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Regulation and Compliance > State Regulation

Captives, SPV subgroup draft recommends fixes to system

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In a white paper draft exposed today, the NAIC Captive & SPV (special purpose vehicle) Use Subgroup called for enhancement of the current regulatory process so that regulators can actually see the captive transactions of commercial insurers, and changes to rein in, or at least better view, the practice by some insurers to offload perceived excess reserves to free up capital. It also suggested beefing up the state accreditation requirements to include a key model law, the Special Purpose Reinsurance Vehicles (SPRVs) model act.

Some industry regulators and participants called the dealings of commercial insurers stowing excess reserves in captives and SPVs opaque, for one, and possibly damaging to the solvency of the company and creating a race to the bottom, as one mutual life insurance executive described it.

To that end, the NAIC subgroup recommended enhanced disclosure in ceding company statements on the impact of these transactions to the financial position of the insurers so regulators can peer into what is actually being ceded. Insurance companies worry that this would also allow competitors to peer in to their finances and strategies.

New York regulators say the transactions are so spotty that they do not know what is going on — there is no consistency in disclosure and they cannot keep a handle on what their own domestics, which number almost 80, are up to in other states. 

The subgroup said that commercial insurer-owned captives and SPVs should not be used to avoid statutory accounting, as has been suspected by some state regulators. 

The subgroup offered several other recommendations to the parent committee, the NAIC Financial Condition Committee, today. 

The Captives Subgroup recommended examining the use of conditional letters of credit (LOC) or parental guarantees, and whether they even meet the requirements of real credit for reinsurance under NAIC model laws or even state solvency requirements.

One recommendation is the formation of a separate subgroup to develop possible solutions for addressing any remaining Triple X (XXX) and A-Triple X (AXXX) reserve redundancies.

Triple X regulations are NAIC-generated regulations that determine how many reserves life insurance companies must keep for benefits. Some say the high reserve requirements slow down the company by stockpiling too much money that could be used as capital to deploy for growth opportunities. This is especially felt by stock life insurers who must show quarterly earnings statements and report to shareholders. 

Because of the resolution of Actuarial Guideline 38 (AG 38), there should be no more creation of new captives and SPVs, the subgroup said. If there are, the NAIC could, in specific circumstances, consider changes to statutory accounting to eliminate the need for these separate transactions, the subgroup said. However, Robert Easton, the top insurance deputy from the New York Department of Financial Services (DFS) yesterday noted to a federal advisory panel at the Federal Insurance Office that his domestics have intimated they would not stop using captives, even with the advent of PBR. He is worried that the transactions are being framed as reinsurance transactions when they are not.

The subgroup determined that the vast majority use of captives and SPVs by commercial insurers was related to the financing of XXX and AXXX reserve redundancies. 

“The implementation of principle-based reserving (PBR) and AG 38 could reduce the need for commercial insurers to create new captives and SPVs to address perceived reserve redundancies; but, existing captives and SPVs that are not addressed by the guidance in AG 38 are likely to remain in existence for several years or decades, until the existing blocks of business are run-off,” the report summarized.

The subgroup also recommended that the NAIC study the issue of confidentiality related to commercially owned captives and SPVs more closely. More specifically, it may be appropriate to consider the type of information that should, and should not, be held confidential, the subgroup said.

It also recommended the use of access to alternate markets — these are acting as solutions designed to shift risk to the capital markets or provide alternative forms of business financing. The NAIC might have to consider updating a model law reflecting alternative market solutions acceptable to state insurance regulators to ensure there is a uniform framework for the implementation of alternative market solutions. The NAIC should further encourage the states to adopt Model #789 on SPRVs, and should consider making the model an accreditation standard.

According to the states that responded to the request for comment, 26 states indicated that their respective state’s laws define captives and nine states indicated that their state’s laws do not define captives – the NAIC is defining captives in the white paper and noted that a majority of captives are formed as pure captives — an insurer that only insures the risk of the company’s affiliates and controlled businesses. The paper is exposed for comments for 45 days, due April 22.

Meanwhile, the Federal Insurance Office (FIO) deployed its advisory committee on insurance (FACI) to spearhead and effort to look into the use of captives, headed by a very active member of the NAIC nationally and internationally, Washington, D.C. Commissioner William White. It is unclear what further information Treasury wants to investigate or further actions it might recommend, but FIO Director Michael McRaith made it clear Wednesday at the meeting that no less than the “U.S. Treasury” wants to know about what is going on with the use of captives to stow away reserves and loosen up balance sheets in the commercial life industry during a meeting yesterday of FACI in Washington.

FIO has staff that actively monitors NAIC meetings and pick up on key issues of contention affecting solvency and/or consumers, such as use of captives, contingent deferred annuities, and claims handling.

See: Reserving emerges as key fed-state issue

The NAIC subgroup also has its eye on international implications and possibly enhancing the U.S. framework for regulating captives to win more favorable reviews from international bodies, specifically the International Association of Insurance Supervisors (IAIS) and the IMF/World Bank’s financial sector assessment program (FSAP), an in-depth review of U.S. financial sector. State regulators apparently received high marks on this assessment in 2010.

The Subgroup also recommended the development of guidance in the Financial Analysis Handbook for states’ review and on-going analysis of transactions involving captives and SPVs, including specific considerations of such transactions when performing holding company analysis. The guidance should be developed for perspectives of the ceding state, the captive state and the lead state.

Life insurers are reviewing the white paper. Insurers are very interested in the scrutiny of regulators and have expressed concern, as they use captive and SPVs.


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