CIPR Newsletter March 2016 a · Solvency Assessment Model Act (#505) and most of the adop ng states...

March 2016 | CIPR Newsle er

MARCH 2016

Eric Nordman CIPR Director 816-783-8232

[email protected]

Kris DeFrain Director, Research & Actuarial

816-783-8229 [email protected]

Shanique (Nikki) Hall Manager, CIPR 212-386-1930 [email protected]

Dimitris Karapiperis Research Analyst III


Anne Obersteadt Senior Researcher


NAIC Central Office Center for Insurance Policy and Research 1100 Walnut Street, Suite 1500 Kansas City, MO 64106-2197 Phone: 816-842-3600 Fax: 816-783-8175 h p://cipr.naic.org

Inside this Issue

Roadmap to the Future 2 This ar cle, wri en by NAIC President and Director of the Missouri Department of Insurance, Financial Ins tu ons and Professional Registra on John M. Huff, shares his views on some of the key ini a ves the NAIC and its members will be working on in 2016 and beyond including the challenges of Big Data; cybersecurity concerns; changes in health insurance markets, re rement security, principle-based reserving standards for life insurers; the private flood insurance market; and our rela ons with interna onal regulators. The ORSA Journey Has Begun 10 The majority of states have now formally enacted the Risk Management and Own Risk and Solvency Assessment Model Act (#505) and most of the adop ng states required an Own Risk and Solvency Assessment (ORSA) Summary Report to be filed by the end of 2015. As regulators gear up to review these reports, this ar cle provides an overview of the observa-

ons for improving the quality of an ORSA Summary Report. NAIC to Consider Adop ng Price Op miza on White Paper 14 State insurance regulators are evalua ng price op miza on tools and whether they should be allowed to be used by property and casualty insurers in their ratemaking processes. This ar -cle will summarize the proposed state regulatory ac ons and the policy recommenda ons for regulators to consider included in the NAIC Casualty Actuarial and Sta s cal (C) Task Force price op miza on white paper. Implica ons of a Warming World on the Insurance Industry 16 Interna onal focus centered on adap ng and mi ga ng the effects of climate change has intensified in recent years. This was exemplified when nearly 200 countries agreed (Paris Accord) late last year to take steps to cut global emissions to a level that would avoid the worst effects of climate change. This ar cle examines the Paris Accord, U.S. efforts to lower carbon emissions, and iden fies the risk of climate change to insurers and how they are re-sponding to the low carbon movement. Phase Two of Index-Based Illustra ons Guideline Soon to Be Effec ve 22 March 1 ushers in the second phase of compliance with Actuarial Guideline XLIX—The Appli-ca on of the Life Illustra ons Model Regula on to Policies with Index-based Interest (AG 49). This ar cle provides a brief overview of AG 49 and serves as a quick reminder for companies that have yet to complete the programming required to comply with Sec on 6 and Sec on 7 of the guideline. Data at a Glance: Property and Casualty Profitability and Market Share 23 This ar cle features an analysis of market concentra on and profitability for several proper-ty and casualty lines of business. Insurer profitability results can be used in conjunc on with concentra on sta s cs to determine whether a market is a rac ve to insurers. Persistently high levels of profitability could indicate that a market is failing to a ract compe tors, thus enabling non-compe ve rates of return to be earned. IAIS Releases 2015 Global Insurance Market Report 25 The Interna onal Associa on of Insurance Supervisors recently released its 2015 Global In-surance Market Report (GIMAR). The annual report discusses the global insurance sector from a supervisory perspec ve, focusing on the sector’s performance as well as key risks. This ar cle will provide a summary of key developments in the global insurance market, as well as the special topics included in the GIMAR.

2 March 2016 | CIPR Newsle er

R F

By John M. Huff, NAIC President & Director of the Missouri Department of Insurance, Financial Ins tu ons and Profes-sional Registra on I I am energized and honored to have been chosen to lead the NAIC in 2016. I am also humbled by the enormity of the tasks we face as the na on’s insurance regulators. State-based insurance regula on has a 145-year history of consumer pro-tec on. Effec ve regula on of insurer solvency is the corner-stone of consumer protec on as insolvent insurers do not pay claims. While solvency may have been the ini al focus of regula on, consumer protec on efforts have evolved along with the industry. Insurance regulators provide consumer educa on about insurance products, mediate disputes be-tween consumers and their insurance companies, and ensure insurance companies fulfill the promises made in insurance contracts. Insurance regulators also work to foster compe -

ve insurance markets, assuring consumers have a wide se-lec on of insurance products to meet their risk management needs. As the NAIC President, I am commi ed to further strengthening our state-based regulatory system. The state-based na onal system of insurance regula on consists of 56 independent jurisdic ons. Collec vely, we regulate more than $8.3 trillion of insurer assets and $1.8 trillion in premiums. Almost 12,000 dedicated state insur-ance regulators help the chief insurance regulator fulfill their obliga ons to the public. While insurance regula on is state-based, there are many ways in which regulatory ac vi-ty is coordinated. It is the NAIC that is the mechanism for this regulatory coordina on. The NAIC also provides the pla orm for a transparent collabora on with stakeholders. Input from consumers, state legislators, regulated en es, other stakeholders, and regulators is ac vely sought to en-sure sound public policy decisions are made. I am an cipa ng a busy and issue-packed year in 2016. At the end of the year, I hope collec vely we will have reached new heights in consumer protec on, while promo ng healthy compe on in our 56 insurance markets. A er all, state regula on is successful because we know best how to balance the needs of consumers and the insurance industry. C O B D The insurance industry is, and always has been, a data-driven industry. Insurers and insurance advisory organiza-

ons have a long history of collec ng data, which is used by actuaries to predict future losses based on past experience. However, the raw data itself is of limited value. It must be

converted to meaningful informa on to drive the ever im-portant decisions about what price to charge and how best to manage risks. Data can also help insurers learn more about the customers they serve. The amount of consumer data has grown exponen ally in just a few years. Today, almost everyone has a smartphone, newer cars are equipped with data ports and sensors and most households have a computer or tablet or other mobile device. We are reading, sharing, storing and interac ng with immense amounts of online data every day. Those interac ons result in addi onal data that can be mined for the most granular of insights into our everyday lives. Ac-cording to Gartner,1 “Big Data is high-volume, high-velocity and high-variety informa on assets that demand cost-effec ve, innova ve forms of informa on processing for enhanced insight and decision making.” While the defini on is interes ng, it is not of much use as a prac cal ma er. As insurers collect more granular informa on from policyhold-ers and from other sources, what regulators need is greater insight into what data is available to the insurance industry and how it is being used. The challenge for insurance regulators related to big data is to sort out whether it is beneficial or harmful to consumers. My ini al impression is big data can be both. Are insurers using telema cs to a ract high-end customers or to make auto insurance more affordable and available to everyone? Does big data lead to more accurate pricing, therefore re-sul ng in be er solvency of insurance companies? Regula-tors also need to know the impact big data is having on compe on. Does it foster or impede compe on? Will we find ourselves with more or fewer insurers in the markets we regulate? An example of a regulatory challenge related to insurer use of big data is the controversy surrounding price op miza-

on. It seems everyone has their own defini on of price op miza on and a corresponding opinion about whether certain prac ces included in their defini on are appropriate for purposes of pricing or underwri ng. Gathering data about the consumer’s propensity to shop for coverage or propensity to make an insurance claim can provide valuable insight into consumer behavior. However, just because the informa on is available does not mean it should be used to take advantage of a consumer by charging the person more for coverage than another similarly situated individual.

(Continued on page 3)

4 Gartner is one of the world’s leading informa on technology research and advisory companies.

March 2016 | CIPR Newsle er 3

R F (C )

Availability and affordability of personal lines insurance products and details regarding the cost of terrorism insur-ance risk are per nent public policy ques ons that require the collec on of data by regulators to answer policymakers’ inquiries. Just as the insurance industry has increased its use of data for its purposes, regulators also have a need for data beyond what has been tradi onally collected. Insur-ance regulators, individually and collec vely through the NAIC, have a long history of collec ng data to measure the financial performance of the insurers they regulate. They have also begun to collect informa on on market perfor-mance through the Market Conduct Annual Statement (MCAS). In the future, you can expect insurance regulators to collect more data to allow greater insight into the market to further enhance regula on. The point is not simply to collect more data, but rather to collect useful data to an-swer important public policy or solvency ques ons. R S Advances in health care and more focus on overall health and fitness have led to people living longer. Living longer means more me spent in the golden years of re rement. In the past, folks could rely on a defined benefit pension plan to accompany their Social Security check and provide for a comfortable re rement. But, mes have changed. Em-ployers have been moving away from pension plans and, in their place, our country has solidly moved towards personal responsibility for funding and managing re rement assets. To take on this responsibility, a broad spectrum of insur-ance-related products can be used, including life insurance, annui es, and long-term care insurance. While many re rement savings op ons exist, sta s cs show that consumers are not taking full advantage of these op-

ons to create re rement security. According to a recent report published by the Insured Re rement Ins tute (IRI), “only 27% of baby boomers are confident their savings will last throughout re rement2…” In another report, the IRI found that, “21.6% of baby boomers and 40.8% of Genera-

on Xers have less than $50,000 saved for re rement” and “21.7% of baby boomers and 27.8% of Genera on Xers re-ported having no savings for re rement3.” When combined with the low-interest rate environment and declining stock prices, all of these elements form a perfect storm threaten-ing to derail re rement plans. These alarming sta s cs re-garding re rement security have prompted me to concen-trate the organiza on’s focus on educa on, consumer pro-tec on, and innova on.

I believe insurance regulators have an obliga on to help educate consumers to be er prepare for re rement. Many studies show financial literacy is lacking for many consum-ers. I would like to see individuals of all ages become more educated in order to adequately plan for re rement. At the same me, I want to ensure insurance consumers are pro-tected in the marketplace. Rest assured state insurance reg-ulators will con nue to diligently monitor the marketplace, pursue and address fraud and other unlawful prac ces, and help to strengthen consumer protec on laws. While educa ng and protec ng consumers, we also need to make sure we do not s fle innova on. I would like to iden -fy and address areas in current laws and regula ons that could unnecessarily s fle innova on or that do not take advantage of new technologies to benefit consumers, such as laws that do not recognize electronic signatures. Regula-tors should also work with consumer groups and the insur-ance industry to help iden fy new or redesigned projects to be affordable and meet the needs of consumers, thereby mee ng the changing needs for future re rement security. I am commi ed to expanding our outreach to help consum-ers get smart about their insurance choices and improve their overall financial literacy. It is one of my priori es for 2016. A comfortable re rement is something we all should be able to enjoy. It is our job to help people achieve a com-fortable re rement armed with the knowledge and re-sources to make it last a life me. C Recent high-profile data breaches have led regulators to work toward strengthening insurer defenses against cyber a acks. Managing cybersecurity risk has become more im-portant as cri cal consumer personal, financial and health informa on is increasingly stored in electronic form. As peo-ple become more reliant on electronic communica on, and as businesses collect and maintain ever more granular piec-es of informa on on their customers, the opportunity for bad actors to cause difficul es for businesses and the public is exploding.


2 h p://myirionline.org/docs/default-source/research/state-of-the-insured-re rement-industry---2015-review-and-2016-outlook.pdf?sfvrsn=4; accessed at 1:15 pm, Jan. 21, 2016.

3 h ps://avectra.myirionline.org/eweb/uploads/Boomers%20and%20Gen-X%20Final.pdf. Accessed at 1:35 pm, Jan. 21, 2016.


R F (C )

In 2015, insurance regulators made great progress toward development of a comprehensive framework for the insur-ance community to address the challenges of cyber risk management. The NAIC Cybersecurity (EX) Task Force, un-der the able leadership of North Dakota Insurance Commis-sioner Adam Hamm and South Carolina Insurance Director Ray Farmer, accomplished a lot. The Task Force developed the Principles for Effec ve Cybersecurity Insurance Regula-tory Guidance. The guiding principles present a framework for protec on of sensi ve personal informa on necessary for business purposes. Insurers, insurance producers, insur-ance regulators and the NAIC all collect certain personal financial or health informa on that if accessed by an unau-thorized person might lead to adverse consequences. The 12 principles promote careful protec on of sensi ve per-sonal informa on and demand accountability when the informa on is accessed by unauthorized persons. The second major project of the Task Force was develop-ment of the NAIC Roadmap for Cybersecurity Consumer Protec ons. The roadmap supplements the guiding princi-ples by providing clarifying details on consumer protec on. Generally, the roadmap suggested the consumer is en tled to: 1) know what informa on is collected; 2) know about the insurer’s privacy policies; 3) know the insurer is taking appropriate measures to protect sensi ve data; 4) receive no ce if the data is compromised; 5) receive informa on about consumer rights; and 6) receive free iden ty the coverage for at least one year. One of the 2016 projects is to dra a model law incorpora ng the consumer protec on elements of the roadmap. The model is intended to include standards for insurers and insurance producers regarding their obliga on to safeguard sensi ve personal financial and health informa on and remedies if they do not. The Cybersecurity (EX) Task Force also worked with the Property and Casualty Insurance (C) Commi ee and the Fi-nancial Condi on (E) Commi ee to develop the Cybersecuri-ty and Iden ty The Coverage Supplement for insurer finan-cial statements to gather financial performance informa on about insurers wri ng cyber-liability coverage na onwide. The NAIC also updated its Financial Condi on Examiners Handbook to make sure the guidance it contains is con-sistent with the Na onal Ins tute of Standards and Technol-ogy (NIST) cybersecurity framework. This is important be-cause other financial regulators use the NIST framework to measure compliance of banks and securi es firms. In 2016, I expect the Cybersecurity (EX) Task Force to con n-ue its important work on cybersecurity ma ers, including

comple ng its work on a model law incorpora ng the con-sumer protec ons from the roadmap and per nent parts of the 12 guiding principles. To address the need for a uniform approach, I expect the Task Force will propose the new mod-el be made part of the NAIC accredita on standards. This is warranted because the possibility of a cyber-breach is ac-companied with substan al costs to the vic mized firm. The known remedia on costs associated with one of the major 2015 breaches exceeded $250 million. A major cyber breach could absolutely threaten the solvency of an insurer. I also expect con nued collabora on among state insurance regulators and other financial regulators through the Finan-cial and Banking Informa on Infrastructure Commi ee (FBIIC). Insurers must become key players in sharing threat informa on through one of the informa on sharing and analysis centers. I look forward to the first submission of data from insurers required by the Cybersecurity and Iden ty The Coverage Supplement. This informa on should provide us with insight on how this important market segment is developing and what, if anything, regulators need to do to help it grow in ways that do not threaten the solvency of any insurer choosing to par cipate in the market place for this im-portant risk management product. PBR L I The NAIC has made great progress in recent years in the con nued transi on to principle-based reserving (PBR) in the life insurance area. As insurance products have changed over me, the use of the tradi onal formula-based ap-proach to determine the necessary reserves to support to-day’s more complex products has proven less than op mal. The tradi onal formula-based approach results in some products having excessive amounts of conserva sm built into reserve requirements, while other products result in inadequate reserves. Over the past several years regulators have refined the PBR concepts so that they are now ready to replace the formula-based approach for some life insur-ance products, primarily those involving certain term insur-ance policies and universal life insurance policies. There are two key components necessary to implement the change from formula-based reserves to PBR: 1) changing the NAIC Valua on Manual; and 2) convincing state legislatures to adopt changes to the Standard Valua on Law (SVL). Changes were also made to the Valua on Manual in 2012 to make the reserving process more dynamic and in touch with today’s insurance products. Changes were made to the SVL



R F (C )

and to date, 39 states represen ng 71% of the required pre-mium have adopted the revised SVL. There must be at least 42 states represen ng 75% of the applicable premium with substan ally similar terms and provisions before the legisla-

on becomes effec ve. We are close to mee ng the thresh-olds established in the model. The NAIC stands ready with technical resources to assist states through the transi on. I expect states will reach the thresholds in 2016 so the PBR concept can begin to be implemented in 2017. C H I M The markets for health insurance face many uncertain es as the various provisions of the federal Pa ent Protec on and Affordable Care Act (ACA) con nue to unfold. Regardless of one’s poli cal persuasion, it is undeniable that the ACA has changed how health care is delivered in the U.S. There are a number of very posi ve developments for consumers. More people now have health insurance coverage. Caps on annual and life me benefits have been eliminated, along with preexis ng condi on exclusions. Enhancements have been made to coverage of preventa ve health care services like immuniza ons and wellness visits. Health plans providing dependent coverage must now allow coverage for adult children up to age 26. Changes have been made in how individuals and families access informa on on health care and new tools have been developed to help people be more effec ve shoppers. Among these improvements are standardiza on of defini-

ons and standardiza on of the summary of benefits and coverage (SBC) explana ons. The number of ra ng factors insurers use to price individual health insurance coverage has been limited to age, smoking status, geographic loca on and whether coverage is for an individual or family. Some of the rate classifica ons have ra ng constraints such as the 3-to-1 ra o for age ra ng. This has the effect of reducing the cost for people in the 50–64 age range at the expense of younger, healthier consumers. There have also been some significant headwinds. It seems the ACA is having a difficult me living up to the “affordable” part of its name. Health insurance rates have been rising in most states because the cost of underlying health care con nues to rise. This is occurring in spite of measures contained in the ACA designed to constrain insur-er profits, such as the medical loss ra o (MLR) standards. Last year there were two significant court challenges to the ACA. The first involved a cons tu onal challenge to the ACA claiming the language in the law prohibited the federal gov-ernment from providing subsidies to par cipants in federal

health insurance exchanges. In a 6-to-3 decision, the inter-preta on of the provision allowing subsidies for people par-

cipa ng in either state or federal health insurance ex-changes was upheld by the Supreme Court. The second in-volved the requirement for employers to provide coverage for contracep ves to employees and dependents. In the Hobby Lobby case (Sebelius, Sec. of H&HS v. Hobby Lobby Stores, Inc.), the Supreme Court held that the federal Reli-gious Freedom Restora on Act allows certain closely held for-profit en es to exclude contracep ve benefits if the owner has a religious objec on to providing contracep ve coverage. Regulators con nue to monitor the House v. Burwell case, which could eliminate the cost-sharing subsidy without ap-propria ons. We know the law of the land requires Ameri-cans to purchase health insurance coverage or face a tax penalty. The tax penalty has reached meaningful levels where it is becoming a real incen ve for individuals and families to encourage personal responsibility. Americans who fail to maintain minimum essen al coverage are re-quired to pay an annual tax penalty of the greater of $695 or 2.5% of household income star ng in 2016. This is ex-pected to nudge more people into purchasing health insur-ance in lieu of paying the tax penalty. Mergers and acquisi ons in the health insurance markets are a fact of life. This is an area where insurance regulators must remain vigilant. Maintaining a compe ve balance is important in health insurance markets as it is in other mar-ket segments. Regulators must be mindful of how a merger will impact the delivery of health care and whether it makes the insurer more nimble or instead harms consumers by limi ng compe on and consumer choice. The topic of network adequacy has also become mely. The ACA requires qualified health plans (QHPs) sold on the Ex-changes to meet network adequacy standards. Through 2016, many state standards have been deemed sufficient. However, for 2017 the federal government is considering the establishment of federal standards that would be ap-plied in all states that use the Federal Exchange. These one-size-fits-all standards would be applied unless the state has established its own standards based on the NAIC Managed Care Plan Network Adequacy Model Act (#74) (Model Act). The Model Act has recently been amended to strengthen protec ons for consumers while balancing the need for health insurers to promote quality and reduce costs. It pro-vides significant la tude for states to establish appropriate



R F (C )

network adequacy measures that take into account the state’s geography, density and markets, which work to en-hance the benefits for consumers. I hope the federal Center for Medicare & Medicaid Services (CMS) will concur. Another challenge is the struggle of the health insurance co-ops created under the auspices of the ACA. Closures of co-ops in Arizona, Colorado, Iowa, Kentucky, Louisiana, Michigan, Nevada, New York, Oregon, South Carolina, Ten-nessee and Utah give pause to the future financial challeng-es for remaining co-ops. In addi on to those already ceasing to write policies, several other state co-ops are being close-ly monitored by regulators. Will the remaining co-ops be successful? Only me will tell. It is one of the important issues at the top of minds for insurance regulators in 2016. P F I . T NFIP Floods are the most common natural disaster in the U.S. and all 50 states have experienced floods or flash floods in the past five years.4 Since the 1960s the only way for the public to insure against flood loss is to purchase a policy from the Na onal Flood Insurance Program (NFIP). State insurance regulators are keenly aware of the devasta ng effects floods have on consumers. Regulators believe it is cri cal that flood insurance is available and affordable to protect homes, businesses and personal property. Insur-ance consumers should have access to mul ple op ons in order to find the best balance between coverage and price. I believe facilita ng increased private sector involvement in the sale of flood insurance will help promote the consumer choice and spur compe on. There appears to be limited interest at this me from ad-mi ed insurers. However, several surplus lines insurers have expressed interest in providing flood insurance cover-age equivalent to or broader than the offerings of the NFIP. It is not unusual for new coverage offerings to first appear in surplus lines markets. As the industry becomes more comfortable with the ability of the surplus lines market to write private flood insurance coverage profitably, the inter-est of admi ed insurers will grow. We appear to be in the early stages of this market development. One of the barriers to private flood insurance market growth has been the nega ve reac on of lenders to surplus lines coverage of flood risk. One of the stated principles of the federal Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters) is to provide opportuni es for grow-ing the private market as an alterna ve to the NFIP. Yet Biggert-Waters allows banking and housing regulators and

the government-sponsored enterprises (GSEs) to apply their own requirements related to the financial solvency, strength, or claims-paying ability of private insurers. This is an area where they have no exper se to make these insur-ance regulatory decisions. As a result, there is regulatory duplica on and the overlap is constraining the private mar-ket development. One of my goals for 2016 is to overcome the lender reluc-tance to surplus lines flood insurance policies as acceptable evidence of flood insurance. While the surplus lines insur-ance market is not subject to rate and policy form review by states, flood insurance contracts issued by surplus lines in-surers mirror the provisions of the policy issued by the NFIP. State insurance regulators oversee the surplus lines insur-ance marketplace by imposing capital and surplus require-ments on eligible U.S.-based carriers and licensing and su-pervising surplus lines brokers. Surplus lines insurers domi-ciled in a U.S. state are regulated by their state of domicile for financial solvency and market conduct. Surplus lines in-surers domiciled outside the U.S. may apply for inclusion in the NAIC Quarterly Lis ng of Alien Insurers. The carriers listed on the NAIC Quarterly Lis ng of Alien Insurers are subject to: 1) capital and surplus requirements; 2) a require-ment to maintain U.S. trust accounts; 3) and character, trustworthiness and integrity requirements. There does not appear to be any good reason for lenders to hamper the development of the private flood insurance markets. I I For several years we have been hearing Solvency II is com-ing. At long last it is here. Insurers in Europe and U.S. insur-ers wri ng in Europe now have to deal with the fallout. One of the features of Solvency II is the imposi on of group capi-tal standards on regulated en es opera ng in the Europe-an Union (EU). Solvency II also has the concept of equiva-lence embedded in it. This has led to many mee ngs and much dialog between European regulators and Team USA, which consists of state insurance regulators and representa-

ves of the Federal Reserve, and the Federal Insurance Office (FIO). The regulatory approaches in Europe are very different in purpose and scope. European regulators view stockholder protec on as their primary mission, while U.S. regulators view policyholder protec on as job one. To protect stock-holders, Solvency II applies group capital standards at a high enough level to minimize the likelihood of a financial services

(Continued on page 7) 4 h ps://www.floodsmart.gov/floodsmart/pages/flood_facts.jsp.


R F (C )

group failing. Their view tends to require the firms to hold a very high level of capital to meet regulatory requirements. The U.S. approach to solvency regula on starts at the en ty level and relies on the unique U.S. concept of statutory ac-coun ng to add elements of conserva sm. Both systems have a risk-based capital (RBC) tool. However, the U.S. RBC levels are designed as a regulatory tool, rather than a target capital amount the en ty must obtain. The U.S. system con-structs regulatory walls around the legal en ty insurer and has protected policyholders from raids on capital from other en es within the group. As such, the U.S. RBC is applied at the en ty level rather than to the group as a whole. EU insurance regulators and U.S. representa ves, including state insurance regulators have been engaging in regulatory dialogues over the last 10 years on issues of mutual regula-tory concern. In January 2012, they embarked on the EU-U.S. Mutual Regulatory Understanding Dialogue Project, with the objec ve of further enhancing understanding and coopera on between the two systems for the benefit of insurance consumers, business opportunity and effec ve supervision. With the involvement of technical experts from both con nents, the project produced a report on common-ali es and differences between the jurisdic ons in key areas of supervision. A detailed project plan was developed in early 2013 and plans were laid to periodically update the plan as certain common objec ves and ini a ves are pur-sued over the next five years. The no on of measuring equivalence and the U.S. requirement for pos ng of rein-surance collateral by non-U.S. reinsurance were among the topics being discussed. In late 2015, the FIO and the Office of the United States Trade Representa ve (USTR) jointly announced pursuit of a “covered agreement.” The no on of a covered agreement was included in Title V of the federal Dodd-Frank Wall Street Reform and Consumer Protec on Act (Dodd-Frank Act) as a unique stand-by authority for the U.S. Department of Treasury (Treasury Department) and the USTR to ad-dress, if necessary, those areas where U.S. state insurance laws or regula ons treat non-U.S. insurers differently from U.S. insurers. A covered agreement can serve as a basis for preemp on of state law under certain circumstances, but only if the agreement relates to measures substan ally equivalent to the protec ons afforded consumers under state law. Historically, in the area of reinsurance collateral, U.S. insur-ance regulators have required non-U.S. reinsurers to hold 100% collateral within the U.S. for the risks they assume

from U.S. insurers. This is consistent with tradi onal U.S. approaches to policyholder protec on, as reinsurers are ul mately providing security to primary insurers that are directly protec ng U.S. policyholders. Requiring reinsurers to hold collateral in the U.S. is intended to ensure claims-paying capital is available and reachable by U.S. firms and regulators if needed. However, foreign reinsurers’ regula-tors and other stakeholders have objected to foreign insur-ers having to post collateral in the U.S. because this makes such capital unavailable for other purposes, including in-vestment opportuni es. Recognizing the poten al for varia on in collateral require-ments across states to make planning for collateral liability more uncertain and thus poten ally more expensive, state regulators have been working together through the NAIC to reduce collateral requirements in a consistent manner com-mensurate with the financial strength of the reinsurer and the quality of the regulatory regime that oversees it. The NAIC passed amendments to the NAIC Credit for Reinsur-ance Model Law (#785) and Credit for Reinsurance Model Regula on (#786) (Credit for Reinsurance Models) in 2011. Once implemented by a state, the amendments will allow foreign reinsurers to post significantly less than 100% collat-eral for U.S. claims, provided the reinsurer is evaluated and cer fied. Individual reinsurers are cer fied based on criteria that include, but are not limited to, financial strength, me-ly claims payment history, and the requirement a reinsurer be domiciled and licensed in a qualified jurisdic on. In August 2013, the NAIC adopted the Process for Develop-ing and Maintaining the NAIC List of Qualified Jurisdic ons, which established a comprehensive process for evalua ng a jurisdic on’s oversight of reinsurers in order to determine whether it is a jurisdic on for purposes of reduced collat-eral. The 2011 amendments to the Credit for Reinsurance Models require an assuming insurer to be licensed and domiciled in a qualified jurisdic on in order to be eligible for cer fica on by a state as a cer fied reinsurer. Bermuda, France, Germany, Ireland, Japan, Switzerland and the UK have been placed on the NAIC List of Qualified Jurisdic ons. The NAIC has also established a peer review system sur-rounding the cer fica on of foreign reinsurers by states, which provides a foreign reinsurer an opportunity for a pass-port throughout the U.S. As of Aug. 1, 2015, 26 foreign rein-surers have been cer fied under this peer review system. U.S. regulators were hopeful the EU/U.S. Insurance Dia-logue Project would be sufficient to reach accord on rein-



R F (C )

surance collateral and other regulatory ma ers such as equivalence. Apparently the FIO and the USTR did not con-cur. At the me of this wri ng regulators are wai ng to see what might be included in the proposed covered agree-ment. I remain hopeful an accord can be reached without preemp on of state laws, as state insurance regulators are well on the way to implemen ng the reinsurance collateral solu on and have recognized several of the European na-

ons as qualified jurisdic ons. Only me will tell. Another work stream involves discussions on development of group capital standards for U.S. firms. Insurance regula-tors, working collec vely through the NAIC, have been engaged with the Federal Reserve and FIO on develop-ment of a U.S. version of group capital standards. The Fed-eral Reserve is obligated by Dodd-Frank to develop capital standards for the groups it oversees. State insurance regu-lators have regularly conducted group supervisions through the Insurance Holding Company System Regulato-ry Act (#440) and the corresponding Insurance Holding Company System Model Regula on with Repor ng Forms and Instruc ons (#450). The NAIC adopted significant revisions to the model law and model regula on in 2010. The revisions included: 1)expanding the ability to evaluate any en ty within an insur-ance holding company system; 2) enhancements to the regulators’ rights to access books and records and compel-ling produc on of informa on; 3) establishment of an ex-pecta on of funding with regard to regulator par cipa on in supervisory colleges; and 4) enhancements in corporate governance, such as board of directors and senior manage-ment responsibili es. Addi onally, regulators adopted an expansion to the Insurance Holding Company System Annu-al Registra on Statement (Form B) to broaden require-ments to include financial statements of all affiliates. A new Form F (Enterprise Risk Report) has also been introduced for firms to iden fy and report their enterprise risk. In addi on to these changes, U.S. insurance regulators are currently implemen ng a U.S. version of the interna onal concept of the Own Risk and Solvency Assessment (ORSA). In an ORSA, every U.S. insurer (or its holding company group) will complete a self-assessment of its risk manage-ment, stress tests and capital adequacy on a yearly basis. Through the ORSA, U.S. regulators will be able to add to their exis ng assessment of group capital with analysis of the insurer’s own assessment of its group capital needs. In March 2012, the NAIC adopted the ORSA Guidance Manual which provides guidance to an insurer and/or the insurance

group with regard to repor ng an ORSA. In September 2012, the NAIC adopted the Risk Management and Own Risk and Solvency Assessment Model Act (#505). Model #505 sets out the legal framework for requiring a risk management frame-work and the filing of a summary report. Many states have already adopted the model law. ORSA pilot projects have been successful and it is expected the ORSA will be imple-mented by 2017. LTC I M C Long-term care (LTC) insurance refers to a wide range of services that meet the medical and non-medical needs of those who cannot care for themselves. People may need this type of care if they have a prolonged illness or disabil-ity. This care can encompass home health care, adult day-care, nursing home care or care provided in a group living facility. LTC insurance is one way, but not the only way, to pay for these long-term care needs. LTC insurance is de-signed to cover all or some of the services provided by medical, in-home care and social services personnel. In many cases family members provide primary care to aging parents when LTC insurance is not present. The LTC market has evolved significantly. In the past decade those requiring LTC has grown from less than 3 million peo-ple to now more than 7 million. According to the U.S. De-partment of Health and Human Services (HHS), about 12 million of America’s senior ci zens will require long-term care by 2020. As the baby boomers age, the demand for LTC services will con nue to grow. The primary challenge for this segment of the popula on is to be able to figure out how to fund their LTC needs. LTC insurance products were first developed in the 1960s following the crea on of the Medicare program in 1965. These ini al policies were intended to supplement payment for the primary form of LTC at the me—nursing homes. LTC insurance policies now incorporate a myriad of long-term care service alterna ves including home health care, respite care, hospice care, personal care in the home, services pro-vided in assisted living facili es, adult day care centers and other community facili es. Public programs, such as Medi-care and Medicaid, also cover certain LTC services. As our popula on ages, the need for LTC support and services will become increasingly important and require innova ve new approaches. Insurers wri ng LTC insurance share in the senior’s dilem-ma. They do not have a crystal ball they can use to predict health care delivery costs in the future. In addi on, insurers



R F (C )

that have been ac ve for some me in the LTC insurance marketplace are suppor ng the burden of some inade-quately priced business wri en in the past. When com-pounded with the low-interest rate environment limi ng investment returns, the situa on is quite challenging. These challenges have dampened the enthusiasm of insurers to par cipate in the long-term care insurance markets. I believe current economic condi ons are dicta ng short-term product trends. However, demographics will dictate long-term product trends. We are faced with an aging pop-ula on which will result in a declining number of working-age people paying for each re ree going forward. People are living longer and all these factors lead to concern about the future viability of public programs such as Medicare and Medicaid. I expect these dynamics will drive increased de-mand for LTC insurance over the long run. C I hope this ar cle has provided some insight into many of the challenges insurance regulators will face in 2016. I am op mis c these challenges are really opportuni es for us to improve this industry, our insurance markets, and the quality of consumer protec on state insurance regulators provide.

A A

Director John M. Huff, a na ve of Potosi, Missouri, was appointed Direc-tor of the Missouri Department of In-surance, Financial Ins tu ons and Pro-fessional Registra on by Gov. Jay Nixon on Feb. 6, 2009. An a orney, he leads the department that protects consum-ers through the regula on of profes-sionals and businesses that impact Missourians' lives daily.

Director Huff was elected by his peers to serve as the 2016 Presi-dent of the Na onal Associa on of Insurance Commissioners, the na onal insurance standard-se ng organiza on for the U.S. In September 2010, he was appointed to the U.S. Financial Sta-bility Oversight Council by the NAIC. Director Huff served two terms on the council and was the ini al state insurance regula-tor appointee. The council was created by the 2010 Dodd-Frank Wall Street Reform and Consumer Protec on Act. Before entering public service, he spent 11 years as an execu ve with leading insurers and reinsurers, including Swiss Re and GE Insurance Solu ons. Director Huff earned his bachelor's degree in business administra on from Southeast Missouri State Uni-versity. He earned an MBA at Saint Louis University, and his juris doctor degree from the Washington University School of Law in St. Louis.


T ORSA J H B

By Elisabe a Russo, NAIC ERM Advisor, and Shanique (Nikki) Hall, CIPR Manager I The Own Risk and Solvency Assessment (ORSA) is a new regulatory repor ng tool intended to foster effec ve enter-prise risk management (ERM) and provide a group level perspec ve on risk and capital. An ORSA1 is an internal pro-cess undertaken by an insurer or insurance group to evalu-ate its own risk management framework and current and prospec ve solvency posi ons under normal and severe stress scenarios. It requires companies to regularly evaluate and describe their risk management strategies and how they align with their overall business objec ves. The ORSA will become an important addi onal tool for state insurance regulators to carry out risk-focused surveillance as it pro-vides addi onal informa on on the key risks insurers are exposed to, how they manage and control them and ul -mately on the financial resources available to cover unex-pected losses. As part of the NAIC Solvency Moderniza on Ini a ve,2 the NAIC adopted the Risk Management and Own Risk and Sol-vency Assessment Model Act (#505) in 2012. Model #505, which went into effect on Jan. 1, 2015, requires insurers above a specified premium threshold to maintain a risk management framework, complete an ORSA, and file a con-fiden al annual ORSA Summary Report with their lead state supervisor.3 The NAIC ORSA Guidance Manual was also for-merly adopted in 2012 and provides guidance to insurers on performing an ORSA and presen ng its findings in an ORSA Summary Report. Since the ORSA Guidance Manual and Model #505 were introduced, the NAIC and a number of state departments of insurance carried out three ORSA Feedback Pilot Projects (Pilot Projects). The Pilot Projects provided a small number of insurers an opportunity to voluntarily take a “dry run” at comple ng an ORSA Summary Report prior to formal sub-mission. The par cipa ng companies in the Pilot Projects received high-level feedback regarding their ORSA Summary Report to help them in preparing their first formal filings.4 The observa ons from the reviews also helped fine-tune the ORSA Guidance Manual, with amendments and enhance-ments made to the manual over the past several years. The majority of states have now formally enacted Model #505. All states are expected to adopt Model #505 by the end of 2017, as the Model becomes a standard for accredita-

on of the state departments. Most of the adop ng states required an ORSA Summary Report to be filed by the end of 2015. The remainder of states require the first filing to be

made by the end of 2016 or 2017, depending on the state. State departments of insurance around the country have now received ORSA Summary Reports from qualifying insur-ance companies (27 of the 35 states that have adopted Mod-el # 5055 received ORSA Summary Reports in the second half of 2015, mostly towards the end of the year.) The NAIC es -mates about 300 reports will be filed every year, once all states have adopted Model #505, of which approximately 200 will be at group level and 100 at single-en ty level. As regulators gear up to review these reports, the remain-der of this ar cle provides an overview of the observa ons for improving the quality of an ORSA Summary Report. NAIC ORSA F P P The three ORSA Pilot Projects occurred in 2012, then again in 2013, and most recently during October 2014−June 2015.4 The number of states par cipa ng in the Pilot Projects grew from 12 in 2012, 16 in 2013, to 26 in 2014. The number of voluntary ORSA submissions from various insurers/groups also grew from 14 in 2012, 22 in 2013 and to 28 in 2014. All three Pilot Projects were very informa ve and beneficial for both regulators and industry. The findings of the last Pilot Project helped the development of regulatory guidance to financial analysts and financial examiners of state insur-ance departments for reviewing the ORSA filings. Moreover, they helped regulators provide more specific guidance to the industry on their expecta ons as the industry prepared for the first filings of the ORSA Summary Reports. The ORSA Guidance Manual provides insurers with general guidance on comple ng an ORSA Summary Report. The manual is deliberately non-prescrip ve as each ORSA will be unique and will vary depending on risks unique to each company. During each Pilot Project, regulators went through each report line-by-line to provide addi onal insight to the indi-vidual companies submi ng the reports, and also to ad-dress improvements to the ORSA Guidance Manual.

(Continued on page 11) 1 Much has been wri en on the basics of ORSA and the benefits of the ORSA process.

For addi onal informa on see the October 2012 CIPR Newsle er ar cle “Insurers, Are You Ready? The Own Risk and Solvency Assessment (ORSA) Is On Its Way.” www.naic.org/cipr_newsle er_archive/vol5_orsa.pdf.

2The NAIC Solvency Moderniza on Ini a ve (SMI) began in June 2008. It is a cri cal self-examina on of the U.S.’ insurance solvency regula on framework and includes a review of interna onal developments regarding insurance supervision, banking supervision and interna onal accoun ng standards and their poten al use in U.S. insurance regula on.

3An ORSA Summary Report is a high-level level summary of the assessment to be submi ed to the insurer's domiciliary commissioner.

4 General feedback, observa ons and summarized results were published and made available to the public at the conclusion of each Pilot Project. The 2014 Pilot Project results are available at: www.naic.org/documents/commi ees_e_is f_group_solvency_related_orsa_feedback_pilot_project.pdf and all results are available on the NAIC website at: www.naic.org/cipr_topics/topic_own_risk_solvency_assessment.htm.

5 As of March 1, 2016.


T ORSA J H B (C )

A feedback report was prepared by the NAIC and made pub-lic at the conclusion of each Pilot Project, which included the observa ons of state insurance regulators reviewing the filings. Because many companies did not par cipate in the Pilot Projects, the feedback and observa ons provided in the feedback reports offer more granular guidance to compa-nies. The Pilot Projects also helped guide the development of ERM educa onal materials for state insurance regulators. The NAIC has been providing na onal hands-on training since 2015 to prepare states for the review and u liza on of the ORSA Summary Report in the regulatory process. In addi on, the NAIC conducted an “ORSA Pilot Key Results and Recommenda ons to Industry” webinar in August 2015 to share key results from the Pilot Project. The webinar, which is available on the NAIC website, reviewed ORSA best prac ces and provided addi onal insights, beyond the pub-lished observa ons, for improving the quality of the ORSA—or more specifically, detailing a ributes of what makes a “good” ORSA summary report in the eyes of a regulator. 2014 P P O I ORSA The ORSA Guidance Manual requires insurers to detail the elements of their ERM framework and ORSA results in a three-sec on ORSA Summary Report. The three-sec on structure includes: Sec on 1–Descrip on of the Insurer’s Risk Management Framework; Sec on 2–Insurer’s Assess-ment of Risk Exposure and Sec on 3–Group Risk Capital and Prospec ve Solvency Assessment. Overall, regulators found the ORSA Summary Reports submi ed were generally in compliance with the requirements with regard to the or-ganiza on of the reports in the three sec ons.

The following six observa ons were noted as opportuni es for improving the quality of an ORSA Summary Report: 1. Providing addi onal explana on of the risk manage-

ment strategy in the context of the key business strate-gy objec ves.

2. Highligh ng the maturity of the ERM process and status of development by covering what has been developed and embedded in the organiza on and what is s ll in development.

3. Offering addi onal informa on and clarity regarding the legal en es included in the scope of the group ORSA.

4. Maintaining consistency between the key risks iden -fied in Sec on 1, those assessed in terms of exposure in Sec on 2 and those quan fied in terms of risk capital in Sec on 3.

5. Providing addi onal support for the methodologies and assump ons selected in Sec on 2 for assessing and stress tes ng the exposures for key risks and to quan -fy risk capital in Sec on 3.

6. Offering addi onal evidence regarding how the man-agement team u lizes the informa on provided in the ORSA Summary Report to pursue its business strategy objec ves and how the board of directors u lizes it to oversee the company.

The following highlights some of the features state insur-ance regulators found in a “good” ORSA Summary Report. Sec on 1 • Provides a descrip on of each of the five building blocks

of the ORSA Guidance Manual (risk governance and culture, risk iden fica on and priori za on, risk appe-


2012 2013/2014 2015 2016

Industry • North American CRO Council ac vely involved in dra ing of NAIC ORSA Guidance Manual

• A number of insurers par-cipated in the ORSA Pilot

• Prepara on for first ORSA filings

• First ORSA filings in 27 states (approx. 200)

• Second ORSA submis-sions in 27 states

• First ORSA filings in five states

NAIC/State Insurance Regulators

• RMORSA Model Act • ORSA Guidance Manual • First ORSA Pilot Program

• Second and third ORSA Pilot Programs

• Enhancements to the ORSA Guidance Manual

• ORSA sec ons of Financial Condi on Examiners Handbook and Financial Analysis Handbook

• ORSA training for state insurance regulators

• Ini al ORSA feedback to companies

• ORSA Training for state insurance regulators

• Ongoing review of ORSA filings

• Implementa on of ORSA handbooks processes


T ORSA J H B (C )

te tolerances and limits, risk management and con-trols, and risk repor ng and communica ons).

• Places the ORSA processes in the context of the maturi-ty of ERM and clarifies what has been developed and what has not and how far into the group organiza on chart the ERM processes is embedded in the business opera ons.

• Provides a meline for the annual ORSA cycle explain-ing when the various ERM ac vi es take place in the course of the year and the frequency of each ac vity. • Under risk culture and governance, provides clear

defini ons of roles and responsibili es of all key stakeholders involved in risk management and the repor ng and communica on lines among them. Whilethe ORSA Guidance Manual does not dictate a specific governance model, it is expected the insur-er/group will make clear who are the risk owners, risk managers, ul mate supervisors and providers of independent assurance and how they operate and exchange informa on.

• Under risk iden fica on and priori za on, pro-vides a robust and detailed process of iden fica-

on of the key risks throughout the group, describ-ing the priori za on criteria (e.g., likelihood, im-pact, controllability, velocity, etc.) and tools used (e.g., mee ngs, targeted ques onnaires, enter-prise-wide ques onnaires, etc.), as well as the par-

cipants in the process. • Under risk appe te, tolerances and limits, ar cu-

lates tolerances and limits for each of the key risks and provide explana on for the selec on of the tolerance and limits and for se ng the overall risk appe te at insurer/group level. Limits, toler-ances and appe te should make sense in the con-

text of the business objec ves pursued by the insurer/group.

• Under risk management and controls, provides an outline of the process in place to manage, monitor and control both key and non-key risks, se ng out the key ac vi es, the key risk controls and key mi -ga on ac vi es and escala on ac vi es in case of breaches. Examples of breaches occurred and ac-

ons taken are included in the best ORSA Summary Reports.

• Under risk repor ng and communica ons, provides a descrip on of the risk reports produced, a sum-mary of the content, the intended audience and the owner of the report. Also provides an explana on of how feedback loops coming from the implementa-

on of the ERM processes are embedded in the ERM processes.

Sec on 2 • Provides a detailed descrip on of the assessment of the

exposures for each key risk iden fied in Sec on 1 with an explana on of the methodology selected (whether qualita ve or quan ta ve), the assump ons and under-lying data used (i.e. descrip on, source, valua on date/period), and the ra onale for the selec on of the meth-odology.

• Assesses exposures under both normal and stressed environments, that can be qualita ve or quan ta ve. Each key risk iden fied in Sec on 1 is stressed or reason for exclusion is iden fied, the risk drivers for each key risk that are stressed are clearly iden fied, and a de-tailed descrip on of each stress is provided together with a summary of the results of the stresses and of the mi ga on ac vi es.


S 1 D R

M F

S 2 I ’ A

R E

S 3 G R C P -

S A Risk culture and governance Detailed descrip on of material risks,

assessment methodology and assump-ons, risk mi ga on ac vi es

Quan fica on of required risk capital at group level against available capital

Risk iden fica on and priori za on Assessment (qualita vely or quan ta ve-ly) of risk exposures for each material risk

Stress tes ng of current solvency posi on

Risk appe te, tolerances and limits Comparison of risk exposures against limits, tolerances and risk appe te

Prospec ve assessment of risk profile and solvency posi on

Risk management and controls Stress tes ng of risk exposure Stress tes ng of prospec ve solvency posi ons

Risk repor ng and communica on Valida on of results


T ORSA J H B (C )

Sec on 3 With regard to the group assessment of risk capital: • The assessment is conducted for each of the key risks

iden fied and assessed in Sec ons 1 and 2. • The metric used to define risk capital and provide a

ra onale for its selec on is described. • The methodology used to aggregate individual risk cap-

itals to obtain one group risk capital amount (before any diversifica on benefit) is explained.

• The accoun ng basis used to measure the available capital that is compared with the aggregate risk capital to show the current solvency posi on of the insurer is stated.

• The correla ons between key risks and provide robust support to the methodology selected to determine the “diversifica on benefit” are analyzed.

• The valida on framework (i.e. governance, tes ng of models, data and results, documenta on) and the cur-rent state of valida on of the models used is described.

With regard to the prospec ve assessment of risks and cap-ital adequacy: • The changes in the insurer/group’s risk profile (i.e. the

key risks) over the me horizon of the business plan in light of the changes to the insurer/group’s business strategy objec ves are explained.

• The future risk capital needed at aggregate level to cover unexpected losses from these key risks are es mated.

• The es mated projected risk capital against the es -mated projected available capital to determine future solvency posi ons are compared.

• In case of poten al insolvency, addi onal sources of cap-ital available to cover any shor all (in par cular: access to capital markets, liquidity of exis ng assets, and fungi-bility of capital within the group) are iden fied.

C The year 2016 will be an important year as regulators review the first ORSA Summary Reports that were submi ed in 2015. State insurance regulators will decide the regulatory value of these reports and to what extent the informa on provided enhances their risk-focused surveillance of insur-ance groups. They will also provide feedback to the insur-ance companies. The NAIC will con nue training state de-partments of insurance on how to u lize the ORSA Summary Reports in their financial exams and financial analysis. As the ORSA is brought onto the agenda of interna onal and domes c supervisory colleges,6 the discussion over regulatory expecta ons from ORSA Summary Reports will broaden to include the views of other regulators. How

these expecta ons converge and how they are communicat-ed to the insurance companies will be key to the develop-ment of the next round of ORSA reports. For the me being, it is crunch me for both regulators to dig into the reports, and for companies to soon collect the feedback and implement it into the 2016 filings.

A A Elisabe a Russo is a risk actuary. She joined the NAIC in July 2014 to be the ERM Advisor to the state insurance departments. Ms. Russo is currently focusing on helping the state Depart-ments of Insurance to be ready to supervise the ORSA submissions. At the NAIC, she is also involved in inter-na onal issues such as the develop-ment of a global interna onal capital standard. Prior to joining the NAIC, for

nearly 3 years, Ms. Russo led the Deloi e Solvency prac ce and P&C risk modeling team for the Unites States in New York City. Prior to that, she worked for nearly 15 years for PwC in London and in Moscow. She set up the actuarial prac ce for Central Eastern Europe and she served as member of the Global Sol-vency II Steering Commi ee for Europe, advising the largest European insurance groups on all 3 pillars (capital assessment, ERM and ORSA and risk repor ng). During her consul ng ca-reer, Ms. Russo worked with other non-US regulators as advi-sor, model validator and trainer.

Shanique (Nikki) Hall is the manager of the NAIC Center for Insurance Policy and Research (CIPR). She joined the NAIC in 2000 and currently oversees the CIPR’s primary work streams, in-cluding: the CIPR Newsle er; studies; events; webinars and website. Ms. Hall has extensive capital markets and in-surance exper se and has authored

copious ar cles on major insurance regulatory and public policy ma ers. She began her career at J.P. Morgan Securi es as a research analyst in the Global Eco-nomic Research Division. At J.P. Morgan, Ms. Hall analyzed regional economic condi ons and worked closely with the chief economist to publish research on the principal forces shaping the economy and financial markets. Ms. Hall has a bachelor’s degree in economics from Albany State University and an MBA in financial services from St. John’s University. She also studied abroad at the London School of Economics.

6 Supervisory colleges are joint mee ngs of interested regulators with company officials and include detailed discussions about financial data, corporate govern-ance, and enterprise risk management func ons. They are intended to facilitate over-sight of interna onally ac ve insurance companies at the group level.


NAIC C A P O W P

By Kris DeFrain, NAIC Director of Research and Actuarial Department I State insurance regulators are evalua ng “price op miza-

on” tools and whether they should be used by property and casualty insurers in their ratemaking processes.1 The use of price op miza on is specifically being evaluated in light of the statutory standards in most states that rates shall not be “inadequate, excessive, or unfairly discriminatory.” The NAIC Casualty Actuarial and Sta s cal (C) Task Force began dra ing a price op miza on white paper in early 2015 analyzing price op miza on and its use in personal lines insurance ratemaking. At the 2015 Fall Na onal Mee ng, the Property and Casualty Insurance (C) Com-mi ee adopted the Task Force’s Price Op miza on White Paper (white paper). The white paper provides background informa on on price op miza on, iden fies poten al bene-fits and drawbacks of using price op miza on, and presents op ons for state regulatory responses regarding the use of price op miza on in personal lines insurance ratemaking. The NAIC’s full membership will consider adop ng the white paper at the upcoming Spring Na onal Mee ng in New Orleans. This ar cle will summarize the Task Force’s white paper, including the proposed state regulatory ac ons and the policy recommenda ons for regulators to consider. P S R A R Under most states’ laws, insurance personal lines’ “rates shall not be inadequate, excessive or unfairly discriminato-ry.” While accep ng some ra ng devia ons from indicated rates and ra ng factors, state regulators are concerned the use of sophis cated methods of price op miza on could deviate from tradi onal ratemaking, extending beyond ac-ceptable levels of adjustment to cost-based rates and re-sul ng in prices that vary unfairly by policyholder. Because of these concerns, the Task Force proposed state regulators consider taking the following ac ons: 1. Consider issuing a bulle n to address insurers’ use of

methods that may result in non-cost based rates. (A dra bulle n for considera on is included in the white paper.)

2. Consider enhancing requirements for personal lines rate filings to improve disclosure and transparency around rates, rate indica ons and rate selec ons.

(Ideas for poten al requirements for rate filings are included in the white paper.)

3. Analyze models used by insurers in ratemaking to en-sure the model adheres to state law and actuarial prin-ciples. (A list of possible ques ons to assist the regula-tory analysis is provided in the white paper.)

In the white paper, the Task Force made recommenda ons regarding rates and the regulatory rate review for personal lines insurance, summarized as follows: 1. Under any defini on of price op miza on, states

should address the requirement in their state ra ng laws that “rates shall not be excessive, inadequate or unfairly discriminatory.”

2. Ra ng plans should be derived from sound actuarial analysis and be cost-based. The proposed rates devel-oped from an actuarial analysis need to comply with state laws. They should also be consistent with the ac-tuarial principles derived from a professional actuarial body and the actuarial standards of prac ce established by the Actuarial Standards Board (ASB).

3. Two insurance customers having the same risk profile should be charged the same premium for the same cov-erage. Some temporary devia ons in premiums might exist between new and renewal customers with the same risk profile because of capping or premium transi-

on rules.

4. Not all rates and ra ng plans accepted or approved strictly adhere to the actuarial indica ons. While actu-arial indica ons are largely preferred over pure judg-ment, regulators acknowledge the actuarial indica ons are only an es mate of the cost to transfer risk and some insurer judgment will inevitably enter the rate se ng process. The Task Force recommends states al-low flexibility reflec ng insurance loss and expense costs in the selec on of ra ng factors. Some addi onal recommenda ons regarding the acceptance of devia-

ons from the actuarial indica ons are as follows:

a. The Task Force recommends the selec on of a pro-posed rate between the currently approved rate and the actuarially indicated rate be allowed if based on reasonable considera ons adhering to state law and consistent with actuarial principles and Standards of Prac ce reflec ng expected insur-ance loss and expense costs.

(Continued on page 15) 1 For more on price op miza on, visit: www.naic.org/cipr_topics/

topic_price_op miza on.htm.


NAIC C A P O W P (C )

b. The Task Force recommends a selected rate out-side the range defined by the current and indicated rate may be acceptable provided it is disclosed, complies with state law and is shown to be con-sistent with actuarial ratemaking principles and Standards of Prac ce.

c. The Task Force acknowledges capping and transi-onal rules can be in the public’s best interest but

recommends regulators consider the extent to which they will allow capping and transi onal ra ng. Considera on should be given to the length of me over which premium changes will be lim-ited before they reach the approved rate level, the size and reasonableness of capping upper and low-er bounds, and the extent to which capping of one rate might affect rates charged to others.

5. Under the requirement “rates shall not be … unfairly discriminatory,” insurance ra ng prac ces that adjust the current or actuarially indicated rates or the premi-ums, whether included or not included in the insurer’s ra ng plan, should not be allowed when the prac ce cannot be shown to be cost-based or comply with the state’s ra ng law. With due considera on as to wheth-er prac ces are cost-based or in compliance with state ra ng law, the Task Force believes the following prac-

ces, at a minimum, are inconsistent with statutory requirements that “rates shall not be … unfairly dis-criminatory”:

a. Price elas city of demand.

b. Propensity to shop for insurance.

c. Reten on adjustment at an individual level.

d. A policyholder’s propensity to ask ques ons or file complaints.

6. Ra ng plans in which insureds are grouped into homo-geneous ra ng classes should not be so granular that resul ng ra ng classes have li le actuarial or sta s cal reliability. The use of sophis cated data analysis to de-velop finely tuned methodologies with a mul plicity of possible ra ng cells is not, in and of itself, a viola on of ra ng laws as long as the ra ng classes and ra ng fac-tors are cost-based.

C The issues and concerns about the use of price op miza-

on remain a key priority for state insurance regulators. As of March 1, 2016, 18 jurisdic ons2 have taken public ac on with respect to price op miza on. Many of the ac ons have been to issue bulle ns restric ng the use of price op miza on under the defini on in each bulle n. A copy of the white paper, as well as a list of the jurisdic ons that have taken public ac on, along with their regulatory bulle-

ns, is available on the Casualty Actuarial and Sta s cal (C) Task Force Web page.3 Other states are awai ng adop-

on of the NAIC white paper by the full membership or believe their current state law is sufficient and no addi on-al ac on is necessary.

2 California Bulle n (Feb. 2015), Connec cut (Dec. 2015), District of Columbia (Aug. 2015), Delaware (Oct. 2015), Florida (May, 2015), Indiana (July 2015), Maine (Aug. 2015), Maryland (Oct. 2014), Minnesota (Nov. 2015), Missouri (Jan. 2016), Mon-tana (Sept. 2015), New York (March 2015), Ohio (Jan. 2015), Pennsylvania (Sept. 2015), Rhode Island (Sept. 2015), Vermont (June 2015), Virginia (July 2015) and Washington (July 2015).

3 www.naic.org/commi ees_c_ca .htm.

A A

Kris DeFrain is the NAIC Director of the Re-search and Actuarial Department. She is cur-rently charged as primary NAIC staff for the Principle-Based Reserving and the Casualty Actuarial and Sta s cal Task Forces. Ms. DeFrain manages a staff of actuaries, sta-

s cal analysts, insurance contract experts, and research analysts working on regulatory solvency- and market-related issues, provid-ing regulatory services, and conduc ng research for the Center for Insurance Policy and Research. Ms. DeFrain received her bachelor’s degree in finance/actuarial science from the University of Nebraska in 1989. She received her FCAS designa on from the Casualty Actuarial Society (CAS), where she previously served as Vice President—Interna onal. Ms. DeFrain is a member of the American Academy of Actuaries and a Char-tered Property & Casualty Underwriter.


I W W I I

By Anne Obersteadt, CIPR Senior Researcher Interna onal focus centered on adap ng and mi ga ng the effects of climate change has intensified in recent years. This was exemplified when nearly 200 countries agreed late last year to take steps to cut global emissions to a level that would avoid the worst effects of climate change. The agree-ment, termed the Paris Accord, comes on the heels of new research indica ng the world is already facing the impacts of climate change. Scien sts warn climate change could reach devasta ng levels without significant proac ve efforts to curb emissions and increase resiliency. The Paris Accord could provide the impetus for a transi on to a lower carbon world—as long as countries execute their commitments. Insurers will need to prepare for the adverse weather im-pacts from an unavoidable warmer world, as well as new risks arising from a transi on to a low carbon future. This ar cle examines the Paris Accord, U.S. efforts to lower carbon emissions, and what scien sts are telling us on the current and future environmental impacts of climate change. Addi onally, the ar cle iden fies the risk of climate change to insurers and how they are responding to the low carbon movement. T P A On Dec. 12, 2015, leaders from 195 countries signed a his-toric accord to limit the rise in greenhouse gas emissions to below 2% of the pre-industrial level at the 21st Conference of Par es (COP21) in Paris. The accord establishes a legally binding framework for countries to monitor and report their efforts to transi on to a lower carbon world. As part of the framework, countries are required to submit their long-term emission-cu ng plans by 2020. Countries are then required to reassess and adjust their plans and publicly re-port their progress on mee ng their commitments every five years. Limi ng global warming to two degrees Celsius above pre-industrial levels is an important threshold. Many scien sts predict this threshold cannot be surpassed if the worst effects of climate change are to be avoided. According to the Intergovernmental Panel on Climate Change (IPCC), the average global temperature rose 0.85 degrees Celsius be-tween 1880–2012. Scien sts warn na ons will need to cut emissions substan ally to stave off destruc ve and unstable weather pa erns that would contribute to rising sea levels, droughts, flooding and water shortages. Many scien sts have advocated for a stronger target to safely avoid irre-versible devasta ng weather pa erns. Addi onally, several countries have advocated for a lower emissions target to

limit the impact to small island states at risk of losing the most from climate change, despite contribu ng the least to it. For this reason, the accord also includes language to pur-sue efforts to limit long-term global temperature rise to 1.5 degrees Celsius. T G Although ambi ous, the emission targets established during COP21 are es mated to achieve only about half of the nec-essary emissions cuts needed to reach the two-degree Celsi-us target and avoid the most devasta ng consequences of climate change. Many na ons submi ed their intended na-

onally determined contribu ons (INDC) prior to the confer-ence, publicly outlining what climate ac ons they intend to take to cut emissions through 2030. The United Na ons Environment Programme’s (UNEP) annually published Emis-sions Gap Report provides a scien fic assessment of the mi ga on contribu ons from the countries that submi ed INDCs. The 2015 report analyzed 119 INDCs from 146 coun-tries, represen ng 88% of global emissions. It es mated emission levels in 2030 from fully implemented INDCs would result in the earth warming to almost three degrees by the end of the century. An addi onal 12 gigatonne in emission cuts will be needed to reach the level sufficient to achieve the target of two degree Celsius by 2100.1 To bridge the gap, the report suggests an expansion of efforts around en-ergy efficiency, renewable energy technologies, city and regional ini a ves, and forest mi ga on ac ons. T R N The accord provides an interna onal framework for cu ng emissions with legally required measuring and repor ng requirements, but countries’ individual commitments are voluntary. As such, its success hinges largely on countries’ abili es to implement their agreed upon carbon reduc ons. The U.S. commitment was largely based on curbing carbon emissions from power plants, which account for about one-third of all domes c greenhouse gas emissions, and transi-

oning to renewable energy.2 As a first step, the U.S. Envi-ronmental Protec on Agency (EPA) proposed carbon stand-ards for new power plants in September 2013. In November 2014, the U.S. and China issued a bilateral announcement to jointly reduce emissions. In September 2015, the U.S. and China then issued a Joint Presiden al Statement of Climate Change, building on the previous year’s agreement and


1 United Na ons Environment Programme (UNEP), 2015. “UNEP Emissions Gap Report 2015: 2°C Goal S ll Within Reach,” accessed from h p://climate-l.iisd.org/news/unep-emissions-gap-report-2c-goal-s ll-within-reach/. 2 Accessed from h ps://www.whitehouse.gov/climate-change.


I W W I I (C )

se ng common goals for an agreement at COP21. This agreement between the U.S. and China, the world’s largest polluters, helped secure commitments from other na ons. However, the U.S.’s ability to comply with the accord has recently been put into ques on, leading to addi onal con-cerns on the commitments of other countries. On Feb. 9 of this year, the U.S. Supreme Court halted the implementa-

on of the current administra on’s Clean Power Plan fol-lowing a lawsuit filed by 27 states challenging the plan’s legality. The plan was aimed at reducing carbon emissions 32% from 2005 levels by 2030 by se ng carbon emission reduc on standards for exis ng power plants and imple-men ng incen ves for states to transi on to renewable energy. The D.C. Circuit Court of Appeals will take the issue up on June 2, 2016.3 Although any mandatory implementa-

on of the plan’s regula ons are suspended un l a er the Court takes up the issue, individual states can s ll choose to implement the plan voluntarily. Addi onally, new power plants would s ll be addressed under the proposed EPA regula ons, which the EPA has stated will be finalized by mid-summer 2016. C C H The COP21 accord comes at an important me. The world is already beginning to experience the effects of climate change, making the need to respond to the inherent risks both a current and a long-term need. Given its probability and poten al for significant worldwide disrup on, the World Economic Forum 2016 Global Risks Survey iden fied failure to adapt and mi gate climate change as the risk with the greatest poten al impact in 2016. Addi onally, the re-port found climate change is amplifying other risks such as water crisis, food shortages, migra on and security, which in turn further hampers mi ga on and adapta on efforts. The report is based off of an annual survey of 750 experts’ perspec ves on 29 global risks over a 10-year me frame.4 The IPCC’s Fi h Assessment Report (AR5) found the globally averaged combined land and ocean surface temperatures warmed 0.85 degrees Celsius between 1880–2012 (Figure 1). Figure 1 also shows global average surface temperatures warmed 1 degree Celsius from the preindustrial mean tem-perature. Addi onally, the IPCC AR5 found emissions of green-house gases have con nued to rise over the last three decades and are currently the highest in history. The report found more than half of the earth’s warming is linked to hu-man ac vi es. The recent rise in temperature was primarily driven by economic and popula on growth increasing fossil fuel carbon emissions, par cularly from coal. The IPCC report is designed to inform policymakers and assist the work of the United Na ons Framework Conven on on Climate Change

(UNFCCC). The IPCC is an intergovernmental organiza on that leverages the research of scien sts globally to produce re-ports on climate change. The UNFCCC is the main interna on-al treaty on climate change5.


3 New Europe, 2016. “U.S Supreme Court Torpedoes Paris COP21 Accord,” accessed from h p://neurope.eu/ar cle/u-s-supreme-court-torpedoes-paris/. 4 World Economic Forum, 2016. The Global Risks Report 2016: 11th Edi on, accessed from h p://www3.weforum.org/docs/GRR/WEF_GRR16.pdf. 5 IPCC, 2014: Climate Change 2014: Synthesis Report. Contribu on of Working Groups I, II and III to the Fi h Assessment Report of the Intergovernmental Panel on Climate Change [Core Wri ng Team, R.K. Pachauri and L.A. Meyer (eds.)]. IPCC, Geneva, Switzerland, 151 pp.

Source: IPCC AR5 Synthesis.

F 1: C C I


I W W I I (C )

The implica on of a warming world is evidenced across the globe. The IPCC AR5 concluded rising surface temperatures have likely changed the global water cycle, contribu ng to the Arc c sea-ice mel ng, ocean warming and sea-level rise observed since the mid-20th century. Arc c sea-ice has de-creased every decade since 1979. In annualized mean terms, Ar c sea-ice decreased 3.5% to 4% per decade be-tween 1979–2012. More than 90% of the earth’s tempera-ture rise between 1971–2010 is stored in oceans. This has resulted in a 0.11 degree Celsius increase in temperature in the upper ocean during this period, as well as a 26% in-crease in water acidity from pre-industrial mes. Terrestrial ice melts from higher surface temperatures and water ex-pansion from ocean warming con nue to increase sea lev-els. Global average sea level rose 19 cm to 21 cm from 1901 to 2010. These environmental changes have been accompanied by changes in the earth’s ecosystems, weather pa erns and crop yields. Addi onally, changing precipita on pa erns combined with snow and ice melt are affec ng water quan-

ty and quality in many regions. Weather-related ex-tremes—such as heat waves across Europe, Asia and Aus-

tralia; droughts; floods from extreme precipita on; and wildfires—are increasing in frequency. It should be noted there is s ll some controversy surrounding the anthropogenic nature underlying climate change. Howev-er, the AR5 report points out changes in the climate are re-sponsible for these observed impacts on natural systems, regardless of a ribu on to the cause of climate change. F C C P Climate change is projected to con nue to increase in the coming decades, but the extent to which it will change de-pends greatly on how and when the world responds. The IPCC AR5 predicts average global surface temperatures will likely rise by 0.3 degrees Celsius to 4.8 degrees Celsius above the 1986–2005 average by 2100. This predic on is based on a range of emissions scenarios predic ng future climate change (Figure 2). The scenarios incorporate various assump ons such as climate policy, advances in technology, energy de-mand, and popula on and economic growth. The scenarios assess the resul ng impact of various response levels, ranging from no ac ons to aggressive ac ons, taken to mi gate cli-


F 2: C IPCC M A M S ‘B U ’ S

Change in average surface temperature (a) and change in average precipita on (b) based on mul -model mean projec ons for 2081–2100 rela ve to 1986–2005 under the RCP2.6 (le ) and RCP8.5 (right) scenarios. The number of models used to calculate the mul -model mean is indicated in the upper right corner of each panel. Source: IPCC AR5 Synthesis.


I W W I I (C )

mate change. Figure 2 compares changes in average surface temperature and average precipita on under the most strin-gent mi ga on scenario to the scenario of no ac on.6 Surface temperature over the 21st century is predicted to increase under all the scenarios. However, the lowest-end emissions scenario (0.3 degree Celsius to 1.7 degree Celsius rise) ensures average global surface temperatures remain safely below the 2-degree target. It should be noted this scenario includes stringent mi ga on efforts, including not-yet developed carbon sequestering technologies. Irrespec ve of which emissions scenario proves most valid, the earth will con nue to experience extreme weather events. Heat waves and extreme precipita on will con nue with increased frequency, intensity and dura on. The earth and ocean will con nue to warm, and ocean acidifica on will intensify. Sea levels will con nue to rise by 26 cm to 82 cm for the period 2081–2100 rela ve to 1986–2005. By the end of the 21st century, 70% of all coastlines will be affect-ed by sea level rise. Arc c sea-ice will con nue to melt, with the Arc c Ocean becoming nearly ice-free in the summer months by mid-century under the worst-case scenario. Climate change will con nue to nega vely affect crop produc on and water resources, which, when combined with rising popula on, will challenge food and water security. Certain popula ons will become displaced, and health risks are an cipated to rise from heat waves. The most vulnerable popula ons are expected to feel the brunt of many of these climate change impacts.7 C C I I There is a growing movement among insurers on the need to prepare for the poten al impact of climate change-related risks. Many insurance segments are facing changing risks from the increase in frequency and severity of extreme weather events in recent decades. Beyond weather-related risks from a warming world, insurers could also face risks from a changing economy. As the world prepares to mi -gate the most extreme effects of climate change through interna onal policy agreements, insurers could face addi-

onal risk from changing economic condi ons. These addi onal risks were outlined in the Pruden al Regu-la on Authority (PRA) of the Bank of England report, The Impact of Climate Change on the U.K. Insurance Sector.8 The PRA report, released in September 2015 ahead of COP21, provides a framework for considering the financial risks arising from climate change. The report iden fies three

main channels through which climate change may affect the insurance sector: 1) direct and indirect physical risks from weather-related events; 2) transi on risks from the transi-

on to a lower-carbon economy; and 3) liability risks from par es who have suffered loss and damage from climate change and are a ribu ng causa on to the insured. Physical Risks The PRA report warned increases in physical risks due to climate change could present significant challenges to insur-ers’ business models. Physical risks include losses stemming from weather-related events. According to Munich Re, se-vere weather events, heat waves, droughts, floods and trop-ical storms have accounted for 85%–90% of natural hazards since 2005. Insurers’ exposure to physical risks is largely from indirect exposure to the physical assets they insure. Addi onally, insurers face poten al losses from first-party claims to business interrup on, con ngent business inter-rup on and builders’ risk from weather disasters. Insurers may also face direct losses to real estate holdings, which could pressure the asset side of the balance sheet. It is well accepted that poten al losses from physical risks are rising as popula ons migrate to areas with higher natural catas-trophe risk, such as coastlines and wildfire-prone regions. However, the PRA warns there are indica ons climate change is also influencing loss pa erns, which could chal-lenge insurers’ modeling assump ons because of higher weather vola lity. Liability Risks The PRA report highlighted coverage for insured liability risks from climate change is an emerging risk for insurers providing liability coverage. Climate change could affect third-party claim costs for coverages such as directors’ and officers’ liability, comprehensive general liability, employers’ liability, and errors and omissions liability. The PRA report points out liability insurers could be legally liable for losses from par es seeking compensa on for the insured’s alleged failure to prevent climate change damages. Legal liability for climate change damages could poten ally result from the insured’s failure to mi gate and adapt to climate change. This would include acts such as failure to reduce emissions, protect against physical risks or ins tute proper governance. Failure to properly disclose climate-related risks or comply with climate legisla on or regula ons could also poten ally be a legal liability for insurers.

(Continued on page 20) 6 Ibid. 7 Ibid. 8 Available at: www.bankofengland.co.uk/pra/documents/supervision/ac vi es/pradefra0915.pdf.


I W W I I (C )

Transi on Risks The PRA warned insurers face poten al risks from the tran-si on to a lower-carbon world. Climate policies, technology advances and physical asset risks could poten ally devalue certain assets. This could place pressure on insurers’ assets and investment income. According to IPCC AR5 emissions scenarios, the world will reach its carbon budget limit—the maximum emi ed car-bon allowable to remain at the 2-degree Celsius warming target—in approximately 20 years.9 This will leave a good deal of the earth’s oil, gas and coal reserves as undevel-oped. Assets dependent on fossil fuels would become stranded, resul ng in the repricing of carbon-heavy invest-ments. Insurers who do not account for this poten al in repricing could see nega ve impacts to their long-term as-sets and the liabili es they were meant to match. Regula ons or climate policies can also nega vely affect fossil fuel prices, leading to stranded assets. Addi onally, economic factors unrelated to climate change could affect the produc on and pricing of fossil fuels. Changes in inves-tor preferences and sen ment can also affect asset values. For instance, a large natural catastrophe or new climate science findings can change investor preferences related to fossil fuel investments. Furthermore, technological advanc-es could facilitate a shi from high-carbon to low-carbon energy sources by making clean technologies more afforda-ble. Shi s in investment strategies from companies volun-tarily embracing the social campaign for fossil fuel divest-ment could also intensify a demand shi from high- to low-carbon investments. A I P C R As some of the world’s largest investors, insurers must as-sess the asset implica ons of an interna onal move to low-er-carbon energy sources. Insurers should an cipate the poten al risks arising from this transi on and allocate in-vestments in a way that supports their strategic long-term objec ves. Insurers who fail to adequately address climate-related risks in their investment por olios expose them-selves to reputa onal risk and poten al solvency stresses. In January 2015, Towers Watson published a paper, Fossil Fuels: Exploring the Stranded Assets Debate, outlining a framework for investor response to fossil fuel investments. In the paper, the consultancy firm stated it did not advocate for a par cular response but it did believe companies with medium- to long-term investments should consider the poten al for stranded asset risk. Companies are an cipated

to use the framework based on their individual exposure assessments and unique investor beliefs and strategies. The framework calls on investors concerned with stranded asset risk to influence policy and investor prac ces through en-gagement. Investors may limit downside risk by reducing their por olio’s exposure to carbon intensive investments. Another strategy is to hedge against downside risk by in-ves ng in clean and renewable technologies. Addi onally, investors may choose to eliminate stranded asset poten al by dives ng carbon intensive investments.10 Timing of dives ture is a key market considera on. The flu-idity in assump ons required in predic ng the path of car-bon-intensive asset demand and prices will complicate in-surers’ ability to iden fy which fossil fuels to priori ze for dives ture. Addi onally, unpredictability in ming of invest-ment risk could poten ally leave insurers at risk for di-ves ng too soon or too late. Asset stress tes ng should be an important part of an insur-er’s risk management protocols. Addi onally, insurers should consider related investments along the value chain when measuring their por olio’s carbon exposure. There are several methods used to measuring carbon risk in equity and credit investments. The most commonly used approach is the Greenhouse Gas Protocol (GHGP), which categorizes carbon emissions as either direct or indirect. Other prac ces include measuring exposure to fossil fuels in rela on to a par cular financial metric.11 T I I B R L -C M Insurers contribute to climate change ini a ves in several ways. They support financial viability and sustainability by compensa ng damages from extreme events and lowering risks through mi ga on ini a ves. Insurers enable renewa-ble energy products and green infrastructure development by providing innova ve product coverage. Addi onally, a growing number of insurers are suppor ng a lower carbon economy through investments in clean and renewable tech-nologies and energy efficiency. In May 2015, AXA announced it would divest $554 million in coal investments. The company stated it would divest in-vestments in mining companies with more than half their

(Continued on page 21) 9 Ibid. 10 Towers Watson, 2015. “Fossil Fuels: Exploring the Stranded Asset De-bate,” accessed from www.towerswatson.com/en-US/Insights/IC-Types/Ad-hoc-Point-of-View/2015/01/Fossil-fuels-Exploring-the-stranded-assets-debate. 11 Ibid.


I W W I I (C )

turnover from coal mining. It also planned to divest electri-cal u li es with more than half their energy derived from thermal coal plants. Addi onally, the company commi ed to tripling its green investments to $3.3 billion by 2020 and providing more climate related disclosures.12 QBE an-nounced the following month a three-year plan to invest up to $78.11 million in green bonds. Zurich has also stated it will invest more than $2 billion in green bonds.13

Aviva joined the list of companies entering divestment cam-paigns in July 2015 when it announced it would divest from fossil fuel companies not inves ng in emissions reduc on technologies.14 It also stated it planned to invest £500 mil-lion ($698 million) a year over five years in low-carbon tech-nologies. In November, Alliance also stated it would elimi-nate €4 billion ($4.4 billion) in coal investments in favor of wind power investments.15 Addi onally, Munich Re reached its goal to become carbon-neutral in 2015.16

In January of this year, California Insurance Commissioner Dave Jones called for U.S. insurers doing business in his state to join the list of interna onal insurers de-carbonizing their investment por olios. The divestment request is the first from a state insurance regulator. Divestment is volun-tary and applies to thermal coal investments or any compa-ny deriving 30% or more of its revenues from thermal coal. Commissioner Jones also stated an annual data call will be ini ated this April requiring insurers licensed in California and wri ng more than $100 million in premium to disclose carbon-based investments. In his announcement, Commis-sioner Jones stated public disclosures will assist regulators, policyholders and investors in examining financial risk from carbon-based assets.17 California’s call for coal dives ture is aimed at protec ng insurers from the poten al for stranded assets. Recent price devalua ons for both coal and coal extrac on companies illustrate the poten al for stranded assets. The coal indus-try has lost about three-quarters of its value, with coal pric-es falling to $50/tonne in 2015 from its peak of $200/tonne almost seven years earlier.18 Falling prices are the result of declining demand and rising coal supplies. The reduc on in demand is linked in part to reduced consump on from coal’s biggest consumer, China, as it transi ons to renewa-ble energy sources. In the U.S., cheaper natural gas prices and new regula ons have decreased the demand for coal. It should be noted that coal accounts for about half of the world’s carbon risk.19 Future prices and mine asset valua-

ons could deteriorate further as the world transi ons to lower carbon energy sources.

T F As the IPCC AR5 illustrates, the effects of a changing climate are becoming more prevalent. The frequency and intensity of extreme weather events, likely exacerbated by climate change, have increased notably in recent decades. Further-more, even the best-case emissions reduc on scenario re-ported in the IPCC AR5 predicts irreversible warming. If le unchecked, the world could face trillions of dollars in finan-cial losses. This could challenge insurers’ exis ng business models and have adverse effects on the availability and affordability of insurance. Many researchers warn the inter-connec vity of risk will eventually result in every asset being directly or indirectly affected by climate change. Many in-surance segments are already facing changing risks. As such, it is important insurers examine their role in the transi on to a lower carbon world. Adapta on and mi ga on of the worst of climate change’s impacts should be a central focus to help stabilize vulnerability to the changing risk landscape.

A A

Anne Obersteadt is a researcher with the NAIC Center for Insurance Policy and Re-search. Since 2000, she has been at the NAIC performing financial, sta s cal and research analysis on all insurance sectors. In her cur-rent role, she has authored several ar cles for the CIPR Newsle er, a CIPR Study on the State of the Life Insurance Industry, orga-

nized forums on insurance related issues, and provided support for NAIC working groups. Before joining CIPR, she worked in other NAIC Departments where she published sta s cal reports, provided insurance guidance and sta s cal data for external par es, ana-lyzed insurer financial filings for solvency issues, and authored com-mentaries on the financial performance of the life and property and casualty insurance sectors. Prior to the NAIC, she worked as a com-mercial loan officer for U.S. Bank. Ms. Obersteadt has a bachelor’s degree in business administra on and an MBA in finance.

12 Harvey, F., 2015. “Axa to Divest from High-Risk Coal Funds Due to Threat of Climate Change, The Guardian. 13 Jergler, D., 2015. “Insurers Stepping Toward Greater Green Investment Footprint,” Insurance Journal. 14 Morales, A., 2015. “UK’s Aviva to Target $3.9B in Renewable Energy Investments,” Insurance Journal. 15 Associated Press, 2015. “Allianz to Cut Investments in Companies Using Coal in Favor of Renewable Energy,” The Guardian. 16 Munich Re. “Climate Protec on–Leading by Example,” accessed from www.munichre.com/corporate-responsibility/en/management/environment/climate-protec on/index.html. 17 California Department of Insurance, 2016. “California Insurance Commissioner Dave Jones Calls for Insurance Industry Divestment from Coal,” accessed from www.insurance.ca.gov/0400-news/0100-press-releases/2016/statement010-16.cfm. 18 Seth, S., 2016. “Is the Coal Investment Story Over?” Investopedia. 19 Carbon Tracker Ini a ve, 2015. “The $2 Trillion Stranded Assets Danger Zone: How Fossil Fuel Firms Risk Destroying Investor Returns.”


By Reggie Mazyck, NAIC Life Actuary

With a slight twist to the words penned by a 16th century bard, I remind companies illustra ng policies with index-based interest credits to “beware the first of March.” March 1 ushers in the second phase of compliance with Actuarial Guideline XLIX—The Applica on of the Life Illustra ons Mod-el Regula on to Policies with Index-based Interest (AG 49). This ar cle provides a brief overview of AG 49 and serves as a quick reminder for companies that have yet to complete the programming required to comply with Sec on 6 and Sec on 7 of the guideline.

B AG 49 was adopted by the NAIC on Aug. 16, 2015. The guideline provides guidance on the applica on of The Life Insurance Illustra ons Model Regula on (#582) to policies whose benefits are ed to an external index or indices. Be-cause these policies contain features that are not explicitly referenced in the model, companies took broad la tude in the determina on of their illustrated credi ng rates. This resulted in a lack of uniform prac ce in the implementa on of Model #582, such that two illustra ons using the same index and credi ng method could illustrate with credited rates that were significantly different. As might be ex-pected, consumers found the differences difficult to com-prehend. When asked to explain the differences, financial advisors found it challenging to provide acceptable explana-

ons. This led to widespread agreement among regulators, consumer advocates and industry advocacy groups that the issue needed to be addressed. B C AG 49 was developed to bring uniformity to the illustra ons of these policies with benefits ed to external indices. The guideline provides a reasonable cap on the illustrated cred-ited rate and provides the client with more of an “apples to apples” comparison when considering the offering of differ-ent companies. It also limits the credited rate on policy loans such that leveraging of policy loans to enhance illus-tra ons is limited. While AG 49 is primarily for the benefit and protec on of their clients, financial advisers may also benefit from it. The guideline levels the playing field in a manner that facilitates the marke ng efforts to focus on the policy features, com-pany quality and reasonable projec ons of policy values without having to defend the lower, but sensible illustrated credi ng rate of their policy against compe tors’ illustrated credi ng rates that may be a ainable only under the most unlikely scenarios.

E D Sec on 4 and Sec on 5 of AG 49 were effec ve Sept. 1, 2015, for all new business and in force life insurance illustra-

on on policies sold on or a er that date. Sec on 4 uses an average rate generated from the benchmark index account to limit the credi ng rate for the illustrated scale. If the in-surer does not offer a benchmark index account with the illustrated policy, the company is required to use a hypo-the cal, supportable index account that meets the defini-

on of a benchmark index account. Model #582 states that the illustrated scale is not to exceed the company’s disciplined current scale. Sec on 5 limits the earned interest rate for the disciplined current scale to the annual net investment earnings rate on the company’s gen-eral account assets suppor ng the policy. Companies that engage in a hedging program for index-based interest are allowed to use a higher earned interest rate defined in the guideline to recognize the benefit of the hedging program. Sec on 6 of the guideline limits the policy loan leveraging that occurs when a policy is illustrated with rates credited to policy loan balances that are in excess of the policy loan interest charge. AG 49 limits that excess to 100 basis points. The limita on inhibits a company’s ability to enhance illus-trated values while illustra ng the policy owner’s ability to use policy loans as a source of income. Sec on 7 requires the alternate scale be displayed in equal prominence as the illustrated scale and that for each index account the tables suppor ng the calcula on of the credited rate be shown. Due to the complexity of the programming required to make these changes to the policy illustra on, the effec ve date for Sec on 6 and Sec on 7 was deferred un l March 1. That deadline has approached. I end with another quote from Shakespeare, “Be er three hours too soon than a minute too late.”


P T I -B I G N E

A A Reggie Mazyck is a Life Actuary with the NAIC. He advises state regulatory actuaries and other par es regarding issues related to reserving, valua on, nonforfeiture and other actuarial concepts. He works closely with the Life Actuarial (A) Task Force and its sub-groups on the development of principle-based reserving standards, model laws and

actuarial guidelines. He has wri en and contributed to several CIPR publica ons, including the State of the Life Insurance Industry: Implica on of Industry Trends study. Mr. Mazyck is a graduate of the Wharton School of the University of Pennsylvania, where he earned a Bachelor of Science in Economics with a major in Actuarial Science. He is an Associate of the Society of Actuaries and a Mem-ber of the American Academy of Actuaries.


D G : P C P M S

By Jennifer Gardner, NAIC Research and Actuarial Manager This ar cle features an analysis of market concentra on and profitability for several property and casualty lines of business. Insurer profitability results can be used in con-junc on with concentra on sta s cs to determine whether a market is a rac ve to insurers to enter (i.e., thereby cre-a ng greater compe on) or una rac ve (i.e., causing in-surers that are in the market to leave). Persistently high levels of profitability could indicate that a market is failing to a ract compe tors, thus enabling non-compe ve rates of return to be earned. The data referenced in this ar cle was derived from the 2015 Compe on Database Report which contains infor-ma on from the NAIC database and the NAIC 2015 Report on Profitability by Line by State (Profitability Report). The Compe on Database Report provides data for five person-al lines and 10 commercial lines countrywide, as well as by state or territory. The report provides reference measures that serve as a star ng point for studies of compe on and can provide insight when used to make mul -state and mul-

-year comparisons. The report should not be used exclu-sively to determine whether compe on exists in a par cu-lar state or line of business. M C Market concentra on reflects the degree of compe on in a market. There are several methods that exist to examine market concentra on. The Compe on Database Report uses methods contained in the Property and Casualty Com-mercial Rate and Policy Form Model Law (#777) for deter-mining compe on. One method, the concentra on ra o, assesses the market share of the four largest groups in an insurance line. This tradi onal measure of market concen-tra on is o en used as a rough indicator of market compe-

on. While there is no formal way to determine market

compe veness based on this calcula on, values above 50% suggest concentra on at least be given a closer look in judg-ing the overall compe veness of a market. Figure 1 shows the market share of the four largest groups, denoted as a percentage, for medical professional liability, homeowners mul ple peril, financial guaranty and mort-gage guaranty. As illustrated in Figure 1, two of these lines exceeded the 50% concentra on threshold in 2014: finan-cial guaranty and mortgage guaranty. Another widely used measure of compe veness listed in the Compe on Database Report is the Herfindahl-Hirschman Index (HHI). The HHI measures the size of firms in rela on to the industry and indicates the amount of com-pe on among them. It is calculated by summing the squares of the market shares (as a percentage) of all groups in the market. Although there is no precise point at which the HHI indicates a market or industry is concentrated highly enough to restrict compe on, the U.S. Department of Jus-

ce (DOJ) has developed objec ve guidelines with regard to corporate mergers. Under corporate merger guidelines used by the DOJ, a post-merger market with an HHI of less than 1,000 is considered to be a compe ve marketplace; a post-merger market with an HHI between 1,000 and 1,800 is considered to be a mod-erately concentrated marketplace; and a post-merger mar-ket in excess of 1,800 is considered a highly concentrated market. Because these numbers are guidelines, judgment must be used to interpret what informa on is provided for a par cular market by its HHI. Figure 2 illustrates the HHI for these same four lines by wri en premiums. Based on the HHI guidelines, two of the four markets are considered rela vely unconcentrated, and


87.65%

79.36%

41.51%

26.25%

0% 50% 100%

Financial Guaranty

Mortgage Guaranty

Homeowners Multiple Peril

Medical Professional Liability

F 1: M S F L G F 2: HHI B P

313 652

1,729

3,147

0

500

1,000

1,500

2,000

2,500

3,000

3,500

MedicalProfessional

Liability

HomeownersMultiple Peril

MortgageGuaranty

FinancialGuaranty


D G (C )

the DOJ would most likely not challenge a merger that would leave the HHI in that range. Mortgage guaranty is considered moderately concentrated, and financial guaran-ty is considered highly concentrated. P The Compe on Database Report also includes informa on by line by state on premiums wri en, number of sellers (groups), number of entries in the past five years, number of exits in the past five years, market growth over the past 10 years, market shares for risk reten on groups and surplus lines insurers, and a 10-year mean of return on net worth. The return on net worth stated in the Compe on Data-base Report is obtained from the Profitability Report. It is calculated to help regulators and others evaluate the profits earned in a par cular market in rela on to the net worth commi ed to that market. Figure 3 displays the 10-year mean return on net worth for property and casualty lines of business over the period of 2005 to 2014. Figure 4 shows the return on net worth in the property and casualty insurance industry over the past 10 years. Over the period of 2005 to 2014, the property and casualty insurance industry had an average return on net worth of 6.7%. In 2013, several companies experienced an increase in sur-plus as favorable loss development trends, and lower than an cipated claim costs led to reserve releases. Premium growth in many lines, be er accident year results and fewer catastrophic events contributed to surplus growth and high-er profits for the insurance industry in 2013. However, mul-

ple lines of business experienced loss of premium growth in 2014. Premiums wri en for financial guaranty decreased over 20% from 2013 to 2014. Premiums wri en for mort-gage guaranty and medical professional liability also de-creased, although much less substan ally. Losses incurred increased for several lines of business in 2014, leading to a decrease in the return on net worth for the industry to 6.6%, slightly less than the 10-year industry average.

F 3: R N W | 10-Y M

F 4: R R N W P C I

A A

Jennifer Gardner is a manager in the NAIC Research and Actuarial Department. She joined the organiza on in 2011. Ms. Gard-ner conducts economic and sta s cal research for the NAIC and its members. She is responsible for publishing various sta s cal reports including the Report on

Profitability By Line By State and the Compe on Database Report. She provides support for numerous NAIC working groups and assists the state insurance departments in data collec on related to catastrophe. Ms. Gardner earned a bache-lor’s degree in business administra on with an emphasis in finance from the University of Missouri-Kansas City. Prior to joining the NAIC Research and Actuarial Department, Ms. Gard-ner worked on the State Based Systems (SBS) products and services within the NAIC.


IAIS R 2015 G I M R G I M D

The GIMAR notes that in 2015, the global insurance sector func oned well and was stable in the midst of an o en chal-lenging economic and financial environment. Evidence sup-por ng this includes the high capital levels held by insurers, the overall stable profitability shown by the sector and an ongoing inflow of addi onal capital. Partly reflec ng increasing compe on, the insurance pre-miums charged by non-life insurers and reinsurers in the commercial lines, property and catastrophe markets have come under pressure. Compe on is especially strong in the reinsurance market, in part due to an increasing supply of capital from ins tu onal investors, such as pension funds or hedge funds, to support alterna ve reinsurance capacity, including insurance-linked securi es. Driven by the low level of interest rates in most markets, investment yields for insurers over the years have declined, along with those of other financial ins tu ons. However, the margin of investment income versus guaranteed credi ng rates has held up reasonably well. While some interest rates and investment yields began to rise at the end of 2015, in-vestment performance will likely remain under pressure for some me. Noted also is a risk that stock market perfor-mance will be less favorable once interest rates recover, meaning an important pillar of investment returns may fade. S T This year’s GIMAR also focuses on a variety of special topics on regulatory, financial and economic developments and risks. Following is a brief summary of some of these special topics. M&A Ac vity in Insurance–Key Trends and Underlying Mo va ons The insurance industry has experienced a surge of mergers and acquisi ons (M&A), with one es mate on the reinsur-ance side that more than 10% of the global reinsurance indus-try has been involved in major merger ac vity. Among other


By Edward L. Toy, Director, NAIC Capital Markets Bureau Director and Chair of the IAIS Macropruden al Policy and Surveillance Working Group

The Interna onal Associa on of Insurance Supervisors (IAIS) released its 2015 Global Insurance Market Report (GIMAR) on Jan. 10. The annual report discusses the glob-al insurance sector from a supervisory perspec ve, focus-ing on the sector’s performance as well as key risks faced by it. This is the third issue of the GIMAR. The GIMAR assesses developments relevant for the insur-ance industry—including reinsurance companies—and iden fies and documents main risks and vulnerabili es for the industry. It does so to promote awareness of these developments and risks among IAIS members and stake-holders. By providing a financial system-wide assessment of developments and risks, the GIMAR also plays an im-portant role in the IAIS macropruden al policy and sur-veillance framework. Such a global system-wide dimen-sion is an important complement to micropruden al in-surance supervision, which is more focused on the sound-ness of individual financial ins tu ons. The report is wri en by the IAIS Macropruden al Policy and Surveil-lance Working Group. It is neither an official policy paper nor an applica on paper, and it is not intended to reflect the views of the members of the IAIS.1 In a press release announcing the publica on, Dr. Victoria Saporta, chair of the IAIS Execu ve Commi ee, noted, “The IAIS is commi ed to promo ng awareness of devel-opments, risks and vulnerabili es in the insurance indus-try. GIMAR plays an important role in the IAIS’ macropru-den al policy and surveillance framework and our efforts to provide our members and stakeholders with insight into the global insurance marketplace.” The GIMAR is divided into three chapters. As was the case in prior edi ons, the first chapter provides an analysis of the overall macroeconomic and financial environment. Chapter 2 focuses specifically on global insurance market developments, and Chapter 3 focuses on a variety of spe-cial topics on regulatory, financial and economic develop-ments and risks. The special topics include: the liquidity of corporate bond markets and its relevance for life insurers, insurers’ reach for yield and its implica ons for supervi-sors, capacity developments in reinsurance, changes in the insurance-linked securi es market, the impact of Sol-vency II on non-European Economic Area jurisdic ons, and the use of deriva ves by U.S. insurers. This ar cle will provide a summary of key developments in the global insurance market, as well as the special topics included in the GIMAR.

1 Established in 1994, the IAIS represents insurance regulators and supervisors of more than 200 jurisdic ons in nearly 140 countries, cons tu ng 97% of the world's insurance premiums. Its objec ves are to promote effec ve and globally consistent supervision of the insurance industry in order to develop and maintain fair, safe and stable insurance markets for the benefit and protec on of policyholders, as well as to contribute to global financial stability. The IAIS Macropruden al Policy and Sur-veillance Working Group is mandated to develop a macropruden al policy frame-work for considera on by its parent commi ee, including the development of a global macropruden al surveillance framework and assessment of tools to iden fy, assess, monitor and mi gate the adverse consequences of any systemic risk to be used by supervisors, adapted, as required, for their jurisdic ons. The Working Group is also responsible for the Key Insurance Risks and Trends (KIRT) Survey conducted annually and with maintaining the Macropruden al Surveillance Knowledge Portal, where insurance supervisors can find suppor ng materials.


things, M&A ac vity has the poten al to create efficiencies in the provision of insurance, enabling insurers to improve, for example, the kind, price, amount or geographical reach of the coverage supplied. This should benefit consumers. M&A ac vity also has the poten al to improve the financial condi-

on of insurers, providing them, for example, with a stronger capital base or a sounder risk diversifica on horizon. Addi onally, M&A ac vity may introduce a wide and com-plex variety of new risk issues, from market dominance con-cerns to corporate culture fric ons, from overlooked risk-taking considera ons to increased cross-border intricacies. The phenomenon seems to have reached global propor-

ons, involving insurers and intermediaries in developed and emerging economies, with the flow of acquisi ons go-ing in both direc ons. Some key factors driving the M&A ac vity are: the pursuit of cross-border markets, the effect of run-off por olios, the influence of private equity and other investment funds, the need for increasing scale, gaining strength to improve bar-gaining power (on price and on terms), achieving ver cal integra on, more efficient access to capital markets or the sheer fear of being le behind. With specific reference to reinsurance, M&A ac vity can be explained in rela on to developments in the alterna ve cap-ital segment and a perceived need to achieve greater scale. Importantly, key macroeconomic factors like the persis ng environment of low interest rates and low economic growth have oriented insurers to rely less on ”organic” growth ob-jec ves and toward “inorganic” ones like M&A ac vity. There are a number of supervisory considera ons that are affected by M&A ac vity, specifically as related to certain Insurance Core Principles (ICPs). These are authoriza on of mergers and/or acquisi ons (ICP 6), governance of the mer-ger and/or acquisi on (ICP 7), risk management ma ers emerging from mergers and/or acquisi ons (ICP8), and spe-cial supervisory considera ons related to mergers and ac-quisi ons of reinsurers (ICP 13). Corporate Bond Liquidity and Life Insurance Companies The liquidity of corporate bond markets has been a signifi-cant topic of discussion in recent years as market dynamics have changed following the 2008 financial crisis. While di-minished liquidity affects all investors, what is its relevance to insurance companies, especially life insurance companies given their significant holdings of corporate bonds? Life insurance companies are es mated to hold between 20% and 40% of the corporate bonds in the United States (20%), Europe (21%) and Japan (40%).

Recent developments have brought into ques on the role bond dealers have tradi onally performed in providing li-quidity in the corporate bond market. Since these dealers are primarily banks, the bonds they hold are subject to Basel III rules on capital and liquidity. Basel III increased the amount of capital banks must hold against corporate bonds and imposed liquidity rules that may further increase the cost to banks from holding bond inventories. Addi onally, in the U.S. (home of many bond dealers), the so-called “Volcker Rule,” a part of the federal Dodd-Frank Wall Street Reform and Consumer Protec on Act (Dodd-Frank Act), limits dealer banks trading corporate bonds for their own gain (proprietary trading). These reasons may have contrib-uted to the sharp drop in the corporate bond inventories at dealer banks. Smaller inventories at dealer banks may make it more difficult to trade larger posi ons, especially in mes of market vola lity. These developments in the corporate bond market suggest supervisors should re-examine the liquidity of insurers’ asset por olios and how those assets match with the insurer’s liabili es. Cash flow management is also very important. If an insurer is reasonably matched from those perspec ves, there will be li le likelihood it will need to sell assets. If these aspects are not well managed, it is possible the insur-er would have to sell corporate bonds in a hurry, and it may be able to do so only with a large price concession. Reaching for Yield by Insurance Companies With the low interest rate environment, there con nues to be concerns insurers and other investors have been driven into less tradi onal investments, o en referred to as “alterna ve assets,” which tend to be less liquid, and where values may be more vola le and opaque, but offer higher expected returns. This includes lower quality bonds, private equity and hedge funds, commercial real estate mortgages and real estate equi es, and structured securi es. In the U.S., for lower quality bonds, the percentage of total below investment grade bonds cked downward from 2009 un l 2014. On the other hand, within the investment grade uni-verse, the industry’s exposure to BBB-rated bonds has in-creased modestly from 23% of total bonds in 2009 to 26% of total bonds in 2014. For the other asset types, it has been noted that while the U.S. industry has increased its expo-sure in recent years for some assets, such as commercial mortgages and real estate equity, the current levels as a percent of total invested assets are within the range of where the U.S. industry has had exposure in the past. With respect to certain asset classes that have seen signifi-cant growth, as in private equity funds, the total exposure is s ll rela vely insignificant rela ve to overall assets. A Capi-


IAIS R 2015 G I M R (C )



A.M. Best noted that just aggrega ng the capital posi ons of reinsurers was overly simplis c and would overstate the amount of capital available for reinsurance. A.M. Best has compiled an es mate of dedicated global re-insurance capacity, working in conjunc on with Guy Carpen-ter. This es mate is not a simple aggrega on of the share-holders’ equity of all companies that write reinsurance since not all of a company’s capacity is necessarily allocated to its reinsurance business. Most global reinsurers are engaged in business other than reinsurance, such as specialty insurance or other outside interests. At year-end 2014, there was ap-proximately $334 billion of tradi onal capital and $60 billion of convergence capital, including industry loss warran es, collateralized reinsurance and cat bonds. On this basis, A.M. Best es mated marginal growth in tradi onal sector capital as strong earnings were offset by sustained share buybacks and dividends. It is expected that condi ons in the global reinsurance mar-ket will remain compe ve and challenging, as primary companies are expected to con nue retaining more busi-ness and/or seek be er terms and condi ons for sharing their profitable business. Reflec ng on concerns about the impact of ILS on the tradi onal reinsurance market and tra-di onal reinsurers, the NAIC Capital Markets Bureau re-leased a report in September 2014 tled The Development of Capital Market Alterna ves and Its Impact on the Reinsur-ance Industry.2 Areas of Solvency II Which Have an Impact on Non-EEA Jurisdic ons With Solvency II coming into effect, there have been ques-

ons raised about the impact on non-European Economic Area (EEA) jurisdic ons. The European Insurance and Occu-pa onal Pension Authority (EIOPA) was asked to provide some insights. Solvency II recognizes the insurance industry is a fully interna onalised business. To avoid unnecessary duplica on of regula on, the Solvency II Direc ve intro-duced the concept of equivalence. Equivalence decisions are mutually beneficial to EEA (re)insurers and third-country (re)insurers. They promote open interna onal in-surance markets, while simultaneously ensuring policy holders are adequately protected globally. Coopera on between the group supervisor and other relevant supervi-sors takes place within a college of supervisors, which is obligatory for EEA groups under Solvency II. Coopera on in colleges should involve relevant non-EEA supervisory au-thori es, for the purpose of efficient informa on exchange. In prac ce, the colleges for all EEA groups already operate, but some of the aspects of their func oning will change a er implementa on of Solvency II.


tal Markets Special Report was published in July 2015 tled Are US Insurers Reaching for Yield in the Low Inter-

est Rate Environment?, highligh ng recent trends in these various asset classes over the last five years.2 In Europe, there is also evidence of increased risk appe-

te among insurance companies in an a empt to offset low interest rates. The Bank for Interna onal Se lements (BIS) reported in 2015 that the risk profile of European insurance companies’ assets has deteriorated albeit from a conserva ve star ng point. Indeed, in recent years, there has been a shi in the asset re-alloca on from the AAA to BBB ra ng category. The European Central Bank also notes some European insurers appear to be taking on more investment risks, with evidence of por olio shi s toward infrastructure financing, equi es and lower-quality bonds. Changes in the Insurance-Linked Securi es Market The IAIS Macropruden al Policy and Surveillance Working Group held discussions earlier in 2015 on reinsurance. One specific issue was with regards to the impact of insur-ance-linked securi es (ILS) on the tradi onal reinsurance market. It has been noted the ILS market has grown, with recent size es mates at approximately $25 billion. Thus far, the majority of ILS issuance has been for property and casualty risk, and referred to as catastrophe bonds or “cat bonds.” One concern is the rela ve permanence of that capital. The average maturity based on the number of issuances decreased in 2004–2006 as certain issuers found effec ve pricing for smaller deals with maturi es of one and two years. A er 2006, maturi es tended to increase slightly. In 2014 and 2015, the average maturi es increased as issuers con nued to come to market with tenors of three years or more as investors have become comfortable with the asset class. Recent years have seen the growth of dedicat-ed ILS funds, where a significant amount of capital has been contributed by pension funds. The increasing ma-turity length provides issuers—primary insurers as well as reinsurers that use cat bonds to retrocede risk—with pro-tec on against rising premium rates. Investors are binding their capital, which provides some reassurance that alter-na ve capital is here to stay for a longer period of me even in case of a major insured catastrophe event. Dedicated Global Reinsurance Capacity Closely related to the discussions about changes in the ILS market, there have been other concerns expressed about excess capital available for reinsurance and alterna ve forms of risk transfer. In response to queries from the IAIS Macropruden al Policy and Surveillance Working Group,


Deriva ves Use by U.S. Insurance Companies Use of deriva ves use has con nued to grow among U.S. insurers through 2014. While no onal value is o en not the best measure of exposure for deriva ves, it is the most commonly used measure. Based on no onal value, U.S. licensed insurers’ use of deriva ves now exceeds $2 trillion. This is compared with just over $1 trillion at the end of 2010. A more detailed analysis of deriva ves use by U.S. insurers can be found in the August 2015 NAIC Capital Mar-kets Special Report tled Update on the Insurance Indus-try’s Use of Deriva ves and Exposure Trends.2 Con nuing to be noteworthy is that roughly 95% of U.S. insurers use de-riva ves to manage or reduce risk, or hedging. Use of credit default swaps con nues to be rela vely modest within the insurance legal en es, totaling $35 billion in no onal val-ue, of which 47% is bought protec on. Another considera on in recent years is the impact of changes to the deriva ves market, partly as a result of changes in deriva ves regula on. A central component of that is the expected migra on of over-the-counter deriva-

ves to centralized clearinghouses. Many observers agree that the mandated changes to what is referred to by the U.S. Securi es and Exchange Commission (SEC) and the U.S. Commodity Futures Trading Commission (CFTC) as the “swaps market” will increase hedging costs, with some ob-servers predic ng investors will change their hedging prac-

ces in response to the rising cost of swaps. It remains to be seen, however, how significant an impact this will be over the long term. A discussion of these changes was reported in the August 2015 NAIC Capital Markets Special Report tled Developments in the Deriva ves Market with Respect to Hedging Costs and Prac ces in the U.S. Insurance Industry.2 External Investment Managers Over the last few decades, outsourcing has been an increas-ing trend within all financial services industries. From a su-pervisory perspec ve, one of the challenges that is then created is the ability of the supervisor to “reach into” the outsourced provider and obtain informa on, carry out ex-amina ons and ensure that risks are properly mi gated. More specifically, outsourcing of investment management to unaffiliated third par es by insurers has been growing at a significant rate for several years. The benefits to insurers of outsourcing to external invest-ment managers are: 1) asset managers with well-developed infrastructure and resources allow insurers to effec vely implement new strategies and fine-tune tac cal asset allo-ca ons in a shi ing market; 2) small-to medium-sized insur-

ers may access investment opportuni es that are otherwise not available; and 3) outsourcing generally costs less to im-plement compared to the cost of developing the exper se and infrastructure in-house. While the benefits to the insur-er can be significant, the trend has also raised concern among insurance supervisors, especially when viewed in conjunc on with concerns about insurers reaching for yield in the prevailing low interest rate environment. The NAIC Capital Markets Bureau also published a Special Report in May 2015 on this topic tled U.S. Insurance Industry Third-Party Investment Management. S The conclusion of the 2015 GIMAR is that the global insur-ance industry con nued to func on well. Notwithstanding, there are a number of macro trends and forces that repre-sent challenges for the insurance industry and supervisors. Monitoring these issues and addressing them as appropriate with insurance en es will serve to enhance risk-focused regula on.


A A

Edward L. Toy is the Director of the NAIC Capital Markets Bureau. In that capacity, he works with state insurance regulators in the development of tools for oversight of the insurance industry as they relate to invest-ment por olios. He coordinates with other NAIC staff and state insurance regulators on ma ers impac ng financial/solvency regula-

on of insurers and capital markets. Mr. Toy also works closely with representa ves from the insurance industry and trade associa ons on ma ers related to investment prac ces. Prior to this he was a por olio manager and director of trading with Artesian Capital Management, a hedge fund focused on arbitrage opportuni es in corporate credit. Before joining Arte-sian, he was a Managing Director at Teachers Insurance and Annui-ty Associa on (TIAA), which along with its affiliate, the College Re rement Equi es Fund (CREF), was one of the largest financial services organiza ons in the U.S. and the largest re rement system in the world.

2 All of the NAIC Capital Market Special Reports referenced in this ar cle can be found on the Capital Markets Special Reports Archive Index at: www.naic.org/capital_markets_archive_index.htm or visit their webpage at www.naic.org/members_capital_markets_bureau.htm.


© Copyright 2015 Na onal Associa on of Insurance Commissioners, all rights reserved. The Na onal Associa on of Insurance Commissioners (NAIC) is the U.S. standard-se ng and regulatory support organiza on created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best prac ces, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collec ve views of state regulators domes cally and interna onally. NAIC members, together with the central resources of the NAIC, form the na onal system of state-based insurance regula on in the U.S. For more informa on, visit www.naic.org. The views expressed in this publica on do not necessarily represent the views of NAIC, its officers or members. All informa on con-tained in this document is obtained from sources believed by the NAIC to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such informa on is provided “as is” without warranty of any kind. NO WARRANTY IS MADE, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICU-LAR PURPOSE OF ANY OPINION OR INFORMATION GIVEN OR MADE IN THIS PUBLICATION. This publica on is provided solely to subscribers and then solely in connec on with and in furtherance of the regulatory purposes and objec ves of the NAIC and state insurance regula on. Data or informa on discussed or shown may be confiden al and or proprietary. Further distribu on of this publica on by the recipient to anyone is strictly prohibited. Anyone desiring to become a subscriber should contact the Center for Insurance Policy and Research Department directly.

NAIC Central Office Center for Insurance Policy and Research 1100 Walnut Street, Suite 1500 Kansas City, MO 64106-2197 Phone: 816-842-3600 Fax: 816-783-8175

http://www.naic.org http://cipr.naic.org To subscribe to the CIPR mailing list, please email [email protected] or [email protected]

CIPR Newsletter March 2016 a · Solvency Assessment Model Act (#505) and most of the adop ng states...

Documents

Transcript of CIPR Newsletter March 2016 a · Solvency Assessment Model Act (#505) and most of the adop ng states...