Update On Principle-Based Reserving

The Principle-Based Reserving ("PBR") Implementation (EX) Task Force1 held an open meeting on March 31, 2014 at the Spring National Meeting (the "Spring Meeting") of the National Association of Insurance Commissioners (the "NAIC"). The Task Force's "mission" is (1) to serve as the coordinating body with all NAIC technical groups (e.g., the Life Actuarial (A) Task Force) involved with projects related to the PBR initiative for life and health policies and (2) to further assess the solvency implications of life insurer-owned captive insurers and other special purpose vehicles.

This Stroock Special Bulletin looks at some of the highlights from that meeting, including the Legislative Status of PBR Implementation, the PBR Consultant's Supplemental Report, discussion regarding the proposed PBR statistical agent framework, Life Actuarial (A) Task Force developments, and PBR impact on small companies.

Legislative Status of PBR Implementation

Ms. Julie Mix McPeak (Co-Chair of the Task Force and Commissioner of the Tennessee Department of Insurance and Commerce) began the meeting by giving an overview of the adoption by NAIC-member jurisdictions of the revised Model Standard Valuation Law ("SVL"). The SVL refers to an updated NAIC Valuation Manual (the "VM"), which includes guidance for PBR to be used with respect to new business after the VM's operative date. Before the VM can become operative, a super-majority of NAIC-member jurisdictions (i.e., 42 jurisdictions representing at least 75% of total U.S. premiums written for life, annuities and health insurance) must have adopted the revised SVL.

As of April 7, 2014, 12 states representing 11.3% of relevant premium had adopted the revised SVL. One additional state had the legislation awaiting the governor's signature; once signed into law, 13 jurisdictions representing 13.8% of relevant premium will have enacted the revised SVL. In addition, 9 jurisdictions have either proposed legislation, or have legislation pending, to enact the revised SVL and 7 jurisdictions plan to consider such legislation in 2015. Assuming the revised SVL legislation is adopted as currently anticipated, 30 states representing 60.3% of relevant premium will have adopted that legislation by the end of 2015.

PBR Consultant's Supplemental Report

Rector and Associates' February 17, 2014 Report

In 2013, the NAIC engaged Neil Rector and Associates ("Rector and Associates") as its PBR consultant to assist the Task Force with its work on the following projects:

Analyzing life insurer-owned captive transactions representing a cross section of the industry in order to further evaluate the business purpose of captives from the various regulator and industry perspectives. Evaluating the findings and recommendations set forth in the Captives/SPV Use White Paper and providing further recommendations regarding the potential regulatory treatment of captive transactions. As described in more detail in our October 7, 2013 Stroock Special Bulletin2, Rector and Associates set out in its initial report, dated September 13, 2013 (the "Initial Consultant's Report"), a "regulatory framework" for consideration of captive transactions. This regulatory framework was formulated under the assumption that the Task Force accepted the "general logic" for captive transactions, but also concluded that changes to the existing regulatory framework are needed to promote consistency and to ensure that approved transactions are "appropriately conservative."

On February 17, 2014, Rector and Associates issued a follow-up to the Initial Consultant's Report (the "Supplemental Consultant's Report"), available at http://www.naic.org/documents/committees_ex_pbr_implementation_tf_140414_report_rector.pdf.

The Supplemental Consultant's Report contained the following 9-point executive summary of the framework:

The ceding insurance company should only get credit for reinsurance if it retains (on a funds withheld or trust basis) "Primary Assets"3 in an amount approximately equal to what the statutory reserve would be under PBR. The remainder of the credit for reinsurance may be supported by any assets approved by regulators for both the ceding insurance company and the assuming insurer, subject to certain regulatory protections and oversight. Full risk-based capital ("RBC") calculations using traditional NAIC methodology should be performed by at least one party to the financing transaction. Key information about the use of financing transactions and assets supporting such transactions should be publicly disclosed. Ceding insurance companies and their auditors should determine compliance with the requirements of the framework on an annual basis. All reinsurance involving Triple X and AXXX reserves is within the initial scope of the framework; however, exemptions are provided for most traditional reinsurance arrangements (including for arrangements with reinsurers that follow NAIC accounting and RBC rules). The concept of "financing" the reserves at the ceding insurance company level (without the use of reinsurance) is theoretically viable, but more work remains before recommendations can be made as to how to implement the concept. The proposed effective dates for the new requirements are: July 1, 2014 for the newly created financing structures; December 31, 2014 for the new "Disclosure Requirements";. January 1, 2015, 2015 for business ceded to existing financing structures; and. December 31, 2015 for the new RBC rules. A new "[Triple X] and AXXX Model Reinsurance Regulation"4 should be an accreditation standard to "codify" the requirements of the framework. The Supplemental Consultant's Report also included the list of action items set forth below, which were designed to "codify" the framework and to provide additional detail regarding implementation.

Adopt the recommendations set forth in the Supplemental Consultant's Report in concept (e.g. general approach, definitions and proposed effective dates). Refer items to other NAIC working groups and task forces: Refer to the Life Actuarial (A) Task Force a charge to develop modifications to VM-20Requirements for Principle-Based Reserves for Life Products so it can be used as the "Actuarial Method." Refer to the RBC (E) Working Group charges (1) to develop a list of anticipated "Other Assets," (2) to determine RBC asset charges relative to "Other Assets," and (3) to require that full RBC calculations using traditional NAIC methodology be performed by at least one party to financing transactions. Refer to the Blanks (E) Working Group a charge to finalize the "Disclosure Requirements" and to add them to the annual statement blanks. Refer to the Statutory Accounting Principles (E) Working Group a charge to include a note to the annual audited financial statements to set forth relevant aspects of financing transactions. Refer to the Financial Analysis (E) Working Group ("FAWG") a charge to add review of the "Disclosure Requirements" to the standard monitoring criteria for life insurance companies. Make decisions as to which "Other Assets" should be referred to FAWG for review if used in financing transactions. Identify insurance companies interested in exploring Alternative B (reduced retention of Triple X and AXXX reserves at the direct insurance company level) and further develop that alternative. Finalize and adopt the proposed "[Triple X] and AXXX Model Reinsurance Regulation" and take action to make it an accreditation...