The Federal Insurance Office Report Had a Few Noteworthy Surprises for Insurers and Regulators

Although its mission seemed innocent enough—the modernization and improvement of insurance regulation in the U.S.—initial fears were that the federal government was hell-bent on taking over the regulation of insurance and/or giving carriers yet another layer of reporting in an age of over-regulation of everything. 

Time will tell but the U.S. Department of the Treasury’s Federal Insurance Office—which had put critics and proponents alike on hold for two years past its deadline for the recommendations—came out and said, yes, nationwide uniformity is needed in many cases, but that regulation of the U.S. insurance market  “is best viewed in terms of a hybrid model, where state and federal oversight play complementary roles.”  The report was a requirement of the Dodd-Frank Wall Street Reform & Consumer Protection Act.

For perspectives on the report we turned to Mike Nelson, chairman of Nelson Levine de Luca & Horst (NLdH), as well as commentary published by Patton Boggs attorneys, Micah Green, John Nonna, Larry Schiffer, Carolyn Walsh and Mara Giorgio.

Mike Nelson, who represents insurers and reinsurers, said he was surprised by the breadth of the 65-page report and the level of monitoring the FIO plans of state insurance department activities.  Shortly after the report was released, Nelson wrote about it in the NLdH FIO Focus newsletter.   The FIO addressed a broad range of insurance regulatory activity from company ratings to solvency laws, he said, noting that because health insurance is not within FIO’s purview it was not addressed. 

“The focus of the report,” Nelson wrote, “is not whether there should be federal or state regulation of insurance, but whether federal involvement in the current state-based system is warranted. The FIO concludes that the state-based system of insurance regulation can be modernized and improved in the near term through a combination of steps by both the states and the federal government.”

“The report contains a balanced discussion of the strengths and weaknesses of the current state-based system and encourages implementation of many current regulatory initiatives,” Nelson wrote. “The industry and many regulators have previously advocated for many of the initiatives, such as a better system of agent licensing, market conduct reform and speed to market reform initiatives. But one of the main concerns for the FIO is the lack of uniformity in our current system. The report suggests that the nature and structure of the state-based system presents inherent difficulties in achieving uniformity. The FIO goes beyond mere uniformity and points to areas where the laws are uniform, but the application of those laws by regulators is not.”

“The FIO outlines an active role for itself,” Nelson continued, “indicating that it will monitor whether and how states implement FIO’s recommendations. The report does not recommend federal regulation of insurance, but it does suggest that Congress should strongly consider direct federal involvement if states do not implement the FIO’s recommendations.”

Nelson: Threat of Federal Action Not Anticipated

“I was surprised by the breadth of the report as it touches on all aspects of insurance regulation and, in some cases, at a granular level. I was also struck by the amount of monitoring of states’ activities that the FIO intends to do,” Nelson wrote.   “One recommendation that seemed to insert the FIO directly into the regulatory process, despite not having any regulatory authority, was the FIO’s recommendation that it participate in supervisory colleges for large national insurers and internationally active insurers. The FIO apparently wants information from those supervisory colleges to assist it in its role as monitor of financial stability for the insurance industry.”

“State regulators will have to decide how cooperative they will be with respect to the monitoring and the colleges,” Nelson wrote.  “I think that the failure to cooperate would not be a positive thing for state regulation. Some regulators may welcome the oversight as a mechanism for promoting uniformity.

“Perhaps most surprising was the FIO’s statement that if states do not reform their laws and processes to meet the recommendations of the report, they could face federal action,” Nelson wrote. “The FIO did not shy away from controversial topics. The report includes discussions of the implementation of principles-based reserving (PBR) and the use of reinsurance captives, both of which have been the subject of considerable debate among state regulators.”

What is Next?

“The modernization report may foreshadow a potentially active FIO, but it is not going to lead to any immediate changes in the way insurance is regulated,” Nelson predicts. “The FIO does not have regulatory authority, and the recommendations in its report could be viewed as advisory in nature. Most suggestions for federal standards and involvement would require Congressional action. However, the report will undoubtedly influence the discussions and actions of state insurance commissioners. We can also expect to see the FIO asking more questions of state regulators on substantive issues as it monitors the progress of regulatory reforms and modernization initiatives.”

“Perhaps the suggestion that will have the most immediate effect is the recommendation that the Treasury and the United States Trade Representative pursue a covered agreement for collateral requirements for foreign reinsurers. Negotiating and implementing such an agreement, however, will be complicated and time consuming,” Nelson wrote.

To read Nelson’s complete article click here.  Click here for a detailed examination of the report posted by NLdH.  The NLdH site has a considerable number of links, resources and articles about the FIO, including the firm’s FIO Focus newsletter.

Patton Boggs Reviews Key Recommendations

Patton Boggs attorneys, in addition to their insights on the report, broke down what they see as the key recommendations of the report this way:

1.  Capital standards and solvency oversight are key recommendations in the FIO Report. States are asked to develop cooperative processes that allow the domiciliary regulator to coordinate with regulators in other states in which the insurer operates to improve consistency in solvency oversight. Part of this recommended consistency includes the establishment of an independent, third-party review mechanism for the National Association of Insurance Commissioners’ (NAIC) Financial Regulation Standards Accreditation Program.

2.  Another key recommendation is that states develop a uniform and transparent solvency oversight regime for the transfer of risk to special purpose reinsurance vehicles by affiliated insurers. The use of special purpose vehicles (SPVs) in the life insurance market is discussed at length in the FIO Report. Capital and solvency standards are the main concern with the use of SPVs (called insurance captives), where the SPV, according to the FIO Report, does not need to maintain the same capital as the ceding insurer, but the transaction allows the ceding insurer to take full reinsurance credit on its financial statement. The FIO Report concludes that, if an insurer is to receive credit against its capital or reserve requirement because of risk transferred to an SPV, “the rules governing the quality and quantum of assets offered in support of the captive should be uniform across the states and sufficiently robust and transparent in order to prevent arbitrage by insurers.” Interestingly, the FIO Report cites to the New York State Department of Financial Services June 2013 report on the use of SPVs in the life insurance market in support of its recommendations.

3. Insurance reserves is another area of concern in the FIO Report. The FIO Report recommends that states “should move forward cautiously with the implementation of principles-based reserving.” The FIO Report recommends establishing consistent, binding guidelines to determine whether an insurer complies with accounting and solvency requirements, and developing a professional staff and guidelines to review principles-based reserving.

4. Credit for reinsurance has been a major area of debate for years. The FIO Report encourages national uniform treatment of reinsurers and recommends that the Department of Treasury and the Office of the U.S. Trade Representative pursue agreements for reinsurance collateral requirements based on the NAIC’s Credit for Reinsurance Model Law and Regulation.

5. The FIO Report recommends that the states continue to develop approaches to group supervision that address the current shortcomings of solo entity supervision. Supervisory colleges are recommended, in which the FIO would participate to monitor financial stability and identify issues or gaps in the regulation of large nationally and internationally active insurers.

6. The FIO report also discusses receivership recommendations. The recommendations include adopting a uniform approach to resolving contracts with counterparties (derivatives and other qualified financial contracts), developing requirements for transparent financial reporting on the administration of a receivership estate, and adopting uniformity on how policyholders should recover from state guaranty funds.

7.  The FIO Report also makes recommendations for uniformity on producer licensing, product approval, suitability of annuities, market conduct examinations, and the appropriate use of personal information for insurance pricing and coverage purposes. It recommends that states consider whether or in what manner marital status is an appropriate underwriting or rating factor. It also recommends that states monitor the impact of different rate regulation regimes on the various markets to identify best practices that foster competitive markets for personal lines consumers. The FIO did not recommend any action on the nonadmitted and reinsurance markets. However, the FIO Report indicates that FIO will continue to monitor state progress on implementation of the Nonadmitted and Reinsurance Reform Act of 2010 (Subtitle B of Title V of the Dodd-Frank Act) to determine whether federal action may be warranted in the near term. The FIO Report also recommends that states work on best practices to mitigate losses from natural catastrophes.

8.  With regard to international insurance regulation, the FIO Report recognizes that insurance regulatory issues will increasingly require international attention and cooperation.  Further, it highlights ongoing efforts through the EU-U.S. Insurance Project and the International Association of Insurance Supervisors (IAIS).  Of note, the FIO Report does not discuss potential issues that may arise concerning uniform designations of U.S. systematically important financial institutions (SIFIs) and Globally Systematically Important Insurer (G-SII).  However, it states that the FIO plans to work with its colleagues to “ensure the rigor and quality of the IAIS methodology, as well as to align the IAIS process” with the U.S. SIFI designation process.

To read Patton Boggs’ full article, click here and download the PDF.

The LexisNexis® Corporate Counsel Advisory wishes to thank Mike Nelson of NLdH and Micah Green, John Nonna, Larry Schiffer, Carolyn Walsh and Mara Giorgio of Patton Boggs for allowing us to excerpt their articles.