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This edition of Insurance Perspectives discusses the future of U.S. Statutory Accounting, pending implementation of healthcare reform's high risk pools, doubt about having an IASB insurance contracts standard by 2011 and prospects for ORSA requirements in the U.S. In addition, we take an early look at industry leaders who will present at the upcoming Emerging Risks Forum.

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. Gazing Through the Crystal Ball – the NAIC Probes the Future of U.S. Statutory Accounting
2. Summer’s Here, and Pools are Open – Healthcare Reform’s High Risk Pools are Ready for Business
3. FASB Responds to Concerns and Prioritizes Certain Projects; an IASB Insurance Contracts Standard by 2011 is Looking Doubtful
4. “ORSA” – Own Risk and Solvency Assessments – Moving Forward to Discussion Paper Stage
5. Travelers, Zurich Financial, Fitch Ratings and Other Industry Leaders Join Slate of Speakers at 4th Annual Emerging Risks Forum
6. Upcoming Speaking Engagements

Gazing Through the Crystal Ball – the NAIC Probes the Future of U.S. Statutory Accounting
by Tom Finnell

For the past couple of years, an issue that has lingered in the background of some NAIC meetings has been the future of U.S. Statutory Accounting, or “SAP.” Long the bastion of the financial regulatory regime over insurers in the U.S., a number of developments have occurred that have placed the future of SAP in doubt. These include the anticipated eventual adoption in the U.S. of International Financial Reporting Standards (IFRS) by public companies; the potential residual impacts on U.S. GAAP combined with the fact that SAP currently is maintained by explicit reference to U.S. GAAP; and that other countries with major financial centers around the globe support the use of IFRS for regulatory purposes. That a separate SAP basis of accounting is maintained makes the U.S. somewhat of an outlier. These and related issues were aired at length last August in an Insurance Perspectives article and in a related Q&A document published by Invotex. However, the NAIC is now getting some traction toward a process to resolve the future of SAP.

The NAIC recently formed a Statutory Accounting and Financial Reporting Subgroup whose mission is to “recommend the future of U.S. statutory accounting and financial reporting.” The subgroup recently worked with other NAIC working groups to draft a list of the “primary consideration points” and the positive or negative implications of each as a foundation for future discussion. The draft list begins with several primary questions posed by the subgroup, which aims at the most fundamental of levels: What should be the purpose of the regulatory accounting model; should the NAIC continue to maintain the codification of statutory accounting; and should financial filings be bifurcated into public financial statements v. entirely different, regulator-only confidential filings?

As we gaze through the crystal ball at where these inquiries might take the industry, we foresee much debate. Many will say, and perhaps rightfully so, that the recent crisis has demonstrated that the national system of state-based regulation over insurers in the U.S. has proven itself, that SAP is a key component of that system, and that SAP therefore should be maintained.

On the other side of the spectrum will be those who believe that it is costly and burdensome to maintain two sets of financial reporting. They likely will contend that much of what is accomplished with SAP can be accomplished by using IFRS as a foundation for regulatory oversight and/or by recalibrating RBC for application against GAAP or IFRS statements. Furthermore, they may posit that it would benefit all in the long run if there was a single global standard for accounting by insurers.

The debate will surely also bring to the surface a myriad of more pragmatic issues pertaining to the cost of maintaining SAP in the absence of a U.S. GAAP model; implementation and training issues for all companies and regulators should IFRS be adopted – not just for those companies that are public or that write business internationally; the impact on those small to medium U.S. only insurers that do not currently prepare U.S. GAAP financials; and much more.

While the future of SAP has been a wistful issue lingering in back hallways at NAIC meetings, it is about to come to the forefront. The draft list has been exposed for comments until August 4, 2010, and comments received will likely be discussed at the subgroup’s next meeting, which is scheduled for August 14, 2009 at the National Meeting in Seattle. With the input of all interested parties about to emerge, we will soon know the full scope of the issue, the possible alternatives and relative merits of each, and we can then begin to see the key issues that will shape the debate going forward. We’ll keep our readers advised as these developments unfold.

For more information, contact Tom Finnell.

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Summer’s Here, and Pools are Open – Healthcare Reform’s High Risk Pools are Ready for Business
by Kerby Baden

Who will jump into the pool, and how many will take that leap? In some states, one of the first provisions of the newly-enacted healthcare reform law will begin to be rolled out this month. The Patient Protection and Affordable Care Act of 2010 (PPACA) provides for an interim period where high risk pools will provide subsidized coverage to qualifying individuals. Intended beneficiaries are those who are currently uninsured with pre-existing conditions and who have not been covered under creditable coverage during the six-month period prior to applying for coverage in a high risk pool. Despite the progress and the hype about the new pools, some muddy waters may lie ahead.

Under the new law, the Secretary of the Department of Health & Human Services (HHS) is charged with establishing a temporary high risk pool or approving states’ use of their own pools no later than 90 days after the PPACA’s enactment. Such pools at both the national and state level are a temporary stop-gap measure and would continue in operation until 2014 by which time other PPACA provisions would take effect. Key provisions with 2014 effective dates include, among others, proscribing the ability of health insurance carriers to deny coverage for pre-existing conditions and the availability of health insurance exchanges to offer more competition.

According to HHS, states have the following options to carry out their statutory requirement with respect to high risk pools:

• Operate a new high risk pool with federal funds alongside their current state high risk pool;
• If a state does not currently have a high risk pool, establish a new high risk pool with federal funds;
• Build upon other existing coverage programs designed to cover high risk individuals;
• Contract with a current HIPAA carrier of last resort, or other carrier, to provide subsidized coverage for the eligible individuals;
• Allow HHS to carry out a coverage program in their state.

On April 2, 2010, HHS Secretary Kathleen Sebelius wrote to all states requesting an expression of their interest in participating in the temporary high risk pool program. According to data provided by the NAIC, 31 states intend to operate their own high risk pool program pursuant to PPACA. The new law appropriated $5 billion in funding to pay claims and administrative costs of high risk pools that are in excess of the amount of premiums collected from eligible individuals enrolled in those pools.

As HHS works to implement the rules related to funding, eligibility, benefits and the establishment of premiums, it also faces many other difficult issues, including the following:

• How many eligible uninsureds will join the pools? Using data from a 2007 Medical Expenditure Panel Survey conducted by the Agency for Healthcare Research and Quality, the National Institute for Health Care Reform estimated that the number of eligible Americans who may qualify for high risk pools ranges from 5.5 to 7 million. However, a study for the Office of the Actuary of the Center for Medicare and Medicaid Services estimates that only 375,000 individuals will enroll in 2010, which is less than 10% of the total eligible individuals who have been denied health insurance because of pre-existing medical conditions. This suggests that many who might otherwise qualify due to their health conditions may nonetheless find coverage by a high risk pool unaffordable, notwithstanding the involvement of a federal subsidy.
• Will the $5 billion in funding last until 2014? The Office of the Actuary study also noted that, even if only 375,000 individuals joined the high risk pools, annual health spending would increase by $4 billion and “by 2011 and 2012, the initial $5 billion in federal funding for this program would be exhausted.” Since states are not allowed to spend more than their respective allotment of the $5 billion federal subsidy, it is unclear as to how states would fund any excess costs. Potential solutions range from requiring premium increases on members, reducing covered services or enrollment, or some combination thereof. Indeed, the uncertainty of funding adequacy has led some states to opt out of a state-specific high risk pool, concluding that such a program would be best administered at the federal level.
• There is the risk that applicants will merely be shifted from state-sponsored pools to the federal program without reducing the noninsured population by the extent expected or desired by the PPACA’s authors. Experts expect that the new federal program will offer members superior benefits and at a lower cost relative to existing state-sponsored pools. Existing members of state-sponsored pools, therefore, may want to switch immediately to the federal program; however, PPACA requirements will prevent them from doing so without first going without coverage for six months – a risky and potentially expensive proposition. By contrast, new applicants who meet the six-month requirement can gain immediate coverage in the federal program. States whose budget problems are exacerbated by their own pool programs may also try to gently steer applicants in the federal direction.
• What effect will this have on providers who will start seeing these previously uninsured and now federally-subsidized members? Will the subsidized payments sufficiently reimburse providers, or will it only perpetuate the legacy of inadequate rates by government payors?

As the calendar slowly rolls toward January 2014, the implementation of these high risk pools will be the first big test under PPACA in providing subsidized health insurance to qualified individuals as well as in trying to stretch the federal dollar to pay for this program. Only time will tell if the high risk pools successfully accomplish their objectives and at what cost.

For more information, contact Kerby Baden.

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FASB Responds to Concerns and Prioritizes Certain Projects; an IASB Insurance Contracts Standard by 2011 Looks Doubtful
by Tim Foley

In a July 1, 2010 webcast, the FASB announced changes to the work plan within the joint Memorandum of Understanding (MoU) with the IASB. The changes are intended to respond to stakeholder concerns about the unprecedented number of new accounting standards and exposure drafts slated for release in 2010 and 2011 – including the long awaited Insurance Contracts standard – and the ability of stakeholders to respond timely and adequately to what is certain to be a number of very complex proposals. In the course of discussing the status of the highest priority projects on the FASB’s agenda, the work plan also raises serious doubts over the June 2011 targeted completion date.

The FASB is now seeking much more stakeholder input during its self-described “rigorous due-process” with the goal of improved, high-quality and converged (with IFRS) accounting standards. Stakeholders have expressed their doubts over the ambitious timetable for the planned changes to a set of significant and broad-reaching accounting standards. The recently updated MoU work plan seeks to address those concerns, emphasizing that the key goal of convergence of accounting standards and the elimination of differences between U.S. GAAP and IFRS (as stated in the original Norwalk Agreement of 2002) by the June 2011 target date may nonetheless be secondary to the goal of remediating weaknesses identified in both sets of standards.

The previous work plan had scheduled the release of 10 new exposure drafts or standards this summer alone. However, based on stakeholder responses and Board deliberations, it was concluded that such an aggressive schedule would not allow sufficient time for the due process activities of review, analysis and thoughtful comment. Nor would this work plan allow for “orderly and cost effective” implementation. Therefore, the FASB prioritized the projects, with more near-term resources focused on projects that include Financial Instruments, Fair Value Measurement, Revenue Recognition and Leases.

Progress on the insurance contracts project continues but at a slow pace, and with uncertainty as to the ultimate direction. The FASB and the IASB have reached differing conclusions in many key areas. The IASB exposure draft on insurance contracts is now targeted for release in late August 2010 following a series of delays. The FASB has yet to decide on how it might respond to the IASB exposure draft, e.g., by issuing its own exposure draft or discussion paper, or soliciting feedback through other means such as round-table discussions. While the IASB is still targeting June 2011 for a final insurance contracts standard, the FASB has yet to commit to that date.

The SEC has responded favorably to the revised FASB work plan, and has indicated that the FASB revisions do not impact the SEC’s own work plan issued earlier this year with the stated objective of achieving a common set of high quality global accounting standards. In fact, the revised work plans of both the SEC and FASB share a common theme – that target dates are useful planning tools, but will not be slavishly followed at the expense of sound improvements in existing accounting standards. And that must occur before moving forward with more serious discussions about whether or not the U.S. will adopt IFRS and, if so, when.

We believe the FASB has taken the appropriate course of action by prioritizing certain projects and by recognizing the importance of due process and stakeholder feedback, while simultaneously emphasizing its desire to implement improved standards in an orderly and cost effective manner. Significant differences remain between the FASB’s and the IASB’s positions on certain key aspects of the insurance contracts and financial instruments projects. In some cases there appears to be more divergence than convergence of these standards, which calls into question whether 2011 is a realistic target date for these two standards of such great importance to insurance companies.

For more information, contact Tim Foley.

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“ORSA” – Own Risk and Solvency Assessments – Moving Forward to Discussion Paper Stage
by Tom Finnell

Last month we reported that the NAIC’s International Solvency Working Group would discuss whether the risk management practice known as “Own Risk and Solvency Assessment,” or ORSA, should be adopted for application in the U.S. ORSA is one of the central elements of Solvency II, the regulatory regime that is being developed for application in Europe and that is currently scheduled to become effective in late 2012.

The working group held a conference call earlier this month to air some views about a potential U.S. ORSA requirement, concluding that the logical step forward would be the development of a discussion document to be released prior to the upcoming NAIC National Meeting to be held in Seattle in August. Although that is yet a month away, the outline prepared for the call and the views of regulators and interested parties that were shared on the call provided a glimpse of the issues that may frame the debate ahead.

For example, it is likely that the discussion will touch on these and other factors:

• The experience of other countries with ORSA.
• Whether a U.S. ORSA requirement should be a prescriptive checklist-like approach or a more open format to accommodate the unique aspects of each company and to encourage management’s responsibility over capital and risks.
• Whether an ORSA requirement is even needed in the U.S., or whether the necessary components of an ORSA are already covered by other regulatory tools and initiatives.
• Whether and to what degree modeling should be a component of ORSA in order to express an indicated amount of capital, or whether ORSA should simply be the optics through which regulators gain a view into management’s judgment about their interpretation of the adequacy of capital held in light of the risks facing the company.
• The scope and frequency of an ORSA requirement, and how might that differ for type or size of insurer.
• Whether it would apply at the group or legal entity level, or both.

Minimally, the NAIC will have to evaluate and respond to the International Association of Insurance Supervisors’ Financial Sector Assessment Program requirement for an ORSA. That may result in new requirements for U.S. insurers, or simply referencing where corresponding (or even stronger) requirements may already be covered in our regulatory regime.

For more information, contact Tom Finnell.

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Travelers, Zurich Financial, Fitch Ratings and other Industry Leaders Join Slate of Speakers at 4th Annual Emerging Risks Forum

Invotex Group and Interactive Solutions LLC will again co-sponsor the Emerging Risks and Insurance Management Forum, the 4th of such annual events, on September 22-23, 2010 at the Kimmel Center in downtown Philadelphia.

This year’s Forum will focus on the very significant and profound changes facing insurers as they emerge from the crisis. These include the need to implement healthcare and financial regulatory reforms, the pressures to conform to international regulatory and solvency standards, and the challenges posed by preparing for an entirely new accounting model – International Financial Reporting Standards.

Jay Muska of the Travelers Companies, Al Iuppa of Zurich Financial Services and Cynthia Crossan and Greg Dickerson of Fitch Ratings will join Beth Sammis, Acting Commissioner for the Maryland Insurance Administration, George Brady, International Counsel for the NAIC, Randi Reichel of Mitchell, Williams, Gates & Woodyard PLLC, Gary Burke of Union Labor Life Insurance Company, Mark Lastner of Cigna, Joe Zolecki of the BlueCross and BlueShield Association and other speakers. Collectively, they will address the drivers behind these fundamental changes facing the industry; their experiences to date in grappling with these reforms and their perspectives on longer term business implications and practices; and emerging practices and pragmatic ways forward for companies to consider in preparing for and implementing necessary changes.

The Forum is designed for insurance company executives and staff in the areas of finance and accounting, risk management and internal audit. It is also relevant for insurance company directors who may benefit from perspectives on emerging risks facing the industry.

Please mark your calendars for September 22-23, 2010. For more information and to register, visit the conference website at http://www.rmconference.com.

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Upcoming Speaking Engagements

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