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Next Steps: The National Association of Insurance Commissioners is engaged in ongoing efforts to develop capital standards for U.S. insurance groups comparable to its European counterpart's and other international capital requirements.

How much capital and surplus should insurance companies be required to hold? The answer to that question can tell us a lot about the trajectory of insurance regulation in the U.S. and its increasing interplay with regulation in the rest of the world. As we enter a post-pandemic regulatory environment, capital will continue to be a focal point for industry and regulators alike.

Capital is understood as a kind of "shock absorber" for any business, but particularly for a financial activity such as insurance that relies on solvency to make good in the future on past promises. Capital is intended, very generally, to bear the losses that may occur in excess of posted reserves. These losses may arise from excess claims on policies, volatility in investment markets or other loss contingencies. COVID-19 has been an unwelcome reminder of the critical importance of capital adequacy in insurance.

In the U.S. insurance ecosystem, we can identify two key axes of regulatory focus--state versus federal regulation and entity-level versus group-level supervision. Historically the amount of capital that an insurer needs to hold has been subject mainly to entity-level oversight, conducted (like almost all insurance regulation) at the state level. In recent years, there has been strong movement along one of those two axes, as group-level regulation has become more rigorous. However, movement along the other axis--state versus federal--has been more episodic, with the states holding the line against a more consequential federal role in insurance.

Entity vs. Group Oversight

In the realm of entity-level versus group-level oversight, since the 1990s U.S. insurers have been subject principally to the Risk-Based Capital, or RBC, framework developed by the National Association of Insurance Commissioners (NAIC). This framework, which is codified by NAIC model laws enacted in every state, requires each insurer to determine a customized level of required capital based on its particular risks. The determination is made using a prescribed set of calculations. The measured risks include (depending on line of business) asset risk, insurance product risk, interest rate risk, premium, reserves and business risk. The insurer then computes its actual amount of surplus ("total adjusted capital" or TAC), yielding a ratio of TAC to the benchmark required level. If TAC is below certain defined multiples of the ratio, indicating inadequate capital levels, the insurer can be subject to remedial measures and even receivership.

The 2008 financial crisis highlighted concerns over enterprise risk--the perception that risks in an insurer's affiliated businesses can adversely affect the insurer itself, even though the insurer may have sufficient capital as measured on an entity-level basis. Thus the NAIC took steps to enhance visibility into insurers' financial conditions and resources beyond the statutory entity. These steps, taken over the 2010-2012 period, included both amending the model holding company act (which regulates corporate control over insurers) to require reporting at the group, and not just insurer, level (i.e., enterprise risk reporting), and adopting the Risk Management and Own Risk and Solvency Assessment model act, which requires insurers to measure their capital adequacy at the group level. While not primarily quantitative in nature, these steps marked a meaningful foray into group supervision.

As international efforts ramped up during this time to heighten a focus on insurance groups (e.g., ComFrame from the International Association of Insurance Supervisors, or IAIS, and the European Union's Solvency II), the NAIC followed suit in 2015 with a conceptual framework for a group capital calculation, or GCC, based on the so-called RBC aggregation approach, which came to be known as the "aggregation method." The aggregation method analysis would look at an insurer and its entire group of affiliated companies--both insurer and noninsurer--and tally up the relevant capital ratio at each in turn. This aggregated capital, after making adjustments to eliminate duplication, would yield a capital ratio for the group as a whole.

State vs. Federal

On the other axis of focus--state versus federal--a parallel effort of sorts was being undertaken in the post-crisis period to impose a greater federal stamp on the regulation of some key insurers. The landmark Dodd-Frank legislation of 2010 had empowered the Federal government to designate non-banks, including insurers, as systemically important financial institutions, or SIFIs, and to regulate their group capital levels. Dodd-Frank also imposed new, groupwide capital standards on holding companies of depository institutions, even where those holding companies were themselves insurers that were included in the so-called Collins Amendment to Dodd-Frank, named after its author, Sen. Susan Collins (R-Maine). The Federal Reserve embarked on efforts to develop detailed capital requirements for these institutions now in its remit (or which might be designated in the future as SIFIs). For a time in the mid-2010s, it seemed as though capital standards for a number of prominent insurers might become significantly more group-oriented and significantly more federally imposed--like those applicable to bank holding companies under Basel III.

However, the state regulatory system proved durable and encouraged an alignment of industry participants, state regulators and Federal elected officials of both parties. Industry and regulators decried Basel-like, "bank-centric" capital measures that they feared might emerge from the Fed, adducing the key differences between banks and insurers. Over time, the three insurers that had initially been designated as SIFIs shed their designation, either as a result of litigation or administrative action. The Collins Amendment was itself amended in 2014 on a bipartisan basis to clarify that the capital standards for an insurance SIFI or for a holding company of a depository institution, where the holding company was itself an insurer, need not be GAAP-based. This represented a significant accommodation to state insurance regulation. In 2019, taking its cue from this Collins "fix," the Fed proposed a detailed "building block approach" for setting capital requirements for these groups that expressly incorporated state RBC standards in the case of statutory insurance entities. State regulation had again showed its resilience.

Group-Based Standards

Contrast that with the movement toward group-based standards. Since embarking on the group capital calculation, the NAIC has received detailed feedback from industry and observers on how the tool should be constructed and deployed. Trade groups urged the NAIC to consider factors such as differentiating between insurance and noninsurance entities, minimizing the need to adjust existing capital regimes such as RBC, neutralizing differences that might arise from corporate structure and developing "scalars" to produce apples-to-apples comparisons between entities.

These efforts reached critical mass in mid-2019 with the beginning of field testing. The NAIC Fall 2019 National Meeting took place in Austin in December against the backdrop of the IAIS's passage in November of ICS 2.0, a comprehensive capital standard for internationally active insurance groups, or IAIGs. The IAIS launched a five-year monitoring period for ICS 2.0, after which the standard could become prescribed, i.e., could be a predicate for supervisory action. (This five-year period is subject to adjustment due to the global pandemic.) In adopting the new standard, the IAIS announced that it would seek to assess, by the end of the monitoring period, whether the aggregation method being developed in the U.S. provides "comparable outcomes" to ICS 2.0.

In other words, the IAIS is seeking a U.S. group capital standard that has equivalency with the IAIS's own yardstick. At that December meeting, the NAIC described the group capital calculation as the way in which ICS 2.0 will be implemented in the U.S. But the NAIC emphasized that a "jurisdictionally agnostic" aggregation method, and not necessarily the group capital calculation itself, will be the standard ultimately submitted by "Team USA" (the NAIC, the Fed, the U.S. Treasury's Federal Insurance Office and state insurance regulators) to the IAIS for "comparable outcome" purposes.

Some in the industry perceive from this nuance that Team USA's aggregation method will not necessarily be identical to or co-extensive with the group capital calculation that has been in development for five years. This could include the degree to which the group capital standard will be more than just an "early warning" tool as the NAIC has historically indicated.

The spring national NAIC meeting had been scheduled for March 2020 but was canceled due to the pandemic. As of this writing, over the spring and early summer the NAIC's GCC working group has exposed for public comment (i) draft amendments to the insurance holding company act implementing a GCC requirement as well as (ii) a GCC template and related instructions. Conference calls to discuss these materials and take next steps were scheduled for later July and also at the NAIC's Summer 2020 National Meeting (virtual format, July 28 to Aug. 14).

The move to more group-oriented capital supervision, in some format, seems inevitable. Since the pandemic could raise new issues of identifying and measuring risk, the questions of "how much capital--and where in the structure" seem as timely as ever.

by Dan Rabinowitz

Contributor Dan Rabinowitz is partner and chair of the Insurance Transactional Practice at Kramer Levin Naftalis & Frankel LLP. He can be reached at

Key Points

The Situation: U.S. insurers have to meet rigorous state regulations regarding the amount of capital they must hold.

An International Influence: The International Association of Insurance Supervisors is awaiting a U.S. group capital standard that is intended to produce "comparable outcomes" to those produced by the IAIS's own capital measurement yardstick.

Waiting for the Answer: A "jurisdictionally agnostic" aggregation method, related but not necessarily identical to the emerging group capital calculation, will be the standard ultimately submitted by the NAIC, the Fed, the Federal Insurance Office and state insurance regulators to the IAIS for "comparable outcome" purposes. The NAIC's deliberations on this, and consultations with industry, are ongoing.
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Title Annotation:Regulation
Author:Rabinowitz, Dan
Publication:Best's Review
Date:Aug 1, 2020
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