November 2011

Greetings!

The November edition of Insurance Perspectives addresses recent updates on ORSA’s adoption, IFRS convergence and the NAIC’s credit for reinsurance models as well as upcoming Invotex speaking engagements.

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, Les Schott and Jim Stangroom
Managing Directors, Insurance Services

In this Issue

1. ORSA Has Arrived at the Station; Train to Follow
2. IASB Seeks to Regain IFRS Momentum
3. Years in the Making, NAIC Adopts Credit for Reinsurance Models
4. Upcoming Invotex Speaking Engagements

ORSA Has Arrived at the Station; Train to Follow
by Tom Finnell

After almost a year of drafting and deliberations, the Own Risk and Solvency Assessment (ORSA) Guidance Manual was adopted by the NAIC’s Group Solvency Issues (EX) Working Group and then by the Solvency Modernization Initiative (EX) Task Force at the NAIC’s Fall National Meeting last week. That said, the manual provides guidance for insurers and regulators as to what an ORSA is, what is included and how an ORSA is to be performed and used; the manual does not however provide the legal authority that would actually impose a requirement for an insurer or group to implement an ORSA.

While there had been some discussion about exactly what vehicle would provide that legal authority, the related issues did not galvanize until the working group issued its proposal on October 28 that Form B of the Insurance Holding Company System Model Regulation be amended to provide that legal authority. That met with much resistance from industry groups in their response to the Form B proposal, and strong words by some regulators at last week’s working group meeting to the effect that industry was trying to delay the process.

The principal concerns raised by industry about the notion of using Form B as the triggering language to require an insurer or group to implement an ORSA include the following:

• Lack of confidentiality requirements in Form B.
• Form B is filed by all insurers within a group with their domestic states, which is inconsistent with the working group’s consensus that an ORSA be filed only at the group level with the lead regulator.
• Form B applies only to insurers that are part of a holding company group, and does not address stand-alone insurers that also exceed the premium thresholds in the manual.

In lieu of using Form B as the vehicle to require an ORSA, industry representatives offered up other ideas that generally relate to the examination authority of the states, such as adding a provision to the Annual Financial Report Model Regulation (a.k.a., the Model Audit Rule) or the Model Law on Examinations.

At the meeting’s end, the vehicle to provide legal authority to ORSA was left undecided. Industry is now challenged to work quickly and collaboratively to offer up a workable suggestion, which will be taken up in short order by the working group on a conference call.

The working group also released a letter to the Financial Condition (E) Committee with certain recommendations relating to ORSA’s implementation:

• “Establish an effective date for the receipt of the first ORSA Summary Report to ensure that the U.S. can receive acknowledgement for implementing elements of an IAIS International Core Principle during its 2014 FSAP [Financial Sector Assessment Program, a review performed by the International Monetary Fund], as well as to allow applicable insurers/groups to have at least one year to prepare for the filing.”
• “Establish charges … to incorporate some initial guidance into the applicable regulatory handbooks to assist analysts and examiners when reviewing the ORSA Summary Reports…”
• “Consider a proposal to the Financial Regulations Standards & Accreditation (F) Committee to ensure the practice of collecting and reviewing the ORSA Summary Reports during the financial analysis and examination process is uniformly adopted and applied among state insurance departments.”
• “… identify areas related to ERM where regulators might benefit from additional guidance and/or training…”
• “… create an ORSA Feedback Pilot Project in 2012 for five to ten undisclosed groups to voluntarily submit an ORSA Summary Report for regulatory review under a confidentiality agreement in order for regulators to be able to provide some high-level (non-group specific) feedback to industry prior to the actual ORSA Summary Report effective date…”

We believe that the legal requirement issue will be resolved in short order. Insurers and groups that meet, or may soon meet, the premium thresholds in the manual should waste no time in assessing their own preparedness to address the manual’s requirements. While they would not be required to perform an ORSA, smaller companies could benefit from a similar effort to consider certain aspects of ORSA as potential best practices. While comprising fewer than 10 pages of text, there are some requirements that are certain to be challenging to insurers as they go about their ORSA process. The more time an insurer has to recognize those challenges and incorporate changes in ERM and related assessment processes, the better.

For more information, contact Tom Finnell.

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IASB Seeks to Regain IFRS Momentum
by Tim Foley and Jim Stangroom

It was only about five weeks ago that Ian Mackintosh, Vice-Chairman of the International Accounting Standards Board (IASB), expressed concern over the lack of progress on many key U.S. GAAP/IFRS convergence projects. Addressing a conference of chartered accountants in Scotland on September 30, 2011, Mr. Mackintosh suggested that the two boards are on a “completely different page” on the standard for financial instruments, seem to be “heading in a different direction” on hedging and are in “a bit of a muddle” when it comes to the many unresolved issues on the accounting for insurance contracts. In doing so, he hinted that it might be time for the IASB to move forward on its own, work to complete its major projects and begin to “look to our future responsibilities.” In expressing his frustration with the convergence process, Mr. Mackintosh seemed to echo many of the concerns expressed here in the U.S. by accounting practitioners and other interested parties over the “hurry up and wait” pattern of activity that seems to have developed.

A very different tone was set by the IASB shortly thereafter at the start of last month’s AICPA/IFRS Foundation Conference held in Boston. In his first speech in the United States since taking over as chairman of the IASB, Hans Hoogervorst clearly articulated his views about why the goal of a single set of world-wide accounting standards is critical, and why he is optimistic that the SEC will ultimately reach a “positive decision” on U.S. incorporation of IFRS.

Regardless of the direction the SEC may take, The FASB and IASB continue their joint efforts to forge ahead on the insurance contracts project. There appears to have been a recent break-through involving the accounting for changes in the discount rate used to determine insurance contract liabilities. At the October 24th IASB Insurance Working Group meeting there appeared to be general acceptance for the concept of accounting for changes in discount rate assumptions through Other Comprehensive Income (OCI) as a means of mitigating income statement volatility. Acceptance of the use of OCI could keep the IASB project moving forward and is one step towards convergence with a similar FASB project.

Mr. Hoogervorst’s comments at the AICPA/IFRS Foundation Conference were immediately followed by a keynote address from Harvey Goldschmid, former SEC Commissioner, co-chair of the Financial Crisis Advisory Group and trustee of the International Financial Reporting Standards Foundation. In his presentation, U.S. Incorporation of IFRS is a National Imperative, Mr. Goldschmid emphasized the need for transparency and integrity of financial reporting. He also stressed the danger of “regulatory arbitrage,” where U.S. and international standards are played off against each other, resulting in political interference that could weaken both systems. He concluded his remarks by providing his views about what might happen if the SEC “fails to commit to incorporation in the next [few] months or simply says no.” The result, in his opinion, would be one of two scenarios:

Scenario 1 – the coalition of nations supporting IFRS would break apart, with many countries resorting back to their local GAAP standards, resulting in a return to fragmentation with the resulting lack of transparency, comparability and general inefficiency.

Scenario 2 – The coalition of nations supporting IFRS holds together, isolating the U.S. The U.S. could lose its seats on the IASB, lose its representation among the IASB Trustees and possibly have no future role in the IFRS standard development process. The loss of a constructive role for the U.S. would reduce the overall quality of IFRS moving forward.

The AICPA/IFRS Foundation Conference was attended by about 200 individuals representing both large and small corporations, as well as representatives from both the FASB and the IASB, large and small public accounting firms, and regulators. The most prominent industry representation was found in banking and insurance. While much of the conference focused on technical updates on the key convergence projects, a series of round-table discussions and other presentations gave interested parties plenty of opportunity to voice their opinions.

AICPA President and CEO, Barry Melancon, called on the SEC to immediately allow U.S. companies the option of using IFRS, stating the option would be “an effective way for U.S. companies, if they so choose, to level the playing field with their international competitors.” An informal poll of conference participants revealed that a large majority support the “big bang” approach to adoption of IFRS. The success of other countries in their adoption efforts, coupled with the prospect of a prolonged period of transition and change, was cited as the primary reason for this preference. However, and again by a large majority, this same group predicted that the actual move towards IFRS will instead resemble something similar to the SEC’s “condorsement” approach outlined in a staff paper earlier this year.

Jerry de St. Paer, Executive Chairman of the Group of North American Insurance Enterprises (GNAIE), spoke about the ongoing insurance contracts project. He said the current proposal included fatal flaws that would result in “significant non-economic volatility for long duration life contracts and will obscure underwriting results for the property/casualty business.” He went on to criticize the inclusion of risk margins for short duration contracts and the concept of discounting within the non-life measurement model.

The OCI breakthrough is just one of several key issues being re-deliberated by the IASB and its Insurance Working Group. If the IASB were to reach final decisions on insurance contracts accounting in the first half of 2012, we predict that the IASB would likely re-expose a proposed standard for comment. In that case, a final standard would not likely be issued until 2013.

The SEC is still expected to announce a decision by the end of the year on whether to incorporate IFRS into the U.S. financial reporting system. However, they were also expected to release a few more staff papers outlining other possible approaches to the incorporation process. While we expect more news soon from the SEC, it appears the IASB and its supporters will be keeping the pressure on the SEC to reach a decision.

For more information, contact Tim Foley or Jim Stangroom.

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Years in the Making, NAIC Adopts Credit for Reinsurance Models
by Tom Finnell

After years of deliberation, the NAIC adopted amendments to the Credit for Reinsurance Model Act and the related Model Regulation at the conclusion of its Fall National Meeting held outside of Washington, DC this past weekend. Despite the often acrimonious debate that has persisted around this topic for years, passage of the Models came in a swift and unanimous vote of the NAIC’s Executive Committee and Plenary, as some last minute tweaking had apparently ameliorated any remaining concerns of members. Nonetheless, concerns remain among some in industry that reducing the regulatory collateral requirements in the U.S. is an ill-conceived notion that can only prove detrimental to U.S. insurers.

The notion of revising U.S. regulatory requirements for reinsurance collateral has been a topic at the NAIC for over a decade. Pressure had been mounting by foreign reinsurers who must post collateral to secure their exposures in the U.S., notwithstanding that their own domestic regulatory regimes have seen no need for such a requirement. Other issues had been raised regarding the impact of collateral requirements on free trade. The debate culminated several years ago when the NAIC adopted its Reinsurance Modernization Framework Proposal, an effort which it then hoped to implement quickly and uniformly through federal enacting legislation; however, and in the absence of a sponsor on Capitol Hill, that was not to be. In the meantime, some states have been taking action on their own to reach agreement with foreign reinsurers over collateral reduction, introducing the possibility of variances in approach and impact on a state-by-state basis. The NAIC has been working over the past several years to adopt amendments to the Models in order to implement the Reinsurance Modernization Framework Proposal within the constraints of existing federal law and to achieve uniformity across the states.

The amendments to the Model that were adopted on Sunday by the NAIC thus conform to the Framework, and include an additional means for a U.S. domestic insurer to take credit for reinsurance:

• A U.S. domestic insurer may take credit for reinsurance relating to business ceded to an assuming reinsurer that is domiciled in a qualified jurisdiction as determined by the commissioner directly or by the commissioner’s deferral to a list of qualified jurisdictions to be published by the NAIC.
• Qualified reinsurers would be assigned a rating based on published ratings by two NRSROs as well as other factors.
• The amount of collateral that would be required would vary based on the assigned rating, ranging from zero for a rating of “Secure-1” (A++ from AM Best; AAA from S&P or Fitch; and Aaa from Moody’s) to 100% for a rating of “Vulnerable – 6” (ratings below B+ from AM Best; BBB- from S&P or Fitch; and Baa3 from Moody’s).
• Credit for reinsurance under this additional manner would apply only to reinsurance contracts entered into or renewed on or after the effective date of the certification of the assuming insurer.

While they are still free to negotiate for more collateral than would be required by the Models, some primary writers are concerned that their negotiating power has now been lessened. And while the Models require assuming insurers to post full collateral in certain situations (e.g., if the reinsurer is downgraded), there are concerns that the reinsurer may then be unable or unwilling to do so.

Our view is that as the amended Models are implemented and their terms begin to cover an increasing number of contracts prospectively, the onus will be on U.S. ceding insurers to institute enhanced credit risk management policies and procedures. Ceding companies will need to diversify their reinsurance program, i.e., to avoid putting too many of their eggs in one reinsurer's basket. They will also have increased compliance requirements, for example, to monitor and report when reinsurance recoverables exceed stated thresholds.

The role of the NAIC will also take on more importance as states look to it for assistance in determining qualified jurisdictions and in providing other support. Indeed, it is a stated goal that “the NAC will continue to work on requirements for NAIC review and approval of qualified jurisdictions, and will undertake a re-examination of the collateral amounts within two years from the effective date of the revisions of the models.”

For more information, contact Tom Finnell.

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Upcoming Speaking Engagements

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