Q&A: NAIC's CEO and president on group supervision, systemic risk and captives

Louie Woodall speaks to leading members of the National Association of Insurance Commissioners in the US about the challenges of coordinating regulation across borders, both domestic and foreign

Ben Nelson at the NAIC

The National Association of Insurance Commissioners (NAIC) has a full in-tray these days. In a country where the responsibility for insurance supervision is jealously guarded by individual states, the NAIC has the unenviable task of setting standards agreeable to more than 50 different markets – the US, plus five overseas territories and the District of Colombia.

Right now the association, led by chief executive officer Ben Nelson (a former US senator) and president James Donelon, is grappling with a series of issues both foreign and domestic, while working to improve the system of state-based regulation through a number of new initiatives. Insurance Risk spoke to Nelson, Donelon and Jeffrey Johnston, senior director of financial regulatory affairs at the NAIC, about the challenges ahead.

On group supervision…

The regulation of insurance companies within the US is evolving. Since 2008, the NAIC has been working to update the country’s regulatory system as part of the Solvency Modernization Initiative (SMI), which involves navigating new laws on risk governance and reporting through each state legislature and testing firms’ readiness for new procedures such as the Own Risk and Solvency Assessment.

In this the US is no different from the many other countries around the world, looking to revamp outmoded regulatory systems. However, in one area – group supervision – the US is out of step with much of the rest of the world.

Insurance Risk: Why does the NAIC continue to trust in regulation at the legal entity level when so much of the international discussion is focused on regulation at the group level?

Donelon: Because we have more than 100 years of proven, successful regulation of the insurance industry under the model we have in place now at the entity level. We are very open to expanding that and looking at other options. Frankly, we are under way in expanding it through our efforts on the SMI, including on group supervision [the introduction of the] supervisory college and, most recently, our change from a strict formulaic method of risk assessment to a principles-based assessment. The bottom line is we have a system that has proven to be very successful. We are open to change, but we don’t want to risk what has worked so well just in the name of reform.

Nelson: We’ve modernised our holding company law. We have a ‘window’ into the holding company and whatever the holding company is doing, but [the holding
company] continues to wall off the assets of the insurers to protect the rights of the policyholders.

Our approach is a bit different in that regard [compared to other jurisdictions]. We’re not interested in changing that overall approach. We will work to [develop] things like group supervision and supervisory colleges, but the approach that the UK and other regulators in the European Union subscribe to would be a consolidated regulator, and we think group supervision through the supervisory colleges should create an environment where we are looking for equivalent results even though it may have different systems.

IR: Do you envision a time when the US will adopt a system where groups are assigned a group supervisor with special responsibilities? This seems to be the direction of travel in the International Association of Insurance Supervisors’ (IAIS) ComFrame, for example.

Nelson: It really falls on the domestic domiciliary commissioner to be the lead supervisor, but others are invited in. It’s sort of a red herring to talk about a lead supervisor other than the commissioner that is in charge of the domiciliary of the insurer. I don’t see where you gain anything by turning it over to someone else to be the lead supervisor.

Johnston: We have upwards of 20 US-based groups that have IAIG [internationally active insurance group] status. The NAIC has gone through each of the IAIGs and we now have one state that is assigned a special role to coordinate group-wide oversight, whether it be ongoing financial analysis, a review of intercompany transactions or coordinating on-site examinations of the legal entities.

On the international regulatory challenges…

The NAIC, while not a federal supervisor, is one of the most prominent voices for the US industry on the global stage. As such its officers are embroiled in the current debates over a prospective common framework for internationally active insurance groups (ComFrame) and new regulation for global systemically important insurers (G-Siis) led by the IAIS. To complicate matters, the 2010 Dodd-Frank Act introduced a new agency – the Federal Insurance Office (FIO) – with a statutory duty to represent US insurers in international forums. Can we expect a turf war over rights and responsibilities between the two organisations in the years to come?

IR: What do you see the  role of the FIO is in representing the US industry internationally, and does  it conflict with the role of  the NAIC?

Donelon: We have Commissioner Thomas Leonardi and Commissioner Kevin McCarty on the technical committee of the IAIS, and the FIO chairs that committee. We [the NAIC] were founding members of the IAIS and continue to be active members relative to technical and executive committee membership – and that is a regulatory activity. We acknowledge the FIO’s role as international spokesman in that arena and every other arena, and supported its creation. As to the regulatory arena, that is our lane of traffic.

Nelson: When it comes to the IAIS, [the Dodd-Frank Act states] the FIO’s role as “representing the United States as appropriate in the IAIS”. There is a question in my mind about whether or not serving as chairman of the technical committee constitutes an appropriate role given the fact that everyone else on that is a regulator. Nothing in the statute empowers the FIO to be a regulator or a quasi-regulator; it is well spelled out. And if you go to the ‘saving grace’ section of [the Dodd-Frank Act], it says “nothing in the act takes away the power or authority of the states to regulate”.

The FIO has a job, and the job is very well spelled out.

It can be of great benefit to state regulation in monitoring and making suggestions, and looking at under-represented markets. There’s plenty to do in those areas without [the FIO] having to become a regulator.

Donelon: A month ago we had a fly-in, as we do annually, to Washington, DC. We had presentations by secretary Kathleen Sebelius [United States Secretary of Health and Human Services], governor Daniel Tarullo of the Federal Reserve, and chairman Randy Neugebauer from House Financial Services, and I dare say without exception the feedback was we aren’t interested in federal regulation of insurance. It works well at the state level and has done so for a long time, so we’re not about to fix something that is working well.

The reaction the senator [Nelson] got during his testimony [to the Subcommittee on Housing and Insurance on June 13], is that without exception they expressed support for our state-based regulation of insurance.

Nelson: The subcommittee was concerned that the fabled report by the FIO [on how to modernise and improve the system of insurance regulation], mandated in the Dodd-Frank Act was 16 months late. Not picking on the FIO, but there isn’t a good explanation. The explanation given by the FIO was “we’re trying to get it right” – well, obviously! You can use that excuse as a delaying tactic for almost anything. It needs to be out, that is the role, it is statutory and it’s not the NAIC that’s calling the FIO out on it, it’s Congress.

How is the systemically important financial institution (Sifi) process in the US coordinated with the IAIS efforts on global systemically important insurers (G-Siis)?

Nelson: It’s our position that they do need to be coordinated and that the G-Siis should be consistent with the US Sifis, because the process of determining the Sifis has a statutory process in place, and that may not be the case with the Financial Stability Board for G-Siis.

Johnston: There is a fundamental question of how do you enact whatever the FSB determines in terms of insurance companies being globally systemic. How do you enact that status without anchoring it in the home jurisdiction of the entity involved? They’re both [G-Sii and Sifi processes] advanced to the point now where you can start to have that conversation [about coordination]. Some of these questions about the next step, what does the designation mean, both in terms of the FSOC [Financial Stability Oversight Council] and the FSB in terms of capital requirements and things of that nature, are yet to be seen.

Nelson: There will be a lot of speculation up until, and maybe even after, this is put in place with both the FSB and the FSOC.


On the home front…

The NAIC also has to deal with squabbles on the domestic front too. Recently, the New York Department of Financial Services (DFS) has been hogging the headlines with highly-charged attacks on insurance companies’ use of captives and the buying-up of fixed annuity backbooks by firms linked to private equity businesses. Benjamin Lawsky of the DFS has even gone as far as to say that insurers are operating as ‘shadow banks’ in some cases and has called for a national moratorium on the use of captives for funding redundant reserves – something not endorsed by the NAIC. The challenge for the NAIC is to act fast to develop a coordinated response to these issues.

IR: One of the things the NAIC has been investigating is insurers’ use of captives. What does the NAIC consider is an appropriate and inappropriate use of captives?

Donelon: We think there needs to be more oversight of the use of captives, there needs to be more transparency in the process, and that falls to the NAIC to put those requirements in place and hold our individual members, where these captives are present, accountable through our accreditation system. Our move to put a principles-based reserving (PBR) structure in place of a strictly formulaic assessment of reserve requirements depends on our ability to put more transparency and oversight into the use of captives, so to the degree that New York pointed that out last week, we’re in agreement.

We are committed to a joint and executive-level task force, to adopt the implementation aspects of PBR specifically and inclusive of the use of captives [to resolve the issue regulators like the DFS are wrestling with]. We recognise that as a challenge, but we do not feel like it is one that is beyond our ability to oversee and feel very strongly that there is a legitimate role for the use of captives [although] there can be an opportunity for shenanigans in [their] not being properly regulated.

So we share New York’s concerns, but we disagree that it necessitates a knee-jerk reaction in the form of a moratorium on the use of captives.

Nelson: If you get the transparency and you get the regulatory oversight, you can determine whether or not there has been a true transfer of risk. If you have a transfer of risk then it is hard to say if it is a shadow operation or that there is something skullduggerous about it. When you understand why companies are concerned about redundancy in their reserves, it is because capital costs money – and capital costs reflect the costs of the product to the public – so it doesn’t make sense for it to be over-reserved. The formulaic approach was resulting in redundancies, but if you go to the PBR system, maybe that will obviate the need for some people to have captives.

Donelon: I would add there is a legitimate concern among the industry between those insurers that are using captives as part of their reserving mechanism and those that are not, and the competitive disadvantage they can be put at if forced to compete with companies that are misusing the system. We are very cognisant of that, and we are committed to addressing it in a thorough and comprehensive fashion across the US.

IR: There has been some concern over the sale of insurance backbooks to non-traditional or private equity players. What is the NAIC’s thoughts on this development?

Johnston: We put this squarely on our radar in the last two-to-three months. The NAIC has created a new special working group under our Financial Condition Committee to examine this trend and provide more guidance to the states that are being asked to review these transactions, to give them some pointers on what to be aware of.

The issue is that private equity firms have a different business model than the insurance company. It tends to be relatively shorter-term; they are focused on managing assets differently than what the traditional life insurance company might do given its liability structure. We’re going to take a closer look at it. The current thinking is that the statutory framework is sufficient for the states, they had broad discretion as well as explicit requirements in their statutes for evaluating these types of transactions. I think this is just a situation where it is new, it just requires looking at these transactions through a different lens.

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