"Hot fun in the summertime": insurance regulatory activity heats up

by DLA Piper
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The now iconic song of 1969 aptly describes the insurance regulatory activity we are seeing in the summer of 2013.

During the last two weeks of July, the International Association of Insurance Supervisors (IAIS) announced new standards for regulation of G-SIIs, including releasing the initial list of insurance group G-SIIs; the National Association of Insurance Commissioners (NAIC) officially adopted a number of initiatives relating to captive insurance transactions; and the New York Department of Financial Services (NYDFS) moved forward with its scrutiny of private equity and hedge fund investments in insurance by imposing higher policyholder protection standards in a private equity acquisition.

These activities are summarized below.

1.         IAIS ANNOUNCES NEW STANDARDS FOR THE REGULATION OF G-SIIS; THE FINANCIAL STABILITY BOARD NAMES INITIAL G-SIIS

On July 18, the IAIS issued final guidance regarding the methodology to be used by the Financial Stability Board (in conjunction with the IAIS) to determine which global insurers are considered to be systemically important (Globally Systemically Important Insurers: Initial Assessment Methodology) and regarding the framework of policy measure that should be applied to insurers that are determined to be Globally Systemically Important Insurers (G-SIIs) (Globally Systemically Important Insurers: Policy Measures).

Almost immediately after IAIS’s action, the FSB announced an initial list of insurance groups that are considered to be G-SIIs.  The list will be updated each year in November, starting in 2014.

All three of these announcements sparked controversy.

The final IAIS determination methodology is considered by many to be too bank-centric.  The IAIS has adopted an “Indicator-based assessment approach”  that it readily acknowledges is based on the Basel Committee for Banking Supervision’s methodology for evaluating systemically important banks.

The IAIS asserts that its methodology takes into consideration that “the traditional business model is different from banking”.  Indeed, one of the factors considered in the IAIS methodology is the amount of “non-traditional and non-insurance activities” that an insurer engages in.  However, the IAIS’s methodology also considers indicators related to “size,” “global activity,” “interconnectedness” and “substitutability.”  Within these five categories are 20 “indicators” (e.g., total assets and revenue, revenue outside home country, intra-financial assets and liabilities, amount of derivatives outstanding and derivatives trading, amount of financial guarantee insurance issued and intra-group commitments) that the IAIS has determined bear some relationship to the degree to which an insurance group may be systemically important.

The IAIS assesses these indicators by assigning a 5 percent weight to the size, global activity and substitutability categories, a 40 percent weight to interconnectedness and a 45 percent weight to non-traditional and non-insurance activities.

Serious questions remain, however, with respect to how the IAIS and the FSB applied this methodology to come up with the nine insurance groups that have been designated G-SIIs, with most of such criticism being directed at the notion that size and global activity should be irrelevant if an insurer is engaged only in traditional insurance activity.

In addition, reportedly, insurance groups were ranked by the IAIS and the FSB in order of their perceived systemic importance relative to other insurers, but were not compared with the systemic importance of banks.  The leadership of the NAIC issued a press release calling this approach into question, saying “understanding whether the most systemically risky insurer (by virtue of its nontraditional insurance activities) is still less risky than the least systemically risky bank, is relevant before making a designation and recommending additional requirements that will bifurcate the market.”

Turning to those “additional requirements that will bifurcate the market,” the IAIS’s newly announced policy measures are also based on work that has already been done with respect to the oversight of systemically important banks.  The IAIS’s measures consist of the following three main types: (i) Enhanced Supervision; (ii) Effective Resolution; and (iii) Higher Loss Absorption (HLA) Capacity.

The HLA proposal is clearly the most contentious element of the IAIS’s policy measures, because the application of capital requirements to G-SIIs feeds into related concerns by many that the IAIS and the FSB are pushing too aggressively for new substantive standards governing the capital of all large globally active insurance groups.  Ominously to some, in announcing the initial list of nine G-SIIs, FBS Chairman Mark Carney said that “a sound capital  framework for the insurance sector is essential for supporting financial stability.”  The IAIS echoed this statement and declared that it will prepare by October 2013 a workplan to develop a quantitative capital standard in conjunction with its work on ComFrame.

2.         NAIC EXECUTIVE AND PLENARY ACTS ON CAPTIVE TRANSACTION PEER REVIEW, CAPTIVE AND SPECIAL PURPOSE VEHICLE WHITE PAPER AND RECOMMENDATIONS; PRINCIPLES-BASED           RESERVING AND CORPORATE GOVERNANCE

On July 26, the NAIC held a joint Executive Committee and Plenary teleconference, one week after committee and working group activities advanced proposals on such hot-button topics as captive and special purpose vehicle transactions, principles-based reserving (PBR) and corporate governance.

The committee adopted the proposals on the agenda with little discussion despite the participation of more than 100 attendees on the teleconference, including representatives from 47 jurisdictions. This suggested to some that, as is often the case, the NAIC kept any disagreements among regulators behind closed doors.  Public comment was not requested on any agenda items.

A brief summary of the action taken by the NAIC follows:

 (a)       Captives white paper and captive transaction peer review

            The Committees adopted the Captives and Special Purpose Vehicles white paper the NAIC has been working on for over a year and assigned many of its recommendations to a newly-formed Captive Working Group that will report to the Principle-Based Reserving Implementation Task Force.  Implementation of other recommendations in the White Paper were assigned to the Reinsurance Task Force.

Time may tell, though, that the most important action taken during the conference call regarding captives was the approval of new charges to Financial Analysis Working Group (FAWG), regarding peer review of XXX and/or AXX transactions related to the use of captives in life insurance reserve financing transactions.  (The FAWG is a standing NAIC working group tasked with analyzing financially troubled nationally significant insurers and addressing various matters related to solvency.)

The new charges for the FAWG are:

 (i)        Perform analytical reviews of new transactions by nationally significant US life insurers to reinsure XXX and/or AXXX reserves with affiliated captives, special purpose vehicles, or any other US entities that are subject to different solvency regulatory requirements than the ceding life insurers, to preserve the effectiveness and uniformity of the solvency regulatory system

 (ii)       For such transactions that have already been entered into and approved, collect specified data in order to provide regulatory insight into the prevalence and significance of these transactions throughout the industry and

 (iii)      Provide recommendations to the domiciliary state regulator to address company specific concerns and to the PBR Implementation Task Force to address issues and concerns regarding the solvency regulatory system.

It was reported that the proposal to conduct peer review of captive transactions emerged during the Commissioners’ retreat held two weeks prior to last Friday’s conference call.  Some regulators have since expressed concern about the storage of data at the NAIC; whether states would be ceding authority to the FAWG; and the ability of the FAWG to implement practical and efficient peer review of XXX and AXXX transactions.  States with a statutory limited time period in which to review such transactions, such as Indiana, were particularly concerned that peer review would pose problems if it delayed regulatory decision-making.

Regulators who supported the proposal, including Commissioner Dave Jones (CA), raised the specter of federal oversight of these transactions if the NAIC did not act because of the need to study the transactions, referencing the New York Department of Financial Services recent call for a moratorium on such transactions.  Superintendent Joseph Torti III (RI) assured the committees that peer review by the FAWG would be voluntary on the part of the domestic regulator and was not meant to serve as a substitute for state review, that the FAWG had the capabilities to review the transactions efficiently, and that he would be personally involved in peer reviews to ensure specified evaluation criteria would be followed and the peer review would not complicate a state’s review of a transaction.

Delaware was the only jurisdiction to object to the new FAWG charges.

 (b)      PBR Implementation Task Force charges and working groups

During the conference call, new charges were assigned to the PBR Reserving Implementation Task Force, including creating the PBR Review Working Group and adopting new charges for committees, task forces, working groups and subgroups from the PBR Implementation Plan.  The PBR Implementation Task Force’s mission has been to serve as the coordinating body with all NAIC technical groups involved with projects related to the PBR initiative.

(c)        Initiative to adopt a corporate governance model act and model regulation

Finally, the NAIC approved a request for a new model law proposed by the Corporate Governance Working Group (CGWG).  The proposed new model law is intended to facilitate an annual collection of confidential information about insurers’ corporate governance practices and is a result of a white paper regarding corporate governance that was completed by the CGWG earlier this year.  The CGWG determined that the most direct, effective, and confidential way to collect corporate governance information on a regular basis would be through the development of a new model law.  Supporters of the proposed new model law intend that it will eventually become an accreditation standard.

3.         REGULATORY INTEREST IN PRIVATE EQUITY FIRMS CONTINUES TO SURGE AS NEW YORK MOVES FORWARD IN REGULATING PRIVATE EQUITY TRANSACTIONS

We reported in a June 26, 2013 client alert that the FAWG had issued a memorandum regarding the increased interest by private equity firms and hedge funds in investing in insurance companies, particularly annuity writers.  The FAWG expressed concerns in that memorandum that the interests of private equity investors and hedge funds may not be aligned with the interests of annuitants and beneficiaries when the funds own controlling shares of an insurer and can therefore manage the insurer’s assets.  The memorandum contains a list of “Possible Best Practices” that regulators should consider to address these issues, including factors related to reviews of Form A filings.  On July 17, 2013, the NAIC’s Financial Conditions Committee supported the FAWG’s recommendations and unanimously voted to create the new “Private Equity Issues Working Group.”  Deputy Commissioner Doug Stolte (VA) was named chair of the working group.

Although this new working group has yet to meet, the New York Department of Financial Services has already taken steps on its own to implement various of the recommendations related to Form A reviews.  On July 31, New York announced that Guggenheim Partners LLC has agreed to put in place “a set of heightened policyholder protections” as part of its planned acquisition of Sun Life Insurance and Annuity Company of New York (Sun Life New York).  According to the DFS press release, “these policyholder protections include heightened capital standards; the establishment of a separate, additional ‘backstop’ trust account dedicated to further safeguarding policyholder claims; enhanced regulatory scrutiny of investments, operations, dividends, and reinsurance; and other strengthened disclosure and transparency requirements.

Guggenheim will maintain Sun Life Risk-Based Capital Levels (RBC Levels) at an amount not less than 450 percent and will establish a separate backstop trust account, held separately for at least seven years and dedicated to the sole purpose of protecting policyholders, totaling US$200 million.  This backstop is extremely large for a company with a 2012 capital and surplus of approximately US$349 million.

Given the publicity surrounding this issue, this is likely to be the new normal for parties seeking to acquire life insurers.

The NAIC’s Summer National Meeting will be held on August 24 – 27.  Maybe the weather will be not quite so warm as it has been so far this summer.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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