United States: Latest Developments In Regulation Of XXX/AXXX Captives

The National Association of Insurance Commissioners (the "NAIC") is forging ahead with its work on captive insurance companies used by life insurance companies to finance reserves required under current regulations; these reserves are commonly referred to as "XXX reserves" for certain term life insurance policies, and "AXXX reserves" for certain universal life insurance policies. We last addressed the NAIC's actions in a Duane Morris Alert entitled " NAIC Moving Forward on Regulation of XXX/AXXX Financing Transactions," dated August 29, 2014. In that Alert, we described the newly-adopted XXX/AXXX Reinsurance Framework (the "Framework"), which was introduced by Neil Rector of Rector and Associates, Inc. ("Rector") in response to a charge from the NAIC to develop regulatory responses to the use of captive insurers to finance XXX and AXXX reserves. This Alert discusses actions on the Framework taken since then, concluding with the NAIC 2014 Fall National Meeting, which was held from November 16–19, 2014.

Actuarial Guideline 48

The purpose of the Framework is to "further[ ] an action plan to develop proposed changes to the insurer/captive regulations specific to XXX/AXXX transactions." As a key part of the action plan called for in the Framework, in June, Rector introduced a draft "Actuarial Guideline XLVIII—Actuarial Opinion and Memorandum Requirements for the Reinsurance of Policies Required to be Valued under Sections 6 and 7 of the NAIC Valuation of Life Insurance Policies Model Regulation (Model 830)" (referred to as "AG 48").

The Principle-Based Reserving Implementation (EX) Task Force (the "Task Force") held a series of conference calls in October and November, along with an in-person meeting on November 7, 2014, to consider comments on the draft by regulators, industry representatives and other interested parties. These meetings and calls culminated in the adoption of AG 48 by the Task Force, with a recommendation that AG 48 be adopted by the NAIC as a whole by the end of 2014, so that it will be effective on January 1, 2015. Although AG 48 was not finally adopted at the Fall Meeting, it is anticipated that it will be by the end of 2014 in Executive Committee/Plenary conference calls.

AG 48 is seen as the linchpin of the NAIC's efforts to regulate the use of captives for XXX/AXXX reserve financings until principle-based reserving ("PBR") requirements become generally effective. The core concept of AG 48 (and of the Framework generally) is that some portion of XXX and AXXX reserves are "excessive," or "redundant," in the sense that they exceed reserves computed on a more realistic basis, but that PBR reserving methods will eliminate that redundancy. The question before the Task Force is how to deal with the redundant reserves in the interim. Some regulators (particularly the New York Department of Financial Services and the California Insurance Department), as well as some industry members, would like to end the use of captives altogether. Indeed, New York also opposes PBR, and has taken steps to reduce some of the redundancy in reserves under current regulations. Other regulators and industry members have taken a range of views, from advocating for no changes to attempting to craft a middle ground. AG 48 reflects the latter approach.

It is of particular note that during the course of the November 7 meeting, the chairman of the Task Force stated that the goal is not to end XXX/AXXX reserve financing transactions; rather, the Task Force's goal is to eliminate certain perceived problems that have arisen in XXX and AXXX financing transactions, such as the use of letters of credit ("LOCs") or parental guarantees, rather than traditional admitted assets, to back reserves. At the same time, companies will be allowed to continue to finance the redundant portion of the reserves (determined under AG 48 principles) on a more controlled basis, until PBR is effective.

The adoption of AG 48 is viewed as an interim step in developing a more comprehensive approach to the use of financing transactions for XXX and AXXX reserves. As a "second stage" solution, the NAIC Reinsurance Task Force will seek Executive Committee permission to create a new model regulation incorporating AG 48 principles, and to amend the existing Credit for Reinsurance Model Act (Model 785). Although many in the life insurance industry believe that some level of redundancy will continue to exist under PBR, under the new regulation, companies will be required to fund the full statutory (PBR) reserve with assets that meet the requirements of AG 48, which would appear to eliminate any financial incentive to use captives to finance reserves.

Exemptions from AG 48

The Framework is not intended to apply to "conventional" reinsurance transactions, even when they include XXX and AXXX policies. Accordingly, AG 48 exempts reinsurance transactions with reinsurers that meet the following criteria: they must be licensed, accredited or maintain trust funds in the United States; they must prepare their statutory financial statements in compliance with the NAIC Accounting Practices and Procedures Manual without any material deviations from statutory accounting principles ("SAP"); and they must not be subject to certain events under the risk-based capital ("RBC") rules. In addition, AG 48 exempts certain "certified" reinsurers (reinsurers that meet certain ratings and other requirements). Moreover, AG 48 allows the ceding insurer's domiciliary regulator to determine, after consultation with the NAIC's Financial Analysis Working Group ("FAWG"), that a particular transaction is outside of the intended scope of AG 48. In such cases, the regulator must publicly disclose that it has exempted a transaction, and include a summary of the transaction, although it is not required to disclose the names of the parties. It is important to note that the application of AG 48 is not limited to the use of captive reinsurers—any reinsurer that does not fall under one of the exemptions, and reinsures policies with XXX or AXXX reserves, will be subject to the new rules.

Grandfathering

The original draft submitted by Rector proposed limiting the application of AG 48 to policies with XXX or AXXX reserves issued on or after January 1, 2015, and ceded to a reinsurer under a reinsurance agreement that does not meet one of the exemptions described above (such policies are referred to in the draft as "Covered Policies"). The effect of this definition would be to "grandfather" all pre-2015 business (i.e., exclude all pre-2015 policies from the new rules, even if they are reinsured in a financing transaction after the effective date of AG 48).

Recognizing that the "base" proposal would be opposed by some regulators and industry members, the Rector draft set out two alternative proposals. One would have essentially frozen XXX and AXXX financing transactions as of the end of 2014, subject to relatively minor post-2014 changes. Both California and New York, as well as some large life insurers, expressed a preference for this alternative. The other would have allowed changes to existing reinsurance agreements, but would neither allow new reinsurance agreements covering policies with XXX or AXXX reserves after the end of 2014 nor would it allow the addition of new policies to a pre-2015 reserve financing transaction, regardless of the issue date of the policies.

The compromise position adopted by the Task Force is reflected in the introduction to AG 48, which states that "the provisions of this Actuarial Guideline are not intended to apply to policies that were issued prior to 1/1/2015 if those policies were included in a captive reserve financing arrangement as of 12/31/2014." Thus, Section 4.B. of AG 48 grandfathers all pre-2015 reserve financing transactions, but any post-2014 financing transactions for XXX or AXXX policies, including those issued before January 1, 2015, will be subject to the Framework regime.

Primary and Other Security

In order to ensure that any XXX or AXXX transaction requires the funding of a conservative, but reasonable, level of reserves with "hard" assets, AG 48 calls for the use of the "Actuarial Method" to determine a "Required Level of Primary Security" for the Covered Policies. The Actuarial Method is the "Requirements for Principle-Based Reserves for Life Products" included in the NAIC Valuation Manual (VM-20), subject to certain modifications for purposes of AG 48. In other words, the Actuarial Method is used to approximate the portion of XXX or AXXX reserves that would be required under the new PBR regime. The Required Level of Primary Security must be funded with the following types of assets, which qualify as "Primary Security":

  • Cash.
  • Securities listed by the NAIC's Securities Valuation Office (the "SVO") meeting the requirements of Section 3.B. of the NAIC Credit for Reinsurance Model Law (Model 785) (which includes securities deemed exempt from filing under the Purposes and Procedures Manual of the SVO), and are otherwise admitted assets under relevant law, but not including:

    • any synthetic letter of credit;
    • contingent note;
    • credit-linked note; or
    • other similar security that operates in a manner similar to a letter of credit.
  • For assets retained by the ceding insurer in a modified coinsurance or funds-withheld reinsurance arrangement, Primary Security can include:

    • commercial loans in good standing (CM3 quality or higher);
    • policy loans; and
    • derivatives acquired in the normal course and used to support and hedge liabilities pertaining to the actual risks ceded under the reinsurance agreement.

The types of assets listed as Primary Security reflect concerns by regulators about the use of LOCs to back XXX and AXXX reserves. One of the perceived concerns in existing transactions is the use of "conditional" LOCs; i.e., LOCs that are subject to various limitations on draws. Although industry representatives argued for the use of "unconditional" LOCs of the type that are currently allowed under the credit for reinsurance rules set out in Section 3.C. of Model 785, regulators are concerned about imposing another credit risk into the types of assets to be used as Primary Security.

AG 48 would allow "Other Security" to be held to back the redundant portion of the XXX or AXXX reserves. Other security is defined as any asset, including assets that would qualify as Primary Security, that is acceptable to the ceding insurer's domiciliary regulator.

Both Primary Security and Other Security may be held by the ceding company in a funds withheld or modified coinsurance arrangement, or they may be held by the reinsurer in a trust that qualifies for credit for reinsurance purposes generally, except that both Primary Security and Other Security held in a trust are valued according to SAP, as if the assets were held in the ceding insurer's general account (although affiliate investment limitations do not apply to Other Security).

Qualified Actuarial Opinion

AG 48 requires the ceding company's appointed actuary to analyze any transaction in which Covered Policies are reinsured to determine: (i) if funds consisting of Primary Security are held in an amount at least equal to the Required Level of Primary Security, and (ii) if funds consisting of Other Security are held in an amount at least equal to the remaining portion of the XXX or AXXX reserves. In the event that a reinsurance agreement relating to Covered Policies does not meet these requirements (or certain "Remedial Options" are applicable), the appointed actuary will be required to issue a "qualified actuarial opinion."

Related Matters

A number of other activities relating to the Framework are under way. The NAIC adopted a Supplemental XXX/AXXX Reinsurance Exhibit to be part of the 2014 Annual Statement. The Life Risk-Based Capital Working Group has been addressing issues relating to an "RBC Cushion" for insurers ceding XXX or AXXX business to reinsurers when the assuming insurer does not file an RBC report. The Working Group is also charged with developing RBC charges for Other Security; these charges could be incorporated in the RBC Cushion. Also, the Working Group is charged with considering whether existing RBC treatment of qualified actuarial opinions is appropriate; the Working Group is of the view that the current RBC treatment of qualified actuarial opinions would not be appropriate in the case of a shortfall of Primary Security under AG 48, and that the better answer is to adjust the RBC ratio. Finally, the Financial Regulation Standards and Accreditation (F) Committee is reviewing amendments to the Financial Analysis Handbook relating to XXX and AXXX transactions.

Multi-State Reinsurers

As was also discussed in our August 29 Alert, the NAIC's Financial Regulation Standards and Accreditation (F) Committee is considering amending the preambles to Part A and Part B of the NAIC Accreditation Program Manual to add a new term, "multi-state reinsurer," which is defined as a reinsurer that is licensed in only one state (and thus would not be treated as a multi-state insurer under the current rules), but that reinsures business originated by its ceding insurers in other states. The effect of this amendment would be to require states that are accredited by the NAIC to subject these reinsurers to the full range of NAIC regulatory requirements that currently apply to multi-state insurers. For this purpose, proposed language that was circulated by the Committee at the Spring 2014 NAIC meeting would have defined the term to include "captive insurers, special purpose vehicles and other entities," which means that a captive that reinsures any risk arising outside of its state of domicile would be covered. The proposal noted that captive insurers owned by non-insurance entities for management of their own risks would not be included in the new definition. The application of the new regulatory regime for multi-state reinsurers was intended to apply to reinsurers entering into multi-state reinsurance agreements on or after July 1, 2014, or to reinsurers under existing reinsurance agreements covering business written on or after January 1, 2015.

That proposal generated numerous comment letters, many of which were negative; some commented that the change was not needed at all, and others noted that the proposed definition could sweep in more than the primary target, XXX and AXXX captives. In response, NAIC staff was directed to revise the definition to limit its effect to captives reinsuring policies with XXX or AXXX reserves, variable annuities and long-term care insurance. In addition, the revised definition was to state that any multi-state reinsurer used in an XXX or AXXX transaction that meets the terms of the Framework will be deemed to meet NAIC accreditation standards.

In a memorandum dated November 13, 2014, the Committee noted that NAIC staff believes that the current version of the preambles reflects years of add-ons and revisions to the extent that it makes it "difficult (if not impossible) to simply add a section on Multi-State Reinsurers that both adequately and transparently addresses the proposed revisions." As a result, staff has been directed to prepare new and completely revised preambles that will clarify the scope of the accreditation standards, including their applicability to XXX/AXXX transactions, and to reinsurance of variable annuities and long-term care insurance. The revised preambles (referred to during the Fall Meeting as a "straw man") are due to be available for exposure and comment by the end of 2014.

If you have any questions about this Alert, please contact Hugh T. McCormick, K. Oliver Rust, Cameron F. MacRae III, any member of our Insurance - Corporate and Regulatory Practice Group or the attorney in the firm with whom you are already in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions