State regulatory discussion of captives and special purpose vehicles (SPVs) may be heading toward a focus on life insurance solvency and a referendum on long-held statutory accounting practices (SAP), according to a panel today on an NAIC subgroup white paper.

The discussion also revealed divisions between the captive–friendly regulators and those that think their heavy use reveals an underlying solvency problem—when the group met at the NAIC National Meeting in National Harbor, Md., November 29.

However, the subgroup will soften its portrayal of captives in the next draft of its white paper, according to the subgroup’s chair, Doug Slape of Texas.

Some state regulators are concerned about the way captives are being used to avoid the burden of reserve redundancies and free up much-needed capital while some are concerned about how captives are being portrayed.

“This has become a commentary on captives rather than a problem we are trying to address,” Rhode Island Insurance and Banking Superintendent Joe Torti III said.

Despite pushback from fellow regulators on the portrayal of captives, which Torti bristled at, he remained firm that he would continue to study the underlying issue.

“I am not going away. This is a solvency issue,” said Torti, who chairs the NAIC’s Financial Condition Committee, under which the subgroup operates, but is a nonvoting member of the subgroup.

The Captive and SPV Use Subgroup has decided to remove  the “shadow industry“ allusion from the draft white paper, but Torti says the growing use of captives to reinsure or securitize excess reserves makes solvency monitoring more difficult.

Companies are using these to avoid certain statutory accounting tenents…thinking of creative solutions on how to work their way around problems, Torti said.

“You might as well not have statutory accounting if you can do whatever you want to,” Torti said. Ceding billions of dollars in reserves, as is being done, is not a permitted practice of statutory accounting, according to Torti.

Torti goaded the representative from the captive-rich state of Delaware, Steve Kinion, who serves as director of the Bureau of Captive and Financial Insurance Products for the Delaware Insurance Department, by asking if was a member of the NAIC.

“We are the NAIC—there is concern that the NAIC is going to do something to the captive industry. I have been here 27 years but I don’t think we have done anything foolish to intentionally harm the captive industry. Delaware is part of this NAIC and I just resent the fact that somehow we are going to do something harmful to the captive industry when 40 states have a captive industry—including Rhode Island. There is no history of the NAIC or any state doing anything harmful to the captives,” Torti argued.

Delware’s Kinion had come before the subgroup worried about the affect on some businesses the NAIC subgroup might be having with companies worried about a perceived threat from the NAIC, if competitors could use their captive standing against them, it could become a monetary issue for them if certain insurers are demonized.

Kinion replied that Delaware is indeed a member of the NAIC, but as a member of the NAIC, “it is important to give different view points.”

“I do not see this as an attack on captives. It is not. I have been involved in captives longer than anyone in this room,” noted Washington Insurance, Securities and Banking Commissioner William P. White, who held Kinion’s job in Delaware previously and has a thriving captive industry under his regulation in Washington.

Torti asked how does one work in a uniform solvency system under these rules and acknowledged there was a problem with a formulaic approach creating an excess of reserves.

“This is a very, very serious solvency issue,” White said, not, he said, a captives issue.

“I think we need to focus on that rather than see it as an attack—we need to look more closely at safeguarding our solvency framework,” White said. He also emphasized consistency over uniformity in the U.S. solvency system, as has been in the conversation on the international supervisory front in which he is deeply involved. “This is not about captives—this is about alternative risk transfer market.”

“[It points to] point to some of the issue we already have. This is much bigger than just the captives,” White said.

This statutory accounting stress is supposed to be addressed by principles-based reserving but commissioners on the panel acknowledged that it would be awhile before PBR is actually in effect.

Thus, in comments afterwards, Slape reframed the debate.

“The fundamental question is–-is SAP something we want or not?”  http://publish.lifehealthpro.com/vendor/tinymce/jscripts/tiny_mce/themes/advanced/img/trans.gif

Slape mentioned GAAP accounting and International Financial Reporting Standards (IFRS) as alternatives if statutory accounting is creating the pressure to send reserves to captives and to be backed by conditional letters of credit (LOC) The LOC situation shows that some ultimately accept GAAP accounting, he said.

Slape said the review of SAP should be done at the Executive Committee level or at least among the commissioners on a higher level. He is not sure where the captives/solvency/reserving issue is headed, whether a new group might form under the parent Financial Condition Committee, or whether there might be a joint parent working group as there was for AG 38, and as some in the industry have asked. 

Some XXX and AXXX transactions may not have met the requirements under the credit for reinsurance models in instances where conditional letters of credit were accepted as collateral that define the order of a draw down on the LOC (i.e., the arrangement requires that other available collateral be exhausted before the LOC can be drawn upon), which are not otherwise permitted, the draft white paper states.

Conditional LOCs proliferated after the financial meltdown as strict LOCs became harder to get at a time when insurers needed more capital. Now, analyzed data in research done by SNL Financial’s editorial team show major insurers such as MetLife and AIG are offloading vast sums into captives to free up coveted capital.

The white paper asks whether the accounting and reporting for captives should differ from commercial insurers if the business that is being transacted within the captive or SPV is the assumption of insurance risk from an affiliated commercial insurer. The question arose since the concern is that such transactions are being done to provide relief from statutory accounting, the draft paper states.

Results of the regulator-only request for comment suggest that the vast majority of the transactions that are occurring are from a commercial insurer and a captive insurer or SPV are a means of dealing with perceived reserve redundancies while reserving the NAICs Valuation of Life Insurance Policies Model Regulation (commonly referred to as Regulation XXX, or AXXX for short.)

The reserves that the company has determined to be redundant are secured by a letter of credit LOC to the benefit of the ceding company. So far, for most of the transactions reviewed, usually XXX and AXXX transactions pass muster, according to regulators.

Virtually all of the regulators that have been involved in these types of transactions have indicated that they review such proposed transactions in detail to ascertain at a minimum that the transaction does in fact match its intent, the draft paper stated. Most states also determine and require that the transaction meets the credit for reinsurance requirements.

However, the question that has been raised by some regulators is whether a more appropriate treatment of such transactions would be to deal with the accounting for this transaction within the ceding company, thereby eliminating the need for the separate transaction outside of the commercial insurer.