U.S. Insurance Regulators Seek Solvency II Equivalence Without Major Changes to Current System

Although major reforms aren't likely, the NAIC and the FIO continue to push both sides of the Atlantic to achieve Solvency II equivalence for the U.S. state-based regulatory system.

The United States insurance regulatory system will likely be deemed equivalent to the European Union's Solvency II Directive, according to Therese Vaughan, CEO of the National Association of Insurance Commissioners ("NAIC"). Solvency II, a uniform system of insurance regulatory standards adopted by the EU that is scheduled to go into effect in 2013, requires foreign insurance companies operating in the EU to have "functionally equivalent" regulation. [1]

The U.S. risk-based capital solvency system gives policyholders the same protection as Solvency II, according to experts.

Despite "fundamental differences in the underlying methodologies," the long-established risk-based capital solvency system in the United States gives policyholders the same protection as Solvency II, according to Fitch Ratings Ltd as reported by Business Insurance. U.S. regulators began a solvency modernization initiative in 2008 in response to the development of Solvency II.[2]

Regulatory cooperation already has begun between Europe and the United States. For example, several U.S. states recently relaxed rules on the collateral that overseas reinsurers must post to be able to underwrite reinsurance. This, Fitch said, is a "positive sign that cooperation will lead to an agreement on equivalence." [3]

The European Insurance and Occupational Pensions Authority ("EIOPA") is the body charged with determining Solvency II equivalence, and whether the United States is granted equivalence is a political issue according to Paul Clarke of PricewaterhouseCoopers, L.L.P., in London. There are significant differences between the US insurance regulatory system and Solvency II which could make an equivalence determination difficult, especially since U.S. authorities will likely be reluctant to make widespread changes to the U.S. system just to meet equivalence requirements.[4]

The U.S. continues to have one of the world's most respected regulatory systems, and the NAIC is firm in its view that there is more to equivalence than identical methods, processes and philosophies…[5]

NAIC CEO Vaughan says Solvency II "equivalence should be assessed on an outcomes basis," and on that basis, the U.S. "should be found equivalent." Additionally, Vaughan indicated that the NAIC is not pushing a Solvency II agenda here at home:

We've made it clear we're not going to adopt Solvency II. We have a system. We think our system works. We're engaged in continuous improvement.[6]

Strict Solvency II compliance would not work in the U.S. according to Howard Mills, chief adviser of Deloitte LLP's insurance industry group, as reported by InsuranceNewsNet.com. One of the main reasons is the state-based regulatory system in the U.S. While the newly-created Federal Insurance Office ("FIO") represents the U.S. in international insurance affairs, it currently has very little authority over the regulatory practices of the individual states.[7]

Nevertheless, representatives of the NAIC and the FIO continue to work with European insurance regulatory officials to reach understanding and compromise on insurance industry oversight under both the U.S. and the EU systems.[8]

The NAIC has also been diligently working on the U.S. Own-Risk and Solvency Assessment proposal to close some of the gaps between Solvency II and current U.S. standards. While the proposal has no formal implementation date as yet, the NAIC expects ORSA to be implemented prior to 2014 when the U.S. financial solvency equivalence assessment process review by the EIOPA is expected.[9]

1.  NAIC CEO: US Will Gain Solvency II Equivalence, Sean P. Carr, A.M. Best Company, Inc., InsuranceNewsNet.com, November 14, 2011.
2.  Solvency II equivalence likely for U.S., Sarah Veysey, Business Insurance, November 6, 2011.
3.  Solvency II equivalence likely…, Id.
4.  Solvency II equivalence likely…, Id.
5.  NAIC Fall Meeting Highlighted Challenges, Tom Sullivan, PropertyCasualty260.com, November 14, 2011.
6.  NAIC CEO…, Id.
7.  NAIC CEO…, Id.
8.  NAIC CEO…, Id.
9.  NAIC Fall Meeting…, Id.

NAIC to Tout State Regulation to U.S. and Foreign Policymakers

As reported by Insurance Journal, the National Association of Insurance Commissioners (NAIC) is "Protecting the Future" with its new educational initiative in U.S. capital, the European Union capital, and the seat of the Financial Stability Board (FSB) for the G-20. The NAIC initiative will extol "the virtues of the 150-year old state-based insurance regulatory system" in Washington, D.C.; Brussels; and Basel, Switzerland.[1]

“The U.S.’s state-based insurance regulation system has an unmatched track record and can best adapt to meet our future economic and financial challenges,” said Ben Nelson, NAIC chief executive officer. “By ensuring soundness, solvency, stability and competition, state-based insurance regulation does more than make insurance markets work — it protects the future for American consumers, employers and the economy as a whole.[2]

The pro-state insurance regulation is motivated in part by the NAIC's view that "some federal officials and global regulators are seeking unprecedented authority over American insurance markets, including the imposition of bank-centric regulation on insurance companies." [3]

The NAIC, Nelson and its other leaders have been critical of recommendations for an expanded role for the federal government in U.S. insurance regulation, attempts to apply capital requirements suitable for banks to insurance companies, and moves to introduce global capital requirements on insurers.

State regulation advocates are also concerned that the international Financial Stability Board in Basel, Switzerland, could be gaining too much influence in the U.S. when it comes to financial regulation.[4]

Adam Hamm, current NAIC President who is also North Dakota insurance commissioner, explains that "[s]tate insurance regulation works because it's specific to the industry's unique risks and able to reflect state-specific considerations."[5]

Read the full article:

NAIC Roadshow to Tout State Regulation to U.S., Foreign Policymakers
InsuranceJournal.com

1. NAIC Roadshow to Tout State Regulation to U.S., Foreign Policymakers
2. NAIC Roadshow to Tout State Regulation to U.S., Foreign Policymakers
3. NAIC Roadshow to Tout State Regulation to U.S., Foreign Policymakers
4. NAIC Roadshow to Tout State Regulation to U.S., Foreign Policymakers
5. NAIC Roadshow to Tout State Regulation to U.S., Foreign Policymakers

Top NAIC Officials to Scrutinize Lender-Placed Insurance

Insurance regulators focus attention on lender-placed / force-placed insurance amid allegations of monopoly and excessive premiumrates.

Both the current President of the National Association of Insurance Commissioners ("NAIC"), Kevin M. McCarty, and the NAIC President-Elect, James J. Donelon, have turned the insurance regulatory spotlight onto insurance that protects mortgage lenders and lien holders from certain property risks when homeowners allow their property insurance coverage to lapse – known as lender-placed or force-placed insurance.

McCarty intends to examine lender-placed insurance premiums and business practices.

McCarty, who is also Commissioner of the Florida Office of Insurance Regulation, intends to examine lender-placed insurance premium rates and the business practices of insurance carriers who write lender-placed insurance amid allegations of excessive rates. Two companies, Assurant, Inc. and QBE Insurance Group, Ltd., control as much as 90% of the force-placed market, according to McCarty.[1]

Donelon, also Commissioner of the Louisiana Department of Insurance, said the force-placed insurance industry is a "monopoly… that is perpetuating itself" at a recent NAIC hearing, according to an article from Bloomberg. The situation is "extremely profitable for two remaining companies in the market," according to Donelon, "Nobody is minding the store."[2]

Force-placed premiums more than tripled to $5.5 billion in 2010 from $1.5 billion six years earlier, according to New York Department of Financial Services Superintendent Benjamin Lawsky. The insurers often pay out less than 25 cents for every dollar in premiums they collect, he said, compared with about 63 cents on a typical homeowner’s policy.[3]

According to the executive director of the Center for Economic Justice, Birny Birnbaum, premium rates currently charged by force-placed insurers "are not justified when examining the companies' performance and profits over the years."[4]

Others suggest the rate increases are justified by the recent rise in foreclosures, as well as other market forces.

But John Frobose, president of American Security Insurance, suggests the increase in lender-placed insurance is justified by the recent rise in foreclosures, as well as other market forces. Because insurance carriers that write force-placed insurance have been subject to greater hazards, the associated premiums have also risen.[5]

Robert Hartwig, president of the Insurance Information Institute, suggests that the rise in lender-placed premiums has peaked. Hartwig predicted that the market for lender-placed insurance should "contract as foreclosures drop and the U.S. economy improves."[6]

Hartwig, along with the executive director of the American Bankers Insurance Association, Kevin McKechnie, defended lender-placed insurance premium rates, explaining that "carriers do not underwrite individual risks, but rather provide a portfolio of coverage to lenders where insurers are taking on risks… with virtually no information about them."[7]

Insurers also defended the higher rates they charge, saying that because the risks are primarily in catastrophe zones, higher premiums are needed to prepare for what they say is the inevitability of major losses.[8]

Nevertheless, Commissioners McCarty and Donelon, as well as other insurance regulators like Kentucky Insurance Commissioner Sharon Clark, intend to take a critical look at force-placed insurance premium rates and business practices, as well as the costs associated with the administration of lender-placed insurance placement, including the compensation paid to agents and lending institutions.[9]

The lender-placed insurance industry also faces proposed new regulations from the Consumer Financial Protection Bureau.

In addition to increased scrutiny by state-based insurance regulators, the lender-placed insurance industry also faces proposed new rules from the Consumer Financial Protection Bureau, created under the Dodd-Frank Act. The proposed new rules require servicers "to give advance notice and pricing information before charging consumers for the coverage" and "to terminate the insurance within 15 days" upon receipt of evidence that the homeowner has the necessary insurance.[10]

1. U.S. Regulators to Examine Forced-Place Insurance, Zachary Tracer and David Beasley, Bloomberg, August 10, 2012.
2. Insurance for Lapsed Borrowers Lacks Oversight: Regulator, Zachary Tracer and David Beasley, Bloomberg, August 9, 2012.
3.  U.S. Regulators..., id.
4. NAIC Promises Greater Focus on Force-Placed Insurance as CFPB Proposes Rules, By Mark E. Ruquet, PropertyCasualty360.com, August 10, 2012.
5.  U.S. Regulators..., id.
6.  U.S. Regulators..., id.
7. NAIC Promises..., id.
8. NAIC Promises..., id.
9.  U.S. Regulators..., id., NAIC Promises..., id.
10. NAIC Promises..., id.

Prior Approval and Affiliate Examination Authority: NAIC Expands Regulatory Authority under the Model Insurance Holding Company System Regulatory Act

The NAIC has adopted amendments to its model Insurance Company System Regulatory Act that, if adopted by state legislatures, would expand state insurance regulatory authority to examine the affiliates within an insurance holding company system, require prior notice of divestiture of a controlling interest of an insurer in a insurance holding company system and require prior approval of reinsurance pooling agreements.

As noted in a previous article, the National Association of Insurance Commissioners ("NAIC") adopted substantial amendments to its model Insurance Holding Company System Regulatory Act and its Insurance Holding Company System Model Regulation (collectively, the "Model Law") in December of 2010. The amendments, if adopted by the individual state legislatures, would broaden the authority of state insurance regulatory authorities and impose additional requirements on insurers, controlling persons and affiliates within insurance holding company systems such as requiring the annual filing of a Form F "enterprise risk" report.[1]

The amendments authorize state insurance regulators to require annual filing of financial statements of all affiliates within an insurer's holding company system.

Additionally, the amendments to the Model Law authorize the state insurance regulator to require annual filing of the financial statements of all affiliates within an insurer's insurance holding company system. In the event that an insurer is ordered by the state regulatory authority to produce information not in the insurer's possession, the insurer can be penalized and fined under the amended Model Law if it cannot provide a valid reason why it is unable to produce such information. Further, the state insurance regulator may compel the production of information via subpoena or court order.[2]

Significantly, the amended Model Law expands a state insurance regulator's examination authority to include any or all of an insurer's affiliates within the insurance holding company system in order to ascertain the financial condition of the insurer. This includes an examination of any "enterprise risk" to the insurer by the ultimate controlling party, or by any entity or entities within the insurance holding company system, or by the insurance holding company system on a consolidated basis.

Prior notice to the state regulator is required before divestiture of a controlling interest in an insurer.

The amendments to the Model Law require that any controlling person of a domestic insurer, before it may divest itself of its controlling interest in the insurer, must file a notice of proposed divestiture with the state insurance regulatory authority. The acquiring party must also file a pre-acquisition notice. Upon receipt of the notice, the state insurance regulator has thirty (30) days in which it will determine whether the controlling person shall be required to file for and obtain approval for the proposed divestiture.[3]

The amended Model Law also requires the following:

• An annual statement that the insurer's board of directors oversees the corporate governance and internal controls of the insurer, and that the insurer's officers and senior management have approved and implemented, and continue to maintain and monitor, corporate governance and internal control procedures;


• Prior approval of amendments or modifications to any agreements with affiliates (previously approved under the Model Law) with an explanation of the reasons for the change and the financial impact on the insurer;


• Prior approval of all reinsurance pooling agreements; and


• Documents, materials or other information filed with the NAIC under the Model Law shall be confidential and privileged by law, and shall not be subject to public records requests, nor shall such be subject to subpoena or discovery, or admissible as evidence, in any private civil action.[4]

Finally, the amended Model Law includes provisions designed to allow cooperation between state insurance regulatory authorities and regulators outside of the United States with respect to insurance holding company systems that operate in other countries.

1. Top Ten Items to Watch in Insurance Regulation in 2011, Dewey & LeBoeuf, LLP, January 14, 2011.
2. NAIC Adopts Revised Holding Company System Model Act Requiring Enterprise Risk Disclosure, Anthony Roehl, Morris, Manning & Martin, LLP, March 23, 2011.
3. The NAIC model Insurance Company System Regulatory Act.
4. NAIC Adopts Revised..., Id.

Form F and Enterprise Risk: NAIC Expands Regulatory Authority under the Model Insurance Holding Company System Regulatory Act

The amended model Insurance Holding Company System Regulatory Act, if adopted by state legislatures, will significantly expand the scope of state insurance regulatory authority over insurance holding company systems, including controlling persons and affiliates.

In December of 2010, the National Association of Insurance Commissioners ("NAIC") adopted substantial amendments to its model Insurance Holding Company System Regulatory Act (the "Model Act"). The amendments significantly broaden the authority of state insurance regulatory authorities under the Model Act, and impose additional requirements on insurers, controlling persons and affiliates within insurance holding company systems.

The NAIC is seeking to add the provisions to its accreditation standards for state insurance departments.

The provisions of the Model Act are only effective if adopted by the individual state legislatures. However, the NAIC is moving to include the amendments as part of the national accreditation standards for state insurance departments, increasing the likelihood that state lawmakers will adopt the Model Act provisions.

The Model Act amendments are a response to concerns that insurance regulators previously lacked the necessary authority to oversee and intervene with respect to activities within an insurer's holding company system that might pose material risks to the insurer. Many of these concerns were inflamed by the financial difficulties recently experienced by certain affiliates of the AIG insurance holding company system.[1]

The new Form F is one of the most significant amendments to the Model Act.

One of the most significant amendments to the Model Act is the addition of a new annual reporting requirement for insurance holding company systems: the Form F. The newly created Form F requires, among other things, that the ultimate controlling person of an insurance holding company system report any "enterprise risk" within the system, including:

...any activity, circumstance, event or series of events involving one or more affiliates of an insurer that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole, including, but not limited to, anything that would cause the insurer’s Risk-Based Capital to fall into company action level . . . or would cause the insurer to be in hazardous financial condition. . .[2]

The Model Act amendments also expand the examination authority of a state insurance regulator to examine the non-insurer affiliates within an insurance holding company system in order to determine what enterprise risks could ultimately impact the insurer. [3]

The amendments move beyond the "walls" that the Model Act originally created, introducing "windows" of reporting requirements and expansion authority.

While the amendments to the Model Act expand its authority beyond providing the "walls" of protection that it was originally designed to create, the amendments stop short of authorizing direct oversight and control of insurance holding company systems like Solvency II. Instead, the amendments add "windows" of reporting requirements and examination authority with respect to controlling persons and affiliates such that insurance regulators have increased oversight of activities that could pose enterprise risks to regulated insurers.[4]

Enterprise Risk Reports must contain detailed information, including: (i) a description of the holding company’s business plan and strategies; (ii) material developments concerning risk management and internal audit findings; and (iii) rating agency and other discussions that could reflect potential "negative movement" in an insurer’s ratings.[5]

However, the question remains as to exactly what remedies that state insurance regulators will bring to bear against the so-called enterprise risks.

Whether insurance regulators will try to use traditional remedies such as conservation or rehabilitation of the insurer itself to remedy these potential enterprise risks is a significant concern.

To what extent the judiciary will allow state insurance regulators to exercise authority over non-insurance company affiliates within insurance holding company systems remains to be seen. The alternative remedies are those tools traditionally available to state insurance regulators, such as exercising conservation or rehabilitation authority over the insurer itself. Just such an option was proposed by at least one state insurance regulator when questions arose as to how the AIG insurance subsidiaries might be "protected" from the financial difficulties within that system. The extent to which this "solution" might actually do more harm than good is certainly up for debate.[6]

West Virginia became the first state to adopt new laws substantially similar to the Model Act amendments in April of 2011.[7] Texas became one of the first large states to adopt principal provisions of the Model Act amendments in June of 2011.[8]

1. Top Ten Items to Watch in Insurance Regulation in 2011, Dewey & LeBoeuf, LLP, January 14, 2011.
2. The Model Act, §1(F).
3. Top Ten Items to Watch..., Id.
4. Top Ten Items to Watch..., Id.
5. NAIC Adopts Final Changes to Holding Company System Model Act and Regulation, Insurance and Financial Services Update, January 6, 2011, Jeff Liebmann and Mike Goldman, Sidley Austin LLP.
6. Top Ten Items to Watch..., Id.
7. West Virginia Becomes the First State to Adopt the Amendments to the NAIC's Insurance Holding Company System Regulatory Act, Dewey & LeBoeuf, April 7, 2011.
8. Texas Adopts Key Features of NAIC's Amended Model Insurance Holding Company Act; Chadbourne & Parke, LLP, June 28, 2011.