The purpose of insurance regulation is to protect policyholders through the provision of tools to ensure that companies operate in accordance with acceptable standards of corporate governance, financial strength and market conduct...
The purpose of insurance regulation is to protect policyholders through the provision of tools to ensure that companies operate in accordance with acceptable standards of corporate governance, financial strength and market conduct. This promotes efficient, safe, fair and stable insurance markets that, in turn, encourage growth and competition in the sector.
Over many years, US regulators have developed a detailed and uniform financial regulatory system. In the early 1990s, the National Association of Insurance Commissioners (NAIC) Solvency Policing Agenda resulted in a number of major changes to financial regulation (eg, RBC, accreditation, FAST system, FAWG), which provided more early warning systems and standards for regulation. There has been continuous improvement over the past 20 years resulting in many enhancements (eg, model audit rule, risk-focused exams, uniform statutory accounting model). However, global and national developments made it clear that the US insurance regulatory system was due for another comprehensive review, which led us to the Solvency Modernisation Initiative (SMI).
Launched in 2008, the SMI task force was charged with performing a critical self-examination of the US’s insurance solvency regulation framework and a review of international developments regarding insurance supervision, banking supervision, and international accounting standards and their potential use in US insurance regulation. While US insurance solvency regulation is updated on a continuous basis, the SMI task force focused on five key solvency areas: capital requirements, international accounting, insurance valuation, reinsurance, and group regulatory issues with an objective to ultimately improve the US solvency system.
The State of Missouri has been an active participant in the SMI as Missouri’s insurance director John Huff served as the last appointed chair of the national SMI task force that spearheads this initiative. Having spent 11 years as an executive with leading insurers and reinsurers, including Swiss Re and GE Insurance Solutions where he led global teams, director Huff was uniquely qualified for this position.
From the start, SMI’s objective has been to improve solvency regulations in the US and implement best practices from around the world. US insurance regulators believe that well-executed risk management improves a company’s chances of continuing to operate in a strong and healthy manner. A further uniformly accepted belief is quantitative analysis should improve the regulator’s ability to assess when a company is in a hazardous financial condition, assist with risk-focused examinations, and aid in evaluating the industry’s overall ability to withstand certain stresses.
The US solvency framework is a national system of state-based financial regulation that relies on an extensive system of peer review through an accreditation programme, communication and collaborative effort that produce checks and balances in regulatory oversight and ensures all states meet uniform requirements.
Financial solvency core principles underlie the active regulation that exists today. A core principle is an approach, a process, or an action that is fundamentally and directly associated with achieving the mission. Seven core principles have been identified for the US insurance regulatory system, including: (i) regulatory reporting, disclosure and transparency; (ii) off-site monitoring and analysis; (iii) on-site risk-focused examinations; (iv) reserves, capital adequacy and solvency; (v) regulatory control of significant, broad-based risk-related transactions and activities; (vi) preventive and corrective measures, including enforcement; and (vii) exiting the market and receivership.
Solvency modernisation in the US
As mentioned previously, the SMI has focused on five key solvency areas: capital requirements, international accounting, insurance valuation, reinsurance, and group regulatory issues, which for the purpose of discussion can be grouped into the categories of corporate governance, own risk and solvency assessment (ORSA), group solvency, principle-based reserving and credit for reinsurance.
Corporate governance
After performing a comparative analysis of existing requirements to regulatory needs and international standards, the NAIC developed a number of specific enhancements. The proposed enhancements do not prescribe a list of explicit governance requirements, but instead seek to gain a better understanding of an insurer’s governance practices and to use that information to modify supervisory monitoring accordingly.
These proposed enhancements have led to the development of a new model law to facilitate the annual collection of confidential information on insurers’ corporate governance practices. The development of the Annual Reporting of Corporate Governance Practices of Insurers Model Act provides a means for regulators to get a better understanding of the governance practices of their domestic insurers. The development of this model law also ensures the confidentiality of governance information collected from insurers and assists US regulators in achieving greater consistency with international standards.
The NAIC adopted the Risk Management and ORSA Model Law in September 2012 and the initial ORSA Guidance Manual in March 2012. The regulators completed pilot projects in 2012 and 2013 to study ORSA Summary Reports to improve the ORSA Guidance Manual. The 2014 ORSA pilot project is currently underway. Presently, 20 states have adopted the model law in full or part with legislation under consideration in five states.
The ORSA is an insurer’s own process for assessing its risk profile and the capital required to support its business plans in normal and stressed environments on a forward-looking basis. The guidance manual requires insurers or insurance groups to carry out this risk and solvency assessment process on a regular basis.
The ORSA is also a regulatory filing: on an annual basis, insurers will be required to provide a regulatory filing that explains their ORSA process and results. The filing does not have a prescribed format but needs to contain three sections: (i) description of enterprise risk management (ERM) framework; (ii) assessment of risk exposure under normal and stressed environments; and (iii) group capital adequacy and prospective solvency assessment.
A description of ERM framework would include the following key ERM elements: (i) risk culture and governance structure; (ii) risk identification and prioritisation; (iii) risk appetite, tolerances and limits; (iv) risk monitoring and control; and (v) risk reporting and communication process.
Further, an explanation of how the insurer identifies and categorises the relevant and material risks as it executes its business strategy is mandatory. Documentation of assessment tools used to monitor and respond to risk profile change due to changes in environment, operation and business strategy, and documentation of critical risk management policies and procedures are also required.
Each material risk category identified would need to be assessed and both quantitative and qualitative assessments of risk exposures in both normal and stressed environments would need to be detailed. Explanations of assessment methods used, key assumptions made and outcomes of any plausible adverse scenarios would need to be included and considerations of stress impact on available capital and required capital under regulatory, economic and rating agency would need to be detailed. Additionally, rationale of how risk tolerances and limits are determined and documentation of model validation, model calibration and assumption setting process would also need to be provided.
The group capital adequacy and prospective solvency assessment must include an evaluation of insurance group level available capital versus risk capital under different scenarios, lenses, time horizons and valuation approaches. Considerations of intra-group transactions, diversification benefits, contagion risk and liquidity risk must be noted.
The capital assessment should be tied to the business planning and consider normal and stressed scenarios over a two to five year timeframe and forecasting should consider relevant and foreseeable changes to insurer’s internal operations and external business environment. This assessment must also demonstrate the link between business strategy and the amount and quality of capital needed to support the business strategy.
Group solvency/supervision
The solvency framework of state insurance regulation has included a review of the holding company system for decades, including approval of certain affiliate transactions with a domestic insurer, but with emphasis placed on taking actions to protect the legal insurance entity writing the policies.
The NAIC adopted revisions to its Model Insurance Holding Company System Regulatory Act and Regulation in 2010 to enhance the ‘windows and walls’ approach to group supervision.
The revisions call for enterprise risk reporting at the ultimate controlling entity level, enhanced regulator access to data and information from non-insurance operations, clear authority to participate in supervisory colleges, and enhanced information sharing between regulators.
The Insurance Holding Company System Regulation has been adopted in full or part in 14 states and is under consideration in another six states while the Model Insurance Holding Company System Regulatory Act has been adopted in full or part in 38 states, with legislation under consideration in six states.
Principle-based reserving
The purpose of principle-based reserving (PBR) is to replace the existing formulaic reserve requirements with a model based framework, to improve accuracy of reserves and to account for continuously evolving products that constantly make the formula outdated. Outdated formulas can result in reserves too high or too low. Reserves that are too high create unnecessary surplus drain. Reserves that are too low create insolvency risk for the insurer and policyholders.
The model Standard Valuation Law (SVL) establishes requirements for PBR valuation and what the valuation manual must provide. The valuation manual is to include all reserve requirements for life and health companies including details of PBR and non-PBR reserve methodologies. The valuation manual was adopted by the NAIC in December 2012.
Eighteen states have adopted the amended SVL and valuation manual. Implementation of PBR will only occur when at least 42 states (writing at least 75 percent of life insurance premium) have adopted the amended SVL and valuation manual.
Actuarial Guideline (AG) 48 is currently under development and is a PBR-based solution to address standardisation concerns with insurer’s use of captives to finance life reinsurance reserves through captives.
Credit for reinsurance
Reinsurers licensed in the US are directly regulated through financial regulation (similar to primary insurers). In addition to direct financial regulation of licensed reinsurers, the US uses an indirect approach to reinsurance financial supervision through statutory accounting requirements for US primary companies (or “ceding” companies) that transfer business via reinsurance.
Revised reinsurance model laws (#785 and #786) were adopted in November 2011. These revisions serve to reduce reinsurance collateral requirements for non-US licensed reinsurers that are licensed and domiciled in qualified jurisdictions. Seventeen states have adopted both #785 and #786, six states have taken up only #785, and five states are presently considering legislation related to the two model acts.
Generally, the following changes are expected through the adoption of these model laws: potential collateral reduction for reinsurers meeting certain financial strength and business practices; and reduced collateral requirements for assuming reinsurers that are not otherwise licensed or accredited in a state, but have been “certified” as reinsurers by the state.
A certified reinsurer is one domiciled in a ‘qualified jurisdiction’ and that meets other criteria relating to capital and surplus, financial strength ratings and other matters. Foreign jurisdictions will be treated as qualified jurisdictions if they meet standards as to ‘appropriateness and effectiveness’ of the reinsurance supervisory system of the jurisdiction. Individual states must designate each qualified jurisdiction or can rely on the NAIC list.
The NAIC will produce a list of qualified jurisdictions. In 2013, the NAIC conditionally approved the supervisory authorities in Bermuda, Germany, Switzerland and the UK. This year, the NAIC is considering full approval for these jurisdictions as well as Japan, Ireland and France.
Additionally, work is underway to standardise the initial and renewal requirements for certified reinsurers in these jurisdictions as well as an efficient process where reinsurers may be ‘passported’ as a certified reinsurer through an abbreviated filing process in other states upon review by the NAIC’s reinsurance financial analyst working group.
The globalisation of insurance makes it clear that insurance supervisors around the world need to provide well-defined and unambiguous guidance to afford the financial system with a pillar of stability and consumers with peace of mind.
The role of insurance supervisors has never been more critical. They need to work with present supervisory systems rather than thinking new globalised standards can be used to dramatically reshape those established under existing law.
As we move forward on these solvency issues, practical and implementable change should be evolutionary, not revolutionary. Further, the work done by insurance supervisors must be credible and therefore transparent. Transparency is critically important in developing the national and global response to financial stability.
As insurance regulators, it is important to recognise the specific nature of the insurer and the risks posed. The most efficient supervisory regime tailors its approach so that policyholders are protected and financial stability is maintained, without applying regulation that, with regard to the nature of the company, is unnecessary and may hinder the efficiency of the market.
Insurance supervisors should take the necessary time to develop standards appropriate to the insurance industry, and resist the pressure to homogenise regulation to treat all products the same. It should be well recognised that confidence in the integrity of insurance regulation must be maintained in order to ensure the viability of the industry.
