Kramer Levin Naftalis & Frankel LLP

At the recent National Association of Insurance Commissioners (NAIC) Summer National Meeting held in Philadelphia from August 6, 2017, to August 9, 2017, the NAIC continued its work on group capital calculation standards, life insurance reserve financing and related issues.

At the meeting, the Reinsurance (E) Task Force adopted an accreditation standard for the Term and Universal Life Insurance Reserve Financing Model Regulation (Model No.787) and recommended to the Financial Regulation Standards and Accreditation (F) Committee that the standard become effective January 1, 2020, with “substantially similar” elements as outlined by the task force. A state would need to adopt Model No.787 in such “substantially similar” form in order for that state’s insurance department to maintain its accreditation with the NAIC.

By way of background, in December 2016, the NAIC adopted the Term and Universal Life Insurance Reserve Financing Model Regulation (Model No.787), a codification of Actuarial Guideline 48. Model No.787 establishes standards governing reserve financing arrangements pertaining to term life and universal life insurance policies with secondary guarantees (ULSG). Model No.787 also includes provisions to ensure that funds held backing these captive reinsurance transactions — which consist of “primary” and “other” security — are sufficient. Model No.787 is a response to the balance sheet strain imposed by Regulation XXX/AXXX and its overly formulaic reserving imposed on in-force term and ULSG policies and also places additional checks and balances on the quality of assets being used to reserve for these liabilities in financing contexts.

Also at the meeting, the Accreditation Committee was briefed on the Reinsurance Task Force’s efforts on Model No.787. In a recent memorandum, delivered August 24, 2017, by the Reinsurance Task Force to the Accreditation Committee, the task force formally submitted the accreditation standard and provided further elaboration on the “substantially similar” standard to be established. The August 24 memorandum explains that the drafting notes for the authorizing model law (i.e., Model No.785, the basic Credit for Reinsurance Model Law) included the stronger review standard of “substantially similar in all material respects” (emphasis added) for that particular model. In light of this heightened standard for the older model, the memorandum recommends that the NAIC legal division “note any material changes in a state’s [version of Model No.787] during an accreditation review for consideration by the Financial Regulation Standards and Accreditation (F) Committee.” The task force recommended to the Accreditation Committee that the accreditation standard become effective on an expedited basis beginning January 1, 2020.

The Group Capital Calculation (E) Working Group discussed a previously exposed memorandum that outlines possible approaches to designing group capital standards for U.S. insurance groups. In particular, the working group is focusing on insurers within such groups that, unlike typical insurers, do not prepare risk-based capital, or RBC, calculations (the conventional, entity-specific capital benchmark used by the states). Captives are the principal universe of insurers that fall into this category of insurers to which RBC does not apply, although the working group is mainly concerned with captives set up to finance life insurance reserves rather than “pure” captives used as self-insurance type mechanisms.
The working group also tentatively agreed with the memorandum’s proposal that, for purposes of the group capital calculation, captives that do not assume XXX/AXXX business be required to complete an RBC calculation for purposes of rolling up into the group capital calculation of its group, using their own basis of accounting with certain adjustments related to asset and liability valuation. Most of the comments received in response to the memorandum related to captives that do assume XXX/AXXX business. In order to solicit more information, the working group exposed a revised version the memorandum with the five specific inquiries set forth below directed to relevant interested parties and set a 30-day comment period: 

  • For captives that assume XXX/AXXX business, should assets backing XXX/AXXX reserves receive credit in the group capital calculation only when they are admissible under NAIC statutory accounting principles?
  • Should existing captives be allowed to utilize “principle-based reserving” (PBR), the more discretionary reserving regime coming into effect in place of XXX/AXXX, when calculating reserves for both new business and business that was in force prior to Jan. 1, 2017? (PBR itself as a reserving tool generally applies only to new business.)
  • Should the direct writer of business ceded to a captive be allowed to utilize PBR on both new and in-force business?
  • Should the direct writer be allowed to use PBR on both new and in-force business, regardless of whether the business is retained by the insurer, ceded to a reinsurer or captive insurer, or otherwise financed?
  • How should policies that are “grandfathered” under the “NAIC XXX/AXXX framework” be treated in the group capital calculation? (This appears to refer to grandfathering under Model No.787, a concept under which policies ceded under certain types of legacy reinsurance relationships are not subject to the new credit-for-reinsurance rules.)

Meanwhile, the NAIC’s actions on group capital come at a time when efforts on such issues internationally are heating up as well. In late July, the International Association of Insurance Supervisors (IAIS) issued its “Risk-based Global Insurance Capital Standard Version 1.0 for Extended Field Testing” on its ongoing development of a group capital framework for internationally active insurance groups. The document introduces its third quantitative field testing of this capital benchmark (known as Insurance Capital Standard 1.0 or ICS 1.0), with data to be collected in September. While the paper is not a “consultation document,” stakeholders are invited to provide feedback. By the end of 2019, a more advanced version of the standard, ICS 2.0, is expected to be adopted within the IAIS’ “common framework,” or ComFrame, its broader umbrella project for financial regulation of insurers generally.

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