Greetings!

The prospect of regulatory reform continues to garner much attention of insurance company executives and regulators alike. Much of what has been proposed is in response to the ongoing credit/economic crisis, a situation that has amplified demand for those who can provide timely and insightful analyses of an insurer’s investment strategies, risks, and related risk management policies and practices. At the same time, international developments have much potential to shape the future of financial reporting in the U.S., including with respect to the anticipated eventual adoption of IFRS and the potentially significant related impact that may have on statutory accounting.

Invotex® Group is pleased to share insights about these and other current matters of interest to the insurance industry and the regulatory communities. We welcome your feedback and invite you to share Insurance Perspectives with your colleagues and business acquaintances.

Tom Finnell
Managing Director

Jim Stangroom
Managing Director

In this Issue

1. Insurance Regulatory Reforms: The Devilish Details Begin to Emerge
2. Insurers and Regulators Vie for Investment and Risk Management Expertise
3. IFRS: The Demise or the Future Foundation of U.S. Statutory Accounting Principles for Insurers?
4. Invotex Secures Successful Outcome for Investors of Fraudulent Viatical Settlement Company
5. Upcoming Speaking Engagements

Insurance Regulatory Reforms: The Devilish Details Begin to Emerge
by Tom Finnell

In late July, the U.S. Treasury Department fleshed out more details of its plans for a proposed Office of National Information in draft legislation that generally parallels previous bills sponsored by Rep. Paul. E. Kanjorski (D-PA). However, the Treasury draft is different in some respects from the earlier Kanjorski-sponsored bills and is causing some to rethink their position on the Office of National Insurance (“ONI”) concept.

A key feature of the Obama administration’s Blueprint for Financial Regulatory Reform is the “establishment of the ONI within Treasury to gather information, develop expertise, negotiate international agreements, and coordinate policy in the insurance sector.” The ONI concept dates back to 2008 as H.R. 5840, reintroduced as H.R. 2609, the Insurance Information Act of 2009. Both bills had been sponsored by Rep. Kanjorski and garnered wide support throughout the insurance industry, including the support of the NAIC.

One impetus behind the movement to an ONI is that in the international arena, the U.S. insurance industry is disadvantaged by having no single authoritative voice that can speak on its behalf from the regulatory perspective. As the roles of the International Association of Insurance Supervisors and the International Accounting Standards Board have quickly ascended to more prominence in recent years, the lack of such a single U.S. spokesperson has become increasingly evident and problematic.

Most troubling about the Treasury draft to some, including state insurance regulators and the NAIC, are changes to federal preemption language. Both the Treasury draft and H.R. 2609 allow for preemption of state insurance measures if such measures treat a non-U.S. insurer more or less favorably than a U.S.-domiciled insurer and if the measures are determined to be inconsistent with international insurance agreements.  The Kanjorski version had included language that also would have provided the opportunity for a stay of such determination and an appeal for administrative review, language which is notably absent in the Treasury-prepared draft legislation.

In addition, the role of the NAIC itself is now less clear. In the Kanjorski bill, the NAIC is mentioned on several occasions, including in one provision that would have provided the NAIC with authority to nominate a number of state insurance commissioners to join others on a 13-member Advisory Group. The Treasury proposal does not provide for such an Advisory Group nor does it otherwise mention the NAIC at all. In fact, neither does the more comprehensive blueprint of the Obama Administration’s reform proposal that was released earlier on June 17, 2009. Among other things, it would create a Financial Services Oversight Council to facilitate information sharing and coordination, identify emerging risks including about firms whose failure could pose a threat to financial stability, and provide a forum for resolving jurisdictional disputes between regulators — but without representation on the Council either by the NAIC or by any states through their insurance regulators.

The Treasury draft also has included some new provisions, including assisting in administration of the Terrorism Insurance Program and in using subpoena powers if necessary to force the production of data or information.

We will continue to report on further developments at both the federal and state levels in future editions of Insurance Perspectives.

For more information, contact Tom Finnell.

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Insurers and Regulators Vie for Investment and Risk Management Expertise
by Jim Stangroom

Insurers have long appreciated the need for knowledge and insight about investing to develop related strategies, to enable informed decision-making, and to manage risk. However, the economic crisis has some insurers scrambling to re-think the composition of their investment teams, from the CIO level to portfolio managers, advisors, and risk managers.

At the same time, state insurance departments are implementing the new risk-focused surveillance approach, which includes risk-focused financial examinations. Regulators’ focus on risks – including prospective risks – has increased their demand for qualified resources to assist as an integral part of state regulatory financial examination teams in evaluating investment strategies and practices and related risk management.

Certain investment activities may be considered high risk areas when exam teams assess risk as part of conducting a risk-focused exam. This high risk assessment is typically due to concerns such as:

• Complexity and/or inherent risk underlying certain types of financial instruments
• The prospective risk that can result from unpredictable market volatility
• Potential for significant impairment losses and inherent judgment in determination or measurement of losses
• Securities lending activities and related liquidity risk of reinvested collateral
• Use of complex investment strategies to achieve asset-liability matching objectives
• Materiality, which can compound the potential impact of risks

The Financial Regulation Standards and Accreditation Committee of the NAIC recently adopted accreditation review team guidelines for use with those examinations performed under the new risk-focused exam approach. The updated guidelines are effective January 1, 2010, and include guidance covering the use of an Investment Specialist on such exams. According to these guidelines, some examples of when an Investment Specialist may be necessary include situations when an insurer has:

• A sophisticated derivatives program
• Material holdings of collateralized mortgage obligations
• Unusual real estate or limited partnership holdings
• High or unusual portfolio turnover
• Material asset movements between related parties
• Unusual securities lending activities

Other examples where use of an Investment Specialist may be appropriate include evaluating the:

• Effectiveness of equity-indexed annuity hedging programs
• Reasonableness of investment valuation methods, models and policies
• Adequacy of investment policies and strategies and their documentation
• Adequacy of investment risk management, governance and oversight programs
• Analysis of impairment losses and specific problem assets
• Credit risk exposure to private placement securities
• Asset-liability matching strategies for certain product lines

Commercial real estate vacancy rates and delinquency rates are on the rise, causing many analysts to predict that commercial mortgage loans may be the next asset class to experience impairment losses. Insurance company professionals can expect Investment Specialists to ask probing questions about a company’s ongoing monitoring controls over its commercial mortgage loan portfolio. The Investment Specialist would likely also review loan valuation methods and the reasonableness of underlying assumptions.

The qualifications and experience of the Investment Specialist should be appropriate for the investment risks inherent in the specific examination. For example, a CPA might be best suited for accounting, internal control and valuation issues; a Certified Financial Analyst might be most appropriate for valuation issues as well as for credit risk and investment policy matters; and an actuary might be ideal for issues concerning hedging strategy and asset-liability matching.

The risk-focused exam approach requires a thorough understanding of a company’s investment risk management activities. Some state insurance departments have investment and capital markets expertise in-house. However, many states do not, and may engage third party consultants to evaluate complex investment risks.

For more information, contact Jim Stangroom.

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IFRS: The Demise or the Future Foundation of U.S. Statutory Accounting Principles for Insurers?

The proposed future migration from U.S. GAAP to International Financial Reporting Standards (IFRS) leaves the future of statutory accounting practices (SAP) in the U.S. in doubt. While IFRS and SAP are conceptually quite different and serve different purposes and users, there is a potential domino effect that may impact SAP because of the manner in which it is currently maintained by the NAIC. Further, any resulting change to the SAP framework will impact all insurers in the U.S. — large and small, stocks and mutuals.

Invotex has excerpted questions and answers on this topic from a panel discussion held at the International Accounting and Systems Association’s 2009 Annual Conference. Panelists included Ramon Calderon, the Deputy Commissioner for the California Insurance Department and Chair of the NAIC’s International Solvency and Accounting Working Group and who has recently accepted the position of Senior Financial Regulation Adviser at the NAIC’s Center for Insurance Policy and Research; Bill Boyd, Financial Regulation Manager for the National Association of Mutual Insurance Companies (NAMIC); and Tom Finnell, Managing Director of Invotex Group and leader of the firm’s insurance practice.

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Invotex Secures Successful Outcome for Investors of Fraudulent Viatical Settlement Company

After nearly seven years of trials and appeals, Invotex, acting as the court-appointed Receiver for a viatical settlement company, succeeded in litigation regarding the validity of certain life insurance policy benefits. A recent federal Court of Appeals ruling held that the insurer, First Penn-Pacific Life Insurance Company, will pay $3 million in benefits and interest to policy investors.

In 2002, at the request of the Maryland Securities Commissioner, Invotex was appointed by the Circuit Court for Baltimore City as the Receiver of Answer Care, Inc. As a viatical settlement company, Answer Care served as a broker that invested funds in acquiring all or part of the death benefit of life insurance policies issued to insureds, most  typically individuals who had been diagnosed with a terminal illness, such as AIDS. Such insureds could thus receive and enjoy during their lifetime the existing death benefits of a life insurance policy they owned, at a discount consistent with their respective life expectancy.

Answer Care was formed to deal with the riskiest of such investments from other viatical settlement companies, i.e., life insurance policy benefits from policies still within their two-year contestability period. Answer Care would then invest its investors’ funds in such policies providing investors with a life expectancy of the insured that matched the investors’ goals for a return in either a three, four or five year period, as determined by medical professionals who had not examined the insureds.

After a forensic investigation, Invotex determined that Answer Care was insolvent. More than half of the policies had been cancelled by the insurance companies during the two-year contestability period and many of the remaining policies were not expected to produce the “promised” investment returns. The courts ruled that title to and responsibility for the remaining active policies belonged to their investors who then, in turn, hired a third-party to administer and monitor those policies.

First Penn filed suit to declare its policy void. The administrator asked the Court to be released from its responsibility for that policy. The Court then appointed Invotex to act as administrator of the policy for the benefit of its 49 investors. Invotex hired Baltimore-based Gallagher Evelius and Jones to represent the investors and the Fourth Circuit Court of Appeals ultimately ruled in their favor.

For more information, contact Raymond J. Peroutka.

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Upcoming Speaking Engagements

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