PRIL 2014 Inside this Issue · APRIL 2014 Eric Nordman CIPR Director 816-783-8232 [email protected] Kris DeFrain Director, Research & Actuarial 816-783-8229 [email protected] Shanique

April 2014 | CIPR Newsle er

APRIL 2014

Eric Nordman CIPR Director 816-783-8232

[email protected]

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


Anne Obersteadt Senior Researcher


NAIC Central Office Center for Insurance Policy and Research 1100 Walnut Street, Suite 1500 Kansas City, MO 64106-2197 Phone: 816-842-3600 Fax: 816-783-8175 h p://cipr.naic.org

Inside this Issue

Director’s Corner 2 TRIA Renewal: Why Are We Wai ng? 3 The tragic events of the Sept. 11, 2001 a acks have undeniably changed things. One of the major changes was how the insurance industry views the risk of loss from acts of terrorism. This ar cle explores the risk of loss from acts of terrorism and the collec ve response known as the Terrorism Risk Insurance Program. We will explore the debate surrounding the sunset and possible renewal of this program. A Closer Look at Con ngent Deferred Annuity Issues 6 The need for re rement income solu ons has come to the forefront as our aging popula on moves into re rement, people live longer, and pensions disappear. Con ngent deferred annu-i es (CDAs) emerged in 2008 as a way to solve the growing need for access to life me in-come, without the purchase of a tradi onal annuity. This ar cle explores how CDAs work and provides background regarding the concerns raised as insurance regulators evaluate the ade-quacy of the current regulatory framework to govern CDAs. The Rising Cost of Wildfires 11 The frequency, size and intensity of wildfires have increased significantly over the years. Many of the worst years for wildfires have been in the past decade. Acres burned, one way of measuring a wildfire season’s ferocity, has only surpassed 9 million three mes since 1960: in 2006, 2007 and 2012. Many factors are involved in crea ng condi ons that are primed for severe wildfires, such as climate and weather variability. This ar cle discusses some of these factors, as well as provides an overview of recent wildfire trends. Agricultural Act of 2014: Crop Insurance Highlights 15 Crop insurance is an important risk management tool available to farmers and ranchers to help protect them against declines in crop yields and/or revenue. The Agricultural Act of 2014 (the 2014 farm bill) makes major changes in commodity programs, adds new crop in-surance op ons and expands programs for specialty crops, organic farmers, bioenergy and rural development. While the 2014 farm bill affects much more than just farming, this ar cle focuses mostly on the impacts of the 2014 farm bill on crop insurance. Working Capital Finance Investments: A New Asset Class for Insurance Companies 17 The NAIC Securi es Valua on Office, along with several other NAIC groups, began evalua ng Working Capital Finance Investments (WCFI) as a poten al invested asset for the insurance industry in 2010. A er significant input from state departments of insurance, NAIC staff, industry representa ves, and other par cipants, WCFI were recently approved as an ad-mi ed asset for repor ng en es with an effec ve date of Jan. 1, 2014. The culmina on of all this hard work has resulted in new investment for insurance companies: WCFIs. Interna onal Regulatory Developments on Group Capital Standards 21 Since the recent financial crisis, the Financial Stability Board has advanced a major program of financial regulatory reforms to address the shortcomings in the financial system exposed by the crisis while striving to create globally consistent rules and a level playing field across countries and sectors. This ar cle will discuss the interna onal movement to iden fy globally interconnected financial en es with such poten al nega ve impact of their failure that they need enhanced capital requirements to make the world safer. NAIC Research and Actuarial Department: Data at a Glance 24

2 April 2014 | CIPR Newsle er

D ’ C

The staff at the Center for Insurance Policy and Research (CIPR) is pleased to provide the latest issue of the CIPR Newsle er. I hope you will find it enlightening and enjoya-ble. Inside this issue are some mely ar cles on a variety of topics. We start with an ar cle on the highly successful Terrorism Risk Insurance Program. Once again the program is subject to a sunset provision requiring congressional ac on to keep it going. The ar cle explores the successes and challenges of the program, as well as the “appe te” of the insurance in-dustry for voluntarily wri ng insurance coverage for acts of terrorism. With a sunset of Dec. 31, 2104, will the U.S. Con-gress act in me to avoid disrup ons in the marketplace? This ar cle will get you up to speed on the current debate. Time marches on. As the baby boomers age, they have be-come more focused on the need for adequate re rement income. People are living longer and predictable defined benefit pensions are nearing ex nc on. The baby boomers’ greatest risk today might be outliving re rement income. An ar cle by CIPR Senior Researcher Anne Obersteadt covers the emergence of con ngent deferred annui es (CDAs) as a way to solve the growing need for access to life me income. CDAs offer an alterna ve to the purchase of a fixed annuity or an equity-indexed annuity to provide an income stream. This ar cle explores how CDAs work and provides background regarding the concerns raised as insur-ance regulators evaluate the adequacy of the current regu-latory framework to govern CDAs. An ar cle by NAIC Research Analyst Jennifer Gardner looks at the devasta on caused by wildfires. All of us watching the news are aware that the frequency, size and intensity of wildfires have increased significantly in recent years. Data confirms our fears, showing many of the worst years for wildfires have been in the past decade. Acres burned, the U.S. Fire Administra on’s preferred way to measure a wild-fire season’s ferocity, has only surpassed 9 million three

mes since 1960: in 2006, 2007 and 2012. Many factors are involved in crea ng condi ons that are primed for severe wildfires, such as climate and weather variability. This ar -cle discusses some of these factors and provides an over-view of recent wildfire trends. Each year, Congress has to figure out how to support agri-cultural endeavors in the U.S. In short, it is an important part of federal policy to make sure Americans have enough food on the table. This year, the 2014 farm bill (formally known as the Agricultural Act of 2014) recognizes crop in-surance is an important risk-management tool. While the 2014 farm bill affects support of farmers generally, this ar -cle focuses on the impacts of the 2014 farm bill on crop

A D Eric Nordman, CPCU, CIE, is the director of the NAIC Regulatory Services Division and the CIPR. He directs the Regulatory Services Division staff in a wide range of insurance research, financial and market regulatory ac vi es, suppor ng NAIC commi ees, task forces and working groups. He has been with the NAIC for 22 years. Prior to his ap-

pointment as director of the Regulatory Services Division, Nord-man was director of the Research Division and, before that, the NAIC’s senior regulatory specialist. Before joining the NAIC, he was with the Michigan Insurance Bureau for 13 years. Nordman earned a bachelor’s degree in mathema cs from Michigan State University. He is a member of the CPCU Society and the Insur-ance Regulatory Examiners Society.

insurance. Authors Sara Juliff and Brooke Stringer provide facts and insight on recent changes. In an ever-changing regulatory environment, every now and then a new asset class appears. In 2010, the NAIC Securi es Valua on Office (SVO), along with several other NAIC groups, began evalua ng working capital finance investments (WCFIs) as a poten al invested asset for the insurance industry. A er significant input from insurance regulators and regulated en es, WCFIs were recently approved as admi ed assets for repor ng en es with an effec ve date of Jan. 1, 2014. An ar cle by Robert Carca-no, senior SVO counsel, describes this new investment opportunity for insurers. An ar cle by Josh Windsor and Lou Felice looks at interna-

onal regulatory developments related to group capital standards. In the ar cle, they discuss the interna onal movement to iden fy globally interconnected financial en es with such poten al nega ve impact of their failure that they need enhanced capital requirements to make the world safer. They describe the Common Framework for the Supervision of Interna onally Ac ve Insurance Groups (ComFrame) and the basic capital requirements under considera on by the Interna onal Associa on of Insurance Supervisors (IAIS). As always, we feature data at a glance. This quarter, we look at direct wri en premiums, market shares and pure loss ra os for the homeowners and private passenger auto lines of business. I hope you enjoy this issue of the CIPR Newsle er. Your comments and sugges ons for improve-ment are always welcome. Eric Nordman CIPR Director

April 2014 | CIPR Newsle er 3

TRIA R : W A W W ?

By Eric Nordman, Director of Regulatory Affairs and CIPR It is hard to believe it has been almost 13 years since our view of terrorism was forever changed by the tragic events of Sept. 11, 2001. For many Americans, the name Osama bin Laden s ll evokes a chill when spoken … but no more so than in the days and months following those deadly a acks. And, even though overwhelmed with shock and grief, Amer-icans went back to work and to their daily lives with a re-newed sense of purpose: to prove no terrorist could change our way of life. However, the 9/11 terrorist a acks have undeniably changed things. One of the major changes was how the insurance industry views the risk of loss from acts of terrorism. This ar cle explores the risk of loss from acts of terrorism and the collec ve response known as the Ter-rorism Risk Insurance Program (TRIP). We will explore the debate surrounding the sunset and possible renewal of this program. R TRIA E When the World Trade Center buildings collapsed, the in-surance industry’s perspec ve about the risk of loss from acts of terrorism changed drama cally. The industry real-ized a determined terrorist could cause substan al damage under the right circumstances. The defini on of “substan al damage” shi ed from millions of dollars to billions of dol-lars. The natural ini al reac on of the industry is always predictable. They move to limit their exposure to the latest threatening event. They do so by raising prices, limi ng cov-erage and cancelling those with the greatest exposure. This phenomenon is not limited to acts of terrorism; natural disasters invoke the same response. Generally insurers re-turn to the market a er the ini al shock has passed. What is different for acts of terrorism is that insurers’ willingness to write the coverage has never returned. The federal Terrorism Risk Insurance Act (TRIA) was ini ally established as a temporary (three-year) program where the U.S. government agreed to share the risk of loss from acts of terrorism with the insurance industry. TRIA was renewed for two years in 2005 and again for seven years in 2007—with the con nuing understanding the program was a tem-porary solu on. In the interim, it has become clear there is nothing temporary about the insurance industry’s unwilling-ness to write substan al amounts of coverage for acts of terrorism. State insurance regulators have not seen evi-dence to suggest the insurance marketplace is capable or willing to voluntarily take on a substan al por on of the risk of providing terrorism risk coverage. Improvements have been made to computer simula on modeling; however, es ma ng the risk of loss from acts of

terrorism remains uncertain. Yet, neither frequency nor severity can be predicted with any level of certainty. As a result, insurers would likely choose to avoid providing cov-erage for acts of terrorism if given the opportunity. If TRIA expires, regulators expect some insurers to place limita ons on commercial insurance policies to exclude terrorism cov-erage or choose to withdraw from the market completely. Currently, TRIA is the en cement to encourage the insurers to venture where they otherwise would not be inclined to go. TRIA provides insurers with a cap on the severity of ex-posures. With limita ons in place, insurers can more rea-sonably assign a price to coverage that will not threaten their solvency and will place them in a be er posi on to make such coverage available to American businesses. In the macroeconomic sense, it is the availability of affordable insurance coverage that allows American businesses to suc-ceed. Without insurance, economic development stops. While coverage for acts of terrorism is only a subset of all the insurance coverage American businesses need to pros-per, it is an important component. Unfortunately, there is no empirical measure of availability and affordability because they are both subjec ve measures. One could argue coverage for every peril is avail-able to anyone if they are willing to pay any price. However, as a prac cal ma er, if businesses perceive coverage for acts of terrorism is too expensive for the risk of loss pre-sented, they will choose not to buy the coverage. Further, if insurers perceive not enough is known about the frequency or severity of losses caused by acts of terrorism, they will choose not to make the coverage available, unless either the state or federal government forces them to do so. If TRIA is not reauthorized, the absence of a federal backstop could lead insurers to choose to withdraw from the market completely. Insurance regulators generally agree termina on of TRIA would result in an availability crisis, as insurers would not voluntarily offer coverage for acts of terrorism to most U.S. businesses. Evidence for this comes from the fact the insur-ance industry has filed condi onal exclusions. It is possible a limited market for terrorism coverage would develop; how-ever, regulators expect the cost would be high and the cov-erage very limited in scope. Terrorists are mo vated to inflict maximum loss in the most visible way possible. As a result, there is no limit to the magnitude of property or casualty loss. Major U.S. ci es such as Boston, Chicago, Houston, Los Angeles, Miami, New York, San Francisco and Washington, D.C., are the most

(Continued on page 4)


TRIA R : W A W W ? (C )

a rac ve targets for terrorists. This leads to adverse selec-on, as the strongest demand for terrorism insurance origi-

nates from businesses in these geographic areas. If TRIA is not extended, state insurance regulators believe terrorism insurance will become less available and affordable in the areas where there is the greatest demand for coverage. State insurance regulators also believe the elimina on of the program would nega vely impact the availability of in-surance in mid-size ci es and some types of commercial enterprises, as well. Workers’ compensa on presents special issues because terrorism cannot be excluded from individual workers’ compensa on policies. An expira on of TRIA would be es-pecially disrup ve to the workers’ compensa on market. It is likely the size of residual markets would grow. In par cu-lar, businesses with large numbers of employees concen-trated in a single loca on would be vulnerable, as would businesses located near iconic buildings perceived to be a rac ve targets for terrorists. W M H ? There are some things we know about terrorism and terror-ists, but many things we do not. We know the threat of ter-rorism remains, and is, a concern for the U.S. economy. We do not know when the next terrorist will strike or what tar-get will be selected. We do not know the extent of damage the terrorist will inflict or the number of lives that will be lost. We know terrorists are planning their next a ack and communica ng with fellow terrorist about their plans. We rely on our government to be vigilant in thwar ng these terrorist plots and protec ng Americans from harm—both physical and economic. In fact, some have suggested a suc-cessful terrorist a ack proves the government failed in its duty to protect its ci zens. Insurers are disinclined to provide all of the coverage for acts of terrorism demanded by American businesses with-out “encouragement” from the government. The current encouragement comes in the form of the TRIP. Arguably, the program might be one of the most efficient and least costly federal programs in place today. Ini ally, a small staff for the TRIP office was housed in the U.S. Department of the Treasury. The staff worked on publishing regula ons and other guidance. They also frequently communicated with state insurance regulators to seek guidance and collab-ora on on how the program should be structured and what regula ons might work best for all par es. When the federal Dodd-Frank Consumer Protec on and Wall Street Reform Act of 2010 was adopted, the TRIP staff were transferred to the Federal Insurance Office. For the

price of some office space and a few federal employees, the TRIP provides comfort and certainty to insurers, provides affordable and available insurance to American businesses covering the risk of loss from acts of terrorism, and encour-ages sound economic development. It is a sound use of pub-lic funds, as it has a reimbursement mechanism so if funds are expended, most will be recouped by a policyholder sur-charge in the following year(s). So, what would happen if TRIA is not reauthorized? Some opponents say TRIA is costly and temporary. They say clos-ing it now would save the country money and allow the funds saved to help reduce the federal deficit. They main-tain TRIP gets in the way of the private markets, crowding out the insurers and reinsurers clamoring to write the busi-ness. That is the alterna ve view … if the opponents are right. If, however, the opponents are wrong, this could be their alterna ve reality: Insurers will lose the incen ve to write coverage for terrorism risk when TRIA sunsets. Simply put, insurers are not willing to jeopardize their finan-cial health by accep ng the poten al unlimited severity and unpredictable frequency terrorist a acks present. This would lead to many businesses not having proper terrorism risk coverage, leaving them vulnerable to acts of terrorism. In the absence of TRIA reauthoriza on, many businesses would not be able to get proper coverage. During past debates over the reauthoriza on of TRIA, regu-lators reported receiving numerous inquiries from policy-holders about not being able to obtain construc on loans from banks. A slowdown in lending would have a chilling impact on the economy, because mortgage lending and the securi za on of mortgage loans provide a significant por-

on of the gross domes c product (GDP). One ra ng agen-cy has said it may decline to rate commercial mortgage-backed securi es on transac ons lacking sufficient terror-ism insurance. The result is extreme price increases, loss of coverage for most businesses, difficulty in obtaining workers’ compensa-

on coverage for employers with large numbers of employ-ees is a single loca on and a general drag on economic de-velopment, par cularly in high-profile urban centers. Banks will not lend when terrorism insurance coverage is unavaila-ble or unaffordable. If banks will not lend, builders will not build. When building stops, the economy slows down. The result is a recession at a me when the U.S. economy is just beginning to show signs of a solid recovery. When the econ-omy declines, tax revenues go down, adding to the deficit rather than reducing it.



TRIA R : W A W W ? (C )

A worst-case scenario would include a major terrorist event striking an area with li le or no insurance coverage. There would be incredible pressure for the U.S. president to de-clare the event a federal disaster. Then the Treasury would be called upon to provide funds to rebuild the damaged area. Without TRIA, the federal government would be with-out the claims paying facili es of the insurers they currently enjoy with TRIA in place. Further, the funding would be en-

rely at taxpayer expense, as there would be no recoup-ment as there is today. S Knowing all we know about terrorism risk and the provision of terrorism insurance coverage, how can we risk allowing TRIA to sunset? It seems obvious the economy, businesses and the taxpayers are all be er off with TRIP in place. So, what are we wai ng for? Let’s renew TRIP and keep the economy running smoothly.

A A Eric Nordman, CPCU, CIE, is the director of the NAIC Regulatory Services Division and the CIPR. He directs the Regulatory Services Division staff in a wide range of insurance research, financial and market regulatory ac vi es, suppor ng NAIC commi ees, task forces and working groups. He has been with the NAIC for 22 years. Prior to his ap-

pointment as director of the Regulatory Services Division, Nord-man was director of the Research Division and, before that, the NAIC’s senior regulatory specialist. Before joining the NAIC, he was with the Michigan Insurance Bureau for 13 years. Nordman earned a bachelor’s degree in mathema cs from Michigan State University. He is a member of the CPCU Society and the Insur-ance Regulatory Examiners Society.

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CIPR E :

Issues with Ride-Sharing and Car-Sharing Arrangements

August 2014 During the NAIC Summer Na onal Mee ng in Louisville, KY

Please visit the CIPR Events Page for the latest informa on: www.naic.org/cipr_events.htm


A C L C D A I

By Anne Obersteadt, CIPR Senior Researcher The need for re rement income solu ons has come to the forefront as our aging popula on moves into re rement, people live longer, and pensions disappear. Con ngent de-ferred annui es (CDAs) emerged in 2008 as a way to solve the growing need for access to life me income, without the purchase of a tradi onal annuity. CDAs are a type of prod-uct designed to protect against this longevity risk. They are o en marketed to advisors of mutual funds, separately managed accounts and fee-based brokerage products. However, sales of the product remain limited, due in part to regulatory uncertain es inherent with an emerging prod-uct. This ar cle explores how CDAs work and provides back-ground regarding the concerns raised as insurance regula-tors evaluate the adequacy of the current regulatory frame-work to govern CDAs. W CDA? This product allows the policyholder to retain ownership of their re rement assets—typically mutual funds or man-aged accounts. This is an important feature, as loss of con-trol of re rement assets is one of the o en-cited reasons investors do not purchase annui es.1 Instead, CDAs seek to provide a stand-alone benefit similar to those of a guaran-teed life me withdrawal benefit (GLWB). As long as inves-tors, as CDA policyholders, meet guidelines for permi ed asset classes and investment types established by the in-surer, a predetermined income stream is guaranteed if covered assets are exhausted during the life of the contract holder through allowable withdrawals and/or poor invest-ment performance. A CDA has three dis nct phases: the accumula on phase, the withdrawal phase and the se lement phase. During the accumula on phase, the CDA annual guaranteed life me income payment is determined based on a percentage of the total assets in the separately managed account. The benefit amount can increase or decrease with the value of the assets un l it is set, and then it can never be reduced due to poor market performance. The CDA moves to the withdrawal phase when the policyholder begins to draw funds from the covered assets. Benefit amounts are re-duced if the policyholder exceeds withdrawal limits set in the contract. The final phase, the se lement phase, begins when the account is exhausted and the policyholder begins receiving life me periodic benefit payments.2 C R F Insurance regulators are reviewing the adequacy of the cur-rent regulatory framework to ensure clear guidelines exist

for the applica on of CDAs. Specifically, regulators are work-ing toward iden fying and addressing concerns surrounding supervisory authority, solvency, consumer protec on, re-serving and capital requirements. Through the NAIC’s vari-ous commi ees and working groups, insurance regulators are discussing the need for poten al modifica ons to mod-els related to annuity disclosure, suitability, producer licens-ing, and adver sing. The applicability of the following items is also being as-sessed: Actuarial Guideline XLIII—CARVM for Variable Annu-i es (AG 43); the Standard Nonforfeiture Law for Individual Deferred Annui es (#805) and the Synthe c Guaranteed Investment Contracts Model Regula on (#695). Addi onally, Na onal Organiza on of Life and Health Guaranty Associa-

ons (NOLGA) has determined CDA policyholders would be covered under the model guaranty fund law, should the insurer become insolvent. However, the par culars of guar-anty fund coverage have not been determined. Ul mately, the applica on of the state guaranty funds is governed by each state’s law. P C Ini ally, there existed much confusion on how to classify a CDA. Regulators reported receiving product filings for CDAs as variable annui es, fixed annui es, equity indexed annui-

es and financial guaranty insurance. This variance in filings type reflects, in part, the unique and complex nature of CDAs. Some states and insurers view CDAs as financial guar-anty insurance providing asset preserva on, because a CDA essen ally “wraps around” an external investment account. Others believe CDAs to be various types of annui es, given their exposure to longevity and market risk. For example, in the accumula on and withdrawal phases, CDAs face market risk much the way variable annui es do. In the se lement phase, payments under CDAs share the same characteris cs as fixed annui es. As a first step, the NAIC established a defini on of and a product classifica on for CDAs. In March 2012, the Life In-surance and Annui es (A) Commi ee resolved CDAs are annui es and should be sold by life insurers. Furthermore, the Commi ee found these products were subject to state-based insurance regula on. Acknowledging the shared char-acteris cs, in February 2013, the Commi ee established


1 Beshears John, James Choi, David Laibson, Brigi e Madrian, and Stephen Zeldes. 2012. “What Makes Annui za on More Appealing?” Na onal Bureau of Economic Research (NBER) Working Paper No. 18575. 2 NAIC Life Insurance and Annui es (A) Commi ee. 2013. Memorandum to the NAIC Life Insurance and Annui es (A) Commi ee regarding Con ngent Deferred Annuity (A) Working Group Findings [Commi ee Document].


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CDAs should be filed as dis nct CDA products, and not un-der other annuity classifica ons. R A As stated previously, the NAIC established in 2012 that CDAs are subject to regulatory oversight by state insurance regulators. Addi onally, because a CDA derives its value from an underlying registered security, they are registered with the U.S. Securi es and Exchange Commission (SEC), with the excep on of Employee Re rement Income Security Act (ERISA) covered plans. This means CDAs are subject to SEC disclosure requirements. Addi onally, insurance pro-ducers, brokers, and investment advisors selling CDAs need to be licensed by the Financial Industry Regulatory Authori-ty (FINRA) and comply with its suitability and fiduciary re-quirements. Given these determina ons, the NAIC is now looking into amending its Producer Licensing Model Act (#218) to clarify producers selling CDAs registered with the SEC must be dually licensed.3 C P Suitability and Disclosure Standards CDAs may not be suitable for all consumers and consumer advocates have expressed concern they are a poor value to consumers, who may pay annuity fees over an extended period of years and never receive a benefit. Because CDAs pay out only when the investment account is exhausted, the likelihood of a CDA reaching the payout phase is correlated to the aggressiveness of a policyholder’s investment strate-gy. Consumer advocates stress conserva vely invested con-sumers may not be suitable for CDAs, as the probability of receiving a benefit is low. The converse would also be true. Similarly, investment fund restric ons within CDA contracts could minimize consumer benefits to an unfavorable level. For this reason, consumer advocates stress the need for suitability requirements to address CDA pricing transparen-cy, benefit expecta ons and the prohibi on of producer compensa on favoring the sale of subop mal CDAs. Specifi-cally, producers should provide informa on, such as the expected benefit ra o of CDAs and appropriate marke ng demographics, to poten al policyholders to reduce the pos-sibility of being steered into subop mal investments.4 Proponents of CDAs point out the product design allows investors to maintain ownership of their assets and secure guaranteed income protec on. Addi onally, because CDAs isolate coverage to guaranteed income protec on, and do not provide a death benefit, they can be priced compe -

vely against variable annui es with GLWB riders, which

offer both. They contend limi ng product design would raise product costs, thereby limi ng sales. Furthermore, they maintain exis ng laws and regula ons under the SEC, FINRA and state insurance departments provide sufficient suitabil-ity protec ons and disclosure requirements. This includes disclosure requirements, such as providing a prospectus, and complying with FINRA adver sing and marke ng rules. Addi onal concerns were raised in a 2012 U.S. General Ac-coun ng Office (GAO) report, which found CDAs are complex products requiring policyholders to navigate many suitability and withdrawal considera ons best done in conjunc on with a professional advisor. The GAO indicated producers need to be adequately trained to provide appropriate advice when selling these complex products.5 Insurance regulators and consumer advocates acknowledged the need to ensure pro-ducers receive sufficient training to appropriately advise poli-cyholders on the risks and advantages of CDAs. While CDAs share many of the same risks and characteris cs as variable annui es with living benefit riders, they also have unique features requiring product specific training. In 2013, the Life Insurance and Annui es (A) Commi ee charged the Con ngent Deferred Annuity (A) Working Group with reviewing, among other things, the applicability of CDAs to the NAIC models related to suitability, disclosure and adver sing. In April 2013, the Working Group released dra revisions to the suitability, disclosure and adver sing models and asked for comment by the end of April. Included were dra revisions to the Suitability in Annuity Transac-

ons Model Regula on (#275) to specifically reference the product and to make clear producer training requirements include CDAs. Also included were dra revisions to the An-nuity Disclosure Model Regula on (#245), specifically ex-emp ng CDAs, as the SEC prospectus preempts all other state disclosures. Similarly, dra revisions to the Adver se-ments of Life Insurance and Annui es Model Regula on (#570) specifically referenced CDAs in the model to avoid conflict with FINRA adver sing and marke ng rules.6


3 NAIC Life Insurance and Annui es (A) Commi ee. 2013. Memorandum to the NAIC Life Insurance and Annui es (A) Commi ee regarding Con ngent Deferred Annuity (A) Working Group Findings [Commi ee Document]. 4 NAIC Life Insurance and Annui es (A) Commi ee. 2013. March 7, 2013, Comment Le er from Center for Economic Jus ce to the Con ngent Deferred Annuity (A) Work-ing Group [Commi ee Document]. 5 U.S. Government Accountability Office, “Re rement Security: Annui es with Guar-anteed Life me Withdrawals have Both Benefits and Risks, but Regula on Varies Across States,” GAO-13-75, December 2012. 6 AIC Life Insurance and Annui es (A) Commi ee. 2013. Con ngent Deferred Annuity (A) Working Group Recommenda ons [Commi ee Document].


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Coverage Under Guaranty Fund Associa ons Should a CDA insurer fail, there is uncertainty about the existence and scope of guaranty fund coverage of CDAs. It is unclear whether there would be coverage of a CDA s ll in the accumula on stage, for example. Furthermore, assets kept on insurers books for CDAs are limited to mainly mor-tality reserves and fees, because the invested assets are separately managed. For this reason, consumer advocates urge the impact of a failed CDA insurer on guaranty assess-ments and taxes be be er understood.7 NOLHGA has indicated coverage would be determined on a state-by-state basis, but it appears the product is covered under the Life and Health Insurance Guaranty Associa on Model Act (#520). NOLGA also stated coverage would be subject to certain limita ons and exclusions, such as pay-ment being limited to the se lement phase, but a final de-termina on is dependent on the outcome of their mul -year review process. Separately, the Receivership and Insol-vency (E) Task Force is reviewing if defini onal changes to Model #521 are needed to cover CDA products.8 F S Managing Risks Product design, hedging effec veness and pricing are key components in mi ga ng the risks insurers issuing CDAs face. At its core, CDAs are designed to protect against lon-gevity risk. Longevity risk is the risk policyholders will live longer than expected and thus outlive their assets. Insur-ers reduce their exposure to longevity risk by controlling the benefit levels, as well as the issuance and commence-ment ages defined within the product contract. Addi on-ally, insurers offset their longevity risk by diversifying their product mix. Insurers also rely heavily on hedging programs to offset longevity risk. Both CDAs and variable annuity riders are funded through fee income. However, with CDAs, insurers do not have the added advantage of relying on secondary support from revenue collected in conjunc on with the underlying annuity. As a result, insurers that issue CDAs have a heighted need to ensure hedge effec veness. Insurers are also exposed to market risk stemming from the link between CDA benefits and the value of the cov-ered assets. That is, benefits fluctuate with the fund per-formance of the separately managed accounts. Managing market risk through investment and alloca on restric ons is par cularly important, given covered assets are held in

accounts external to the insurers. The poten al for third-party advisors to deviate from investment guidelines pre-sents opera onal risk to the insurer. For this reason, insur-ers must con nually track investment ac vi es related to the CDA.9 Insurers also make sure CDA policyholders are no fied when their investments have deviated such that the CDA is at risk. The CDA policyholder is also made aware of other Investment op ons to which they can switch to preserve the CDA. The fee structure on CDAs has also been iden fied as a po-ten al for solvency risk exposure. Because coverage under CDAs is limited to stand-alone income guarantees and the products have no surrender value, insurers charge much lower fees on CDAs than variable annui es with GLWBs. Although the compara vely low fee structure of CDAs serves as an incen ve for poten al policyholders, they add li le to an insurer’s capital. CDA fees predominately cover hedging and administra ve expenses, with only a small amount contribu ng to capital. Consumer advocates have raised a concern hedging alone may not be sufficient to protect against a down market and the asset-based fee income will not provide enough of a buffer to ensure capital adequacy during mes of extreme market vola lity. This solvency risk would be par cularly per nent if a market event triggered numerous CDAs in the same meframe—a risk which could be either exasperated or mi gated by the weigh ng of CDAs within an insurers’ book of business. What’s more, given the long-tailed nature of this product, there is the fear any deficiency in pricing, reserving and capital would not become evident un l the payout phase. CDAs are also exposed to policyholder behavior risk. CDA benefits begin only once the investment account has been depleted. Thus, policyholders have an incen ve to maximize their benefits with aggressive investments. (However, it should also be acknowledged aggressive investment strate-gies could also produce more investment income, thus po-ten ally decreasing the likelihood of deple on.) Insurers can


7 NAIC Life Insurance and Annui es (A) Commi ee. 2012. Oct. 8, 2012 Comment Le er from Center for Economic Jus ce to the Con ngent Deferred Annuity Working Group [Commi ee Document]. 8 NAIC Life Insurance and Annui es (A) Commi ee. 2013. Con ngent Deferred Annui-ty (A) Working Group Recommenda ons [Commi ee Document]. 9 NAIC Life Insurance and Annui es (A) Commi ee. 2012. June 27, 2012, American Council of Life Insurers Presenta on to the Con ngent Deferred Annuity (A) Working Group [Commi ee Document], Retrieved April 5, 2014 from www.naic.org/documents/commi ees_a_con ngent_deferred_annuity_wg_120627_cda_pres.pdf.


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protect against this moral risk by limi ng aggressive fund choices within the contract. However, consumer advocates warn adding investment restric ons well into the policy term unfairly decreases the value of the CDA.10 Fund balances can also be depleted faster if policyholders are allowed to withdraw excessive amounts, resul ng in a sooner than an cipated payout period. Therefore, regula-tors are concerned insurers issuing CDAs set effec ve with-drawal rates within their policy designs. Addi onally, regu-lators are concerned with insurers’ abili es to effec vely manage lapse rates.11 For all of these reasons, the American Academy of Actuaries has stressed CDAs require compre-hensive risk management prac ces by insurers, and careful oversight of these prac ces by regulators.12 Capital and Reserves Most industry representa ves and the American Academy of Actuaries believe the appropriate methodology for re-serving requirements and risk-based capital (RBC) for CDAs is within AG 43 and RBC C-3 Phase II (C3P2).13 Both AG 43 and C3P2 apply to variable annui es with GLWBs, of which GLWBs are substan ally similar to CDAs. Most per nent to CDAs is the principle-based stochas c component within AG 43, which specifically addresses market risks, such as inter-est rates and equity movements, inherent with CDAs. AG 43 also includes a standard scenario, which establishes a floor incorpora ng prescribed assump ons on mortality, policy-holder behavior and investment returns.14 Insurers would also model CDA-covered assets similarly to variable annui-

es with separate accounts. Under both AG 43 and C3P2, credits are given for a “clearly defined hedging strategy.” The Life Actuarial (A) Task Force has a charge to evaluate AG 43 to determine whether the reserve guidance, as it applies for variable annuity guarantees, would be deficient when applied to CDAs. The Task Force will recommend changes, as appropriate, to address any deficiencies and determine whether clarifying guidance would be useful due to different nomenclature than variable annui es with guarantees. The Life Risk Based Capital (E) Working Group has a charge to develop guidance, for inclusion in the proposed NAIC CDA guidelines, for states as to how current regula ons governing RBC requirements, including C3P2, should be applied to CDAs. The Working Group will recommend a process for reviewing capital adequacy for insurers issuing CDAs and prepare clarifying guidance, if necessary, due to different nomenclature then used with regard to CDAs. The

development of this guidance does not preclude the Work-ing Group from reviewing CDAs as part of any ongoing or future charges, where applicable, and is made with the un-derstanding this guidance could change as a result of such a review. The Life Actuarial (A) Task Force is also charged with consid-ering revisions to Model #805 to exclude CDAs from the scope of the model. The model already exempts guarantees related to payouts of underlying investments in variable annui es. Since these guarantees are substan ally similar to those of CDAs, excluding CDAs from this law also seems ap-propriate. The decision to exclude CDAs from the model also reflects that CDA fees represent risk charges for longevity con ngency risk and do not include amounts to fund an accumula on of benefits for payout. However, not everyone agrees. Some consumer advocates believe CDAs should have a surrender value, as a life con ngency calcula on is included in their reserves. At the very least, these consumer advocates believe CDAs should not be excluded from the model un l an alterna ve method for determining a nonfor-feiture benefit for CDAs has been developed. T F State insurance regulators are working to establish a regu-latory framework which provides clear guidelines for super-visory authority and the applica on of regula ons to en-sure insurer solvency and consumer protec on. Insurance regulators, working through the NAIC, achieved great pro-gress in 2013 by establishing CDAs as an annuity product best sold by life insurance companies. In 2014, insurance regulators will con nue working through the various per -nent NAIC groups to evaluate and enhance, where appro-priate, the adequacy of exis ng laws and regula ons appli-cable to CDAs.


10 NAIC Life Insurance and Annui es (A) Commi ee. 2013. Aug. 20, 2013, Comment Le er from Center for Economic Jus ce to the Con ngent Deferred Annuity (A) Work-ing Group [Commi ee Document]. 11 NAIC Life Insurance and Annui es (A) Commi ee. 2012. American Academies of Actuaries Presenta on to the Con ngent Deferred Annuity (A) Working Group [Commi ee Document], Retrieved April 5, 2014 from www.naic.org/documents/commi ees_a_con ngent_deferred_annuity_wg_120627_academy_cda_pres.pdf. 12 NAIC Life Insurance and Annui es (A) Commi ee. 2013. Con ngent Deferred Annuity (A) Working Group Recommenda ons [Commi ee Document]. 13 NAIC Life Insurance and Annui es (A) Commi ee. 2012. Dec. 21,2012, Report from the American Academy of Actuaries to the Con ngent Deferred Annuity (A) Working Group [Commi ee Document], Retrieved April 5, 2014 from www.actuary.org/files/CDA_Reserve_and_Capital_Memo_12-21-12.pdf. 14 NAIC Life Insurance and Annui es (A) Commi ee. 2012. June 27, 2012, American Council of Life Insurers Presenta on to the Con ngent Deferred Annuity (A) Working Group [Commi ee Document], Retrieved April 5, 2014 from www.naic.org/documents/commi ees_a_con ngent_deferred_annuity_wg_120627_cda_pres.pdf.


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Specifically, insurance regulators will be examining model regula ons related to annuity disclosure, suitability, adver-

sements, replacements and non-forfeiture benefits for pos-sible modifica on. Addi onally, actuarial guidelines and RBC standards will be clarified to allow for clearer interpreta on by insurers. Furthermore, addi ons to the NAIC Life Financial Repor ng Blank and the development of tools to assist the states in the review of CDA product filings will be considered. It remains to be seen if CDAs will become prevalent prod-ucts within the re rement income marketplace. Product distribu on has been slow, with only five insurers repor ng an account value of $46.6 million for covered contracts at financial year-end 2013.15 Once the regulatory framework is established, insurers will need to illustrate the product’s value to advisors and their clients. Pairing a CDA with a non-qualified account does not offer the same tax-deferred sta-tus afforded to variable annui es. For this reason, insurers issuing CDAs may find qualified employer-sponsored plans, which offer preferen al tax treatment, a stronger distribu-

on channel. Addi onally, insurers will need to balance keeping fees, which drag down investment returns, at a rac ve levels, while also collec ng enough to provide a rac ve benefits. Similarly, insurers must manage third-party risks while also allowing advisors to accomplish desired investment strate-gies. Finally, regulators must ensure insurers issuing CDAs

can honor their long-term obliga ons by monitoring their use of appropriate risk control mechanisms, suitable prod-uct design, appropriate actuarial assump ons, and hedge effec veness.

A A

Anne Obersteadt is a researcher with the NAIC’s Center for Insurance Policy and Research (CIPR). She has more than 13 years of experience with the NAIC per-forming financial, sta s cal and research analysis on all insurance sectors. In her current role, she has authored several ar cles for the CIPR Newsle er, a CIPR

Study on the State of the Life Insurance Industry, organized forums on insurance related issues, and provided support for NAIC working groups. Before joining CIPR, she worked in other NAIC Departments where she published sta s cal reports, pro-vided insurance guidance and sta s cal data for external par-

es, analyzed insurer financial filings for solvency issues, and authored commentaries on the financial performance of the life and property/casualty insurance sectors. Prior to the NAIC, she worked as a commercial loan officer at U.S. Bank. Ms. Ober-steadt has a bachelor’s degree in business administra on and an MBA in finance.

15 Aggregate amount reported in Exhibit 5 of the 2013 NAIC Life Annual Financial Statement.


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Figure 1 shows the insured and overall losses for the 10-year period, 2003 through 2013. A er a near-record wildfire season in 2012, insured losses due to wildfire decreased to $385 million in 2013. In the year 2013, less than 50,000 fires were reported and 4.3 million acres burned, according to the Na onal Interagency Fire Center. This reduc on could be due, in part, to increased wildfires elimina ng the under-growth in prior years. These figures include the Yarnell Hill Fire in Arizona, which occurred in June 2013. The Yarnell Hill Fire was of major significance due to the death of 19 mem-bers of the Granite Mountain Hotshot crew. The fire burned 8,400 acres and damaged or destroyed 129 homes. While all 50 states have incurred wildfire damage at some point in the past 10 years, wildfires are most common in the Western states, where dry condi ons, strong winds and extreme heat fuels fire and increases the number of acres burned. The West has seen a drama c increase in the number and size of wildfires burning each year. Wildfires in the West are burning about six mes more acres each year, on average, than in the early 1970s, according to Climate Central’s 2012 report on western wildfire trends. The re-port also revealed there are at least seven mes as many 10,000-acres wildfires burning each year, on average, as there were 40 years ago. F F The past has seen more severe fires seasons with high num-bers of acreage burned. Opinions differ on the precise rea-


By Jennifer Gardner, NAIC Research Analyst II I The frequency, size and intensity of wildfires have increased significantly over the years. Many of the worst years for wildfires have been in the past decade. Acres burned, one way of measuring a wildfire season’s ferocity, has only sur-passed 9 million three mes since 1960: in 2006, 2007 and 2012. A recent U.S. Department of Agriculture (USDA) re-port predicts the acreage burned by wildfires will double by 2050 to about 20 million acres annually. Many factors are involved in crea ng condi ons that are primed for severe wildfires, such as climate and weather variability. This ar -cle discusses some of these factors, as well as provides an overview of recent wildfire trends. E W R According to the Insurance Informa on Ins tute, the year 2012 was one of the costliest and most destruc ve wildfire seasons in U.S. history, with more than $1 billion in total economic losses, $595 million in insured losses and 9.3 mil-lion acres burned. Clima c condi ons were ideal for wildfire outbreak in 2012 with high temperatures, widespread drought, early snowmelt and spring growth. A er an abnor-mally warm and dry 2011/2012 winter, the first six months of 2012 were the driest since records began in 1895, fol-lowed by the ho est July since 1895, crea ng the ideal cli-mate for extreme risk of wildfire. Wildfires are cyclical and follow the weather pa erns. Heat and drought are precur-sors to wildfire, while abundant rainfall and cooler tempera-tures result in fewer fires. However, cool wet condi ons contribute to vegeta ve growth, which can later contribute to wildfires. Four historically significant wildfires occurred in 2012. The largest wildfire in New Mexico, the Whitewater-Baldy Com-plex, burned 297,845 acres in May. In June, the White Draw Fire in South Dakota burned 9,000 acres and four crew-members were killed in a C-130 air tanker crash. In early June, the High Park Fire in Colorado occurred, which de-stroyed 259 homes and burned more than 87,000 acres. Less than two weeks later, the Waldo Canyon Fire in Colora-do burned 18,947 acres and destroyed 346 homes. The Waldo Canyon Fire resulted in 6,648 insurance claims and amounted to $453.7 million in es mated losses. The total losses, including uninsured losses due to the Waldo Canyon Fire, are es mated to be around $900 million. The largest wildfire in 2012 was the Long Draw Fire, which occurred in July in Oregon and burned 557,628 acres. It was Oregon’s largest fire on record in almost 150 years.

$1,113

$620$595

$385

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Overall losses Insured losses

F 1: W L U S (2012, $ )*

* Adjusted for infla on. Source: Munich Re/NatCatSERVICE.


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sons for the recent increase; however, experts tend to agree climate and weather variability, human development near tradi onally fire-prone ecosystems, and state and fed-eral policies on fire preven on have contributed to the rise in extreme wildfires. Clima c changes are likely influencing recent wildfire trends. Wildfire seasons are star ng earlier, due to warmer spring temperatures and earlier snow melt, and they are las ng longer into the fall.1 According to Forest Service Chief Tom Tidwell in tes mony before the U.S. Senate Commi ee on Energy and Natural Resources in June 2013, the West’s fire season is now two months longer, on average, than it was in the early 1970s.2 Years with warmer spring temperatures and reduced spring snowpack tend to be the years with the most wildfires, according to Climate Central’s 2012 Report. Wildfires can also be man-made. While some wildfires oc-cur naturally without human interven on, such as those a ributable to lightning strike, wildfires are o en caused by humans either inten onally or uninten onally. These fires mostly occur during the summer months when the weather is hot, dry and windy. Unlike other catastrophes, wildfires can be circumvented by early fire suppression. Emergency response personnel can mi gate losses by ex nguishing or containing fires early. Man-made fires are o en caught ear-lier and, therefore, losses are not as high as natural fires. This is most likely due to the fact man-made fires are start-ed closer to habitable areas and are, therefore, detected much earlier.

However, this prac ce of early fire suppression robs the land of the cyclical process to clear away the undergrowth and can result in rapidly spreading fires and intense heat. In these cases, burn pa erns can be unpredictable and fires can spread rapidly. According to the Na onal Interagency Fire Center, the Las Conchas Fire in 2011 in New Mexico at one point was es mated to be burning an area the size of a football field every two seconds. The number of communi es being built in natural wildland areas, known as wildland-urban interface (WUI), could be contribu ng to rising wildfire losses. More people are mov-ing into the WUI to take advantage of the privacy, natural beauty and affordable living. Between 2000 and 2010, 10 million new homes were built in WUI areas in which resi-dences either border or are built on land prone to wildfires.3 The popula on shi has brought in new fire threats; as addi-

onal neighborhoods are built in rural areas, the poten al for incurred losses has grown. As the economy rebounds from recession, housing develop-ments are added to the landscape and home prices recover, the risk of losses due to wildfire is sure to increase. Urban


1 Norrington, Bill. “Climate Change Is Escala ng Wildfire Risk in the U.S.” UC Santa Barbara Geography. August 2013. 2 Wildland Fire Management. Statement Thomas Tidwell Chief, USDA Forest Service Before the commi ee on Energy and Natural Resources U.S. Senate. June 4, 2013. 3 “Insurers, Government Grapple with Costs of Growth in Wildland-Urban Interface.” Insurance Journal, August 15, 2013.

F 2: T M W P S (2013) By Household By Percentage

Rank State Households at high or

extreme risk from wildfires*

Rank State Percent of households at high or extreme risk from

wildfires

1 California 1,989,100 1 Idaho 24.10% 2 Texas 1,299,800 2 Colorado 16.9 3 Colorado 373,600 3 California 14.5 4 Washington 163,400 4 New Mexico 13.6 5 Idaho 160,800 5 Texas 13 6 Oregon 159,800 6 Utah 12.8 7 Arizona 159,100 7 Oregon 9.5 8 Utah 125,500 8 Washington 5.7 9 New Mexico 122,600 9 Arizona 5.6 10 Nevada 59,100 10 Nevada 5.1 * Number of households is based on data from the 2010 U.S. Census. Source: Verisk Insurance Solu ons—Underwri ng and Verisk Climate units of Verisk Analy cs.


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sprawl contributes to the increase in homes and commer-cial structures built in the WUI. Farmland in these areas is also at risk and crop losses can be substan al. The top 10 most wildfire-prone states by insured wildfire loss and by household is portrayed in Figure 2 on the previ-ous page. According to 2010 Census data, California has the highest number of residences at risk, with approximately 2 million; this accounts for 14.5% of the total residences in California. Texas has the second-highest number of houses at high risk of damage due to wildfire, with almost 1.3 mil-lion homes, or 13% of the total residences built in 2010. Colorado is third on the list with 373,600 houses at risk, or 16.9% of all residences built in the state. Residences are not the only exposure to loss due to wildfire. Commercial prop-erty could be at risk, which means business-interrup on losses may be incurred. Private and commercial automo-biles, infrastructure and crops are also at risk of loss. W M It is important to understand the level of risk and expo-sure to losses, not only for insureds and insurers but also for local urban planners, city officials, developers, inves-tors, lenders and emergency response teams. The loca on of homes and the corresponding degree of wildfire risk should be considered before new developments are under way, and measures should be taken to mi gate risks where possible. Wildfire risk data, including local charac-teris cs—such as climac c condi ons, makeup of the ter-rain, cyclical pa ern and scrub or undergrowth available to provide fuel for fire—can be used to understand loss exposures. Risk data can be used to support be er under-wri ng, mortgage lending and other financial services. Mi ga on ini a ves have been started in many areas where risk of wildfire is high. The Community Wildfire Protec on Plan (CWPP) is a collab-ora ve plan created by fire departments, state and local forestry staff, land managers, community leaders and the public. The CWPP assesses a given community’s wildfire risk and outlines ways to reduce or mi gate that risk. One risk-mi ga on technique is land management. Land-management techniques can be put to use by foresters, land managers and homeowners to create and maintain defensible areas around homes and businesses. The Fire Adapted Communi es (FAC) Mi ga on Assessment Team was created in response to losses from the Waldo Canyon Fire. The team included representa ves from the USDA For-est Service, the Insurance Ins tute for Business & Home Safety (IBHS), the Interna onal Associa on of Fire Chiefs, the Na onal Fire Protec on Associa on (NFPA) and The

Nature Conservancy. The FAC Coali on recommends using igni on-resistant construc on techniques through codes, ordinances and development reviews on structures built near the WUI. Insurers can work with property owners and landowners in and around areas at high risk of wildfire to reduce exposures. Moreover, protec ng property from wildfire damage re-quires preventa ve ac on well before the flames start. As displayed in Figure 3, in terms of acres burned and number of fires, 2012 was not the highest in the past 10 years. How-ever, the dollar amount of insured losses, as displayed on Figure 1, is higher in recent years. As noted earlier, more homes are being built in the WUI and property values are rising. Property insurance policies typically provide protec-

on against losses due to wildfires. ISO Homeowners 3 Spe-cial Form (HO-3) provides coverage for a house and its con-tents. There are several applicable coverages under HO-3 in case of wildfire damage or even loss of use due to forced evacua on. Coverage A provides coverage for a house and its contents, as well as any structures a ached to the premises, such as a garage or deck. Coverage B covers detached structures, such as fences, sheds or barns, but excludes any structure for which rental income is collected or that is used for busi-ness purposes. Personal property is covered under Cover-age C and includes not only property on the premises but also owned and stored elsewhere. Property loaned to a


F 3: W F S

Source: Na onal Interagency Fire Center.


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neighbor and destroyed in a fire would be covered under the neighbor’s policy. Coverage D covers loss of use, includ-ing rental and living expenses if the insured must vacate the premises due to unsafe living condi ons, as well as lost rental income for any income producing por on of the property. Coverage D also includes loss of use, even if the property is not damaged, in cases where civil authori es have prohibited the property owner from remaining in the residence. In case of loss of use due to civil authority, living expenses are covered for a maximum of two weeks. The Biggert-Waters Flood Insurance Reform Act, passed into law July 6, 2012, includes an exemp on for flooding prompted by wildfire. The law calls for changes to the Na-

onal Flood Insurance Program, including an update regard-ing exposures related to wildfire. The por on of the law related to wildfires was implemented in July 2012. Accord-ing to the Federal Emergency Management Agency (FEMA), the law created an excep on to the 30-day wai ng period for insurance coverage for private proper es affected by flooding from federal lands as a result of post-wildfire con-di ons. The excep on applies to homeowners who pur-chased flood insurance less than 30 days prior to flooding and within 60 days of the fire containment date. R C W S As wildfires have become more frequent in the West, the cost of figh ng wildfires has soared. It costs the federal gov-ernment about $1.4 billion a year to suppress wildfires, which is more than the U.S. Congress has budgeted. A re-cent report from Headwaters Economics noted federal wild-fire protec on and suppression costs averaged less than $1 billion a year in the 1990s but, since 2002, have averaged more than $3 billion annually. To make up the difference, the U.S. Department of the Interior (DOI), the USDA and the U.S. Forest Service have relied on transfers from other pro-grams to fund fire suppression. With the costs of wildfire suppression rising, Western state lawmakers have called on the federal government for addi-

onal help. President Obama recently announced plans to change the way the federal government pays to fight wild-fires. The president’s recent budget proposal asked the U.S.

Congress to pay the costs of figh ng extreme wildfires the same way it finances the federal response to other disas-ters, such as earthquakes, hurricanes and tornados. The president’s proposal includes a measure to allow the DOI and the USDSA to tap a special relief account when the costs of figh ng wildfires exceed their annual budgets. The fund-ing plan would be earmarked for the largest and most ex-pensive fires; i.e., the 1% of wildfires consuming 30% of the budget. C Wildfire-related losses have escalated in the past decade. According to the Na onal Research Council’s Board on At-mospheric Sciences and Climate’s 2010 report, large and long-dura on forest fires have increased fourfold over the past 30 years in the West. Several reasons have been noted for the increase in fire frequency and severity. The increas-ing number of homes and businesses built in the WUI, in addi on to an increase in property values, will con nue to exacerbate the issue. Mi ga on techniques have been iden-fied and implemented in many areas. The cost of these

techniques, as well as their effec veness in diminishing risk, will con nue to be monitored so total losses can be reduced in the future.

A A

Jennifer Gardner is a research analyst with the NAIC. Jennifer joined the organi-za on in 2011. She conducts economic and sta s cal research for the NAIC and its members. She is responsible for pub-lishing sta s cal and market share re-ports, provides support for numerous

NAIC working groups and assists the state insurance depart-ments in data collec on related to catastrophe. Jennifer earned a bachelor’s degree in business administra on with an emphasis in finance from the University of Missouri-Kansas City. Prior to joining the NAIC Research and Actuarial Depart-ment, Jennifer worked on the State Based Systems (SBS) prod-ucts and services within the NAIC.


A A 2014: C I H

By Sara Juliff, NAIC Sta s cal Analyst II and Brooke Stringer, NAIC Financial Policy and Legisla ve Advisor Crop insurance is an important risk management tool avail-able to agriculture producers’ including farmers and ranch-ers to help protect them against declines in crop yields and/or revenue. According to the Na onal Crop Insurance Ser-vices, in 2013 farmers spent roughly $4.5 billion to purchase more than 1.2 million crop insurance policies, protec ng 128 different kinds of crops.1 There are two types of crop insurance; the federally subsidized mul ple-peril crop insur-ance and state-regulated private crop insurance. The U.S. Department of Agriculture’s (USDA) Risk Manage-ment Agency (RMA) administers the subsidized mul ple-peril federal crop insurance program. The program is per-manently authorized by the Federal Crop Insurance Act; however, it is occasionally modified by Congress. Typically, every five years Congress passes a “farm bill,” that sets na-

onal agricultural policy. In 2012, the Food, Conserva on, and Energy Act of 2008 (the 2008 farm bill) expired and then was consequently extended for one year. A er long, careful delibera ons, a new farm bill has finally emerged. The U.S. House of Representa ves approved the Agricultur-al Act of 2014 (the 2014 farm bill) by a vote of 251-166 and the U.S. Senate by a vote of 68-32, and President Barack Obama signed the measure into law Feb. 7, 2014. The 2014 farm bill makes major changes in commodity pro-grams, adds new crop insurance op ons and expands pro-grams for specialty crops, organic farmers, bioenergy and rural development. While the 2014 farm bill affects much more than just farming, this ar cle focuses mostly on the impacts on crop insurance. For an overview of crop insur-ance, please see the ar cle Crop Insurance Takes Center Stage published in the January 2013 CIPR Newsle er2 and visit some of the websites provided at the end of the ar cle. C P One of the biggest changes in the 2014 farm bill is the com-modity tle of the law repeals direct payments, countercy-clical payments, and the Average Crop Revenue Elec on (ACRE) Program.3 Instead of receiving direct and countercy-clical payments, which were automa c and based on farm prices, acreage and yields, the role of crop insurance as pro-ducers’ safety net will expand. The federal government will con nue to subsidize a por on of producers’ crop insurance premiums. Beginning with the 2014 crop year, a producer will have the op on to choose between two new programs to augment their crop insurance policy: either the Price Loss

Coverage (PLC) program or the Agricultural Risk Coverage (ARC) program.4 These new programs, in addi on to their crop insurance policy, are designed to compensate farmers against losses or low farm prices. PLC provides payments when the price of a crop drops below a fixed reference price while ARC covers revenue losses at either the individual farm level or at the county-level.5 Another provision in this sec on per-manently establishes a livestock disaster program and pro-vides emergency assistance to eligible producers of live-stock, honey bees, and farm-raised fish. This sec on pro-vides livestock indemnity payments to eligible producers on farms that have incurred excess livestock death losses. C I The 2014 farm bill also introduces new products—including Supplemental Coverage Op on (SCO) and the Stacked In-come Protec on Plan (STAX)—to help producers expand their protec on against losses due to natural disasters or price declines.6 Supplemental Coverage Op on: SCO covers part of a crop insurance policy deduc ble. This insurance program estab-lishes coverage levels beginning when losses exceed 14% and has a premium subsidy of 65%.7 Stacked Income Protec on Plan: STAX was created for co on producers and covers county-wide revenue losses less than 10% and not more than the farmer-selected de-duc ble amount. Beginning Farmers and Ranchers Development Program: Under the law, a “beginning farmer or rancher” is defined as a farmer or rancher who has not ac vely operated and managed a farm or ranch with a bona fide insurable interest in a crop or livestock as an owner-operator, landlord, ten-ant, or sharecropper for more than five crop years. Begin-ning farmers and ranchers will be exempt from paying the


1 Na onal Crop Insurance Services, Bi-Weekly Crop Insurance Update. Mar. 13, 2014.

2 Available on the CIPR Website: www.naic.org/cipr_newsle er_archive/vol6_crop.pdf. 3 These programs are s ll available through the end of the 2013 crop year. 4 H.R.2642 Agricultural Act of 2014, h p://beta.congress.gov/bill/113th-congress/house-bill/2642. 5 U.S. Senate Commi ee on Agriculture, Nutri on and Forestry, Title by Title Sum-mary of 2014 Farm Bill, www.agriculture.senate.gov. 6 Cropinsuranceinamerica.org. Just the Facts. www.cropinsuranceinamerica.org/about-crop-insurance/just-the-facts/. 7 Ibid.


A A 2014: C I H (C )

$300 administra ve fee for catastrophic coverage policies, and will receive premium subsidy assistance for addi onal coverage policies. Addi onally, there is increased access to credit and loans provided for in Title V which allows for more opportuni es to beginning farmers and ranchers. Conserva on Compliance: The 2014 farm bill includes a new provision s pula ng crop insurance premium subsidies are available only if farmers are in compliance with wetland conserva on requirements and conserva on requirements for highly erodible land. Other Related Provisions: The law also tasks the USDA to carry out research and development for new crop insurance policies; establish a peanut revenue insurance program; develop a whole farm risk management insurance plan; and undertake a study of food safety insurance. O I According to the U.S. House of Representa ves’ Commi ee on Agriculture, the Agricultural Act of 2014 will save taxpay-ers $23 billion in mandatory federal spending and includes the most significant reduc on to farm policy spending in U.S. history.8 This farm bill puts much more emphasis on risk management and crop insurance. In its newsle er, the Na onal Crop Insurance Services, a sta s cal agency for crop insurance writers, reported the widespread industry support for the farm bill.9 A I For addi onal informa on on the Agricultural Act of 2014 or to understand the different types of crop insurance, you can visit the USDA10 and RMA11 websites. You can also visit the following helpful links. • NAIC Crop Insurance Working Group (www.naic.org/

commi ees_c_ciwg.htm) • H.R.2642: Agricultural Act of 2014 (h p://

beta.congress.gov/bill/113th-congress/house-bill/2642) • USDA 2014 Farm Bill Highlights (www.usda.gov/

documents/usda-2014-farm-bill-highlights.pdf) • Na onal Crop Insurance Services (www.ag-risk.org/)

A A Sara Juliff serves as a sta s cal analyst for the NAIC’s Research and Actuarial Department. She joined the NAIC in early 2007 and currently works on conduc ng insurance research, authoring of several NAIC publica ons, suppor ng numerous NAIC working groups, answering insur-

ance or data related ques ons from federal, state, academic, and industry professionals, and assis ng with NAIC data calls. Before joining the Sta s cal Unit, she served for a short me in the NAIC’s Informa on Systems Department as a Business Ana-lyst. Juliff has a Bachelor of Science in Social Psychology from Park University.

Brooke H. Stringer joined the NAIC in 2012 as a Financial Policy and Legisla ve Advisor. Based in their Washington, D.C office, she represents the NAIC before Congress and federal agencies on insur-ance regulatory issues, with a focus on property and casualty insurance and life

insurance and annui es. Prior to joining the NAIC, Ms. Stringer worked for 10 years in

the United States Senate, including posi ons on the Appropria-ons Commi ee, the Commi ee on Homeland Security and

Governmental Affairs, and in the office of U.S. Senator Susan Collins. Ms. Stringer received a Bachelor of Arts in Interna onal Rela ons from Middlebury College in Middlebury, VT.

8 U.S. House of Representa ves’ Commi ee on Agriculture, h p://agriculture.house.gov/sites/republicans.agriculture.house.gov/files/pdf/legisla on/AgriculturalActSummary.pdf. 9 What’s Cropping Up: Farm Bill Reduces the Deficit, Boosts Crop Insurance. Cropin-suanceamerica.org Newsle er. February 2014. www.cropinsuranceinamerica.org/farm-bill-reduces-the-deficit-boosts-crop-insurance/ 10 United States Department of Agriculture (www.ers.usda.gov) 11 Risk Management Agency (www.rma.usda.gov/help/faq/farmbill.html)


W C F I : A N A C I C

By Robert Carcano, Senior SVO Counsel I Star ng in 2010, the NAIC Securi es Valua on Office (SVO), along with several other NAIC groups, began evalua ng working capital finance investments (WCFIs) as poten al invested assets for the insurance industry. The SVO devel-oped a process to underwrite and assign NAIC designa ons to WCFIs. At the same me, the Statutory Accoun ng Prin-ciples (E) Working Group developed accoun ng standards for this new investment vehicle. A er significant input from the state insurance departments, NAIC staff, industry repre-senta ves and other par cipants, WCFIs were approved as admi ed assets for repor ng en es with an effec ve date of Jan. 1, 2014, during the 2013 Fall Na onal Mee ng. The Statutory Accoun ng Principles (E) Working Group adopted Statement of Statutory Accoun ng Principles (SSAP) No. 105—Working Capital Finance Investments and the Valua-

on of Securi es (E) Task Force followed by adop ng in-struc ons for the Purposes and Procedures Manual of the NAIC Securi es Valua on Office (SVO). The culmina on of all this hard work has resulted in a new investment vehicle for insurance companies: WCFIs. W W C F I ? The founda on of a WCFI is the recurring financial exchange between buyers and suppliers of goods. The actual products bought and sold could be almost anything, from appliances and furniture to windshield washer fluid and wiper blades. Consider a large retail store and the many items they offer for sale. The store constantly purchases goods from a num-ber of suppliers to stock its inventory. As goods are sold, the store uses the money from those sales to buy more goods and replenish its inventory. This ongoing buying and selling of goods between these companies is the type of recurring financial exchange men oned earlier. When the buyer (the retail store in our example) places an order to purchase items from the supplier, it creates a fi-nancial obliga on between itself and the supplier to pay for those goods. For the buyer, this obliga on is called a “payable”; i.e., an obliga on or liability to pay a specified amount to the supplier. In turn, the supplier of the goods has a “receivable”; i.e., a right to receive a specified pay-ment from the buyer, which is personal property and an asset. Con nuing our store example, a supplier may manufacture and deliver 50,000 gallons of windshield washer fluid of a specified quality to a large retail store chain. The retail store (or buyer) agrees under contract or purchase order to pay

the supplier a specified amount of money in 90 days from the date the goods are delivered (not upon delivery). The supplier may lack the financial ability to enable it to finance its opera ons independently of the cash flow from the sale of the goods. The supplier’s cost of financing may be high in its na on’s capital markets. The supplier may have an im-mediate need for cash and, therefore, an incen ve to con-vert the receivable it holds from buyer into cash, thereby “mone zing” the receivable sooner than the 90 days it agreed to with the buyer. For these reasons and many more, the supplier can choose to sell the receivable before the buyer of the goods is required or obligated to pay it. The supplier can do this because a receivable is an asset (i.e., a form of personal property). By selling the receivable, the supplier is transferring its asset (and its right to receive payment) to another person/en ty in exchange for the pay-ment of cash today. W C F I P Under a WCFI program, the par es are referred to by their legal role. The party that purchased the goods is called the “obligor”; i.e., it has an obliga on to pay for the goods that it purchased. The “supplier” is the party that holds the re-ceivable and is the one en tled to receive the payment for the goods or services it supplied and to which the obligor agreed to pay. The more important or cri cal a supplier is to an obligor, the greater incen ve the obligor has to ensure the supplier is not financially distracted. An obligor may try to protect its own interest by having reliable financial liquidity within its supply chain. Addi onal-ly, the obligor can lower its cost of goods by cu ng the fi-nancing cost of the supplier. The obligor may create or ask a financial ins tu on (i.e., its bank) to create and administer a working capital finance program that will permit its suppli-ers to nego ate the sale of the supplier’s receivables (due from the obligor) to the bank. The bank will seek appropri-ate compensa on for advancing money today in exchange for the right to receive repayment from the obligor in the future; typically in the form of a discount to the full amount of the receivable. A WCFI program is then an open account/evergreen financ-ing facility created by a bank for a single obligor and its sup-pliers. Under the terms of the financing facility, the bank agrees to consider offers made by suppliers to sell its re-ceivable due from an obligor for its own account. But bank managers may conclude that por olio concentra on limits, regulatory capital limita ons or similar concerns could limit or constrain the amount of receivables due from a certain



W C F I (C )

obligor that the bank could buy for its own account. If a bank es mates that its obligor customers could generate receivables in an amount greater than the bank thinks is prudent for it to purchase for its own account, it can build flexibility into the program by developing a process to offer supplier receivables it does not want to purchase to one or more investors that have previously been added to the obli-gor’s program for that purpose. This becomes the basis for the WCFI program. T R F There are other tradi onal receivables financing alterna-

ves available to the supplier. One example is factoring. In these other processes, the supplier also wants to sell its receivables to a third party in order to generate the imme-diate cash it needs to finance its opera ons. The purchaser of the receivables will seek appropriate compensa on for advancing money today in exchange for the right to receive payment from one or many obligors in the future. However, in these other alterna ves, the buyer of the receivable may take it subject to the possibility that the obligor has a de-fense against paying the full amount of the receivable to the supplier, which it will assert against the buyer. There are a number of structural ways to manage or mi -gate this risk. For example, the financing source can “cherry pick”; i.e., select only the most creditworthy receivables. The discount rate can also be used to reflect these risks to the buyer, such as those associated with obligor defenses to payment, which is a kind of dilu on risk. Such other alterna-

ves can be expensive for the supplier. As discussed, factor-ing does not have the restric ons and controls associated with a WCFI program to protect the buyer of or investor in the receivable. Moreover, if the supplier is based abroad, the supplier’s local capital markets may not be mature enough to have factoring as an available service. T D B A WCFI P T F In contrast to tradi onal receivables financing, a WCFI pro-gram addresses the opera onal risk so that the buyer of the receivable (i.e., the bank or, as discussed below, the insur-er) is not exposed to dilu on risk and the exposure to fraud risk is significantly reduced. Dilu on risk refers to and im-plies non-cash reduc ons in the receivable balance. This non-cash reduc on can occur for a variety of reasons, such as product returns, discount programs, rebates or adver s-ing allowances. As a legal ma er, a supplier can never transfer more rights than it has in fact. The rights the suppli-er has to a specified payment are created during, and lim-ited by, the underlying transac on between the obligor and

the supplier that generated the receivable. Consider the following examples: 1. A retailer may have an agreement that the supplier re-

ceive less on a per-unit basis when the retailer places an order in excess of a defined size or amount.

2. The receivable could have been generated with the wrong pay rate.

3. A quan ty of goods delivered might be less than or-dered.

4. Some propor on of goods delivered may be defec ve. The defec ve goods would be subject to return with an adjustment made on the amount due under the receivable.

5. An obligor may decide to take a discount to which they are not en tled.

6. A supplier may fraudulently generate duplicate receiv-ables.

The first four situa ons are examples of dilu on risk; i.e., the risk the obligor will assert a right gained in the underly-ing transac on to pay the supplier less than the face amount expected or stated on a receivable. Dilu on risk is unique to receivables financing. The last situa on described is an example of fraud. Both types of risks imply par al pay-ment or non-payment, but are referred to as “opera onal risk” because they are not related to the obligor’s actual ability to pay (credit risk). Similar to other investments, an investor in a WCFI program is exposed to the obligor’s credit risk. Credit risk is ability of the obligor to pay its obliga on on me and in full. The WCFI program requires the obligor to acknowledge in wri ng the receivable payment amount and date. The obli-gor is also required to acknowledge that the payment, with respect to the receivable, is a binding payment obliga on and that the obligor has no legal defense to payment of the specified amount. T E WCFN NAIC WCFIs developed from an SVO project that was originally requested by the Nebraska Department of Insurance (DOI). That project resulted in the development of a working capital finance notes (WCFNs) program specifically for Nebraska. The Nebraska DOI approached the SVO because it was evalu-a ng a ques on posed by Pacific Life Insurance Company: whether certain receivables could be assigned an NAIC desig-na on by the SVO, because, if so, a Nebraska statute would permit the insurer to report the receivables as admi ed as-sets. The Nebraska DOI asked the SVO to assess whether it could assign an NAIC designa on to a receivable. The SVO



W C F I (C )

worked with Pacific Life representa ves1 to obtain examples of transac ons that it could evaluate and consider issues raised by the asset class, the market and governing law.2

A team was formed comprising senior SVO staff members to assess the issues presented by the Nebraska DOI re-quest. The team found that trade receivables generated in the U.S. totaled about $2.6 trillion in 2010. The overall ob-jec ve of the team’s analysis was credit-centric; i.e., the focus was on iden fying credit and legal characteris cs of the asset; credit, legal and structural program elements; and parameters necessary to reduce nonpayment risk to the level of an NAIC 1 or NAIC 2 designa on. Part of this analysis focused on how an investor (i.e., the insurer) would be able to enforce contract rights to the receivable payment in a default situa on. The assessment included evalua ng the severity of default, in addi on to under-standing likelihood of default. This overall credit assess-ment helped quan fy the risk of default for WCFNs and, thereby, understand how to manage such risk. Ul mately, the SVO and the Nebraska DOI were able to work through the analysis and frame a WCFN program in which Pacific Life was permi ed to invest. This framework then became the star ng founda on for a wider project. T N S The Nebraska DOI requested that the SVO proposal be pre-sented to the Valua on of Securi es (E) Task Force for con-sidera on as a na onal standard. The SVO presented the Nebraska program to the Task Force at the 2011 Spring Na-

onal Mee ng. The Task Force received the proposal and released it for a short comment period, intending to refer it to the Statutory Accoun ng Principles (E) Working Group. The Working Group asked for further informa on, whereby the Task Force referred the proposal to the Invested Asset (E) Working Group. This Working Group worked through the issues related to statutory accoun ng, repor ng and risk-based capital (RBC). A er a list of poten al issues was de-veloped, and hearings were held to discuss those issues with interested par es, the Invested Asset (E) Working Group ul mately recommended that WCFNs be considered admi ed assets and provided the Task Force with a list of proposed criteria to be considered. The SVO and the NAIC statutory accoun ng staff were then asked to develop a joint statutory accoun ng proposal us-ing the original SVO proposal, along with the Invested Asset (E) Working Group’s proposed criteria as a basis. A revised proposal incorpora ng these changes, along with others provided by regulators and interested par es, was adopted

by the Task Force and referred to the Statutory Accoun ng Principles (E) Working Group (to develop final statutory accoun ng guidance), the Capital Adequacy (E) Task Force (to determine which RBC factors would apply) and the Blanks (E) Working Group (to develop repor ng instruc-

ons) with recommenda ons to each of the groups. The three groups proceeded to determine guidance for their respec ve areas. T WCFI P A SSAP N . 105 The WCFI program that was recently adopted by the NAIC retained many of the proposed asset and program charac-teris cs ini ally recommended by the SVO. Importantly, the proposal also addressed concerns from NAIC regulator groups regarding issues other than credit, reflec ng that WCFIs would permit a new type of investment ac vity and asset for insurers. These changes ul mately added addi on-al requirements to address other concerns and provide oth-er protec ons as described below. The new requirements were included in Statement of Statutory Accoun ng Princi-ples (SSAP) No. 105—Working Capital Finance Investments. General Requirements of SSAP No. 105: • Relates the confirmed receivable process to Uniform

Commercial Code (UCC) processes for crea ng a securi-ty interest.

• Requires an annual audit of the consolidated financial statements of the finance agent and a Statement on Standards for A esta on Agreements (SSAE) No. 16, Repor ng on Controls at a Service Organiza on, report, or an annual audit of controls to be reviewed by the SVO for materiality.

• Requires the insurer to monitor the obligor’s receivable ac vity and credit worth.

• Requires dispute resolu on in a U.S. forum. • Excludes insurance or insurance-related asset receiva-

bles from use in designated programs. • Measures the maximum one-year receivables maturity

from the date the invoice was issued. • Excludes receivables issued by a parent or affiliate of

the insurer. • Requires the obligor to be an NAIC 1 or NAIC 2 desig-

nated en ty. (Continued on page 20)

1 We express sincere gra tude for the confidence reposed in us by the Nebraska Department of Insurance and the assistance provided by the professional staff of the Pacific Life Insurance Company in the development of the ini al proposal and the consistency of effort, professional skill, diligence and honesty they exhibited. 2 Under NAIC guidance at that me, a receivable was a nonadmi ed asset under statutory accoun ng guidance and a short-term obliga on not subject to filing with the SVO under the Purposes and Procedures Manual of the NAIC Securi es Valua-

on Office (SVO).


W C F I (C )

• Requires the finance agent (typically a bank) to be an NAIC 1 or NAIC 2 designated en ty.

Requires the finance agent to have the obligor confirm, pri-or to the sale of the receivable by the supplier or its pur-chase by the finance agent or an insurer, that it has no de-fenses to payment of the monetary obliga on represented by the receivable. R A NAIC WCFI SVO A WCFI program can only be submi ed to the SVO as a sub-mission to the Regulatory Treatment Analysis Service (RTAS). The applicant will receive an RTAS le er showing a preliminary NAIC designa on only for the program. When the insurer files the program’s executed documents with the SVO, the SVO will issue an official NAIC designa on for the WCFI program. An NAIC designa on is assigned to a WCFI program on the basis of regulatory, legal, credit and structural assessment. • Regulatory – The primary source of regulatory require-

ments is SSAP No. 105. Many of the same requirements are also iden fied in the Purposes and Procedures Man-ual of the NAIC Securi es Valua on Office (SVO) as cri-teria, either because they relate to assessment of credit and other risk and have always been part of the SVO assessment or because SSAP No. 105 requires the SVO to verify or obtain specified documenta on. Regulatory requirements are concerned with the reliability and u lity of processes used by the finance agent and how it is regulated; verifica on that the insurer has a rea-sonable belief it has obtained or can obtain a UCC secu-rity interest, compliance with provisions in SSAP No. 105 that require non-affilia on with insurer and with provisions that exclude certain receivables from the program, documenta on standards as to remedies, payment to the finance agent or insurer, and other similar issues.

• Credit Risk – The obligor’s credit risk is derived through tradi onal corporate methodologies, such as financial analysis. This assessment is augmented by a review of the short-term risks that could affect payment, as well as an understanding of the level of opera onal risk pre-sented by obligor processes and the industry of which it is a part.

• Structure – It is an cipated that WCFI programs will differ in the structure (i.e., the various internal mecha-

nisms, processes, procedures used to sell the receiva-ble, conduct the confirma on process and effect pay-ment to the insurer). An assessment will be conducted by reviewing the governing legal documents for suffi-ciency, along with an assessment on other par cipants in the opera ons of the working capital finance pro-gram or investment as to quality, degree of legal re-sponsibility owed to ensure the process works and oth-er investor protec ons. Adjustments for deficiencies in structural elements are made to the obligor’s credit ra ng or quality designa on.

• Legal Issues – Core legal issues center on the legal effec veness of the transfer of the receivable as a true sale and of the manner and effec veness of the confir-ma on process. Consistent with the revolving nature of the program, it is expected that the insurer will not be commi ed to buy new receivables from the finance agent.

C A WCFI represents a new asset and a new investment op-portunity for insurers. While there were ini ally many ques-

ons raised about the asset class and how it operates, the road to its approval by the NAIC reflects the successful col-labora on of NAIC staff, insurance regulators and industry.

A D Bob Carcano is senior counsel at the NAIC Capital Markets and Investment Analysis Office. He provides legal, regulatory and analy cal support to the Securi es Valua-

on Office and the Structured Securi es Group. He is a graduate of the Dickinson School of Law (J.D.), the Fordham University Graduate School of Arts and Science,

(master’s degree in compara ve poli cs) and Fordham Universi-ty, Fordham College (bachelor’s degrees in history and poli cal science). Before joining the NAIC in 1991, Carcano was a senior analyst in the Structured Finance Group of Moody’s Investors Service, where he performed legal and credit analysis of a variety of structured securi es. Prior to his assignment with Moody’s, Carcano was with the bou que investment banking opera on of the Financial Services Corpora on of New York City, where he was engaged in asset-based financing, economic development lending and industrial development bond financing.


I R D G C S

By Josh Windsor, NAIC Interna onal Technical Policy Advisor and Lou Felice, NAIC Health and Solvency Policy Advisor In response to the 2008 global financial crisis, the Group of Twenty (G-20) Finance Ministers and Central Bank Gover-nors created the Financial Stability Board (FSB) in 2009 as a successor to the Financial Stability Forum (FSF). The FSF, founded in 1999 by the G-7 finance ministers and central bank governors, was re-established as the FSB with an ex-panded membership and broader mandate to address vul-nerabili es affec ng the global financial system, and to de-velop and promote the implementa on of effec ve supervi-sory and regulatory policies promo ng financial stability. The FSB membership now includes, in addi on to prior FSF members, all G-20 economies, Spain and the European Commission.1 Since the financial crisis, the FSB has advanced a major pro-gram of financial regulatory reforms to address the short-comings in the financial system exposed by the crisis, while striving to create globally consistent rules and a level play-ing field across countries and sectors. The FSB has also been tasked with providing recommenda ons and exploring how to treat global systemically important financial ins tu ons (G-SIFIs) so as to prevent another financial crisis. The FSB defines G-SIFIs as “ins tu ons of such size, market importance, and global interconnectedness that their dis-tress or failure would cause significant disloca on in the global financial system and adverse economic consequenc-es across a range of countries.” A global systemically important bank (G-SIB), is one class of G-SIFI. Another class of G-SIFI are global systemically im-portant insurers (G-SIIs). As insurance markets have be-come increasingly global and interconnected, and ac vi es they engage in become increasingly ed to the financial markets, the FSB asked the Interna onal Associa on of In-surance Supervisors (IAIS) to set up a process to iden fy G-SIIs.2 In response to the request, the IAIS established an assessment methodology to assist in iden fying G-SIIs, and in July of 2013 published a set of policy measures that would apply to them. One of the policy measures recommended is higher loss absorbency (HLA) which represents the addi onal capital required to address the systemic nature of these insurer-led groups. Rather than have the HLA be added as upli on ju-risdic onal capital requirements, the FSB instead asked the IAIS to develop a consolidated backstop capital require-ment—subsequently changed to basic capital requirement (BCR)—as a comparable base for applying the HLA upli .

In addi on to its focus on G-SIIs, the IAIS, in July 2010, be-gan developing its Common Framework for the Supervision of Interna onally Ac ve Insurance Groups (ComFrame). As part of these important ini a ves, the IAIS is currently simultaneously developing the following work streams: • ComFrame which will apply to all Interna onally Ac ve

Insurance Groups (IAIGs). • A BCR that is being developed for G-SIIs. A methodolo-

gy for calcula ng the BCR is due later this year. • An HLA to be applied to G-SIIs star ng in 2019. A rec-

ommended approach for HLA is due by late 2015. • A group-wide insurance capital standard (ICS) which

will become part of ComFrame and is expected to apply to all IAIGs beginning in 2019. The IAIS indicates that the objec ve is to complete cra ing the ICS by the end of 2016.

C F ComFrame is a set of interna onal supervisory requirements focusing on the effec ve group-wide supervision of IAIGs. ComFrame sets out a comprehensive range of qualita ve and quan ta ve requirements specific to IAIGs, as well as the supervisory processes and prerequisites for supervisors to implement ComFrame. ComFrame is built and expands upon the high level requirements and guidance currently set out in the IAIS Insurance Core Principles (ICPs) which gener-ally apply on both a legal en ty and a group-wide level.3 ComFrame is structured in three modules with each module made up of a number of elements. Module 1, Scope of ComFrame, includes the criteria and process for the iden fi-ca on of IAIGs by supervisors, the scope of the IAIG subject to group-wide supervision and the iden fica on of the group-wide supervisor. Module 2, The IAIG, contains the requirements supervisors will require an IAIG to meet. Module 3, The Supervisors, covers the process of supervi-sion, highligh ng the role of the group-wide supervisor and other relevant supervisors’ responsibili es within the pro-cess as well as supervisory process, enforcement, coopera-

on and interac on requirements.4

(Continued on page 22) 1 CIPR Financial Stability Board Key Issue Topic Page (www.naic.org/cipr_topics/topic_financial_stability_board.htm). 2 The IAIS is the interna onal standard-se ng body for the pruden al supervision of the insurance industry. 3 IAIS About ComFrame: www.iaisweb.org/Common-Framework--765. 4 CIPR ComFrame Key Issue Topic Page (www.naic.org/cipr_topics/topic_comframe.htm).


I R D G C S (C )

The development phase of ComFrame began in 2010 and concluded at the end of 2013. The field tes ng process began in 2014 to evaluate ComFrame in prac ce so it can be modified as necessary prior to formal adop on. The IAIS is currently scheduled to formally adopt ComFrame at the end of 2018, with its members implemen ng ComFrame therea er. B C R The IAIS has developed six principles to guide development of the BCR. These principles provide a high-level framework against which approaches and proposals may be reviewed. The principles are as follows: Substan ve Principles: BCR Principle 1: Major risk categories should be reflected. The BCR must reflect major insurance risks, including risks from assets and liabili es, as well as non-insurance risks. BCR Principle 2: Comparability of outcomes across jurisdic-

ons. Outcomes should be comparable across jurisdic ons. This implies the need to minimize distor ons, including those arising from differing levels of conserva sm included in valua on processes. The level of discre ons that may be applied or introduced should be minimized across jurisdic-

ons and over me. BCR Principle 3: Resilience to stress. The BCR should be able to func on in a wide variety of circumstances (including a stressed macro environment) and remain valid. Approaches adopted should be testable against historic data and will be developed with the goal G-SIIs con nue as “going concerns.” Construc on Principles: BCR Principle 4: Simple design and presenta on. The de-sign of the BCR needs to be pragma c and prac cal. The form of presenta on of the BCR, focusing on meaningful communica on to external par es, should be “simple” and “intui ve” at a high level, yet sufficiently granular for the results to be fit for purpose. The BCR should u lize the mini-mum number of parameter and data requirements while a aining valid and robust outcomes with a focus on materi-al issues. BCR Principle 5: Internal consistency. The structure of the BCR needs to be consistent and should be applicable over the range of insurance and non-insurance en es it will need to cover and over me.

BCR Principle 6: Op mize transparency and use of public data. The level of transparency, par cularly with regard to the final results provided, and the use of public data should be op mized. Development of the BCR is the IAIS’s current highest priori-ty. Several NAIC staff members, state insurance regulators and representa ves of U.S. federal agencies are involved in this work which is expected to deliver a comparable base capital upon which to add the HLA capital requirements for G-SIIs. In December 2013, the IAIS released a consulta on paper on BCR which was, at that me, in its early stages of development. Responses to the key themes of the BCR consulta on paper were discussed and a large number of comments from observers were considered in its further development. The current thinking is the BCR will apply factors to expo-sures that proxy various categories of risk (e.g., assets, life insurance, non-life insurance, asset liabili es management, as well as non-tradi onal insurance and non-insurance ac-

vi es). In order to help cra the BCR, the IAIS commenced a quan ta ve field tes ng study on March 21, 2014, and a number of IAIGs from various jurisdic ons have volun-teered to par cipate in the study. The ini al data is ex-pected to be provided in May 2014 and analyzed over the following several months. The level the BCR will be set with-out HLA (as well as in combina on with HLA) is a significant area of delibera on. A second consulta on on the BCR is then expected to take place in the summer of 2014, to be approved by the IAIS and then go to FSB in the fall for its review. The IAIS hopes the proposal will be endorsed by the G-20 in November 2014. H L A Implementa on of the BCR as a base for HLA is expected in 2019 a er a period of review and analysis. The methodolo-gy for the HLA upli will be developed during the second half of 2014 and the first half of 2015. The IAIS expects the ICS will ul mately replace the BCR as the base capital for G-SIIs upon which the HLA will be added. It is unclear how the ICS will interact with the BCR, given they may both be opera ve in 2019. The IAIS hopes this will crystalize once the field tes ng begins and the ming for jurisdic onal ac ons necessary to adopt the ICS (and Com-Frame more broadly) is determined.



I R D G C S (C )

I C S The ICS is a quan ta ve part of ComFrame. Development of the ICS is in its ini al stages, but some ini al thoughts and key points have been developed and will con nue to evolve as the work moves forward. The capital component of the solvency assessment in ComFrame, which is currently being finalized in concept, will be used as a star ng point for de-velopment of the ICS. The IAIS is commi ed to developing the ICS by end-2016 and full implementa on is scheduled to begin in 2019 a er two years of tes ng and refinement with supervisors and IAIGs. The IAIS hopes that the ICS will provide a more comparable measure of capital across jurisdic ons. The common under-standing of IAIG capital adequacy will enhance supervisory coopera on and coordina on among group-wide and host supervisors. It will also allow host supervisors to have great-er confidence in the group-wide supervisor’s decisions and analysis. While neither the BCR nor the ICS are expected to replace jurisdic onal en ty-based insurance capital requirements, there will be con nuing discussion at the IAIS about how the ICS might interact with U.S. risk-based capital (RBC) le-gal en ty requirements and RBC ra os. Both are being de-signed to pick up financial risk and material non-financial risk from all sources within the group, including risk ema-na ng from en es that were heretofore not subject to en ty-based regula on. S There are many interna onal capital-related work streams in process, some of which impact one another. It requires significant effort to follow all the nuances of each and eve-ry aspect of each and every proposal a ached to the ongo-ing work. The IAIS is working with volunteer IAIGs to devel-op short-term and longer-term group capital standards, and will con nue to issue consulta on papers along the way to make sure the results of the work are transparent and ul mately beneficial to financial stability and policy-holder protec on. The NAIC is keeping abreast of developments through staff par cipa on in all the relevant IAIS commi ees. In addi on, NAIC members are assessing the impact on current U.S.

insurance capital requirements via the open commi ee process. The Financial Stability (EX) Task Force is monitoring progress related to systemic risk and G-SIIs. The newly formed ComFrame Development and Analysis (G) Working Group will assess developments pertaining to ComFrame generally and to the capital standards specifically including how these ini a ves will interact with the U.S. state-based system of insurance regula on. The Working Group will use the usual channels of par cipa on to keep regulators and interested par es informed and involved.

A A Josh Windsor is an actuary who recently joined the NAIC a er nearly 20 years of insurance-related experience. In his current role, he joins the Financial Regulatory Affairs, Interna onal Policy & Market Sur-veillance unit where he will lend his tech-nical actuarial exper se and regulatory experience to a variety of na onal and

interna onal projects. He comes to the NAIC from a consul ng firm that serves regulator clients on a variety of projects, includ-ing the risk-focused examina on of insurance companies, risk assessment and capital requirements for various insurance en -

es. Windsor is a fellow of the Society of Actuaries, a fellow of the Ins tute and Faculty of Actuaries and a member of the American Academy of Actuaries. He is also the Secretary of the Actuarial Society of New York.

Lou Felice is the health and solvency policy advisor at the NAIC. His role is to provide technical and policy analysis and advice to NAIC senior staff and leadership on sol-vency ma ers generally, including the solvency impact of the federal Affordable Care Act, as well as advising on enhance-ments to U.S. RBC and represen ng the

NAIC in interna onal dialogues and projects related to solvency and capital requirements. Before joining the NAIC, Felice served as chief of the Health Bureau at the New York State Department of Financial Services. Felice was co-recipient of the NAIC’s 2010 Robert L. Dineen Award for Outstanding Service and Contribu on to the State Regula on of Insurance.


D G : P L M S

By Jennifer Gardner, NAIC Research Analyst II The data in this issue includes direct wri en premiums, market shares and pure loss ra os for the homeowners and private passenger auto (PPA) lines of business. PPA includes liability and physical damage. The data is taken from the Exhibit of Premiums and Losses from the NAIC property/casualty financial statement. The direct loss ra o for homeowners insurance improved 12 points over the past year. Figure 1 shows the trend of loss ra os for homeowners and PPA over the past five years. In 2011, winter storms, Hurricane Irene, wildfires and tornadoes across the South and Midwest caused large losses in the homeown-ers lines. Winter storms caused an es mated $790 mil-lion to $1.4 billion in insured losses. Es mated losses due to Hurricane Irene were between $3 billion and $6 bil-lion. There were 1,897 tornadoes on record in 2011, making it the costliest year ever for tornado losses with $26 billion in damage. Claim frequency hit historic highs in 2011 as a result of these catastrophes. Losses in the PPA line decreased minimally, dropping by just one point, over the past year. There were fewer cat-astrophic events in 2012. Superstorm Sandy wreaked

F 1: L R H P P A

havoc on the Northeastern coastline, but losses were dwarfed in comparison to losses sustained in 2011. Calen-dar year 2013 was an uneven ul year in terms of cata-strophic events. According to the Na onal Oceanic and At-mospheric Administra on, 2013 was the least ac ve Atlan-

c hurricane season since 1982. (Continued on page 25)

F 2: 2013 T 10 M S —H * Group/

Company Code

Group/Company Name Direct Premiums Wri en

2013 Market Share

2012 Market Share

2011 Market Share

2013 Pure Loss

Ra o

2012 Pure Loss

Ra o

2011 Pure Loss

Ra o

176 STATE FARM GRP 17,073,508,419 20.99 20.42 18.62 49.13 60.41 74.48

8 ALLSTATE INS GRP 7,428,694,116 9.13 9.21 10.32 41.81 53.16 77.89

111 LIBERTY MUT GRP 5,236,892,156 6.44 5.95 7.94 47.25 58.66 73.48

212 FARMERS INS GRP** 5,029,554,779 6.18 6.28 9.07 53.81 55.19 57.95

200 UNITED SERV AUTOMOBILE ASSN GRP 4,328,005,246 5.32 4.95 5.9 50.56 64.38 79.48

3548 TRAVELERS GRP 3,368,962,025 4.14 4.43 4.6 36.78 56.89 84.39

140 NATIONWIDE CORP GRP 3,092,293,312 3.80 3.78 4.54 49.82 63.07 83.18

473 AMERICAN FAMILY INS GRP 2,272,518,991 2.79 2.04 1.8 53.55 61.17 88.86

38 CHUBB INC GRP 1,972,792,527 2.43 2.4 4.05 37.66 66.74 65.33

10064 CITIZENS PROP INS CORP 1,272,335,759 1.56 2.1 2.08 26.85 38.99 62.59

INDUSTRY TOTAL 81,321,436,166 46.38 58.71 75.76

*This data includes line 4 of the 2012 Property/Casualty Annual Statement. ** Formerly filed under Zurich ins Grp; Zurich and Liberty Mutual switched places in 2013.


D G (C )

As shown in Figures 2 and 3, market share among compa-nies did not vary to a large degree over the past three years. Liberty Mutual Group moved up one spot above Farmers Insurance Group for direct wri en premium in the homeowners line of business. Farmers Insurance Group was formerly reported under Zurich Insurance Group. In 2013, Zurich Insurance Group separated its busi-ness filings so that it now files under Farmers Insurance Group for its homeowners and PPA lines of business. Ci -zens Property Insurance Corpora on fell to the 10th spot in homeowners, surpassed by American Family Insurance Group in direct premiums wri en. Berkshire Hathaway Group moved up one spot in PPA, taking second place above Allstate Insurance Group. The NAIC publishes market share reports for various types of insurance. Data in this ar cle are based on the 2013 Top 25 Property/Casualty Market Share. This report can be found on the Research and Actuarial Department’s Web page at www.naic.org/research_actuarial_dept.htm.

A A

For more detailed informa on on a par cular line of busi-ness, Market Share By Line reports provide the top 99% of the market share by state for each line of business.

Jennifer Gardner is a research analyst with the NAIC. Jennifer joined the organi-za on in 2011. She conducts economic and sta s cal research for the NAIC and its members. She is responsible for pub-lishing sta s cal and market share re-ports, provides support for numerous

NAIC working groups and assists the state insurance depart-ments in data collec on related to catastrophe. Jennifer earned a bachelor’s degree in business administra on with an emphasis in finance from the University of Missouri-Kansas City. Prior to joining the NAIC Research and Actuarial Depart-ment, Jennifer worked on the State Based Systems (SBS) prod-ucts and services within the NAIC.

F 3: 2013 T 10 M S —T P P *

Group/ Company

Code Group/Company Name Direct Premiums

Wri en

2013 Market Share

2012 Market Share

2011 Market Share

2013 Pure Loss Ra o

2012 Pure Loss

Ra o

2011 Pure Loss

Ra o

176 STATE FARM GRP 33,610,200,519 18.53 17.85 18.62 67.38 67.05 76.04

31 BERKSHIRE HATHAWAY GRP** 18,622,625,537 10.27 9.71 9.07 68.71 68.04 69.11

8 ALLSTATE INS GRP 18,067,452,324 9.96 10.14 10.32 64.63 63.94 61.70

155 PROGRESSIVE GRP 15,373,142,367 8.48 8.37 7.94 63.81 65.17 61.89

212 FARMERS INS GRP*** 9,880,904,899 5.45 5.96 5.90 58.89 63.13 61.11

200 UNITED SERV AUTOMOBILE ASSN GRP

9,167,241,811 5.05 4.87 4.60 72.97 71.91 74.04

111 LIBERTY MUT GRP 9,036,455,075 4.98 4.79 4.54 63.07 59.75 60.12

140 NATIONWIDE CORP GRP 7,279,834,888 4.01 4.14 4.05 65.47 64.23 71.05

473 AMERICAN FAMILY INS GRP 3,441,682,470 1.90 1.91 1.80 65.52 62.97 62.59

3548 TRAVELERS GRP 3,178,691,672 1.75 1.97 2.08 59.93 64.13 76.96

INDUSTRY TOTAL 181,390,949,723 65.42 66.36 67.52

*This data includes lines 19.1, 19.2, and 21.1 of the 2012 Property/Casualty Annual Statement. ** Berkshire Hathaway Grp and Allstate Ins Grp switched places in 2013. *** Formerly filed under Zurich ins Grp.


© Copyright 2014 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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PRIL 2014 Inside this Issue · APRIL 2014 Eric Nordman CIPR Director 816-783-8232 [email protected] Kris DeFrain Director, Research & Actuarial 816-783-8229 [email protected] Shanique