Regulatory Update: NAIC Fall 2019 National Meeting

2019 Revisions to the Credit for Reinsurance Model Law and the Credit for Reinsurance Model Regulation

In June of 2019, the NAIC adopted revisions to the CFR Model Laws to allow a ceding insurer to take credit for reinsurance ceded to a qualifying unauthorized reinsurer without collateral if the reinsurer satisfies certain criteria, including being domiciled in a “reciprocal jurisdiction.” If adopted by the NAIC, the accreditation standard proposed by the Financial Regulation Standards and Accreditation (F) Committee would require states to adopt the 2019 revisions to the CFR Model Laws (including the recognition of all categories of “reciprocal jurisdictions”) no later than September 1, 2022, for states to maintain their accreditation status.

Under the 2019 revisions to the CFR Model Laws, a “reciprocal jurisdiction” includes (a) a non-U.S. jurisdiction that has entered into a covered agreement with the United States (such as the European Union, or EU, and the United Kingdom, or UK), (b) a “qualified jurisdiction” that meets certain additional requirements consistent with the terms and conditions of the covered agreements and (c) any NAIC-accredited U.S. state. At the Fall Meeting, the NAIC approved Bermuda, Japan and Switzerland as “reciprocal jurisdictions.” As a result, it is expected that as states adopt the 2019 revisions to the CFR Model Laws, reinsurers domiciled in Bermuda, Japan and Switzerland (as well as reinsurers domiciled in NAIC-accredited states) will receive similar treatment to reinsurers domiciled in covered agreement jurisdictions.

Term and Universal Life Insurance Reserve Financing Model Regulation and 2016 Revisions to the CFR Model Laws

In 2016, in connection with the NAIC’s efforts to establish standards governing reserve financing arrangements involving term life and universal life insurance policies with secondary guarantees, the CFR Model Laws were amended and the new Term and Universal Life Insurance Reserve Financing Model Regulation was adopted. The NAIC put discussion of the status of these regulations as accreditation standards on a temporary hold pending the adoption of revisions to the CFR Model Laws to incorporate the reinsurance collateral reduction reforms in accordance with the covered agreements with the EU and the UK. Now that the 2019 revisions to the CFR Model Laws have been adopted, the NAIC has placed the 2016 revisions to the CFR Model Laws and the Term and Universal Life Insurance Reserve Financing Model Regulation on the same schedule for accreditation purposes.

Accelerated Underwriting Working Group

The Accelerated Underwriting Working Group was recently formed based on a referral from the Big Data (EX) Working Group, and it is charged with considering the use of external data and data analytics in accelerated life underwriting (i.e., underwriting life products without the use of traditional medical examinations or blood and urine tests), including consideration of the ongoing work of the Life Actuarial (A) Task Force on the issue and, if appropriate, drafting guidance for the states. The Accelerated Underwriting Working Group held its first conference call on October 2, 2019, during which it discussed a draft work plan. Initial efforts of the Accelerated Underwriting Working Group are focused on information gathering through various presentations to better understand accelerated underwriting in life insurance. At the Fall Meeting, an interested party from the University of Texas at Austin kicked off the information-gathering stage by giving a “level-setting” presentation on underwriting in life insurance. The Accelerated Underwriting Working Group anticipates reaching a decision on the type of work product it will prepare by the Summer 2020 National Meeting and finalizing such work product prior to or at the Fall 2020 National Meeting.

AI Working Group

At the Summer 2019 National Meeting, the IT Task Force adopted a motion to form the AI Working Group. The AI Working Group is charged with studying the development of artificial intelligence, its use in the insurance sector and its effect on consumer protection and privacy, marketplace dynamics and the state-based insurance regulatory framework. The AI Working Group will develop regulatory guidance, beginning with guiding principles, and make other recommendations to the IT Task Force, as appropriate, by the Summer 2020 National Meeting. The AI Working Group exposed a draft of guiding principles (AI Draft Guiding Principles) prepared by the North Dakota Insurance Department for comment ending January 17, 2020. The AI Draft Guiding Principles set out high-level principles related to fairness, ethics, accountability, compliance, transparency, security and risk management that insurance companies and other persons facilitating the business of insurance should follow when playing an active role in the artificial intelligence system lifecycle.

Privacy Protections Working Group

Privacy of consumer information has become an area of regulatory focus as recent technological innovations in the insurance industry have increased the collection and use of information gathered in connection with insurance transactions. In the wake of the adoption of the General Data Protection Regulation and the California Consumer Privacy Act, the newly formed Privacy Protections Working Group is charged with reviewing state insurance privacy protections and making recommended changes, as needed, to existing NAIC model laws. Such review expressly excludes a review of data security, which deals with how information that a business has already collected and has in its possession is protected from unauthorized access.

Throughout 2020, the working group will consider the industry requirements and consumer rights appropriate for the collection, use and disclosure of information gathered in connection with insurance transactions and draft and adopt amendments, if needed, to existing NAIC privacy models, such as the NAIC Insurance Information and Privacy Protection Model Act (#670) and the Privacy of Consumer Financial and Health Information Regulation (#672). The working group plans to present adopted amendments, if any, to the Market Regulation and Consumer Affairs (D) Committee at the Summer 2020 National Meeting in August 2020.

Revisions to Unfair Trade Practices Act

The Executive (EX) Committee approved the IT Task Force’s model law development request to draft amendments to the NAIC Unfair Trade Practices Act, focusing on Section 4H to clarify what is considered a “rebate” or “inducement.” The model law development request was submitted to address concerns raised by interested parties that perceive that the existing antirebating laws are an obstacle to innovative insurance solutions. The IT Task Force is forming a drafting group to develop such amendments.

Initial discussions resulted in confusion as to whether the U.S. Group Capital Calculation (GCC), which is undergoing field testing, would be submitted to the IAIS for evaluation as the AM. During the International Insurance Relations (G) Committee meeting, Commissioner David Altmaier clarified that it would not. It is contemplated that the GCC will be the U.S. group capital standard, while the AM will be a “jurisdictionally agnostic” approach influenced by the GCC and developed in cooperation with the IAIS. Using a construction analogy, Commissioner Altmaier referenced the AM as the blueprint and the GCC as the house. Discussions also confirmed that no regulatory intervention points are contemplated for the GCC but left open the possibility for such intervention points in the AM.

The Group Capital Calculation (E) Working Group received a report of initial results from the GCC field test. Industry expressed a preliminary concern that certain GCC elements conflict with state risk-based capital requirements and suggested that the GCC be revised to conform with such requirements. Once data submissions from three additional insurance groups participating in the field test are analyzed, which is expected to be completed in January 2020, a more fulsome report will be prepared to inform any additional concerns with and proposed revisions to the GCC template and instructions.The Executive (EX) Committee also approved a model law development request from the Group Capital Calculation (E) Working Group to amend the Insurance Holding Company System Regulatory Act and the Insurance Holding Company System Model Regulation (the Holding Company Model Laws). Such amendments are expected to (i) require the filing of the GCC with the state, (ii) provide for confidential treatment of the GCC and (iii) provide exemptions to the requirement to file the GCC.

With the adoption of ComFrame, state insurance regulators will also begin a gap assessment to identify areas where the U.S. regulatory standards do not meet the standards under the Insurance Core Principles, which the IAIS adopted in October 2011 and on which ComFrame was built. The Group Solvency Issues (E) Working Group is expected to lead this effort to assess the implementation of ComFrame.

With the adoption of the Holistic Framework, the Financial Stability Board (FSB) has temporarily suspended the identification of global systemically important insurers (G-SIIs) beginning in 2020. In November 2022, based on the evaluation of implementation of the Holistic Framework, the FSB will consider whether to permanently discontinue or re-establish an annual identification of G-SIIs.

The material aspects of the proposed revisions are as follows:

• Any related party identified under U.S. generally accepted accounting principles (GAAP) or SEC reporting requirements also is considered a related party subject to disclosures under SAP.
• Noncontrolling ownership over 10 percent results in a related party classification regardless of any allowed Disclaimer.
• Concerning the effect of a Disclaimer under SAP, although a Disclaimer affects holding company group allocation and reporting as a Subsidiary, Controlled and Affiliated Entity under SSAP No. 97 — Investments in Subsidiary, Controlled and Affiliated Entities, a Disclaimer does not eliminate either the classification of an entity subject to a Disclaimer as a related party or the disclosure of material transactions with such entity as required under SSAP No. 25.
• Certain GAAP standards and related accounting standards updates (ASUs) issued by the Financial Accounting Standards Board (FASB) addressing the consolidation of a variable interest entity, which FASB defines as an entity (an investee) in which an investor holds a controlling interest that is not based on a majority of voting rights, are rejected. The rejection of those standards and ASUs is based on the fact that the concept of consolidation is generally not allowed under SAP.

The deadline to submit comments to the exposed revisions is January 31, 2020.

Industry cited certain 1996 issue papers that drew a distinction between levelized commission arrangements described as funding agreements and those that are based on traditional elements, such as policy persistency and premium payments, and advocated that because the proposed revisions will eliminate that distinction, they are substantive and subject to the procedures for substantive SSAP revisions. NAIC staff was not persuaded and cited the general intent of SSAP No. 71 to require the establishment of a liability for the full amount of unpaid principal and accrued interest for any levelized commission arrangement.

NAIC staff agreed with industry concerns that the proposed revisions could be interpreted to require that a traditional persistency commission be accrued for multiple years, which is not intended, and incorporated modifications to the revisions in response to those concerns. NAIC staff reiterated that the intent of the exposed guidance is to require accrual of levelized commission arrangements that are termed “persistency,” not to change the annual accrual of traditional persistency commissions.

Industry also observed that the newly implemented principles-based reserving methodology includes consideration of commissions when projecting future cash flows and expressed concern that the effects of the proposed revisions have not been analyzed to determine if there are any unintended consequences, such as double counting. Following preliminary discussions with the Life Actuarial (A) Task Force, double counting is not anticipated to be an issue as projected future cash flows would not double count if there is an existing liability. However, the SAP Working Group has requested comments as to whether there is specific Valuation Manual language in VM-20 and VM-21 that needs to be addressed.

The deadline to submit comments to the exposed revisions, as modified, is January 31, 2020.

The Longevity Risk (A/E) Subgroup was formed in 2016 and was charged with providing recommendations for recognizing longevity risk in statutory reserves and/or risk-based capital, as appropriate, by the 2019 Spring National Meeting. This charge was previously narrowed after the Longevity Risk (A/E) Subgroup determined that statutory reserves would be better addressed by other NAIC groups. Over the past three years, the Longevity Risk (A/E) Subgroup has worked closely with the Academy to analyze and develop a proposal to the life risk-based capital formula to incorporate longevity risk.

At the Fall Meeting, the Life RBC Working Group exposed for a 60-day comment period a recommendation by the Longevity Risk (A/E) Subgroup that includes proposed changes to the risk-based capital blanks and instructions, which are intended to provide for a capital structure with longevity C-2 factors applied to base statutory reserves. At the Fall Meeting, the Life RBC Working Group also exposed for comment the Academy’s alternative proposal, which incorporates a covariance adjustment within C-2 to reflect the correlation between mortality and longevity risk.

While the Life RBC Working Group recognized that additional updates to the blanks and instructions may be required to address longevity reinsurance transactions (LRTs), such changes were not included in the proposals. The Life RBC Working Group agreed to continue its work on LRTs and instructed the Longevity Risk (A/E) Subgroup to continue evaluating LRTs as well.

As previously discussed by the VOS Task Force, there are concerns that principal-protected notes, which would otherwise be ineligible for reporting on Schedule D, are being reported on Schedule D through financial structuring. Previously exposed changes to the P&P Manual indicate that such assets would be removed from the filing exemption process. Following a conference call held on October 31, 2019, the VOS Task Force agreed to work with industry participants to refine the definition of “principal-protected notes.” While the VOS Task Force was not ready to re-expose a definition at the Fall Meeting, it intends to do so in early 2020. The VOS Task Force anticipates that the definition will include specific examples of securities that are considered principal-protected notes.

The VOS Task Force also exposed for a 60-day comment period a proposed amendment to the P&P Manual related to NAIC Designations for RMBS and CMBS. The proposed amendment would adjust the financial modeling instructions from the current practice of providing a series of book-adjusted carrying value price breakpoints to companies to determine the NAIC Designation for RMBS and CMBS to a single NAIC Designation. Prior to the end of the comment period, various impact studies will be conducted to determine how such changes could affect companies.

The VOS Task Force made a related recommendation to the Statutory Accounting Principles (E) Working Group (SAP Working Group) regarding Statement of Statutory Accounting Principles No. 43R  —  Loan-Backed and Structured Securities, and the SAP Working Group exposed related revisions that would eliminate the multistep financial modeling designation guidance in determining final NAIC Designations for RMBS and CMBS.