March 17, 2015 Washington Wire

NAIC Announces New Scrutiny On Captives

WASHINGTON – The National Association of Insurance Commissioners (NAIC) said that it is “now turning its sights” to the use of captives by insurers in their variable annuity (VA) businesses.

An NAIC spokesman said the issue will be taken up at the group’s spring meeting later this month in Phoenix.

The issue will be discussed at the meeting by the NAIC Financial Condition Committee. It is headed by Joseph Torti III, superintendent of the Rhode Island Department of Insurance and Banking.

This follows a report last fall by economists at the Federal Reserve Bank of Boston, which voiced concern about increased use of contingent assets to back captive reserves since the economic crisis in 2009, especially the top five issuers of VAs with guarantees.

In addition to the Fed, the Treasury Department and the Financial Stability Oversight Council also have voiced concern about use of captives by insurers.

The Boston Fed report found that in the aftermath of the financial crisis, large VA issuers, particularly the top five issuers, increasingly turned to captives to finance their risk.

VA risk exposure is growing and is more concentrated, particularly among the top five VA life insurers, the report said.

From 2009 to 2012, total reserves transferred to captives increased from $10.8 billion to $25.8 billion, or 139 percent, according to the report. The report said that an increased portion of these reserves is supported by lower quality assets in captives.

The report added that, on a statutory basis, the financial strength of the top 10 VA life insurers using captives appears to have weakened, despite the growth in reserves and high reported risk-based capital (RBC) ratios.

“This is demonstrated by: modest and stagnant statutory capital levels, increased reserve leverage, and increased use of contingent assets backing captive reserves since 2009,” the report said.

The report added that, without the RBC benefit derived from captive transfers, an estimated $14.4 billion to $34.9 billion of additional statutory capital would be required of the top 10 VA life insurers transferring VA risk to captives.

“Different regulatory requirements present captives with the opportunity to finance portions of their reserves with contingent assets, such as letters of credit (LOCs),” the report said. While not all reserve transfers are supported by LOCs, their use is increasing, the report said.

However, new captive financing rules that took effect in January bars the use of LOCs, including clean and unconditional letters of credit.

However, those guidelines apply only to a specific set (XXX/AXXX) of captives used by the life insurance industry, level premium term life insurance policies and reserves required for universal life insurance policies sold with secondary guarantees.

The NAIC spokesman said that the group now is turning to the use of captives related to VAs and long-term care insurance after dealing with the captive reinsurance component of life insurance industry products.

Most of the work on captive reinsurance transactions “has already occurred and is implemented,” the spokesman said.

“We are now finalizing the last portions of our framework project by completing risk-based capital (RBC) and disclosure requirements and then moving the provisions of AG48 into a XXX/AXXX Reinsurance Model Regulation,” the NAIC spokesman said. He noted that work on this item has just begun.

InsuranceNewsNet Washington Bureau Chief Arthur D. Postal has covered regulatory and legislative issues for more than 30 years. He can be reached at [email protected].