The National Association of Insurance Commissioners’s (NAIC) review of the insurance industry’s use of affiliated captive reinsurers to satisfy certain reserve requirements is making waves among top US life insurers.
The National Association of Insurance Commissioners’s (NAIC) review of the insurance industry’s use of affiliated captive reinsurers to satisfy certain reserve requirements is making waves among top US life insurers.
It has emerged that in late 2013 filings to the US Securities and Exchange Commission (SEC), Genworth Financial and Reinsurance Group of America (RGA) moved to defend their captive strategies.
A small number of life insurers have recently entered the captive market, according to the NAIC. They have formed captive reinsurance subsidiaries and used insurance securitisations to transfer risk and side-step conservative reserve requirements.
As a result, the NAIC produced seven recommendations to address the issue, which it has worked on since 2011. They cover: accounting considerations; confidentiality; access to alternative markets; International Association of Insurance Supervisors principles, standards and guidance; enhancements to the credit for reinsurance models; disclosure and transparency; and Financial Analysis Handbook guidance.
Although the recommendations are still being studied, Genworth and RGA are worried about their consequences, specifically how they could affect capital costs and efficiencies.
In its 14 November 2013 filing to the SEC, Genworth indicated that US- and Bermuda-based affiliates assumed about $8.3 billion of reserves from its main businesses at the end of 2012.
“Uncertainties associated with our continued use of US and Bermuda-based captive life reinsurance subsidiaries are primarily related to potential regulatory changes,” it explained.
“Although we do not believe it to be likely, a potential outcome of the NAIC review is that we will be prohibited from continuing our use of captive life reinsurance subsidiaries. The expected effect of such prohibition would depend on the specific changes to state regulations that are adopted as a result of the NAIC review, including whether current captive life reinsurance structures would be allowed to continue in existence or, if not, the method and timing of their dissolution, as well as the cost and availability of alternative financing.”
“At this time, given the uncertainty around these matters, we are unable to estimate the expected effects on our consolidated operations and financial position of the discontinuance of the use of captive life reinsurance subsidiaries to finance statutory reserves subject to Regulations XXX and AXXX and Actuarial Guideline XXXVIII in the future.”
If Genworth discontinued using captive life reinsurance subsidiaries to finance statutory reserves, “the reasonably likely impact would be increased costs related to alternative financing, such as third-party reinsurance, and potential reductions in or discontinuance of new term or universal life insurance sales”.
“All of which,” said Genworth, “would adversely impact our consolidated results of operations and financial condition”, adding: “We cannot be certain that affordable alternative financing would be available.”
RGA was equally worried about the outcome of the NAIC’s review, saying in its 24 October 2013 filing: “If a state insurance regulator that regulates any of the Company’s domestic insurance companies restricts the use of captive reinsurers, the Company’s ability to reinsure certain products, maintain risk based capital ratios and deploy excess capital could be adversely affected.”
“As a result, the company may need to alter the type and volume of business it reinsures, increase prices on those products, raise additional capital to support higher regulatory reserves or implement higher cost strategies, all of which could adversely impact the company’s competitive position and its results of operations.”
RGA acknowledged that no changes in the use or regulation of captives have been proposed and it is too early to predict the extent of any changes that may be made. “Accordingly, the company expects to continue its strategy of using captives to enhance its capital efficiency and competitive position while it monitors the regulations related to captives and any proposed changes in such regulations.”
But it warned: “[RGA] cannot estimate the impact of discontinuing or altering its captive strategy in response to potential regulatory changes due to many unknown variables such as the cost and availability of alternative capital, potential changes in regulatory reserving requirements under a principle-based reserving approach which would likely reduce required collateral, changes in acceptable collateral for statutory reserves, the potential introduction of the concept of a ‘certified reinsurer’ in the laws and regulations in certain jurisdictions where the company operates, the potential for increased pricing of products offered by the company and the potential change in mix of products sold and/or offered by the company and/or its clients.”
New York effect
The controversy surrounding life insurer-owned captives came to a head in 2013 when the New York State Department of Financial Services published critical commentary on ‘shadow insurance’ transactions in the state and the oversight provided by the NAIC.
The department concluded that the reserve transfers related to the ‘shadow insurance’ transactions have artificially inflated capital. It also asserted that certain other states may be racing to the bottom in governing such transactions, while concurrently making information on their captive unavailable to other state regulators.
New York-based MetLife, the largest US life insurer, indicated last year that it was planning to combine an offshore reinsurer with three US life insurance businesses, partly because of the New York enquiry.
But captive industry commentators have blasted the New York State Department of Financial Services enquiry, calling it premature and unfounded. They point out that the NAIC was already looking at the situation with life insurer-owned captives.
Various NAIC task forces are working on the association’s seven recommendations, while one is assessing the solvency implications of life insurer-owned captives and alternative mechanisms. The NAIC has also asked consulting firm Rector & Associates to report on life insurer-owned captives, so much remains to be done before this debate reaches a conclusion.
