Talking Points for Executive (EX) Committee Meeting

Nov. 17, 2014

Talking Points for Executive (EX) Committee Meeting

Superintendent Joseph Torti, III

Principle-Based Reserving Implementation (EX) Task Force

Actuarial Guideline XLVIII (AG 48)

At the Summer National Meeting, the Executive (EX) Committee adopted the XXX/AXXX Reinsurance Framework in concept, adopted charges to other NAIC groups relating to the Framework, and agreed to several model law and regulation development requests. Subsequent to the Executive Committee action, a number of NAIC groups have been working to develop the technical aspects of the new Framework.

The Framework itself anticipates that it will be implemented in stages, with one stage to become effective in 2015 and a second stage to become effective several years from now, once states have the chance to adopt amendments to their laws and regulations. I’m pleased to report that we are ready to launch the first stage to be effective in 2015.

Two components of the Framework to be effective in 2015 are: (1) a new reporting schedule in the annual statement to provide greater transparency pertaining to XXX/AXXX transactions (which is already adopted by Plenary), and (2) revised financial analysis procedures to allow states to improve their regulatory review of XXX/AXXX transactions (which are expected to be approved by E Committee tomorrow).

Another component to be effective in 2015 was adopted by the Principle-Based Reserving Implementation (EX) Task Force this morning for your consideration as part of the Task Force’s report. That is Actuarial Guideline 48, or AG 48.

AG 48 does not prohibit XXX/AXXX captive reserve transactions. What it does, instead, is establish uniform, national standards regarding those transactions so that all companies and regulators will use the same approach, thereby providing a far more level playing field than exists today. AG 48 is also applicable prospectively, for the most part. It does not apply to policies that were issued prior to 1/1/2015 if those policies are part of a captive reserve financing arrangement when AG 48 takes effect.

To meet the standard set forth in AG 48, a portion of a ceding insurer’s statutory reserve approximately equal to the PBR reserve must be secured by high quality types of assets. The portion of the statutory reserve exceeding the PBR-level may be backed by other forms of security, but only as approved by the ceding insurer’s domiciliary regulator.

AG 48 provides that the ceding insurer’s opining actuary is to analyze whether the insurer has complied with the various requirements. If the insurer is found to be out of compliance, it is given a remediation period to come into compliance. If the insurer remains out of compliance once the remediation period ends, the opining actuary would be required to issue a qualified actuarial opinion reflecting, in part, the risk posed by the non-compliant transaction. It is anticipated that another consequence of non-compliance would be an adjustment to the insurer’s required level of risk-based capital, although that piece is technically outside of AG 48 itself.

Some additional changes will be adopted over the next few months to complete this first stage (for example, a new Note in the financial statement, and the RBC charges I mentioned above). However, the most important substantive components of the Framework are located in AG 48, and we believe it is important to adopt AG 48 this year to give industry notice of the formal requirements prior to the 1/1/2015 effective date.

As I mentioned, the Framework includes a second stage. It will consist of developing a new Credit for Reinsurance model regulation pertaining specifically to XXX/AXXX transactions and of amending the Credit for Reinsurance model law (#785) to allow for the new regulation. However, because this stage requires state-by-state adoption of changes to laws and regulations, it is a longer-term solution. Because we want to get something implemented quickly, AG 48 was developed to serve as an interim step until the second stage is completed. AG 48 will sunset and be replaced by the new model law and model regulatory provisions once they are adopted by the states.

We expect captive financing transactions of the type covered by the Framework to effectively stop once PBR becomes effective. This is for two reasons. First, PBR is intended to largely address the perceived reserving redundancies that have precipitated captive financing transactions. Second, any insurer wishing to engage in such a transaction will be required by AG 48 or the new Credit for Reinsurance model (as applicable) to hold admitted assets in an amount approximately equal to what will become the full statutory reserve when PBR becomes effective. Accordingly, both the incentive to create these types of captive arrangements, and the financial benefit from doing so, would be eliminated.

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The following is provided for background information, only if needed:

Exhibit 1

Rector & Associates, Inc. Modified Recommendations June 4, 2014

Exhibit 1—XXX/AXXX Reinsurance Framework (Updated to reflect certain changes in terminology)

1. The Framework applies only to reinsurance involving certain types of XXX and AXXX policies (those required to be valued under Sections 6 or 7 of the NAIC Valuation of Life Insurance Policies Model Regulation).

2. The Framework does not materially change the ability of insurers to obtain credit for reinsurance ceded to professional “certified” reinsurers or to obtain credit for reinsurance ceded to “licensed” or “accredited” reinsurers that follow statutory accounting and RBC rules. (See “Exemptions” below).

3. As a practical matter, therefore, the new Framework requirements apply to reinsurance ceded to captive insurers, special purpose vehicles, reinsurers that are not eligible to become “certified” reinsurers, reinsurers that deviate from statutory accounting and/or RBC rules, etc. In those situations, the ceding insurer may receive credit for reinsurance if, but only if:

· The ceding insurer establishes gross reserves, in full, using applicable reserving guidance (currently, the “formulaic” approach).

· The ceding insurer receives the Required Level of Primary Security (i.e., the ceding insurer receives as security Primary Security in at least the amount determined pursuant to the Actuarial Method).

· Portions of the statutory reserve exceeding the Primary Security Requirement may be secured by Other Security.

· There is an appropriate RBC impact for non-compliance.

· The reinsurance arrangement is approved by the ceding insurer’s domestic regulator.

4. The Framework also includes provisions to police and enforce the new requirements, and to determine whether any “exemptions” relied upon are warranted, including:

· AG 48, which requires the opining actuary for the ceding insurer to issue a qualified opinion if the Framework is not followed (absent an exemption).

· A Note to the annual audited statement requiring the ceding insurer, and its independent auditor, to indicate whether the Framework is being followed (absent an exemption).

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Exhibit 1 (Cont’d.)

The following is a summary of each of the terms in bold above:

1. Exemptions. Other than certain limited disclosure provisions, the new requirements generally do not apply to reinsurance ceded to an assuming reinsurer meeting the definition of Section 2.A. (authorized insurers), 2.B. (accredited insurers), or 2.C (insurers domiciled in another state) of the Credit for Reinsurance Model Law, as revised pursuant to our modified recommendation, or to reinsurance ceded pursuant to Sections 2.D (reinsurers maintaining trust funds) or 2.E (certified reinsurers) of the Model Law. AG 48 also sets out an exemption process to be followed if a transaction is clearly not of the type AG 48 was designed to cover and is only covered as a technicality.

2. Required Level of Primary Security. The ceding insurer would need to receive as security (on a funds withheld, trust or modified co-insurance basis) Primary Security in at least the amount determined pursuant to the Actuarial Method.

3. Actuarial Method. The Actuarial Method consists of VM-20[1], modified to incorporate changes to mortality tables as developed by the American Academy of Actuaries and any other modifications suggested by LATF. It includes a “net premium reserve” component.

4. Primary Security. Primary Security consists of cash and SVO-listed securities, as well as, funds-withheld and modified coinsurance transactions, commercial loans (CM3 and higher), policy loans, and some derivatives to hedge risk.

5. Other Security. So long as Primary Security in an amount at least equal to the Required Level of Primary Security is received, the ceding insurer may receive as security for the remainder of the statutory reserve any other security approved by the ceding insurer’s domiciliary regulator. The Capital Adequacy Task Force is in the process of determining RBC “asset charges” for anticipated categories of Other Security and an appropriate “catch-all” charge to apply to assets that are not specifically listed.

6. RBC adjustment. The Capital Adequacy Task Force has also recommended an RBC adjustment to the authorized control level (denominator) if any insurer does not comply with AG 48.

7. AOMR. We no longer believe a permanent change to the AOMR is needed. We recommend that AG 48 sunset once states adopt the permanent changes to the Credit for Reinsurance model law and regulation.

8. Note. The details of this item are being worked out by the Statutory Accounting Principles Working Group.

[1] NAIC Valuation Manual, VM-20, Requirements for Principle-Based Reserves for Life Products.