Regulatory Update: NAIC Fall 2018 National Meeting

The National Association of Insurance Commissioners (NAIC) held its Fall 2018 National Meeting (Fall Meeting) in San Francisco, California, from November 15 to 18, 2018. This post summarizes the highlights from this meeting.

1. NAIC Continues its Evaluation of Insurers’ Use of Big Data

The NAIC is continuing its review of property and casualty insurers’ use of predictive modeling in rate filings and is developing related guidance materials for states to use in reviewing predictive models. The Casualty Actuarial and Statistical (C) Task Force exposed for public comment (until January 15, 2019) a draft white paper regarding insurers’ use of predictive modeling, which addresses: (a) the sources of data used by companies; (b) data points selected by companies as inputs for predictive modeling; (c) how the predictive models were developed and the results that they produce; and (d) final rate filings with states. The white paper identifies best practices currently used in a number of states and provides guidance for regulators in implementing those best practices.

2. NAIC Exposes Group Capital Calculation Field Testing Template For Public Comment

The Group Capital Calculation (E) Working Group (GCC Working Group) exposed the group capital calculation (GCC) field testing template and related instructions (Template) for a public comment period ending January 30, 2019. The Template is in furtherance of the NAIC’s efforts to develop an analytical tool for regulators to evaluate the financial condition of an insurance group through a U.S. GCC using a risk-based capital aggregation methodology. The initial round of field testing is anticipated to begin on March 1, 2019, and participation will be voluntary. The GCC Working Group emphasized that the Template is a preliminary draft that will be revised following its analysis of issues emerging from the field testing results.

To that end, the Template was designed to provide maximum flexibility and multiple testing criteria and options in order to analyze the impact of tentative possibilities for a GCC. For example, the Template allows for: (a) multiple grouping options (e.g., grouping based on the type of entity such as banking entities or asset managers); (b) exclusion of certain entities from its scope (e.g., certain entities within a group may be excluded based on lack of materiality); and (c) multiple adjustments (e.g., allowance of subordinated debt as additional capital and XXX/AXXX reserve adjustments).

Furthermore, there are no limits on the types of groups that may participate in the field testing (e.g., groups with non-U.S. and federal regulators may participate in order to provide additional perspectives). The GCC Working Group expects that the field testing will enable it to better evaluate, among other matters, whether: (i) the tentative possibilities for a GCC provide the desired result for the GCC; (ii) there are any unintended consequences; and (iii) any additional data points or factors need to be considered to serve the objective of the GCC.

3. IAIS Activities Update, Including Release of Draft Holistic Framework for Systemic Risk in the Insurance Sector for Public Consultation

On November 14, 2018, the International Association of Insurance Supervisors (IAIS) published its proposed Holistic Framework for Systemic Risk in the Insurance Sector (Holistic Framework) for a public consultation period ending January 25, 2019. The Holistic Framework seeks to assess and mitigate systemic risk in the insurance sector by focusing on an “activities” based approach. It recognizes that systemic risk may arise from not only the impairment of individual insurers but also the collective activities and exposures of insurers at a sector-wide level. Subject to any further refinements by the IAIS based on public comments, the Holistic Framework is slated for adoption in late 2019, with implementation beginning in 2020.

The Holistic Framework’s approach to systemic risk is “holistic” in three primary respects:

  • it takes into account both relevant sources of systemic risk (i.e., the first arising from the potential impact of effects resulting from the impairment of individual insurers, and the second arising from the spreading of shocks from solvent entities, through their collective risk exposures or responses to shocks);
  • it addresses cross-sectoral aspects of systemic risk by comparing the potential
    systemic risk of insurers with other parts of the financial system, notably the banking
    sector; and
  • it moves away from a binary approach whereby certain additional policy measures are only applied to a relatively small group of insurers (i.e., the specified Global Systemically Important Insurers) to an approach with a proportionate application of an enhanced set of policy measures to address activities and exposures that can lead to systemic risk targeted to a broader portion of the insurance sector.

The key elements of the Holistic Framework are as follows:

  • as the preemptive part of the framework, an enhanced set of supervisory policy measures for macroprudential purposes;
  • a global monitoring exercise by the IAIS designed to detect the possible build-up of systemic risk in the global insurance sector at an individual insurer level and a sector-wide level;
  • where a potential systemic risk is detected, supervisory powers of intervention that enable a prompt and appropriate response;
  • mechanisms designed to ensure the global consistent application of the framework, by having a collective assessment of potential global systemic risk and a coordinated supervisory response when needed; and
  • the IAIS’s assessment of the consistent implementation of enhanced ongoing supervisory policy measures and powers of intervention.

In addition to finalizing the Holistic Framework in 2019, the IAIS also plans to finalize the Common Framework for the Supervision of Internationally Active Insurance Groups and International Capital Standard Version 2.0, each of which will be in final field testing in 2019. Thereafter, as part of its strategic plan for 2020 through 2024, the IAIS plans to focus on emerging risks in the areas of FinTech/Big Data, Cybersecurity, Climate Change and Digital Inclusion (e.g., initiatives to ensure that all individuals, including those in disadvantaged and underserved communities, have access to and knowledge regarding the use of digital technology, including the Internet).

4. NAIC Seeks to Better Understand “Best Interest” Standard Proposed by Federal Regulators Before Finalizing Related Amendments to Suitability in Annuity Transactions Model Regulation

The Life Insurance and Annuities (A) Committee ((A) Committee) voted to expose for comment (until February 15, 2019) draft amendments to the NAIC’s Suitability in Annuity Transactions Model Regulation (SAT). Such vote occurred over objections made by both California and New York that consideration of the amendments by the (A) Committee was inappropriate in light of the fact that the Annuity Suitability (A) Working Group (ASWG), which was charged with drafting the amendments, had not officially voted to adopt the proposed amendments. During discussion, the Chair of the ASWG and the Chair of the (A) Committee explained that further federal regulation (from both the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Labor) is expected in 2019 with respect to the “best interest” standard and, in the interest of “harmonization between regulatory enforcers,” it might be necessary to pause the development of the amendments until the NAIC has further clarity around the proposed federal rules.

Notably, the draft amendments exposed for comment do not adopt a standard that expressly references the “best interest” of the consumer. By way of explanation, the ASWG added the following drafting note to the current version of the draft amendments: “[T]he NAIC is not yet convinced that this November 2018 Draft of the amended Suitability in Annuity Transactions Model Regulation (#275) is legally distinct from the enhanced standards that are intended by the SEC. Until such time [as] the NAIC can evaluate any distinction in the text of the SEC proposal between a “best interest” recommendation and investment adviser fiduciary duties, and the SEC and FINRA have finalized relevant terms, definitions and related requirements, the NAIC would opt to refrain from using the phrase ‘best interest’ in Section 6A(1) of the proposed modifications to the Suitability in Annuity Transactions Model Regulation (#275).”

As currently proposed, the amendments to the SAT would require a producer (or an insurer where no producer is involved), when making a recommendation to an individual consumer regarding the purchase, exchange or replacement of an annuity, to “act in the interests of the consumer at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interests.” Under the current draft, a producer (or insurer) would comply with this requirement (in relevant part) by: (a) “[a]cting with reasonable diligence, care, skill and prudence”; (b) making suitable recommendations (as further described in the SAT); and (c) making certain disclosures, including the cash and non-cash compensation to be received by the producer in connection with the transaction and “[a]ny and all material conflicts of interest.”

5. NAIC Considering Circumstances Where the Use of Indexes with Limited Lifespans Should be Allowed to Illustrate Fixed Index Annuities 

The Annuity Disclosure (A) Working Group (ADWG) is working on revisions to the Annuity Disclosure Model Regulation (#245) to allow for the use of indexes that have been in existence for less than 10 years in fixed index annuity illustrations. Such use is currently prohibited in states that have adopted the relevant portion of the current version of Model 245. In June 2018, the ADWG exposed for comment draft revisions to Model 245, which would allow illustrations to use an index in existence for less than 10 years, provided that: (a) the index satisfies certain other criteria (e.g., the index is comprised entirely of components that have been in existence for at least 10 years, the index value is calculated according to an algorithm that is not subject to discretion, and if the insurance company is affiliated with the index provider, indexes published by that index provider are also used by entities unaffiliated with the insurance company); and (b) certain disclosures accompany the illustration. Despite working on the issue for over a year, the ADWG has been unable to reach consensus regarding appropriate revisions. The ADWG has agreed to form a small drafting group to develop additional language for review and discussion. In light of this, the (A) Committee granted an extension of the model law development request to the Spring 2019 National Meeting.

6. NAIC Preparing Regulatory Guidance Regarding Changes to Life Risk-Based Capital Following Federal Tax Reform

The Capital Adequacy (E) Task Force approved changes to the life risk-based capital (RBC) formula in June 2018 to account for the effects of the 2017 Tax Cuts and Jobs Act, specifically focusing on changes to the RBC ratio denominator in order to reflect the corporate tax rate decrease from 35% to 21%. Such changes were subsequently adopted by the Financial Condition (E) Committee and Plenary. With the assistance of the American Academy of Actuaries, the Life Risk-Based Capital (E) Working Group (Life RBC WG) is preparing a guidance document for state regulators to use in evaluating companies’ year-end 2018 RBC ratios in light of tax reform and these recently adopted changes to the RBC factors and instructions. The purpose of the document is to serve as a starting point for future communications from the Life RBC WG to a broader group of state regulators in order to assist state regulators in interpreting the results of year-end 2018 life RBC calculations in light of tax reform.

7. NAIC Expected to Adopt Amendments to Credit for Reinsurance Model Law and Model Regulation

The Reinsurance (E) Task Force (Task Force) and the Financial Condition (E) Committee ((E) Committee) voted to adopt amendments to the NAIC’s Credit for Reinsurance Model Law and the Credit for Reinsurance Model Regulation (together, the CFR Model Laws) to implement reinsurance collateral reforms for reinsurers that meet certain conditions, as required in connection with the Bilateral Agreement Between the European Union and the United States of America on Prudential Measures Regarding Insurance and Reinsurance (Covered Agreement), which was signed by the U.S. and the EU in September 2017. The amendments are expected to be officially adopted by the NAIC during an upcoming meeting of the Executive Committee and Plenary on December 19, 2018.

The Covered Agreement prohibits a U.S. territory (i.e., state) from imposing any reinsurance collateral requirements upon a qualifying EU assuming reinsurer that would result in the EU reinsurer receiving less favorable treatment than assuming reinsurers domiciled in the state. As adopted by the Task Force and the (E) Committee, the amendments to the CFR Model Laws: (a) eliminate reinsurance collateral requirements for EU-based reinsurers meeting the conditions of the Covered Agreement; (b) extend similar treatment to reinsurers from other jurisdictions covered by potential future covered agreements; and (c) extend similar treatment to reinsurers domiciled in “reciprocal jurisdictions” that are not necessarily parties to existing or future covered agreements.

As adopted by the Task Force and the (E) Committee, the amendments to the CFR Model Laws would allow a U.S. ceding insurer to take 100% credit for reinsurance for transactions with non-U.S. reinsurers that meet all of the following requirements (in relevant part):

  • The assuming reinsurer has its head office, or is domiciled, in a “reciprocal jurisdiction.” A “reciprocal jurisdiction” includes: (i) any non-U.S. jurisdiction that has entered into a treaty or international agreement with the U.S. regarding credit for reinsurance; and (ii) any “qualified jurisdiction” (for certified reinsurer purposes) that is not a party to such an agreement with the U.S. and that satisfies certain requirements with respect to the treatment of U.S. reinsurers operating in such jurisdiction.
  • The assuming reinsurer maintains minimum capital and surplus (or its equivalent) of not less than $250 million.
  • The assuming reinsurer maintains a prescribed minimum solvency or capital ratio.
  • The assuming reinsurer agrees to be subject to U.S. jurisdiction for certain limited purposes and to make certain informational filings with state insurance departments.

In a comment letter regarding the draft amendments that were up for adoption by the Task Force, the European Union continued to express concerns regarding whether the proposed amendments to the CFR Model Laws were fully consistent with the requirements of the Covered Agreement. In response, the Chair of the Task Force stated that the position of the Task Force is that the proposed amendments are fully consistent with the Covered Agreement, and the Task Force has discussed the same with the Federal Insurance Office.

Other interested parties raised concerns with last-minute changes to the language regarding the effective date of the proposed amendments. The language used in the proposed amendments was copied from the Covered Agreement and the U.S. policy statement regarding the Covered Agreement, and reads as follows: “Credit under this subsection may be taken only for reinsurance agreements entered into, renewed, or amended on or after the date the commissioner has determined that the assuming insurer is eligible for credit, and may not be taken for reinsurance of losses incurred or reserves reported before that date. This subsection shall not apply to reinsurance agreements entered into before the subsection’s application, or to losses incurred or to reserves posted before the subsection’s application.” In explaining the changes, the Task Force stated that the intent is for the amendments to apply to reinsurance collateral requirements prospectively and that it would not be permissible to terminate an existing reinsurance agreement, enter into a new reinsurance agreement covering the same business, and apply the revised collateral requirements to such new agreement.

8. Receivership and Insolvency (E) Task Force to Consider Application of Warrantech Decision to Long-Term Care Products

The Receivership and Insolvency (E) Task Force (RITF) heard comments from interested parties regarding pending litigation in Pennsylvania related to whether the assets of the insolvent estates in the Penn Treaty/American Network liquidations can be used to pay benefit claims that accrued more than 30 days after the liquidation date and that exceed the applicable guaranty association coverage limits. At issue is the applicability of the Supreme Court of Pennsylvania’s decision in the case of Warrantech Consumer Products Services, Inc. v. Reliance Insurance Company in Liquidation (Warrantech), which held that the estate of an insolvent property and casualty insurer was not liable for service contract claims that arose 30 days after the order of liquidation of such insurer.

In applications currently pending before the Penn Treaty/American Network liquidation court, groups of health insurers asked the Penn Treaty/American Network liquidation court to apply the Warrantech decision to uncovered benefits that have accrued more than 30 days after the Penn Treaty/American Network liquidation date. Interested parties, including the American Council of Life Insurers, have asserted to RITF that it would be inappropriate to apply Warrantech to long-term care insurance or other life or health insurance products, which, unlike the property and casualty insurance claims at issue in Warrantech, are long-duration products. Comments from interested parties also suggest that the issue may be an anomaly of Pennsylvania’s receivership and insolvency laws, which do not include an on-point provision from the NAIC’s Insurer Receivership Model Act (#555) that distinguishes between the rule applicable to life, disability income, long-term care, health insurance and annuities and the rule applicable to other types of insurance.

After reviewing comments from interested parties, RITF determined not to take any action that could influence the outcome of the pending litigation in Pennsylvania. Instead, RITF decided to monitor developments in the pending cases and to research the extent to which the Pennsylvania statute at issue in Warrantech differs from similar laws in other states.

9. NAIC Considering Insurance Regulatory Issues Related to Legalized Cannabis Business 

The recently formed Cannabis Insurance (C) Working Group (Cannabis WG) met in person for the first time at the Fall Meeting to hear reports and presentations regarding the cannabis insurance industry. The Cannabis WG heard: (a) a panel discussion examining California as a case study in cannabis insurance; (b) an overview of the supply chain and architecture of the cannabis industry; and (c) a panel discussion on insurance coverage availability and gaps in coverage for cannabis businesses. Among other things, these presentations raised as issues the need for clarity between state and federal laws regarding the legality of cannabis and the regulation of cannabis and the cannabis insurance industry, as well as a need by the cannabis industry for greater access to the services of financial institutions and insurers. The Cannabis WG is in the process of drafting a white paper outlining issues and making recommendations for the development of related regulatory guidance. The Cannabis WG expects to have a draft of this white paper available for review during the NAIC’s Spring 2019 National Meeting.

10. NAIC Continues its Evaluation of Pet Insurance

The NAIC is evaluating the need for additional regulation with respect to pet insurance. At the Fall Meeting, the Property and Casualty Insurance (C) Committee ((C) Committee) exposed for comment a white paper, titled “A Regulator’s Guide to Pet Insurance,” which provides an overview of current regulations governing the pet insurance industry.

  • The states that participated in drafting the white paper were California, Colorado, Kansas, Louisiana, Maryland, Massachusetts, New Hampshire, Ohio, Rhode Island and Washington. The white paper identifies a number of regulatory concerns regarding the pet insurance industry, including, but not limited to:
  • whether a limited lines producer license should be available to sell pet insurance;
  • whether individuals involved in claims handling should also have an adjuster license;
  • whether pet insurance should be reported on a separate line in the statutory financial statements, rather than being included in inland marine (as it is currently);
  • marketing practices (e.g., use of insurer’s brand name instead of legal name, offering discounts and incentives); and
  • lack of pet-specific product data (e.g., premium and complaints).

The (C) Committee will continue to evaluate the pet insurance white paper in 2019, as the 2019 charges for the (C) Committee include the following: “Review findings in the pet insurance white paper and consider whether any additional regulatory activities are warranted, including the possibility of drafting a model law or guideline.”