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April 2013 | CIPR Newsle er
L I -O C By Shanique (Nikki) Hall, CIPR Manager and Dan Daveline, Assistant Director, Financial Regulatory Services The use of cap ve reinsurers by commercial life insurers has recently garnered a lot of a en on. Following the financial crisis, life insurers have increasingly used cap ves to fi-nance the perceived “reserve redundancies” associated with XXX1 and AXXX2 reserves (reserve requirements for universal life products employing secondary guarantees). These cap ve reinsurance transac ons free up capital the insurers can use to help gain a compe -
ve edge in the marketplace. Concerns over cap ve reinsurance transac ons have led regu-lators to develop a dra white paper tled, Cap ves and Special Purpose Vehicles3 (White Paper). This ar cle will examine some of the preliminary findings in the White Paper, as well as its conclusions and recommenda ons. C Historically, cap ves were originally established as an insurance company by one or more non-insurance companies to insure the risks of its owner (or owners). Cap ves are essen-
ally a form of self-insurance, whereby the insurer is owned wholly by the insured. They are formed to cover a wide range of risks. Prac cally every risk underwri en by a com-mercial insurer can be provided by a cap ve. The type of en ty forming a tradi onal cap-
ve varies from a major mul na onal corpora on—the vast majority of Fortune 500 companies have cap ve subsidiaries—to a nonprofit organiza on. Once established, the cap ve operates like any commercial insurance company and is sub-ject to state regulatory requirements, including repor ng, capital and reserve require-ments. However, because cap ves were tradi onally insuring the risks of their owners, the regulatory requirements for cap ves are generally less stringent than for other commercial insurers. Currently, more than 30 states, the District of Columbia and the U.S. Virgin Islands allow cap ves to domicile and form in their respec ve jurisdic ons. The number of cap ve domiciles has increased significantly in recent years. For more on cap ves, including the types of cap ves and the origin and domicile of cap-
ves, please see “Recent Developments in the Cap ve Insurance Industry” published in the January 2012 CIPR Newsle er.4
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APRIL 2013
http://cipr.naic.org
Insidethisissue
Life Insurer-Owned Cap ves 1
The Debate over Hurricane Deduc bles .......................... 5
U.S.-EU Dialogue Project: A Comparison of the Two Regula-tory Regimes and the Way Forward ............................... 7
Is Terrorism an Insurable Risk? ..................................... 12
Managing Longevity Risk ...... 14
CIPR Website Expands Regulatory Support Services ..................... 20
Data-at-a-Glance .................. 21
Eric Nordman CIPR Director 816-783-8232
Kris DeFrain Director, Research & Actuarial
816-783-8229 [email protected]
Shanique (Nikki) Hall Manager, CIPR 212-386-1930 [email protected]
Dimitris Karapiperis Research Analyst III
212-386-1949 [email protected]
Anne Obersteadt Senior Researcher
816-783-8225 [email protected]
1 Used to describe the actuarial reserves required to be held under the NAIC Valua on of Life Insurance Policies Model Regula on (#830), which is more commonly referred to as Regula on XXX (or, more simply, XXX). 2 Used to describe the actuarial reserves required to be held under the NAIC Actuarial Guideline XXXVIII—The Applica on of the Valua on of Life Insurance Policies Model Regula on (AG 38), which is more commonly referred to as AXXX. 3 Dra ed by the NAIC Cap ve and Special Purpose Vehicle Use (E) Subgroup. 4 www.naic.org/cipr_newsle er_archive/vol2_cap ve.htm.
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L I -O C (C )
L I C Following ar cles in The New York Times and The Wall Street Journal portraying cap ves as a “shadow insurance industry,” the NAIC formed the Cap ve and Special Purpose Vehicle (SPV) Use Subgroup (Subgroup) under the Financial Condi on (E) Commi ee in early 2012. The Subgroup was charged to study insurers’ use of cap ves and SPVs to trans-fer risk in rela on to exis ng state laws and regula ons. The Subgroup’s focus and concerns do not relate to the tradi-
onal self-insurance cap ve structure but, rather, to the use of cap ves and SPVs by life insurance companies or insurance holding companies to transfer risks off of the in-surers’ books, thereby relieving themselves of conserva ve reserve requirements. The Subgroup began to study whether the exis ng regulato-ry framework for cap ves is appropriate for regula ng an insurance company or SPV that is reinsuring insurance risks. A confiden al regulator-only request for comment was sent to state insurance regulators in all 50 states and the District of Columbia with respect to their respec ve states’ laws on cap ves and SPVs.5 Results from the survey suggested that, while commercial insurers cede business to cap ves for a variety of reasons, the majority use of cap ve/SPVs by com-mercial insurers was related to the financing of XXX and AXXX reserve redundancies. Thus, the Subgroup concluded that it appears the use of cap ves may be more prevalent among life insurers than other lines of business. The introduc on of Regula on XXX by the NAIC in February 2001 sparked the crea on of various XXX reserve funding securi za on structures to help ease conserva ve reserving standards. Triple-X reserves require conserva ve assump-
ons and valua on methodologies for determining the level of statutory “excess reserves” required to fulfill long-term premium rate guarantees on term life insurance policies. These conserva ve assump ons can result in higher reserve levels than were previously maintained and have fueled a significant expansion in cap ve reinsurers and through affil-iated SPVs, such as insurance securi za ons. Following the financial crisis, these transac ons became more common, when life insurers recognized the ability or costs associated with using securi za on to finance these redundancies had materially changed. Under the transac ons with a cap ve, the commercial life insurer cedes its XXX and/or AXXX reserves to the cap ve. The cap ve assumes the full statutory reserve liability and secures those reserves through various means. The ceding insurer regulator and the cap ve regulator require the in-surer to determine the economic reserves (or actual ex-pected losses) associated with the obliga ons and to obtain
a third-party actuarial review to ascertain such value. These economic reserves, plus a small margin for adverse devel-opment, must be secured by tradi onal high-quality assets held by the ceding company. Reserves the company has determined redundant are required to be secured by a le er of credit (LOC) to the benefit of the ceding company. R C / W P The Subgroup iden fied a number of regulatory concerns associated with the broadened use of cap ve reinsurance transac ons. The primary concern is that these transac ons are being used to circumvent statutory accoun ng reserve requirements. Of par cular concern is the use of LOCs to support cap ves. Statutory accoun ng requirements limit the types of assets that can count as admi ed assets. An LOC is not an admi ed asset under statutory accoun ng; however, some states allow cap ve insurers to count a LOC as an admi ed asset. Thus, a life insurer can improve its balance sheet and preserve capital resources by transfer-ring the XXX and AXXX reserves to their cap ve. Other con-cerns are that such transac ons are not as transparent as they should be and the lack of consistency, as each state has implemented its own unique regulatory structure for cap ves. The Subgroup began working on the White Paper in 2012, which summarizes its findings of the survey. In an effort to reach a stronger consensus among regulators and to seek input from the industry, the White Paper was released for public comment prior to the NAIC 2012 Fall Na onal Mee ng. Based on comments received, the White Paper was subsequently redra ed and re-exposed in March 2013 for a 45-day public comment period. The revised dra makes the following recommenda ons regarding the regula on of cap ves and SPVs to the Finan-cial Condi on (E) Commi ee for their considera on and/or further possible study. 1. Accoun ng Considera ons With the recent adop on of the Valua on Manual to pro-vide for a principle-based approach for valuing life insur-ance reserves, and more immediately changes made to Ac-tuarial Guideline XXXVIII—The Applica on of the Valua on of Life Insurance Policies Model Regula on (AG 38) by the NAIC in 2012, concerns with perceived reserve redundan-cies should be addressed. Under a principle-based ap-proach, the impetus to form new cap ves and SPVs in these
(Continued on page 4)
5 Thirty-five states responded to the survey. Summary of the responses can be found at www.naic.org/documents/commi ees_e_cspv_sg_related_docs_survey_results_march_2012.pdf.
4 April 2013 | CIPR Newsle er
L I -O C (C )
instances should be eliminated. However, the Subgroup recommends a separate subgroup be formed to develop possible solu ons for addressing any remaining XXX and AXXX perceived redundancies issues. 2. Confiden ality The Subgroup recommends the issue of confiden ality be studied more closely, in par cular, greater clarity regarding the specific reason for and against the use of confiden ally for such en es. In addi on, because each jurisdic on has implemented its own unique structure for cap ves, the Sub-group notes a framework might need to be developed that would provide greater uniformity. Appropriate types of in-forma on that should/should not be held confiden al might also need to be considered. 3. Access to Alterna ve Markets The Subgroup supports the use of solu ons designed to shi risk to the capital markets or provide alterna ve forms of business financing. The Subgroup suggests the Special Purpose Reinsurance Vehicle Model Act Model (#789) be re-evaluated and updated as necessary to reflect alterna ve market solu ons acceptable to state insurance regulators to ensure there is a uniform framework for the implementa-
on of alterna ve market solu ons. In addi on, the Sub-group suggests the NAIC should further encourage the states to adopt Model #789 and should consider making Model #789 an accredita on standard in those states that have an ac ve cap ve and SPV market. 4. IAIS Principles, Standards and Guidance The Subgroup recommends the NAIC closely monitor the ongoing developments with respect to Interna onal Associ-a on of Insurance Supervisors (IAIS) principles, standards and guidance. In addi on, the NAIC should consider, where appropriate, enhancements to the U.S. cap ve and SPV regulatory framework in prepara on for future Financial Sector Assessment Program (FSAP)6 reviews. 5. Credit for Reinsurance Model Enhancements The Subgroup recommends transac ons involving condi-
onal LOCs or parental guarantees effec vely permit assets to support reinsurance recoverables, either as collateral or as capital, in forms that maybe otherwise inconsistent with requirements under the credit for reinsurance models or other financial solvency requirements applicable to U.S.-domiciles commercial assuming insurers. Moreover, consid-era on should be given to further study the effects of, and poten al limits on, the variability in qualified LOCs or any
other security that might not provide the intended protec-ons provided within Model #785.
6. Disclosure and Transparency The Subgroup recommends enhanced disclosure in ceding company statements regarding the impact of the transac-
ons on the financial posi on of the ceding insurers. The Subgroup suggests disclosure requirements be enhanced in this area within the Note to Financial Statement 10M. 7. Financial Analysis Handbook Guidance The Subgroup recommends the development of guidance in the Financial Analysis Handbook for the states’ review and ongoing analysis of transac ons involving cap ves and SPVs, including specific considera ons of such transac ons when performing holding company analysis. C Life insurers in the United States have long debated the reserve redundancies associated with XXX and AXXX. This concern was recognized by insurance regulators in the mid-2000s with the NAIC principle-based reserving (PBR) project. This project has recently resulted in the NAIC’s adop on of a Valua on Manual, which, once adopted by the states, will specifically address the concern, but doing so in a comprehensive manner to allow similar “principles” to be used with other products in the future. However, PBR will not be effec ve for a number of years as there are numerous implementa on issues to be addressed before it is opera onal. At the NAIC 2012 Fall Na onal Mee ng, the NAIC’s adop on of PBR included a commitment to address issues with cap-
ve use by life insurers. Regulators generally agreed that, under a principle-based approach, rather than using cap-
ves or other SPVs, concerns with the level of reserves should be addressed within the tradi onal insurance solven-cy system, even if it means carving out a temporary niche to address an immediate problem. The NAIC also recently adopted revisions to AG 38 that address these concerns in a more immediate manner. The Subgroup con nues its work on the White Paper. Fol-lowing the exposure period and any addi onal redra ing, it is expected the Subgroup will submit the White Paper to the Financial Condi on (E) Commi ee, which, in turn, will deter-mine next steps.
6 For more on the FSAP see www.naic.org/cipr_topics/topic_fsap.htm.
April 2013 | CIPR Newsle er 23
© Copyright 2013 Na onal Associa on of Insurance Commissioners, all rights reserved. The Na onal Associa on of Insurance Commissioners (NAIC) is the U.S. standard-se ng and regulatory support organiza on created and gov-erned by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best prac ces, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collec ve views of state regulators domes cally and interna onally. NAIC members, together with the central re-sources of the NAIC, form the na onal system of state-based insurance regula on in the U.S. For more informa on, visit www.naic.org. The views expressed in this publica on do not necessarily represent the views of NAIC, its officers or members. All informa on contained in this document is obtained from sources believed by the NAIC to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such informa on is provided “as is” without warranty of any kind. NO WARRANTY IS MADE, EXPRESS OR IM-PLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY OPINION OR INFORMATION GIVEN OR MADE IN THIS PUBLICATION. This publica on is provided solely to subscribers and then solely in connec on with and in furtherance of the regulatory purposes and objec ves of the NAIC and state insurance regula on. Data or informa on discussed or shown may be confiden al and or proprietary. Further distribu on of this publica on by the recipient to anyone is strictly prohibited. Anyone desiring to become a subscriber should contact the Center for Insur-ance Policy and Research Department directly.
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