This Winter’s “Blizzard” – Comments to the Federal Insurance Office about Insurance Regulation
by Tom Finnell
As the saying goes, one must be careful what they ask for as they just might get it. That is certainly true of the Federal Insurance Office’s (FIO) recent effort to solicit input as to how to modernize and improve the system of U.S. insurance regulation. A six-inch pile of comment papers was submitted, over which the FIO is presumably now poring in preparation for the issuance of its widely-anticipated report to Congress near the end of the month. The comment letters provide an interesting array of perspectives as to which areas of insurance regulation may require improvement and why. In the process of responding to specific areas of focus, as requested by the FIO, many responders also took the opportunity to raise other items on their wish list as well, perhaps an apt thought as, at the time, we were heading into the Christmas season.
We’ll delve into some of the comments to get a sense of the issues that have been laid at the feet of the FIO and explore some of the potential implications on insurance regulation here in the U.S. We’ll start with our own perspective from our review of the comment letters, describe some background about the Dodd-Frank Act that led to the issuance of the FIO’s request for comments and then provide a smattering of the comments themselves.
Our Perspective: Many years ago, insurance regulation was largely the outcome of a three-way dance between those in industry, their state regulators and the various state legislatures. Beginning in the early 1990s and with the advent of the NAIC’s Accreditation Program, the NAIC became a fourth sphere of influence, increasing its sway over the points of view taken by its members and their ability to cause legislatures to adopt an increasing number of more contemporary NAIC models and in a more uniform fashion. Much more recently, others on the international stage have also become very influential, often to the chagrin of many U.S. insurers and regulators; these international players include the International Association of Insurance Supervisors (IAIS), the International Accounting Standards Board (IASB), the Financial Stability Board, the G20, the European Insurance and Occupational Pensions Authority and others. The NAIC’s Solvency Modernization Initiative is a clear indication that these international players are becoming a significant influence here in the states (see article below) .
What the comment letters make clear is that a wide cross-section of respondents are hopeful that the FIO will quickly become yet another significant element of influence in insurance regulation and can shift its direction, hopefully in their favor. The difficulty, of course, is with a fragmented industry that cuts across fundamentally different lines of business and markets, there are many opposing views as to what that direction should be. Even if interested parties succeed in bending the ear of the FIO, the FIO lacks direct regulatory powers and is itself just another point of contact with an increasingly intransigent Congress. While the FIO’s report due later this month likely will make for interesting reading, how much action may ultimately result from it is, therefore, very uncertain. So, there may be winners and losers in this power struggle, but it is not clear that anyone will win very much or, at least, very fast.
Another issue that is evident in the comment papers is the potential impact to the FIO itself of the vast array of issues in which interested parties assume the FIO will master and quickly become engaged in various forums around the globe. Not only would the FIO have to be mindful of what is going on in the U.S. through NAIC and legislative developments across a wide variety of topics – ranging from consumer protection to accounting, risk, actuarial and others – it would presumably have to gear up to be just as involved with other international organizations, including the IAIS, the IASB and more. In the now famous words of actor Roy Scheider, who in 1975 played the role of Police Chief Brody in the movie Jaws, “you’re going to need a bigger boat.” The implication here is that “we’re going to need a bigger FIO.” How big is anybody’s guess, but with size comes an increase in capabilities, a phenomenon that has been seen in the NAIC’s own growth over the past 20 years; the NAIC is clearly now involved in activities that it would not have been able to handle in 1992. So, assuming the FIO begins to grow to accommodate the interests of respondents, its role may also evolve, subject of course to limits placed on it by Congress.
Background: The Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) provided for a new Federal Insurance Office that, among other responsibilities, will monitor all aspects of the insurance industry; coordinate federal efforts and develop federal policy on prudential aspects of international insurance matters, including representing the U.S. before the IAIS; and consult with the states, including state insurance regulators, regarding insurance matters of national importance and prudential insurance matters of international importance. The DFA did not, however, provide the FIO or the Department of the Treasury with general supervisory or regulatory authority over the business of insurance, which is retained by the states.
The FIO has been open for business only since June 2011 when former Illinois Insurance Commissioner Michael T. McRaith assumed the role as its first director. On top of his other new responsibilities, the DFA tasked him with conducting a study on how to modernize and improve the system of U.S. insurance regulation and with submitting a report thereon to Congress within 18 months after the DFA was enacted – or, in other words, by January 21, 2012, only 7 months after Mr. McRaith’s arrival at the FIO.
To that end, in October 2011 Mr. McRaith headed down at least two tracks. He met with a number of interested parties in late 2011 to discuss their issues with insurance regulation. In addition, he issued a request for public comment on the matter, with a filing deadline of mid-December 2011.
In the overall context of how to modernize and improve the system of U.S. insurance regulation, the FIO sought written input on a number of areas as required by the DFA: systemic risk; capital standards; consumer protection; uniformity of state insurance regulation; group supervision; international coordination of insurance supervision; the costs and benefits of federal regulation, either across lines or for specific lines (except for health insurance); regulatory arbitrage; impact of foreign developments; and the impact of subjecting insurers to a federal resolution authority.
The deadline for written comment has now come and gone. Almost 150 comment letters were submitted by insurance industry trade organizations; insurers of various sizes and types, both domestic and international; agents, brokers, advisors and other intermediaries; academics; consumer representatives and interest groups; and others.
The FIO’s task to analyze and consider the comments will not be easy. Aside from the number of comments, their length and the diversity of their subject matter, many comments were made in the context of particular types of insurance, insurance companies or markets. Commenters also expounded on specific areas of high interest to them, in many cases appearing to go beyond the specific areas posed to them by the FIO.
A Sampling of Comments from Respondents to the FIO: In our own effort to review and comment on the letters, it was not our intent to provide a complete summary; rather, we sought to develop a high-level perspective about the breadth and depth of the issues brought forward by respondents to frame a point of view about some of the potential implications to U.S. insurance regulation. With respect to the topic of federal resolution authority, we will reserve commentary until the next edition of Insurance Perspectives, which follows the International Association of Insurance Receivers’ Insolvency Workshop later this month. Invotex Director Kerby Baden will participate on a workshop panel to discuss the impact of the DFA on insurance receiverships. With those caveats, some excerpts, snippets and quotes from the comment letters follow.
Systemic Risk: Industry commenters generally replied in unison that the business of insurance does not create systemic risk; they contend that the key indicators of leverage, liquidity, correlation, concentration, sensitivities and connectedness do not indicate the existence of systemic risk for insurers. However, some acknowledged that in 2008 some banking, “shadow banking” or capital markets activities of entities affiliated with insurers could have had a systemic effect, e.g., underwriting credit default swaps or collateralized debt obligations (CDOs).
In the minority was one insurer that asserted that the failure of a single large insurer could be sufficient to cause a loss of confidence and a 1930s style “run on the bank.” An individual in academia commented that systemic risk is relatively low in insurance markets as opposed to banking; that such risk may be higher for life insurers rather than property/casualty insurers, but that most if not all life insurers would likely be excluded from systemic risk designation.
By contrast, a consumer group posited that there are some significant systemic risks associated with insurance, e.g., the potential failure of large reinsurers, which could produce a domino effect on the primary market, and that there could be an impact of a large insolvency on guaranty funds which, in most states, are not pre-funded.
Capital Standards: Most industry commenters spoke favorably about existing capital standards, pointing to a plethora of regulatory tools under the state-based system in the U.S., such as statutory accounting standards, reserve requirements, risk-based capital, the NAIC’s Own Risk and Solvency Assessment (ORSA) initiative and more. That said, some took the opportunity to suggest specific improvements in some of those areas, as well as to implore the FIO to make sure that inappropriate banking regulation concepts (e.g., increased capital charges, leverage ratios and rapid resolution requirements) not be adopted by insurance supervisors.
Consumer Protection: Comments of one insurance trade organization relative to consumer protection appeared to be shared by most of the other industry commenters as well: The state-based system provides a robust system of consumer protection, largely focused on financial oversight and assuring that the promise of financial protection is fulfilled; consumer protection is an area in which the state system works exceedingly well; there is little evidence of underserved populations with respect to personal lines insurance; and that no crisis of availability or affordability exists.
Other industry comments included that the FIO should:
- Monitor the impacts of price controls when they are imposed by states and advocate for their repeal
- Highlight the extremely harmful market effects of state rate suppression with respect to catastrophe risks
- Monitor insurance availability in underserved communities
Comments from one consumer group chided state insurance regulation as often producing poor overall consumer protection due to “excessive industry influence on legislation and regulation, inadequate resources, timid regulators and inadequate consumer representation before state legislature and regulators.” It urged the FIO to undertake efforts to begin to collect and evaluate data by census track regarding access to affordable, fairly rated insurance, as well as to analyze the impact on consumers of computerized models and programs sold by private vendors to insurers for tasks ranging from modeling hurricane risk to calculating claims payments.
A group of NAIC-funded Consumer Representatives presented their views on a number of hot topics regarding consumer protection, including the nature of insurance, insurance regulation and the inherent need for consumer protection; that neither modernization nor international coordination be a pretext for the elimination of significant state regulatory authority or the reduction or elimination of vital consumer protection laws; the need for transparency in insurance regulation; the use of web-based tools to enhance consumer protection and education; the need for substantive regulation of contractual terms in insurance policies; the implications of credit scoring and the need for regulator access to models; catastrophic risk; industry exposure to climate change; insurance claims handling; and industry data transparency and disclosure.
National Uniformity of State Insurance Regulation: In the context of this topic, the FIO also sought comments regarding the identification of, and methods for assessing, excessive, duplicative or outdated insurance regulation or regulatory licensing processes. The topic of uniformity – or lack thereof – and its implications on regulation and competitiveness drew comments from many respondents.
Many in industry acknowledged that much progress has been made to improve uniformity over the past 20 years but that significant challenges remain. Some examples:
- The NAIC’s System for Electronic Rate and Form Filing (SERFF) speeds review time of product filings but has had little impact on uniformity
- Market regulation is still largely state-by-state, with little coordination among states without deference to the domestic regulator on market conduct matters
- Market analysis has made headway, but legacy regulatory approaches continue to exist in duplication
- The state-based system results in a patchwork of standards with inconsistent implementation and enforcement generating excessive costs, and is exacerbated by differing case law across jurisdictions
Based on one industry trade group’s member survey, the most critical areas in the most need of improvement include policy/contract form approval, market conduct exams and producer appointments. It urged the FIO to support federal legislation that would establish the National Association of Registered Agents and Brokers (NARAB).
Agents, brokers and other intermediaries appeared as a group to be very supportive of state-based regulation, but many took the opportunity to urge only a targeted federal role, i.e., for producer licensing reform and passage of NARAB legislation.
Reinsurers noted that they operate on a global basis and that being regulated on a multi-state basis is cumbersome and inefficient for a global marketplace. They would like to see greater efficiency in the regulation of reinsurance, citing significant differences among the states regarding reinsurance regulatory requirements, including extra-territorial application of regulations to insurers.
A consumer group contended that a lack of uniformity in state insurance regulation is not a failing but a strength and that consumers are not better off if every state has the same low national standards. It contended that the mere fact that protections vary by state is not a sufficient reason to deprive consumers in those states with strong protections.
Group Supervision: An industry trade group responded that regulators’ processes should be focused on understanding the risks of the business, which is why the trade group supports the NAIC’s risk-focused surveillance system and ORSA. It also asserted that a legal entity approach to regulation must be maintained; that group or consolidated regulation must not involve shifting surplus among group members to benefit the regulatory shortcomings of a jurisdiction seeking to exploit the strength of the group; and that the parameters and broader regulatory implications of any group supervision should be well delineated and clearly defined.
Another group offered that regulating on a consolidated basis is complicated in light of the U.S. requirement of regulating on a legal entity basis but that the FIO could foster regulatory cooperation within the U.S. and with foreign regulators through supervisory colleges and other means. This group referred to the NAIC’s recently revised holding company models, commenting that concerns noted “suggests the NAIC is moving in a problematic direction.” Combined with the nature of ongoing discussions at the IAIS, various forums where the regulation of systemically important financial institutions (SIFIs) and global systemically important financial institutions (G-SIFIs) is being proposed and debated, and the equivalence issue presented by Solvency II, they contend that the FIO should be our national voice and engaged in such discussions.
Another commenter suggested that the specifics of the supervisory framework will depend on the characteristics of the group itself as well as on the nature of the legal and supervisory regime relevant to the group’s insurance members.
International Coordination of Insurance Regulation and Impact of Foreign Developments: Much like their members’ views on domestic regulation in the U.S., one trade group suggested that coordination of an international insurance group should also be centered on understanding the risks of the group from the perspective of how the insurance group identifies and manages its risk. Like many, the trade group supports the use of supervisory colleges. But they are concerned that the IAIS’ core principles have become too prescriptive and, if adopted in the U.S., could weaken our regulatory system.
One respondent was more focused in their response, commenting that the FIO should not make further changes in reinsurance collateral rules until it becomes clear how the new state rules will impact the market.
Another commented that reinsurance regulation should be coordinated by a single national regulator that focuses on ensuring the reinsurer’s financial solvency, and that the FIO needs to be involved in equivalency discussions as well as discussions at the IAIS to protect the interests of the U.S. industry.
A number of commenters appeared to share this view of another respondent, that there is a need for increased resources for the FIO to represent the U.S. and to coordinate and participate with state insurance prudential supervisors on all matters and with counterpart national insurance and financial services regulators on a case-specific basis, especially regarding multinational insurance groups doing business in the U.S. It was also suggested that the FIO can serve as a coordinator of U.S. representation in insurance supervisory colleges.
Federal Regulation: On the threshold question about a possible role for federal regulation, a consumer group responded that, while they believe the federal government has a natural role to play in insurance regulation, they do not have a reassuring model for either dual (“optional”) or exclusive federal regulation of financial services. They also warned that regulatory modernization must avoid any system - including proposals for an Optional Federal Charter (OFC) or “passport system” – wherein insurers are readily able to select among different regulators.
The ACLI noted that it is not in a position at present to offer specific federal legislative suggestions on the matter and that it has a CEO task force that is studying the issues with the aim of affirming or updating the group’s current policy position. That position has called for a two-track approach, with one track focusing on improvements to the state-based system and the second track calling for the implementation of an OFC. The group does support a line-of-business approach notwithstanding its potential complexities, although that position was predicated on a federal structure that would have been optional for all companies; post Dodd-Frank, the industry is now subject to a hybrid regulatory structure that is increasingly complex and difficult to coordinate, but reinsurance might be a natural candidate for regulation at the national level.
A reinsurance industry trade group supports a reinsurance regulatory system with a national regulator and a single set of rules that focuses on efficient and effective solvency regulation.
Another industry group commented that the price of federal regulation could be high, yet there is no evidence that it would provide a significant benefit. It supports the state-based system with a limited federal role, e.g., to prohibit states from limiting p/c insurers’ ability to set prices and from limiting or restricting the use of underwriting variables and techniques.
Another group suggested that a federal role would be problematic, would create an unlevel playing field, would needlessly complicate solvency regulation and would undermine the functioning of the state guaranty fund system.
For more information, contact Tom Finnell.
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On the Road with the NAIC – Following the Solvency Modernization Initiative Roadmap
by Tom Finnell
The NAIC’s Solvency Modernization Initiative (SMI) Task Force recently released an update to its SMI Roadmap, showing progress made to date and the current prognosis as to future direction and timing. The SMI came about several years ago due to the need for a high-level reassessment of various aspects of solvency regulation. SMI was partly in response to the passage of time and the risk that regulatory tools had become outdated. It was also in response to developments in other regions and countries and the need to maintain a regulatory regime in the U.S. that recognizes current and emerging risks in today’s environment and a more contemporary means to address those risks, both on the part of insurance company management as well as of regulators.
The SMI Roadmap details the various NAIC activities underway to assess and improve upon regulations and guidance in the areas of capital requirements; governance and risk management; group supervision; statutory accounting and financial reporting; and reinsurance. Many aspects of each of those areas have been covered in prior issues of Insurance Perspectives and, where relevant, our coverage here links to those articles. We also take this opportunity to highlight some other key aspects of the SMI’s roadmap as well as provide some of our points of view along the way.
This writing does not purport to be a complete summary or analysis of the SMI Roadmap. In that regard, the roadmap speaks for itself and can be viewed on the NAIC’s website.
An important aspect of the roadmap pertains to timing; the NAIC anticipates that almost all policy decisions will be completed by the end of 2012. That said, in some cases some heavy lifting will then still be required to implement those decisions.
Future of Statutory Accounting: One notable exception that is footnoted in the roadmap involves decisions around international accounting and, more specifically, whether statutory accounting in the U.S. will further evolve – or even be supplanted – due to conversion to, convergence with, or “condorsement” of International Financial Reporting Standards in the U.S. A decision on those matters had been targeted for late 2010, but was put on ice by the NAIC pending decisions by the FASB and the IASB over accounting for insurance contracts and by the SEC as to what it would allow or require of U.S. issuers with regard to the notion of reporting their financial results on the basis of IFRS. Neither of those decisions has been made, but some news on each of those fronts may be forthcoming later this year. Hence the NAIC’s decision over the future of statutory accounting remains on the roadmap, and both its ultimate destination and estimated time of arrival remain unknown. For more information, see these articles from past editions of Insurance Perspectives:
Capital Requirements: With respect to capital requirements and, more specifically, risk-based capital or RBC, the SMI calls for RBC to be maintained as a regulatory tool to ferret out weakly-capitalized companies. There had been some discussion about calibrating RBC to a higher level to better distinguish between the relative capital levels of adequately or even well-capitalized insurers, but this is no longer in the cards. Also, and while there had been some earlier discussion about an overall calibration of RBC on a top-down basis, that is no longer deemed to be feasible. Instead, incremental improvements will be made to RBC, including the following priorities:
- Provide an explicit property/casualty catastrophe risk charge
- Provide more granularity in the C-1 factors for investment risk charges
- Refine the credit risk charges for reinsurance recoverables
- Modify or refine credits for risk diversification, i.e., to better recognize the degree of correlation among multiple risks
A separate issue that is also being addressed with respect to RBC is whether RBC data should always be public, be public only if an action/control level event is triggered, or should never be public. Since the inception of RBC in the 1990s, insurance company annual statements have reported total adjusted capital and authorized control level RBC in the Five-Year Historical Data section. Anyone with a calculator can quickly derive the ACL RBC ratio and compare that to other companies, notwithstanding the NAIC’s admonition that RBC is not intended to compare surplus adequacy levels among adequately capitalized companies. In fact, such data is often cited in the trade press and even by regulators themselves. If such data were to become confidential in the future, that would be a significant change.
In lieu of fundamentally modifying RBC and moving it beyond its traditional goal to isolate weakly-capitalized insurers, SMI has now provided for a new regulatory tool, an Own Risk and Solvency Assessment, or ORSA. The ORSA guidance manual was adopted at the NAIC’s Fall National Meeting. Left hanging was the legal means to actually require an ORSA to be performed by an insurer; the NAIC hopes to iron out that issue shortly, and has a conference call scheduled for this Thursday, January 12, 2012 to discuss a stand-alone model act to implement ORSA. For more information about the NAIC’s ORSA initiative, see these articles in prior editions of Insurance Perspectives:
Governance and Risk Management: In this area, the NAIC has strived to better understand what best practices are around governance for insurers and related supervision requirements with the goal to achieve enhancements where deemed necessary in U.S. requirements. After a period of debate with industry, this initiative has now settled in on the following:
- A review of existing legislation and case law in certain key states as well as in other countries, which has been completed
- The compilation of existing corporate governance requirements within “NAIC/insurance-specific sources” and in other sources, which is now largely completed
- The identification of gaps in the existing U.S. requirements and adoption of a plan to address those gaps, targeted for completion by the end of November 2012
For more information, see the following articles from earlier editions of Insurance Perspectives:
Reinsurance: In the reinsurance arena, the SMI has been focusing on implementation of the NAIC’s Reinsurance Regulatory Modernization Framework with the hope of doing so quickly and uniformly through federal legislation. The absence of a sponsor in the U.S. Congress to shepherd that proposal into the federal legislative mill made that goal unattainable. In the meantime, the NAIC worked many of the components of that framework into amendments to the NAIC’s Credit for Reinsurance Model Law and the related Credit for Reinsurance Model Regulation. Those amendments were adopted by the NAIC last November. For more information, see the following article from that month’s edition of Insurance Perspectives:
With those amendments enacted, future plans include adoption of guidance towards making the amended models an accreditation standard; development of a process to publish a list of jurisdictions recommended to be recognized by the states as qualified jurisdictions; provide advisory support and assistance to the states in the review of reinsurance collateral reduction applications; and reexamine the collateral amounts included in the revised models.
The SMI remains a significant part of the overall NAIC agenda, and is certain to result in more changes that will impact insurers and insurance supervision.
For more information, contact Tom Finnell.
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