As expected, the NAIC’s Captive and Special Purpose Vehicle (SPV) Use (E) Subgroup adopted its white paper, which it has been toiling with for many months.

The white paper adopted by the subgroup and sent to the parent committee on June 6 during an NAIC open conference call puts to bed the classification by some of captives as a “shadow” industry, and brings to fruition the product of much regulatory concern. 

The white paper was adopted by the subgroup a week before the Federal Advisory Committee on Insurance at Treasury’s Federal Insurance Office (FIO) will receive a report on regulatory developments relating to reinsurance captives done under Washington’s top financial regulator, William White. FIO Director Michael McRaith also targeted captive reinsurance transactions as something Treasury should follow in its monitoring of the domestic industry.

In another group meeting, on the same day, a new committee was being born.

Some state regulators pointed to the work done on captives to try and stay on top of developing issues that could cause real solvency concerns down the road in deciding to go ahead with a new subgroup devoted to examining how investment managers, whether hedge funds or private equity firms, are getting into insurance, specifically in the purchases of large fixed annuity businesses.

The Financial Analysis (E) Working Group (FAWG), which is charged with, among other tasks, promoting multistate efforts in addressing potential solvency problems, including identifying industry trends, has been discussing the increased interest in the insurance industry by private equity (PE) interest and hedge fund managers.  

In a conference call June 6, Pennsylvania’s Deputy Insurance Commissioner Steve Johnson, FAWG’s chair, said the group was trying to be proactive as regulators.

During the call, Johnson said that investment firms might never create a problem, but we don’t want to be in that position, if they do, and we aren’t involved. The call was hosted by Rhode Island Insurance Superintendent Joseph Torti III (who chairs the Financial Condition (E) Committee and who spurred much of the work on the captives and SPV oversight issues.

Torti agreed that the industry developments were important issues that needed to be further explored and discussed, and the group unanimously voted to release  for comment Johnson’s May 6 memo outlining possible best practices and new procedures to address the market trend, including potentially changing the Credit for Reinsurance Model Law to provide regulators additional authority to require approval of transactions with nonaffiliates and changing state investment laws to provide regulators more authority in limiting risks. 

There will also be a new subgroup, as there was for captives, to study the issues. There are a number of transactions underway or pending, including the sale of Des Moines, Iowa-based Aviva USA to Athene Holding Ltd.  

Athene Holding is not the only company with ties to a global alternative investment manager (in this case, Apollo Global management) which has been active in the indexed annuity space in recent months. Guggenheim Partners, one of the rumored buyers of Aviva USA, snapped up the U.S. annuity line of Sun Life Financial Inc. for $1.35 billion in December 2012. In August, two Guggenheim affiliates, Security Benefit Life Insurance Co. and Equitrust Life Insurance Co., agreed to purchase the U.S. fixed annuity business of another Canadian-based insurer, Industrial Alliance Insurance and Financial Services Inc., for $800 million.

Some wonder what these investment managers managing risks for five years out, not a lifetime, can do with the annuity portfolio. Overall annuity sales continued their downward arc in the first quarter, according to several recently released statistical reports. But there were some rays of light peeking through the clouds despite the lingering slump.

Industry-wide, annuity sales in the first quarter totaled about $49.6 billion, down 2 percent from $50.6 billion in the final quarter of last year and a 6.6 percent drop from Q1 2012 when sales amounted to $53.1 billion, the Insured Retirement Institute (IRI) reported.

Former Iowa insurance commissioner and NAIC President Susan Voss spoke up on the conference call to express concern for the developments. Former NAIC CEO Terri Vaughan, and a former Iowa insurance commissioner, also expressed concern for these transactions at a conference in Washington last month, and asked what regulators were doing to address these purchases. Wary New York regulators are taking more aggressive action and subpoenaing these investment firms and hedge funds for information. 

As for the Captive and SPV Use Subgroup’s white paper, it takes a measured approach compared with former incarnations, recommending the development of guidance and on-going analysis of transactions involving captives and SPVs, more monitoring and more disclosure in ceding company statements. The paper has an eye toward on-going developments with respect to International Association of Insurance Supervisors’ (IAIS) principles and passing muster with future FSAP reviews.

One regulator, Steve Kinion, director of the Bureau of Captive and Financial Insurance Products for the Delaware Department of Insurance, argued on the conference call against the paper’s adoption. He stated that it should be noted in the paper that captives do lower the cost of term and other life insurance, and the subgroup did not involve all of the states, and it should not be adopted without revisions.

The white paper recommends further work by the NAIC, including a possible formation of a separate subgroup to address “any remaining Triple X and Triple X perceived redundancies.” The use of captives in an attempt by some life insurers to right-size the reserves required for these actuarial guidelines for certain term and life products spurred the NAIC subgroup’s examination of captive industry in the first place.

The NAIC subgroup concluded that because changes made to the treatment AG 38 by the NAIC in 2012 under an industry-embraced compromise for the bifurcated treatment of old business and prospective business, the creation of new captives and SPVs should no longer be needed for such financing transactions.

However, if there are XXX and AXXX issues that have not been addressed, those issues should be addressed directly — not through the use of captives and SPVs, the white paper stated. For example, the NAIC could consider modifications to the statutory accounting framework to recognize, “in strictly limited situations,” certain tier 2 type assets so that the need for the separate transaction wouldn’t be needed.

The American Council of Life Insurance (ACLI)  supports the NAIC in exploring modifications to the current statutory accounting framework to allow “tier two type assets,” such as letters of credit (LOC), in certain situations. 

Some state regulators had been 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. The subgroup approach creates more leniency so insurers in some instances do not have to go running to a captive for reinsurance reserves.

The Captives subgroup also recommends that the NAIC should further encourage the states to adopt the NAIC’s Special Purpose Reinsurance Vehicle Model Act (#789) and should consider making the model an accreditation standard, which remains controversial.

Due to changes made to AG 38 by the NAIC in 2012, the creation of new captives and SPVs should no longer be needed for such financing transactions; but, if there are XXX and AXXX issues that have not been addressed, those issues should be addressed directly, as opposed to through the use of captives and SPVs, the white paper stated.

The subgroup also recommends that the NAIC study the issue of confidentiality related to commercially owned captives and SPVs more closely. The Subgroup believes it may be necessary to develop a framework that would provide greater uniformity in what should and should not be considered confidential.

“We appreciate the hard work of the subgroup and look forward to further discussions,” stated the ACLI, which was very supportive of the white paper on the call.