ASSAL Presentation
US Risk-Based Supervision
Lou Felice
Health and Solvency Policy Advisor
NAIC
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Primary goal is to ensure financial health of insurers
for purposes of protecting policyholders
• Work with companies to remedy areas of concern
• More severe interventions if company continues to
deteriorate e.g. regulators will run off or liquidate the insurer
if necessary to ensure protection of existing policyholders
• A zero insolvencies goal would require a different system
• Additional goals include availability and affordability
of insurance, stable and competitive markets
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework – Key
Elements
• Pillar 1 – Comprehensive body of laws and regulations provide
and define the framework boundaries
• Laws address all of the key elements of solvency regulation and
provide conservatism, consistency, and regulatory authority for
intervention
• Pillar 2 – Regulatory oversight provides an assessment within
those boundaries
• Focus on a targeted quantitative and qualitative analysis.
• Financial analyses tools provide for risk focused surveillance and
examination and identification of outliers
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework – Key
Elements (cont.)
• Pillar 3 – Detailed financial reporting
• Provides transparency
• Facilitates financial analyses at the both the entity level and across
firms
• Provides basis for early warning and intervention
• Overarching Accreditation System
• Solvency Modernization Initiative
• Wrap-Up
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Pillar 1
– Laws and Regulations
– Risk-Based Capital (RBC)
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Licensing
• Each state of operation requires compliance with its laws
and regulations (subject to NAIC accreditation requirements);
not a passport system
• Domiciliary state, typically first state of licensure, is lead regulator
• Adequate business plan required to apply
• Fixed minimum capital or simple capital calculation must be met, and
subject to RBC once up and running
• Fit and proper management checked for licensure
• Criminal background check
• Proper experience, skills
• Guaranty fund participation
• Unique State-based policyholder protection system
• Remaining insurers in the sector are assessed a portion of the
shortage of policyholder liabilities less assets
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Notice of Material Transactions, including
intra-group transactions:
• Acquisition/disposition of assets
• Revisions to reinsurance agreements
• Material guarantees/transactions
• Acquisition/change of control of insurer is approved or
rejected by the insurance commissioner
• Investment limitations
•
•
•
•
Prudent person approach
Defined limits approach
Derivative use plan requirements
Asset adequacy tests and asset/liability matching requirements for
life products
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• RBC Overview
• Developed in early 1990s; Finalized formulas:
• Life RBC 1993
• Property/Casualty RBC 1994
• Health RBC 1998
• Maintained and evaluated continuously with eye toward predominant
risks for each industry segment
• The formula considers the entity’s size, structure and risk profile
• Standardized approach, mainly factor based but with some
stochastic and full modeling (predominantly Life RBC) upgrades
over the years
• Not all risks are accounted for – only material categories of risks
• RBC formulas are uniform among the states
• Largely tied to annual financial reporting for verifiability
• Annual modifications occur, both maintenance and enhancements
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Risk-Based Capital (RBC) Results
• RBC is a baseline tool for providing legal authority for specific regulator
action
• Provides 4 action level triggers based on minimum regulatory capital
levels - NOT a target capital level or intended as a financial strength
indicator above the action levels
• RBC is supported by a number of Pillar II and Pillar III tools
• Used in concert with other analysis and exam findings
• Augmented by robust annual and quarterly financial reporting and State
authority for supplemental reporting or data submission
• Not totally accurate for all companies but reasonably accurate for
most companies
• Found to be highly effective in HELPING to identify weakly
capitalized insurers
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Pillar 2
– Regulatory Oversight, Assessment and
Monitoring
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Financial analyses (at least quarterly)
• Automated tools in addition to RBC use audited public data:
• Ratios
• Scoring
• Benchmarking
• Used to prioritize insurers of concern as well as to compare insurers
• Prioritization and analysis tools assess:
•
•
•
•
•
•
Reserve adequacy
Leverage
Liquidity
Surplus
Asset quality
Trends, etc.
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework - ANALYSIS
Level 1
Overall Analysis of the Insurer and its Operations
Level 2
Detail Analysis of Areas of Concern
Supplemental
Management Considerations
Statement of Actuarial Opinion
Management Discussion and Analysis
Holding Company Analysis
Audited Financial Report
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Risk-focused, on-site examinations
• Full scope at least once every 3-5 years
• Risk-focused:
•
•
•
•
•
Interview senior management
Identify key activities and inherent risks
Assess/test controls
Establish residual risks and plan exam
Conduct exam
• Test and validate residual risks;
• Modify plan as needed based on findings
• Target exams as needed based upon concern with
company/findings from oversight
• Some compliance testing for state laws
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework - EXAMS
Phase 1
Phase 2
Phase 3
Understand the Company and Identify Key
Functional Activities to be Reviewed
Identify and Assess Inherent Risks in Activities
Identify and Evaluate Risk Mitigation
Strategies/Controls
Phase 4
Determine Residual Risk
Phase 5
Establish/Conduct Exam Procedures
Phase 6
Update Prioritization and Supervisory Plan
Phase 7
P
l
a
n
n
i
n
g
Draft Exam Report and Management Letter
© 2012 The National Association of Insurance Commissioners
Based on Findings
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US Solvency Framework
• Continuous monitoring/qualitative assessments using
regulator only data – assess:
•
•
•
•
•
Changes in business plan
Material transactions, including group transactions
Implications for reputation/contagion risks
Impacts of major economic and insurance events, and
Stress testing
• In depth assessments of (potentially) troubled insurers
• More frequent/extensive:
• Insurer reporting
• Regulator analyses/exams
• Authorities for regulatory actions include
• Conservation/rehabilitation/liquidation in the domiciliary state
• Suspending or revoking license to write in the state
© 2012 The National Association of Insurance Commissioners
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US Solvency Framework
• Pillar 3
– Public and Regulatory Reporting
Requirements for Insurers
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Transparency, uniformity and verification
• Detailed public disclosure (annual and quarterly)
• Uniform reporting format
• Electronic data capture allows creation of prioritization/analytical
tools and ad hoc queries, sensitivity analysis
• Conservative statutory accounting
• Uniform definitions
• Nonadmitted assets (not counted toward statutory capital/surplus)
•
•
•
•
Annual independent CPA audit, public
Annual actuarial opinion, public
Annual detailed actuarial memorandum, regulator only
Annual risk-based capital (RBC) calculation, results only public
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© 2012 The National Association of Insurance Commissioners
STATUTORY ACCOUNTING
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© 2012 The National Association of Insurance Commissioners
Statutory Accounting
• A separate codification of accounting
requirements for US insurance
regulatory purposes
• Based on US GAAP
– Accept GAAP
– Accept GAAP with modifications
– Reject GAAP
– Separate Statutory Accounting Guidance
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© 2012 The National Association of Insurance Commissioners
GAAP and SAP Differences
GAAP
• Designed to meet the
varying needs of
different users
• Stresses measurement
of profitability/income
• Emphasis on earnings
• Going concern concept
SAP
• Designed to address
concerns of regulators
• Stresses ability to
satisfy policyholder
obligations
• Balance sheet
emphasis
• Focuses on liquidity
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© 2012 The National Association of Insurance Commissioners
Foundation Concepts
•
•
•
•
•
GAAP
Relevance
Reliability
Neutrality
Comparability
Materiality
SAP
Additional Emphasis:
• Conservatism
• Consistency
• Recognition
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© 2012 The National Association of Insurance Commissioners
Nonadmitted Assets
GAAP Balance Sheet
Statutory Balance Sheet
Assets
Total Assets
$3,111,000
$2,794,000
• GAAP does not
recognize the concept of
“nonadmitted assets”.
Assets Not Net Admitted
Admitted
Assets
$ 260,000
$ 2,534,000
• SAP does not allow
certain assets to be
“admitted” in the balance
sheet.
• A nonadmitted asset is
one which is accorded
limited or no value in
statutory reporting.
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© 2012 The National Association of Insurance Commissioners
Investments
GAAP
• Classifies investments as
follows in FAS 115:
– Securities held to maturity are
reported at amortized cost;
– Securities available for sale
are reported at fair value;
– Trading securities are
reported at fair value.
• GAAP does not recognize the
concept of nonadmitted assets
or investment limitations.
SAP
• Bonds are reported at
amortized cost except
those that are low quality –
lower of amortized cost or
market (SSAP No. 26).
• Common Stocks are
generally reported at SVO
fair value (SSAP No. 30).
• Nonadmitted assets due to
state investment limitations
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© 2012 The National Association of Insurance Commissioners
Goodwill
GAAP Balance Sheet
Goodwill
20,000
• GAAP goodwill =
purchase price less
market value
• GAAP does not limit
goodwill.
Statutory Balance Sheet
Assets
Net
Not
Admitted
Assets Admitted Assets
Investment in
50,000
33,000 17,000
Firemen's Insurance
Company
• SSAP No. 68 goodwill =
purchase price less
book value
• Goodwill in excess of
10% of adj. capital &
surplus is nonadmitted.
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© 2012 The National Association of Insurance Commissioners
Agents Balances
GAAP Balance Sheet
Statutory Balance Sheet
Assets
Premiums receivable and
agents' balances
55,000
Agents' balances and uncollected
premium
• GAAP requires receivables
for premiums and agents’
balances to be reported
net of a valuation
allowance for doubtful
accounts.
55,000
Assets Not Net Admitted
Admitted
Assets
5,000
50,000
• Companies are simply
required to nonadmit any
premium receivable
balances greater than 90
days past due. (Exception
for government insured
plans is within SSAP No.
84.)
• Uncollectible amounts are
written off.
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© 2012 The National Association of Insurance Commissioners
Reinsurance Recoverable
GAAP Balance Sheet
Reinsurance recoverables
Statutory Balance Sheet
50,000
Reinsurance recoverables
• GAAP requires all amounts
due from reinsurers to be
recorded as assets.
Assets
30,000
Assets Not Net Admitted
Admitted
Assets
30,000
• SSAP No. 61 and SSAP No.
62 requires reinsurance
recoverables on unpaid claims
and IBNR to be recorded as a
contra-liability and netted
against gross losses and loss
adjustment expenses or in
cases where the right of offset
exists, reinsurance payables.
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© 2012 The National Association of Insurance Commissioners
Deferred Acquisition Costs
• DAC calculation includes:
– Commissions;
– State premium taxes;
– Underwriting expenses; and
– Issuance costs.
• DAC is usually the largest difference
between GAAP and SAP
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© 2012 The National Association of Insurance Commissioners
DAC
GAAP Balance Sheet
Statutory Balance Sheet
Assets
Deferred policy acquisition costs
Assets Not Net Admitted
Admitted
Assets
170,000
• FAS 60 allows
acquisition costs and
commissions to be
capitalized and
amortized to expense
over the life of the
policy.
• SSAP No. 71 requires
acquisition costs and
commissions to be
expensed as incurred.
• Premiums are recognized
as income on a pro rata
basis.
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© 2012 The National Association of Insurance Commissioners
Furniture, Fixtures & Equip.
GAAP Balance Sheet
Furniture, fixtures and equipment
Statutory Balance Sheet
15,000
Furniture, fixtues and equipment
• FF&E is capitalized and
depreciated over its
useful life.
• FAS 13 requires
reporting entities to
classify leases as capital
or operating leases.
Assets
10,000
Assets Not Net Admitted
Admitted
Assets
10,000
-
• SSAP No. 19 nonadmits
all such equipment.
• SSAP No. 22 requires all
leases to be considered
operating leases.
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© 2012 The National Association of Insurance Commissioners
P & C Reserves
GAAP Balance Sheet
Reserve for property-liability claims
Statutory Balance Sheet
$
800,000
• Management’s best
estimate of the liability
• Generally allows
discounting of this liability
• Requires recording of the
minimum point in a range
as its liability when all
points are equally
probable
Reserve for property-liability claims
$
9900,000
• Management’s best
estimate of the liability
• Generally does not allow
discounting of this liability
• Requires recording of the
mid-point in a range as its
liability when all points
are equally probable
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© 2012 The National Association of Insurance Commissioners
A & H Reserves
GAAP Balance Sheet
Reserve for A&H claims
Statutory Balance Sheet
900,000
• Management’s best estimate
of the liability
• Generally allows discounting
of this liability
• Requires recording of the
minimum point in a range as
its liability when all points are
equally probable
Reserve for A&H claims
900,000
• Management’s best estimate
of the liability
• Generally does not allow
discounting of this liability
• Requires recording of the midpoint in a range as its liability
when all points are equally
probable
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© 2012 The National Association of Insurance Commissioners
Unearned Premiums
GAAP Balance Sheet
Unearned premiums
Statutory Balance Sheet
250,000
Unearned premiums
Advance premiums
• FAS 60 only allows premiums
to be recognized on a prorata basis (daily pro-rata or
monthly pro-rata). This results
in the recording of an
unearned premium liability for
the portion of premium
received but not yet earned.
10,000
240,000
• SSAP No. 53 also only
allows premiums to be
recognized on a pro-rata
basis (daily pro-rata or
monthly pro-rata).
• SSAP No. 54 requires
premiums to be
recognized when due.
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© 2012 The National Association of Insurance Commissioners
Debt
GAAP Balance Sheet
Long-term debt
Statutory Balance Sheet
100,000
• GAAP requires L/T debt to
be recorded as a separate
liability on the balance
sheet. GAAP generally
does not allow debt to be
used as an offset against
the related asset acquired
with the debt.
Borrowed money
25,000
• SAP allows certain debt to
be used as an offset to
the related asset for which
the debt was obtained.
• SAP No. 41 allows
reporting entities to issue
instruments with
characteristics of both
debt and equity, referred
to as surplus notes. These
are reported in surplus.
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© 2012 The National Association of Insurance Commissioners
Surplus
GAAP Balance Sheet
Common stock
12,000
Additional paid in capital
100,000
Retained earnings
675,000
Accumulated other
comprehensive income
208,000
• GAAP recognizes stockholders’ equity adjusted for
net income within R/E.
• GAAP requires recognition of
“Other Comprehensive
Income” (OCI).
• GAAP requires surplus notes
issued by the company (which
is similar to debt) to be
reported as long-term debt.
Statutory Balance Sheet
Common stock
12,000
Additional paid in capital
100,000
Unassigned funds (surplus)
216,000
Surplus notes
50,000
• Unassigned funds include the
cumulative effect of net income,
unrealized gains and losses,
exchange rate fluctuations,
nonadmitted assets, provision
for reinsurance, asset valuation
reserve, and changes in DTAs
and DTLs.
• No OCI
• SSAP No. 41 allows surplus
notes to be reflected in surplus.
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© 2012 The National Association of Insurance Commissioners
SAP - Final Thoughts
• GAAP and SAP have fundamentally
different approaches.
• Although SAP reviews and uses some
of the GAAP pronouncements, the
objectives are different.
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© 2012 The National Association of Insurance Commissioners
ACCREDITATION PROGRAM
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Accreditation Program
o
o
o
o
o
Peer review making States accountable to each
other for solvency oversight
Formed in 1989
Voluntary program for state insurance
departments administered by the NAIC
Focus on multi-state life/health and
property/casualty insurers
50 states, District of Columbia and Puerto Rico
accredited
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© 2012 The National Association of Insurance Commissioners
Supervision and Administration
of the Accreditation Program
• Financial Regulation Standards and Accreditation
(F) Committee
o
o
Chair: Eleanor Kitzman (TX)
Vice Chair: Tom Leonardi (CT)
• Open Session:
o
Discuss standards/guidelines
• Regulator-to-Regulator Session:
o
Discuss state-specific issues/reviews
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© 2012 The National Association of Insurance Commissioners
Mission Statement of the
Accreditation Program
The objective of the accreditation program is:
•
To provide a process whereby solvency regulation of
multi-state insurance companies can be enhanced and
adequately monitored with emphasis on the following:
o
o
o
•
Adequate solvency laws and regulations to protect consumers
and guarantee funds.
Effective and efficient financial analysis and examination
processes
Appropriate organizational and personnel practices
To allow states to rely on the work performed by other
states.
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© 2012 The National Association of Insurance Commissioners
Accreditation Standards
• Part A: Laws and Regulations
• Part B: Regulatory Practices and
Procedures
• Part C: Organizational and Personnel
Practices
• Part D: Organization, Licensing and
Change of Control
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© 2012 The National Association of Insurance Commissioners
Part A: Laws and Regulations
• States must adopt certain laws and
regulations for solvency
• 19 laws and regulations are currently
required
• The state must have all the laws and
regulations in effect to be accredited
(i.e. pass or fail)
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© 2012 The National Association of Insurance Commissioners
Part B: Regulatory Practices
& Procedures
• Financial Analysis
o
8 standards
• Financial Examinations
o
10 standards
• Information Sharing and Procedures for
Troubled Companies
o
2 standards
• Scored by the accreditation team
members
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© 2012 The National Association of Insurance Commissioners
Part C: Organizational &
Personnel Practices
• 3 Standards
o
Professional Development
o
Minimum Educational and Experience
Requirements
o
Retention of Personnel
• Not scored by the accreditation team
members
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© 2012 The National Association of Insurance Commissioners
Part D: Organization, Licensing &
Change of Control
•
•
•
•
6 Standards
New company applications
Applications for mergers/acquisitions
Not scored by the accreditation team
members
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© 2012 The National Association of Insurance Commissioners
Types of Accreditation
Reviews
• Pre-Accreditation Review
• Accreditation Review
• Sub-Part Re-Review
• Interim Annual Review
• Periodic Reporting
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© 2012 The National Association of Insurance Commissioners
Pre-Accreditation Review
• Performed one to two years prior to full review
by NAIC Staff
• Duration is approximately 1.5 days
• High level review of financial analysis and
financial examination functions to identify areas
of improvement
• Voluntary but strongly recommended
• Confidential pre-accreditation report issued to
the Commissioner
• No Committee responsibility
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© 2012 The National Association of Insurance Commissioners
Accreditation Review
• Once every 5 years subject to interim annual reviews
• Duration is approximately 1 week (5 business days)
• Review Team composition supervised by the NAIC
Accreditation Program Manager
• Full review of Part B & C Standards by Review Team
• Full review of Part A Standards by NAIC Legal
Division
• Reports distributed to the Financial Regulation
Standards and Accreditation (F) Committee (FRSAC)
• FRSAC members vote
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© 2012 The National Association of Insurance Commissioners
How has accreditation
helped the regulatory process?
• Information provided by companies was not
verified
o
Annual CPA audit and actuarial opinion required
• No mandatory requirement regarding
frequency of examinations
o
Domestic companies must be examined no less
frequently than every five years
• Lack of interstate coordination and
cooperation
o
Documented policy regarding such is required
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© 2012 The National Association of Insurance Commissioners
Communication Tools
• NAIC Administrative Policies Manual of the
Financial Regulation Standards and Accreditation
Program
o
o
o
Published each year as of January 1st
Hard copies of manual sent to state insurance
departments
Updates to manual included on the website
• Accreditation Website
http://www.naic.org/committees_f.htm
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© 2012 The National Association of Insurance Commissioners
SOLVENCY MODERNIZATION INITIATIVE (SMI)
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© 2012 The National Association of Insurance Commissioners
0
• Solvency Modernization Initiative (SMI)
o
Group Solvency Lessons Learned
• Own Risk and Solvency Assessment (ORSA)
o
A Review and Evaluation of RBC for
Possible Enhancements
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• Lessons learned from financial crisis:
o
o
o
Holding company enterprise risk
Re-assessing Impact of Rating Agencies on solvency tools
“Windows and Walls”
• Responses to lessons learned:
o
Revisions to Holding Company Model Act and Regulation
• Enhance coordination with banking and other regulators as well as
insurance regulators from non-US jurisdictions
o
o
Adjustments to valuation / quality designations / RBC
requirements for mortgage backed securities
Own Risk and Solvency Assessment (ORSA)
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• US Own Risk & Solvency Assessment (ORSA)
o
o
ORSA Manual developed with industry comments
Two primary goals:
•
Foster effective level of ERM, thru which each insurer identifies and
quantifies material and relevant risks using techniques appropriate to the
nature, scale and complexity of the insurer’s risks, in a manner adequate to
support risk and capital decisions
•
Provide a group-level perspective on risk and capital as a supplement to the
existing legal entity view
• ORSA Exemption
o
o
o
Individual insurer’s annual direct written and unaffiliated assumed premium,
including international direct and assumed premium but excluding premiums
reinsured with the Federal Crop Insurance Corporation and Federal Flood
Program, is less than $500,000,000; and
Insurance group’s (all insurance legal entities within the group) same annual
premium is less than $1,000,000,000
Insurer specific waiver granted by Commissioner based upon unique
circumstances including, but not limited to, type and/or volume of business written
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• ORSA process is one element of insurer’s broader ERM
framework
o
o
Links the insurer’s risk identification, measurement and prioritization
processes with capital management and strategic planning
Each insurer’s ORSA process will be unique, reflecting its business, strategy and
approach to ERM
• Regulators will use the ORSA Summary Report to gain a high-level
understanding of the process
o
o
o
Summary Report may be provided in any combination as long as all insurance
legal entities within the group are represented
Summary Report will be supplemented by the insurer’s internal risk management
materials
Summary Report, at a minimum, should discuss:
• Section 1 – Description of Insurer’s Risk Management Framework
• Section 2 – Insurer’s Assessment of Risk Exposure
• Section 3 – Group Risk Capital and Prospective Solvency Assessment
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework
• SMI review of RBC:
o
Purpose of RBC in U.S. Regulatory Framework
• US regulators’ response:
• Maintain RBC as one of many analytical tools, not a target
capital level
• Rely upon RBC for explicit actions authorized by statute
o
RBC Enhancements
• Assess missing risks - considering a catastrophe component
for property/casualty RBC
o
Partial Internal Models for RBC
• Life RBC currently uses modeling for variable annuities with
certain guarantees and similar products
• Considering expansion to other life products
• Principle-Based Reserve project will increase RBC models
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework –
Wrap UP
• Focus on a targeted, robust quantitative and qualitative
analysis rather than establishing target capital levels
o
o
Consistent, comparative public data reviewed by 3rd parties (e.g. CPA)
RBC – legal authority for regulatory intervention when minimum capital
is breached, and used in concert with other analysis and exam findings
• Regulatory review/approval of significant transactions
• Multiple eyes on same insurer/issue; coordinated review
o
o
Domiciliary state leads solvency oversight, but other licensed states
also perform analysis and can participate in exams; FAWG peer review
Accreditation Program establishes appropriate, common framework
• ORSA provides insurer’s own assessment of capital adequacy
• Collaborative, group-wide stress testing
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© 2012 The National Association of Insurance Commissioners
QUESTIONS?
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© 2012 The National Association of Insurance Commissioners