The National Association of Insurance Commissioners (NAIC) held its Summer 2023 National Meeting (Summer Meeting) from August 12–16, 2023. Highlights include continued development of accounting principles and investment limitations related to certain types of bonds and structured securities, continued discussion of considerations related to private equity ownership of insurers, a proposed model bulletin addressing the use of artificial intelligence by the insurance industry, and continued development of a new consumer privacy protections model law.
1. NAIC Progresses Revisions to Statements of Statutory Accounting Principles Relating to Investments
At the Summer Meeting, the Statutory Accounting Principles (E) Working Group (SAP Working Group) adopted revisions to Statement of Statutory Accounting Principles (SSAP) No. 26R — Bonds, SSAP No. 43R — Loan-Backed and Structured Securities, and other related SSAPs in connection with its principle-based bond definition project (Bond Project). The SAP Working Group also adopted a limited-time interpretation to allow insurers to admit up to a specified percentage of negative interest maintenance reserve (IMR) under SSAP No. 7 — Asset Valuation Reserve and Interest Maintenance Reserve. The SAP Working Group also reexposed changes to SSAP No. 21R — Other Admitted Assets with respect to accounting for debt securities that do not qualify as bonds under the new bond definition and revisions to clarify that any pledged collateral must qualify as an admitted invested asset in order for a collateral loan to be admitted and to require the use of net equity value for valuation assessments when the pledged collateral is in the form of partnerships, limited liability companies, or joint ventures.
a. NAIC Adopts Revisions to Statements of Statutory Accounting Principles as Work Continues on Principle-Based Bond Definition Project
At the Summer Meeting, SAP Working Group adopted revisions to SSAP No. 26R, SSAP No. 43R, and other related SSAPs in connection with the Bond Project but reexposed for comment the revisions to SSAP No. 21R with respect to accounting for debt securities that do not qualify as bonds under the new bond definition.
The adoption of these revisions marks a significant milestone in the SAP Working Group’s Bond Project, which began in October 2020 through the development of a principle-based bond definition to be used for all securities in determining whether they qualify for reporting on Schedule D-1. Within the bond definition, bonds are classified as an “issuer credit obligation” or an “asset backed security.” An “issuer credit obligation” is defined as a bond where repayment is supported by the general creditworthiness of an operating entity, and an “asset backed security” is defined as a bond issued by an entity created for the primary purpose of raising capital through debt backed by financial assets. The revisions to SSAP No. 26R reflect the principle-based bond definition, and SSAP No. 43R provides revised accounting and reporting guidance for investments that qualify as asset-backed securities under the revised bond definition.
NAIC staff have drafted updates to a proposed statutory issue paper entitled “Principles-Based Bond Definition” that details the discussions and directions in developing the bond definition and resulting guidance to date, which the SAP Working Group exposed for comment until September 29, 2023.
In connection with above changes, the SAP Working Group has also proposed revisions to SSAP No. 21R that provide guidance for the accounting for debt securities that do not qualify as bonds as well as proposed measurement guidance for residual tranches. For debt securities that do not qualify as bonds, the revisions clarify that if the primary source of repayment is derived through underlying collateral, the investment will be admitted only if the underlying collateral itself qualifies as admitted invested assets. For residual tranches, if the reporting entity holds a debt tranche from the same securitization, and the debt tranche does not qualify as a bond (i.e., either an issuer credit obligation or asset-backed security), and the debt security does not qualify as an admitted asset under SSAP No. 21R, then the residual tranche also will not qualify as an admitted asset. The revisions to SSAP No. 21R also include a proposed new measurement method for residual tranches, which requires all cash flows received to be treated as a return of principal until the book-adjusted carrying value is zero. At that point, further cashflows received would be treated as interest income. The SAP Working Group has requested comments on the proposed measurement method for residual tranches in general and also for individual types of residual tranches. Comments on the revisions to SSAP No. 21R are also due September 29, 2023.
The revisions to SSAP Nos. 26R and 43R, as well as the proposed revisions to SSAP No. 21R (once adopted), will be effective January 1, 2025. As the SAP Working Group has noted, investments that do not qualify as bonds after such revisions are adopted will not be permitted to be reported as bonds on Schedule D-1 thereafter as there will be no grandfathering for existing investments that do not qualify under the revised SSAPs. However, certain accommodations may be made to prevent undue hardship for reporting entities complying with the new guidance.
b. NAIC Adopts Interim Guidance to Permit the Admittance of Negative Interest Maintenance Reserve
The SAP Working Group adopted INT 23-01T — Net Negative (Disallowed) Interest Maintenance Reserve, an interpretation of statutory accounting principles that provides optional, limited-term guidance for the admittance of net negative (disallowed) IMR under SSAP No. 7 for up to 10% of adjusted general account capital and surplus. An insurer’s capital and surplus must first be adjusted to exclude certain “soft assets” including net positive goodwill, electronic data processing equipment and operating system software, net deferred tax assets and admitted net negative (disallowed) IMR. An insurer will only be permitted to admit the negative IMR if the insurer’s risk-based capital (RBC) is over 300% authorized control level after adjustment to remove the assets described above.
As adopted, negative IMR may be admitted first in the insurer’s general account and then, if all disallowed IMR in the general account is admitted and the percentage limit is not reached, to the separate account proportionately between insulated and noninsulated accounts. There is no exclusion for derivatives losses included in negative IMR if the insurer can demonstrate historical practice in which realized gains from derivatives were also reversed to IMR (as liabilities) and amortized.
INT 23-01T will be effective through December 31, 2025, but may be nullified earlier or extended based on actions by the SAP Working Group to establish specific accounting guidance on net negative (disallowed) IMR to serve as a long-term solution. In connection therewith, the SAP Working Group also voted to form an ad hoc subgroup to work on developing such guidance.
c. NAIC Working Group Continues Discussion on SSAP Changes Related to Collateral for Loans
The SAP Working Group agreed to extend the exposure of proposed revisions to SSAP No. 21R, which require audits of investments governed by SSAP No. 48 — Joint Ventures, Partnerships, and Limited Liability Companies and SSAP No. 97 — Investments in Subsidiary, Controlled, and Affiliated Entities if pledged for collateral loans to specifically consider whether fair value or book value should be used for purposes of determining the collateral coverage.
The SAP Working Group initially exposed revisions to SSAP No. 21R in December 2022 to clarify that invested assets pledged as collateral for admitted collateral loans must themselves qualify as admitted invested assets. Under the proposed revisions, when the collateral pledged to secure a collateral loan would be in the scope of SSAP No. 48 or SSAP No. 97 if held directly by the reporting entity, such as a joint venture, partnership, or limited liability company or a subsidiary controlled or affiliated entity, audited financial statements are required for the collateral (and thus the collateral loan) to qualify as an admitted asset. The proportionate audited equity valuation (or “book value”) must be used for the determination of the adequacy of pledged collateral. If the collateral loan exceeds the audited book value of these pledged investments, then the excess must be nonadmitted.
While interested parties were generally in support of the changes as most recently exposed by the SAP Working Group, one interested party provided comments specifically with respect to the portion of the guidance that would require insurers to use book value when testing the sufficiency of the collateral, asking the SAP Working Group to revise the exposure to allow reporting entities to make an accounting policy election, applied consistently and across all applicable collateral loans, to use either fair value or book value when performing the collateral test.
Although members of the SAP Working Group disagreed with the proposal to allow insurers to make an accounting policy election and were eager to finalize the proposed revisions to SSAP No. 21R, the SAP Working Group did agree to extend the exposure for an additional 30 days to allow industry members additional time to submit comments regarding the measurement of collateral pledged from SSAP No. 48 and SSAP No. 97 entities. Comments are due by September 12, 2023.
2. NAIC Continues Progress on its Review of Ratings for Insurer Investments
a. NAIC Discusses Proposed Amendment to Update Definition of NAIC Designation
The Valuation of Securities (E) Task Force (VOS Task Force) continued its discussion on a proposed amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) that would, if adopted, consolidate the instructions defining an NAIC designation (NAIC Designation) and address questions and concerns raised over the years as to the purpose of an NAIC Designation versus credit rating provider (CRP) ratings.
The NAIC has stated that the reason for these clarifications is that the P&P Manual, as currently formatted, has led to the interpretation that there are two different meanings of an NAIC Designation, one of which is applicable to all securities whether assigned an NAIC Designation pursuant to the filing exemption (FE) process or by the Securities Valuation Office (SVO) and the second of which is applicable only to securities assigned NAIC Designations by the SVO. The SVO intends to clarify that there is only one definition of an NAIC Designation and that it is applicable however the NAIC Designation is assigned.
The amendment, as initially exposed, also stated that an NAIC Designation should reflect the likelihood of timely and full payment of principal and scheduled periodic interest, as appropriate, and the probability of principal and interest payment default. It will also reflect consideration to potential “tail risks” (e.g., the probability that a security’s payment default will be more than three standard deviations from the mean is greater than what is shown by a normal distribution).
The amendment also included a recommendation to include NAIC Designation subscript “S” for other nonpayment risks in the consolidated definition of NAIC Designation. The VOS Task Force has expressly assigned to the SVO the responsibility for assessing other nonpayment risks and the authority to notch NAIC Designations pursuant to the P&P Manual and assign the Subscript S symbol, accordingly. During an interim conference call held on July 13, 2023, the VOS Task Force heard a number of comments on the P&P Manual amendment regarding the amendments on the NAIC Designation definition, many of which specifically addressed the inclusion of the tail risk component and the use of subscript “S.”
The VOS Task Force did not take any specific action on this item at the Summer Meeting but directed the SVO to continue to work with industry members on the amendment, specifically with respect to the need to understand how tail risk analysis will be used. A revised amendment is expected to be presented to the VOS Task Force for consideration on a future date.
b. NAIC Continues Discussion on a Proposed Amendment to Authorize Procedures for the SVO’s Discretion Over NAIC Designations Assigned Through the Filing Exempt Process
The VOS Task Force spent the majority of its time at the Summer Meeting discussing comments received to the VOS Task Force’s exposure of a proposed amendment to the P&P Manual that would set forth procedures for the exercise of the SVO’s discretion over NAIC Designations assigned through the FE process.
By way of background, at the 2023 Spring National Meeting, the VOS Task Force exposed a proposed amendment to the P&P Manual that would remove a new category of investment, defined as “Structured Equity and Funds,” from the FE process, based on the SVO’s review of private letter rating rationale reports. As part of that review, the VOS Task Force noted that when the SVO finds a significant potential issue with the CRP rating for an investment, the SVO should bring that issue to the VOS Task Force, along with a proposed solution, which may include a change to the NAIC Designation.
In response to industry comments to that exposure, the VOS Task Force directed NAIC staff to draft a distinct process for the SVO’s challenge of an NAIC Designation assigned from a CRP rating in the FE process that the SVO believes does not represent a reasonable assessment of risk for regulatory purposes. The proposed amendment to the P&P Manual outlining this process was initially exposed in May 2023.
The process, as initially proposed, would permit either a state insurance regulator (subject to confirmation by the SVO) or the SVO itself to identify any FE-eligible security for which a determination has been made that the NAIC Designation equivalent is not a reasonable assessment of risk of the security for regulatory purposes. The process includes a materiality threshold wherein the difference between the CRP rating used in the FE process and the SVO’s own assessment of the risk must be three or more notches different than the SVO’s assessment based on the SVO’s review (e.g., NAIC Designation Category 1.G versus 2.C). Once a security has been identified as being subject to the SVO’s analytical review, the SVO will have 120 days to make a final determination, during which time the insurer will have the option to submit an appeal. Following this 120-day notice period and optional appeal by the insurer, the CRP rating or the security’s filing exemption eligibility could be maintained or revoked. If revoked, the insurer would then have the option of filing the security with the SVO for assignment of an NAIC Designation. An insurer can appeal revocation in subsequent filing years.
Several members of the U.S. House of Representatives submitted a joint letter dated July 13, 2023, to the NAIC noting that the proposed amendment has the potential to provide RBC uncertainty for all FE investments held by U.S. insurance companies, creating liquidity and market disruption, and urging the NAIC to withdraw the proposed changes to the P&P Manual. In a July 25, 2023, response letter, the NAIC stated that it believes the process “is an appropriate approach to ensure that insurers are holding sufficient capital based on the risk they are taking with their investments,” noting that the materiality thresholds included in the proposal “ensure that challenging a CRP will only commence when a significant red flag occurs, and even then, the notice and appeal process ensures fair treatment for all parties.”
Both the NAIC in its letter and the VOS Task Force have stated that the SVO does not have any intention of challenging the methodologies or opinions of CRPs or disrupting the important role they play in public markets but do not feel obligated to defer to them without judgment or exception as the de facto driver of the NAIC’s RBC framework.
During the Summer Meeting, the VOS Task Force heard comments from industry members to the proposed amendment, which (i) requested clarity as to whether the SVO’s review may be focused on a specific security or an entire class of securities, (ii) requested the opportunity for additional time in the process for insurers to provide information as the SVO would be making its decision based on incomplete information, and (iii) reiterated concerns regarding the uncertainty the process could impose on insurers and the financial markets. The VOS Task Force noted that it intends to move forward with the review process generally as currently outlined but would consider making revisions in response to industry comments that would increase transparency of the SVO’s review process and provide the ability for insurers to provide information prior to initiating an appeal process.
c. NAIC Progresses Collateralized Loan Obligation Modeling Project
During the Joint Meeting of Executive (EX) Committee and Plenary, the NAIC adopted the interim solution to address residual tranches, which was developed and adopted by the Risk-Based Capital Investment Risk and Evaluation (E) Working Group (Investment RBC Working Group) prior to the Summer Meeting. During the Summer Meeting, the Investment RBC Working Group heard a presentation from the American Academy of Actuaries (Academy) related to the long-term project to update C-1 factors for collateralized loan obligations (CLOs).
As adopted under the interim solution to address residual tranches, for reporting as of year-end 2023, the residual tranche base factor will be 30%, with a 15% sensitivity test factor. For reporting as of year-end 2024, the residual tranche base factor will increase to 45%, although the Investment RBC Working Group has agreed to hear additional information from industry that could support a factor other than 45% prior to that factor’s taking effect. For reporting as of year-end 2024, the sensitivity test factor would be reduced to 0%, although that may also be adjusted if the residual tranche base factor is set at an amount other than 45%. The interim solution will apply to all residual tranches, not just CLOs. As adopted, the factors are consistent with the compromise approach proposed in the June 9, 2023, comment letter submitted by the Texas Department of Insurance. Texas explained that the proposal is intended to address concern that changing the charge for year-end 2023 reporting may be too disruptive and may cause companies to divest assets at depressed prices, resulting in adverse effects to surplus.
In connection with updating the C-1 factors for CLOs, the Academy intends to develop a model specification document that takes a de novo look at how to model CLOs for RBC purposes. At the Summer Meeting, the Investment RBC Working Group heard a presentation from the Academy regarding principles for structured securities RBC. In the presentation, the Academy proposed a flowchart to determine whether (i) an asset class needs to be modeled and (ii) whether securities within an asset class need to be modeled individually to determine C-1 factors.
With respect to C-1 asset modeling, the Academy emphasized its preference for simpler solutions, meaning that if an existing factor can be used, it should be used, and that individual security modeling for C-1 determination should be a last resort. If the result of the flowchart is that an asset class requires modeling, then the Academy supports a principles-based approach to the derivation of C-1 factors. The Academy presented seven candidate-principles for further consideration and evaluation by regulators:
- Candidate-Principle #1 (The RBC formula is a blunt filtering tool). “The purpose of RBC is to help regulators identify weakly capitalized insurers, therefore small inaccuracies in RBC formulaic requirements will seldom justify a change to the RBC formula.”
- Candidate-Principle #2 (RBC is based on statutory accounting). “RBC measures the impact of risk on statutory surplus. Changes in accounting treatment will affect C-1 requirements.”
- Candidate-Principle #3 (C-1 is established for underlying collateral). “RBC arbitrage can only be measured for asset-backed securities (ABS) where the underlying collateral has an established asset-class-specific C-1 requirement.”
- Candidate-Principle #4 (Intentions don’t matter for C-1 requirements). “The motivation behind creating an ABS structure should have no bearing on its C-1 requirements.”
- Candidate-Principle #5 (C-1 requirements reflect likely future trading activities). “C-1 requirements on ABS should treat the collateral as a dynamic pool of assets, incorporating future trading activity that is likely to occur based on historical data or mandated by the structure’s legal documents.”
- Candidate-Principle #6 (C-1 requirement for each tranche is independent). “RBC is based on the holdings of an insurer; assets not owned by an insurer should not impact its RBC.”
- Candidate-Principle #7 (Different risk measures). “C-1 requirements for ABS should be calibrated to different risk measures where appropriate.”
The Investment RBC Working Group plans to discuss the Academy’s presentation and the candidate-principles during an interim conference call before formally exposing the information for public comment.
During the Summer Meeting, the VOS Task Force also discussed the status of the CLO modeling project. The VOS Task Force previously adopted an amendment to the P&P Manual to add reporting instructions for the financial modeling of CLOs. Specifically, the P&P Manual amendment makes CLOs ineligible to use CRP ratings to determine an NAIC Designation if the NAIC’s Structured Securities Group can model the security. The P&P Manual amendment was introduced after the NAIC’s Investment Analysis Office (IAO) identified that NAIC Designations assigned to CLOs were inconsistent when relying on CRP ratings and had recommended this change to the VOS Task Force to ensure reporting equivalency for NAIC regulatory purposes. The amendment will become effective January 1, 2024, with insurers first reporting the financially modeled NAIC Designations for CLOs with their year-end 2024 financial statement filings. The VOS Task Force ad hoc group is in the process of finalizing the CLO modeling methodology and expects to hold its next meeting in early September.
d. NAIC Task Force Discusses Next Steps for Review of Credit Rating Providers and Exposes Framework for Regulation of Insurer Investments
During the Summer Meeting, the VOS Task Force reported that it has published its final list of proposed questions that it developed to aid in conversations with CRPs regarding issues raised with respect to CRPs’ role in financial regulation of insurance companies. Following its review of these questions and initial conversations with the CRPs, the VOS Task Force intends to undergo a more formal due diligence process of CRPs and the NAIC’s reliance on CRP ratings.
The VOS Task Force’s review of CRPs began in August 2022 when the VOS Task Force developed an ad hoc study group consisting of selected VOS Task Force members, other state regulators, NAIC staff, and industry representatives in response to a memorandum received by the VOS Task Force from the IAO noting concerns regarding the NAIC’s reliance on CRP ratings.
The study group drafted a list of 22 questions intended to be answered by CRPs. After responses from the CRPs have been received, SVO staff will follow up with the CRPs to schedule a private meeting with the VOS Task Force members and NAIC staff to discuss the responses and answer any additional questions from the CRPs.
The NAIC is also considering a draft Framework for Regulation of Insurer Investments (the Investment Framework) that sets forth various proposals for the modernization of the role and capabilities of the SVO. The proposals include implementing a strong due diligence framework on the use of CRP ratings, increasing staffing of the SVO to enhance the SVO’s portfolio risk analysis capabilities and structured asset modeling capabilities, and building out a broad advisory function at the SVO. The Investment Framework states it is both inefficient and impractical for the SVO to effectively replicate the capabilities of CRPs on a large scale and doing so would not provide incremental benefit if the output is substantially similar. Rather, the SVO will focus primarily on holistic due diligence around CRP usage. That process must be vigorous and consequential (e.g., clear quantitative and qualitative parameters for CRPs utilized to provide ratings for use as NAIC Designations). The Financial Condition (E) committee exposed the draft Investment Framework for comment until October 2, 2023.
3. NAIC Continues its Review of Private Equity Ownership in the Insurance Industry
The Financial Stability (E) Task Force (Financial Stability Task Force) and its Macroprudential (E) Working Group (Macroprudential Working Group) met at the Summer Meeting in a joint session, during which the Macroprudential Working Group provided an update on its review of private equity (PE) ownership in the insurance industry and on the status of the Regulatory Considerations for Private Equity Owned Insurers (List of PE Considerations).
The List of PE Considerations was developed after the topic of PE ownership in the insurance industry gained attention internationally as well as at the state and federal levels in the U.S. The Macroprudential Working Group developed the List of PE Considerations to address, among other things, any regulatory gaps with respect to the increase in PE ownership of insurers, the role of asset managers more generally in insurance, and the increase in private investments in insurers’ portfolios. NAIC adopted the List of PE Considerations in August 2022, after which various NAIC groups received referrals from the Macroprudential Working Group for further assessment. A copy of the current List of PE Considerations can be found here.
The Macroprudential Working Group provided the following updates on the List of PE Considerations at the Summer Meeting:
- Item 1 (Holding Company Structures) and Item 2 (Ownership and Control). The Macroprudential Working Group referred Items 1 and 2 to the Group Solvency Issues (E) Working Group, which has formed a drafting group to develop best practices for insurance company acquisition transactions and “control” determinations.
- Item 3 (Investment Management Agreements). The Macroprudential Working Group sent a referral to the Risk-Focused Surveillance (E) Working Group (RFS Working Group) to be considered in connection with the RFS Working Group’s existing work involving affiliated agreements and Form D filings. The RFS Working is nearing the completion of its project to update the NAIC’s Financial Analysis Handbook and Financial Condition Examiners Handbook related to affiliate agreements. During the Summer Meeting, the RFS Working Group received a presentation on key considerations for state insurance regulatory review of affiliated investment management agreements and agreed to form a drafting group to develop guidance for the NAIC handbooks in this area.
- Item 4 (Ownership of Insurers With Short-Term Focus) and Item 10 (Privately Structured Securities). The Macroprudential Working Group sent a referral to the RFS Working Group to add this consideration to existing work involving affiliated agreements and fees and to the Life Actuarial (A) Task Force (LATF) in connection with its existing work to ensure that the long-term life liabilities (reserves) and future fees to be paid by insurers are supported by appropriately modeled assets. LATF provided an update that regulators are conducting targeted reviews of the disclosures provided under Actuarial Guideline LIII — Application of the Valuation Manual for Testing the Adequacy of Life Insurer Reserves (AG 53), which became effective for year-end 2022, to ensure that long-term liabilities are appropriately supported and that complex and/or privately structured securities’ risks are appropriately modeled.
- Item 5 (Operational, Governance, and Market Conduct Practices). The Macroprudential Working Group discussed that it will soon begin considering this item now that the Reinsurance Worksheet to address Item 13 (Offshore/Complex Reinsurance) is complete, as discussed below.
- Item 7 (Identifying Related Party-Originated Investments (Including Structured Securities)), Item 8 (Identifying Underlying Affiliated/Related Party Investments and/or Collateral in Structured Securities), and Item 9 (Asset Manager Affiliates and Disclaimers of Affiliation). The Macroprudential Working Group had sent a referral to the SAP Working Group regarding these items, which have been addressed by the SAP Working Group’s recent adoption of revisions to SSAP No. 25 — Affiliates and Other Related Parties to (i) add related party codes for investment reporting and (ii) clarify that any invested asset held by a reporting entity that is issued by an affiliated entity, or that includes the obligations of an affiliated entity, is an affiliated investment. Additional work on these considerations may be forthcoming as regulators gain more insights from reviewing statutory financial statements, including the new disclosure and accounting clarifications.
- Item 11 (Reliance on Rating Agencies). The Macroprudential Working Group sent a referral to the VOS Task Force in connection with the VOS Task Force’s ongoing work to address various rating agency considerations. As described above, the VOS Task Force has had, and will continue to have, discussion and activity around this consideration and is in the process of submitting questions to the CRPs for further review by the VOS Task Force. As those discussions continue, this consideration may expand in scope.
- Item 12 (Pension Risk Transfer (PRT) Business Supported by Complex Investments). The Macroprudential Working Group has sent referrals to LATF and the SAP Working Group and projects remain underway to address such considerations in respect of LATF’s work on VM-22 (Statutory Maximum Valuation Interest Rates for Income Annuities) and to address the RBC treatment of PRT business. The Macroprudential Working Group is also monitoring the U.S. Department of Labor’s updates to the fiduciary requirements under Interpretive Bulletin 95-1, which require due diligence in assessing an insurer prior to a PRT transaction.
- Item 13 (Offshore/Complex Reinsurance). At the Summer Meeting, the Financial Condition (E) Committee adopted the reinsurance comparison worksheet (Reinsurance Worksheet), which the Macroprudential Working Group and Financial Stability Task Force adopted at an interim meeting held on June 20, 2023. The Reinsurance Worksheet is designed as an optional tool to allow regulators to obtain additional information for the regulator to understand the economic effects of a reinsurance transaction, either upon initial review of the proposed transaction or when the regulator is performing a historical review of the transaction for some specific purpose. While the Reinsurance Worksheet was designed with affiliated life reinsurance transactions as the initial focus, the template is not fixed and may be altered to be used by regulators for nonaffiliate transactions or property-casualty reinsurance transactions where the regulator requires such information in connection with its review. Completed worksheets will be treated as confidential under state-specific confidentiality laws and regulations.
4. NAIC Continues Efforts to Address Innovation and Technology in the Insurance Sector
The Innovation, Cybersecurity, and Technology (H) Committee ((H) Committee) continued its work to address the insurance and privacy implications of emerging technologies, including big data and artificial intelligence (AI). Key updates include the development of a model interpretive bulletin outlining the regulatory framework for the use of AI by the insurance industry and ongoing work to develop the new Insurance Consumer Privacy Protections Model Law (#674) (New Privacy Model Law).
a. NAIC Committee Discusses Model Bulletin Regarding the Use of AI by the Insurance Industry
At the Summer Meeting, the (H) Committee received initial public comments on the NAIC Model Bulletin: Use of Algorithms, Predictive Models, and Artificial Intelligence Systems by Insurers (AI Model Bulletin), an initial draft of which was exposed on July 17, 2023, for a comment period ending September 5, 2023. The AI Model Bulletin reflects the (H) Committee’s view that AI is a means by which the insurance industry engages in conduct that is already subject to regulatory standards (including, among others, regulations relating to underwriting, rating, and unfair trade practices).
The AI Model Bulletin describes regulatory expectations for the use of AI by insurers (including both governance and enterprise risk management standards) and provides standards for insurance regulators to oversee and examine the use of AI by insurance carriers. It articulates standards at a high level and applies to the use of AI-supported decision making in general.
Trade group representatives commenting at the Summer Meeting raised concerns with the following provisions of the AI Model Bulletin (among others): (i) broad requirements for insurers to oversee AI systems developed or deployed by third parties, including preuse diligence and ongoing monitoring and auditing of such AI systems, and (ii) definitions that had not been previously legislated. Consumer representatives, in contrast, took issue with the AI Model Bulletin’s principles-based approach to setting governance expectations, noting that the AI Model Bulletin does little more than flesh out the NAIC’s Principles on AI, which were initially adopted in August 2020.
b. NAIC Continues Development of the New Insurance Consumer Privacy Protections Model Law
At the Summer Meeting, the Privacy Protections (H) Working Group (Privacy Working Group) received oral comments on the New Privacy Model
At the Summer Meeting, the Privacy Protections (H) Working Group (Privacy Working Group) received oral comments on the New Privacy Model Law, a revised draft of which was exposed on July 11, 2023, for a comment period ending July 28, 2023. The revised draft, which is intended to enhance consumer privacy protections, addresses comments received from interested parties at a public in-person interim meeting held by the Privacy Working Group from June 5-6, 2023, in Kansas City.
Trade associations commenting at the Summer Meeting raised concerns with the following provisions of the New Privacy Model Law (among others): (i) opt-in rights for consumers with respect to use of data and (ii) broad and detailed notice requirements.
In the coming months, the Privacy Working Group intends to continue its series of private, one-on-one meetings with interested parties (including insurers, trade associations, and consumer representatives) to discuss the New Privacy Model Law.
Due to the volume of comments received, the Privacy Working Group intends once again to extend its timeline for developing the New Privacy Model Law. After completing is review of the comments received on the current draft, the Privacy Working Group will expose a further revised draft for a four- to six-week comment period. After considering the comments received on the further revised draft, the Working Group will determine its timeline for presenting the New Privacy Model Law to the Innovation, Cybersecurity, and Technology (H) Committee for approval.
5. NAIC Discusses Updates on Key Projects of the International Association of Insurance Supervisors
During the Summer Meeting, NAIC members heard an update on key projects of the International Association of Insurance Supervisors (IAIS), including the comparability assessment of the Aggregation Method (AM) to the Insurance Capital Standard (ICS), and the IAIS’ Global Monitoring Exercise (GME).
On June 23, 2023, the IAIS released a public consultation on a “candidate” version of the ICS to solicit feedback from stakeholders on the global ICS ahead of its adoption as a group Prescribed Capital Requirement (PCR) for Internationally Active Insurance Groups (IAIGs) at year-end 2024. The ICS is the group capital component of the IAIS’ Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame), which was adopted in November 2019 as part of a set of reforms designed to enable effective cross-border supervision of IAIGs and contribute to global financial stability. The ICS is being implemented in two phases, the first of which is a five-year monitoring phase (which ends in 2024), followed by full implementation of the ICS as a groupwide PCR.
The U.S. and other jurisdictions developed the AM as an alternative to the ICS to avoid the application of multiple capital standards to groups domiciled in the U.S. and such other jurisdictions. The AM will be used as a PCR under ComFrame only if the AM is determined to provide “comparable outcomes” to the ICS. If the IAIS determines by the end of the monitoring period that the AM provides comparable (i.e., substantially the same) outcomes to the ICS, then the AM will be considered an outcome-equivalent approach for implementation as a PCR in lieu of the ICS.
To help provide more detailed information about the AM, the U.S. IAIS members committed to producing a document describing a provisional AM (Provisional AM) that is being used in the comparability assessment before the process begins. Industry members were requested to provide any feedback to the Provisional AM document by September 1, 2023, before a final version of the document is provided to the IAIS in September. A decision on whether the AM provides comparable outcomes to the ICS is expected in the third quarter of 2024.
The IAIS also provided an update on the GME, which is part of the IAIS’s Holistic Framework for Systemic Risk in the Insurance Sector (Holistic Framework), which takes a broader approach to financial stability and macroprudential surveillance. On December 9, 2022, the Financial Stability Board (FSB) announced that in consultation with the IAIS, it had decided to discontinue the annual identification of global systemically important insurers and endorsed the use of the Holistic Framework to inform its considerations of systemic risk in the insurance sector.
The GME includes individual insurer monitoring (IIM) and sectorwide monitoring (SWM) and the data collections from the IIM and SWM help determine the scope for an annual collective discussion by the IAIS on potential systemic risk issues. Key themes identified for 2023 include (i) risks faced by insurers in light of the challenging macroeconomic backdrop, notably interest rate, liquidity, and credit risk; (ii) structural shifts in the life insurance sector, specifically the use of cross-border asset-intensive reinsurance; and (iii) the increased allocation of capital to alternative assets.
The IAIS has also released its first public consultation regarding climate risk and governance, which outlined proposed changes to the IAIS’ Insurance Core Principles to position climate risk within the global framework for insurance supervision and sought feedback on whether changes were also needed related to governance, risk management, and internal controls. The IAIS is developing draft application paper materials on both climate-related market conduct considerations and climate scenario analysis, which are scheduled to be published for consultation by the end of 2023.
6. NAIC Task Force Reexposes Amendments to Property and Casualty Insurance Guaranty Association Model Act Following Working Group Adoption
During its interim meeting on July 24, 2023, the Receivership Law (E) Working Group (Receivership Working Group) adopted proposed amendments to the Property and Casualty Insurance Guaranty Association Model Act (#540) (Guaranty Association Model Act) to address (i) the effect of certain restructuring mechanisms, such as insurance business transfer (IBT) and corporate division (CD) transactions, on the availability of guaranty association coverage and (ii) guaranty association coverage for cybersecurity insurance. However, during the Summer Meeting, the Receivership and Insolvency (E) Task Force (RITF) reexposed the proposed amendments for a 30-day comment period in response to concerns raised by interested parties regarding the effect of the proposed amendments on guaranty association coverage for assumed claims.
In 2009, the Guaranty Association Model Act was amended to afford guaranty association coverage to assumed claims (i.e., claims related to obligations assumed by the insolvent insurer — such as via an assumption reinsurance transaction — notwithstanding that the original insurer was not a member insurer). In connection with proposing amendments to the Guaranty Association Model Act to address the effect of IBT and CD transactions on the availability of guaranty association coverage, the revised definition of “covered claim” would make provisions related to coverage for assumed claims optional for states to adopt. Some interested parties objected to this change as exceeding the authority of the Receivership Working Group under the existing model law development request. In response to such objections, the RITF made additional changes (in the nature of technical corrections) to the version of the amendments as adopted by the Receivership Working Group and reexposed the amendments for a 30-day comment period ending September 14, 2023.
7. NAIC Adopts Amendments to Mortgage Guaranty Insurance Model Act
During the Joint Meeting of Executive (EX) Committee and Plenary, the NAIC adopted amendments to the Mortgage Guaranty Insurance Model Act (#630) (MGI Model Act). The amendments were adopted by the Mortgage Guaranty Insurance (E) Working Group (MGI Working Group) prior to the Summer Meeting.
As adopted, the amendments to the MGI Model Act include (among other changes) updated capital and surplus requirements and new sections on risk concentration, reinsurance, sound underwriting practices, quality assurance, rescission, and records retention.
The amendments to the MGI Model Act also authorize the amount of the required contingency reserve to be calculated net of contingency reserves maintained by reinsurers. The specific provision is “The mortgage guaranty insurance company shall make an annual contribution to the contingency reserve which in the aggregate shall be equal to fifty percent (50%) of the direct earned premiums reported in the annual statement or net earned premiums reported if the reinsurer maintains the contingency reserve.” Although industry raised concerns regarding this language because many reinsurers do not complete statutory financial statements in which they would record contingency reserves, the MGI Working Group ultimately decided not to revise the language to reference ways in which the reinsurer may satisfy the requirement (e.g., by maintaining separately held collateral in a trust or segregated account to support the reinsurer’s obligation).
As adopted, the amendments to the MGI Model Act also omit a section that was included in a prior version, which would have prohibited a private right of action to enforce compliance with the MGI Model Act. The MGI Working Group removed that provision after criticism from consumer groups. As a result, the amendments to the MGI Model Act, as adopted, are silent as to whether a private right of action exists.
8. NAIC Adopts Updated Cannabis Insurance White Paper
During the Joint Meeting of the Executive (EX) Committee and Plenary, the NAIC adopted the Understanding the Market for Cannabis Insurance: 2023 Update white paper (2023 White Paper). The 2023 White Paper provides an update on activities and trends with respect to insurance coverage for the cannabis industry since the adoption in 2019 of the prior NAIC white paper, Understanding the Market for Cannabis Insurance.
The 2023 White Paper focuses on issues affecting affordability and availability of insurance for cannabis-related risks in states that have legalized its use. The 2023 White Paper finds that although capacity has improved since the 2019 version of the white paper, most commercial insurance for cannabis-related businesses is still found in the nonadmitted market. According to the 2023 White Paper, insurance gaps are most prevalent in the emerging areas of the cannabis industry, such as ancillary services, cannabis-infused products, and social consumption lounges. The 2023 White Paper finds that the potential structures being explored to facilitate cannabis-related business coverage include the use of state-based commercial insurance programs, risk retention groups, captives, and joint underwriting associations.
As revised, the handbook includes guidance related to reviewing the fairness and reasonableness of agreements that provide for services to be provided at cost or at market value. The proposed revisions also include guidance for reviewing “cost-plus” arrangements in cases where the services provided by an affiliate are not directly comparable to services available in the open market. In these situations, the updated guidance provides that it is the responsibility of management to justify the use of a “cost-plus” approach and to provide adequate supporting rationale and documentation demonstrating its analysis supporting the profit margin selected under the approach. The guidance cautions regulators to review transactions at “cost-plus” carefully to ensure that they meet the “fair and reasonable” standard.
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