that will direct the NAIC to publish a list of qualified jurisdictions that commissioners will consider in determining qualified jurisdictions in their states. If a commissioner approves a jurisdiction as qualified that does not appear on the NAIC list of qualified jurisdictions, the commissioner must provide documented justification for approving the jurisdiction in question.

The scope of the collateral reform will be limited by the retention of the new ‘effective date’ language that was added at the September joint meeting of the Reinsurance (E) Task Force and its parent Financial Condition (E) Committee to Section 8.A.(5) of the Model Regulation. It provides that credit for reinsurance from certified reinsurers “shall apply only to reinsurance contracts entered into or renewed on or after the effective date of the certification of the assuming insurer. Any reinsurance contract entered into prior to the effective date of the certification of the assuming insurer that is subsequently amended after the effective date of the certification of the assuming insurer, or a new reinsurance contract, covering any risk for which collateral was provided previously, shall only be subject to this section with respect to losses incurred and reserves reported from and after the effective date of the amendment or new contract.” This will limit the ability of reinsurers to reduce their collateral obligations on in-force business that is already reinsured and has existing collateral.  

The NAIC has specifically stated that the amendments to the models will be evaluated and potentially revisited in two years. While many states base their credit for reinsurance statutes and regulations directly on the NAIC models, the NAIC models are not recognized as law in any of the states. The NAIC models remain influential as accreditation standards, and states may choose to amend their laws and regulations to conform to the models. Since the amendments establish a floor for collateral requirements, states that choose to maintain their current stricter requirements will still meet the accreditation standard. The next step in the reinsurance reform process will be to see which, if any, additional states adopt the amended models. A small number of states have already either enacted provisions similar to the amended models or are considering such reforms, with Florida having led the way in 2008.

AG 38

The NAIC Life Actuarial (A) Task Force (the “LATF”) has been in discussions regarding Actuarial Guideline 38 (“AG 38”), which provides guidance for life insurance companies to calculate reserves on universal life policies with premium guarantees. In recent years, some regulators and industry participants have contended that some insurance companies may be improperly applying the provisions of AG 38 in determining the reserves for universal life policies with multiple secondary guarantees. Scrutiny began at the end of 2010 with the New York Insurance Department and expanded to LATF in the spring of 2011. This September LATF released a draft statement on the issue for comment. The draft statement was met with letters of objection from various trade groups and interested parties.  

The statement was discussed at length by LATF at the Fall Meeting and narrowed in scope. However, during the Fall Meeting a joint group between the Life Insurance and Annuities (A) Committee and the Financial Condition (E) Committee was formed to further study AG 38 reserving issues. The special working group formed by the NAIC Executive (EX) Committee will be comprised of representatives from Alaska, California, Florida, Iowa, New Jersey, New York, Tennessee, Texas and Virginia.

Captive Insurance Companies Companies

The establishment of captive insurance companies is becoming more prevalent as the number of captive-friendly jurisdictions continues to proliferate. States have seen an opportunity to increase revenues in their states by creating an environment and regulatory regime that is designed to entice captive insurance companies to establish themselves in such a captive-friendly state. Some states have enacted additional provisions for special purpose financial captives that may be used in the securitization of insurance risk. Concerns have been raised that laws and regulations tailored specifically for captive insurance companies may be too lax with respect to monitoring the operations and solvency of captive insurance companies. Previous to the Fall Meeting, the NAIC did not have a group dedicated to researching and evaluating captive and special purpose vehicles and their effects on the marketplace. The Financial (E) Committee has now been given a 2012 charge to “…study insurers’ use of captives and special purpose vehicles to transfer third-party insurance risk in relation to existing state laws and regulations and establish appropriate regulatory requirements to address concerns identified in this study. The appropriate regulatory requirements may involve modifications to existing NAIC model laws and/or generation of a new NAIC model law.” A new Captives & SPV Use Subgroup of the “E” Committee is being launched to carry out that mandate.

Solvency Modernization Initiative

The SMI is the NAIC’s on-going effort to assess and revise the U.S. insurance solvency regulatory framework focusing on five key areas: capital requirements, governance and risk management, group supervision, statutory accounting and financial reporting, and reinsurance.  

A key aspect of the SMI with regard to group solvency is a proposal to require insurance companies to prepare an Own Risk and Solvency Assessment (“ORSA”). The purpose of an ORSA is to ensure that a company develops a risk management policy that identifies the type and amount of its material risk, and also monitors and manages such risk. At the Fall Meeting, the NAIC SMI (EX) Task Force adopted the NAIC ORSA Guidance Manual. The purpose of the Guidance Manual is to provide guidance to an insurer or insurance group with regard to reporting on its ORSA as outlined within the Form B – Insurance Holding Company System Annual Registration Statement required by the NAIC’s Insurance Holding Company System Model Regulation (#450). The matter has now been referred to the Financial Condition (E) Committee, which has been tasked with determining the measures that will be taken to implement the ORSA requirements. Industry groups are working to piece together standards for the industry for what an ORSA is supposed to look like in practice in the field. Some states have indicated that they believe that the ORSA should be presented through the Form B but will work with interested parties to investigate other options as well.

With respect to the timing of the completion and implementation of the SMI, SMI Task Force Chair Christine Urias (who is Director of Insurance for the State of Arizona) stated that the task force is still planning to complete the work of the SMI Task Force by December of 2012. She said that when the SMI Task Force completes its work, it will issue a comprehensive report to the Financial Condition (E) Committee and the Executive (EX) Committee, detailing all of the SMI-related material that has been developed, with the expectation that implementation will take place in 2013 or 2014.