Superintendent Joe Torti III RI SystemicStability Concerns Pt 1 Federal agencies and the media have expressed potential systemicstability concerns with captive transactions FSOC FIO Federal Reserve OFR ID: 234046
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Slide1
The Real Deal on Captives
Superintendent Joe Torti, III
(RI)Slide2
Systemic/Stability Concerns – Pt. 1
Federal agencies and the media have expressed potential systemic/stability concerns with captive transactions
FSOC, FIO, Federal Reserve, OFR
Initial Response: Do not paint with a broad brush!
The Differences Matter!
“Pure” Captives vs. Captive Reinsurance
XXX/AXXX vs. Variable Annuity vs. Long Term Care vs.
??
Risks and concerns differ by type and even by transactionSlide3
Consistent Solvency Framework
Insurance types and transactions differ much more widely than banking transactions
NAIC Solvency Framework establishes a consistent baseline of accounting to enhance comparability and efficiency, yet allows flexibility through Permitted/Prescribed Accounting Practices
Disclosure of impacts to Net Income and Surplus to retain comparabilitySlide4
Regulatory Flexibility
Regulation involves judgment
More variety in insurance products requires more flexibility for the regulator;
Tailoring the regulation to the specifics of the product/transaction to increase effectiveness
NAIC Solvency Framework includes various checks and balances to discourage outlier judgments
Information sharing with licensure states, e.g., permitted accounting practice requests
Transparency via significant disclosures
Financial Analysis Working Group review
NAIC Accreditation programSlide5
Flexibility vs. Arbitrage
Such flexibility can turn into concerning regulatory arbitrage when two somewhat similar insurance risks, transactions, etc., are treated very differently
Unlevel
playing fields can occur
Must assess if solvency protection is adequate
If you add a lack of transparency on top of the
unlevel
playing field, it makes it more difficult for regulators and other market participants to
Compare transactions/insurers/groups
Assess industry dynamicsSlide6
How Did this Captive Situation Occur?
NAIC Accreditation baseline for multi-state insurers
Baseline statutory accounting in NAIC
Accounting Practices & Procedures Manual
– usually more conservative than GAAP
Permitted/Prescribed differences are allowed but must disclose impact on Net Income and Capital & Surplus in Note 1 of
public
financial statements
Capital Requirements – fixed $ and RBC
Reinsurance Transactions
Reviewed and/or Approved
by Regulator; Collateral Requirements; Material Transactions, etc.
Captives were historically used by
corporations & non-profit
organizations to self-insurer risks (pure captive)
Captives were excluded from NAIC Accreditation using the traditional “pure” captive concept
Developed outside of NAIC process since self-insuranceSlide7
NAIC Priority
Life insurers more recently began to use captives to reinsure third party risks—so called captive reinsurance transactions
NAIC priority of reviewing captive reinsurance:
XXX\AXXX Transactions (i.e., Term Life and Universal Life)
Variable Annuities
Long Term Care
Other Business Types?
Risks differ based upon policy type; depends upon the nature of the potential regulatory arbitrage
Regulatory response will need to differ as wellSlide8
XXX/AXXX Captive Reinsurance
Similar issue – redundant (excess) reserves
Similar structure in arbitrage solutions
Economic reserve level supported by normal, high quality assets (admitted assets)
Remainder of formulaic reserve supported by other security (e.g.,
LoCs
, Parental Guarantees)
Details differed by state with no correspond-
ing
differences in product designs, transaction structures = potential for concerning arbitrageSlide9
Regulatory Review
XXX/AXXX captive reinsurance transactions reviewed/approved by state of domicile of the ceding insurer as well as the captive reinsurer
Solvency assessment was performed
If the regulatory actuary agreed the economic reserve was an adequate reserve, including an appropriate level of conservatism, then no solvency concern
NAIC established consistent analysis procedures for
all
XXX/AXXX captive transactions – Accreditation RequirementSlide10
Additional Point on Solvency with XXX/AXXX Captive Transactions
Ceding Insurer w/o
Captive
Ceding Insurer w/ Captive
∆ to Formulaic Reserve for Ceding Insurer
Admitted Assets
$ 100
$ 100
- $60
= $40
$ 100
Non-admitted
“Assets”
Formulaic Reserve
$ 100
$100
- $100
= $0
Conservative “Economic”
Reserve
$ 60
Surplus
$0
$40
$
40Slide11
Consistency and Transparency
Thus, NAIC response is to tackle the problems of concerning regulatory arbitrage
Lack of consistency with similar products/ transactions
And
Lack of transparencySlide12
1/1/2015 and Beyond
AG 48 requires Qualified Actuarial Opinion if new transactions do not meet its provisions
Prior transactions not covered
But are covered by consistent analysis procedures and transparency requirements for the ceding insurer
Not a solvency concern if actuarial and financial analysis do not identify concerns; just not consistent in the transaction structureSlide13
VARIABLE ANNUITY AND
LTC
CAPTIVE TRANSACTIONS
Financial Condition (E) Committee will consider any appropriate modifications to solvency framework
After studying the reasons for and nature of the transactions
Financial Regulation Standards and Accreditation (F) Committee has adopted revisions to multi-state definition for XXX/AXXX, variable annuity and LTC captives
Captives assuming business that was written in more than one state by the ceding insurer would be included in the Accreditation standards as multi-state Insurers
XXX/AXXX captive cessions meeting the NAIC Framework result in the captive being deemed in compliance with Accreditation requirements
Regulators will need to decide on retroactivity for any regulatory change
Variable annuities do not have the contractual language issues of older life insurance policies, but it might be difficult to address without having bifurcated approaches to allow time to unwind existing hedges against statutory
require-
ments
as opposed to the more preferred economic risk management hedgesSlide14
Systemic/Stability Concerns – Pt. 2
SIFI designation was designed to identify non-banks including insurers with potential to “threaten” US financial stability
FSOC believes utilization of captive reinsurers can potentially increase concerns for a SIFI
We say risks must be assessed for each transaction; captive reinsurance is not always a stability issue
Lack of consistency and transparency undermine confidence in the national system of state-based insurance regulation, causing these concerns