Invotex® Group is pleased to share insights about current matters of interest to the insurance industry and its regulators. We hope you find this information helpful, and we welcome your feedback. Please feel free to forward this issue to your colleagues and invite them to subscribe.

Tom Finnell
Managing Director

In this Issue

1. For the NAIC, the Best Defense is a Strong Offense
2. Is the IFRS Train on Schedule?
3. New Era of Reinsurance Modernization Requires Robust Credit Risk Management
4. Invotex to Chair Panels on International Financial Reporting Standards

For the NAIC, the Best Defense is a Strong Offense
by A. Thomas Finnell

State insurance regulators and the National Association of Insurance Commissioners have again come into the crosshairs of those calling for some form of federal oversight of the insurance industry. But far from cowering under the scrutiny of such critics, the NAIC has a full plate of initiatives under consideration of which some could expand, perhaps significantly, the support it provides to state insurance regulators and the role of the NAIC itself.

Perhaps not since the early 1990s has there been so much clamoring for change to the system of insurance regulation in the U.S. The spate of insurer insolvencies that prompted the crisis back then led Rep. John Dingell (D-Mich.) to introduce the Federal Insurance Solvency Act of 1992, calling for a federal role in insurance regulation. That bill ultimately was not enacted, but the threat it presented at the time may nonetheless have played a key role in prodding the states and the NAIC to enact numerous improvements of their own to the state-based system of insurance regulation. Indeed, the ensuing development by the NAIC of the Financial Regulatory Standards and Accreditation Program, and other initiatives, led to a higher and more consistent degree of financial regulation across the states.

Now the states and the NAIC find themselves in a state of déjà vu, again threatened with calls for a federal role in insurance regulation. Rep. Paul Kanjorski, (D-Pa.), Chairman of the House Financial Services Committee’s Subcommittee on Capital Markets and Insurance, has signaled that federal regulation of insurance in some form may now be inevitable, especially if some insurers tap federal funds to shore up their financial position.  An alternative federal charter system for insurers and the creation of a federal Systemic Risk Regulator has been proposed through the recent introduction of the National Insurance Consumer Protection Act by Reps. Melissa Bean (D-Ill.) and Ed Royce (R-Calif.). And the Obama administration is apparently close to recommending a regulatory plan for the banking sector, although it is unclear as to whether or how such a plan may impact the insurance sector.

Yet despite all the hoopla and the hype, the fate of the U.S. insurance industry as regards any notion of a federal regulatory scheme is still very much uncertain at the present time. In the meantime, the NAIC and state insurance regulators are not sitting idly by waiting for news from Capitol Hill. Far from it, the NAIC has a full agenda in the form of its Solvency Modernization Initiative which calls for enhancements in the following areas:

• Capital requirements: Enhancements to risk-based capital that are in the works include a better means to address asset concentration and liquidity issues, credit default risk, catastrophe risk, consideration of a charge for operational risk, and consideration of economic capital.

• International accounting: The NAIC’s International Solvency and Accounting Working Group is reviewing activities of the International Accounting Standards Board and providing input relative to solvency, actuarial and accounting issues. A key emerging issue that the working group has its eyes on is the possibility that adoption of International Financial and Reporting Standards in the U.S. may result in the elimination of U.S. GAAP, currently the underpinning of the framework utilized by the NAIC to maintain statutory accounting principles.

• Group supervision: The NAIC is revisiting the provisions of its Model Holding Company Act in light of recent experience during the economic/credit crisis; considering international solvency issues related to groups, including interaction between federal and state regulators; evaluating the need for group-wide supervision requirements, including capital requirements, enhanced group-wide reporting, and consideration of non-regulated entities; and working to improve coordination and communications with regulators across state/country borders and industry sectors.

• Reinsurance: The NAIC’s Reinsurance Regulatory Modernization Framework was adopted late last year; the NAIC continues to evaluate an appropriate time to push for implementation of its provisions, among which include eliminating the time-honored tradition of requiring collateral from foreign insurers as a matter of regulatory requirement in favor of a system that adjusts the regulatory requirement for collateral as a function of quantitative (e.g., ratings-based) and qualitative factors; the onus would then be on U.S. ceding insurers to negotiate for additional collateral should they deem that necessary based on their own evaluation of credit risk. See related article by Elise Brenneman.

• Valuation: The NAIC’s Principal-Based Reserving Working Group is reviewing issues related to principles-based regulation, including corporate governance, examination and analysis, and staff resources with the aim of balancing theoretical approaches with effective regulatory practices; the working group’s efforts includes consideration of a shorter-term solution to reduce redundant life and annuity reserves.

While it may appear that the foregoing long list of NAIC initiatives underway is the result of the financial crisis, our view is otherwise. Many of these items have been agenda items of various NAIC working groups for quite some time. If the crisis did anything, it may simply have provided a burning platform on which these seemingly disparate enhancements could be better presented as an integrated master plan, and prodded through with more support and on a more expedited basis.

Certain of these and other NAIC initiatives may also require expansion of the NAIC’s resources and the support that it provides to state insurance departments around the country. For example, the Reinsurance Regulatory Modernization Framework calls for the development of a Reinsurance Supervision Review Department. Likewise, there has been some discussion that states should increase their use of sophisticated financial models and stress testing to evaluate an insurer’s ability to withstand risk; combined with the possibility that insurers may someday be required to calculate and share economic capital with their regulator, the NAIC may further expand its resources to provide the technical wherewithal to assist states in the review of such complex information.

For more information, contact Tom Finnell.

Back to top.

Is the IFRS Train on Schedule?
by Tim Foley and Jim Stangroom

In recent years we have heard that the International Financial Reporting Standards (IFRS) train was coming and we had better get ready. So where is that train now? Is it on schedule, or has it derailed? 

There is no clear answer, but it does appear as if the train may be proceeding more cautiously, perhaps as a result of the current economic crisis and the resulting recession. Clearly government officials, regulators and business leaders have more immediate problems on their hands.

For insurance companies in particular, we see some fundamental issues that must be addressed. Chief among them is to resolve the question of accounting for insurance contracts under IFRS, especially the concept of valuing insurance contracts at current exit value. Our perspective is that while there may be delays along the way, IFRS will eventually happen here in the U.S. Therefore, it is in the best interest of insurance company management to be prepared and to be a part of the decision making process.

The momentum gained by proponents of a U.S. switch to IFRS resulted in large part due to the support of then-SEC Chair Christopher Cox. These efforts were dealt a setback when Mary Schapiro, the current SEC Chair, told a congressional committee during her confirmation hearing that she will take a careful look at the Roadmap, as she is concerned about IFRS being “looser” than U.S. Standards, and that she has concerns about governance over the IASB. She added that the IASB has not shown it can deflect political pressure, and that she has concerns over the quality of the standards as well as the pace of conversion as outlined in the Roadmap. And that comes from the head of the SEC, the organization that, until recently, was the strongest voice for adoption of the international standards and the very author of the Roadmap. And while the SEC digests the content of the hundreds of responses it has received to its proposed Roadmap, one point has become quite clear. While most interested parties still feel the move to a single set of accounting standards is a worthwhile and achievable objective, there remains significant work ahead to keep the train on its tracks.

It is not too soon to begin planning for the eventual adoption of IFRS. The following is an outline of some important aspects of preparation:

• Stay on top of IFRS 4, Phase II developments regarding accounting for insurance contracts;
• Engage your Chief Information Officer and actuaries early;
• Involve the attention of the entire senior management group, and the board;
• Form a project management team and approach;
• Develop and document a project plan;
• Discuss and get in sync with your auditors, share implementation plans;
• Assess the potential impact of IFRS on your financial statements and accounting policies;
• Obtain an understanding of IFRS 1 regarding requirements of initial adoption.

For more information, contact Tim Foley or Jim Stangroom.

Back to top.

New Era of Insurance Modernization Requires Robust Credit Risk Management
by Elise Brenneman

In December 2008, the NAIC adopted a conceptual framework, key provisions of which will create two new classes of reinsurers that could be authorized to assume business of U.S.-domiciled cedants: a U.S.-domiciled national reinsurer and a non-U.S.-based port-of-entry reinsurer. This new framework also introduces modified collateral requirements for certain reinsurers. The impact of these new requirements may be substantial to the industry as a whole, and to many ceding companies.

While a number of steps, including adoption of federal enabling legislation, must be taken prior to full adoption of reinsurance modernization, some states have advanced ahead by adopting rules or amending regulations in anticipation of passage. Most importantly, adoption of the framework will significantly alter the credit risk profile of many ceding companies from the standpoint of reinsurance counterparties, and such insurers need to act now to mitigate any potential adverse impacts.

At the end of 2008, collateral held by all U.S.-domiciled p&c cedants on recoverables from unauthorized reinsurers was a significant $116 billion. Some industry participants expect – in exchange for the new lower collateral requirement – insurers may be better positioned to demand more competitive reinsurance pricing. But the trade-off is added risk. With the option to release some or all of the current security requirement, and in the absence of negotiated collateral to fill the gap, insurers will transition from secured credit counterparties to partly or fully unsecured parties with respect to their non-U.S. reinsurers.

In order to take full advantage of these important reinsurance developments, while at the same time limiting credit counterparty risk, insurers will require robust in-house credit risk management and collateral administration practices. As insurers approach developing and implementing these new practices, an assessment of capabilities to manage these risks is essential to evaluate and design a sound reinsurance credit counterparty risk management discipline. Reinsurance credit counterparty risk assessment should consider the following areas:

• Reinsurance credit counterparty policy and procedures
• Reinsurance counterparty risk analysis and administration
• Collateral management
• Financial strength ratings as assigned by nationally-recognized credit rating organizations
• Local regulatory regimes customs and practices
• Accounting standards and disclosures, including IFRS
• Capital adequacy tests (including Solvency II)

For more information, contact Elise Brenneman.

Back to top.

Invotex to Chair Panels on International Financial Reporting Standards

Invotex will lead two separate panels on International Financial Reporting Standards (IFRS) at the Annual Conference of the Insurance Accounting and Systems Association June 7-10, 2009 in Orlando, Florida.

Managing Director Tom Finnell will lead a panel that will explore the possible fate of statutory accounting, a cornerstone of financial regulation of the insurance industry in the U.S. that could nonetheless change dramatically or even disappear altogether should IFRS replace U.S. GAAP. Accompanying Tom will be William Boyd, Financial Regulation Manager for the National Association of Mutual Insurance Companies, and Ramon Calderon, Chief Deputy for the California Insurance Department and Chair of the NAIC’s International Solvency and Accounting Working Group.

Invotex Managing Director Jim Stangroom and Director Tim Foley will chair a separate panel focusing on IFRS implementation issues and potential implications for insurers. Other panelists include Patrick Coyne, Vice President of MassMutual Financial Group, and William Hines, a Principal in the Boston MA office of Milliman.

Back to top.