The past two years have seen a lot of regulatory action on the use of captives to finance XXX/AXXX “redundant” reserves.
The inspiration for the NAIC actions focus on three sources of pressure. The Federal Insurance Office’s report on reinsurance singled out the use of life reinsurance captives as needing more regulatory scrutiny/regulation. The second source was the press. One of the significant forces that caused the financial crisis in 2008 was non-banks providing banking services without bank regulation (“shadow banking”). The result of a New York Times investigation of the use of life reinsurance captives to finance “redundant” reserves (“shadow insurance”) was that the practice could be the next source of an economic meltdown. Finally, there were certain regulators and insurers who felt that these structures were dodging reserve requirements, increased solvency risk and gave insurers using captive reinsurers an unfair competitive advantage.
Given all of these events, the NAIC wrote a white paper on these captives and hired Rector and Associates to create a new regulatory framework for redundant reserves financing transactions. As a way to get the recommendations in effect immediately Rector proposed language for an Actuarial Guideline (AG). Once AG 48 was in place, the NAIC would have more time to write a regulation that would replace the AG.
The crux of AG 48 is that reserves similar to Principle Based Reserves (called the Actuarial Method) would be calculated. These reserves were to be backed by Primary Securities (cash and certain SVO rated assets). Regulators felt that the combination of PBR-like reserves backed by conservative assets would bring the system back to a more financially sound basis. The difference between current statutorily required reserves and the Actuarial Method reserves could be backed by Other Securities (securities that are acceptable to the company’s domiciliary commissioner). If by March 1, between the captive reinsurer and the insurer Primary Securities were less than Actuarial Method reserves and Other Securities were inadequate to back the excess, then a qualified actuarial opinion would need to be filed.
Up until now, captives were subject to the laws and regulations of the state in which it was domiciled. A new proposal, which I believe goes into effect next year, would require a captive reinsuring AG 48 business from policyholders residing in more than two states would have to conform to all accreditation standards rather than captive specific state standards.
The regulation that is to replace AG 48 has not been completed and will likely not be finished before early 2016. Recently the NAIC Reinsurance Task Force made a significant change from AG 48 in the proposed regulation. Instead of a qualified actuarial opinion, if at March 1 the total Primary Securities were less that the Actuarial Method reserves and/or Other Securities less than the excess reserves there would be no reinsurance credit. Said another way if either the Primary or Other Securities are off by a dime as of March 1, there will be no reserve credit. Brother (Sister), can you spare a dime?
