State, national and international insurance regulatory activity reflects steps toward more regulation and heightened scrutiny

Insurance Alert (US)

The past few weeks have seen a flurry of insurance regulatory activity at the federal, state and international level.  Individually these developments are noteworthy; taken together, they evidence the depth and breadth of changes and policy debates under way regarding the regulation of insurance.  The summer months may bring time off for many, but not, it seems, for those reshaping the landscape of insurance regulation.


Within the past month:


  • the Financial Stability Oversight Council (FSOC), after months of delay, voted to propose the designation of at least three insurance groups as non-bank Systemically Important Financial Institutions (SIFIs).  FSOC, however, still has not released the final list to the public and the designation process has further to run
  • the Federal Insurance Office (FIO) released its first annual report on the insurance industry; however, not the long-awaited Dodd-Frank Act mandated reports on insurance modernization and reinsurance 
  • the New York Department of Financial Services (NYDFS) pushed for the nuclear option on the use of captives by insurers (or at least life insurers) by calling for a nationwide moratorium on approval of all captive transactions 
  • the US Department of Treasury’s (Treasury) Federal Advisory Committee on Insurance held a meeting, where the issue of captive insurance was on the agenda
  • the House Financial Committee Subcommittee of Housing and Insurance held a public hearing on the impact of international regulatory standards on US insurers, which brought representatives from three potentially divergent regulatory interests in the US insurance industry, the FIO, the National Association of Insurance Commissioners (NAIC) and the FSOC
  • the International Association of Insurance Supervisors (IAIS) drew closer to releasing for public consultation its paper on insurance company branches in foreign countries
  • the IAIS released a new working draft of ComFrame and conducted a “ComFrame Dialogue” to consider comments regarding the current status of its ComFrame project 
  • an NAIC Committee established a new working group to evaluate what it characterizes as an increased interest in the insurance industry, specifically in large fixed annuity business, by private equity interest and hedge fund managers.  Establishment of the new working group follows the interim action of the NYDFS, which issued subpoenas to several private equity firms regarding the same 


FSOC non-bank SIFI designations


In early June, the FSOC voted to propose the designation of certain insurers as non-bank SIFIs.  Insurers that confirmed they were so designated are Prudential Financial, Inc., American International Group, Inc. and General Electric Capital Corporation.  Although Treasury has not released the list of proposed designated non-bank SIFIs weeks after the vote, the companies themselves are free to disclose whether they were proposed for designation.  It is possible that others insurers are also included on that list. 


Non-bank SIFIs will fall under the jurisdiction of the Federal Reserve, which will provide an additional layer of regulatory oversight on top of the state system of insurance regulation.  SIFIs will be subject to additional scrutiny and requirements related to solvency, capital adequacy and liquidity and will need to pass rigorous stress testing.  Companies proposed for designation have a period of 30 days from the date of the vote to request a hearing regarding the designation.  The FSOC must hold a hearing within 30 days of the request; then the FSOC will have 10 days to make a final determination.


With the vote by FSOC, attention now turns to the Financial Stability Board (FSB), which has delayed disclosure of those non-bank financial institutions that will be designated a Global Systemically Significant Financial Institutions (G-SIFIs).  One of the interesting policy decisions being watched is whether the FSB could name a US institution as a G-SIFI, even if it is not named as a SIFI by FSOC.  Some have thought that the FSB and FSOC would act in concert on these designations; however, this has not happened.  Whether this results in inconsistent designations remains to be seen.


FIO releases 2013 Annual Report


The insurance industry has been anxiously waiting for over 18 months for the FIO to release its potentially game-changing Insurance Modernization and Reinsurance reports mandated by Title V of the Dodd-Frank Act.  FIO released its Dodd-Frank mandated 2013 Annual Report on the Insurance Industry (Annual Report); however, it was not the report the industry had been highly anticipating since January 2012.  The Annual Report merely recited certain facts and figures about the insurance industry, but did not provide any opinions, controversial or otherwise, on how the US insurance industry should be regulated in the future.  The Annual Report did not provide any substantive resolution to or commentary on the significant issues facing the US insurance industry today, especially those issues dealing directly with the competitiveness of the US insurance industry in the global market.


The Annual Report, which covered both the life and non-life sectors, described the state of the insurance industry in the US at an extremely macro-level.  The Annual Report emphasized the strength of the industry in light of the financial crisis and low interest rate environment, as well as its fundamental role in the US economy.  The Annual Report also highlighted national regulatory trends, such as standardizing the regulation of insurance groups and modifying reinsurance collateral requirements, as well as international regulatory developments that would impact US insurers. 


NYDFS pushes for moratorium on insurance captive approvals


Governor Andrew Cuomo announced that after a year-long investigation of captive insurance programs of life insurers, New York-based life insurance companies and their affiliates engaged in US$48 billion of what he characterized as “shadow insurance transactions.”  The NYDFS Report, which many in the industry have described as controversial, focused primarily on the use of captives by life insurers to address reserves for term and certain universal life insurance policies, a topic that has been the subject of hot debate at the NAIC.  Apparently dissatisfied with the NAIC’s approach and timing, NYDFS Superintendent Benjamin Lawksy initiated his own investigation last year and, based on his findings, has called for a broad state and federal probe of the use of captives by life insurers as a means of lowering their reserve and regulatory requirements and a national moratorium on the approval of such transactions. 


The NYDFS Report on the investigation concluded that insurers engaged in:


  • inconsistent and incomplete disclosure on statutory annual financial statements and US Securities and Exchange Commission filings
  • diverting reserves in order to artificially boost risk-based capital (RBC) levels
  • taking advantage of regulatory blind-spots because of varying state confidentiality laws 
  • a regulatory race to the bottom as more states enter into the captive arena with weaker collateral requirements


Based on those conclusions, the NYDFS now requires that New York-based insurers and their affiliates disclose “shadow transactions”; and recommends that the NAIC develop enhanced disclosure requirements in the interest of national uniformity.  The NYDFS also recommends that FIO, Office of Financial Research, NAIC and other state insurance commissioners conduct similar investigations, and state insurance commissioners should consider an immediate national moratorium on approving such transactions until the investigations are complete.  The report also appears to have broadly called into question the use of affiliated reinsurance and letters of credit, which may be of concern to the property/casualty industry, where such practices are also used.


The NAIC President, Commissioner Jim Donnellon (LA) commented on the NYDFS report, stating that “immediately halting the transactions would not be justified, especially since they didn’t appear to jeopardize insurers’ solvency.  The NAIC will stick to the course it set out on 15 months ago and continue studying ways to improve oversight of the transactions, improve transparency and promote information-sharing among regulators.”


In the prior week, the NAIC released a new draft of the white paper on Captives and Special Purpose Vehicles from the Captives and Special Purpose Vehicle Use Subgroup of the Financial Condition (E) Committee.  The paper will move to the full Financial Condition (E) Committee, where additional Commissioners will have an opportunity to vote for its adoption.  As of this writing, the next scheduled meeting of the NAIC will be held at the National Summer Meeting in Indianapolis in late August.  It is rumored that Superintendent Lawsky may face some controversy at future NAIC meetings given his commentary on transactions that have been approved by other regulators.


Congressional House Subcommittee holds hearing on national and international insurance regulation


The US House Financial Services Subcommittee on Housing and Insurance held a hearing titled, “The Impact of International Regulatory Standards on the Competitiveness of US Insurers.”  Despite the build-up to the Congressional hearing, it was mostly uneventful.  Witnesses were Director of FIO, Michael McRaith, CEO of the NAIC, former Senator Ben Nelson and current independent member with insurance expertise on the FSOC, Roy Woodall.  Subcommittee members used the hearing as a forum to complain about the delays in the FIO reports, financial bailouts and the looming threat of IAIS regulatory activities, specifically with respect to the IAIS development of the “Common Framework for the Supervision of Internationally Active Groups” (better known as ComFrame).  The hearing also served as a forum for members to highlight tensions and potential conflicts among the FIO, NAIC and FSOC in the context of international regulatory creep in US markets. 


The highlight of the hearing occurred when Chairman Randy Neugebauer (R-TX) asked each witness to comment on a New York Times article regarding the NYDFS position on captive insurance.  He specifically asked whether each panelist thought the states were doing a good job in regulating these entities.  Director McRaith stated that he was monitoring the work regulators were doing to develop uniform regulatory standards regarding captives and applauded their work.  Senator Nelson added that adoption of Principles-Based Reserving standards would eliminate the need for captive reinsurance programs entirely because it would remove the redundant reserving that the formulaic approach to reserves has caused, causing insurers to use captives as a means to release some of the tied up reserves.  Finally, Mr. Woodall added that he had consulted with Superintendent Lawsky and other regulators as well as insurance companies for and against the practice.  He concluded that since everyone in the industry (regulators and companies) is split on the issue, it will be difficult to find consensus despite the fact everyone is approaching reforms in a good faith effort.


The members raised a number of areas of concern about the IAIS, the Financial Stability Board and Solvency II, including:


  • whether the IAIS would set insurance requirements in the United States – to which Director McRaith responded that the IAIS has no regulatory authority, while Senator Nelson and Mr. Woodall cautioned against the effects of setting international standards
  • the costs associated with ComFrame implementation – to which Director McRaith and Senator Nelson differed in their response.  Whereas Director McRaith stressed that there would be plenty of time to study the impact of ComFrame on insurers because the next phase after drafting would be to test it on a sample of companies, Senator Nelson responded that he wanted to know the cost of testing as well as the cost of full implementation.  He stressed that to his knowledge there has not been a cost/benefit analysis done on the industry regarding the implementation of ComFrame
  • whether the IAIS and ComFrame put US domestic companies at a competitive disadvantage to internationally-based insurers – to which all panelists expressed their desire to prevent this from happening


IAIS releases final paper on insurance company branches in foreign countries


Also this month, the IAIS released to members and observers of the IAIS a nearly final version of its “Issues Paper on Supervision of Cross-Border Operations through Branches to Members and Observers of the IAIS.”  The paper is expected to be released to the public for a formal consultation period soon. 


The paper has stirred controversy in the industry.  Trade associations have commented that that the paper is biased towards subsidiaries instead of branches and that its suggestion that supervisors consider forcing companies into a subsidiary structure is overly broad.  They argue that insurers and reinsurers need the flexibility to establish a branch, subsidiary or joint venture for efficiency reasons as well as to adapt to the different and unique marketplaces where they operate.  “How the company organizes itself should be a matter of preference, not regulatory fiat,” stated the Vice President and General Counsel of the American Insurance Association.


IAIS continues efforts to advance ComFrame


Work has continued on the significant and controversial efforts  by international regulators to develop new requirements for “internationally active insurance groups” (IAGS).  On June 12, the IAIS released a new working draft of its ComFrame paper, one of several drafts that are expected to be released prior to the next formal ComFrame consultation period that is now scheduled to begin in late October 2013.  On June 19, the IAIS’s Technical Committee held another in its series of “ComFrame Dialogues,” in which IAIS Observers are given the opportunity to comment on the status of the ComFrame project.  A presentation by IAIS staff on the ComFrame project was also made during the IAIS’s Global Seminar on June 18.  Based on remarks made during the ComFrame Dialogue and during a question and answer session at the Global Seminar, it is clear that a significant gulf continues to exist between most, if not all, industry representatives and some of the supervisors who are most influential in the development of ComFrame with respect to whether ComFrame should establish new capital adequacy/assessment standards for IAIGs.  Some view this as a step towards establishing  global capital standards and perhaps an effort by EU regulators to export Solvency II capital standards to other markets.  As noted above, the US industry, in particular, as well as other industry representatives, are strongly opposed to this.  Supervisors appear to be divided on this subject, even within the US, and the issue is an emerging flash point between FIO and the NAIC, as was mentioned in the Congressional hearings last week.


Field testing is important because the IAIS plans to conduct four years of field testing, beginning in 2014, before it finalizes ComFrame. A new subcommittee has been organized to oversee field testing and the Technical Committee solicited industry views regarding the early planning for field testing.  Commenters urged that the IAIS must have a transparent process in designing field testing, while at the same time protecting confidential information provided by insurance groups which participate in field testing.  The lack of transparency at the IAIS has historically been a source of frustration to interested parties and it remains to be seen how open the field testing design process will be.


The discussion about economic capital modeling was a direct result of a day-long “CRO-CFO Forum” the IAIS held in March.  Last week, interested parties urged the IAIS to adopt a principles based approach to economic capital modeling, to allow insurers to develop their own models, with supervisory review focused on the process used by insurers in building and conducting their models, and not to have ComFrame prescribe a model. This was generally well received by supervisors (although a handful of supervisors were resistant). At the end of the Dialogue the Technical Committee agreed to hold a day long workshop to discuss the topic, sometime during the next few months, probably in Washington, DC.


NAIC list of qualified jurisdictions to potentially expand


The NAIC is nearing completion of a significant component of their efforts to establish new collateral rules for non-US reinsurers.  As part of the new NAIC model credit for reinsurance standards, non-US reinsurers who are domiciled in “approved jurisdictions” are permitted to apply and be approved for reduced collateral standards, based on an assessment and rating of their financial strength.  As part of its efforts to implement these new standards, the  NAIC Reinsurance Task Force (E) (RTF) has been developing standards and procedures for review of the regulatory integrity of foreign jurisdictions. The RTF held a conference call last week to discuss a new draft of the “NAIC Process for Developing and Maintaining the List of Qualified Jurisdictions.”  The revised draft of the paper will be released for a 30-day public comment period on or before June 28, 2013.


The Chair of the RTF, Commissioner Michael Consedine (PA), highlighted the two main issues with the prior draft: (i) the application of expedited review procedure, and (ii) enforcement of US judgments.  With respect to the expedited review procedure, the new draft was revised to include language that allows for expansion of the expedited review jurisdictions beyond the four already approved by Florida and New York.  The revised draft paper will not include a specific list of expedited review jurisdictions, but the definition of an expedited review jurisdiction was revised to clearly allow for such expansion.  With respect to enforcement of US judgments, the new draft was not revised because enforcement of US judgments was already a criteria for evaluation.  The RTF, pledged to continue to evaluate the effect of the existing criteria to determine whether to reinforce it with stronger language. 


The RTF also addressed the following comments raised during the last public comment period:


  • information sharing and confidentiality concerns, especially with respect to European jurisdictions and more reliance on public information
  • allowance for public comment
  • the scope and discretion on on-sight reviews
  • streamline Appendices A & B to remove repetitive and unnecessary elements and make it more like the Examiners Handbook
  • outreach efforts to the European Insurance and Occupational Pensions Authority, other European jurisdictions and FIO to obtain their comments on the expedited review process 


The regulators are pushing hard to have a final draft prepared for adoption at the NAIC National Summer Meeting in Indianapolis.  After NAIC adoption, expedited review of at least a select number of jurisdictions will start soon thereafter.  Once the expedited review jurisdictions are completed, then the NAIC will move to review other jurisdictions for qualification. 


It is not yet clear how other countries will react to the prospect of being assessed by the US. Some have observed that the NAIC’s approved jurisdiction review process bears some resemblance to the Solvency II equivalence assessment process that US regulators found objectionable.  Nevertheless, US regulators have repeatedly expressed their happiness to work with EU regulators to develop a mutual understanding of each other’s regulatory systems and the hope is that this new review process will advance this understanding.


NAIC examining private equity and hedge fund activities in the insurance market following NYDFS probe


On a conference call held on June 6, 2013, the NAIC, upon the recommendation of the Financial Analysis (E) Working Group (FAWG), created a new working group to examine the trend of  investment managers, whether hedge funds or private equity firms, purchasing or reinsuring large fixed blocks of annuity businesses in order, FAWG suggests, to gain investment control over the corresponding reserves. 


The FAWG conference call was hosted by Rhode Island Insurance Superintendent Joseph Torti III, who chairs the Financial Condition (E) Committee (E Committee) and spurred much of the work on the captives and SPV oversight issues.  The FAWG unanimously voted to release for comment the May 6, 2013 memorandum proposing the new working group and outlining possible best practices and new procedures to address the market trend, including potentially changing the Credit for Reinsurance Model Law to provide regulators additional authority to require approval of transactions with non-affiliates and changing state investment laws to provide regulators more authority in limiting risks.  Pennsylvania’s Deputy Insurance Commissioner Steve Johnson’s, FAWG’s chair, commented that the group was trying to be proactive. 


The vote to establish the working group follows the NYDFS having subpoenaed several private equity firms with interests in buying fixed annuity companies or businesses.  Although Superintendent Lawsky sits on the E Committee and has a representative on FAWG, New York once again moved ahead of the NAIC, possibly (it has been reported) as a precursor to NYDFS development of enhanced regulations regarding private equity company purchase of annuity carriers.  NYDFS is concerned about the rapid growth of private equity firms in the fixed annuity market and the perceived short-term focus of private equity firms.  Superintendent Lawsky has asserted that “private equity firms typically manage their investments for three to five years,… they may not be long-term players in the insurance industry and their short-term focus may result in an incentive to increase investment risk and leverage in order to boost short-term returns.”  The proposed regulations may take the same direction as New York’s regulations on private equity acquisition of banks, which Superintendent Lawsky has described as designed, in part, to encourage long-term outlook on the industry.


On June 21, 2013, Sun Life Financial Inc. announced a delay in the closing of its disposition of its US annuities and certain life business due to the NYDFS having recently undertaken its review of private investor groups as owners of annuity businesses.  Sun Life noted that approvals had already been obtained from the Delaware Department of Insurance and the Financial Industry Regulatory Authority.


To find out more about the topics covered in this alert, please contact:


William Marcoux


David Luce


Peter Rice


Kathleen Birrane


Carla Small