From principle-based reserving to the Department of Labor’s re-proposed fiduciary standard, life insurers and their agents and advisors face a host of regulatory threats. A new report from Deloitte Center for Regulatory Strategies, “Top regulatory trends for 2016 in insurance,” delves into the pitfalls and proposes solutions for tackling them.
Some of the changes may be more costly than others — in terms of capital outlay, technology, people and resources needed to stay in good graces with federal and state authorities. Beginning on the next page is a recap of five of the top regulatory challenges you and your carriers can expect to deal with in the year ahead. The full Deloitte report can be downloaded here.
1) Heightened oversight from multiple authorities
A growing number of federal, state and international regulators are imposing rules on insurers. Their collective impact, the Deloitte report warns, is “tremendous,” both in terms of mounting red tape and the “aggressive tone” with which the regulators seek to circumscribe company practices.
To ward off fines, excess spending on compliance and other potentially negative consequences, the report advises insurers to “closely monitor” state, federal and international regulatory developments. The recommendation applies also to small insurers that operate only in the U.S., given the “high degree of interplay” among regulatory jurisdictions.
2) The DOL’s draft fiduciary rule
The Department of Labor’s re-proposed fiduciary standard for retirement investment advisors may prompt insurers to limit, drop or revamp products and services sold through producers to reduce operational risks. Deloitte recommends that companies and advisors targeted by the rule “start planning now” by identifying business processes that could be impacted, and by formulating solutions (and attendant costs) to remain compliant.
“Organizations that don’t start planning until the rule is actually finalized may find themselves overwhelmed and short on time given the budget requirements and all of the compliance, operations, technology, and process changes that will likely be required,” the report warns.
3) Threats to insurers from cyber intrusions
The report notes that cybersecurity is “at or near the top” of the operational risks insurers face. The cyber threats are a danger not only to the companies’ earnings and reputations, but also to their customers, given the huge quantities of personal data the companies maintain.
To deal with problem, the National Association of Insurance Commissioners’ Cyber Security Task Force issued last year two documents that establish: (1) principles for effective cybersecurity; and (2) a cybersecurity “Bill of Rights” for consumers. The latter highlights data protections that consumers should expect from carriers and “implicitly instruct[s]” insurers to provide these safeguards.
The report cautions, however, that online security breaches undertaken by foreign governments, cyber activists or criminals “may be difficult to guard against.” Still more challenging may be dealing with lax cybersecurity practices among employees or contractors that enjoy access to corporate IT systems.
“Insurers looking for a holistic, principles-based approach to cybersecurity may want to consider using the NAIC’s principles for effective cybersecurity, which are based on the National Institute of Science and Technology’s standards,” the report states. “The NAIC’s principles include a very basic but sometimes misunderstood and overlooked concept: that cybersecurity transcends the information technology department and must include all facets of an organization and be a part of an enterprise-wide risk management process.”
4) Use of affiliated captives
In 2015, the Financial Stability Oversight Council (FSOC) warned that captive reinsurance companies — special purpose vehicles (SPVs) that operate as wholly owned subsidiaries of primary or direct insurers — pose a “systemic threat to the stability of the US economy.”
Key reason: the lack of financial transparency. Critics view the SPVs as black holes — shadow companies set up to shield the parent insurers’ shaky financial statements from scrutiny by state regulators and the public.
To mitigate concerns about the insurers’ financial solvency, the NAIC is now pressing for increased financial disclosure from captives. Recent guidelines promulgated by the organization seek greater transparency about redundant statutory reserves shifted to the captives’ balance sheets; plus greater disclosure on how the captives might impact insurers’ risk-based capital (RBC) calculations.
“Governance of these captives is an important issue for regulators and, as such, should be actively reviewed by insurers,” the report states. “With regulators continuing to seek insight into the assets held by these captives, insurers may wish to evaluate those assets to make sure the asset quality and availability are sufficient to meet regulatory requirements.”
5) Principle-based reserving
A cornerstone of the NAIC’s Solvency Modernization Initiative (SMI), principle-based reserving — a methodology for more accurately determining the capital risks life insurers assume on the policies they underwrite — will provide state regulators with a new tool which will monitor life insurers’ reserve levels through annual reporting and review.
To implement PBR, 42 state legislatures (accounting for 75 percent of U.S. life insurance premiums combined) must adopt (1) a Valuation Model Law the NAIC approved in 2009 and (2) the 2012 revisions to the NAIC Standard Nonforfeiture Law. The Deloitte report observes that, as of November 2015, 39 states representing 71.78 percent of premium passed legislation adopting PBR; and that eight states may enact the methodology before year-end 2016. If so, nationwide adoption of PBR can be expected by January 1, 2017.
The Deloitte report views PBR positively, believing it will provide “certainty around reserving;” and it may lessen capital requirements for some insurers. But, citing an August 2015 Society of Actuaries (SOA) survey, Deloitte cautions that some insurers may not be prepared (notably in respect to systems and training) for the transition to the new reserving model.
“The implementation of PBR will likely have ripple effects throughout the insurance business, starting with the actuarial, product design, and pricing functions,” Deloitte states. “To avoid getting blindsided, insurers should already be examining the potential impacts and adjusting their products and processes accordingly.”
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