May 2011

Greetings!

The May edition of Insurance Perspectives highlights changes impacting the insurance industry, including new roles brought on by healthcare reform, developments impacting valuations of insurers' assets and liabilities and progress on the IFRS front. In addition, we have listed upcoming speaking engagements in which our professionals will address these and other topics.

As always, we welcome your feedback and invite you to share Insurance Perspectives with your colleagues and business acquaintances. If you do not currently receive our newsletter via e-mail, please subscribe at the left.

Tom Finnell, Jim Stangroom and Les Schott
Managing Directors, Insurance Services

In this Issue

1. “Navigators” – New Players in the Market to Troll the Uncharted Waters of Health Insurance Exchanges
2. New International Developments May Impact Valuations of U.S. Insurers’ Assets and Liabilities
3. Accounting Standards Boards Report Significant Progress on IFRS; Some Insight as to the Possible Impact on the Future of Statutory Accounting
4. Upcoming Speaking Engagements

“Navigators” – New Players in the Market to Troll the Uncharted Waters of Health Insurance Exchanges
by Les Schott

Many states are currently grappling with design and implementation issues related to the Health Insurance Exchanges that are required by the Patient Protection and Affordable Care Act (PPACA). A significant aspect of the PPACA involves Exchanges, which are intended to create a more organized and competitive market for health insurance by offering a choice of plans, establishing common rules regarding the offering and pricing of insurance and providing information to help consumers better understand the options available to them.

One of the nuances of the federal law relating to Exchanges is the introduction of a new role, referred to as a “Navigator.” However, until federal regulations are developed to provide more clarity about such a role, questions remain as to how these new intermediaries in the marketplace might relate to or even impact the role of traditional brokers or producers.

Navigators are to be nonprofit, impartial advisors who will assist consumers in learning how they can buy coverage and otherwise facilitating their purchase of coverage through an Exchange. Each Exchange must establish a program under which it awards grants to Navigators to perform, among other things, duties relating to the dissemination of information and the facilitation of enrollment in health plans, public education and outreach to the population served by the Exchange. There is limited information in the PPACA as to the role of Navigators, but additional insight is expected from regulations that will be promulgated by the U.S. Department of Health and Human Services. In the meantime, some are wondering how the role of a Navigator will differ from that of traditional insurance broker or producer.

The Exchanges (B) Subgroup of the NAIC’s Health Insurance and Managed Care Committee attempts to address this and other key questions within its recently issued draft White Paper titled, The Comparative Roles of Navigators and Producers in an Exchange – What are the Issues?(1) The White Paper highlights the numerous issues and uncertainties of the role of the Navigator and how it compares to that of a producer. State regulators have long acknowledged the important role producers play in the health insurance marketplace, and the White Paper says determining the future role of producers and how they will interact with Navigators is a vital part of the implementation process for the Exchanges. The White Paper lays out a number of substantial issues for federal and state policymakers to consider concerning how producers and Navigators will interact in an Exchange, including the following:

• Should states license or certify Navigators?
  The PPACA requires that regulations be established for Navigators, including provisions to ensure that they are licensed, if appropriate. While it is unknown how prescriptive the related federal regulations might be, the White Paper states that flexibility is essential so that states may enforce their existing licensure laws. The extent to which states will need to regulate Navigators will depend on the scope of services they provide. However, if Navigators’ services are defined to include services/activities that require licensure for producers, then the White Paper contends Navigators should be subject to the same state regulations as producers, e.g., licensure, requirements to hold errors and omission coverage, compliance with privacy regulations, etc.
  
  
• Who will establish educational and continuing educational requirements for Navigators?
  To the extent Navigators are selling, soliciting or negotiating insurance, the White Paper contends they should be subject to the laws of the jurisdiction in which they are operating. To do otherwise would be to allow persons or entities to avoid licensure requirements by using the term “Navigator,” thus undercutting the states’ regulation of the insurance marketplace for the protection of the consumer.
  
  
• What is meant by “facilitate enrollment”? How will the Navigator be involved with Medicaid and other public programs? What will Navigators need to know?
  The White Paper states that Navigators and producers must have a thorough knowledge of the Exchange marketplace. They should understand the private insurance market and public programs. However, the PPACA, in describing the duties of a Navigator, consistently makes reference to qualified health plans to the exclusion of public plans or programs. Therefore, it is unclear whether Navigators are expected to facilitate enrollment in public plans or programs.
  
  
• May producers serve as Navigators? How will commissions be paid?
  There are some indications that the marketplace is moving toward a structure that would allow compensation of producers by employers in lieu of carriers. One large national health insurer recently unveiled such a methodology. However in some market segments, such as small groups with less than 50 members, employers may not have the resources to pay direct fees in addition to premiums. The White Paper notes that states should anticipate that producers will continue to serve a vital role in the industry, although it is expected that the nature of their services will evolve. Producers may already have working relationships with client employer groups, with the employer often utilizing the producer as an expert. In these instances the producer may be fulfilling the role intended for the Navigator. In this instance, the producer, as opposed to a Navigator, may be the individual with the best relationship and tie to these individuals.

The Exchange Subgroup plans to hold a conference call sometime next month to consider adoption of the White Paper.

For more information, contact Les Schott.

(1) Click here to view the NAIC’s Exchanges Subgroup White Paper.

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New International Developments May Impact Valuations of U.S. Insurers’ Assets and Liabilities
by Tom Finnell

For many who work in financial roles in and around the insurance industry, these are exciting times. The financial crisis provided a real-life stress test of the industry’s financial strength. The industry has been in the throes of a long-running effort to converge, and perhaps eventually convert, to International Financial Reporting Standards (IFRS), which would presumably include accounting guidance for insurance contracts that may be fundamentally new and very different from current U.S. Generally Accepted Accounting Principles (GAAP). The movement towards IFRS may also eventually lead to some form of adoption of, or reliance on, IFRS for U.S. Statutory Accounting Principles (SAP) as well. At the same time, risk-based capital formulas are slated for overhaul, and standards are being considered that would require insurers to have in place Enterprise Risk Management programs with related reporting to regulators about their risks and how risk appetite is aligned with regulatory and economic capital.

In other words, there are efforts underway to change what is to be measured and the very length of the yardstick that would be used to do the measuring.

While the focus of much of the recent debate about financial reporting standards has been on the convergence efforts between the Financial Accounting Standards Baord (FASB) and the International Accounting Standards Board (IASB), the International Association of Insurance Supervisors (IAIS) has entered the fray with its proposed Insurance Core Principle (ICP) 14 that would require insurance supervisors to establish certain requirements for the valuation of assets and liabilities. The NAIC has led the efforts on the part of insurance regulators in the U.S. to respond to the proposal, including incorporating comments from industry trade groups and other interested parties. A recent mark-up of the proposal reflects that some of those comments were considered by the IAIS, but industry remains concerned in light of its potential impact on SAP in the U.S., as well as the potential for contradiction with GAAP or IFRS standards that may ultimately emerge.

An opening salvo in the proposed ICP 14 is the comment that “it is most desirable that the methodologies for calculating items in general purpose financial reports can be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements.” The U.S. is somewhat unique because of the requirement by state insurance regulators that insurers file financial statements prepared on the basis of SAP; other countries largely allow their domestic insurers to file general purpose financial statements. While the proposal does go on to permit the filing of financials prepared on a regulatory basis of accounting with disclosure or reconciliation of differences to general purpose statements, it is not clear how those who would test compliance by the U.S. with IAIS standards might interpret these aspects of the proposed rule. Industry observers fear that an adverse determination of compliance could force changes to U.S. SAP that would otherwise be unwarranted or deemed unwise by state insurance regulators.

A particular emphasis in the proposal is the use of a total balance sheet approach on an “economic basis,” which appears to be directionally consistent with the significant aspects of IFRS that are currently under development. However, there is no assurance that it will remain consistent when the IASB completes its work on financial instruments and insurance contracts. Interested parties are perplexed as to why the IAIS would consider its own standard at this time and recommended that it stick to higher-level principles that give countries more discretion in making their own decisions about what information is most useful for them.

In an e-mail to regulators and industry, Rob Esson, the NAIC’s Senior Policy Fellow for International Affairs, emphasized that readers should focus on the nuances of certain phrases within the ICP. For example, he stated that, “the standard does not mandate fair value. It does mandate that valuations be ‘an economic valuation,’ but this is deliberately differentiated from a subset valuation that is a ‘market consistent economic valuation,’ which would be akin to fair value. An economic valuation is required to be realistic and reflects risk adjusted present values. The word ‘reflects’ is pretty important: it was a word negotiated to be inclusive but not exclusive - i.e. if a value does not reflect a risk adjusted present value, it would be invalid, but it may also have other facets. In particular, amortized cost with expect [sic] loss impairment does reflect a risk adjusted present value - but it does not require a re-set of the interest rate unless there is impairment.” While it is helpful to understand one’s interpretation of such nuances of language, there is the concern that any current interpretation, while perhaps valid, ultimately may not carry the same weight by those eventually charged with interpreting a regulatory regime’s compliance with the ICP.

Many were concerned that the proposal would preclude the use of SAP in the U.S. for valuing insurers’ assets and liabilities. These concerns appear to have eased as recommendations submitted by Northwestern Mutual to provide for an amortized cost valuation have been included in the most recent mark-up of the draft ICP, as an alternative to the market-consistent valuation that had been put forth in the original draft. The language added includes that “amortized cost methods determine the value of an asset or liability at any point in time as the present value of future cash flows discounted at an appropriate interest rate, with an appropriate adjustment for risk.”

Some observers are not convinced that the current trend to depart from historical cost as an objective foundation for reporting is warranted. The National Association of Mutual Insurance Companies commented that “our fundamental unease…in contemplating this draft ICP is that its substance permeates or is taken on a broad basis into statutory accounting, a system and discipline in which conservatism, generally based on historical cost and contract obligation, has served well. We wonder at its efficacy and objectivity for solvency judgments.”

The foregoing comments are just a few of the concerns expressed by industry in their comment letters. Discussions will continue at the IAIS, and we will keep readers informed of further developments.

For more information, contact Tom Finnell.

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Accounting Standards Boards Report Significant Progress on IFRS; Some Insight as to the Possible Impact on the Future of Statutory Accounting
by Jim Stangroom and Tim Foley

On April 21, 2011, the FASB and the IASB released their fourth progress report on their joint efforts towards convergence of U.S. and international accounting standards. Their prior report, issued November 29 of last year, amended their work plan to give priority status to a number of projects for which improvements were deemed most critical and affirmed the commitment for broad-based and effective outreach to stakeholders considered a critical component to achieving a quality final product.

In this most recent report, the commitment to quality was affirmed by the announcement that work on four key projects would extend well beyond the June 30, 2011, target date. The boards also reported that work has been completed on five other priority standards. So, what does this mean for the insurance industry? What happens next? Is the impact limited to SEC registrants? And, will all U.S. insurers be impacted by a rewrite of statutory accounting principles?

Progress has been reported, but work on the following key projects will continue into the second half of 2011:

• Accounting for Insurance Contracts – Board deliberations on the most significant issues are expected to be completed by the end of June 2011. However, it will be well into the second half of 2011 before all topics are adequately addressed. One of the key issues now under debate is the determination of the discount rate. However, other issues remain, including the approach towards the risk adjustment, contract boundaries, unbundling and the potential unlocking of margins.
  
  
• Financial Instruments – The FASB is now considering three categories for financial instruments: trading or holding for sale with fair value changes recognized in net income; investing with a focus on managing risk exposures and total return, with changes to fair value recognized in other comprehensive income; and direct lending or customer financing measured at amortized cost, subject to a revised impairment approach that introduces a “good book/bad book” concept. Both boards have proposed simplified hedge accounting standards and, while there remain differences between the proposed IASB and FASB standards, indications are that the boards will eventually resolve their differences. The FASB and IASB have held a series of joint meetings in recent months with the clear intention of achieving convergence on accounting for financial instruments.
  
  
• Revenue Recognition – The boards are close to completing deliberations on feedback to the joint discussion paper that proposes a single revenue recognition model built on the principle that an entity should recognize revenue when it satisfies its performance obligations in a contract by transferring control of goods or services to a customer. The existing revenue recognition guidance under IFRS is vague, and as a result, preparers tend to look to U.S. GAAP for specific guidance.  One goal of the new standard is to replace volumes of detailed, industry-specific guidance found in U.S. GAAP with a consistent set of principles applicable across industries.  As a result, the final revenue recognition standard must be internally consistent with the new insurance contracts standard. The boards will next decide whether to re-expose or move forward with development of the draft standard.
  
  
• Leases – The August 2010 joint exposure draft would result in lease obligations, including operating leases and related “right-of-use” assets, moving to the balance sheets of the lessee. Feedback has been received and additional deliberations are taking place. The next step would be either the release of the final standard or, possibly, a re-exposure of a draft.

The boards insist that the June 30, 2011, target date was just that, a target date, rather than an externally imposed deadline. They contend that work on these standards will continue until “quality” is achieved, differences between the boards’ conclusions are reconciled and consultation with stakeholders is completed. The amended target date is December of 2011.

The boards also reported they have completed work on five priority standards. These projects are as follows:

• Consolidated Financial Statements
• Joint Arrangements
• Post-employment Benefits
• Fair Value Measurement
• Presentation of Other Comprehensive Income

Final standards for each of these important areas are expected to be released in the coming weeks.

We now know that significant progress toward the goal of convergence has been achieved and that the FASB and IASB continue to work at an unprecedented pace on improvements to existing accounting guidance. Through its words and actions, the boards have made it clear that the quality of the work and the need for stakeholder input will take precedence over deadlines or target dates previously communicated. It is also clear that full convergence of U.S. GAAP and IFRS (including “priority projects” and those judged lower priority) will not be completed until 2012 at the earliest.

Any decision by the SEC as to the possibility of requiring U.S. filers to actually convert to IFRS will likely be predicated upon the ultimate success of the convergence efforts. It would not seem unreasonable to suggest that the recently announced delay by the accounting standard-setters will result in an SEC decision to delay its decision as to the use of IFRS in the U.S. as well. When SEC Chief Accountant James Kroeker announced in January of this year that the commission “could decide sometime in 2011” if and how it will require U.S.-registered companies to incorporate IFRS into its financial reporting, he went on to add, “…particularly important to that [timing] is the projects that the FASB and IASB are working on [at that time]… .”

Perhaps a better indication on what that timing will be can be drawn from another recent SEC announcement. The SEC will be hosting a roundtable meeting on July 7 to discuss benefits or challenges in potentially incorporating IFRS into the financial reporting system for U.S. issuers. The SEC said in a press release that the meeting will include three panels representing investors, smaller public companies and regulators. The discussion will focus on investors’ understanding of IFRS as well as the impact on smaller public companies and the regulatory environment.

The timing of this meeting seems to fit nicely given the extended period of convergence activity for priority projects. It is conceivable that the boards could be wrapping up their priority convergence work at the same time the SEC is concluding its consideration of the input from the roundtable discussions. Also, the SEC quite likely will be interested in and consider the implementation date for all of the new standards. With a large number of new standards set to take effect within the next few years, coordination of those changes and any potential IFRS adoption announcement would be both logical and essential.

U.S. insurers of course have to consider the actions of yet another standard setter, the state insurance regulatory authorities orchestrated through the efforts of the NAIC. Efforts that began over a year ago to consider the future of the statutory accounting model in the U.S. have been put on hold by the NAIC pending the outcome of the work of the FASB and the IASB on the proposed standard for insurance contracts and the outcome of the SEC decision regarding possible adoption of IFRS.

In the meantime, a possible insight as to which way the NAIC may be leaning might be drawn from recent comments made by NAIC CEO Terri Vaughan to the NAIC’s Solvency Modernization Initiative (SMI) Task Force in March. Ms. Vaughan addressed a handful of key points that the NAIC and the Task Force need to wrestle with as they go forward, one of which is the need for an accounting benchmark that is on a common basis across regulatory regimes. Ms. Vaughan stated, “In the U.S., our statutory accounting system serves as that common benchmark.... I don’t know what that benchmark measuring system will be for internationally active groups, but the logical candidate at this point is IFRS....” While this brief comment falls well short of an endorsement of a future regulatory accounting model in the U.S. based on IFRS, such an outcome remains a distinct possibility.

Not so long ago, June 30, 2011, appeared to be a critically important date relating to the future of accounting and financial reporting in the U.S. While that date has now slid to year-end 2011, the delay was necessitated by the sheer enormity of the task and the overarching desire to complete due process over a number of extremely complex proposed standards. Yet, despite the delay, the prospect of change now looms more largely through the front windshield.

For more information, contact Jim Stangroom.

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Upcoming Speaking Engagements

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