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Leonardi critical of FIO's new captives task force

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Connecticut’s insurance commissioner is contending that the Federal Insurance Office (FIO) might be unnecessarily overlapping state turf through its examination of use of captives and special purpose vehicles (SPVs) to finance perceived excess reserves.

Concern that FIO might be duplicating state regulatory efforts in an area of mutual concern was underscored by Connecticut Commissioner Tom Leonardi in a meeting and in remarks to a reporter last week.

Examination of issues involving the use of captives and SPVs to finance perceived redundant reserves set certain life insurance contracts should continue to be led by state regulators, Leonardi said in a phone interview March 15.

The issue has caught the attention of FIO staff, and ultimately the director, Michael McRaith. 

Leonardi’s public suggestion during a Federal Advisory Committee on Insurance (FACI) March 13 discussion that the NAIC already was handling the issue and no group would be necessary at the federal level was quickly countered by McRaith. 

McRaith said he was not interested in duplicating the efforts of the states, but needs the U.S. Treasury Department to be “fully informed” about what is going on with this type of risk transfer.

To that end, McRaith called for the creation of a task force operating out of the FACI.

“My feeling then and now is that it is a duplication of effort,” Leonardi said in the follow-up interview, adding that duplications of efforts are costly, inefficient and an ineffective way to find solutions to issues.

The NAIC has been examining the use of captives (to transfer perceived excess XXX (Triple X) and AXXX reserves) for some time, and it is one the NAIC’s top priorities, Leonardi said of an NAIC subgroup’s study of insurers’ use of captives and SPVs.

Some regulators have been very concerned that reserves are being stored in captives, or transferred using letters of credit, away from the eyes of regulatory examiners, falsely inflating the insurers’ risk-based capital numbers and gaming the system to free up more capital for use in the market at the possible expense of future financial solvency.

These XXX reserve standards for the industry are The Valuation of Life Insurance Policies Model Regulation (Regulation XXX) and the much-fraught Actuarial Guideline 38 (AG 38), The Application of the Valuation of Life Insurance Policies Model Regulation (AXXX).

“What some see as appropriate levels of statutory reserves, other see as excessive, unnecessarily raising the cost to buyers of term insurance and SGUL (universal life products with secondary guarantees),” wrote Christian DesRochers in an actuarial article for Taxing Times back in 2008. “Arguably, the issues surrounding XXX and AXXX have been a driving force in the development of principles-based reserves (PBR). The story of XXX and AXXX also has federal income tax aspects.”

Genwoth splashed on the redundant reserve securitization scene was in late 2006. It announced the establishment of a $475 million financing facility to securitize the noneconomic portion of AXXX reserves associated with a block of ULSG business, marking a milestone as the first securitization to finance the redundancy in statutory reserves underlying ULSG products calculated under AG 38, according to the actuarial firm Milliman. 

“Securitizing redundant reserves typically involves a reinsurance transaction with a captive,” a January 2007 article by Steven I. Schreiber and Eric S. Schwartz, consulting actuaries in the New York office of Milliman, stated.  “In an AXXX transaction, either the entire ULSG product risk or just the secondary guarantee risk may be ceded to the captive. The insurer ceding the business needs to make sure that if it cedes just the secondary guarantee risk, it gets the appropriate reserve credit it is expecting.”

However, development of robust models for AXXX business is challenging because of the complexity of the products as well as because of the complexity of the AXXX calculations, the actuaries, who were involved in the first wave of securitizations, warned.

The NAIC began its work in earnest in early 2012 on studying insurers use of captives and securitization vehicles as it hammered out AG 38 issues and final PBR development work simultaneously, and published a survey last March on each state or jurisdiction’s laws captive industry and regulations governing it.

Leonardi referred to the NAIC subgroup’s 59-page white paper on captives that was exposed March 14, the day after the FACI meeting, saying it incorporates months of feedback in a transparent process, and is open for further comment from all interested parties until April 22. “The NAIC white paper is now open to regulators, industry, the FACI, it is very open and transparent, it is the second round of a major run through,” Leonardi said. “We welcome FIO involvement as part of the NAIC process.”

But, to have the FACI focus separately on this is not necessary because “it is already being done within spades at NAIC,” Leonardi said. 

The FACI is not structured to do anything with an item except to discuss it — there is no follow up, he said. That contrasts with a “very robust process” at the NAIC, now in its second stage.

Leonardi asked aloud what was the purpose of this effort by FIO for FACI. 

One answer may not be the one either the FIO or Leonardi is looking for.

“Forming this subcommittee just further increases the visibility of the captives issue and keeps the pressure on the NAIC to act which is a good thing,” noted one observer who would like to see more scrutiny of captive use for perceived excess term life insurance reserves.

The task force will be led by fellow insurance commissioner and FACI member, Washington D.C.’s William White. White’s office, Treasury, and the NAIC did not comment for this article. 

Leonardi said he thinks FIO should show its concerns by participating actively in the NAIC (white paper) process.

McRaith may have a different white paper in mind for his participation. 

McRaith commented during the FACI meeting that some of the feedback from the new FACI’s captives/reserving task force could be in the white paper, possibly referring to the insurance regulatory modernization report.

Leonardi is head of the insurance supervisory branch of the state government that, like many others, has recently welcomed the captives industry as an economic driver after passing enabling legislation in 2011. 

“Insurance is one of the most significant economic drivers of our state and there is no place better to grow the industry than the Insurance Capital,” Gov. Dannel P. Malloy said in a statement last August welcoming the state’s first captive insurance company, Thomson Reuters Risk Management Inc.

“The much-needed changes we made to outdated laws have done exactly what we intended – encourage and attract more business and revenue. I am proud to welcome TRRMI, and I am confident that because of the environment we have established in Connecticut, more captive insurance companies will put down roots here,” Malloy stated then.

Leonardi is also heavily involved in the international regulatory oversight process, serving on the executive committee International Association of Insurance Supervisors (IAIS), an arena where FIO also has much voice and representation, as well as chairing the NAIC’s International Insurance Relations (G) Committee. He will be in Switzerland this week for bilateral talks with regulators from China and India, and other IAIS matters. McRaith and NAIC CEO Ben Nelson are also expected to be there.