US insurers are ‘suffering’ because while the industry is aware of the regulatory burden it faces, uncertainty over the rules both domestically and internationally means it is difficult for providers to plan for growth and structure their offerings, according to research conducted by Life Insurance International.
US insurers have recently been confronted with multiple regulatory reforms including the Dodd-Frank Wall Street Reform and Consumer Protection Act, the solvency modernisation initiative and Solvency II.
“Regulatory anticipation fatigue is a description of the insurance industry’s current reaction to regulatory reform,” Deloitte’s 2012 Global Insurance Outlook says.
“The industry is aware of the impending burden of new regulations, but unable to prepare definitively for what is often no more than the ghost of regulations yet to come.”
Since the McCarran-Ferguson Act of 1945, each of the 50 states, Washington DC and the five US territories have been responsible for regulating insurers domiciled in their jurisdiction.
McCarran-Ferguson bars the US government from overruling state insurance regulations. All state regulators belong to the National Association of Insurance Commissioners (NAIC), which establishes regulatory standards, but lacks enforcement powers.
Sam Stuckal, research director at CEB TowerGroup’s insurance practice says: “Although individual states have varying regulations, the NAIC tries to ensure individual state rules are not impediments to doing business.”
“State regulators conduct on-site exams a minimum of every three to five years,” says NAIC CEO Therese Vaughan.
“They also conduct off-site reviews. Insurers provide regulators with comprehensive financial data
every quarter, including information by line of business and on their investment portfolios.”
The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange
Commission (SEC) have jurisdiction over insurance products that are registered investment
vehicles, such as variable annuities and variable life products.
“The SEC doesn’t directly regulate insurers, but insurers are affected by how it regulates the securities markets,” says Stuckal. “FINRA regulates and licenses brokers and dealers who sell investment-based insurance products.”
Created following the 2008-2009 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act passed into law in 2010. While primarily intended to regulate the banking industry, it has implications for insurers.
Firstly, Dodd-Frank created the Federal Insurance Office (FIO). “Dodd-Frank didn’t weaken state insurance regulators’ power,” says Howard Mills, director and chief advisor of Deloitte’s insurance industry group. “State regulators remain the primary regulators for solvency, market conduct and customer sales.
The FIO’s director Michael McRaith says the FIO isn’t a regulator.”
The FIO has caused uncertainty among insurers, as it’s unclear what the agency’s role is. “The FIO has a broad mandate, but limited enforcement powers,” says Mills.
Dodd-Frank mandates the FIO to become the US voice in international regulatory affairs. “It’s authorised to speak for the NAIC and state regulators abroad and sign regulatory treaties with other countries,” says Mills.
“But it doesn’t have power of coercion over individual state regulators.” Dodd-Frank created the Financial Stability Oversight Council (FSOC), which can determine which banks, insurers and asset managers are systemically important financial institutions (SIFIs) – and commonly referred to as “too big to fail”.
“For the first time, through Dodd-Frank, the US government has the power to deem insurers are SIFIs,” says Thomas Sullivan, a partner in PwC’s Financial Services Regulatory Practice.
“Although the US insurance industry is united in saying that insurers should not be designated as SIFIs, the expectation is that, for political reasons, several big insurers will be,” says Mills.
“The concern is SIFI designation will add extra regulatory hoops for insurers deemed to be SIFIs and disadvantage them competitively,” says Stuckal.
In May, the International Association of Insurance Supervisors (IAIS) proposed a methodology for identifying global systemically important insurers (G-SIIs).
Moody’s Investor Service senior credit officer Laura Bazer said: “Although we expect very few insurers to go on G-SII lists, greater regulatory coordination and monitoring of large, higher-risk international insurance groups would be credit-positive for the global insurance industry.”
She expects Prudential Life, AIG and MetLife to be designated as G-SIIs and SIFIs.
Mills says if an insurer owns a bank the state of the insurer’s domicile is its primary regulator, but, through Dodd-Frank, it also comes under the Federal Reserve’s scope.
MetLife plans to sell its bank holding company to avoid coming under Federal Reserve supervision. “It’s because we don’t believe our insurance business should be governed by regulations written for banks that we have decided to sell our depository business,”
William Wheeler, president of MetLife’s Americas division, told the House of Representatives’ Financial Institutions and Consumer Credit Subcommittee in May.
Dodd-Frank gave the FIO a January 2012 deadline to submit a report to Congress about the effectiveness of the state regulatory systems.
However, the report has been delayed. “I suspect the report won’t be published until after the 2012 presidential election, as it will be controversial,” says Stephen Applebaum, a senior analyst for property and casualty insurance at Aite Group.
“FIO director McRaith will probably try to align US regulations with Solvency II to make it easier for US insurers to do business overseas.
He’ll also press for insurers to have the option of being regulated at the state level or federally.”
Being regulated solely at the federal level would be popular with insurers doing business throughout the 50 states, says Applebaum.
The vast majority of the property and casualty insurance market share is held by carriers that operate nationwide, he notes.
Mills say that under Dodd-Frank the FIO has the power to require data from insurers about their sales and customers’ geographical distribution.
“This is so the FIO can establish if there are areas of the US where consumers are underserved or people are over-paying for insurance,” he says.
Although the FIO has yet to issue data requests, the insurance industry is concerned. “Insurers don’t have the infrastructure to comply with such requests, as they are challenged by legacy systems resulting from decades of acquisitions,” says Mills.
The problem is that, not only do state regulators have the power to request data from insurers, but Dodd-Frank also created an entity called the Office of Financial Research (OFR).
The OFR has the right to request data from any financial institution. “Insurers are concerned it will be expensive to comply with data requests from the FIO, the OFR and state regulators,” says Mills.
“They’re worried about the privacy of the data supplied to the FIO and OFR. Insurers have agreements with state regulators to protect proprietary data they supply, so it’s not disclosed to competitors.”
In response to the European Union’s Solvency II reforms, the NAIC has created the solvency
modernization initiative (SMI).
“The SMI’s purpose is to incorporate the best practices of all the insurance solvency regulatory regimes around the world,” says James Wrynn, a partner at US law firm Goldberg Segalla.
The initiative focuses on issues such as capital requirements, governance and risk management, group supervision, statutory accounting/financial reporting and reinsurance.
Wrynn says: “Every day the decision to grant the US Solvency II equivalence is delayed, the industry suffers. Insurers and reinsurers are left with uncertainty as to how to plan their growth and structure their offerings.”
For two decades, risk-based capital (RBC) has been a core part of state regulators’ solvency
The NAIC says RBC will remain a component within US solvency regulations to maintain a floor for triggering regulatory intervention. RBC involves weighing the various risk factors faced by an insurer.
The SMI proposes revisiting the calculations for life insurance RBC with a particular focus on asset risk charges.
The initial life insurance RBC formula was implemented in 1993, and this formula has undergone several revisions since then, including the introduction of scenario modelling.
“State regulators require life insurers to do annual asset adequacy analyses, which involve stress-testing their future cashflows,” says Vaughan.
“One scenario requires them to assume a permanent 3% drop in yields and calculate how this affects their cashflows.
In 2010, US life insurers posted an extra $6.5bn to their technical provisions as a result of these stress tests.”
Within SMI, the NAIC wants life insurers to move to principle-based technical provisioning where the insurer’s policy liabilities more accurately reflect all risks.
“We hope to finalise the life insurance principle- based methodology by the end of 2012,”
says Vaughan. “Non-life insurers have historically used principle-based reserving.”
“Principle-based reserving is important in life insurance where calculations are based on
mortality rates,” says Stuckal.
“If mortality rates differ from state to state, insurers should reflect this when entering data into models.”
SMI contains a requirement for US insurers to file Own Risk and Solvency Assessments (ORSAs) of the risks threatening their solvency to their state regulators. Solvency II also includes a requirement for insurers to file ORSAs.
“From 2014, every state regulator will require insurers to file ORSA-based self-assessments,” says Stuckal.
“There’s been a growing trend towards enterprise risk management (ERM) among US insurers, which will help them adapt to ORSA, as ORSA is similar to ERM.”
Another factor helping US insurers comply with emerging solvency regulations is the Sarbanes-Oxley Act (SOX) of 2002. SOX requires US publicly-quoted companies to ensure the accuracy and transparency of information they give investors.
“SOX forced insurers to tighten controls on all the underlying processes, such as accounting
and policy systems and software development, that support the information provided
to investors,” says Stuckal.
Solvency II includes the concept of equivalence, which establishes regulatory characteristics non-EU countries must implement for their capital standards to be deemed “equivalent” to Solvency II.
Where a decision on full equivalence cannot be supported, the EU allows for a five-year temporary equivalence, with the possibility of extension for a further year.
There is a strong feeling in the US insurance industry that, because US insurers weathered the 2008-2009 crisis, the US does not need to substantially upgrade its solvency regulations to achieve equivalence.
“US regulators and the European Insurance and Occupational Pensions Authority are having good discussions to better understand each other’s regulations,” says Vaughan.
“While the US won’t seek equivalence status, I’m confident we’ll see a resolution allowing
US and European insurers to do business in each other’s jurisdictions.”
“US insurers and regulators have a good story to tell about how they survived the 2008-2009 crisis,” says Chuck Johnston, director for Americas Life/Annuity and group practice at Celent.
“The expectation is that the US will be granted provisional equivalency status for Solvency II. As the US is the world’s largest insurance market, it’s hard to see that the US wouldn’t get equivalency status.”
In June 2012, the Supreme Court upheld the constitutionality of the Patient Protection and Affordable Care Act of 2010.
The Act mandates that, from January 2014, all Americans not covered by employers’ health insurance programmes or by government- provided schemes must buy private health insurance, or pay a fine.
Insurers won’t be able to bar applicants based on pre-existing conditions. Individuals will be able to buy health insurance direct from insurers or from the health insurance exchange in their state.
The exchanges, which take effect in 2014, will act as pools of health insurers providing coverage eligible for federal subsidies to people on low incomes.
Already in effect is a clause which says that, in the case of large group health insurers, 85%
of premium revenue must be spent on paying for medical services and 15% on expenses.
For small group and individual health insurers, 80% must be spent on paying for medical services and 20% on expenses.
If insurers’ expenses exceed these thresholds, they are required to pay rebates to their policyholders.
Despite the Act, US health insurers are still regulated at the state level.
In September 2011, a rule within the Act came into effect stipulating that health insurers wanting to raise their rates by 10% or more must submit a request to state or federal reviewers who will determine whether the request is reasonable.
However, the federal Department of Health and Human Services says states still have the primary responsibility for reviewing insurance rates.