## 1. U.S. Insurance Companies—Capital Adequacy ## Source details **Canonical URL:** [1. U.S. Insurance Companies—Capital Adequacy](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10126.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10126.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10126.pdf.json) --- ### Executive summary and key findings - Insurance regulation in the United States, which is mostly carried out by states, is generally thorough and effective, although there are areas where significant development is needed. - Strong regulation contributed to the overall resilience of the insurance sector during the financial crisis. - There is generally a high level of observance of the Insurance Core Principles. - Data collection and analysis in relation to individual insurance companies are world-leading. - Mechanisms exist to ensure individual states implement solvency requirements effectively. - Needs identified: - Development of the policy framework in relation to insurance and financial stability and international issues. - Extensive reform to the laws governing state insurance departments, including on appointment and dismissal of commissioners, to secure the independence of regulatory work. - Significant development of the approach to supervision of groups. ### Institutional and market structure—overview - Market size and composition: - The U.S. insurance market is the largest in the world. - There were 7,948 licensed insurance companies at the end of 2008. - Total premium volume in 2008 of US$1.24 trillion accounted for 29 percent of the global market. - Insurance density (premiums per capita) in 2008: US$4,078 (United States ranked ninth). - Insurance penetration (premiums as a percentage of GDP) in 2008: 8.7 percent (United States ranked thirteenth). - Main sectors: life, property and casualty (personal and commercial lines), and health insurance. - Specialist lines: financial guaranty (monoline insurers), mortgage insurance, title insurance. - Other participants: captive insurance companies and Risk Retention Groups (RRGs). - Total employment in insurance companies: 1.6 million at the end of 2008. - Market characteristics: - Low market concentration in most sectors; “excess and surplus lines” permitted. - Residual market mechanisms and state/federal programs for hard-to-insure risks (federal: TRIA, flood, crop loss; state: workers compensation, Florida Hurricane Catastrophe Fund). - Reinsurance: 58 percent of all premium ceded to reinsurers by U.S. insurers is to markets in Europe and Bermuda (85 percent, if premium ceded to offshore affiliates of U.S. companies is included). - Cross-sector groups: 17 groups headed by a bank holding company regulated by the Federal Reserve; 42 contain a thrift regulated by the Office of Thrift Supervision. - Distribution: mainly through agents and brokers (“producers”); banks distribute insurance but have limited market share. - NAIC role: - NAIC employs some 430 staff; states employ nearly 12,000 in total for insurance departments. - NAIC develops model laws and regulations (over 200), operates Financial Regulation Standards and Accreditation Program (all 50 states and District of Columbia accredited), and runs centralized financial analysis via FAWG (covers around 1,600 “nationally significant companies” representing 85 percent of the market). ### Recent performance and capital adequacy - Overall resilience: - Capital and surplus fell by 6.7 percent in life and 8.5 percent in property and casualty between end-2007 and mid-2009. - Companies whose capital adequacy fell to regulatory intervention levels accounted for only 3 percent of the total in 2008. - Several firms placed in receivership; only one receivership directly related in cause and timing to the financial crisis. - Absolute dollar capital fell, but required RBC fell too, so capital coverage ratios fell more slowly. - Actual capital in each sector is many times greater than required RBC levels and, on average, about two to three times the capital levels at which regulatory intervention would occur. - Significant stresses in 2007–2009: - Monoline insurers lost previously high ratings after severe losses on impaired structured finance products. - American International Group (AIG) received federal support after major losses at its capital markets affiliate. - Two other insurance groups with federally regulated banking or thrift subsidiaries were granted federal government capital support under TARP. - Insurers benefited from Federal Reserve programs, particularly TALF. - Life insurance sector specifics: - Large unrealized investment losses and downward pressure on regulatory capital ratios. - “Permitted practices” granted by regulators in some cases. - Strains from growth in non-traditional savings products such as variable annuities with generous guarantees. - Illiquidity in asset markets affected securities lending; new business volumes fell sharply. - Ongoing exposures if downturn continues: high commercial property exposure, elevated exposure to banks, and risks from prolonged low interest rates. - Property and casualty: - Investment market falls hit P&C; 2009 natural catastrophe losses were not as high as some recent years. - P&C risks dispersed regionally; largest catastrophe risks carried by reinsurers outside the United States. ### Key statistics — Capital adequacy (Table 1) - Life - Total adjusted capital (US$ billions): 337.9 382.6 363.5 344.4 340.2 - RBC requirement (US$ billions): 44.6 47.7 44.8 42.3 43.9 - Industry aggregate RBC ratio (TAC as % of RBC): 758% 802% 811% 814% 775% - Median RBC ratio of insurers (TAC as % of RBC): 910% 1009% 996% 975% 940% - Number of companies in action levels: 23 13 13 11 17 - Percentage of companies in action levels: 2.7% 1.5% 1.4% 1.1% 1.7% - Property and Casualty - Total adjusted capital (US$ billions): 578.9 640.7 599.3 523.8 484.8 - RBC requirement (US$ billions): 96.8 102.7 98.6 94.2 93.6 - Industry aggregate RBC ratio (TAC as % of RBC): 598% 624% 608% 556% 518% - Median RBC ratio of insurers (TAC as % of RBC): 992% 977% 935% 877% 828% - Number of companies in action levels: 79 71 75 86 108 - Percentage of companies in action levels: 3.0% 2.7% 2.9% 3.4% 4.3% - Health - Total adjusted capital (US$ billions): 75.2 79.9 72.2 61.6 46.8 - RBC requirement (US$ billions): 12.7 12.2 10.9 9.6 8.1 - Industry aggregate RBC ratio (TAC as % of RBC): 592% 655% 662% 642% 578% - Median RBC ratio of insurers (TAC as % of RBC): 545% 589% 582% 574% 548% ### Solvency Modernization Initiative (SMI) and other reforms - SMI scope includes: - Capital requirements: review design and calibration of current requirements; consider regulatory reporting of companies’ economic capital levels and target capital development. - International accounting: review implications of joint FASB/IASB project; regulators to determine changes to statutory accounting from GAAP changes. - Insurance valuation: move toward more principles-based reserving in life insurance; make capital requirements reflect individual company risk characteristics more. - Reinsurance: implement modernization framework; Reinsurance Supervision Review Department to assess non-U.S. regimes under mutual recognition framework. - Group solvency issues: consider revisions to group supervision, supervisory colleges, group-wide supervision requirements, potentially including group-wide capital requirements. - Corporate governance and risk management: consider developing principles and establishing risk management requirements. - Crisis-related and other reforms: - Reforms to bond insurers (monolines) and securities lending treatment. - Actions to reduce reliance on major credit rating agencies. - Congressional and administrative regulatory reform proposals under discussion; possible inclusion of insurance in system-wide regulatory reforms. ### Major findings on observance of Insurance Core Principles (ICPs) - Strong regulation contributed to sector resilience during the financial crisis. - Preconditions for effective supervision generally met, but policy development is needed on financial stability and international issues. - Institutional weaknesses: - Need reform on appointment/dismissal of commissioners, budgetary framework, and remuneration policies to secure independence. - Departments dependent on state legislatures for principal legislation and budgets. - Transparency and stakeholder understanding: - Regulation is open and transparent, but greater free access to NAIC model laws and implementation materials recommended. - Licensing and suitability: - Comprehensive licensing requirements exist, approaches vary by state. - Gaps: no explicit requirement for companies to notify departments of concerns about fitness and propriety; departments cannot disallow functionaries from holding two positions that could create material conflicts. - Governance, internal controls, and risk management: - Requirements limited; recommend extension and formal requirement for comprehensive risk management policies and systems. - Data, market analysis, and group supervision: - NAIC data and analysis capabilities world-leading, but absence of complete group-wide consolidated data hinders group-wide assessments. - Supervisors do not comprehensively assess whole-group financial condition; supervisory colleges not convened for all U.S.-based international groups. - On-site supervision and preventive measures: - Financial examinations are thorough and well documented; prompt corrective action structure is rigorous. - Enforcement and sanctions: - Enforcement comprehensive in practice; no explicit authority to fine individual directors or senior managers or to bar them from future responsible capacities. - Reserves, investments, derivatives, and capital: - Reserving methods generally conservative; no specified target safety level for reserving or capital. - No requirements addressing inflation of capital through multiple gearing. - Intermediaries, consumer protection, and fraud: - Producer regulation less uniform than company regulation; core consumer protection requirements apparently in place in most states. - Fraud requirements exist; gaps remain (e.g., lack of anti-fraud plan requirements in some states). ### ICP observance summary (aggregate grading) - Observed (O): 11 - Largely Observed (LO): 14 - Partly Observed (PO): 3 - Not Observed (NO): 0 - Not Applicable (N/A): 0 ### Key recommended actions (selected, preserved verbatim where numeric/procedural) - ICP 1: - (i) increase information-sharing and coordination between state regulators and federal authorities, including representation of state regulators in national bodies with responsibilities for system wide oversight and financial stability; - (ii) agree policies and procedures for the regulation of systemically important institutions, markets and instruments, where assessed to exist in the insurance sector; - (iii) make new arrangements to increase the authority of federal authorities in relation to the implementation of international agreements. - ICP 2: - Develop a clear, joint statement of the objectives of insurance regulation among insurance departments, the NAIC and state legislatures; align objectives of individual state departments; address potential conflicts between objectives and balance financial safety and consumer protection with market efficiency and competitiveness. - ICP 3: - NAIC and state legislatures should reform to: (i) provide for fixed terms for commissioner appointments with dismissal mid-term only for prescribed causes and publication of reasons; (ii) make departments fully self-funding while maintaining accountability and allowing flexibility to hire specialist staff; (iii) extend rule-making powers of departments to a wider range of technical issues. - ICP 4: - NAIC should: (i) make publicly available some information currently available only for a fee or by subscription (e.g., NAIC model laws and material on state adoption); (ii) publish summary information on their assessment of states’ compliance with accreditation standards; (iii) commit to regular publication (maybe every two years) of their self-assessment of compliance with IAIS Insurance Core Principles; and consider developing regulatory impact analysis as routine. - ICP 7: - Adopt specific requirements on individuals’ fitness and propriety; require companies to notify departments of concerns about key individuals; allow departments to disallow functionaries from holding two positions creating material conflict. - ICP 9 & ICP 10: - As examiners gain experience, NAIC and/or departments should issue guidance on corporate governance and internal control good/bad practices; make internal audit function a formal requirement for insurers (except perhaps smaller firms). - ICP 11 & ICP 12: - Collect more complete group-wide consolidated data for insurance groups and broader financial conglomerates; develop further analysis of developments outside U.S. markets. - ICP 13: - NAIC might consider undertaking an assessment of the implementation of the risk-focused examination approach in the near future (e.g., in the course of 2012). - ICP 15: - Change insurance laws to provide supervisory authority powers to fine individual directors and senior managers and to bar them from acting in responsible capacities in the future. - ICP 17: - U.S. supervisors should: (i) include fuller assessment of the financial condition of entire groups; (ii) extend risk-focused examinations to groups and apply lead regulator/college arrangements; (iii) ensure supervisory colleges for U.S. groups with major international operations are established and functioning effectively and led by U.S. regulators with appropriate expertise. - Consider giving regulators additional powers: authority to license insurance holding companies, apply insurance capital requirements to consolidated insurance groups, and direct holding companies to make group-level changes. - ICP 18: - Change laws/regulations/standards to require insurers to have comprehensive risk management policies and systems capable of promptly identifying, measuring, assessing, reporting and controlling risks. - ICP 19: - Explicitly require insurers to have strategic underwriting and pricing policies approved and regularly reviewed by the Board. - ICP 23: - Consider specifying a target safety level for reserving and an associated target safety level for capital; include requirements to address inflation of capital through multiple gearing; consider further development of stress testing using crisis experience. - ICP 24: - Strengthen producer regulation: (i) extend broker trust fund arrangements across states; (ii) develop uniform approach to regulation of major brokers; (iii) complete work on consistent commission disclosure; require producers to disclose status and appointing insurers to customers. - ICP 28: - Set a timetable for agreement and implementation of new arrangements between state insurance departments and federal authorities to improve resourcing, supervisory activities, and information exchange. ### Funding, resources and governance - Funding and budgets: - State insurance premium tax is passed in full to the general fund; other fees/assessments in most states are retained by departments. - Two funding approaches for excess collections: “dedicated funding system” (retain excess to build reserve) and “quasi-dedicated system” (excesses passed to state general fund). - Resources, staffing, and remuneration: - Total budget for all departments: US$1.6 billion in 2008 (a 50 percent increase on the 2002 level). - Staff totaled over 11,905 at year end (2008). - Many contract staff and staff from other agencies also used—totaling a further 1,325. - NAIC employs just over 400 staff. - Departments face pressures to recruit/retain specialist staff (e.g., actuaries); staff remuneration linked to general pay grades for state employees. - Confidentiality and information sharing: - Information from examinations is protected in all states; states can protect derivative confidentiality. - Recommendation: state laws should be changed, where not already done, to extend protection of information received from other government agencies to foreign agencies. - Recommendation: NAIC and state legislatures should consider extending confidentiality protection to all relevant information received by departments. - Operational independence: - Appointment procedures: 12 of the 56 commissioners are directly elected; others appointed by the governor and hold office at the governor’s pleasure. - Departments subject to state budgetary authority; exposure to budgetary cuts during downturns. - Recommendations: fixed terms for commissioners with dismissal mid-term only for prescribed causes; make departments fully self-funding while maintaining accountability; extend rule-making powers to departments for technical issues. ### On-site supervision, preventive measures and enforcement - On-site inspections: - Financial examinations required at least every five years (three years in some states); risk-focused approach implemented and accreditation standard from January 1, 2010. - Seven phases of risk-focused examinations defined in the Financial Condition Examiners Handbook. - Examination reports are public; work papers and management letters generally not public but available to other state authorities. - Recommendation: strengthen confidentiality of examination work papers; NAIC to assess implementation of risk-focused approach (e.g., in 2012). - Prompt corrective action (RBC Model Law #312) — four action levels: - Company Action Level: trigger—insurer capital less than 200 percent of RBC; or life/health less than 250 percent of RBC and negative trend; or P&C less than 300 percent of RBC and negative trend. Action—insurer must prepare and submit an RBC Plan with corrective actions and 4-year financial projections. - Regulatory Action Level: trigger—capital less than 150 percent of RBC. Action—insurer must prepare/submit RBC Plan or revised Plan; supervisory authority must examine financial condition and issue “corrective order.” - Authorized Control Level: trigger—capital less than 100 percent of RBC. Action—as for Regulatory Action Level, or place insurer under regulatory control (rehabilitation or liquidation) if in policyholders'/creditors'/public interest. - Mandated Control Level: trigger—capital less than 70 percent of RBC. Action—supervisory authority must place insurer under regulatory control (rehabilitation or liquidation), except for P&C insurers in run-off where run-off may continue under supervision. - Enforcement and sanctions: - Supervisory authority can require capital increases, restrict dividends, stop new/renewal policies, change investments, require management changes. - NAIC Model Law #558 allows administrative supervision with direct control; Model Law #555 sets conservatorship/rehabilitation/liquidation procedures. - Penalty provisions allow fines on insurers; limited authority to fine or bar individual directors or senior managers under insurance law. - Recommendation: change insurance laws to provide supervisory authority powers to fine and bar individual directors and senior managers. ### Group-wide supervision and international cooperation - Historical focus on solo-company soundness; extensive information on holding companies and affiliate transactions collected but complete consolidated group-wide data for insurance-only groups not required at intermediate holding company level. - Holding Company Act (#440) presumes control at ten percent (10 percent) voting threshold. - Lead state designated to coordinate regulatory activities for each insurance group. - Supervisory colleges and cross-border cooperation uneven; increased activity following crisis. - Assessment: Partly Observed. - Recommendations: - Include fuller assessment of the financial condition of whole groups; consider applying U.S. RBC to consolidated domestic insurance group. - Extend risk-focused examinations to groups and apply lead regulator/college arrangements. - Ensure supervisory colleges for U.S.-led groups with major international operations are established and led by U.S. insurance regulators. - Consider giving regulators powers to license insurance holding companies, apply insurance capital requirements to consolidated insurance groups, and direct holding companies to make group-level changes. ### Actuarial, accounting, reserving and move to a Principles-Based Approach (PBA) - Regulatory accounting: Statutory Accounting Principles (SAP) codified in the NAIC Accounting Practices and Procedures Manual (APPM). - APPM is large (about 3,500 pages); maintained by NAIC APPTF; SSAPs, ASIs and appendices form hierarchy. - Annual Statement Instructions (ASIs) require actuarial opinion (SAO), audited financial reports, Management’s Discussion and Analysis, investment schedules, and annual supplements. - SAO and Actuarial Memorandum: - SAO is public; Actuarial Memorandum is confidential and available only for regulatory examination. - Qualified actuary must be a member in good standing of AAA or CAS (for P&C). - Move to PBA for life reserving: - Proposed reserve = greater of deterministic component (floor) and stochastic component (conditional tail expectation of 70 percent). - Proposed capital adjustments: target statutory reserves plus capital at conditional tail expectation of 90 percent for products subject to PBA. - C–3 Phase I (2000) and C–3 Phase II (2005) addressed interest rate and equity risks; VA CARVM (2008) introduced insurer-specific variable annuity reserving. ### Variable Annuities (product description and regulatory treatment) - Product features: - Investment-linked products with guarantees (accumulation, income, death or withdrawal); most common guarantee in the United States is on withdrawal. - Customer’s initial capital invested in sub-account; insurer carries risk that sub-account will not fund guaranteed withdrawals. - Product combines an annuity with a call option on residual sub-account at maturity. - Regulatory evolution: - NAIC added internal models-based approach in 2000 to capture interest rate risk; refined in 2005 to capture equity risk. - NAIC risk-based capital system referenced in all state laws—changes automatically applied by all states. - Work underway to refine reserving; insurers reduced writing of such products and scaled back guarantees post-crisis. ### Guaranty funds (policyholder compensation arrangements) - Policyholders protected by guaranty associations in each state; all U.S. insurance companies required to be members of life/health and property/casualty associations. - Associations established by state laws; payments triggered by insolvency; associations seek continuity by transferring policies to other companies. - Associations are not pre-funded; rely on assessments of other insurers writing the same class of business. - State laws set limits on assessment—typically, for life insurance, 2 percent of each insurer’s prior year premium income in the state per year. ### Anti-money laundering and combating financing of terrorism (AML/CFT) - FinCEN rule (31 CFR 103.137) (implemented May 2006) applies to covered products: - permanent life insurance policy (excluding group), - annuity contract (excluding group), - other insurance product with cash value or investment features. - Covered-product insurers must develop and implement AML programs; key elements include risk-based policies, integration of agents/brokers into insurer AML program, designation of compliance officer, training, independent testing, written program approved by senior management and made available to Treasury/FinCEN on request. - IRS delegated examination authority for the insurance sector; IRS has carried out limited examinations since 2007 under MOU with FinCEN; effectiveness and enforcement limited by resources and legal/procedural issues. - FATF Mutual Evaluation Report (June 2006) identified gaps for the insurance sector (selected points preserved verbatim where numeric or procedural): - US$5000 threshold for reporting suspicious activity considered too high. - Beneficial ownership identification obligations limited and not extending to insurance business. - No explicit obligation for ongoing due diligence except in defined circumstances. - No explicit requirement for life insurers issuing covered products to verify true identity of customer (except where product is a ‘security’ under federal securities laws). - PEP measures do not explicitly apply to insurance sector. - Assessment: Partly Observed. - Recommendation: Set a timetable to agree and implement new arrangements between state insurance departments and federal authorities to improve resourcing, supervisory activities, and information exchange. *Source: IMF FSAP assessment chapter “1. U.S. Insurance Companies—Capital Adequacy.”* ### 1. U.S. Insurance Companies—Capital Adequacy ................................................................8 ### 1. U.S. Insurance Companies—Capital Adequacy ### Executive summary and key findings - Insurance regulation in the United States, which is mostly carried out by states, is generally thorough and effective, although there are areas where significant development is needed. - Strong regulation contributed to the overall resilience of the insurance sector during the financial crisis. - There is generally a high level of observance of the Insurance Core Principles. - Data collection and analysis in relation to individual insurance companies are world-leading. - Mechanisms exist to ensure individual states implement solvency requirements effectively. - Needs identified: - Development of the policy framework in relation to insurance and financial stability and international issues. - Extensive reform to the laws governing state insurance departments, including on appointment and dismissal of commissioners, to secure the independence of regulatory work. - Significant development of the approach to supervision of groups. ### Assessment scope and methodology - The assessment addresses national compliance with the IAIS Insurance Core Principles (ICPs) and was carried out as part of the 2010 U.S.A., Financial Sector Assessment Program (FSAP). - Assessors: Tom Karp (insurance expert and former Executive General Manager, Australian Prudential Regulatory Authority) and Ian Tower (Monetary and Capital Markets Department, IMF). - Regulatory responsibility context: - Regulatory responsibility is shared by 50 states, the District of Columbia and the five U.S. territories. - Federal authorities have limited regulatory powers over the insurance sector; certain federal interests exist (e.g., external trade, AML/CFT). - Information base: - Assessment based on information available in November 2009 at the time of an FSAP mission. - NAIC provided a self-assessment and additional information; documentation included relevant laws and regulations (the model laws of the National Association of Insurance Commissioners were the main documentary resource). - Discussions held with NAIC staff, selected insurance commissioners and their staffs (Illinois, Iowa, New York, West Virginia), U.S. Department of the Treasury, insurance companies, intermediaries, and industry and actuarial bodies. - Methodology details: - Assessment based on the 2003 version of the IAIS Insurance Core Principles and Methodology, taking into account relevant IAIS standards and guidance. - ICP 28 (AML/CFT) assessment informed by the 2006 FATF assessment using the 2004 Methodology. - Reliance on NAIC procedures to take a national view despite limits on verifying practices across all states. ### Institutional and market structure—overview - Market size and composition: - The U.S. insurance market is the largest in the world. - There were 7,948 licensed insurance companies at the end of 2008. - Total premium volume in 2008 of US$1.24 trillion accounted for 29 percent of the global market. - On insurance density measures (premiums per capita), the United States ranked ninth at US$4,078 in 2008. - The United States ranked thirteenth on insurance penetration (premiums as a percentage of GDP) at 8.7 percent. - Main sectors: life, property and casualty (personal and commercial lines), and health insurance. - Key specialist lines requiring separate companies: financial guaranty (monoline insurers), mortgage insurance, title insurance. - Other sector participants: captive insurance companies and Risk Retention Groups (RRGs). - Total employment in insurance companies was 1.6 million at the end of 2008. - Market characteristics: - Low market concentration in most sectors; provisions allow “excess and surplus lines” to be written free of some general regulatory requirements where appropriate. - Limited private-sector capacity in certain “hard to insure” risks; existence of “residual market” mechanisms and state/federal programs (federal: TRIA, flood, crop loss; state: workers compensation, Florida Hurricane Catastrophe Fund). - Limited international insurance business; relatively small reinsurance capacity—58 percent of all premium ceded to reinsurers by U.S. insurers is to markets in Europe and Bermuda (85 percent, if premium ceded to offshore affiliates of U.S. companies is included). - Relatively few cross-sector groups offering insurance as well as other financial services: 17 groups headed by a bank holding company regulated by the Federal Reserve; 42 contain a thrift regulated by the Office of Thrift Supervision. - Distribution: mainly through agents and brokers (referred to as “producers”); banks distribute insurance but have limited market share. ### Recent performance and capital adequacy - Overall resilience: - The insurance sector, particularly property and casualty companies, was resilient through the financial crisis. - Capital and surplus fell by 6.7 percent in life and 8.5 percent in property and casualty between end-2007 and mid-2009. - Companies whose capital adequacy (measured by the regulators’ risk-based capital (RBC) requirements) fell to regulatory intervention levels accounted for only 3 percent of the total in 2008. - Several firms were placed in receivership; only one company was subject to receivership for causes and timing directly related to the financial crisis. - Investment market falls hit property and casualty companies; 2009 natural catastrophe losses were not as high as some recent years. - Absolute dollar amounts of capital have fallen, but required RBC has fallen too, leading to capital coverage ratios falling more slowly. - Actual capital in each sector is many times greater than required RBC levels and, on average, about two to three times the capital levels at which regulatory intervention would occur. - Significant stresses in 2007–2009: - Monoline insurers (financial guaranty) lost previously high ratings after severe losses on impaired structured finance products. - American International Group (AIG) received federal support after major losses at its capital markets affiliate. - Two other insurance groups with federally regulated banking or thrift subsidiaries were granted federal government capital support under TARP. - Insurers benefited from Federal Reserve programs, particularly TALF. - Life insurance sector: - Particularly affected by large unrealized investment losses and downward pressure on regulatory capital ratios. - Regulators granted some individual modifications (“permitted practices”). - Strains related to growth in non-traditional savings products such as variable annuities with generous guarantees. - Illiquidity in asset markets affected securities lending practices, causing liquidity strains. - New business volumes have fallen sharply. - Ongoing challenges and risk exposures: - Life companies remain significantly exposed if the economic downturn continues; commercial property exposure is high (loans and investments), and exposure to banks is elevated. - A prolonged low interest rate environment would exacerbate strains. - As life companies have shifted to savings products, insurance risks (mortality and longevity) have become less significant. - Health insurers face significant uncertainty from proposed federal government reforms to health insurance. - Property and casualty risks are dispersed; U.S. exposure to major natural catastrophes is regional, with national companies diversifying risks and the largest catastrophe risks carried by reinsurers outside the United States. ### Key statistics — Capital adequacy (Table 1) - Life - Total adjusted capital (US$ billions) 337.9 382.6 363.5 344.4 340.2 - RBC requirement (US$ billions) 44.6 47.7 44.8 42.3 43.9 - Industry aggregate RBC ratio (TAC as % of RBC) 758% 802% 811% 814% 775% - Median RBC ratio of insurers (TAC as % of RBC) 910% 1009% 996% 975% 940% - Number of companies in action levels 23 13 13 11 17 - Percentage of companies in action levels 2.7% 1.5% 1.4% 1.1% 1.7% - Property and Casualty - Total adjusted capital (US$ billions) 578.9 640.7 599.3 523.8 484.8 - RBC requirement (US$ billions) 96.8 102.7 98.6 94.2 93.6 - Industry aggregate RBC ratio (TAC as % of RBC) 598% 624% 608% 556% 518% - Median RBC ratio of insurers (TAC as % of RBC) 992% 977% 935% 877% 828% - Number of companies in action levels 79 71 75 86 108 - Percentage of companies in action levels 3.0% 2.7% 2.9% 3.4% 4.3% - Health - Total adjusted capital (US$ billions) 75.2 79.9 72.2 61.6 46.8 - RBC requirement (US$ billions) 12.7 12.2 10.9 9.6 8.1 - Industry aggregate RBC ratio (TAC as % of RBC) 592% 655% 662% 642% 578% - Median RBC ratio of insurers (TAC as % of RBC) 545% 589% 582% 574% 548% *Source: IMF FSAP assessment chapter “1. U.S. Insurance Companies—Capital Adequacy.”* ### 15. Insurance is a predominantly state-regulated activity in the United States. While ### 15. Insurance is a predominantly state-regulated activity in the United States. While ### Historical and federal context - Foundation for state responsibility goes back to 1851. - Key event: Supreme Court decision in 1944 declared that insurance was interstate commerce and hence subject to federal regulation, including federal laws such as the Sherman Act and other antitrust laws. - Congressional response: 1945 enactment of the McCarran-Ferguson Act reinstated state regulatory authority “on matters of the business of insurance” and exempted the “business of insurance” as regulated by the states from federal anti-trust laws. - Consequence of the McCarran-Ferguson Act: insurance companies are able to pool data for use in underwriting risks. - Federal measures affecting insurance: - 1974 Employee Retirement Income Security Act (ERISA): imposed federal reporting requirements and enforcement powers for employer-sponsored retirement plans and other related benefits. - Gramm-Leach-Bliley Act of 1999: preserved state regulation by reaffirming the McCarran-Ferguson Act, but pressed states to achieve licensing reciprocity in insurance intermediary licensing or accede to federal intervention. - 2002 U.S.A. PATRIOT Act: extended aspects of the Federal Bank Secrecy Act to insurance and gave examination powers in relation to anti-money laundering and certain specified insurance business to federal authorities. ### State regulatory structure and functions - State insurance departments carry out licensing and oversight under state legislation and budgets; headed by a commissioner (some elected, most appointed by the state governor). - Funding: usually raised from the insurance markets via fees and levies; departments also collect premium taxes which are a significant part of state governments’ total revenues. - Licensing and domicile: - Businesses must obtain a license in each state where they write risks. - “Domiciled” = state that issued an insurer’s primary license; insurer is “domestic” in that state. - Insurers licensed in other states are “foreign” insurers. - Insurer incorporated in a foreign country is an “alien” insurer in U.S. states where licensed. - “Multistate companies” (the vast majority by premium income) write business in more than one state. - Financial regulation is mostly carried out by the state where the insurer is domiciled. - Regulatory activities and requirements: - States set reserving and capital requirements—rules and associated reporting frameworks are complex (details in appendix to assessment). - Financial analysis and onsite examinations are required by law every five years at minimum (or three years in some states). - Most states review or approve policy forms; property and casualty insurers often face premium rate regulation with the objective that rates are “not inadequate, excessive, or unfairly discriminatory.” - Departments handle consumer complaints, license and oversee intermediaries, and possess extensive enforcement powers for financial and market conduct requirements. ### NAIC role and coordination - NAIC established by state insurance commissioners as a not-for-profit organization to centralize functions, achieve economies and greater uniformity, pool resources, and share expertise. - NAIC staffing and scope: - The NAIC itself employs some 430 staff, which compares with nearly 12,000 employed by the states. - Key NAIC functions (as related to this assessment): - Processes and procedures to develop and agree model laws and regulations—now total over 200. States contribute via NAIC working groups. States often implement models with variations, particularly significant in market conduct and producer licensing. - Financial Regulation Standards and Accreditation Program (the accreditation program): - Aims to ensure states meet certain minimum standards in respect to financial regulation. - Covers laws and regulations (including 18 of the NAIC model laws) and key provisions on accounting and solvency; regulatory practices including offsite and onsite supervision; and organizational and staffing practices. - Standards on insurance company licensing will be added in 2012. - To achieve and retain accreditation, states undergo a detailed review by independent examiners once every five years; interim annual reviews are also required. Final decisions on accreditation are taken by a committee of commissioners. - All 50 states and the District of Columbia are accredited. - Formal effect of accreditation: enables states to accept examinations undertaken by the domestic state rather than carrying out their own, although individual states may still impose additional standards on “foreign” companies (i.e., accreditation does not guarantee reciprocity). - Centralized financial analysis via the NAIC’s Financial Analysis Working Group (FAWG): - FAWG comprises 18 senior financial experts who discuss reports from NAIC staff covering all “nationally significant companies” (around 1,600 companies representing 85 percent of the market) based on annual and quarterly statements and other information. - Objective: to challenge domestic state regulators on their analysis of companies and regulatory response. - A similar process is being developed for market conduct regulation. - NAIC-operated databases: financial information (most companies submit statements direct to the NAIC), data on producers, etc. ### Assessment approach and regulatory modernization - The assessment highlights measures subject to the accreditation program as they are most likely to be fully and effectively implemented by states. - Assessors relied heavily on the accreditation program to infer that minimum standards are met in all accredited states. - In assessing compliance with other NAIC model laws and measures, the assessment distinguishes between those implemented in most, many and some states. States were not assessed individually, creating some uncertainty about nationwide compliance. - Modernization efforts since 2000 include shifting from compliance/audit examinations to more forward-looking assessments of risk; this change was to be formally part of the accreditation program from January 1, 2010. - Mixed progress on modernization: - Some objectives met; others, such as greater uniformity in producer licensing, not fully met. - Structural features slowing progress: - State-based system: states are not bound to implement NAIC models; local variations can impede necessary uniformity for nationally active insurers and intermediaries. - NAIC consensus processes involve many stakeholders, slowing delivery of change except where urgent. - Regulatory requirements are heavily rules-based, which increases time to make changes and risks micro-management through incremental rule additions. ### Solvency Modernization Initiative (SMI) and other reforms - SMI launched in 2008 by the NAIC as a review of financial requirements, including study of solvency regimes and developments in other countries and the EU. - SMI scope includes: - Capital requirements: reviewing design and calibration of current requirements and considering whether to require regulatory reporting of companies’ economic capital levels and information about the development of the companies’ target capital. - International accounting: implications of the joint project on insurance contract accounting of the U.S. Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB); insurance regulators are required to review all changes to GAAP accounting and determine what changes should be made to statutory accounting. - Insurance valuation: project to move toward more principles-based reserving in life insurance; consideration of making capital requirements reflect individual company risk characteristics more. - Reinsurance: implementing a modernization framework developed in 2008, once pending federal legislation is in place; a new Reinsurance Supervision Review Department will assess non-U.S. regulatory regimes under a mutual recognition framework. - Group solvency issues: considering potential revisions to the current approach to supervision of groups, use and potential improvement of supervisory colleges with regulators from around the world, and group-wide supervision requirements, which may include group-wide capital requirements. - Consideration will also be given to development of corporate governance principles and establishment of risk management requirements for insurance companies. - These initiatives have the potential to transform U.S. insurance regulation. ### Crisis-related reforms and scope of future regulation - Reforms will address issues highlighted by the financial crisis; insurance will be included in the scope of future system-wide regulatory reforms. - Pending and considered actions: - Reforms to requirements applying to bond insurers (monolines) and to securities lending to take account of crisis events. - Actions to reduce reliance on ratings of the major credit rating agencies. - Congress and the administration working on regulatory reform in response to the crisis; proposals affecting insurance regulation were under discussion at the time of this assessment. ### Variable Annuities (Box 1) — product description and regulatory treatment - Product description: - Variable annuities are investment-linked products with some form(s) of guarantee (accumulation, income, death or withdrawal) sold by life insurers into the retirement and investment market. - In the United States, the most common guarantee offered is that on withdrawal. - Customer’s initial capital is invested in a sub-account at the customer’s discretion. - Customer can withdraw guaranteed periodic amounts up to the amount of the initial capital; product terminates once the initial capital has been withdrawn with any remaining funds in the sub-account returned to the customer at maturity. - Sub-account value fluctuates with movements in the underlying assets and decreases with withdrawals. - Product combines an annuity (guaranteed periodic withdrawals) with a call option on the underlying residual sub-account at maturity. - Customer owning the sub-account carries much of the investment risk; the insurer carries the risk that the sub-account will not be adequate to fund guaranteed withdrawal amounts. - Regulatory evolution: - The NAIC developed its approach to treatment of such products with complex guarantees in its capital adequacy requirements. - In 2000, an internal models based approach was added to the previously factor-based capital approach to capture interest rate risk. - This was refined in 2005 to capture equity risk. - These changes have been automatically applied by all states, as the NAIC risk-based capital system is referenced in all state laws. - Work is under way to further refine reserving requirements for such products. - Over the last few years, and especially since the financial crisis, insurers have reduced their writing of such products and scaled back the types and levels of guarantees offered. ### Guaranty funds (policyholder compensation arrangements) - Policyholders are protected against insurer insolvency by guaranty associations in each state. - All U.S. insurance companies are required to be members of associations covering life and health insurance and, through separate organizations, property and casualty. - Associations are established by state laws (there are NAIC models). - Payments are triggered by the insolvency of an insurer; in practice associations seek continuity of coverage by transferring policies to other companies. - Laws differ on the extent of coverage and maximum amount payable per policyholder. - Associations rely on assessments of other insurers writing the same class of business; they are not pre-funded. - State laws set limits on assessment—typically, for life insurance, 2 percent of each insurer’s prior year premium income in the state per year. *Source: IMF staff assessment text provided in content unit _cr10126 - 15.* ### 27. Insurance regulation in the United States is generally thorough and effective, ### _cr10126 - 27. Insurance regulation in the United States is generally thorough and effective, ### Major findings on observance of Insurance Core Principles (ICPs) - Strong regulation contributed to the overall resilience of the insurance sector during the financial crisis. - Preconditions for effective insurance supervision are generally met, reflecting the highly developed legal and institutional framework and the scale and liquidity of U.S. financial markets; however, development is needed on the policy framework concerning insurance and financial stability and international issues. - Institutional weaknesses: - Need for reform in laws governing state insurance departments on appointment and dismissal of commissioners, budgetary framework, and remuneration policies to secure independence of regulatory work. - Departments are dependent on state legislatures for principal legislation and budgetary resources; ability of governors to dismiss commissioners at any time and statewide remuneration policies can constrain independence and specialist hiring. - Transparency and stakeholder understanding: - Insurance regulation is carried out openly and transparently, but measures are needed (including free access to more information and documents about the NAIC’s model laws and their implementation) to foster improved stakeholder understanding of the state-based regulatory approach. - Licensing and suitability: - Comprehensive set of requirements and processes for insurance company licensing exist, though approaches vary by state. - Gaps in requirements relating to suitability of persons: reliance on supervisory work to identify concerns; companies are not required to notify departments of concerns about fitness and propriety of key individuals; departments cannot disallow functionaries from holding two positions that could create material conflicts. - Governance, internal controls, and risk management: - Requirements are limited and should be extended. - Departments are focusing on these issues in the rollout of a risk-focused examination process, which requires major changes from examiners and needs close NAIC monitoring. - No requirement exists that an insurer have in place comprehensive risk management policies and systems capable of promptly identifying, measuring, assessing, reporting, and controlling their risks. - Data, market analysis, and group supervision: - NAIC data collection and analysis capabilities are world-leading for authorized insurance companies. - Absence of complete group-wide consolidated data for insurance groups and broader financial conglomerate groups hinders supervisors’ ability to analyze and monitor market-wide events and to make group-wide financial condition assessments. - U.S. supervisors do not currently make a comprehensive and consistent assessment of the financial condition of the whole group of which a licensed insurance company is a member. - Risk-focused examinations are not yet generally focusing on group issues; supervisory colleges are not meeting for all U.S.-based international groups. - On-site supervision and preventive measures: - Financial examinations (onsite) are generally thorough and well documented and identify important issues. - Prompt corrective action structure is thorough and rigorously applied; guaranty fund data suggests most shortfalls are in the 5–15 percent of liabilities range. - Enforcement and sanctions: - Enforcement approach is comprehensive in practice, but there is no explicit authority for supervisors to fine individual directors or senior managers or to bar them from future responsible capacities. - Reserves, investments, derivatives, and capital: - Liability reserving methods and bases generally lead to conservative estimates; reserving combined with capital requirements provides a sizable buffer. - There is currently no specified target safety level for reserving or capital; consideration should be given to specifying target safety levels for both. - Investment and derivatives requirements are robust. - No requirements to address inflation of capital through multiple gearing are in place; these should be included in law, regulation, or rules. - Intermediaries, consumer protection, and fraud: - Producer regulation is less uniform than for companies; most states have core requirements (licensing, examinations, powers to act for misconduct). - Need to extend broker trust fund arrangements across states, develop uniform approach to regulation of major brokers, and complete work on consistent commission disclosure regulation. - Consumer protection work is moving toward proactive market conduct supervision but varies across states; core consumer protection requirements are apparently in place in most states. - Fraud requirements (including making insurance fraud a crime) are in place across states; capacity to address fraud-related issues is increasing with market conduct exams and improved fraud data. Remaining gaps (e.g., lack of anti-fraud plan requirements) should be addressed. ### ICP observance summary (grading and notable ICP-level points) - Aggregate: Observed (O) – 11, largely observed (LO) – 14, partly observed (PO) – 3, not observed (NO) – zero, not applicable (N/A) – zero. - Selected ICP-level highlights: - ICP 1 – Conditions for effective insurance supervision: LO — preconditions generally met; need for policy development re financial stability and international issues. - ICP 3 – Supervisory authority: PO — commissioners’ dismissal vulnerability and budget/remuneration constraints expose potential political influence. - ICP 6 – Licensing: O — core licensing requirements comprehensive; extension of accreditation to licensing standards in 2012 noted. - ICP 11 & ICP 12 – Market analysis and reporting/off-site monitoring: LO — NAIC capabilities world-leading, but absence of complete group-wide consolidated data is a key shortcoming. - ICP 13 – On-site inspection: O — financial examinations thorough; rollout of risk-focused approach will require qualitative judgments and implementation assessment (NAIC might consider assessment in 2012). - ICP 14 – Preventive and corrective measures: O — prompt corrective action structure thorough; guaranty fund data suggests most shortfalls are in the 5–15 percent of liabilities range. - ICP 15 – Enforcement or sanctions: LO — no clear authority to fine or bar individual directors/senior managers. - ICP 17 – Group-wide supervision: PO — U.S. approach focused on solo company soundness; supervisors do not assess whole-group financial condition and colleges are not convened for all international groups. - ICP 20 & ICP 23 – Liabilities and Capital adequacy and solvency: O / LO — reserving conservative; recommendation to consider specifying target safety levels for reserving and capital; absence of measures on multiple gearing needs addressing. ### Key recommended actions (selected and preserved verbatim where numeric or procedural) - ICP 1: - (i) increase information-sharing and coordination between state regulators and federal authorities, including representation of state regulators in national bodies with responsibilities for system wide oversight and financial stability; - (ii) agree policies and procedures for the regulation of systemically important institutions, markets and instruments, where assessed to exist in the insurance sector; - (iii) make new arrangements to increase the authority of federal authorities in relation to the implementation of international agreements. - ICP 2: - Develop a clear, joint statement of the objectives of insurance regulation among insurance departments, the NAIC and state legislatures; align objectives of individual state departments; address potential conflicts between objectives and balance financial safety and consumer protection with market efficiency and competitiveness. - ICP 3: - NAIC and state legislatures should reform to: (i) provide for fixed terms for commissioner appointments with dismissal mid-term only for prescribed causes and publication of reasons; (ii) make departments fully self-funding while maintaining accountability and allowing flexibility to hire specialist staff; (iii) extend rule-making powers of departments to a wider range of technical issues. - ICP 4: - NAIC should: (i) make publicly available some information currently available only for a fee or by subscription (e.g., NAIC model laws and material on state adoption); (ii) publish summary information on their assessment of states’ compliance with accreditation standards; (iii) commit to regular publication (maybe every two years) of their self-assessment of compliance with IAIS Insurance Core Principles; and consider developing regulatory impact analysis as routine. - ICP 7: - Adopt specific requirements on individuals’ fitness and propriety; require companies to notify departments of concerns about key individuals; allow departments to disallow functionaries from holding two positions creating material conflict. - ICP 9 & ICP 10: - As examiners gain experience, NAIC and/or departments should issue guidance on corporate governance and internal control good/bad practices; make internal audit function a formal requirement for insurers (except perhaps smaller firms). - ICP 11 & ICP 12: - Collect more complete group-wide consolidated data for insurance groups and broader financial conglomerates; develop further analysis of developments outside U.S. markets. - ICP 13: - NAIC might consider undertaking an assessment of the implementation of the risk-focused examination approach in the near future (e.g., in the course of 2012). - ICP 15: - Change insurance laws to provide supervisory authority powers to fine individual directors and senior managers and to bar them from acting in responsible capacities in the future. - ICP 17: - U.S. supervisors should: (i) include fuller assessment of the financial condition of entire groups; (ii) extend risk-focused examinations to groups and apply lead regulator/college arrangements; (iii) ensure supervisory colleges for U.S. groups with major international operations are established and functioning effectively and led by U.S. regulators with appropriate expertise. - Consider giving regulators additional powers: authority to license insurance holding companies, apply insurance capital requirements to consolidated insurance groups, and direct holding companies to make group-level changes. - ICP 18: - Change laws/regulations/standards to require insurers to have comprehensive risk management policies and systems capable of promptly identifying, measuring, assessing, reporting and controlling risks. - ICP 19: - Explicitly require insurers to have strategic underwriting and pricing policies approved and regularly reviewed by the Board. - ICP 23: - Consider specifying a target safety level for reserving and an associated target safety level for capital; include requirements to address inflation of capital through multiple gearing; consider further development of stress testing using crisis experience. - ICP 24: - Strengthen producer regulation: (i) extend broker trust fund arrangements across states; (ii) develop uniform approach to regulation of major brokers; (iii) complete work on consistent commission disclosure; require producers to disclose status and appointing insurers to customers. - ICP 28: - Set a timetable for agreement and implementation of new arrangements between state insurance departments and federal authorities to improve resourcing, supervisory activities, and information exchange. ### Implementation and operational issues highlighted - Rollout of risk-focused examination approach: - Requires major changes from examiners; implementation needs close monitoring by the NAIC and possibly an assessment (e.g., in 2012). - Information sharing: - Need to continue developing MoUs; ensure state laws updated to protect information received from foreign regulators; consider extending confidentiality protections to all relevant information received by departments. - Anti-money-laundering (AML/CFT): - Relevant insurance business only recently brought into scope; IRS is carrying out examinations but has limited resources and is cooperating with state departments; effectiveness of cooperation limited pending legal issue resolution and agreement on procedures and information sharing; no deadline set yet. *Source: IMF Financial Sector Assessment excerpt on U.S. insurance regulation (text unit _cr10126 - 27).* ### 28. The U.S. authorities welcome the opportunity to take part in the U.S. FSAP and the ### 28. The U.S. authorities welcome the opportunity to take part in the U.S. FSAP and the ### IMF FSAP participation and overall assessment - The U.S. authorities welcome the opportunity to take part in the U.S. FSAP and the IMF’s assessment of a high level of observance of the IAIS Insurance Core Principles (ICPs). - The FSAP provided insurance regulators in the United States with a timely opportunity to undertake a comprehensive self-assessment of the U.S. insurance regulatory system against international standards. - The FSAP has contributed to ongoing internal reviews and assessments of regulatory practices. - The FSAP served as a useful platform for providing an overview of the U.S. insurance regulatory system and its multi-jurisdictional structure. - The authorities appreciate the recognition by the IMF of the strengths in the regulatory system including areas that the IMF itself has coined as “world leading.” ### Context of the assessment (paragraph 29) - The assessment of the U.S. supervisory framework was undertaken in the wake of a severe financial crisis. - Movements toward significant changes in supervisory practices have gained momentum as a result of the financial crisis and circumstances emanating from the crisis, including with respect to group-wide supervision. - The IMF’s assessment of U.S. compliance with ICP 17, the group-wide supervision standard, goes beyond the scope of the current ICP assessment in that it assesses compliance with a group supervision structure, which is still under discussion and development in most jurisdictions and within the IAIS. - Revision of the insurance ICPs that may reflect these changes may not be finalized until 2011. ### Group supervision and international cooperation (paragraph 30) - U.S. insurance regulators are working with regulators around the world on initiatives to enhance group supervision. - Inter-regulatory cooperation processes in place include: - the use of lead state supervisory structures, and - the Financial Analysis Working Group of the National Association of Insurance Commissioners (NAIC). - The Report acknowledges the comprehensive review underway with the Solvency Modernization Initiative which takes into account international and cross-sectoral practices in the analysis of possible additions or modifications to current insurance regulatory practices. ### Prudential regulatory independence and accountability (paragraph 31) - U.S. authorities remain strongly committed to prudential regulatory independence and accountability, including continually striving to improve ways to effectively balance these two objectives. - Transparent rulemaking with opportunity for stakeholder involvement has proven a particularly effective way to provide accountability and improve the regulatory environment, while respecting regulatory independence. - The assessment of ICP 3, the Supervisory Authority standard, appears to rely on structural characteristics while failing to fully recognize the effective operational independence of state insurance regulators. - In practice, the U.S. multijurisdictional approach to insurance regulation holds regulators accountable to each other via: - a peer review process that includes on-going nation-wide monitoring through the NAIC, - regular dialogue among all regulators, and - the ability of states to question the actions of fellow state insurance regulators. ### Principles-based versus rules-based regulation (paragraph 32) - Within the assessment, there appear to be philosophical preferences for a principles-based, rather than rules-based, approach to regulation. - Assessment recommendations inconsistently apply those preferences by variously seeking more, as well as fewer, rules. - There appears to be no empirical evidence in the assessment to suggest that one approach is superior to the other or that the choice of approach affects the U.S. regulators’ ability to meet the standards set out in the various ICPs. - U.S. authorities fully support a regulatory environment based on principles and made operational by rules that can provide consistent standards throughout the marketplace, yet remain flexible enough to adapt to new developments. ### AML and CFT standards (paragraph 33) - The IMF’s assessment of ICP 28, the AML and CFT standard, identified some areas where U.S. AML requirements may be improved upon, but fails to fully recognize the robust protection provided U.S. citizens against money laundering activities. - The United States has a bifurcated regulatory scheme regarding AML regulation: - the federal government has primary jurisdiction of AML statutes, and - the regulation of insurance and expertise in financial examination of insurance is the responsibility of the states. - Both state and federal authorities have agreed to work together to review the current examination process. - An in-depth legal analysis on this subject has yet to be undertaken. *Excerpt from paragraphs 28–33 of the source document.* ### 34. U.S. Authorities appreciate the assessment and will thoroughly review the Report’s ### 34. U.S. Authorities appreciate the assessment and will thoroughly review the Report’s ### Conditions for Effective Insurance Supervision (Principle 1) - Description: - Insurance regulation is principally a responsibility of the states, within a developed national framework of coordination across state insurance departments. - Policy on wider financial sector issues, including the maintenance of financial stability, is handled at the federal level, in Congress and by relevant agencies of the executive branch, including the President’s Working Group on Financial Markets. - The 1999 Gramm-Leach-Bliley Act (GLBA) established the framework for the regulation of cross-sector conglomerates, provides for federal regulation of conglomerates containing insurers, while preserving regulation of individual insurance companies as a state responsibility. - Provisions of the federal Bank Secrecy Act on anti-money laundering apply to certain insurance business (see assessment of ICP 28). - Insurance regulation is not directly represented in federal discussions of wider financial sector issues; expertise in the Treasury Department has traditionally focused on federal programs such as TRIA and on insurance dialogues with foreign governments. - During the financial crisis, monitoring and most action to address insurance sector issues were carried out by states; federal support under TARP extended to insurance groups only where there was a federal regulator (because the group also contained at least one institution federally chartered as a bank or thrift). The intervention in American International Group (AIG), which also included a thrift, was undertaken by federal authorities. - The administration and Congress are working on proposals for reform to strengthen federal government capacity in insurance through a new office within the Treasury Department; one function may be to take the lead on international policy and coordination in relation to prudential supervision of insurance. - Staff from state insurance departments and from the NAIC, rather than the federal government, currently negotiate in international fora on insurance regulation (but not on trade issues). - Reforms may result in some insurance groups being brought within the scope of federal regulation aimed at systemically important institutions; insurance issues affecting financial stability would be handled by the Secretary of the Treasury, supported by the new office, on a proposed new Financial Services Oversight Council. - Legal and court systems at state and federal level provide for disputes on insurance issues to be heard and resolved through enforceable decisions; mechanisms for alternative dispute resolution are rare compared with many other countries. - Extensive framework of accounting, actuarial and auditing standards and relevant professional bodies; standards are in compliance with international standards. - Key features of standards and professional frameworks: - Accounting for insurance assets and liabilities for regulatory purposes must use Statutory Accounting Principles—SAP—developed under NAIC processes, codified in the NAIC’s Accounting Practices and Procedures Manual (APPM) and implemented in state laws and regulations. Regular financial reports to the regulator must be drawn up using these standards and are available to the public via insurance departments or the NAIC. - U.S. GAAP accounting (FASB) standards set accounting requirements for insurance but apply only to publicly-traded insurance companies. - Extensive dialogue exists between insurance regulators, FASB and practicing accountants, particularly on the development of SAP. - Actuarial Standards of Practice (ASOPs) are set by the Actuarial Standards Board (ASB); ASOPs provide a principles-based framework and are not formally part of regulatory requirements but are referenced in regulatory requirements. - Requirement for use of ASOPs is contained in Codes of Professional Conduct adopted by professional bodies; ethical standards are set and enforced by the professional bodies themselves. - The Actuarial Board for Counseling and Discipline (ABCD) hears disciplinary cases and has recommended severe sanctions (public reprimand or expulsion) in 18 cases since it began in 1992. - Auditing standards applicable to insurance: for publicly-traded companies, PCAOB standards as modified or supplemented by the SEC; for others, Auditing Standards Board of the AICPA. PCAOB standards applied and enforced under the Sarbanes-Oxley Act of 2002. The AICPA requires members to use its standards through its binding Code of Professional Conduct. - Accounting, actuarial and auditing standards are publicly available. - Insurance departments monitor quality of accounting, actuarial and auditing work and report concerns to professional bodies; regulatory standards and practices are updated to reflect market-wide concerns. - There are over 16,000 members of the actuarial profession. - Wide availability from public sources of basic economic, financial data and social statistics relevant to insurance (for example, mortality data made available by actuarial bodies). - Money and securities markets provide a variety of short and long term instruments necessary to back insurance liabilities, with some exceptions for particularly long term liabilities associated with some annuity contracts. - Assessment: - Largely Observed - Comments and identified needs: - Preconditions for effective insurance supervision are generally met, reflecting the highly developed legal and institutional framework and the scale and liquidity of U.S. financial markets. - Need for development of the policy framework in relation to insurance and financial stability and international issues. - Risk of lack of coordination on insurance regulatory matters due to state-based insurance regulation and federal responsibility for broader regulatory and financial sector policy, particularly regarding system-wide stability where no explicit responsibilities or coordination arrangements currently exist. - On international insurance regulatory issues, mismatch exists between federal authority to enter international agreements and states’ authority to regulate the insurance sector, creating ambiguity about the status of the NAIC and state regulators in relation to international agreements. - Need for: - (i) increased information-sharing and coordination between state regulators and federal authorities, including representation of state regulators in national bodies with responsibilities for system wide oversight and financial stability; - (ii) agreed policies and procedures for the regulation of systemically important institutions, markets and instruments, where assessed to exist in the insurance sector; and - (iii) new arrangements to increase the authority of federal authorities in relation to the implementation in the United States of international agreements. - Discussions on regulatory reform were continuing at the time of this assessment. ### The Supervisory System (Principles 2 and 3) - Principle 2 — Supervisory objectives - Description: - There is no single statement of supervisory objectives for insurance regulation across the states. - The 1945 McCarran-Ferguson Act returned regulatory jurisdiction over “the business of insurance” to the states and did not set out regulatory objectives; regulatory objectives are generally not set out explicitly in state legislation. - The NAIC’s objectives are expressed in relation to its role in providing assistance and support for state regulators. - Insurance departments express objectives individually and differently (for example, on their websites); the protection of consumers of insurance products is central across departments and usually defined as ensuring financial soundness of insurance companies and promoting appropriate standards of market conduct. - NAIC’s accreditation process reinforces focus on consumer protection by ensuring “adequate solvency laws and regulations in each state to protect insurance consumers.” - Individual departments also have objectives such as maintenance of competitive insurance markets; eliminating fraud, other criminal abuse or unethical conduct in the industry; focusing on consumers’ needs for affordable and available products; and fostering the development of the insurance industry. - Many states organize “residual markets” or provide subsidies/support when private markets are unable or unwilling to underwrite particular risks (see introduction to this assessment). - Some states assign development of the insurance sector (including attraction of more companies) to insurance departments. - Funding arrangements generally link departmental budgets to tasks (examinations, consumer services), making significant deviations from objectives unlikely. - Assessment: - Largely Observed - Comments and recommendation: - Objectives of departments are generally not established explicitly by law, reflecting evolution since the McCarran-Ferguson Act and differences across states; close cooperation through NAIC processes has helped align core objectives. - Departments have a clear understanding that their primary role is to promote consumer protection, understood by industry and consumers. - Differences in how individual departments view objectives may hamper greater uniformity of state regulation and limit understanding of U.S. insurance regulation domestically and abroad. - Potential conflicts of objectives exist, particularly given states’ financial interests in attracting more insurance business; need to balance financial safety and soundness and consumer protection with fostering market efficiency and competitiveness. - Recommendation: Departments, the NAIC and state legislatures should develop a clear, joint statement of the objectives of insurance regulation, taking into account good practice internationally, and align the objectives of individual state departments with these objectives. This work should address whether there are potential conflicts between existing objectives and how to manage them. - Principle 3 — Supervisory authority - Description: - State legislation clearly identifies authorities—state insurance departments for most insurance supervisory work; other authorities, including at federal level, also have certain supervisory responsibilities. - Insurance departments have extensive powers to license, supervise and take enforcement action against insurance companies; powers to make rules—mostly regulations under delegated authority from state legislatures; legislatures enact principal regulatory requirements. - Departments can take urgent action, including using receivership powers to protect policyholders. - Governance structures vary; authority to exercise functions and use powers under state law and regulations is granted to the commissioner (an individual), though some state laws give certain authority explicitly to a chief examiner. - Internal control approaches vary; many departments have internal auditors reporting directly to the commissioner and are subject to state administration audit arrangements. - Appointment procedures: 12 of the 56 commissioners are directly elected and the others are appointed by the state governor, with advice and consent of the state senate, generally to hold office until the term of the appointing governor expires. Appointed commissioners hold office at the governor’s pleasure and can be dismissed at any time. - Departments are accountable to legislatures and state governors and produce annual reports to legislatures (publicly available). - In general, departments act independently of legislatures and other executive offices in day-to-day regulation; independence may be greater where the commissioner is elected. - All departments are subject to state budgetary authority; spending limits are set by the state legislature. - Departments collect a large amount of revenue for the states—totaling over US$18 billion in - Assessment: - (Assessment truncated in source text at end of provided content) *Italicized source: Excerpt from IMF Detailed Assessment — Table 4: Detailed Assessment of Observance of the Insurance Core Principles (U.S. assessment).* ### 2008. The largest element, the state insurance premium tax, is passed in full to the general fund of ### _cr10126 - 2008. The largest element, the state insurance premium tax, is passed in full to the general fund of ### Funding, allocation, and budgetary practice - The state insurance premium tax is passed in full to the general fund; other elements (fees and assessments) in most states are retained by departments as funding for regulatory and other operations. - Fines and penalties usually go into the state’s general fund. - Two approaches to excess collections: - “Dedicated funding system”: amounts raised in excess of spending limits may be retained and used to build up a reserve. - “Quasi-dedicated system”: excesses must be passed to the state general fund. - Shortfalls in revenue collection must be addressed through spending cuts or transfers from reserves. - In practice, legislatures and governors generally determine spending limits according to current priorities and financial conditions, independent of the availability of dedicated funding. - Some legislatures restrict funding to particular purposes or programs (e.g., consumer services funds may not be used for regulation of firms). ### Resources, staffing, and remuneration - Total budget for all departments was US$1.6 billion in 2008, a 50 percent increase on the 2002 level. - Staff totaled over 11,905 at year end (2008). - Many contract staff and staff from other agencies are also used—totaling a further 1,325. - The NAIC employs just over 400 staff, many in IT support for NAIC databases. - Departments have increased resources and overall resources are greater, in proportion to the size of the market, than at any other national insurance regulator in G–7 markets. - Resources appear adequate for core tasks, including financial analysis and examinations. - Departments face pressures to recruit and retain more highly skilled staff (for example, qualified actuaries) and staff equipped for a more risk-focused approach to supervision (see ICP 13). - Accreditation standards expect departments to have specialist resources for examinations of more complex companies or where there are concerns about financial condition. - Departments may hire external experts and outsource work where legislation permits, particularly to support examinations (the model law specifies a wide range of professional competencies) or action taken in response to a breach in minimum RBC requirements (a Regulatory Action Level event—see ICP 14). - Staff remuneration is generally linked to general pay grades for state employees; some states have limited flexibility to pay above normal rates to meet particular needs. - Most departments are free to pay market rates for consultants for examination work; costs are charged to companies, contributing to frequent use of external experts. - External experts are subject to the same confidentiality requirements, under contract, as staff. - Staff have legal protection from lawsuits for actions taken in regulatory work; Model Law on Examination, #390, provides immunity from liability for statements made or conduct performed in good faith while carrying out the Act. - Insurance departments protect staff from the costs of defending their actions, where necessary. ### Confidentiality and information sharing - U.S. administrative practice presumes information should be made publicly available absent specific confidentiality provisions; the ability to maintain confidentiality of supervisory information varies by state. - Information gathered from companies using powers of examination is protected in all states, as are RBC returns (the accreditation process addresses this issue). - All states are able to protect information received from other government agencies, including other state regulators (“derivative confidentiality”). - Following an NAIC initiative in 2000 on confidentiality and information sharing internationally, provisions of several model laws were changed to provide for protection of information received from international regulators. - Recommendation: State laws should be changed, where not already done, to extend the protection of information received from other government agencies to foreign agencies to support wider international information-sharing. - Recommendation: The NAIC and state legislatures should consider extending confidentiality protection, to the extent consistent with the wider legal environment, to all relevant information received by departments rather than limiting protection according to the source of the information. ### Operational independence, governance, and legal recourse - Vesting regulatory powers in the commissioner in principle ensures operational independence, but: - The governor in most states can dismiss commissioners at any time and without a public statement of reasons, exposing departments to potential political influences. - Elected commissioners may be subject to electoral-cycle pressures. - Departments depend on state legislatures for principal legislation and budgetary resources; budgets cannot always be allocated according to departments’ regulatory priorities. - Departments are exposed to budgetary cuts during economic downturns when workloads tend to rise. - Statewide remuneration policies constrain ability to hire specialist skills and can increase reliance on external experts. - Decision-making within departments varies by state; governance arrangements aim to maximize consistency (e.g., delegation to chief examiners or referral to the commissioner with sign-off evidence). - Decisions on regulatory powers are subject to appeal and to judicial review; appeals initially normally to the commissioner, with further litigation through courts. - Specific model law references: - NAIC Model Regulation to Define Standards and Commissioner’s Authority for Companies Deemed to be in Hazardous Financial Condition: section 4 C gives an insurer a right to a hearing; section 5 prescribes judicial review of any order or decision of a commissioner in relation to this regulation. - Insurance Holding Company System Model Act (#440) provides for judicial review on commissioner decisions on application to a court. - Separate procedures apply in the case of receiverships (see Insurer Receivership Model Act). ### Transparency, rule-making, and public availability - Laws and regulations are developed at state level and at the NAIC (for model laws) through an open process that allows extensive input from interested parties; administrative measures are subject to Administrative Procedures Acts requiring publication of proposed rules and public comment. - There is no requirement for quantitative cost–benefit analysis or routine regulatory impact assessment; such work is carried out occasionally rather than routinely. - All laws and regulations of individual states are published and accessible on relevant websites and updated as requirements change. - The NAIC is committed to openness; model acts and material are available, usually for a fee. - Summary information on the NAIC’s accreditation process is publicly available—a 14 page pamphlet sets out the standards and processes and notes all states and the District of Columbia are currently accredited; however, reports and scores relating to individual departments are not publicly available (states see only the reports and not the scores). - The NAIC publishes: - Model Laws, Regulations and Guidelines, with a “state action page” citing each state's enacted model or similar and related legislation. - A Compendium of State Laws on Insurance Topics in chart form for cross-state comparison; these publications are available for a fee. - The NAIC carries out periodic self-assessments of U.S. regulation against IAIS Insurance Core Principles; until recently the most recent published self-assessment related to 2001 and the version of the Insurance Core Principles issued in October 2000, which has since been revised and extended. ### Key recommendations (NAIC and state legislatures) - Provide for fixed terms to be standard for commissioner appointments, with dismissal mid-term possible only for prescribed causes and with publication of reasons. - Make departments fully self-funding, subject to continued accountability to and oversight by state legislatures, while allowing greater flexibility to hire staff with specialist skills and reduce reliance on external experts. - Extend the rule-making powers of departments to a wider range of technical issues (for example valuation and risk-based capital), subject to appropriate consultation and due process; this may help deliver faster implementation of NAIC model laws. - Change state laws to extend protection of information received from other government agencies to foreign agencies. - Consider extending confidentiality protection to all relevant information received by departments, to the extent consistent with the wider legal environment. *Document source: _cr10126 - 2008. The largest element, the state insurance premium tax, is passed in full to the general fund of* ### section 205, which provides for appeal to the receivership court. Once a receivership decision is ### _cr10126 - section 205, which provides for appeal to the receivership court. Once a receivership decision is ### Transparency, publication and accountability - Receivership: section 205 provides for appeal to the receivership court. Once a receivership decision is confirmed by the court, departments are not required to await the outcome of an appeal before appointing a special deputy receiver to manage the company. - Internal processes permit urgent decision-taking to expedite action required to meet regulatory objectives. - Regulatory actions are published. - “Permitted practices” (modifications of accounting requirements on application of an insurance company) are published in full by individual companies, including the impact of the modification on surplus; in some years these have been published on the NAIC’s website soon after the end of the year to which they relate. - Departments publish annual reports on activities and performance. The NAIC publishes an annual report and the Insurance Department Resources Report cataloguing resources available to individual state departments and regulatory actions taken during the year. - Consumer-facing role: information on the role of departments and their role in handling consumer complaints has promoted awareness of regulatory protection for consumers. Recommendations / assessment (Largely Observed) - Consider fostering improved understanding of the work of the states and NAIC and increase regulatory impact analysis. - Specific NAIC actions recommended: - (i) make publicly available some information currently available only on payment of a fee or by subscription (for example the NAIC model laws and material on how states have adopted them); - (ii) publish summary information on their assessment of states’ compliance with accreditation standards (even if scores remain private); - (iii) commit to publication on a regular basis (maybe every two years) of their self-assessment of compliance with IAIS Insurance Core Principles. - NAIC should develop routine regulatory impact analysis for proposed new or changed requirements. ### Principle 5 — Supervisory cooperation and information sharing - Description: Extensive sharing of information between individual insurance departments and between departments and the NAIC. NAIC developed a Master Information Sharing and Confidentiality Agreement into which all states have entered. - Accreditation: the accreditation process assesses whether departments have policies and procedures for sharing information. The standard requires that information be shared with regulatory officials of any state, federal agency or foreign country provided recipients are required, under their law, to maintain confidentiality. - Model law revisions: Model Examination Law, Standard Valuation Law, Risk-Based Capital For Insurers Model Act and Insurance Holding Company System Regulatory Act were revised to extend sharing to foreign countries. - Federal cooperation: extensive information sharing with federal agencies, including banking supervisors (noting nine groups with bank holding companies regulated by the Federal Reserve and 42 groups containing a thrift regulated by the Office of Thrift Supervision). A Joint NAIC/Federal Banking and Thrift Regulatory Agencies Forum meets quarterly. Cooperation with Treasury Department (TRIA), FEMA (flood insurance), Department of Agriculture (crop insurance), Department of Labor (workers compensation). - One-way flow: generally departments and NAIC provide information to these agencies in a one way flow; reciprocal exchange and discussion is limited except when events (e.g., AIG crisis) force exchanges. - MoUs and foreign sharing: - No requirement for a Memorandum of Understanding prior to sharing information with another supervisor, domestic or foreign. - Scope of exchange can include confidential financial data and factual material on companies and officers. - No requirement for reciprocity; departments will exchange without requiring information in return, provided they ensure the recipient can keep it confidential. - NAIC developed with the EU a model information sharing agreement as a basis for bilateral MoUs. - All MoUs are signed by individual insurance departments with foreign regulators. - Current MoUs reflect key international relationships for major global groups; MoUs also in place between some states and countries where global reinsurance companies are located. - Supervisory colleges and targeted exchanges: many exchanges are in response to particular needs for regular information exchange; departments are not likely to proactively inform home or host supervisors of supervisory practice changes that affect relevant groups, but would inform them in advance of taking regulatory action, considering materiality and likely impact. Assessment (Largely Observed) and recommendations - Regulators can share information with relevant federal authorities and with regulators abroad. There is a need to continue developing the network of MoUs; many have been implemented only recently and the network is not comprehensive. - All state insurance departments should ensure laws are updated to enable them to protect information received from foreign regulators to avoid deterring overseas regulators from sharing information freely. ### Principle 6 — Licensing - Licensing requirement: an insurer must be licensed before operating within a jurisdiction. The insurance business requiring licensing is defined in each state's insurance codes by lines of business permitted; states adopt broadly similar but not uniform approaches. - Scope and exclusions: typical exclusions include product warranties, certain pet insurance and prepaid funeral plans. Entities owned by state governments may be subject to licensing depending on the state; miscellaneous exemptions vary. - Corporate structure: life insurance must be undertaken in a different corporate entity from property and casualty (one composite company exists due to grandfathering). Insurers may be corporates or mutuals. - Ownership restrictions: few restrictions on ownership or affiliation by financial or non-financial companies provided owner meets criteria; widespread prohibition on foreign government ownership of an insurer. - Multi-state licensing: insurers generally must obtain a license (certificate of authority) from each jurisdiction they underwrite in. Exceptions: surplus lines business and reinsurance (a company licensed in one state can undertake reinsurance business in other states without a separate license, though subject to other host state requirements). - Foreign insurers: insurers based outside the United States must be licensed in states where they propose to write business, whether as subsidiary or branch. Departments consult the home supervisor before licensing a company or company with a parent based outside the United States. - NAIC and accreditation: - No NAIC model law on licensing and licensing was not covered by accreditation at the time; new accreditation standards related to company licensing were agreed and will take effect on January 1, 2012. - UCAA process (Uniform Certificate of Authority Application): - UCAA is a NAIC guideline (not a model law); all states accept it for all lines except Health Maintenance Organizations (HMO). - Distinguishes: - primary application — company establishing for the first time in a state or redomesticating; - expansion application — company already licensed in one state seeking to do business in another. - Timeframes: primary application—90 days; expansion application—60 days; more time may be required in practice. - States may impose additional licensing requirements. - Information required in application: - business profile; management offices exercising control; delegated operations; plan of operation; “Biographical Affidavit” for all officers, directors, key managerial personnel and individuals with a ten percent (10 percent), or more, beneficial ownership in the applicant and the applicant’s ultimate controlling parent. - Departments investigate litigation, criminal, Uniform Commercial Code and bankruptcy records for officers; at least one business character reference typically required; some states require fingerprints. - States require various degrees of experience for state seasoning requirements; time periods may be reduced for exceptions or demonstrated experience. - UCAA requires applicants to meet each state's statutory minimum paid-in capital and surplus requirements; surplus level determined considering product line, operating record and financial condition; additional surplus may be required. - Expansion or redomestication applications must include the most recent Annual Statement, actuarial opinion, audited report by a CPA not an employee of the applicant. - If applicant, parent or ultimate holding company is publicly traded, submit most recent U.S. GAAP consolidated financial statements. - Applicants in holding company systems must include a comprehensive debt-to-equity ratio statement. - Summary of the applicant's reinsurance program listing all reinsurance agreements and explanations must be included. - Assessment (Observed) and comments: - The UCAA process adopted by all states provides a comprehensive set of licensing requirements and processes. - Differences between state requirements could, in principle, encourage redomestication, but departments and NAIC staff appear alert to these risks and consult with previous domestic state in redomestication cases. Retaliatory taxes may discourage redomestication for tax reasons. - Monitoring: number of redomestications averaged 50 per year in 2006–8, which is less than 1 percent of the total of nearly 8,000 companies at end-2008. - The extension of accreditation to licensing standards in 2012 should provide assurance that core licensing requirements are complied with in practice. ### Principle 7 — Suitability of persons - Objective: significant owners, Board members, senior management, auditors and actuaries must be fit and proper (integrity, competency, experience and qualifications). - Processes: - Departments assess fitness and propriety during new company applications and on examination of licensed companies. - No requirement for individuals to seek authorization or approval (contrast with producer licensing). - No detailed statutory definitions of when an individual is fit and proper. - Significant owners and control: - Based on Insurance Holding Company System Model Act (#440), Section 1 defines control as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person.” - “Control shall be presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing, ten percent (10 percent) or more of the voting securities of any other person.” - Fitness and propriety assessed at application and on change of control. - Ongoing monitoring: - Licensed insurers must report changes in officers, directors and key managerial personnel. After reporting, supervisors may request biographical affidavits for newly appointed officers, directors and key management personnel. - No specific requirement for companies to notify the department when they become aware of issues relating to the fitness and propriety of a key functionary. - On-site examinations conducted at least once every five years assess suitability of Board, management, auditors and actuaries. The approach is set out in the Financial Condition Examiners Handbook, publicly available for a fee. - Assessment focuses on independence, experience, background and ethics; individuals are interviewed. Deficiencies prompt recommendations and adjustments to solvency monitoring (e.g., increased reporting, more frequent examinations). - Powers and standards: - For insurers in hazardous financial condition, departments can order companies to “adopt and utilize governance practices acceptable to the commissioner.” (Model Regulation to Define Standards and Commissioner’s Authority for Companies Deemed to be in Hazardous Financial Condition, #385). - Actuaries: NAIC Actuarial Opinion and Memorandum Regulation (#822) for Life Insurers and NAIC Annual Statement Instructions for Property & Casualty Insurers require appointed actuary to be a member in good standing with the American Academy of Actuaries or the Casualty Actuarial Society; prohibit actuaries with specific violations from acting as appointed actuary. Departments refer concerns to professional bodies. - Auditors: under NAIC Annual Financial Reporting Model Regulation (#205), departments impose independence and experience requirements on auditors but do not prior approve appointments. Departments can prohibit auditors who have committed specific violations or do not meet qualification standards. Auditor must submit a letter of qualifications annually. - Departments may refer CPAs of concern to the American Institute of Certified Public Accountants or the state’s Board of Accountancy (PCAOB covers auditors of publicly-traded companies). - Gaps and limitations: - No specific provisions to disallow actuaries, auditors and senior managers from simultaneously holding two positions that could result in material conflict; departments would use existing powers case-by-case to prevent or rectify conflicts. - Assessment (Largely Observed) and recommendations: - Departments assess significant owners, Board members, senior management, auditors and actuaries and act where concerns arise. However, the approach relies on assessment at application and through examinations rather than prior approval of individuals. - Recommend adoption of specific requirements relating to individuals’ fitness and propriety, including requiring companies to notify departments of concerns about key individuals and granting departments explicit powers to disallow functionaries from holding conflicting positions. ### Principle 8 — Changes in control and portfolio transfers - Principle: supervisory authority approves or rejects proposals to acquire significant ownership or any other interest resulting in control; supervisory authority approves portfolio transfers or mergers of insurance business. - Description: - Change in control of an insurance company is subject to supervisory approval performed during off-site monitoring as required by the NAIC Insurance Holding Company System Regulatory Act and Insurance Holding Company System Model Regulation with Reporting Forms and Instructions (#440 and #450). - Adoption of these two models is required under the accreditation program. *Source: IMF Financial Sector Assessment content unit _cr10126 - section 205 (excerpt).* ### Section 1 of the Act defines control in terms of “the possession, direct or indirect, of the power to ### _cr10126 - Section 1 of the Act defines control in terms of “the possession, direct or indirect, of the power to ### Change in control and portfolio transfers - Control defined as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person.” - Control presumed if any person directly or indirectly “owns, controls, holds with the power to vote, or holds proxies representing, ten percent (10 percent) or more of the voting securities of any other person.” - Fitness and propriety assessed at application and on change of control (see assessment of ICP 8). - Model laws require completion of Acquisition of Control Form (Form A) with background information on each applicant; proposed acquisition approved by the domestic supervisor. - Minimum requirements for resources (financial and non-financial) and background information on applicants. - Requirements to ensure adequate competition and protection of policyholders after change of control. - Grounds for denying change in control (Holding Company Act) include: - inability to satisfy licensing requirements after change; - substantial lessening of competition or creation of monopoly; - acquiring party’s financial condition may jeopardize insurer or prejudice policyholders; - acquiring party’s plans (liquidation, asset sale, consolidation, material changes) unfair to policyholders or not in public interest; - incompetence, inexperience or lack of integrity of controllers; or - acquisition likely hazardous or prejudicial to insurance-buying public. - These change-in-control requirements apply irrespective of location of acquirer (inside/outside state or United States). - NAIC accreditation standards related to change in control effective January 1, 2012: timely review of Form A, sufficient qualified staff, appropriate procedures, use of Form A database. - Holding Company Act requires notification of major transactions with affiliates; material portfolio transfers (assumption reinsurance, bulk reinsurance) subject to thresholds for review/approval; policyholder notice required. - NAIC Disclosure of Material Transactions Act (#285) requires reporting of significant asset and reinsurance transactions to domestic regulator. ### Corporate governance (Principle 9) - Corporate governance standards for publicly-traded U.S. companies set and enforced by the SEC. - Revisions to NAIC Annual Financial Reporting Model Regulation (#205) take effect in January 2010 to introduce SEC-based provisions for all insurance companies. - No NAIC model laws directly addressing corporate governance; departments assess governance via licensing, annual statements, examinations, mergers/change of control reviews, solvency assessment. - Risk-based examination process requires examiners to evaluate corporate governance and risk management; Handbook distinguishes Board oversight role and senior management responsibility. - Issues assessed regarding the Board include: directors’ knowledge and experience; independence; adequacy of Board committees; Board oversight of executive compensation and appointments/terminations; sufficiency/timeliness of information to Board; “tone at the top” and code of conduct. - Issues assessed regarding senior management include: management knowledge and experience; turnover in key positions; business risk acceptance and risk assessment processes; access to financial/operating information; attitudes toward financial reporting and internal controls; management’s role in code of conduct. - If deficiencies identified, examiners make recommendations, update insurer profile and supervisory plan; department may adjust solvency monitoring or require corrective action under NAIC Model Regulation #385. - Assessment: Largely Observed. - Recommendation: NAIC and departments should consider issuing more guidance on good and bad practices in corporate governance as risk-based examination approach is implemented. ### Internal control (Principle 10) - SEC sets internal controls over financial reporting for publicly traded companies under Sarbanes-Oxley Act (2002). - NAIC Model Regulation #205 revisions (effective January 1, 2010) require companies exceeding an annual premium threshold set at US$1,000,000 per year to: - have an independent audit committee (detailed composition and scope; smaller companies exempt from independent members), and - rotate audit partner on regular basis (five years limit). - Insurers with US$500 million or more in premium required to issue Management’s Report of Internal Control Over Financial Reporting; unlike SEC, no separate external auditor attestation required. - All insurance entities required to receive annual audit under Model Regulation #205; CPA must understand and assess internal controls; material weaknesses reported to insurance supervisor. - Risk-based examinations assess internal controls: identify inherent risks, evaluate mitigating controls (design and operating effectiveness), and address delegation, segregation of duties, internal/external audit roles, Board’s role, outsourcing risks. - No universal requirement for insurers to have an internal audit function or specify its scope, though examiners require access to internal audit reports. - When weaknesses are identified, companies asked to correct processes and supervisors adjust solvency monitoring; NAIC Model Regulation #385 can require correction in hazardous financial condition. - Assessment: Largely Observed. - Recommendation: Consider formal requirement for insurers to maintain an internal audit function; NAIC/departments should consider guidance on good and bad internal control practices. ### Market analysis (Principle 11) - State authorities and NAIC receive detailed quarterly and annual statistical and financial information, majority stored in NAIC FDR database, accessible for quantitative market analysis. - NAIC Insurance Analysis and Information Sources Department produces biannual industry commentaries (life & accident and health; property & casualty), each about 6–8 pages with quantitative and qualitative analysis (industry size, premium income, operational performance, investment income, reserves, liquidity, capital, market share, concentration, trend analysis). - NAIC makes industry aggregate and individual insurer data available publicly or for a fee; market is highly analyzed. - NAIC can rapidly analyze databases to assess market events (counterparty collapse, downgrades, asset devaluations). - FAWG uses commentaries and may request special market sector reports; multiple NAIC databases (consumer complaints, producers, supervisory actions, ratings). - Event-specific data collection mechanism for natural catastrophes using state authority under financial examination laws and Information Sharing and Confidentiality Agreement among states. - Some industry stress testing performed by NAIC (see ICP 23). - Assessment: Largely Observed. - Comments: Absence of complete group-wide consolidated data for insurance groups and broader conglomerates hinders supervisors; lack of analysis of developments outside U.S. (given reliance on offshore reinsurers) should be addressed; NAIC capabilities should be used more in international supervisory college discussions. ### Reporting to supervisors and off-site monitoring (Principle 12) - NAIC Model Law #205 Annual Financial Reporting Model Regulation requires: - annual audit by independent CPAs, - communication of internal control matters, and - management’s report of internal control over financial reporting. - Notes to financial statements follow NAIC Accounting Practices and Procedures Manual (APPM) and Annual Statement Instructions (ASIs); ASIs specify Statement of Actuarial Opinion (SAO) and statistical filing requirements. - NAIC Model Law #390 on examinations authorizes collection of any other information; examinations may be conducted at commissioner’s sole discretion. - Group information and financial statements required via NAIC Model Law #450 Holding Company System Reporting, but consolidated group-wide financial and other data enabling monitoring against insurance regulatory capital compliance for an insurance-only group is not required. - ASIs specify reporting of transactions that can lead to off-balance-sheet exposures. - NAIC Model Law #440 requires affiliate transactions to be reported before entry and allows supervisory disapproval. - Assessment: Largely Observed. - Comments: Affiliate transaction prior-notification requirement may lead to undue prior approval burden and ineffective use of supervisory resources; reporting of consolidated group-wide financial and other data should be required (see ICP 17). ### On-site inspection (Principle 13) - NAIC Model Law #390 Examinations provides authority for on-site inspections (examinations); commissioner has absolute discretion on form and scope. - Examination frequency: at least every five years (three years in some states); scope also prioritized by off-site analysis. - Risk-focused examination approach developed since 2001; Financial Condition Examiners Handbook revamped and approved in 2007; application as accreditation standard from January 1, 2010. - Market conduct examinations have separate Handbook; may be combined with financial examinations depending on state resources. - Seven phases of risk-focused examinations in Handbook: 1. understanding the company and identifying key functional activities, 2. identifying and assessing inherent risks, 3. identifying and evaluating mitigation strategies/controls, 4. determining residual risk, 5. establishing/conducting examination procedures, 6. updating prioritization and supervisory plan, 7. drafting examination report and management letter. - Examination reports are public; work papers and management letters generally not public but available to other state authorities; concerns exist about FOI access to work papers in some states. - Extensive NAIC systems for planning, documenting, following up and reporting on examinations; Tables 19–22 of NAIC Insurance Department Resources Report 2008 show extensive exam work. - Assessment: Observed. - Recommendations: Strengthen confidentiality of examination work papers; NAIC to assess implementation of risk-focused examination approach (e.g., in 2012). ### Preventive and corrective measures (Principle 14) - NAIC Model Regulation #385 defines standards and commissioner authority for companies deemed in hazardous financial condition; criteria include reserve adequacy, reinsurance adequacy/collectability, fitness and propriety, timely returns, administrative systems, liquidity, affiliate transactions. - Supervisory actions the regulator can require: adjust reinsurance, reduce/suspend writing/renewal of business, increase capital and surplus, suspend dividend payments, increase reporting frequency, require new business plan, adjust premium rates, change investments, correct governance deficiencies. - RBC (Model Law #312) sets four action levels with trigger events and required actions: - Company Action Level: - Trigger: insurer capital less than 200 percent of RBC; or for life/health capital less than 250 percent of RBC and has a negative trend; or for P&C capital less than 300 percent of RBC and triggers negative trend. - Action: insurer must prepare and submit an RBC Plan with corrective actions and 4-year financial projections (with and without corrective action). - Regulatory Action Level: - Trigger: insurer capital less than 150 percent of RBC. - Action: insurer must prepare/submit RBC Plan or revised Plan; supervisory authority must examine financial condition and issue “corrective order” specifying corrective actions. - Authorized Control Level: - Trigger: insurer capital less than 100 percent of RBC. - Action: as for Regulatory Action Level, or place insurer under regulatory control (rehabilitation or liquidation) if in best interests of policyholders, creditors and public. - Mandated Control Level: - Trigger: insurer capital less than 70 percent of RBC. - Action: supervisory authority must place insurer under regulatory control (rehabilitation or liquidation), except for P&C insurers in run-off where run-off may continue under supervision. - Assessment: Observed. - Comments: Prompt corrective action structure is thorough and rigorously applied; guaranty fund data suggests most shortfalls are in the 5–15 percent of liabilities range. ### Enforcement or sanctions (Principle 15) - Supervisory authority can enforce corrective action and impose sanctions; actions when insurer in hazardous condition include: - requiring capital increases, - restricting dividends/payments, - directing stop of new/renewal policies, - restricting or prescribing handling of investments/assets, - requiring management changes. - NAIC Model Law #558 allows administrative supervision with direct control over transactional activity (investments, assets, mergers, premium rates, reinsurance, surrenders, refunds, management and remuneration). - NAIC Model Law #555 allows conservatorship, rehabilitation, and liquidation with court supervision and supervisory authority as rehabilitator/receiver. - Supervisors use persuasion, civil penalties, follow-up actions and targeted exams; statistics in NAIC Insurance Department Resources Report 2008 (Tables 23–25C) demonstrate active supervisory actions. - Penalty provisions allow fines on insurers; authority to apply penalties to individuals (apart from producers) is limited; no clear authority to bar individual directors or managers from future roles under insurance law. - Assessment: Largely Observed. - Recommendation: Insurance laws should be changed to provide supervisory authority with clear powers to fine and bar individual directors or senior managers. ### Winding-up and exit from the market (Principle 16) - NAIC Model Law #555 Insurer Receivership Model Act provides for conservatorship, rehabilitation and liquidation procedures. - Policyholders receive highest priority in wind-ups after receiver fees. - Supervisory powers enable strong protection of policyholder obligations and minimal disruption via mechanisms (run-off, administrative supervision, transfer obligations to other insurers). - Assessment: Observed. - Comments: Strong focus on meeting individual policyholder obligations; guaranty funds and supervisory arrangements have provided high level of policyholder protection. No equally clear arrangements for exit of financial conglomerate groups with insurance subsidiaries. ### Group-wide supervision (Principle 17) - U.S. supervision historically focused on financial soundness of individual insurance companies with tools to monitor and control holding company transactions and obtain information on U.S. entities in same group. - Holding Company Act (#440) defines insurance holding company system and presumes control at ten percent (10 percent) voting threshold. - Groups containing insurers may fall under GLBA financial holding company definition and requirements. - Extensive information collected on holding companies and affiliate transactions; Annual Statement includes organization chart and summary of intra-group transactions; consolidated financial statements of ultimate parent required to be filed with state of domicile (based on US GAAP, not SAP) but not required at intermediate insurance holding company level. - Required ad hoc reports include holding company registration, notice of material affiliate transactions, notification of mergers/acquisitions, and prior approval of extraordinary dividends (definitions vary by state). - Lead state designated to coordinate regulatory activities for each insurance group. - Supervisors have not traditionally focused on group-level internal controls or risk concentrations; risk-focused examination approach is beginning to extend focus to group management and controls. - International cooperation increased during crisis; participation in supervisory colleges uneven across U.S.-based international groups. - NAIC working group considering changes to Holding Company Model Act to improve group-wide requirements and cross-border coordination. - Assessment: Partly Observed. - Recommendations: - (i) include fuller assessment of financial condition of the whole group of which a licensed insurer is a member (consider applying U.S. RBC to consolidated domestic insurance group); - (ii) extend risk-focused examinations to groups, starting with U.S.-led groups and extending lead regulator/college arrangements; - (iii) ensure colleges of supervisors for U.S.-led groups with major international operations are established and effectively led by U.S. insurance regulators. - Comments: Adding group-wide focus will require skills, training and possibly additional powers (license insurance holding companies, consolidated capital requirements, authority to require group-level changes). ### Risk assessment and management (Principle 18) - No explicit legal requirement that insurers have comprehensive risk management policies and systems; risk management assessed through on-site examinations. - Risk-focused examination approach intends to assess a broad range of insurer risks, mitigation strategies and to rate residual risks. - Assessment: Largely Observed. - Recommendation: Laws, regulations or standards should require insurers to have comprehensive risk management policies and systems capable of promptly identifying, measuring, assessing, reporting and controlling risks. ### Insurance activity (Principle 19) - No legal requirement that Board approve and regularly review strategic underwriting and pricing policies, though expected insurers have detailed underwriting, pricing, expense and reinsurance systems and controls subject to examination. - Financial Examiners Handbook provides detailed guidance on examining premiums, losses, benefits, and reinsurance for life, health and P&C. - Most states have some review or approval authority over policy forms; many regulate premium rates for P&C (filing or prior approval varies). - Reinsurance contract details must be lodged with supervisory authority; Examiners Handbook (Section 6, sub-section VI) provides guidance on evaluation of risk transfer, including cash flow testing. - Assessment: Largely Observed. - Recommendation: Amend laws/regulations to require Board-approved and regularly reviewed strategic underwriting and pricing policies and Board-set strategic limits. ### Liabilities (Principle 20) - NAIC Model Law #820 Standard Valuation Law governs reserving for life and accident & health insurers; reserve requirements for P&C outlined in APPM; ASIs require Statement of Actuarial Opinion (SAO) and adherence to Actuarial Standards of Practice (ASOPs). - SAO must be supported by detailed actuarial report documenting methodologies, assumptions and experience, down to lines and sub-lines where necessary. - Reserves calculated gross and net of reinsurance. - Life/health statutory reserves mostly conservative via net premium valuation; more sophisticated reserving (asset adequacy, cash flow testing, stochastic modeling) used for complex products; movement toward Principles Based Approach (PBA) for life reserving (not in effect at time of assessment). - P&C reserves set by insurer with actuary advice; SAO must state point estimate and high/low ranges; statutory P&C reserves generally on ultimate cost basis (not discounted), allowing for claims inflation and superimposed inflation. - Examinations cover reserving; external auditors obtain actuarial advice; supervisory actuaries read SAOs and reports as needed. - Supervisory authority can require increases in reserves if adequacy concerns exist. - Assessment: Observed. - Comment: Reserving methods/bases generally conservative; no specified target safety level for reserving or capital—consider specifying target safety levels for reserving and capital for transparency and international comparison. ### Investments (Principle 21) - Two regulatory approaches for diversification: - defined limits (NAIC Model Law #280 Investments of Insurers Model Act, Defined Limits Version), and - defined standards (NAIC Model Law #283 Investments of Insurers Model Act, Defined Standards Version). - Detailed annual reporting of all individual investments required; data stored in NAIC databases. - Defined Standards version contains requirements for asset/liability monitoring; Annual Statement requires Management’s Discussion and Analysis covering liquidity, asset/liability matching and capital resources. - Financial examinations scrutinize investment systems and controls; Examiners Handbook provides specific guidance. - NAIC Securities Valuation Office (SVO) provides valuation standards; APPM and ASIs require insurer securities to be valued per SVO standards. - Securities lending and repurchase arrangements allowed up to 40 percent of admitted assets with exposure to any single business entity limited to 5 percent of admitted assets; written investment plan required for such activity covering documentation, reinvestment of cash received, and operational procedures for managing interest rate risk, counterparty default risk, use of proceeds and acceptable collateral reflecting liquidity needs. - Assessment: Observed. - Comment: Requirements robust; as insurers move to defined standards model, ensure asset/liability mismatch risks are well covered in reserving and capital requirements. ### Derivatives and similar commitments (Principle 22) - NAIC Model Law #282 Derivative Instruments Model Regulation sets standards for prudent derivatives use (internal guidelines, documentation, trading requirements); regulation not included in accreditation process. - Investment model laws permit derivatives only for hedging or income generation; restricted to covered transactions and limited to a percentage of admitted assets. - Examiners Handbook contains detailed guidance on examining derivatives (pricing, valuation, hedge effectiveness, documentation, auditing, disclosures); ASIs require detailed reporting of derivative exposures and transactions. - Assessment: Observed. - Comment: Requirements are robust and permit prudent derivatives use; no derivatives requirements at holding company level outside insurer (not required by ICPs). ### Capital adequacy and solvency (Principle 23) - Longstanding Risk-Based Capital (RBC) requirements (Model Law #312) differ between life/health and P&C; risks covered include asset value risk, insurance risk, interest rate risk (life/health), credit risk (P&C reinsurance receivable), underwriting risk, and other business risks. - RBC calculated by applying factors to various asset, premium, claim, expense and reserve items. - Capital and surplus = admitted assets less liabilities; APPM specifies non-admitted assets (intangibles, disapproved/uncollateralized alien reinsurance, investments exceeding limits). - Unrealized gains/losses generally deferred; no tiered capital classification as in banking. - Prompt corrective action structure described under ICP 14 applies. - Stress testing and forward-looking analysis incorporated in reserving/capital frameworks for some products (asset adequacy testing, SAO requirements); stress tests performed occasionally and increasingly systematically post-crisis. - Assessment: Largely Observed. - Recommendations: Consider specifying target safety levels for reserving and associated capital for transparency and international comparison; further develop stress testing using crisis experience. ### Intermediaries (Principle 24) - Producers (agents/brokers) licensing governed by NAIC Producer Licensing Model Act (#218); majority of states implemented with significant variations. - GLBA required states to achieve uniformity or reciprocity in producer licensing; 47 jurisdictions assessed as meeting reciprocity mandate of GLBA. - All individuals who sell, solicit or negotiate insurance must be licensed; both individual and business entity must be licensed. - Resident applicants must pass line-specific tests; some states require pre-licensing education; 16 states fingerprint applicants. - Producers required to obtain non-resident licenses to sell in other states; insurers generally required to notify states of producer appointments. - Continuing education requirements apply; producers must provide product disclosure and assess client needs/suitability; Unfair Trade Practices Act model (#880) prohibits misrepresentation. - Producers are not required to disclose status (independent or appointed companies) to customers. - States can suspend/revoke licenses and levy fines; Federal law 18 U.S.C. 1033 imposes lifetime ban for criminals involving dishonesty or breach of trust. - Producers are not generally subject to financial requirements or reporting; some states impose surety bonds. - Producer examinations not mandated; discretion for departments; insurers’ examinations may extend to producers (MGAs, large brokers). - Four major commercial brokers subject to settlement agreements (2006) requiring business reforms; broader reform not yet enacted. - Producer information stored in national database. - Assessment: Largely Observed. - Recommendations: extend broker trust fund arrangements across states; develop uniform regulation for major brokers; complete consistent commission disclosure work; require producers to disclose business status and company appointments. ### Consumer protection (Principle 25) - Consumer protection framework elements: - producer licensing (ICP 24), - rate and form regulation (state-level variation; IIPRC central approval process for certain life/annuity/disability/long-term care products involving 34 states), - NAIC Unfair Trade Practices Act (#880) and Unfair Claims Settlement Practices Act (#900), - market conduct examinations and MCAS (Market Conduct Annual Statement introduced 2004; not uniformly adopted), - databases (RIRS, SAD) and direct consumer services (complaints handling, education). - Unfair claims practices include misrepresenting facts/policy provisions, failure to effectuate prompt/fair settlements when liability reasonably clear, settling for less than reasonable amount by reference to application materials. - Regulators may levy civil penalties for unfair trade practices. - State guaranty associations provide policyholder protection in insolvency with varying coverage; annual assessment per insurer capped in most states at 2 percent of annual premium income; actual assessments have been well below cap. - Assessment: Observed. - Comments: Departments expanding consumer protection and market conduct oversight, but marked lack of uniformity across states in market conduct, rate/form approval and participation in cross-state initiatives (IIPRC, MCAS). Core consumer protection requirements present in most states. ### Information, disclosure & transparency toward the market (Principle 26) - No formal disclosure requirements from insurance regulators for insurers; publicly-traded companies or groups subject to SEC requirements. - Stakeholders can obtain financial information from NAIC for a fee of US$2 per company (rating agencies/data vendors) or free summary data and up to five full financial statements (public); more than five full statements available for a charge. - Departments make financial statements available and examination reports (matters of fact) available on websites. - Assessment: Observed. - Recommendation: NAIC should consider making more information publicly available for free and review benefits of developing explicit disclosure requirements. ### Fraud (Principle 27) - NAIC Insurance Fraud Prevention Model Act (#680) sets prohibition on fraudulent acts, investigative powers for commissioner, mandatory reporting, confidentiality provisions, creation of fraud prevention units, and company anti-fraud initiative requirements. - As of April 2009, all states that implemented the model did so with significant variations; model not covered by accreditation standards. - Federal legislation exists (e.g., healthcare fraud measures); state fraud bureaus assist in investigations. - Companies required to file anti-fraud plan with commissioner; most companies have Special Investigation Units (SIUs). - Examiners required to identify evidence of fraud; Market Conduct Examiners Handbook provides guidance for fraud assessment. - NAIC Online Fraud Reporting System (OFRS) delivers reports to all states in which relevant insurer does business. - National Insurance Crime Bureau (NICB) supports detection/prosecution, manages databases and shares suspected fraud information with NAIC. - Regulators have authority to share investigation, action and examination information with other regulators and law enforcement. - Assessment: Observed. - Comment: Core requirements in place; remaining gaps (e.g., where departments do not require anti-fraud plans) should be addressed. ### Anti-money laundering and combating the financing of terrorism (AML/CFT) (Principle 28) - Insurers subject to Bank Secrecy Act (BSA) AML/CFT provisions; USA PATRIOT Act (2001) amended BSA to require financial institutions to implement AML programs. - FinCEN administers BSA/AML; IRS delegated examination authority for insurance sector; FinCEN retains enforcement authority. - FinCEN rule (31 CFR 103.137) (implemented May 2006) applies to covered products: - permanent life insurance policy (excluding group), - annuity contract (excluding group), - other insurance product with cash value or investment features. - Covered-product insurers must develop and implement AML programs reasonably designed to prevent use for money laundering/terrorist financing; program covers only covered products. - Key program elements: - policies, procedures and internal controls based on insurer’s risk assessment; - integration of agents and brokers into insurer’s AML program (agents/brokers not required to have separate AML programs); insurer responsible for monitoring compliance by agents/brokers; - designation of compliance officer; - training for appropriate persons; - independent testing of program periodically; - written program approved by senior management and made available to Department of the Treasury/FinCEN upon request. - Expectations include obtaining relevant customer information and appropriate customer assessment; risk-based system requires enhanced measures for higher-risk customers; general AML record-keeping applies. - IRS has conducted limited AML examinations since 2007 under MOU with FinCEN covering agents and brokers; no enforcement cases yet; foreign branches/subsidiaries not examined. - FinCEN/IRS cooperating with NAIC and state departments on procedures and MOUs; potential for state regulators to include BSA AML issues more fully in examinations. - Insurers must file reports for receipt of currency over US$10,000 (in lieu of Currency Transaction Reports) and file Suspicious Activity Reports (SARs); FinCEN guidance includes suspicious indicators (product inconsistent with needs, unusual payment methods, early termination during free look period). - FATF Mutual Evaluation Report (MER) June 2006 identified weaknesses relevant to insurance sector: - beneficial ownership identification obligations limited and not extending to insurance business; - inadequate access to timely/accurate beneficial ownership information of legal persons; - no explicit obligation for ongoing due diligence except in defined circumstances; - occasional transaction customer ID limited to cash deals only; - no requirement for life insurers issuing covered products to verify true identity of customer (except where product is a ‘security’ under federal securities laws); - verification of identity after business relationship established not limited to circumstances essential to not interrupt normal course of business; - no explicit obligation to terminate relationship if verification cannot be accomplished; - US$5000 threshold for reporting suspicious activity considered too high; - PEP measures do not explicitly apply to insurance sector; - no explicit requirement for life insurers to have procedures for non-face-to-face business; - no BSA obligation for employee screening procedures; - no obligation on relying institution to obtain ID/verification from introducer for introduced business; - limited record retention for insurance sector compared to FATF Recommendations (life insurers of covered products required to keep limited SAR/Form 8300/AML program records). - Effectiveness of applicable measures in insurance sector (since May 2, 2006) could not be assessed at time of MER; federal examinations had not started then. - State fraud bureaus have access to FBI LEO website and facilitate AML inquiries in death/missing person cases; state fraud bureaus work closely with federal authorities on suspected money laundering. - Assessment: Partly Observed. - Comments and recommendation: While AML obligations extended to insurance, significant gaps identified in 2006 MER remain; IRS examinations now underway but resources limited; cooperation between federal and state regulators improving but constrained by legal and procedural issues—recommended that a timetable be set to agree and implement arrangements between state departments and federal authorities to deliver greater resourcing of supervisory activities and necessary information exchange. (A factual update since 2006 FATF work is undertaken separately as part of FSAP work.) *Source: IMF assessment content provided in the supplied PDF excerpt.* ### Introduction ### _cr10126 - Introduction ### Overview - There is a well established and comprehensive framework of accounting and related actuarial requirements supporting insurance regulation; it is heavily rules-based but beginning to move toward a principles-based approach. - Regulatory insurance accounting is driven by the NAIC-established Statutory Accounting Principles (SAP), contained in the NAIC Accounting Practices and Procedures Manual – March 2009 (APPM), which in turn utilizes the framework of Generally Accepted Accounting Principles (GAAP) established by the United States Financial Accounting Standards Board (FASB). - GAAP pronouncements do not become part of the SAP until and unless they are specifically adopted by the NAIC. ### SAP vs. GAAP - SAP is designed to address the concerns of regulators (stressing the ability to pay insurance claims in the future); GAAP is designed for varied users and stresses measurement of emerging earnings (matching revenue to expenses). - Put another way: - SAP is balance sheet driven. - GAAP is performance statement driven. - Key areas of difference: - Policy Reserves - Statutory policy reserves are intentionally established on a conservative basis, emphasizing the long-term nature of the liabilities. - Under GAAP, company-specific expected experience with provision for the risk of adverse deviation is used; GAAP reserves may be more or less than statutory policy reserves. - Assets - GAAP recognizes certain assets that are non-admitted or immediately expensed for statutory purposes. - Policy acquisition costs are expensed as incurred under SAP; under GAAP they are deferred and amortized. - Deferred Income Tax Assets - Historically these have not been recognized under SAP. - Reinsurance - Methods of accounting for certain aspects of reinsurance under GAAP may have varied from SAP (e.g., credit for reinsurance in unauthorized companies is not given under SAP). ### APPM (NAIC Accounting Practices and Procedures Manual) - The manual is large (about 3,500 pages), contains some duplication and evolutionary additions, and needs overhaul to improve readability and navigation; however, it is comprehensive and thorough. - Maintenance and governance - MAINTAINED by the NAIC Accounting Practices and Procedures Task Force (APPTF). - New SAP guidance promulgation requires adoption by NAIC membership. - APPTF uses two working groups: - Statutory Accounting Principles Working Group (SAPWG): exclusive responsibility to develop and propose new Statements of Statutory Accounting Principles (SSAPs). - Emerging Accounting Issues Working Group (EAIWG): responds to application, interpretation, and clarification questions narrower in scope than new SSAP development. - Structure (main elements) - SSAPs — contained in the body of the APPM. - Guidance for specific SSAPs — APPM Appendix A. - Interpretations of the EAIWG — APPM Appendix B. - Actuarial guidelines (for life and health insurers) — APPM Appendix C. - GAAP cross-reference to SAP — APPM Appendix D. - Issues papers — APPM Appendix E. - Policy statements (process information only) — APPM Appendix F. - Audit implementation guide — supplements the NAIC Annual Financial Reporting Model Regulation proposed to become effective in 2010. - Hierarchy of APPM elements (specified application order) - Level 1 - Statements of Statutory Accounting Principles (SSAPs) and specific GAAP material adopted by the NAIC, namely: - Category a – FASB Statements and Interpretations, FASB Staff Positions, APB Opinions, AICPA Accounting Research Bulletins; - Category b – FASB Technical Bulletins, AICPA Industry Audit and Accounting Guidelines, AICPA Statements of Position; - Category c – Consensus positions of the FASB Emerging Issues Task Force, AICPA Practice Bulletins; - Note: FASB has completed a major 5-year project of Accounting Standards Codification™ resulting in the Codification, which from 1 July 2009 is the single source of authoritative nongovernmental U.S. generally accepted accounting principles and replaces all previous U.S. GAAP standards. The NAIC APPM does not yet reflect this. - Level 2 - Consensus positions of the NAIC EAIWG. - Level 3 - NAIC Annual Statement Instructions (ASI). - Level 4 - NAIC Statutory Accounting Principles Statement of Concepts. - Level 5 - GAAP reference material below Category c in the GAAP Hierarchy. ### Annual Statement Instructions (ASIs) and Filing Requirements - NAIC issues ASIs for annual statements which insurers must file; ASIs available to all States via NAIC systems. - Separate ASIs exist for each insurer category: life, health, property and casualty, fraternal, title. - ASIs specify detailed information and data and the Annual Statement Blanks (Blanks) filing format. - Signing and attestation - ASIs specify how Blanks are to be signed; state insurance authorities specify which directors, officers and trustees must sign; signing individuals must attest to the accuracy of the statements. - Types of information/data to be filed: - Actuarial Opinion — relation to insurance reserves. - Annual Audited Financial Reports — annual audit by an independent certified public accountant; audited financial report filed as a supplement. - Management’s Discussion and Analysis — must discuss financial condition, changes in financial condition and results of operations; required items include: - material historical developments; - explanation of operating performance, including long term trends; - prospective information likely to have a material impact on business volumes, net income and surplus; - reasons for material changes in line items; - liquidity, asset/liability matching and capital resources; - loss reserves (property & casualty only); - off-balance sheet arrangements; - participation in high-yielding, highly-leveraged or non-investment grade transactions or investments; - preliminary merger and acquisition negotiations. - Financial Statement — usual items (assets, liabilities, surplus/capital, operating statement, cash flow statement) plus detailed analyses and exhibits that vary by business category, such as: - breakdowns by line of business; - breakdowns of major line items (e.g., expenses, premiums, reinsurance); - changes in reserves; - non-admitted assets; - five-year historical data. - Investment Schedules — summary by asset class and detailed listings of individual assets owned, acquired and/or disposed during the year. - Annual Supplements — some universal, some category-specific, including: - director and senior officer compensation — all categories; - allocation of insurance expenses to lines of business — all categories; - investment risk interrogatories — all categories; - various claims experience analyses for specific lines of business; - actuarial opinion certificates. - ASIs are almost identical across categories, with variations in detail. ### Actuarial requirements: Statements of Actuarial Opinion (SAO) and Actuarial Memorandum - Insurers must obtain and file, as part of the annual statement, a Statement of Actuarial Opinion (SAO) by a qualified actuary on insurance reserves for all categories of business. - SAO contents (precise form varies by category) include: - identification of the actuary providing the opinion; - which reserves are covered by the opinion; - any reliance the actuary has placed on others in forming the opinion; - the actuary’s opinion on whether the reserves: - meet the requirement of the insurance laws; - are computed in accordance with accepted actuarial standards and principles; - make a reasonable provision for all insurance obligations of the insurer; - the adequacy of a life or health insurer’s reserves and other liabilities in light of supporting assets and under moderately adverse conditions — a number of asset adequacy analysis methods are available; the most widely used method is cash flow testing. - relevant comments by the actuary (e.g., material assumption changes, risk of material adverse deviation). - SAO support: Actuarial Memorandum (confidential; available only for regulatory examination) - Should provide narrative findings, recommendations, conclusions, significance, and sufficient technical documentation for another actuary to evaluate the work. - Standards and consistency - Both the SAO and Actuarial Memorandum must be consistent with the appropriate Actuarial Standards of Practice (ASOPs) issued by the Actuarial Standards Board (ASB) and any other relevant standards issued by relevant actuarial professional bodies. - Accessibility - The SAO is publicly available; the Actuarial Memorandum is confidential and available only for regulatory examination. ### Qualified Actuary, Appointment, Reporting, and Discipline - Qualified actuary standards - Generally must be a member in good standing of the American Academy of Actuaries (AAA) or recognized by the AAA as qualified. - For property and casualty, the qualified actuary can be a member in good standing of the Casualty Actuarial Society. - Must meet experience requirements and work under review of other qualified actuaries. - Appointment and notification - Qualified actuary must be appointed by the insurer’s Board of Directors (or equivalent) or by a committee of the Board; NAIC must be notified each year of the qualified actuary the insurer will be using for its categories of insurance business. - If a qualified actuary is replaced the insurer must urgently notify the insurance regulatory authority and state if there were any disagreements with the previous qualified actuary over the preceding two years. - The insurer must request the previous qualified actuary provide a letter stating if the actuary agrees with the insurer’s statement and provide that response to the insurance regulatory authority. - Incoming qualified actuary generally consults with the previous qualified actuary; AAA code of conduct requires the previous qualified actuary to cooperate. - Reporting to governance - Qualified actuary must report to the Board of Directors or the audit committee each year on SAO scope items; SAO and Actuarial Memorandum must be made available to the Board. - Board minutes should indicate presentation to the Board or audit committee and availability of SAO and Actuarial Memorandum. - Actuarial discipline - The Actuarial Board for Counseling and Discipline (ABCD) responds to requests for guidance and considers complaints about possible Code(s) of Professional Conduct violations; ABCD may counsel and recommend disciplinary action to the relevant actuarial body. ### Legal authority - NAIC Model Law #205 Annual Financial Reporting Model Regulation (Law #205) - Section 5 requires the annual audited financial report to report financial position as of year end and the results of operations, cash flows and changes in capital and surplus for the year then ended in conformity with statutory accounting practices prescribed or permitted by the state of domicile. - The annual audited financial report shall include: - A. Report of independent certified public accountant. - B. Balance sheet reporting—admitted assets, liabilities, capital and surplus. - C. Statement of operations. - D. Statement of cash flow. - E. Statement of changes in capital and surplus. - F. Notes to financial statements as required by ASIs and the APPM, including reconciliation of differences between audited statutory financial statements and the annual statement with a written description of the nature of differences. - G. Financial statements prepared in a form and using language and groupings substantially the same as the relevant sections of the annual statement filed with the commissioner; statements shall include comparatives. - Through Law #205, SSAPs and APPM requirements and ASIs obtain legal authority; all 50 states and the District of Columbia have adopted this model law. - Life and health insurers - Required by NAIC Model Law #820 Standard Valuation Law to value reserves for liabilities for all outstanding insurance policies; specifies valuation methods and minimum standards. - Along with NAIC Model Law #822 Actuarial Opinion and Memorandum Regulation, requires SAO submission as part of the annual statement and specifies substance and form; SAO requirements also in the life ASI. - Property and casualty insurers - Several SSAPs (SSAPs 5, 53, 55, 57, 58, 60, 62, and 65) specify reserve calculations for various business and reserve types; legal authority obtained through Law #205. - SAO requirements related to property and casualty reserves are contained in the property and casualty ASI. ### Move to a principles-based approach (PBA) - Background - Legislation on insurance reserve calculation in the United States began in the 1850s for life insurance; initial methods specified mortality tables and interest rates with a net level premium reserve method. - For traditional life and health contracts, the minimum reserve remains formula-based with prescribed mortality and interest rates; no actuarial judgment allowed in minimum reserve determination. - Prescribed actuarial assumptions are mostly conservative; minimum reserve standards have been established to be sufficient to cover future claims 75 percent-85 percent of the time. - In the 1990s an asset adequacy analysis test was added to the SAO to test formulaic reserves against supporting assets. - Limitations of formula-based reserves - Static formula may not capture all contract risks. - Slow to respond to new/complex products or economic developments. - 'One size fits all' restricts use of actuarial judgment to reflect insurer-specific risk profiles. - Early principle-based steps - C–3 Phase I (2000) addressed interest rate risk in fixed annuities. - C–3 Phase II (2005) addressed interest rate and equity risk in variable annuities. - VA CARVM (variable annuity Commissioner’s annuity reserve valuation methods) in 2008 introduced insurer-specific calculation for variable annuity reserves. - Principles-based approach (PBA) characteristics - Better allows for insurer ‘tail’ risks (low probability, large adverse impact). - Aligns reserving/capital with how insurers design/price products, manage investments, and internally report and manage exposures. - Involves identifying risks, generating economic scenarios, designing risk models, determining assumptions with appropriate margins, running models for sensitivity testing, and documenting results and processes. - Requires determination of probability of sufficiency or safety desired for reserves and capital. - NAIC solvency modernization initiative for life insurance - Project to develop PBA for life insurance: modify the standard valuation law to enable principles-based reserving by referring to a valuation manual amendable by the NAIC. - Valuation manual will include detailed reserving requirements, be implemented in phases, and apply only to specific products. - Principles-based capital requirements will be developed in phases by risk type and product, commencing with interest rate mismatch and equity risk (C–3). - Proposed reserving and capital framework - Reserve = greater of a deterministic component and a stochastically derived component. - Deterministic component: uses a single economic scenario and acts as a floor under the stochastic component. - Stochastic component: determined using multiple economic scenarios to capture tail risk; reserve level targeted at a conditional tail expectation of 70 percent (i.e., the reserve amount is that needed to meet payouts from the average of the highest 30 percent of the economic scenario results). - Capital adjustments - Initially only the C3 capital requirement will be adjusted for products subject to PBA reserving. - Capital requirement will be determined stochastically and the statutory reserves plus capital will be targeted at a conditional tail expectation of 90 percent. *Source: _cr10126 - Introduction* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10126.pdf_