The National Association of Insurance Commissioners (NAIC) held its Spring 2016 National Meeting in New Orleans, Louisiana, from April 3 to 6, 2016. The meetings were highlighted by the following activities:
1. NAIC Continues Its Work to Implement Principle-Based Reserving
The Principle-Based Reserving Implementation (EX) Task Force (PBRI Task Force) and various working groups continue to prepare for principle-based reserving (PBR), which is expected to become operative on January 1, 2017. Pursuant to the NAIC’s Standard Valuation Law (SVL), PBR goes into effect when the NAIC’s Standard Valuation Manual (SVM) becomes operative. The SVM becomes operative when: (i) at least 42 states, representing 75% of total life insurance premiums written in the U.S., pass legislation to implement PBR; and (ii) the NAIC considers such legislation to be “substantially similar” to the SVL. The required threshold in the first step has now been met—as of May 2, 2016, 43 states had passed legislation to implement PBR, representing 76.17% of total U.S. life insurance premiums. With respect to the second step, the PBRI Task Force has completed its evaluation, with the assistance of the NAIC’s Legal Division, of whether such legislation is “substantially similar” to the SVL. An “outcomes driven” standard of review was applied, which focused on whether individual state deviations from the SVL would impact uniformity in the reserving requirements applied to insurers. Based on such evaluation, the PBRI Task Force determined on May 2, 2016 that PBR legislation in the 43 states met the “substantially similar” requirement, subject to Louisiana successfully passing legislation that amends the exemptions set forth in its PBR legislation (which is expected to occur before the close of the state’s legislative session on June 6, 2016). Additional information available here.
2. NAIC Continues Its Work to Implement the New XXX/AXXX Reinsurance Framework
The Reinsurance (E) Task Force (Reinsurance Task Force) continued its work on implementing the XXX/AXXX Reinsurance Framework (Framework) and Actuarial Guideline 48 (AG 48), each adopted in November 2014, by discussing and revising a draft of a new model regulation containing uniform standards governing XXX/AXXX reserve transactions that are not exempt or grandfathered (A/XXX Model Reg). At this juncture, discussion of the A/XXX Model Reg is focused on the following two issues: (i) the appropriate consequence where a cedent experiences a shortfall in Primary Security or Other Security (terms defined under AG 48); and (ii) appropriate exemptions to the A/XXX Model Reg, particularly for “small professional insurers.” Additional information available here.
3. NAIC Commences Work to Develop a Group Capital Calculation
The NAIC is developing a group capital calculation for U.S. regulators to use in evaluating risks and the financial position of an insurer’s holding company system. The group capital calculation is intended to provide regulators with a consistent method of calculating group capital for typical group risks and will serve as a baseline quantitative measure for group risks. While regulators currently analyze U.S. insurance groups, they do not have a consolidated financial measure in performing their analyses. Additionally, the International Insurance Relations (G) Committee ((G) Committee) expects to use the group capital calculation in its discussions on related issues with the Federal Reserve Board and the International Association of Insurance Supervisors. The specific charge adopted by the NAIC is for the Financial Condition (E) Committee ((E) Committee) to “[c]onstruct a U.S. group capital calculation using an RBC aggregation methodology; liaise as necessary with the ComFrame Development and Analysis (G) Working Group on international capital developments and consider group capital developments by the Federal Reserve Board, both of which may help inform the construction of a U.S. group capital calculation.” Additional information available here.
4. NAIC Developing Insurance Data Security Model Law
The Cybersecurity (EX) Task Force heard comments on the first draft of its Insurance Data Security Model Law, which had been exposed in early March. The Cybersecurity (EX) Task Force received over 100 pages of detailed comments and heard oral comments from 12 interested parties. The majority of commenters advocated for significant revisions to the draft model law. The Cybersecurity (EX) Task Force has scheduled an interim meeting to continue to receive input from regulators and interested parties regarding the draft model law. The meeting is scheduled for May 24 to 25, 2016 in Washington, D.C.
5. NAIC Adopts Model Bulletin Regarding Annual Privacy Notices
The Market Regulation and Consumer Affairs (D) Committee ((D) Committee) adopted a model insurance department bulletin regarding federal Gramm-Leach-Bliley Act (GLBA) annual privacy notices. To conform with recent GLBA amendments included in the Fixing America’s Surface Transportation Act (FAST Act), which took effect December 4, 2015, the bulletin clarifies that an insurance department licensee is not required to provide GLBA annual privacy notices if certain conditions set forth in the FAST Act are satisfied. These conditions are that the licensee: (i) shares non-public personal information (NPI) with non-affiliated third parties only in accordance with applicable laws that do not trigger an opt-out right; and (ii) has not changed its policies or practices regarding the disclosure of NPI since the last privacy notice sent to consumers.
6. NAIC Exploring Changes to Asset Risk Structure and Factors in Risk-Based Capital Formulas
The Investment Risk-Based Capital (E) Working Group exposed for a 45-day comment period a “Way Forward” document addressing possible revisions to the current asset risk structure and factors in the RBC formulas for life, health and property-casualty insurers. The “Way Forward” document sets out certain high-level principles for updating bond and common stock factors that will need to be agreed upon before any detailed work is done to implement them. Once a consensus is reached on these principles, the document will be finalized and presented to the Capital Adequacy (E) Task Force. Additional information available here.
7. NAIC Exploring Insurers’ Use of Big Data
As part of its 2016 charges, the (D) Committee is exploring “insurers’ use of big data for claims, marketing, underwriting and pricing” and “potential opportunities for regulatory use of big data to improve efficiency and effectiveness of market regulation.” If appropriate, by the end of this year, the (D) Committee will recommend 2017 charges to address issues identified by the 2016 exploration. Additional information available here.
8. Receivership and Insolvency (E) Task Force Asks States Not to Adopt Guideline for Stay on Termination of Netting Agreements and Qualified Financial Contracts
Previously, the Receivership and Insolvency (E) Task Force (RITF) adopted a “Guideline For Stay on Termination of Netting Agreements and Qualified Financial Contracts” (Stay Guideline), which recommends that states that adopt Section 711 of the NAIC Insurer Receivership Model Act (IRMA) also consider adopting a 24-hour stay on the ability of swap counterparties to terminate or close-out swaps with insurers in receivership. However, the applicable provisions of certain federal rules define qualifying master netting agreements but do not recognize a state’s insurance receivership law allowing a stay on termination of netting agreements and qualified financial contracts. NAIC staff is coordinating with the Federal Deposit Insurance Corporation and other federal agencies to correct the current conflict between the Stay Guideline and applicable federal rules. Until the NAIC resolves the issue with the federal rules, the RITF has asked states not to consider adoption of the Stay Guideline. Additional information available here.
9. NAIC Continues Efforts to Make Certified Reinsurer Provisions an Accreditation Standard
The Financial Regulation Standards and Accreditation (F) Committee voted to make the certified reinsurer provisions from the NAIC’s recent amendments to the Credit for Reinsurance Model Law and Model Regulation (Amended CFR Model Law) an accreditation requirement, effective January 1, 2019. Accordingly, those states that have not enacted reinsurance collateral reform will need to pass a law that is substantially equivalent to the Amended CFR Model Law in order to maintain NAIC accreditation. Additional information available here.
10. NAIC Exploring Potential Reform of National Flood Insurance Program
The Property and Casualty (C) Committee heard presentations from interested parties relating to potential reforms to the National Flood Insurance Program (NFIP). Additional interested parties presented comments on a subsequent conference call. A recurring theme of commenters was the need to transition to risk-based pricing over time to incentivize private market participation.
1. NAIC Continues Its Work to Implement Principle-Based Reserving (Continued)
Before PBR becomes operative, the NAIC’s Plenary Committee will still need to approve the PBRI Task Force’s decision; it is expected that the Plenary Committee will consider the decision on a conference call before the NAIC’s Summer 2016 National Meeting. Additionally, certain states, pursuant to their PBR legislation, will need to have regulations or other items in place before the SVM becomes operative in such states. In that regard, the NAIC’s Legal Division is encouraging such states to take action with respect to these additional requirements as soon as possible so that PBR becomes operative by January 1, 2017.
The PBRI Task Force has also adopted a PBR Implementation Plan addressing the following PBR-related work it is conducting in 2016:
(a) Determine the “operative date” of the SVM pursuant to a PBR Operative Date Plan adopted by the PBRI Task Force in November 2015. The PBR Operative Date Plan assists the PBRI Task Force in determining whether a state’s legislation can be considered “substantially similar” for purposes of counting towards the threshold triggering the implementation of PBR.
(b) Create or revise the PBR methodology, such as asset spread and default cost PBR data tables.
(c) Establish a PBR pilot project with 12 participating insurers, which will assist regulators and insurers with PBR implementation and will provide reviews by regulators of insurers’ PBR reserve calculations. The NAIC is purchasing modeling software and hiring additional actuaries for purposes of regulatory reviews. A new Valuation Analysis (E) Working Group will conduct peer and quality reviews of PBR, operating similar to the Financial Analysis (E) Working Group, and will make recommendations on insurers’ PBR calculations and implementation.
(d) Create an “experience reporting” framework pursuant to the SVM, which requires that reserve calculations include experience reporting. Such framework will include a process for collecting and disseminating insurers’ experience data. At this juncture, it appears that the NAIC will serve as the reporting entity for such data. Therefore, the PBRI Task Force is evaluating the procedural and legal aspects of the NAIC serving in such a role, such as appropriate fees and how to address confidentiality of data. At the April 5, 2016 meeting, the PBRI Task Force discussed whether states will use the SVL or state examination statutes when collecting experience data. The consensus appears to be that the SVL will be the primary authority, but that a regulator could additionally use a state examination law if necessary. With respect to confidentiality issues, it was noted that the NAIC has a long history of collecting confidential data (such as risk-based capital (RBC) data) from insurers on behalf of state regulators. NAIC staff reported that it is considering an assessment and collection of fees that would be spread across all insurers, not just insurers submitting experience reporting data.
(e) Evaluate RBC requirements in light of valuation changes and PBR’s impact on capital.
(f) Prepare accreditation standards related to the SVL, through the Life Actuarial (A) Task Force.
(g) Develop educational and legislative briefs regarding PBR with the assistance of outside consultants.
2. NAIC Continues Its Work to Implement the New XXX/AXXX Framework (Continued)
Security Shortfall Consequence
With respect to the first issue, the Reinsurance Task Force initially considered four potential approaches to addressing such shortfalls: (i) an “all-or-nothing” approach whereby the entire reserve credit is lost if there is a shortfall in either Primary Security or Other Security; (ii) a “dollar-for-dollar reduction” under which credit for reinsurance is reduced dollar for dollar by the amount of the shortfall between Primary Security holdings and the amount required under PBR; (iii) a reduction in credit for reinsurance by a proportional percentage of the amount of the shortfall between Primary Security holdings and the amount required under PBR; and (iv) calculating credit for reinsurance based on the amount of the cedent’s Primary Security holdings.
The first draft of the A/XXX Model Reg included the first option (the “all-or-nothing” approach), along with a suggestion from the Reinsurance Task Force’s drafting group that the three other options be considered. Some Reinsurance Task Force members and many interested parties expressed their belief that the “all-or-nothing” approach is inconsistent with AG 48, as well as the current Credit for Reinsurance Model Law (CFR Model Law), which allows a cedent to reduce its liabilities for reinsurance ceded to an unauthorized reinsurer in an amount equal to the total collateral provided (i.e., a dollar-for-dollar reduction in reserve credit). Nevertheless, by a 12-8 vote taken in October 2015, the Reinsurance Task Force decided to retain the “all-or-nothing” approach and its decision on the issue of shortfall consequences was meant to be final as the Reinsurance Task Force continued to make changes to other portions of the draft A/XXX Model Reg.
Notwithstanding the October 2015 vote, the issue of shortfall consequences appeared to be back on the table at the Reinsurance Task Force’s April 4, 2016 meeting. There was discussion of the issue and no formal objection by the Reinsurance Task Force on the basis that the issue had already been decided by vote. Even interested parties that supported the “all-or-nothing” option continued discussion of the topic. In fact, one Reinsurance Task Force member (Vermont) submitted a comment letter that essentially rescinded his prior vote for the “all-or-nothing” approach and expressed support for a proportional reduction in credit for reinsurance. The following arguments against the “all-or-nothing” approach were raised (or re-emphasized): (i) the “all-or-nothing” approach could push a cedent into an RBC event or insolvency if, during a credit market crisis, a holding company is in default and prohibited from contributing funds to a captive; (ii) remediating a security shortfall may be more complicated than just having a cedent top off a trust or funds withheld account due to rules on risk transfer; (iii) a shortfall in Other Security should not result in the complete disallowance of all Primary Security and should be treated similar to other “normal course” reinsurance transactions with unauthorized reinsurers; and (iv) in addition to the four options presented in the first draft of the A/XXX Model Reg, the Reinsurance Task Force might consider providing additional time for remediation and the opportunity for the cedent to recapture and re-cede (although a pro rata approach is preferable to avoid the recapture/re-cede process).
Small Professional Reinsurer Exemption
The American Council of Life Insurers (ACLI) and other interested parties urged the Reinsurance Task Force to consider an exemption to the A/XXX Model Reg that goes beyond the professional insurer exemption included in the recent amendments to the CFR Model Law. As noted by the ACLI, the exemption in the CFR Model Law excludes reinsurance treaties with companies having US $250 million in surplus (ignoring the impact of permitted practices) as long as the reinsurer is licensed in multiple states to transact insurance. However, the A/XXX Model Reg is designed strictly for captive reinsurance transactions and as currently drafted would inappropriately include treaties with small, traditional reinsurers that have received a permitted practice from a state. The ACLI recommends screening out such treaties with an exemption for small licensed insurers that meet a minimum RBC threshold (at least 400% of Authorized Control Level RBC). After considerable discussion, most agreed that such treaties should not be subject to the A/XXX Model Reg. Some interested parties suggested that the issue be addressed through a concise definition of “captive transactions.” Others expressed support for including an exemption in the A/XXX Model Reg but noted that applying the 400% Authorized Control Level RBC could be overly broad to the extent that at least 90% of insurers fall within that category. We anticipate further discussion of the issue during future Reinsurance Task Force meetings and conference calls.
Due to the many outstanding issues, the Reinsurance Task Force requested (and later received from its parent committee) an extension of time to complete its work on the A/XXX Model Reg, which will extend into the NAIC’s Summer 2016 National Meeting, and potentially even later in the year.
In addition to finalizing the A/XXX Model Reg, the Reinsurance Task Force will also need to establish the following RBC requirements for 2016 by modifying 2015 requirements as necessary based on an analysis of 2015 filings by insurers: (i) an RBC cushion for insurers ceding XXX/AXXX polices when the assuming reinsurer does not file an RBC report using the RBC formula and instructions; (ii) appropriate asset charges for the forms of Other Security used by insurers under the A/XXX Model Reg, which should then be considered for incorporation into the RBC cushion; and (iii) determining whether the current RBC treatment of qualified actuarial opinions is adequate for purposes of XXX/AXXX reinsurance transactions that receive qualified actuarial opinions. An actuarial opinion from a cedent’s actuary is required under AG 48 when the cedent has entered into a reserve financing transaction that does not adhere to the Framework.
3. NAIC Commences Work to Develop a Group Capital Calculation (Continued)
The Group Capital Calculation (E) Working Group (GCC Working Group) was formed by the (E) Committee to help create the NAIC group capital calculation. At the GCC Working Group’s inaugural meeting, interested parties and GCC Working Group members agreed it should be clear how the calculation will be used (or shared with federal or international agencies) and that before a group capital standard is implemented, field tests should be conducted to ensure that the calculation is capturing what is intended to be captured. Interested parties questioned whether the calculation would be “FSAP-able” (i.e., whether it will be sufficient for purposes of the Financial Sector Assessment Program review of U.S. insurance regulation) and recommended that the group capital calculation should be consistent with a global international capital standard.
The ACLI and the American Insurance Association (AIA) suggested an Aggregation and Calibration (A&C) approach to creating a group capital framework, which aggregates available capital and required capital across an insurance group’s entities, with adjustments as appropriate, to produce a group-wide solvency ratio. As presented by the ACLI and AIA, the A&C approach incorporates five principles: (i) the calculation should reflect the appropriate regulatory regimes for insurance versus non-insurance entities; (ii) minimal adjustments should be made to existing solvency measures; (iii) the calculation should be “indifferent” to corporate structure such that capital at the aggregated level should not be impacted by either an entity’s location within the group structure or intragroup transactions; (iv) group-level aggregation should be comparable across regimes and reflect comparable levels of risk, achieved through scaling of capital ratios across regimes; and (v) insurers should demonstrate transparency by providing a full inventory of all entities listed with a corresponding regime as well as intragroup transactions and related adjustments and company specific/permitted practices, and their treatment with the framework.
The (G) Committee has noted several challenges and key decisions that will need to be addressed in creating a group capital calculation, including: (i) the scope of entities to be included within the group capital calculation; (ii) how to aggregate legal entity capital requirements from other jurisdictions and those legal entities not subject to existing capital requirements; (iii) whether the group capital calculation should be based on a conservative RBC-style “gone concern” or a less conservative “going concern” view of financial strength; (iv) whether and to what extent a holding company’s senior debt will be counted toward available group capital; (v) how to avoid double counting when aggregating available capital for each legal entity; and (vi) how stress testing could be used in connection with the group capital calculation.
6. NAIC Exploring Changes to Asset Risk Structure and Factors in Risk-Based Capital Formulas (Continued)
An overarching principle set forth in the “Way Forward” document is that the “default position” should be that risk associated with owning an asset is the same across each of the three RBC statement types and, therefore, asset factors should be largely the same for as many of the asset types as possible. Differences between statement types should be supported by analysis of underlying data and, if practical, testing of differences in underlying assumptions.
The “Way Forward” document currently recommends updating bond factors so that the NAIC’s RBC designations are expanded from six to twenty (with the exception of residential and commercial mortgage-backed securities modeled by the NAIC), except that consideration will be given to keeping the six designation system with updated factors for non-life RBC statements. It is also recommended that the RBC factor for common stock be the same for each RBC statement type after adjusting for the tax treatment built into the different RBC formulas. The “Way Forward” document recommends that the RBC factor used in the life RBC formula remain unchanged (30%), while the corresponding RBC factor used in the property-casualty and health RBC formulas would increase to 19.5%.
7. NAIC Exploring Insurers’ Use of Big Data (Continued)
As an initial step in the NAIC’s exploration of this topic, the Big Data (D) Working Group held a public hearing on April 3, 2016 to hear presentations from four panels representing the perspectives of academics, industry, consumers and state insurance regulators, respectively. Each panel responded to questions posed regarding: (i) the definition of “big data;” (ii) the sources of big data and examples of data points currently being used; (iii) how data and predictive analytics are being used for different lines of insurance; (iv) the benefits and concerns surrounding the use of big data; and (v) data points that are of value to state insurance regulators. All four panels agreed that one of most significant challenges to regulating insurers’ use of big data will be formulating an appropriate definition of “big data.”
The (D) Committee’s charge on this topic was originally proposed by a consumer representative. Consumer groups object to insurers’ use of big data out of concerns that predictive analytics may be used as a discrimination tool against certain types of consumers. The industry has previously objected to the charge as unnecessary because regulators already have the authority to review insures’ use of big data. As adopted, the charge permits the (D) Committee to evaluate both the concerns and the benefits regarding insurers’ use of big data.
8. Receivership and Insolvency (E) Task Force Asks States Not to Adopt Guideline for Stay on Termination of Netting Agreements and Qualified Financial Contracts (Continued)
The RITF adopted the Stay Guideline in order to match the 24-hour stay that applies to banks under the Federal Deposit Insurance Act (FDIA). The 24-hour stay applicable to banks under the FDIA is a well-recognized and practical provision in light of the fact most bank receivers are appointed on a Friday afternoon, and the bank is typically resolved over the course of the weekend. The practicality and utility of a 24-hour stay in the context of an insurer receivership (which typically moves much more slowly than a bank receivership) raises significant questions.
One of the primary benefits of a state adopting IRMA Section 711 provisions is that insurers domiciled in such states are then able to execute swap and derivatives transactions with banks at lower costs, as such swaps and derivatives transactions qualify for netting treatment. However, under recently adopted federal rules, the applicable banking regulators only recognize a swap or derivatives agreement as a qualified netting agreement if,
“the agreement provides the [bank] the right to accelerate, terminate and close-out on a net basis all transactions under the agreement and to liquidate or set-off collateral promptly upon an event of default, including upon an event of receivership or insolvency, liquidation, or similar proceeding… provided that, in any case any exercise of rights under the agreement will not be stayed or avoided under applicable law… other than under the FDIA, Title II of the Dodd-Frank Act or under any similar insolvency law applicable to [Government Sponsored Entities]” (emphasis added).
Because the applicable provisions of the federal rules do not recognize stay periods such as those recommended by the RITF in the Stay Guideline, insurers domiciled in states that adopt the Stay Guideline will likely be subject to the same higher costs that banks are required to impose with counterparties that are not able to net their swap and derivative transactions under a qualifying netting agreement.
9. NAIC Continues Efforts to Make Certified Reinsurer Provisions an Accreditation Standard (Continued)
Although 32 states, representing approximately 66% of premiums written, have passed collateral reform legislation, states currently are not required to do so. When adopted, the Amended CFR Model Law providing for reduced collateral was not made an NAIC accreditation standard. The NAIC’s recent decision to make the certified reinsurer provisions of the Amended CFR Model Law an accreditation standard was motivated primarily by the prospect of federal preemption of state insurance regulation addressing reinsurance collateral matters. Specifically, the NAIC took this action in an effort to promote state uniformity and strengthen the NAIC’s argument against the necessity of international agreements between U.S. and foreign regulators (Covered Agreements) that could preempt state reinsurance collateral laws that are inconsistent with such Covered Agreements. The issue of Covered Agreements stems from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which authorizes the Federal Insurance Office to assist the United States Department of the Treasury in negotiating Covered Agreements to achieve a “level of protection for insurance or reinsurance consumers that is substantially equivalent to the level of protection achieved under State insurance or reinsurance regulation.”
Notwithstanding the NAIC’s plans to revise existing accreditation standards as described above, the NAIC has expressed continuing concerns regarding the impact of Covered Agreements on credit for reinsurance requirements. At its April 6, 2016 meeting, the NAIC’s Executive/Plenary Committees adopted a charge for the (E) Committee concerning the effect of Covered Agreements. The charge requires the (E) Committee to “consider and develop contingency regulatory plans to continue to protect U.S. consumers and U.S. ceding insurance companies from potential adverse impact resulting from covered agreement negotiations.” In a March 28, 2016 memorandum, the Chair of the (E) Committee expressed concerns that despite promises of meaningful participation in such negotiations, the process and content of the negotiations will not be open and transparent to all regulators and stakeholders. The memorandum notes that the prospect for changes to the U.S. system for determining credit for reinsurance is real, as the European Union (EU) has called for the elimination of collateral imposed on reinsurance contracts placed with EU-based reinsurers.
If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or
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